The beginning of the end of the unit trust's monopoly? A look at corporate CIVs

By Marc Kemp, James Kanabar
Financial Services Funds Japan

In brief

Written by Partners Marc Kemp and Charles Armitage and Senior Overseas Practitioner James Kanabar

In July's edition of Unravelled, we reported on the Board of Taxation's report on tax arrangements applying to collective investment vehicles, released by the Federal Government on 4 June 2015. Consistent with the 2009 Johnson Report, the report considers that offshore investors are dissuaded from investing in Australian funds because they do not understand unit trusts, and that access to a broader range of collective investment vehicles would help Australian fund managers to compete for capital with their offshore counterparts.

The Board of Taxation report advocates extending tax neutrality to three additional collective investment vehicles: corporates (modelled on the Luxembourg SICAV), limited partnerships and common contractual funds. Over the next three issues of Unravelled (and starting in this article with corporate collective investment vehicles), we will examine each of these collective investment vehicles in turn, summarising their key characteristics, and analysing some of the implications of their introduction and use in Australia.

Luxembourg SICAVs

The SICAV (société d'investissement à capital variable) is an investment vehicle used in a number of European civil law jurisdictions, including Belgium, France, Italy, Luxembourg and Spain. By far the most common, Luxembourg SICAVs:

  • have variable share capital, the value of which at any time matches the SICAV's net asset value;
  • can issue or cancel shares at any time not exceeding its net asset value;
  • can be set up as a single entity or, commonly, as an umbrella entity with a range of sub-funds (each of which has a separate investment strategy and is insolvency remote from the other sub-funds);
  • can have a variety of share classes (and each sub-fund can also have a variety of share classes), which may be denominated in different currencies, and have different subscription amounts, dividend policies, fee structures and other characteristics; and
  • are self-managed by a board of directors (appointed by the shareholders), which has ultimate responsibility for the SICAV's business but which may also appoint an investment manager.

This is clearly a flexible vehicle, and it is little surprise that Luxembourg is the dominant jurisdiction for UCITS funds, and has the largest market share of cross-border funds for public distribution – the majority of assets invested in offshore funds by investors in key jurisdictions such as the United Kingdom, France, Germany, Switzerland, Hong Kong, Japan, South Korea, and Singapore are invested in Luxembourg-domiciled funds. As the SICAV is one of the most prolific Luxembourg investment vehicles (the Board notes that in the five main Asian jurisdictions that have authorised the sale of European funds – Hong Kong, Singapore, Taiwan, Japan and South Korea – about 75 per cent are Luxembourg-based UCITS compliant funds, of which 90 per cent are SICAVs), it is safe to say that investors have a high degree of familiarity with its characteristics. Given the Board's view that the use of investment vehicles with which offshore investors are familiar will create a competitive advantage for Australian fund managers, the SICAV has a lot to commend it.

Like an exotic flower, however, transplanting a civil law vehicle into a common law jurisdiction such as Australia's may be trickier than it seems. Before settling on the SICAV, it is therefore worth considering alternative corporate fund vehicles, which have grown in common law jurisdictions such as Australia's.

English OEICs

English and Welsh Open Ended Investment Companies (OEICs) are open-ended collective investment vehicles structured as corporates, allowing investors to realise their interests within a reasonable time at a price calculated by reference to the value of the OEIC's assets.

Like SICAVs, OEICs have variable capital, can be established as a single company or an umbrella structure, and can have a variety of share classes with different characteristics and to which different terms apply. OEICs are also managed by a board of directors and must have at least one director. However, in contrast to SICAVs, market practice dictates that most have a single corporate director, referred to as the authorised corporate director (ACD). The ACD must be authorised to carry on the regulated activity of managing the OEIC, a clear parallel with responsible entities of registered managed investment schemes in Australia.

While OEICs are not as ubiquitous as Luxembourg SICAVs, they are used for both retail and wholesale funds and are the preferred legal form of open ended investment in England and Wales, having replaced the unit trust as the more traditional open-ended investment vehicle.

Protected cell companies

Assuming a clean slate, there are some other features of offshore corporate investment vehicles that we would encourage be considered.

Protected cell companies (also referred to as segregated portfolio companies) are prevalent in a number of traditional 'fund' jurisdictions, including the Cayman Islands, Delaware, Guernsey, Ireland and Jersey. PCCs have a single legal personality, board of directors and set of constitutional documents. However, a PCC may create one or more cells, which are insolvency remote from each other cell and from the core assets of the PCC. Like SICAVs and OEICs, PCCs are familiar to investors and allow the flexibility (and associated cost savings) of housing multiple investment strategies or sub-funds within a single entity. However, they do this without requiring complicated drafting in the founding document, the existence and nature of the separate cells being provided for in the relevant legislation.

A single corporate CIV or a concepts-based approach?

Given the Board of Taxation's preoccupation with overseas investor experience informing the design of Australia's suite of CIVs, its focus on SICAVs is understandable. However, both OEICs and PCCs represent viable alternatives, which also offer familiarity (admittedly to a lesser extent), and which may represent a better fit with existing Australian law.

Where legislation creating CIVs is overly prescriptive, it is often not fit for purpose in the long run and requires constant amendment as market practice develops (for example, the English OEIC regime was amended in 2011 to introduce protected cells for umbrella entities, as it was increasingly seen as a concern for investors that the cells were not insolvency remote, in contrast to vehicles offered in the Channel Islands, Ireland and Luxembourg). Therefore, rather than sticking rigidly to a single form of corporate CIV, a less prescriptive, concepts-based approach will offer more flexibility, and allow the Australian corporate CIV to better keep pace with evolving market practice, and investor experience and preferences. To adapt a recommendation from the Murray Inquiry's December 2015 report, any legislation for new CIVs should as far as possible aim for 'technology neutrality' (or in this case, structural neutrality).

Corporate CIVs in an Australian context

Whichever variation of corporate CIV is used, amendments will be required to existing Australian corporations and tax law, both to legislate for the form and characteristics of the vehicle, and to ensure tax neutrality.

One possible approach is to amend the Corporations Act 2001 (Cth) along the lines of the separate chapter regulating managed investment schemes, to cater for an alternative form of corporate collective investment vehicle. England and Wales provides an example of how this might work. OEICs are established under the Financial Services and Markets Act 2000, and the Financial Conduct Authority's Collective Investment Scheme Sourcebook (referred to as COLL) sets out the FCA's rules and guidance in relation to authorised collective investment schemes. However, provisions dealing with the formation, control and supervision of OEICs, together with the corporate code regulating them, are set out in a single place, the Open Ended Investment Company Regulations 2001 (OEIC Regulations). Therefore, although the authority to establish OEICs and the rules and regulations governing them are spread across a range of sources and build upon existing legislation and regulation, anyone looking to understand their essential features can do so merely by reference to the OEIC Regulations. This approach may represent the easiest way to avoid reinventing the wheel, enabling the inclusion of the new provisions within the existing Australian legal and regulatory framework, while simultaneously providing a single, digestible set of regulations that can be provided and explained to offshore investors.

However, the framework for OEICs is still almost entirely separate to the English and Welsh Companies Act 2006 and, given the complexity of the Australian Corporations Act in its current form, consideration should also be given to enacting separate legislation specifically for such an investment vehicle, thereby possibly reducing the complicated business of integrating a corporate vehicle that is different in fundamental ways from the traditional company – one need only look to the integration of registered managed investment schemes in the Corporations Act framework to imagine the batteries of class orders that ASIC would produce to iron out the differences that would likely emerge. To the extent necessary, the separate legislation could incorporate applicable sections of the Corporations Act (eg the provisions dealing with insider trading and financial reporting), while avoiding sections that would be inapplicable (eg the rules on capital maintenance).

Since a key feature of CIVs is tax transparency, changes will need to be made to the tax legislation to treat a corporate CIV as a flow though entity by exempting the corporate CIV from tax and establishing a regime for taxing the investors. Hopefully, Treasury will adopt a 'blank piece of paper' approach in designing a workable system, rather than trying to squeeze the new entities into an existing regime. Flexibility and recognition that features from several different types of corporate CIV might be desirable should be borne in mind by Treasury when designing the new tax regime.

The consultation process is too nascent to know how it is intended these changes will be made. However, those of us who work (or at least attempt to work) on a regular basis with the Corporations Act, together with the labyrinth of associated Class Orders and ASIC Regulatory Guides, are all too familiar with just how difficult it can be to navigate. As the driver behind the proposed reform is to make things easier to comprehend and more accessible to foreign investors, our view is that it makes much more sense to create standalone enabling legislation, rather than adding an additional layer of complexity to the Corporations Act.

In next month's edition of Unravelled, we will consider the limited partnership in more detail.