Far-reaching reform of the disclosure and governance regimes for managed investment schemes is contained in the draft Financial Markets Conduct Bill (the Bill), released last week.
Submissions on the Bill are due by 6 September and, as we noted in our commentary on the day of the Bill’s release, the Ministry of Economic Development (MED) is encouraging earlier responses.
This Brief Counsel gives a practical overview of some of the more significant reform proposals affecting managed investment schemes (which include, among others, all KiwiSaver schemes, unit trusts and superannuation schemes).
We then list those aspects on which MED has specifically sought guidance.
What is a “managed investment scheme”?
The draft Bill defines a managed investment scheme (MIS), in summary terms, as a scheme:
- the purpose or effect of which is to enable participants to contribute money as consideration to acquire rights to financial benefits produced principally by the efforts of another person under the scheme, and
- in which participants do not have day-to-day control over scheme operations (whether or not they have the right to be consulted or give directions).
An MIS does not include a scheme that involves only managing direct interests in underlying property, a discretionary investment management service or a pure risk contract of insurance. Each of those concepts is defined. Equity and debt securities are excluded in the definition of "managed investment product".
Scope of the exposure legislation consultation
The focus of the MED’s request for submissions in relation to the MIS proposals is firmly on certain technical details. This indicates that policy settings have pretty much been finalised. The key reform directions have been well-signalled for some time and the draft Bill is broadly consistent with those.
Unless an exemption (such as the exclusion for offers to wholesale investors) applies, the issuer of an offer for a managed investment product will be required to:
- prepare and maintain a product disclosure statement (PDS) for the offer, in lieu of an investment statement, for the purpose of giving investors key information
- lodge the PDS and all supplements and replacements with the Registrar of Financial Service Providers (Registrar), and
- in lieu of maintaining a prospectus, lodge other material information relating to the offer in its register entry on a Register of Offers of Financial Products (Register entry).
Everyone to whom disclosure is required to be made will need to be given a PDS before applying for MIS products. Investors will be presumed to have been given a PDS in certain cases, notably if they apply using a form distributed with the PDS.
The PDS and the Register entry must together contain all “material information” relating to the offer. The draft Bill contains two alternative definitions. In summary these are:
- information that a reasonable person would expect (if disclosed) to have a material effect on the demand for the product, or
- information that a reasonable person would expect to influence, or be likely to influence, persons who commonly invest in financial products in deciding whether or not to acquire the products.
In either case the information must relate to the products on offer, rather than to products, issuers or offerors generally.
The commentary accompanying the draft Bill discusses further variants of these options for defining "material information".
The form and content of the PDS and Register entry will be prescribed by regulation. The PDS must be presented “in a clear, concise and effective manner”.
An issuer must not accept applications under offers until five working days after an initial PDS is lodged with the Registrar (the FMA may extend this to 10 working days). The waiting period will generally not apply to the second or subsequent PDS for a continuous offer.
An issuer will be able to replace or supplement a PDS when updates are required. This is a welcome feature of the draft Bill. Currently, investment statements must generally be replaced when amendments or updates become necessary, unless special-purpose exemptions are obtained (a major issue for KiwiSaver schemes since 2007).
Before a PDS (or supplement) is lodged with the Registrar, every director of the issuer (and other prescribed persons) must consent to lodgement. An issuer will be able to correct or update a Register entry by notice to the Registrar. Issuers will also owe yet-to-be-prescribed ongoing Register entry, investor and public disclosure obligations.
There will be a prohibition on further offers if there is defective disclosure in a PDS or Register entry (such as a materially misleading or deceptive statement or the omission of required information). PDSs may also have expiry dates.
The draft Bill confirms that a membership interest in a superannuation or KiwiSaver scheme is a single financial product and ongoing contributions by and for a member do not give rise to the issue of a separate financial product. There are arguments for extending this provision to certain other types of MIS.
The Bill proposes generally prohibiting offers in the course of (or because of) unsolicited meetings, telephone calls or electronic communications. This prohibition may curtail the activities of some current marketing and distribution networks. It is based on a provision in Australia’s Corporations Act 2001 (but is modified, including by way of a provision for exemptions to be prescribed by regulation).
Advertising certificates will no longer be needed. An advertisement will need to refer to and be consistent with the PDS and state where and how the PDS can be obtained (and that a person should consider the PDS in deciding whether to acquire the products).
Advertisements will be subject to the general prohibitions in the draft Bill on misleading or deceptive conduct or false or misleading representations.
A MIS will need to be registered on a Register of Managed Investment Schemes. This will replace other registers such as the KiwiSaver Schemes Register.
The scheme’s trust deed will need to contain adequate prescriptions in areas such as valuation and pricing methodology and permissible fees, and to restrict exoneration and indemnity protections for managers and supervisors to the proper performance of their duties.
The scheme will need a licensed manager and a licensed supervisor (who must be independent of each other). Scheme property will need to be held by the supervisor or an external custodian.
Superannuation schemes will be required, as are KiwiSaver schemes already, to restrict new member admissions to persons who are living or normally living in New Zealand and are entitled to permanent residence. This will require some schemes to be modified to restrict membership offers. It will restrict New Zealand-based managers from making offers of interests in New Zealand-registered superannuation schemes overseas (which seems inconsistent with the Prime Minister’s objectives for making New Zealand a financial services hub).
Statement of Investment Policy and Objectives
Every MIS will require a Statement of Investment Policy and Objectives (SIPO), for which the FMA may prescribe content requirements. Managers will be required to lodge SIPOs with the Registrar and report any asset or sector allocation breaches.
Managers will be required to disclose unit pricing errors to the FMA and take prescribed actions to remedy pricing errors and failures to comply with pricing methodologies.
The requirements for manager licensing and external supervision will not apply to restricted schemes (employer-based and other restricted-offer superannuation and KiwiSaver schemes). The test for “restricted” status will materially mirror the current KiwiSaver Act test.
While it can otherwise remain governed in the same way as currently, a restricted scheme will need at least one independent trustee (or one independent trustee director if it has a corporate trustee). That independent trustee (or director) must be licensed – see below.
The draft Bill appears to contemplate that the trustee(s) of a restricted scheme must contract the holding of scheme property to an external custodian. It also proposes that restricted scheme trustees:
- must not invest more than 5% of scheme property in related party investments, and
- must not lend money (or give financial assistance) to related parties or members.
Any requirement for an external custodian would lead to additional costs for restricted schemes, reducing the benefit of the proposed regime from a cost-efficiency perspective. A requirement for restricted schemes to appoint external custodians was not expected from previous public statements.
We expect the prohibition on investing more than 5% of scheme assets in related party investments to be highly problematic for some employer-based restricted schemes. We consider that there is a case for allowing grandfathering of existing arrangements (with appropriate conditions).
A trust deed amendment will need supervisor or (for restricted schemes) FMA consent, which can only be given if:
- the amendment is approved by scheme participants, or
- the supervisor or FMA is satisfied the amendment will not materially adversely affect scheme participants.
Scheme participants’ approval will be able to take the form of a special resolution (requiring a 75% yes vote). The exception will be defined benefit superannuation schemes where all adversely affected beneficiaries will need to give written consent.
Other exceptions will apply. For example a manager will be able to amend the trust deed with FMA consent if the FMA is satisfied the amendment is necessary for legislative compliance.
For superannuation (including KiwiSaver) schemes, these provisions may in practice allow a little more flexibility to prescribe amendments which are sensible but face technical impediments under the current legislation.
Managers’ and supervisors’ core duties
Managers will be legally responsible for offering and issuing interests in schemes and managing schemes. They will be required to act in the participants’ best interests and to exercise the care, diligence and skill (if professional managers) that prudent persons engaged in that profession would exercise in the same circumstances. “Managers” for this purpose will include the trustees of restricted schemes.
Supervisors will be legally responsible for supervising managers’ compliance and holding scheme property. They will not be able to delegate the performance of any of their core functions (other than to contract custody to a third party which is independent of the manager).
Managers will be required to provide regular reports and information to supervisors.
An interesting feature of the draft Bill is its provision for Australia-like statutory recognition of single-person self-managed superannuation schemes (SMSS) operating for the benefit of New Zealand residents. An approved SMSS would be subject to (we assume, limited) FMA reporting requirements prescribed by regulation.
The licences required for scheme managers (and independent trustees of restricted schemes) will be known as Market Services Licences. These will necessitate compliance with fit and proper person and other eligibility criteria, to be prescribed by regulation. A licensee will also need to be on (or be eligible to be on) the Financial Service Providers Register.
We expect a “licensing lite” regime for individuals acting solely as restricted scheme trustees.
Market Services Licences may be conditional and will have expiry dates. Licensees will be required to deliver regular reports and information to the FMA.
Regulations and exemptions
The draft Bill prescribes regulation-making powers in areas such as the content and layout of a PDS, the requirements for updating the Register and for managers to report to supervisors, the content of trust deeds and licensing criteria.
The FMA will be empowered to grant individual and class exemptions from the disclosure and governance requirements in the Act or supporting regulations.
Transitional provisions will allow the current securities legislation to apply to offers made or prospectuses registered within six months after the new law takes effect.
The draft Bill contemplates the inclusion of yet-to-be-drafted product-specific exclusions from particular registration and supervision requirements. An appropriate exclusion, in our view, would be to exempt restricted schemes from compulsory external custodianship.
Submissions are sought now on… The aspects of the draft Bill which are the subject of “query notes” specific to managed investment schemes include:
- the definition of “managed investment scheme” (there are boundary issues)
- the express purpose of a PDS
- the meaning of “material information” (see above)
- whether all registered schemes should be required to file audited accounts (or only those whose issuers make regulated offers of financial products)
- the extent of the general duties applying in the exercise of a manager’s functions, and
- alternative methods of giving exclusionary relief (under the Act itself) to particular types of issuers and products.
A brave new world…
This is root and branch reform. The new Act will repeal and replace the Securities Act and Regulations, the Unit Trusts Act 1960, the Superannuation Schemes Act 1989 and all the governance provisions in the KiwiSaver Act 2006. It will create a unitary regime under which (subject only to express special-purpose exclusions) all schemes must comply with common substantive requirements.
It is therefore imperative for industry participants to begin getting to grips (at least in overview terms) with how this brave new world of substance over form is likely to affect them in practice.