Treasury Consultation Paper puts 25-year-old managed investment scheme regime under the microscope.
In August, the Commonwealth commenced formal consultation on its review of the regulatory framework governing Australian managed investment schemes (MISs). The Treasury Consultation Paper, which includes 24 questions about possible changes to the MIS regime, invites submissions by the end of September.
The review puts important aspects of MIS law and policy under the microscope. These include the retail/wholesale distinction, liquidity requirements, investment controls, and insolvency. Changes in these areas will significantly impact 420 responsible entities, and many of the 1,800 entities currently licensed to operate wholesale MISs. The review also plans to consider the roles and obligations of responsible entities and whether the governance, compliance and risk management frameworks for MISs are appropriate.
The MIS laws have been reviewed several times since their introduction in 1998. The Consultation Paper identifies two CAMAC reports, six Parliamentary inquiries and two independent reviews over the last two decades. Most of these reviews and inquiries followed MIS collapses that caused significant losses to retail clients; all of them recommended changes that were either not adopted, or adopted only in part.
This latest review first emerged in October 2022, when the Budget Papers allocated funding to re-examine the regime following a Parliamentary inquiry into the failure of the Sterling Income Trust. In an interview with the Australian Financial Review at the time, the Assistant Treasurer and Minister for Financial Services, the Hon Stephen Jones MP, said “the inquiry would closely examine schemes investing in real estate, which are generally not subject to prudential oversight and can be the source of significant investor losses”.[1]
However, in announcing the terms of reference in March 2023, the Minister went further, extending the review beyond schemes involving or linked to real estate to invite a more holistic re-examination of the current regime.
Reviewing the regulation of MISs is tricky. An MIS is neither an asset class, nor a unique investment form. Instead, the MIS regime operates as a catch-all-the-rest regime for a diverse group of projects and legal structures that solicit investors in the retail market, and are not otherwise regulated (for example, as pubic companies, corporate collective investment vehicles (CCIVs) or public offer superannuation funds).
Most large registered MISs are externally-managed collective investment arrangements, structured as unit trusts and treated as managed investment trusts for tax purposes. But not all; there are many varieties of MISs among the approximately 3,700 schemes currently registered with ASIC. For example, schemes may be trust-based, partnership-based or contract-based; large or small; listed or unlisted; open-end, closed-end or hybrid; stand-alone or part of a stapled structure; and fixed term or continuing. They pursue a range of activities. The law leaves open fundamental features of each MIS, such as the permitted underlying investments and investment strategy, portfolio diversification, leverage, term, liquidity, and redemption arrangements.
The challenge for Treasury, and those responding to the consultation, is to remain clear-eyed about how the different features of the current MIS laws work to protect scheme members and facilitate capital formation across different commercial contexts and markets, and the different legal structures that MISs adopt. Another part of the puzzle will be working out how to address regulatory arbitrage between MISs and their alternatives – including public companies raising debt or equity capital, companies using crowd-sourced funding, and CCIVs.
The Minister’s March announcement said that the review would “examine whether the regulatory framework is fit-for-purpose, identify potential gaps, and consider what enhancements can be made to reduce undue financial risk for investors”. The Consultation Paper asks 24 questions, divided into eight groups. They cover: wholesale client thresholds; suitability of scheme investments; scheme governance and the role of the responsible entity; right to replace the responsible entity; right to withdraw from a scheme; winding up insolvent schemes; Commonwealth and State regulation of real property investments; and regulatory cost savings.
As the Consultation Paper acknowledges, none of these issues is new. Treasury will revisit the conclusions of the previous reviews and inquiries summarised in Box 1 of the Consultation Paper. It will also have regard to the Australian Law Reform Commission’s ongoing reference into the financial services legislation, and the Parliamentary Joint Committee’s insolvency review which handed down its findings (including on insolvency and trusts) in July.
Some things, however, are off the table. One seems to be the parameters of regulation, which are a function of the (broadly framed) statutory definition of MIS. Another is the interaction of the MIS regime with the AFS licensing laws in Corporations Act pt 7.6 and the product sales and distribution laws in Corporations Act pt 7.7 – 7.10 and ASIC Act pt 2. In his March announcement, the Minister also confirmed the review would not consider the compensation scheme of last resort; litigation funding or time-shares; the tax treatment of MIS and investors; any changes to the CCIV regime; or the rights and obligations of custodians. Nevertheless, the invitation to make submissions on “regulatory cost savings” might be an opportunity to suggest streamlining the law and removing inconsistencies and overlaps in some of these areas.
Responsible entities, wholesale MIS operators, and assets managers contemplating an Australian presence should keep a close eye on the review. The consultation period is open until the end of September, with a report due from Treasury some time in 2024.
The answers to the questions raised in the Consultation Paper are, we think, different across different types of MISs, including orthodox unlisted managed funds, ETFs, alternative investment funds, listed A-REITs and infrastructure investments, pooled mortgage funds and other non-bank lending vehicles, property syndicates, contract-based agribusiness and enterprise schemes, and novel schemes. It will be important that Treasury hears from a range of voices, not just the 10 largest responsible entities that between them operate 46 percent of all registered schemes.
Professor Hanrahan is the author of the loose-leaf service Managed Investments Law & Practice, published by CCH Australia.
[1] Michael Read, ‘Sophisticated investor test to face fresh scrutiny’, Australian Financial Review (27 October 2022).
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