Posted February 6, 2024
Posted By Meghann Cannon
Investing in the Maze: Will Australia Revamp its Managed Investment Schemes Framework?
This year will be a big year for potential major reforms to the Australian Managed Investment Schemes (MIS) framework. The Australian Treasury’s consultation paper titled “Review of the regulatory framework for managed investment schemes” released in August 2023 has ignited a critical conversation about investor protection and market efficiency. Submissions are now closed, and key stakeholders have had lots to say with big changes likely coming our way.
One of the big-ticket items in the government’s ongoing inquiry into the regulatory settings for MIS is whether the financial thresholds for qualifying wholesale clients should change. It has (literally) become headline news with the Australian Financial Review recently running a story titled ‘Labor to overhaul ‘sophisticated investor’ test’.
The government has also inquired on the following issues that are not directly relevant to you but are good to be aware of:
- Whether certain MIS should be marketed/sold to retail clients
- Whether “Investor Rights” for people who invest in MIS is appropriate
- Whether any changes are required to the liquidity requirements for MIS; and
- Whether issues arise for investors because of the dual jurisdictional responsibility between Commonwealth and State laws when regulating schemes with real property.
CHANGING THE DEFINITION OF A WHOLESALE CLIENT
One of the more controversial inquiries made by the government is whether the classification of a wholesale client should change.
Just as a quick recap, currently, an individual is classified a wholesale client if they meet one of the following tests contained in section 761G and 761GA of the Corps Act.
- Product value test: Is satisfied when the price for the provision of a financial product or the value of the financial product to which the financial service is related equals or is greater than $500,000.
- Individual wealth test: Is satisfied where the person has net assets of at least $2.5 million or a gross income of at least $250,000 per year in the last 2 financial years and is supported by a certificate given by a qualified accountant. The certificate is valid for 2 years after being issued.
- Small business test: Is satisfied where the financial product or service is provided for use in connection with a business that is not a small business (as defined in s761G (12)).
- Professional investor test: Is satisfied if the client is a ‘professional investor’ as defined in section 9 of the Corps Act.
- Sophisticated investor test: Is satisfied when a financial product or service is not being provided in connection with a business; and an AFS licensee is satisfied on reasonable grounds that the client has previous experience in using financial services and investing in financial products that allows the client to assess the merits, value, risks and information about the product or service.
There was plenty of discussion about lifting the thresholds (both for the product value test and individual wealth test) in submissions to the MIS Review. However, the primary focus was on the individual wealth test given the impact property prices have had on the number of people who can meet that test.
CHOICE based their recommendation on minimising the percentage of people who would qualify as wholesale clients. CHOICE also recommended excluding the family home from the asset test. AFCA went further, recommending raising the thresholds and excluding the family home, but also including superannuation on the exclusion list.
The Financial Services Council (FSC) recommended lifting the threshold to $5 million, but including the primary residence (or alternatively excluding the home and maintaining the $2.5 million threshold). The FSC also specified that existing clients should be grandfathered.
We will not know more until the government releases its findings. However, it is certainly possible that the asset threshold will be adjusted up.
For those clients wanting to model the impact that any changes may have on their business, it may be worth testing possible scenarios.
Based on the submissions and other discussion, the adjusted asset figure could be in the realm of $4.5-$5 million. It would also be worth testing the impact of excluding the primary residence.
The following areas of review are not directly relevant to you but we have included them just so you can understand the full context of what is being considered – in other words, optional reading!
SUITABILITY OF SCHEME INVESTMENTS OFFERED TO RETAIL CLIENTS
The Design and Distribution Obligations (DDO) launched in 2021 aimed to rebalance responsibility for consumers outcomes in financial products. Issuers must currently design products for target markets and distribute them responsibly. The government has inquired on whether conditions should be imposed on certain scheme arrangements when offered to retail clients.
ASIC has suggested that it would be challenging to frame an appropriate restriction that does not limit access to existing or future schemes that are not problematic, are well-performing and suitable for a retail client. We agree that further restrictions could impact investor access to good products. ASIC instead advocated for the following:
- Reinforcing that the financial threshold for a wholesale client should be increased. We note, however, that our submissionto the government has been that the financial threshold should not be increased as it is an objective threshold which is easily applied and works well in practice.
- Incorporating investor knowledge and experience factors directly into the existing definition of “wholesale client” or creating a separate category for sophisticated retail investors.
- Requiring scheme operators to provide more comprehensive and accessible information about the risks and complexities of their products e.g. stress testing scenarios.
- Seeking additional powers to intervene and restrict the marketing or distribution of schemes they determine to be unsuitable for retail investors.
The FSC has also suggested that ASIC should have additional rights to request sufficient information at the outset, being the AFSL application and scheme registration process, and adopt a fast track and slow track registration process depending on the MIS. The data collected from this process should then inform ASIC’s future surveillance processes with more oversight on new licensees or schemes that have a history of poor compliance.
CHOICE adopted a similar view to the FSC and has recommended that ASIC should be able to refuse to register a scheme if there is considerable risk of consumer harm.
We do uphold CHOICE and the FSCs suggestion, as tackling any issues at the outset would set the tone for compliance with the DDO regime (and a change to the classification of a wholesale investor is not necessary).
CHANGES TO INVESTOR RIGHTS
Currently, the process by which members can replace a listed scheme’s RE is via an ordinary resolution (50% of the votes) of the members present at a general meeting. For unlisted schemes, this is more difficult as it will need 50% of all votes, even from silent or hard-to-reach investors.
This can be a major hurdle, especially for funds with passive investors or complex voting structures. The result? You might be stuck with a subpar RE, impacting your returns.
The government is considering lowering this 50% barrier.
ASIC has agreed with this consideration and has recommended that at a minimum, the requirement should be reduced to a special resolution of members.
ASIC has further advocated for streamlined proxy voting by making proxy voting easier and more accessible, potentially through online platforms or simplified procedures to encourage broader participation.
The FSC on the other hand has reinforced that the current requirement for an extraordinary resolution to replace the RE of an unlisted fund is appropriate. We agree with this view, as a special resolution may not represent the views of the overall investors of the scheme.
CHANGES TO THE LIQUIDITY REQUIREMENTS
Currently, schemes can label themselves “liquid” if 80% of their assets are deemed “liquid” by the RE. This definition is subjective and allows assets that take far longer than a few days to sell to be classed as liquid, misleading investors.
Further, the lack of a specific timeframe for withdrawals further compounds the problem. REs have discretion, leaving investors unsure when they will actually see their money.
The government has proposed bringing Australia closer to international standards and aligning the definition of “liquid” with investor expectations. This could involve:
- Defining “liquid assets” to include only those like cash,bank bills, and highly traded securities that can be readily sold within a short timeframe, like 7 days.
- Mandating specific withdrawal periods,ensuring investors know exactly when they can access their funds.
CHOICE has supported a more prescriptive and objective definition of liquidity to be introduced to the Corps Act and has agreed with the proposed definition by the government. ASIC has also upheld this view, particularly as they have seen schemes promoting themselves as liquid, even if the scheme constitution specified for lengthy periods for satisfying redemptions e.g. 365 days or longer.
We agree that this change could provide more certainty and flexibility.
The government’s review of the MIS framework aims to strike a delicate balance: fostering innovation, ensuring responsible product design, and strengthening investor safeguards. Ultimately, the answer will lie in the ongoing public conversation and the government’s final decision. In any case, it is a good time for financial service providers to review their existing compliance framework, and ensure they are well-equipped for changes that are likely coming our way.