The Government’s Corporations and Markets Advisory Committee (CAMAC) has just released its extensive reform proposals for Australia’s funds management industry, which could significantly change the way that hundreds of billions of investment dollars are managed in Australia. At the core is a radical proposal to develop a new investment structure in Australia. While ambitious, CAMAC’s proposal would modernise and streamline Australia’s funds management system.
CAMAC started looking at the managed investment scheme (MIS) sector almost two years ago, after the collapse of many agribusiness and forestry schemes. These collapses, and the arduous investigations that followed, revealed not only that the current system didn’t adequately address how these schemes operated, but also that the system for dealing with financially distressed schemes had major shortcomings. Things became even more complicated if the investment scheme’s ‘responsible entity’ was itself also in financial distress, or if the assets of more than one scheme couldn’t be accurately identified and separated.
Most of these significant problems are in what CAMAC calls ‘common enterprise schemes’ – the complex systems of contracts, leases, and tax structures often used in the agribusiness and forestry investment sectors. However CAMAC’s review also extended to the much more common ‘pooled schemes’ – these are the investment trusts (often listed on ASX) that are used in property, infrastructure, and investment management more generally.
At first blush, CAMAC’s most significant proposal appears to be the recommendation that common enterprise schemes be completely prohibited.
However, while this is unquestionably significant, CAMAC has also proposed a more ambitious reform, which would revolutionise the much more common pooled schemes and materially change the structure of hundreds of billions of dollars of investments in Australia. The result could be a reduction in both uncertainty and costs, and a system which is more logical and streamlined. We should mention – as does CAMAC in its report – that this approach was originally proposed by Freehills!
Put simply, CAMAC’s proposal is to convert each pooled scheme into a ‘legal person’. It sounds simple (or, at any rate, minor and technical), but the implications are profound.
At the moment, each pooled scheme is really just a trust – it’s an old-fashioned collection of rights and obligations existing between investors, the responsible entity, and others like financiers and counterparties. Unlike a company, the pooled scheme does not exist as a ’thing’. So if the responsible entity gets into trouble, the eggs can be incredibly difficult to unscramble. Who actually ‘owns’ investors’ assets? Who can enforce contracts? When can the responsible entity use scheme proceeds to meet its own costs and liabilities? What happens if the responsible entity operates multiple schemes, and can’t figure out what belongs to each one?
Creditors can also face problems and uncertainty under the current system. In particular, if a responsible entity acts improperly, innocent creditors may find that they have lost their recourse to scheme assets and can end up out-of-pocket.
Under CAMAC’s proposal, the scheme would be somewhat like a company, but with the responsible entity acting as its agent and its ‘brain’. Under this proposal it would not matter if the responsible entity was replaced or became insolvent. The pooled scheme, and its assets, would be a separate ‘thing’, owned by the investors, rather than being owned by the responsible entity on behalf of the investors. The pooled scheme would own property in its own right, and could sue and be sued in its own name.
Lawyers may get excited about such a radical departure from traditional trust law, but for the wider business community CAMAC’s proposal represents an opportunity to move towards a system which actually reflects the reality of twenty-first century investment, and which could provide greater certainty and lower complexity. The proposal may also encourage foreign investment into Australian funds, as it may result in a system that is more familiar and attractive to foreign investors.
Of course, implementation would be complicated, particularly for existing schemes. Tax and stamp duty implications would also need to be managed extremely carefully.
If CAMAC’s ambitious ‘separate legal entity’ concept doesn’t get up, then CAMAC still proposes a number of piecemeal reforms to improve the mechanics of the managed investment scheme sector. While the benefits of some of these reforms can be debated, on balance they would probably improve the efficiency of the managed investment sector, particularly where investment schemes get into financial trouble or are to be wound up. However, these piecemeal reforms would still run a poor second to CAMAC’s more comprehensive ‘legal person’ proposal – a proposal which would lead to a simpler, more efficient and more modern investment system.