Managed investment schemes regulatory framework: consultation paper released

Recently, Treasury released a consultation paper on the review of the regulatory framework for managed investment schemes. Since the Minister’s earlier announcement which we considered in our earlier article, we now have in this consultation paper some detail on the areas opened up for discussion with industry.

Overview of the consultation

Treasury seeks to consult on 24 clusters of questions. The questions are far reaching, but (as the consultation paper itself notes) some of them are not new because they have been considered in previous reviews and inquiries, and the consultation paper draws on recommendations of previous reviews and inquiries.

The first question is about the wholesale client tests, which are relevant for all financial services not just the issue of interests in managed investment schemes.

Other questions relate to the following:

• whether there should be tests regarding the suitability of scheme investments for retail schemes.
• whether the obligations of responsible entities should change.
• whether responsible entities should be required to have a majority of external board members.
• whether ASIC should have the power to direct the responsible entity to amend a scheme’s constitution.
• whether there should be qualitative standards for compliance plan audits.
• members’ rights to replace the responsible entity, including whether break-fees should be permitted.
• members’ rights to withdraw from the scheme and the notion of a ‘liquid’ scheme.
• whether there should be an insolvency regime for ‘insolvent’ schemes.
• whether there should be law reform where scheme investments in real property are also governed by state/territory legislation.
• whether there are opportunities to modernise and streamline the regulatory framework.

Some interesting questions

In this article, we select a few areas which attract our interest (without diminishing the importance of other areas of inquiry, in particular the wholesale client threshold tests).

Suitability of scheme investments

Treasury poses the question as to whether some investments and scheme features are too complex for retail clients such that, despite adequate disclosure and the operation of the design and distribution obligations (DDO) regime, they should not be permitted to be offered to retail clients. The consultation paper describes the limitations on investment offerings to retail clients in the United States and United Kingdom, being limitations which could – in general terms – be characterised in terms of the nature of the offeror, the investment vehicle, and the investable universe (including restrictions on illiquid assets and the use of leverage).

The consultation paper states that the design and distribution obligations are ‘proving to be an effective gatekeeping mechanism for ensuring investment products are appropriately targeted towards relevant investors’, and notes ASIC’s use of its product intervention power in relation to some products (ie short-term credit products, continuing credit contracts, contracts for difference, and binary options).

It would seem that proposals to place US-style or UK-style restrictions in the Australian market would be radical, and may be unwarranted at this stage in circumstances where the DDO regime is proving to be an effective regulatory tool and ASIC has significant product intervention powers.

Scheme registration process and subsequent amendments to the scheme constitution

Treasury notes in its consultation paper that ASIC has limited statutory ability in the vetting of schemes at the point of scheme registration, and has no power (unlike in relation to corporate collective investment vehicles) to direct a responsible entity to modify a scheme constitution to comply with legislative requirements where the constitution has been modified since registration.

In relation to the content of scheme constitutions, the consultation paper states that the Corporations Act 2001 (Cth) (Corporations Act) ‘allows responsible entities to introduce changes to scheme constitution following registration that may not meet section 601GA or are contrary to other obligations under the Corporations Act’, and the deregistration of the scheme under section 601PB of the Corporations Act ‘if its constitution does not meet the statutory requirements… is a relatively blunt tool that can result in significant consequences for existing scheme members and assets.’

While noting the merits of ASIC’s argument about the risk of scheme constitutions being misaligned to regulatory requirements over time, the argument perhaps does not lend sufficient weight to the limitations of section 601GC as set out in case law for over a decade, to say nothing from the responsible entity’s ongoing obligation to ensure that the scheme’s constitution meets the requirements of sections 601GA and 601GB set out in section 601FC(1)(f). ASIC’s interpretation of section 601GA’s requirements set out in Regulatory Guide 134 should also be examined if ASIC is to be granted this power.

Scheme liquidity

Treasury states in its consultation paper that the test as to whether a scheme could be considered to be liquid – set out in section 601KA of the Corporations Act – is somewhat rubbery, in that the ‘specified period’ for realising liquid assets is not prescribed and is at the discretion of the responsible entity. In contrast, the equivalent regimes in the US and UK are more specific. Further, Treasury states that there can be a mismatch between the notion of a liquid scheme under the Corporations Act and the general investor understanding of a liquid investment as implying an easy conversion to cash, and this mismatch becomes evident ‘when a scheme is marketed as ‘liquid’ while providing for lengthy timeframes in the scheme’s constitution for satisfying withdrawal requests (for example, up to 365 days or sometimes longer).’

One response is that the current regime may not be broken. As Treasury itself notes, ASIC found in a targeted review of 14 registered schemes in the second half of 2020 that the liquidity frameworks were generally adequate and the liquidity challenges and market disruption were well managed. Further, if marketing is a problem, then marketing could be remedied through better promotional and disclosure material without needing to amend the Corporations Act. However, the statutory terms ‘liquid’, ‘liquid assets’, ‘not liquid’ and ‘non-liquid schemes’ could also be changed if they convey the false impression to consumers about the likelihood of their ability to exit their investment.

In addition, the current regime grants a responsible entity the flexibility to manage liquidity without having to resort to the rigid approach of making a withdrawal offer, which can give the wrong impression to consumers that the fund is ‘distressed’ or ‘insolvent’.

Next Steps

Consultation closes on 29 September. We are working with industry groups to prepare a response to the consultation paper.

If you would like to discuss how these proposals might affect your business or your business plans, please contact us.