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Focus: ASIC proposes reforms to wholesale equity investment schemes

20 July 2007

In brief: The Australian Securities and Investments Commission has issued a consultation paper setting out its proposed policy on granting financial services licensing relief to trustees of certain wholesale equity investment schemes. Partner Susan Burns and Lawyer Geoff Sanders outline the key elements of ASIC's proposals and some of the practical issues that remain outstanding.

How does it affect you?

  • ASIC has granted temporary financial services licensing relief to trustees of certain eligible wholesale equity investment schemes where a licensed related body corporate of the trustee accepts responsibility for the provision of financial services by the trustee. 
  • The relief may relieve the sponsor of an eligible wholesale equity scheme from the administrative and compliance difficulties associated with the trustee of such a scheme having to apply for, and comply with, an Australian financial services licence of its own. However, there are some significant practical issues relating to the form of the current proposed relief that may affect the usefulness of ASIC's proposed policy.
  • ASIC's proposed policy is also interesting as it contains a succinct summary of ASIC's view of the application of the licensing regime to trustees more generally.

ASIC's proposed policy

The Australian Securities and Investments Commission (ASIC) has released a consultation paper, Wholesale equity venture capital schemes: trustee licensing (the consultation paper), outlining its proposed policy on licensing relief for trustees of certain wholesale equity schemes. In addition, while ASIC's final policy position is not expected to be released until June 2008 (following a public consultation process), ASIC has also issued Class Order 07/74, which gives immediate effect to its proposed policy.

The necessity for the licensing relief arises because, as succinctly set out in the Appendix to the consultation paper, ASIC takes the view that, subject to certain existing licensing exemptions that may be available in particular circumstances, the trustee of a wholesale equity scheme will be providing ongoing dealing (ie the acquisition and disposal of the financial products that constitute scheme assets on behalf of scheme members and the issuing of interests in the scheme) and custodial or depository services (ie the holding of those scheme assets on behalf of members) to the members of the scheme. (See 'Broader licensing implications of proposed policy' below for further details.)

In summary, ASIC is proposing to grant ongoing class order relief from the obligation for a trustee of a 'wholesale equity scheme' to hold an Australian financial services licence in the following circumstances:

  • Structure of scheme: The proposed relief applies to trustees of 'wholesale equity schemes' structured as unregistered managed investment schemes that issue interests only to wholesale clients. It is worth noting that, while the title of the consultation paper refers to these schemes as 'venture capital' schemes, the application of the proposed policy is not limited to such schemes and will apply equally to private equity funds, fund of fund products and other wholesale investment funds. An important element of the relief is that the scheme may only invest (other than incidental cash and cash-equivalent investments) in securities or managed investment products (or options to acquire securities or managed investment products). The proposed relief is not intended to apply to funds that primarily trade in listed investments (the proposed relief contains a restriction that no more than 20 per cent of the value of the scheme may be attributable to listed investments), nor does the policy apply to schemes that invest in other types of assets, such as real estate.
  • Manager to accept responsibility: The proposed relief only applies where a related body corporate of the trustee (the manager) holds an Australian financial services licence authorising it to provide the ongoing dealing and custody services to be provided by the trustee and, under a condition of its licence, the manager agrees to accept responsibility for the acts and omissions of the trustee in providing the relevant financial services as if the trustee were a 'representative' of the manager. The manager is required to enter into a deed poll to indemnify scheme members in respect of certain liabilities for which the trustee is not entitled to be indemnified out of the assets of the scheme (see 'Potentially increased liability for sponsors' below).

It is important to note that, by making the manager responsible for the acts and omissions of the trustee (and by ensuring that the manager is appropriately licensed), ASIC is not exempting the operation of wholesale equity schemes from the licensing provisions of the Corporations Act 2001 (Cth). Rather, ASIC is simply seeking to recognise that sponsors of such schemes (ie the manager, in many cases) may seek to establish a special-purpose company to act as trustee of the scheme (rather than perform that role itself) and that it may not be practical for that special-purpose company to obtain and comply with a licence of its own.

Practical concerns with the policy

While ASIC's identification of the licensing difficulties faced by the sponsors of wholesale equity schemes is to be welcomed, the practical implementation (and usefulness) of the proposed policy is doubtful, as evidenced by the following issues.

Potentially increased liability for sponsors

Perhaps most importantly, the proposed policy (and, indeed, the current relief offered under Class Order 07/74) may result in a sponsor's liability being artificially extended beyond what would typically have been accepted in the past.

As noted above, one of the conditions of the proposed relief is that the manager of the scheme enter into a deed poll, under which the manager indemnifies each member of the scheme in respect of any liability suffered by a member as a result of the trustee's provision of financial services to the member. While the indemnity does not extend to any liability for which the scheme's trustee is entitled to be indemnified out of the assets of the scheme, it means that the manager is required to indemnify members of the scheme for all other liabilities caused by the trustee. This is in contrast to the current industry practice, where it would be unusual for a trustee or manager to directly indemnify scheme members in such circumstances.

For example, the trust deed for a particular scheme may provide that the trustee is to be indemnified out of the assets of the scheme for all losses or liabilities it suffers, except to the extent that such losses and liabilities arise as a result of the trustee's fraud, negligence or dishonesty. In normal circumstances (ie where the proposed relief is not being relied upon), where the trustee acts with fraud, negligence or dishonesty and it (or the scheme) suffers loss or liability as a result, the trustee would not be entitled to be indemnified for that loss, but neither the trustee nor the manager (if there is one) would contractually agree to indemnify the scheme members for any loss suffered by them or by the scheme (although the trustee and the manager could, of course, still be liable to the scheme members under equity and common law). In contrast, the proposed relief alters this position by requiring the manager to indemnify the members of the scheme for any loss or liability they may suffer in such circumstances, whether or not such loss or liability exceeds the assets of the particular scheme.

We consider the imposition of this obligation as a condition of the relief to be unnecessary, as it alters the standard liability balance currently adopted in the market and significantly diminishes the attractiveness of the proposed relief.

Variation of manager's licence

Of less commercial significance (but of arguably considerable practical difficulty) is the requirement that the manager's Australian financial services licence contains a specific condition (relating to the proposed relief) prior to relying on the relief.

Accordingly, a manager with an existing Australian financial services licence, who intends to establish a wholesale equity scheme in such a manner so as to rely on the proposed relief, must first apply to ASIC to have its licence varied to incorporate the specific condition. While this may not pose a practical problem in cases where a manager has a long lead time for establishing a new fund, it may become an issue where a new fund is to be established quickly (especially given that it can take ASIC several weeks to consider a licence variation application).

No investments in related entities – structuring limitation

Finally, we note that one of the conditions of the proposed relief is that the trustee of the wholesale equity scheme must not 'control' any entity in which the scheme invests, including by owning more than 50 per cent of the voting interests in that entity.

This means that the scheme may be prevented from establishing an effective holding structure for its underlying investment holdings by removing the ability of the scheme to establish wholly owned (or even partially owned) investment vehicles such as holding companies and trusts.

The consultation paper offers no explanation as to the rationale behind this restriction and, given this apparent lack of purpose, we query why the proposed relief has been limited in this manner.

Broader licensing implications of proposed policy

Aside from the particular relief contemplated, the consultation paper is also significant in that it very clearly sets out ASIC's approach to the application of the financial services licensing regime to the operation of wholesale (unregistered) managed investment schemes more generally.

In the Appendix to the consultation paper, ASIC states that it considers that it is very likely that the trustee of any wholesale managed investment scheme will require a licence, unless specific (and limited) exemptions under the Corporations Act can be relied upon. In particular, ASIC has clarified the following issues:

  • Ongoing services are being provided: In the past, some scheme operators have relied upon the 'intermediary authorisation' exemption to argue that the trustee of such a scheme did not need to hold a licence. However, ASIC has made it clear that relying on the 'intermediary authorisation' exemption is not, in itself, sufficient because, following the initial issue of interests in the scheme (which, using the intermediary authorisation exemption, is able to be carried out by a licensed entity without the trustee having to hold a licence), the trustee will still be considered to be providing ongoing financial services directly to scheme members by dealing (ie acquiring and disposing of the financial products that constitute scheme assets on behalf of scheme members) and providing custodial or depository services (ie holding those scheme assets on behalf of members).
  • Trustee not acting as representative of the manager: Furthermore, some scheme operators have also sought to rely upon an argument that such a trustee does not need to hold a licence because it is acting as a 'representative' of a licensed, related body corporate (ie which was acting as the manager of the scheme). Again, ASIC has now made it clear that they consider it 'unlikely' that the trustee could be considered to be acting as a representative of the manager in providing the ongoing financial services to scheme members on the basis that the trustee is acting as principal in providing the relevant financial services (ie the trustee will 'undertake and be personally responsible for obligations to clients' under the terms of the scheme).

Accordingly, unless a specific exemption from licensing can be relied upon, it would now seem difficult for the trustee of such a scheme to properly take the view that it does not need to hold an Australian financial services licence to act as trustee of a wholesale managed investment scheme.

Finally, for completeness, we note ASIC's view that the trustee of such a scheme will be providing custodial or depository services (ie by holding scheme assets on behalf of members) is consistent with the approach adopted in ASIC QFS (FSR Frequently Asked Question) 6. However, in light of the unequivocal approach taken by ASIC in the proposed policy, it is not clear whether, as was contemplated in QFS 6, the appointment of a third-party (licensed) custodian to such a scheme can ever now be sufficient to remove that service from the trustee's responsibilities for licensing purposes.

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