In brief
Written by Partner Penny Nikoloudis
Last month, the Senate Economics References Committee handed down its long-awaited report on the structure and development of agribusiness-managed investment schemes. The Committee's inquiry into agribusiness schemes had been instigated in June 2014 by Greens Senator Peter Whish-Wilson. While there had been an earlier Parliamentary Joint Committee inquiry, in 2009, into the high-profile agribusiness MIS collapses, the 2014 inquiry was intended to give the people and the rural communities affected by the MIS collapses a chance to be heard.
Titled 'Bitter Harvest', the Senate Committee's comprehensive report is focused primarily on the retail investors who participated in the forestry and horticultural schemes operated by Timbercorp, Great Southern, Willmott Forests and Gunns Plantations, and the financial and emotional hardship those investors are still experiencing, years after the MIS collapses. The Committee's 24 recommendations are also presented through that lens.
The report was initially due to be released in October 2014, but the due date was extended several times until, ultimately, 14 March 2016. This delay meant that some of the Committee's key recommendations had already been addressed in the Financial System Inquiry Final Report released in December 2014.
Terms of reference and findings
The Committee's role was to investigate and report on the structure and development of agribusiness managed investment schemes, including:
- the motivation and drivers that established the framework for the schemes;
- the role of governments in administering and regulating the schemes;
- the current policy and regulatory framework of agribusiness MISs;
- the role of some in the financial services industry in promoting and selling agribusiness MISs; and
- the burden on farmers and other agricultural producers who have been left with the uncertainty of plantations and orchards on their land.
The report does not single out any particular stakeholder when attributing responsibility for the consequences of the MIS collapses. Rather, it concludes that all participants in the industry must bear some responsibility for it. They include:
- the product manufacturers and promoters;
- the experts who rated the schemes;
- the financial advisers who recommended the investments;
- the finance companies, credit assistance advisers and lenders that facilitated and provided loans;
- the regulators and governments, for their lack of decisive action in monitoring the marketing and performance of these schemes; and
- the retail investors enticed to enter into highly speculative ventures on borrowed money.
The 24 recommendations
The Committee's 24 recommendations seek to identify measures that could be taken to help protect retail investors from any similar investment failure in the future.
They range from:
- significant legislative reform, such as introducing national legislation that ensures credit provided predominantly for investment purposes is covered by the responsible lending obligations; to
- not-so-significant reforms, such as a recommendation that ASIC strengthen the language used in its regulatory guide on general advice by changing the word 'should' to 'must'.
While some of the recommendations relate solely to agribusiness MISs, many have broader application to other types of managed investment schemes. We focus on those below.
Unsafe products
Chapter 14 of the report is titled 'Unsafe Products', and explores many of the issues addressed in the Committee's 2014 inquiry into the performance of ASIC and in the recommendations of the Financial System Inquiry (accepted by the Government).
In particular, the Committee questions the effectiveness of Australia's regulatory regime, which has traditionally been based on conduct and disclosure, rather than merit regulation that focuses on the substantive 'safety' or quality of a financial product. The Committee described agribusiness MIS as:
…a clear example of where… disclosure was inadequate; information was confusing rather than instructive for retail investors; and oral advice either misinterpreted the disclosure documents, downplayed risks or selectively presented positive messages'.
The Committee's view is that Australia's financial services regulatory regime has not served Australian investors well and can no longer be relied upon as a means of consumer protection. It endorses the recommendations that it had made in its 2014 inquiry into the performance of ASIC, and were also made by the Financial System Inquiry, to:
- introduce stronger measures to protect retail investors from the promotion and marketing of complex and high-risk products;
- confer on ASIC a product intervention power and a 'broader toolkit', which would give it a greater capacity to apply regulatory interventions in a timely and proactive way where there is a risk of significant consumer detriment. This may include the power to restrict distribution of a product to wholesale or sophisticated investors;
- impose an obligation on product issuers to ensure that the products they are marketing to retail investors are appropriate; and
- review the penalties for breaches of obligations by AFSL holders to ensure that they align with the seriousness of the breach and serve as an effective deterrent.
Hindsight is 20/20, as they say
In the aftermath of the agribusiness MIS collapses, there has been much focus on identifying flaws in the structure, business model and distribution of these products to retail investors. However, in their heyday, forestry MISs were actively promoted by governments and by the plantation industry in pursuing a policy goal to increase the total area of forest, in an effort to address Australia's growing trade deficit in wood products. In 1997, Plantation 2020 Vision was released. This was a three-way partnership involving Australian, state and territory governments and industry, which set a target of trebling the plantation estate by the year 2020. Notably, it was recognised that the long-term nature of plantation investments could cause difficulties attracting investment capital, and so pooled investment funds, with associated tax incentives, were proposed to encourage private investment to take on a bigger role in helping to boost the national plantation estate.
Fast forward to 2016. The challenge, today, is to predict which products currently being manufactured and promoted pose the types of risks and structural flaws that were exposed with the unravelling of the forestry and other agribusiness MISs. The fintech revolution exacerbates this challenge, and presents a whole new set of business models and risks that have not been tested before. A fortnight ago, ASIC issued an information sheet on how it proposes to regulate marketplace lending products (also known as peer-to-peer lending platforms) as registered managed investment schemes available to retail investors. In the era of innovation, the pace at which ASIC will be expected to acquaint itself with new products and accommodate them within the existing regulatory framework will only become faster.
An area that has not been fully examined in the report, or in the earlier inquiries, relates to the current process under the Corporations Act for registering a managed investment scheme. Under s601EB, ASIC is required to register a scheme within 14 days if the scheme's constitution and compliance plan satisfy certain content requirements, the responsible entity has an AFSL, and certain other fairly basic requirements are satisfied. This does not give ASIC much time or flexibility to undertake any form of merit review of the product.
Also, although the statutory definition of 'managed investment scheme' is, deliberately, very broad, and recognises that the types of schemes it captures may come in a variety of forms and legal structures (eg pooled trust vehicles or contract-based common enterprises), the statutory regime under Chapter 5C prescribes a set of rules and structural requirements for all MISs, irrespective of the scheme's actual structure. For example, concepts such as 'scheme property' and statutory novation upon a change of trustee proved to be unworkable for agribusiness MISs.
A preferable approach may be for ASIC, together with the relevant industry group, to develop tailored regimes for those managed investment schemes that do not neatly fit within the statutory framework (which presumes a unit trust structure). ASIC has done this, by way of class order, for IPDSs, MDAs, serviced strata schemes and timesharing schemes. Bespoke frameworks may introduce greater clarity and transparency into the business model of the scheme, and therefore enable risks to be more effectively identified and managed.
Tax incentives
A lot has been said about the tax deductions that were available to investors in agribusiness schemes. The report details personal accounts of investors, which suggest that the tax benefits were only part of their reason for investing and certainly not the compelling reason. The report acknowledges that, while the tax advantage may not have been the primary consideration for some investors, it was a factor and a major part in the marketing strategy for these products.
The report also refers to submissions by representatives of the forestry industry, who argue that, despite the agribusiness scheme collapses, the MIS structure and tax incentives should continue to be available to support new plantation investment. The Committee recommends that Treasury commission a review of the tax incentives for agribusiness MIS, to determine whether they had unintended consequences, such as diverting funds away from more productive enterprises.
Greens Senator Whish-Wilson issued a dissenting report because he considered the Committee's report 'seriously underplayed the role that taxation incentives provided in fuelling the forestry MIS bubble'. The dissenting report recommends that the Government legislate to require investment in forestry (and presumably all agribusiness) MIS to be treated as investment in capital, and for tax deductions to be spread across the life of the asset.
The dissenting report also remarks that 'while the economic story of the collapse of MIS has been laid bare, the political story that sits behind it has not been fully told':
Serious questions remain as to why the government didn't act when alarm bells were sounded. Why did cabinet overturn the recommendation of the Minister to change the tax incentives in 2006? What was the role of the industry lobbyists in convincing the government to keep forestry MIS and a highly ambitious plantation target?... It is disappointing that the Chair's report has made little mention of the political failure to prevent the forestry MIS bubble.
Financial advisers
Not surprisingly, the report goes into some detail about the deficiencies in the promotion and selling of agribusiness MIS, which had been identified by ASIC as early as 2001. The poor quality of advice by financial advisers was exacerbated by the payment of commissions as high as 10 per cent.
The Committee recognises that the FOFA reforms have addressed the issue of commissions, but recommends that ASIC be vigilant in monitoring the operation of the FOFA legislation, and advise the Government on any potential or actual weaknesses that would allow any form of incentive payments to creep back into the financial advice sector.
The report also notes that many of the advisers were, in fact, accountants, acting under a licensing exemption or as the issuer's authorised representative. The Committee expresses concerns about accountants, rather than financial advisers, providing investment advice, and recommends that Treasury examine the obligations on accountants providing investment advice, with a view to identifying any situations where investors would not receive the same level of regulatory protection.
Product issuers
The Committee recognises the crucial role and responsibility of product issuers in relation to the distribution of agribusiness MISs, noting that advisers may have misled their clients, sometimes inadvertently, as they themselves may not have understood or appreciated the pitfalls of the products they were promoting:
The producers of agribusiness MIS must then bear some responsibility for the marketing of these speculative ventures to retail consumers.
The report refers to the decisions of the Victorian Supreme Court and the Court of Appeal, which held that the PDSs for the relevant Timbercorp and Great Southern schemes were not misleading or deceptive, adequately disclosed the investment risks and were not defective.
Nevertheless, the Committee believes that 'the time is ripe' to examine once again the efficacy of PDSs when it comes to conveying information to retail investors and enabling them to make informed choices. In particular, the Committee recommends that the Government consult with industry on ways to improve the presentation of a product's risks in PDSs.
MIS insolvency and CAMAC
Chapter 15 of the report examines the difficulties external administrators faced in endeavouring to salvage or wind up the schemes, largely because there is currently no formal insolvency regime for managed investment schemes (particularly those that are contract-based).
The report acknowledges the extensive work that had been undertaken in this area by the Corporations and Markets Advisory Committee (CAMAC) before its abolition in 2014. The report recommends that the Government use CAMAC's report on managed investment schemes as the platform for further discussion and consultation with the industry, with a view to introducing legislative reforms that would remedy the shortcomings in managing an MIS in financial difficulties and the winding up of collapsed schemes.
Financial literacy
The Committee (quoting David ('Kochy') Koch, the Seven Network's finance editor) endorses the view that financial literacy has 'got to get aggressive' to combat the asymmetry of influence and information. The report recommends that the Federal Government explore ways to lift standards, including by considering the work of the Financial Literacy Board. It also recommends that the Government, in consultation with the states and territories, review school curricula to ensure that courses on financial literacy are mandatory and designed to enable school leavers to manage their financial affairs wisely, and that financial literacy should be a standing item on the COAG agenda.
In light of the current education debates in this country, we are not overly optimistic that this recommendation will gain momentum any time soon.