The proposals in brief
- Guarantees and indemnities given by REs will be restricted
- 12-month rolling cash flow projections will be required
- The net tangible asset capital requirements will be increased
- More of the NTA capital will have to be held in cash
- A proposed implementation period for these reforms of 1 July 2011 for new REs, and out to 1 July 2013 for existing REs.
Yesterday ASIC announced proposals to increase the financial requirements for REs which are not regulated by APRA.
ASIC stated it released these proposals to align the interests of the REs and scheme investors and to limit the risk that REs become insolvent because they assume the debts of others. ASIC also stated that the proposals do not seek to prevent RE insolvency or to create unjustifiable barriers to entry.
What are the proposals?
ASIC’s proposals can be summarised in the following four categories.
Restricting guarantees and indemnities
ASIC proposes that REs are prevented from providing guarantees in their capacity as the responsible entity of schemes and that REs who manage more than one scheme do not give guarantees in their personal capacity.1 CP 140 suggests that these limitations may apply only in respect of related parties, but is not clear on this. It is suggested that the prohibition extends to any cross-guarantee arrangements, which suggests that REs will not be eligible to consolidate with the RE’s group for audit purposes.2
A further proposal seeks to restrict REs from providing indemnities in their capacity as responsible entity of a scheme other than indemnities in relation to the scheme’s default.3 This restriction has the potential to affect the outcome of contractual negotiations with REs.
Requiring rolling 12-month cash flow projections
It is proposed that REs must prepare, and make available to ASIC upon request, rolling cash flow forecasts with anticipated revenue and expenses over at least 12 months, to be approved by directors of the RE.4
Increasing the net tangible asset (NTA) requirements
ASIC proposes that the NTA that an RE is required to hold is calculated using one of two relatively complicated options:
- the greater of $150,000, 0.5% of the average value of scheme property (capped at $5 million) and 10% of average gross revenue, or
- 10% of average gross revenue with a minimum of $500,000 and no maximum.
If the average gross revenue of the RE is less than a minimum percentage of the scheme property (1% to 2%) then that minimum percentage may be used to calculate the required NTA.5
This represents a significant increase on the current minimum NTA requirements for REs (currently 0.5% of the assets, subject to a minimum of $50,000 and a maximum of $5 million). A RE who does not use an external custodian will continue to be required to hold $5 million NTA, subject to existing exemptions.
ASIC acknowledged that some REs will be forced to restructure to raise the required capital and that the proposals may lead to more consolidation.
ASIC also proposes that the amount of funds under management and NTA held by a RE is submitted to ASIC annually, but doesn’t explain how this information would be used.6
Specifying NTA liquidity requirements
It is proposed to increase the proportion of NTA which REs will need to hold in cash, so that a RE will hold 50% of its required NTA as cash or cash equivalents (subject to a minimum of $150,000), and the balance of its required NTA in ‘liquid assets’ (which can be converted into cash in six months).7
ASIC’s rationale for these changes is that it considers that the current cash requirements were inadequate during the GFC.
What is the effect of the proposals?
In addition to the creditor and investor protection benefits identified by ASIC, if these proposals are implemented, they are expected to have a number of other impacts:
- reduced cash flow and competitiveness of REs as more of their capital is reserved in cash to meet NTA requirements and less of their capital will be available for use in their businesses
- greater consolidation in the sector and greater barriers to entry, resulting in a reduction in the total number of REs, and
- REs freedom of contract will be more restricted due to the restrictions on giving guarantees and indemnities to related entities.
When and how will the proposals be implemented?
Submissions on CP 140 are due by 15 November 2010.
ASIC suggests that the proposals will be implemented for new REs as of 1 July 2011.
In the case of existing REs, ASIC is contemplating a 12 or 24 month transition period, meaning that these proposals could be implemented by 1 July 2013 at the latest.
Interestingly, CP 140 does not address the means by which ASIC will seek to apply these increased financial requirements to existing REs. The financial requirements are imposed on REs by way of conditions on their Australian financial services (AFS) licences, and ASIC may only vary existing AFS licenses after giving licensees the opportunity for a hearing.8
These changes will be significant, so the manner in which ASIC decides to implement them will be equally important.