ASIC's review into responsible entity governance

By Marc Kemp, Sean Cole, Mai Go
Corporate Governance

14 min read

What the review means for responsible entities

In ASIC's 2021-2025 Corporate Plan published in August last year (the Corporate Plan), ASIC identified the governance of managed investment schemes and responsible entities as an area of focus to reduce the risk of harm to investors exposed to poor governance. The Corporate Plan set out three action items for the regulator to assess governance practices, one of which was a targeted review of responsible entities' governance structures and processes and to publish its findings. Consistent with that action item, on 1 February 2022 ASIC released its findings on its review into the governance practices of 10 large responsible entities that were selected based on total assets under management and their operating models (the Report).

Similar to the earlier Corporate Governance Taskforce report released in 2019 which focused on director and officer oversight of non-financial risk in large financial services companies, the Report has been prepared as a tool for the boards of responsible entities to assess their own governance frameworks and to identify any issues. The underlying themes of the Report and the focus of ASIC's review are on the following:

  • Conflicts of interest – how is the board of the responsible entity dealing with actual and potential conflicts of interest that arise both at the board level and in respect of the responsible entity's business (eg external commitments of a director, the inherent conflicts which arise where material functions of the responsible entity are delegated to another entity in the same group, and conflicts in relation to a matter under consideration by the board handled)?
  • Monitoring of existing arrangements – are responsible entities regularly reviewing their existing arrangements (eg agreements with directors, outsourced service providers, existing related party transactions or group policies) to ensure that they remain suitable for the responsible entity and the scheme?

Unfortunately, ASIC does not provide renewed guidance in the Report on what it considers to be the best framework for managing such conflicts of interest (noting that RG 181 Licensing: Managing conflicts of interest was issued in 2004), and it appears it was beyond the scope of the report for ASIC to provide nuanced recommendations tailored to the different kinds of conflicts that responsible entities may encounter depending on their structure (for example, the types of conflicts to be managed by a third party professional responsible entity with an external manager differs significantly to those faced by a responsible entity who has appointed another group entity as the manager, which differs again for an internally managed stapled responsible entity). That said, ASIC does pose questions for responsible entities to ask themselves in respect of each governance area covered in the Report. ASIC's Corporate Plan notes that there will be a further targeted analysis of the concerns identified in the review, which leaves room for the possibility of a further publication which may shed more light on ASIC's expectations.

Below, we have summarised the key governance areas which ASIC reviewed and what this means for all responsible entities. We suggest that in conjunction with the broader governance considerations that were set out in the Corporate Governance Taskforce report, all responsible entities (irrespective of size) should consider the questions put by ASIC as part of an annual governance 'health check' as it seems that ASIC is not yet finished with its review of the governance practices of responsible entities. We have prepared a downloadable checklist of ASIC's questions from the Report which can be accessed here.

Board composition
Summary of ASIC's review

ASIC reviewed the board composition of each RE board, particularly focusing on the number of executive directors versus non-executive directors and the reasons for an RE's board composition.

ASIC did not comment on whether it considered a particular board composition to be optimal.

What does this mean for REs?

An RE should be able to support its reason for choosing a particular board composition and regularly demonstrate that the composition remains optimal, having regard to the nature of the RE's business.

This also means that in determining its board composition, REs should take into account any conflict management issue that may arise and processes for reviewing the appointment and removal of board directors.

Tenure of directors
Summary of ASIC's review

ASIC reviewed the tenure of the directors of each RE board and noted that an important aspect of the composition of an RE board is the tenure profile of the directors.

ASIC did not say what it considers to be an appropriate tenure for a director. However, it notes that a short tenure might indicate instability but an unreasonably long tenure might suggest a lack of independence and insufficient diversity of perspectives.

What does this mean for REs?

REs should consider whether the tenure profile of its directors means that there may be skills 'gaps' at the board level, particularly where there have been significant changes to the RE's business.

For certain REs, the responsible manager under the RE's Australian financial services licence (AFSL) may be a director. Such REs should also consider whether the tenure profile may affect the organisational competence obligation under s912A(1)(e) of the Corporations Act 2001 (Cth) (Corporations Act) which requires a licensee to maintain the competence to provide the financial services covered by its AFSL.

External commitments of directors
Summary of ASIC's review

ASIC's focus was the number of external commitments each director had (including to organisations in the same corporate group) and the average number of days the director spent on those external commitments. The Report notes that the Corporations Act does not expressly restrict a director from holding other commitments but an RE should ensure that its directors are not overly committed with other business roles as there is a risk that they will not have sufficient time to carry out their duties as an officer of the RE.

What does this mean for REs?

ASIC alludes to the fact that a director who is overcommitted to other business roles may not be carrying out their duties as an RE director under the Corporations Act to an adequate standard, and may compromise the RE’s compliance with its duties under ss601FC and 912A of the Corporations Act.

ASIC does not go as far as prescribing that a particular number of external roles would warrant further investigation by ASIC, but an RE may wish to consider implementing a policy setting out the factors that are to be considered when determining whether a director may take on additional roles (eg potential conflicts and workload). This would assist in demonstrating that the RE has turned its mind to the impact that the additional roles may have on the RE's ability to carry out its duties.

Board charter
Summary of ASIC's review

While ASIC notes that a board charter is not a requirement under the Corporations Act, it states that (in its view) a robust board charter is conducive to the effective functioning of the RE and will assist the RE and its directors to comply with their duties under the Corporations Act.

What does this mean for REs?

It may be prudent for an RE to have a board charter which is sufficiently detailed in respect of all key governance areas, and with a clear review cycle.

Board meetings and committees
Summary of ASIC's review

ASIC considered the frequency of board meetings and board committee meetings (eg audit and risk committee, due diligence committee).

The Report states that for an RE board to function effectively, it should meet frequently enough to ensure it can perform its role and be adequately supported by board committees.

What does this mean for REs?

REs should ensure that the board and board committees meet frequently, and that the terms of reference for committees are clearly documented, the delegations clear (including whether the committee may sub-delegate) and that there are established governance frameworks (eg committee support, and appropriate reporting).

Board performance reviews and skills assessment
Summary of ASIC's review

ASIC reviewed the frequency of board performance reviews and skills assessment and the processes in place for such reviews and assessment (including whether there were established processes and whether the party conducting the review was independent of the board). The obvious focus here is on independence and ASIC notes that the utility of board performance reviews and skills assessments depends on such reviews being evidence-based and carried out with objectivity.

What does this mean for REs?

REs should consider if appointing a third party to undertake board performance and skills assessments may be appropriate, and have a clear framework of the factors that should be considered when undertaking such assessments.

Appointing an independent assessor may also assist an RE to demonstrate that it is comfortable that there is no skills gaps at the board level (discussed above in 'tenure of directors') or any underperformance issues arising from external commitments of the directors (see 'external commitments of directors' above).

Staffing arrangements
Summary of ASIC's review

ASIC was particularly interested in REs that engage other entities within a group structure and noted that eight of the ten REs surveyed obtained all of their staff resources from other entities in the same corporate group - these eight REs did not employ their own staff.

The Report focused on the potential conflicts of interests which arise in circumstances where the interests of a person who is employed by a different group entity does not align with the interests of the RE.

What does this mean for REs?

An RE which relies on staff from other group entities should be prepared to explain the basis on which it is satisfied that it has adequate staffing resources to perform its duties as required under the Corporations Act, and how it identifies and manages any conflicts of interest that may arise from this structure.

ASIC notes that reasonable steps for managing conflicts might include staff being required to declare and manage any conflicts of interest between the interests of their employer and the interests of the RE. An additional consideration may be to require such staff to undertake to comply with the duties of an employee of an RE under section 601FE of the Corporations Act as if they were employees (ie the duties not to misuse their position or information to gain an advantage for themselves or someone else, or to the detriment of members of the scheme).

Business models and reporting arrangements
Summary of ASIC's review

ASIC considered the extent to which REs delegated material functions and whether such delegations and reporting arrangements were documented. Again, ASIC has posed a question to REs on whether there are adequate arrangements in place to deal with conflicts of interest, particularly where the delegate is a related party.

What does this mean for REs?

ASIC does not express any particular concerns with outsourcing of material functions by an RE, but in doing so, the delegation of authority should be clearly documented and monitored, and there should be sufficient oversight by the RE of its delegates.

Outsourced service providers
Summary of ASIC's review

ASIC reviewed the categories of outsourced service providers engaged by the REs, whether such service providers were related entities, and the processes for appointing and monitoring the service providers.

What does this mean for REs?

The theme of conflicts of interest arise again in this governance area. An RE should have adequate processes for appointing and monitoring its arrangements with its outsourced service providers as the RE remains ultimately responsible for the actions of the service provider. The appointment of outsourced service providers should not be a set and forget appointment, but require regular review to ensure that the terms of the agreement are in the best interests of members (including whether the agreements are of a suitable duration and do they include appropriate termination clauses), reflect current servicing requirements and that the providers are performing at a sufficient standard.

Related party transactions
Summary of ASIC's review

ASIC notes that a related party transaction raises the question of whether the transaction is in the best interests of the members and whether the RE has adequately dealt with the conflict of interest.

The Report notes that the processes that an RE has in place to monitor related party transactions will be relevant to whether the RE is complying with its member approval requirements, duties under the Corporations Act and whether the RE has adequate protocols for the management of conflicts of interest.

What does this mean for REs?

It is not uncommon for REs to rely on the arm's length exception for member approval for related party transactions, but the basis on which an RE relies on the exception is not always clearly documented. ASIC's guidance on the arm's length exception and the factors to consider when applying the exception is set out in Regulatory Guide 76: Related party transactions (RG 76). An RE should ensure that in relying on the exception, it clearly documents the process which it undertook to be comfortable that the transaction falls within the exception and how each of the factors set out in RG 76 were taken into account when forming the view that member approval was not required.

REs should also ensure that related party transactions are monitored, including with oversight of material transactions by the board.

Use of independent experts
Summary of ASIC's review

ASIC considered the use of independent experts, and whether they were engaged by management, the board of the RE or others (in some instances, ASIC identified that related entities were in fact deciding on whether to engage experts or consultants).

What does this mean for REs?

REs should consider whether the appointment of independent experts means that there is a skill deficiency at the board level, and whether the directors have the ability to review the information provided by the experts. As noted above, an appropriate review of the board composition, tenure profile and an independent review of the performance and skills of the directors of the board would assist in this.

Material personal interests of directors
Summary of ASIC's review

ASIC was interested in observing compliance with s195 of the Corporations Act which provides that a director of a public company who has a material personal interest in a matter that is being considered at a meeting must not be present while the matter is being considered or vote on the matter (subject to certain exceptions). ASIC observed a wide variety of practices and compliance (and potential non-compliance) with this obligation. In particular, it queried whether REs that have on their boards staff from within the corporate group, considered how best to manage any potential conflicts and ensure those staff understand that material personal interests arising from the group context could be relevant to their role as a director of the RE.

What does this mean for REs?

ASIC notes that whether the actual or potential conflicts identified by each of the REs reviewed by ASIC were caught by s195(1) was outside of the scope of 'this preliminary review', suggesting that ASIC may revisit the application of s195 in the context of RE board meetings in the future. Accordingly, an RE should review its conflicts of interest policies to confirm that it adequately addresses conflicts which may arise in respect of a matter being considered by the board. Does the policy have processes in respect of how the board will approach a conflicted director's involvement in a matter before the board (eg who will determine the director is conflicted?) and how does this tie in with the RE's duties to act in the best interests of the members?

Compliance management
Summary of ASIC's review

ASIC considered whether an RE had a compliance committee, whether a compliance plan was incorporated by reference, and the types of group policies that were adopted by an RE.

What does this mean for REs?

The focus of ASIC's review in respect of compliance management appears to be whether REs are applying a one size fits all approach to compliance. While incorporating a compliance plan by reference is common, REs should consider whether the compliance plan remains fit for purpose for the relevant scheme. Where there is a compliance committee, REs should turn their mind to whether the number of compliance committee members is appropriate, having regard to the size and complexity of the scheme. In respect of group policies, an RE should not assume that the policy is suitable for the RE and/or the scheme and should review the policy prior to adoption, and regularly monitor the policy to ensure that it remains suitable.