Thinking | 30 October 2014
ASIC flags potential areas for reform in managed investment schemes
The senate inquiry into forestry managed investment schemes continues the examination of the forestry scheme and managed investment schemes sector (Senate Inquiry). In its submission to the Senate Inquiry, ASIC has reiterated potential areas of reform which relates to the broader managed investment scheme sector.
On 17 October 2014, the Australian Securities and Investments Commission (ASIC) published its submission to the Senate Inquiry into the collapse of forestry managed investment schemes between 2009 and 2012. ASIC’s views in respect of the business models, structures and risks associated with forestry managed investment schemes has a broader application to operators, promoters and distributors of managed investment products generally.
The legislative framework for managed investment schemes has been the subject of a number of past reviews that have considered potential refinements including CAMAC reviews and the Financial System Inquiry (FSI). However, the legislative framework has remained largely the same. ASIC submits that attention should be directed towards reviewing the recommendations of these previous reviews and inquiries.
Reform of licencing arrangements
ASIC expressed its continued concern about the ease with which an Australian Financial Services (AFS) licence can be obtained and the difficulty experienced by ASIC in suspending or cancelling a licence once it is granted. This makes it difficult for ASIC to remove licensees who may cause substantial losses to investors in order to prevent such loss from occurring.
The low threshold for obtaining an AFS licence is magnified by the fact that ‘representatives’ of a licensee (such as directors, employees or agents) are not directly approved by ASIC – as they are not treated as providing the financial service of operating a registered managed investment scheme. ASIC claims the overall effect is this limits its ability to restrict individual participants in the financial services industry, especially where a person may have worked for another entity that is suspected of engaging in questionable conduct.
Another key issue identified by ASIC concerning the licensing regime is to what extent it should operate as a ‘gatekeeping’ mechanism to maintain market integrity and protect investors by keeping out participants who may otherwise lack the competence, integrity or resources to provide relevant financial services. ASIC has only a limited power to suspend or cancel a licence after a licence is granted. ASIC appears to indicate that reform of the licensing process may be required to allow ASIC to respond to the range of misconduct by licensees in the market place.
In its submission, ASIC points to a growing global trend towards ‘merit’ regulation. Regulation in Australia has traditionally focused on the transparency of the sales process (through disclosure) and the conduct of all intermediaries involved in the sale. There is growing international interest in redirecting financial services regulation to more actively influence the quality of financial services and products provided to investors and financial consumers through ‘merit’ regulation.
‘Merit’ regulation involves regulatory oversight that does not focus solely on disclosure (as in Australia), but also monitors all stages of product design and issue, disclosure and marketing, distribution and post-sale practices. The objective of this is to more actively influence the quality of financial services and products. ASIC suggests that a ‘product intervention approach’ should be adopted as a matter of reform in order to shift to a regulatory regime that acknowledges different tools will be needed to address different problems, through developing a detailed understanding of specific market problems as they arise.
The need for a compensation scheme
Repeating its submission contained in the FSI interim report, ASIC supports a limited independent statutory compensation scheme to supplement professional indemnity insurance and the formal determination of claims by external dispute resolution schemes. ASIC claims this will address the growing problem of uncompensated loss within the financial services sector. ASIC’s concern, as outlined in its second submission to the FSI was primarily with the ‘relatively high levels of uncompensated loss in the financial advice sector’, rather than in the operation of managed investment schemes. This appears to be consistent with ASIC’s observation that commissions were often used to pay advisers who promoted forestry schemes.
The now abolished Corporations and Markets Advisory Committee (CAMAC) made a range of proposals to address issues arising in circumstances where managed investment schemes come under stress. ASIC’s submission endorses the recommendations of the 2012 report of CAMAC (with one exception). The key exception was that while ASIC stated that CAMAC’s proposals warranted careful consideration, ASIC stated that the current arrangements for pooled schemes were adequate. This appears to suggest that CAMAC’s 2012 idea of the introduction of a ‘separate legal entity’ scheme structure is unnecessary.
CAMAC also published a further discussion paper on managed investment schemes in March 2014 which set out the principle that managed investment schemes should be treated the same as companies unless there are compelling reasons otherwise. ASIC noted that this principle and the governance, disclosure and regulatory issues raised in the discussion paper warrants consideration more broadly.
ASIC has taken the opportunity to again highlight the areas which it believes should be subject to further consideration and reforms. These are themes which ASIC has been continuously advocating and provides an insight into the aspects of the managed investment scheme and financial services framework which may be subject to further reform and change.
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