While responsible entities of managed investment schemes still have a reasonable period of time to prepare for the changes ASIC has made to the financial requirements under their Australian Financial Services Licence (AFSL), the changes significantly increase the regulatory and financial burden they face.
Because these changes will apply to existing responsible entities as well as prospective ones, we thought it timely to remind responsible entities of the main features of ASIC’s new financial requirements so that they can ensure that they can take the appropriate steps to meet their new obligations.
Class Order CO 11/1140, released by ASIC in November 2011 and to take effect from 1 November 2012, sets out the revised financial requirements that responsible entities of managed investments schemes must meet under their AFSL.
CO 11/1140 is part of ASIC’s attempt to re-align the financial requirements for responsible entities with the operational risks of the industry that were exposed by the collapse of a number of prominent responsible entities during the global financial crisis.
CO 11/1140 replaces the current AFSL conditions relating to:
- the cash needs requirement
- the net tangible assets requirement and
- the obligation to lodge an audit opinion on the financial requirements.
Cash needs requirement
Under CO 11/1140, responsible entities will now be required to prepare cash flow projections, covering at least a rolling 12 month period, which are to be based on the responsible entity’s reasonable estimate of what will likely happen during that period and approved by the responsible entity’s board at least quarterly.
The responsible entity must be able to demonstrate, based on its projections, /’that it will have sufficient financial resources to meet its not only its existing liabilities, but also any additional liabilities that the responsible entity expects to be incurred during the projection period. The responsible entity will also need to demonstrate that it will hold sufficient cash or cash equivalents to meet that aspect of its net tangible assets requirement.
The responsible entity will need to update the projections whenever there is any material change to the projection, or if the responsible entity has reason to suspect that an updated projection will not allow it to demonstrate the characteristics identified in the preceding paragraph.
While the changes are likely to make the cash flow projections prepared by responsible entities more extensive and detailed, it is questionable whether the changes will actually result in any substantive improvements to responsible entity operations.
Net tangible assets requirement
Previously, the lowest minimum net tangible assets threshold that all responsible entities had to meet was $50,000. CO 11/1140 increases this base level to $150,000 while also including an additional calculation based on the responsible entity’s ‘average RE revenue’ and varying the existing calculations used to determine the minimum net tangible assets requirements.
The concept of ‘average RE revenue’ is introduced as a statutory term by the class order and not only covers the responsible entity’s revenue, but also captures amounts paid or payable out of scheme property to third parties for the performance of certain obligations in relation to the responsible entity’s registered schemes. As such, responsible entities are faced with the situation where their net tangible assets requirements could be determined based on fees received by third parties out of scheme property to which the responsible entity never had any entitlement.
CO 11/1140 also amends some of the definitions which has the potential to affect the level of net tangible assets that responsible entities are required to hold. For example, the ‘adjusted liabilities’ definition adopted in the class order requires the responsible entity to assess its maximum potential liability under certain personal guarantees and exclude that amount from their ‘NTA’ calculation, which is in turn likely to increase the level of net tangible assets that the responsible entity is required to hold
In addition to the general net tangible assets requirement, CO 11/1140 also requires responsible entities to hold minimum levels of cash or cash equivalents (at least the greater of $150,000 or 50% of its net tangible assets requirement), and minimum levels of liquid assets.
These changes are aimed at ensuring responsible entities have appropriate financial substance and sufficient readily accessible funds to meet potential liabilities. Regardless of which calculations apply, the new net tangible assets requirements are likely to result in responsible entities have a greater level of net tangible assets, and to hold more of these assets in certain forms. There is also a risk that responsible entities will need to implement additional internal procedures to identify their required net tangible assets level.
Under CO 11/1140, the responsible entity will be required to lodge an audit opinion prepared by a registered company auditor, addressed to both the responsible entity and ASIC and providing the auditor’s opinion on the responsible entity’s compliance with various aspects of CO 11/1140.
ASIC’s stated aims in implementing the changes contained in CO 11/1140 are to ensure that responsible entities have adequate resources to meet operating costs and to appropriately align interests of responsible entities with the interests of investors. While the amended net tangible assets requirements may go some way to meeting these objectives, the most obvious consequence of the changes is the increased costs that will be faced by responsible entities.
Nevertheless, as these changes will come into effect, responsible entities do need to consider the specific financial or operational impact of CO 11/1140 on their businesses. This could include reviewing their internal procedures such as compliance programs and schedules for board meetings to ensure that appropriate measures are in place to meet their new obligations.
However, the most onerous changes for responsible entities potentially comes in the form of the increases to the amount of net tangible assets to be held, and the new requirements relating to minimum holdings of cash equivalents and liquid assets. These changes may ultimately require responsible entities to use capital to acquire assets specifically to meet the financial requirements imposed on them by ASIC, when the capital could potentially by applied elsewhere.