Reforming managed investment scheme regulation

KEY TAKE OUTS

  • The Financial System Inquiry supported the Commonwealth Government’s review of the CAMAC report on managed investment schemes (MIS), with priority on consumer detriment and regulatory architecture impeding cross-border transactions.
  • In response, the Government agreed to develop legislative amendments to enhance the regulatory framework for MIS.
  • Areas of reform which would also benefit the industry include change of responsible entity voting thresholds and voting restrictions.

Following the collapse of a number of high profile registered schemes, the Corporations and Markets Advisory Committee (CAMAC) released a report in 2012 focused on reform proposals relating to schemes in financial stress, the restructuring or winding up of failed schemes and changing the responsible entity (RE) of viable schemes. 

CAMAC followed this report in 2014 with a broad discussion paper which identified regulatory architecture factors that impede other jurisdictions from recognising the equivalence of Australia’s regulatory regime.

The final report of the FSI released in November 2014 contained a recommendation to support the Government’s review of the recommendations of CAMAC on managed investment schemes, giving priority to matters relating to consumer detriment, including illiquid schemes and freezing of funds and regulatory architecture impeding cross-border transactions and mutual recognition arrangements. 

In its response to the FSI, the Government agreed to develop legislative amendments to enhance the regulatory framework for managed investment schemes, including drawing on CAMAC’s report. The slated timeframe to consult on and develop these reforms is beyond 2016.

While the areas identified by the FSI as priority areas for the Government’s review are key areas of reform for managed investment schemes, the Government’s response provides an opportunity to revisit a number of aspects of scheme regulation which impact on efficient operation of the sector. 

Two areas of reform identified in this article relate to the voting thresholds for changing an RE and the voting restriction applicable to an RE and its associates having an interest in a resolution or matter other than as a member.

Changing the RE of a scheme

There are a number of reasons why the RE of a scheme may wish to be replaced as RE of the scheme, other than in circumstances of financial stress, including a wind down or sale of some or all of its business where disposal of the shares in the RE is not feasible. In addition, scheme members may have legitimate reasons for wishing to replace an RE. 

There are numerous legal and practical difficulties associated with changing the RE of a registered scheme, particularly for an unlisted scheme. The RE of an unlisted scheme can only be replaced by extraordinary resolutions of members relating to the retirement or removal of the existing RE and the appointment of a new RE. This requires the approval of at least 50% of the total votes that may be cast, excluding any votes by the RE and its associates where they have an interest in the relevant resolution or matter other than as a member. 

By contrast, the RE of a listed scheme can be replaced by ordinary resolutions of members and both the RE and its associates are not prohibited from voting their interests on a resolution to remove the RE and choose a new RE. However, there do not appear to be compelling reasons to have significantly different regimes applicable to listed and unlisted schemes.

In practice, the threshold of an extraordinary resolution may make replacing the RE of an unlisted scheme extremely difficult, including for schemes with a large proportion of retail clients or platform investors (whose ability to vote will depend on the platform operator’s voting policy) and where the RE (including as RE of different schemes) and its associates hold interests in the scheme. 
REs often need to actively engage with members to encourage them to vote, including providing incentives to members. The threshold also creates potential difficulties in the context of funds management mergers and acquisitions.

Although these provisions provide some security of tenure for an RE, they may also have the practical effect of entrenching the RE thus making it difficult for members to remove the RE. 

The CAMAC report recommended replacing the voting threshold for changing the RE of an unlisted scheme to a simple majority of votes cast, provided that the total of the votes cast on each of the resolutions constitutes at least 25% of the total eligible votes of scheme members. This would still ensure that a significant proportion of interests in the scheme is in favour of the change.

Consolidation is increasingly common in the industry, with proposed changes in RE a typical feature of such consolidation. Reforms which facilitate a change of RE, while still ensuring members are significantly represented in approving the change, would be beneficial to the industry. 
The CAMAC report also made a number of recommendations to reform other aspects of changes of RE, including an obligation on an incumbent RE to provide reasonable assistance to a prospective RE in its due diligence exercise upon request from at least 5% of members or by court order. This would assist in the case of a contested change of RE.

Voting restrictions

A related aspect of scheme regulation which would benefit from reform is the prohibition on an RE and its associates voting their interest on a resolution if they have an interest in the resolution or matter other than as a member. This applies in the context of any type of resolution, subject to the exception noted above for listed schemes and for voting directed proxies. The underlying policy reason for the prohibition relates to the potential for conflicts. 

In its 2014 discussion paper, CAMAC identified a number of difficulties associated with the voting restriction, including which associate test under the Corporations Act should be applied, which is relevant to whether directors and secretaries of the RE or a related body corporate are automatically caught. 

Difficulties may also arise where the RE or entities in the same corporate group hold interests in a scheme in a fiduciary capacity (including as RE of a different scheme). This may result in the members of those schemes being disenfranchised from the voting process, even though the RE of such a scheme would be required to prefer the interests of those members in determining how to vote. 

It would be helpful for the application of the voting restrictions in these circumstances to be clarified, with an appropriate carve-out for fiduciaries.

There are many aspects of scheme regulation, in addition to those mentioned above, which would benefit from practical reform and the Government’s response to the FSI provides a welcome sign of potential reform for the sector.  

Matthew Farnsworth

It's rewarding to partner with clients to find solutions that add value and help them succeed.

Matthew Farnsworth Special Counsel

Matthew has extensive experience in funds management and financial services law. He advises leading Australian and international financial services clients across a wide range of transactional and regulatory matters.

Matthew advises leading Australian and international financial services clients on transactional and regulatory matters.

Clients look to Matthew to assist them to establish, offer and operate retail and wholesale investment funds. He advises on Australian financial services licensing, fund governance, offer documents and fund restructures, including managed investment schemes and other collective investment vehicles (CIVs).

He also advises on outsourcing arrangements, compliance issues and on ongoing regulatory developments in the financial services sector.

Matthew is experienced in the full range of asset classes and has particular experience in the property funds sector, including fund establishment, capital raising and restructures.

He is also experienced in a wide range of transactions in the financial services sector, joint ventures and funds M&A.

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