The Australian View looks at some of the key regulatory issues and developments in the Australian managed funds and asset management industry.
According to recent figures released by the Australian Bureau of Statistics (ABS) for the December 2010 quarter:
- as at 31 December 2010, the managed funds industry had A$1,793.0 billion of funds under management, an increase of A$42.1 billion (2 per cent) on the September quarter 2010 figure of A$1,750.9 billion
- as at 31 December 2010, the consolidated assets of managed funds institutions was A$1,422.7 billion, an increase of A$29.6 billion (2 per cent) on the September quarter 2010 figure of A$1,393.1 billion.
(Source: Australian Bureau of Statistics, 5655.0 Managed Funds, Australia, Dec 2010)
The pool of capital is forecast to increase further as the Australian Government is proposing to increase the employer compulsory superannuation (pension) contribution obligation from 9 per cent to 12 per cent.
Australia continues to reform its tax and regulatory regime aimed at facilitating investment into Australian private equity, real estate and other funds.
The reforms make Australia a significantly more attractive destination for investor capital. Australia currently has one of the world’s largest pools of investment fund assets. This has been underpinned by Australia’s mandatory retirement income system introduced in 1992. Australia’s investor base is sophisticated and outward looking with significant exposures to global markets and alternative asset classes. Aided by ongoing government reforms, Australia’s funds industry is also looking to export services, drawing on its strengths in portfolio construction, risk management, wealth advisory and distribution capabilities and funds administration and custody services.
(Source: Australian Government, Austrade)
Foreign investment in Australian funds
Australia has introduced significant tax concessions for funds that are structured as managed investment trusts (MITs). A key requirement to access the MIT regime concession is for the foreign investor to be from an 'exchange of information country' (EOI). The list of EOI countries is broad and growing, and extends to many low tax jurisdictions where offshore funds are domiciled (e.g. Cayman Islands has recently been added to this list).
The target fund must qualify as a MIT, and if so, distributions of most gains on sale of underlying assets by the fund to foreign investors in EOI countries may be exempt from Australian tax, or at worst, subject to 7.5 per cent withholding on certain types of distributions from the Australian fund to overseas investors.
Generally, the target trust may qualify as an MIT if it satisfies various requirements:
- the trustee of the trust must be an Australian resident, or the central management and control of the trust must be in Australia
- the trust is not a ‘trading trust’
- a substantial proportion of the investment activities, in respect of Australian assets, are carried on in Australia
- the trust is a 'managed investment scheme', broadly defined to cover most types of collective investment trusts (this requirement will generally be met if there are two or more investors in the Australian trust)
- the trust has wholesale membership (generally, institutional or certain high net worth investors) – MIT status can also apply to trusts with retail membership
- the trust must have at least 25 members (generous tracing rules allow trusts to satisfy this test by looking through certain qualifying investor entities)
- the trust must not breach certain concentration limits (broadly, in the case of a wholesale trust, 10 or fewer persons, not counting interests held by certain widely held investors, have a total interest in the trust of 75 per cent or more and no foreign resident individual has an interest in the trust of 10 per cent or more)
- the operator or manager of the trust must hold an appropriate Australian financial services licence (or be an authorised representative of a wholesale licence holder).
The recent reforms to legislation helpfully remove ambiguity caused by the original version of the legislation, which potentially covered only investment in registered retail funds. Also, the list of qualifying investors has been broadened to cover additional categories of foreign investors including certain sovereign investors and foreign investment funds.
The reforms have attracted interest from various institutional investors in Europe, the Middle East and Asia.
Appointment of Australian fund managers
The Australian Government has also pressed forward with their agenda of reforming the local financial services industry by announcing on 19 January 2011 changes to the income tax treatment of investment income of foreign funds aimed making it more likely foreign-based funds will use Australian-based fund managers.
Generally, under the change, income from relevant investments of a foreign fund, that is taken to have a 'permanent establishment' in Australia, will be exempt from income tax (except to the extent it would otherwise be taxable in Australia (for example, if Australian sourced)). The changes mirror the investment manager regime adopted by many other financial hubs such as the UK. Previously, Australia's taxing rules can potentially tax the investment income of the fund even when the foreign investor has no real presence in Australia, putting Australian fund managers at a disadvantage to foreign funds.
The announcement follows on from a proposal in December 2010 to amend the income tax laws to address concerns of foreign funds following the application of US accounting rules, referred to as 'FIN 48'.
The proposed Australian tax reform to incentivise foreign-based funds to use Australian-based fund managers is also pertinent in the EU context in light of the most recent iteration of the Alternative Investment Fund Managers (AIFM) directive (issued on 27 October 2010 and approved by the Committee of Permanent Representatives and European Parliament) which contemplates the delegation of portfolio management by an AIFM to a ‘third-country undertaking’ where (in addition to satisfaction of other requirements regarding authorisation and capacity) an appropriate co-operation agreement is in place between the relevant third country and the AIFM’s own jurisdiction. The initial text of the AIFM directive only permitted delegation to an AIFM.
Proposed new disclosure rules for hedge funds
The Australian Securities and Investments Commission (ASIC) has released Consultation Paper 147 Hedge funds: Improving disclosure for retail investors (CP 147), which describes ASIC’s proposal to introduce disclosure principles and benchmarks for hedge funds. CP 147 prescribes various key features and risks that ASIC considers will need to be addressed in the Product Disclosure Statement (PDS), and other communications, for a hedge fund. The paper follows a recent approach by ASIC to prescribe specific disclosure principles and benchmarks for particular asset classes such as mortgage schemes, unlisted property schemes and infrastructure funds. A separate disclosure regime does not currently apply to hedge funds and the application of the law and general ASIC policy to a particular hedge fund is left to the individual issuer and its advisers to determine.
It is proposed that the disclosure principles and benchmarks will apply to any registered managed investment scheme that is, or has been promoted as, or is generally regarded as, a hedge fund or a fund of hedge funds. ASIC is formulating its definition of hedge fund for these purposes and it seems it will apply a broad definition that looks at whether a fund has some or all of the following features:
- strategy – the fund pursues complex strategies that aim to generate absolute returns, returns with low correlation to equity and bond indices, or a positive return in both rising and falling markets
- leverage – the fund often uses leverage to increase investment returns
- derivatives – the fund often uses derivatives to create complex investment strategies or for gearing purposes
- short selling – the fund often engages in short selling
- complexity – the fund often has exposure to diverse risks and complex underlying products.
This approach could potentially sweep up a broad range of funds with any or some of these features, even those which may not traditionally be regarded as hedge funds.
The disclosure requirements outlined in CP 147 consist of a combination of disclosure principles (relating to the investment strategy, the investment manager, fund structure, assets, liquidity, leverage, derivatives, short selling and withdrawals) and ‘if not, why not’ benchmarks. An issuer is required to state in the PDS and in certain ‘other disclosures’ whether it meets a benchmark (and if not, why not). Failure to comply with the disclosure principles and benchmarks may result in ASIC issuing a stop order on an offer.
Interestingly, ASIC also notes that ‘as a matter of best practice’, disclosure of information similar to that set out in CP 147 would be useful for investors in other types of funds, not just hedge funds.
ASIC is also considering whether to ‘encourage’ issuers to apply the disclosure benchmarks and principles when providing similar offers to wholesale investors and offers by listed investment companies that have some of the features of hedge funds.
ASIC indicates that it is separately considering alternative or supplementary measures to deal with the perceived risks of investing into hedge funds, e.g. investor education, enhanced licensing requirements, enhanced compliance plan requirements, statutory suitability tests and banning retail investor access to hedge funds. No detail is provided in the paper. These possible measures may have major implications for ‘hedge fund’ issuers if implemented.
ASIC proposes 1 July 2012 as the commencement date for:
- new and current issuers of hedge funds to apply each of the disclosure principles and address each of the benchmarks in PDSs given after that date, and
- existing issuers of hedge fund to provide updated disclosure to existing investors that applies each of the disclosure principles and addresses each of the benchmarks.
The deadline for comments on the paper is 21 April 2011. ASIC has flagged that it may undertake a second round of consultation in mid-2011 once it develops more detailed proposals following on from the first round of consultation. It is expected that, following the close of the consultation and subject to comments from stakeholders, ASIC will release a regulatory guide in late 2011.
In addition, ASIC has indicated that it is considering what ‘other measures’ may be desirable to adopt in light of recommendations flowing from the ‘Hedge funds oversight’ report issued by the International Organization of Securities Commissions (IOSCO) in June 2009 and the ‘Review of the differentiated nature and scope of financial regulation’ report issued by the Joint Forum in January 2010.
Reforms make foreign funds more attractive to Australian investors
In February 2011, the Assistant Treasurer released a further exposure draft (Exposure Draft) of the foreign accumulation fund (FAF) rules. The new rules have attracted the attention of foreign fund managers looking to tap into and grow their Australian investor base, in particular from the $1.3 trillion strong Australian superannuation (pension) system. The FAF regime contemplated by the Exposure Draft legislation should allow increased scope for foreign fund managers to offer a wide range of offshore investment funds to Australian investors (either directly or through an Australian feeder fund) and access Australia’s considerable investor market.
The FAF rules are intended to operate as a limited anti-avoidance measure to replace the draconian foreign investment fund (FIF) regime. The FAF regime is directed at Australian residents, Australian trusts and Australian partnerships that hold interests in a FAF, where the FAF is not a controlled foreign corporation (CFC). Taxpayers holding such interests will be required to include FAF attributable income in their assessable income for the relevant income year.
a. Entities proposed to be treated as FAFs
Critical to the operation of the proposed provisions is what type of entity will be treated as a FAF. A FAF is proposed to be defined as:
- non-resident company or non-resident fixed trust
- that meets the “investments requirement”, and
- that meets the “accumulation requirement”.
An entity will not be a FAF if it lacks any of the above features.
b. Investments requirement
The investments requirement will be satisfied if the market value of all debt interests held by the entity comprises 80 per cent or more of the market value of all assets held by the entity. Notes released by the Government that accompanied the Exposure Draft legislation indicate that this requirement is designed to “target entities investing to receive low-risk, interest-like returns”. This is an important requirement and is expected to significantly limit the types of entities that will be caught by the FAF regime. An offshore fund that predominantly undertakes equity investments would therefore not be treated as a FAF.
c. Accumulation requirement
This requirement will be satisfied unless 80 per cent or more of the profits or gains of the entity are distributed within the distribution period. Entities seeking to avoid satisfying the accumulation requirement must, in the case of companies (or entities taxed as companies), ensure that 80 per cent or more of its profits and gains are distributed in the distribution period which starts at the commencement of the entity’s “FAF statutory accounting period” (which is the 12 month period for which accounts are prepared for the entity in compliance with the tax laws of a country) and ends 3 months after the end of that period.
A foreign trust will not be caught if an amount of 80 per cent or more of its profits and gains is distributed in the distribution period or otherwise constitutes net income of the trust that is included in the assessable income of 1 or more beneficiaries of the trust.
d. Australian superannuation (pension) funds subject to concessional rules
The accompanying notes to the Exposure Draft indicate that complying Australian superannuation (pension) funds and other entities through which they invest, that are similarly “lightly taxed”, will be excluded from the proposed FAF rules. This is on the basis that, as those entities are already concessionally taxed, “they are unlikely to ever be motivated to invest in a FAF in order to achieve a deferral outcome”.
Proposed ASX-SGX merger
On 25 October 2010 the ASX Limited (ASX) and Singapore Exchange (SGX) announced they had entered into a merger implementation agreement to “combine to enable customers globally to capitalise on listing, trading, clearing and settlement opportunities created through the expanded platforms, leveraging on the importance of Asia Pacific as the driver of global growth”.
In the joint news release, it was announced that the ASX and SGX will offer access to:
- the second largest listing venue in the Asia Pacific with over 2,700 listed companies from over 20 countries
- the largest REITs sector (over 80 listings) and the largest number of exchange-traded funds (over 100) in the Asia Pacific
- the world’s widest range of Asia Pacific equity, fixed income and commodity derivatives with over 400 contracts from over 10 countries, including Australia, Greater China, India and Japan, and covering a range of commodities including metals, energy and agricultural products
- Asia Pacific’s largest and the world’s second largest base of institutional investors with combined assets under management of over US$2.3 trillion from existing superannuation, institutional and sovereign wealth funds.
A report released by Access Economics on 6 December 2010 explored, among other things, the impact of the proposed merger on Australia’s funds management industry and investors. The report concludes that the ASX-SGX combination “intends to utilise the shared expertise of both groups to develop new products and services that will potentially deliver a range of benefits for the Australian funds management industry and investors”.
Two examples are provided in the report:
- It is noted that the proposed merger will help to establish a “meaningful ETF sector on ASX over a range of international and domestic asset classes including equities, commodities and market sectors”. ETFs are also likely to generate incremental liquidity on the ASX from additional investment funds flowing into new equity products as well as market makers buying and selling portfolios of underlying assets to provide liquidity in ETF products.
- The ASX-SGX intends to develop indices with constituents from both markets, e.g. a top 50 ASX-SGX index or an ASX-SGX property sector index. In combination with passport listings, the creation of new indices would improve the ability of domestic fund managers to raise funds across both markets to be benchmarked against these indices. This has direct benefits for the Australian funds management industry by increasing funds under management, including potentially being more attractive for overseas funds to be managed from Australia.
Following on from discussions between the ASX and SGX and engagement with ‘a wide range of stakeholders’, a number of key changes and commitments were announced on 15 February 2011 which were made to ‘strengthen’ the merger proposal, including (among other things) the following:
- five Australian and five Singaporean citizens to be appointed to a 13 member board, as well as three international directors (subject to shareholder approval, these arrangements will be maintained for five years)
- ASX-SGX will maintain a listing on both ASX and SGX exchanges
- all physical assets required for the operation of ASX Group businesses, including listing, trade execution, clearing and settlement, and all dedicated data and data recovery centres will continue to be developed and located in Australia, and owned and operated by Australian incorporated entities
- companies and products listed and quoted on ASX exchanges will continue to be listed and quoted on these exchanges
- clearing and settlement of trades conducted on any ASX operated licensed Australian market will occur in Australia
- ASX will continue to meet the needs of the Australian market for a comprehensive range of listing, trade execution, clearing, settlement and market information products and services for Australia’s primary, secondary and derivative markets
- ASX-SGX will work closely with regulators in both jurisdictions and, subject to regulatory approval, introduce a range of initiatives as soon as possible, leveraging the strengths of both ASX and SGX, including:
- an Australian dollar interest rate swaps clearing facility for over-the-counter financial products – this will support the growth of Australia’s capital markets by strengthening links with global OTC markets and reduce systemic risks and costs to market users
- a passport listings service – initially available for the top 200 stocks, this will enable streamlined admission arrangements for SGX issuers to join ASX (and vice versa) to expand their Australian and Asian investor base and improve their access to capital
- mutual offset arrangements – to enable holders of ASX and SGX derivatives positions to consolidate their exposures and reduce their costs
- cross product listing and cross access arrangements – to enable ASX and SGX participants to gain access to the full suite of products offered by the ASX-SGX Group. This will improve distribution, liquidity and widen the breadth of product offering for ASX participants, and
- wholesale and retail fixed income platforms – to enable companies to improve access to, and reduce the cost of, debt capital and to provide alternative debt investment instruments for investors on a transparent and contemporary platform
- continued expansion of the interest rate, equity, energy and environmental derivative product suite to meet the needs of market users for a wide range of trading and risk management instruments, with expertise and resources leveraged from both ASX and SGX
- the Australian operations will continue to be licensed under the Corporations Act and remain subject to oversight and annual assessment by the Australian Securities and Investments Commission (ASIC) and the Reserve Bank of Australia (RBA)
- any proposed acquisition of a merged ASX-SGX will require approval under Australian law, including the approval processes of the Foreign Investment Review Board (FIRB), Treasurer and Corporations Act.
The ASX-SGX proposal follows on from announcements of merger talks elsewhere between the New York Stock Exchange and Deutsche Boerse, operator of the Frankfurt Stock Exchange, and between the London Stock Exchange and the TMX Group, parent company of the Toronto Stock Exchange.