2020 Australian investment funds landscape
Regulatory developments in the funds management and financial services industry have continued unabated in 2020. Many of the developments have been introduced to implement the recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission).
Not all regulatory developments have enjoyed the same level of attention from the Government. In particular, the proposed Corporate Collective Investment Vehicle regime that was first introduced in 2017 has stalled, side-lined to accommodate the additional regulation aimed at addressing the regulatory weaknesses exposed in the Royal Commission.
We have been involved in the consultation of most of these developments. This has left us well placed to advise our clients on the ever-evolving regulatory landscape.
This article provides an overview of the following regulatory developments:
- Regulatory framework for foreign financial services providers;
- Design and distribution obligations;
- ASIC’s product intervention power;
- Australian financial services breach reporting update;
- Recent changes to ASIC’s enforcement approach; and
- Litigation Funding Regulations.
We finish the article with a note about the impact of Covid-19, the growing importance of ESG factors in asset management and a highly anticipated decision to be handed down by the High Court of Australia.
Regulatory framework for foreign financial services providers
On 10 March 2020, the Australian Securities and Investments Commission (ASIC) issued ASIC Regulatory Guide 176(RG 176) which outlined the new regulatory framework for foreign financial services providers (FFSPs) providing financial services to Australian wholesale clients. See more information on RG 176 and our detailed note on the topic.
The revised RG 176 reflects ASIC’s removal of the existing licensing exemption being the “sufficient equivalence relief” that had been first introduced in 2003 for many FFSPs from several foreign jurisdictions. The “sufficient equivalence relief” applied when an FFSP provided certain financial services to wholesale clients in Australia and was regulated by an overseas regulatory framework that was sufficiently equivalent to the regulatory requirements in Australia.
ASIC also removed the “limited connection relief”, which had also been in place since 2003. It applied when an FFSP only required an Australian financial services (AFS) licence because the FFSP was deemed to be carrying on a financial service business in Australia pursuant to section 911D of the Corporations Act 2001 (Cth) (Corporations Act). This section is, effectively, a deeming provision that applies the financial services licensing regime to certain persons located outside of Australia. It provides that a financial services business is taken to be carried on in Australia by a person if, in the course of carrying on the business, the person engages in conduct that is intended to induce people in Australia to use their financial services, or is likely to have that effect, whether or not the conduct is intended, or likely, to have that effect in other places as well.
Like the “sufficient equivalence relief”, the “limited connection relief” only applied when financial services were provided to wholesale clients.
These exemptions have been replaced by the introduction of a foreign AFS licence and funds management licensing relief.
While foreign AFS licensees will be relieved from some of the Australian regulatory requirements, they will be subject to a number of additional regulatory requirements that do not apply to usual AFS licence holders. These include the requirement to do the following:
- carry on a business in the relevant foreign jurisdiction;
- appoint an agent at the time it purports to rely on the exemption and not fail to have an agent for 10 consecutive business days (unless it is a company that is registered in Australia as a foreign company);
- reasonably believe it would not contravene any home jurisdiction laws relating to the provision of financial services if it were to provide them there; and
- notify ASIC, within 15 business days, of significant changes to the licensee’s registration / authorisation in its home jurisdiction, exemptions or other relief it obtains in its home jurisdiction and of any investigation or action undertaken by overseas regulators against it in a foreign jurisdiction in relation to the financial services it provides in that jurisdiction.
From 1 April 2022, FFSPs may be given relief from the requirement to hold an AFS licence if they are only carrying on a financial services business in Australia because of the operation of s 911D of the Corporations Act in relation to the provision of “funds management financial services” to certain “eligible Australian users” – effectively a subset of wholesale clients. Unlike the limited connection relief, FFSPs that wish to rely on this relief will have to notify ASIC and comply with other requirements.
Design and distribution obligations
On 8 May 2020, ASIC announced the deferral of the design and distribution obligations (DD Obligations), which were originally set to take effect from 5 April 2021. The new start date is 5 October 2021.
The DD obligations are aimed at making the design of financial products more consumer focused and to reduce the likelihood that consumers will purchase unsuitable products. The introduction of the DD obligations is similar to existing laws in the United Kingdom and European Union that currently require issuers to design financial products that meet the needs of an identified target market and to be distributed to that specific market.
In Australia, this will be achieved by the requirement to prepare and publish a target market determination (TMD). The TMD must include the following:
- a description of a class of consumers that are considered to be the target market. Consumers can be classed based on commonalities in their objectives, financial situations and needs, which can be influenced by their levels of income and ability to bear losses;
- specifications on any distribution conditions and restrictions. The focus of these requirements is to ensure that the distribution of the financial product is consistent with its TMD;
- an outline of events that would trigger a review of the TMD. These are events that would reasonably suggest that the published TMD is no longer appropriate;
- identification of when the first and subsequent periodic reviews of the TMD must occur; and
- an outline of specific reporting periods for when the distributor should provide complaints and what types of complaints should be provided.
Accompanying the requirement to prepare a TMD are related obligations imposed on both issuers and distributors of financial products, including the obligation to take reasonable steps to ensure that products are issued and distributed within the target market.
Product intervention power
On 17 June 2020, ASIC issued ASIC Regulatory Guide 272 (RG 272). Under RG 272 ASIC has the power to make a product intervention order (PIO) when a financial product or a class of financial products will result, or is likely to result, in significant consumer detriment. ASIC can make an individual PIO which would apply to a specific product issued by a licensee or a market-wide PIO which would apply to a particular class of financial products across the industry. A financial product would be deemed to cause significant consumer detriment if the threshold level of harm or damage arises from the product’s features, defective disclosure, poor design or inappropriate distribution. Under this power ASIC may ban specific products, amend or restrict the marketing of products or order the amendment of financial product features. RG 272 refers to Cigno Pty Ltd v Australian Securities and Investments Commission  FCA 479 in asserting that the detriment is sufficiently connected to the product if it would not have occurred if the product was not available in the those circumstances.
Australian financial services breach reporting update
On 30 March 2020, ASIC released its updated breach reporting regulatory guide for AFS licensees. The full media release can be accessed here and the updated ASIC Regulatory Guide 78 (RG 78) here. The regulatory framework requires AFS licensees and responsible entities to report significant breaches or likely significant breaches of their obligations to ASIC as per section 912D of the Corporations Act. All breaches must now be reported through the ASIC Regulatory Portal.
An AFS licensee is required to report to ASIC as soon as practical, but no later than ten (10) business days of becoming aware of the breach if:
- the AFS licensee breaches any of their specified obligations; or
- the AFS licensee is likely to breach any of their specified obligations; and
- that breach or likely breach is “significant”.
In order to maintain compliance, AFS licensees should:
- ensure that an appropriate compliance system is in place in order to maintain compliance with their obligations under the conditions of their AFS licence;
- ensure than an appropriate risk management system is in place in order to identify trends indicative of potential breaches along with the identification of breaches or likely breaches when they do occur;
- know how to use the ASIC Regulatory Portal; and
- ensure that a breach register is maintained so that, in the event that a breach may occur, it is evidenced that the breach was properly identified, reported and dealt with.
Since March 2019 when the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Bill 2018 came into force, a body corporate that does not report a breach or likely breach, as required by section 912D of the Corporations Act, incurs a civil penalty of the greatest of:
- $11.1 million;
- three times the amount of the benefit derived and detriment avoided because of the failure to report, as determined by a Court;
- 10% of the annual turnover of the body corporate for the 12-month period ending at the end of the month in which the body corporate contravened, or began to contravene, section 912D, capped at the equivalent of 2.5 million penalty units ($555 million).
Previously, a failure to comply with section 912D of the Corporations Act was a criminal offence, but not one of strict liability, so a fault element needed to be established.
Recent changes to ASIC’s enforcement approach
On 17 February 2020 the Financial Sector Reform (Hayne Royal Commission Response—Stronger Regulators (2019 Measures)) Bill 2019 received its royal assent. The Bill gives ASIC greater enforcement powers and introduced the following key changes:
- False or misleading statements. Section 1308 of the Corporations Act was amended so that any deliberate attempt to provide false or misleading statements to ASIC is a strict liability offence. This includes the omission of information itself, an omission of information that results in a document containing false or misleading information or a failure to take all reasonable steps to ensure that a document does not contain false or misleading statements.
- Search and seize. ASIC has the power to search and seize evidential material in relation to contraventions of indictable offences under legislation for which it has oversight. This power extends to taking photos and video recordings of/during the search, accessing and operating of electronic equipment on site and removing electronic devices.
- Interception of telecommunications. Interception agencies are now permitted to provide ASIC with lawfully acquired intercepted information if it relates, or appears to relate, to a matter that ASIC may investigate. The types of offences that would trigger this power include insider trading and market manipulation or financial services fraud.
- Broader banning powers. ASIC now has the power to issue a banning order if it has reason to believe that a person is not trained or competent to be a director or a person in control of a company that provides financial services. A banning order may also be issued if a person has, on two occasions, refused, or failed to give effect to, a determination made by the Australian Financial Complaints Authority.
- Strengthened the AFS and Credit licensing regimes. For AFS licence applications, the former “good fame and character” test has been changed to the “fit and proper person” test to make it consistent with Australian credit licences. The test also applies to “controllers” of the body corporate or entity applying for the AFS licence. The AFS licence application process has also been amended and ASIC has been given the power to cancel a licence if a financial service or credit service is not provided within the first six months since the licence was granted. The six month period began on 18 February 2020 when the new regulations took effect for those licences that had already been granted at that time.
Litigation funding regulation
On 23 July 2020 the Corporations Amendment (Litigation Funding) Regulations 2020 were published. These regulations provide that litigation funders will be subject to the AFS licencing and managed investment schemes (MIS) regulatory regimes for all “litigation funding schemes” (as defined in the Regulations) entered into from 22 August 2020.
- The impact of the Regulations is that:
- third party litigation funders of litigation funding schemes will be required to obtain an AFS licence in order to deal in, or provide financial product advice in relation to, an interest in a litigation funding scheme unless an exemption applies;
- a litigation funding scheme may need to be registered under Chapter 5C of the Corporations Act which, among other things, must be operated by a responsible entity (ie a public company holding an AFS licence with the authorisation to operate the scheme);
- the anti-hawking provisions will apply to interests in litigation funding schemes; and
- Part 7.9 of the Corporations Act (as amended by exemptions issued by ASIC) will apply in relation to interests in litigation funding schemes, thus requiring the preparation and issue of a product disclosure statement and periodic statements to relevant members.
Not all actions funded by litigation funders are “litigation funding schemes”. The Regulations are, effectively, targeted at class actions; single plaintiff actions and insolvency actions continue to be exempt from these requirements.
In midst of the continuing regulatory reform, COVID-19 has presented challenges for the financial services industry. While the Government has introduced changes to facilitate the operation of business in a COVID-19 environment, the decision to permit early access to superannuation has caused many fund managers to have to liquidate assets, giving rise to liquidity concerns. In the context of liquidity concerns, ASIC has reminded responsible entities of their duties in connection with valuing assets of registered schemes.
On 11 August 2020, ASIC issued an article pertaining to the valuation of managed fund assets during the COVID-19 pandemic. In short, it encouraged responsible entities to ensure that:
- the valuations of their managed fund assets are undertaken regularly and use the appropriate methods for the particular asset class;
- where appropriate, they write down the value of fund assets if cash flows are negatively impacted, particularly by restrictions and lockdowns;
- all estimates in relation to asset values and fund performance are developed in a reasonable way with particular consideration for the uniqueness of the future environment when compared to both historic performance and inputs;
- they adhere to their obligations to act in the best interests of the members and to carry at their operations efficiently, honestly and fairly; and
- members are informed in relation to asset values and that the responsible entity has processes in place to monitor current uncertainties.
Appetite for Environmental, Social and Governance (ESG) funds and asset classes
The first half of 2020 has also seen an increase in appetite for funds to engage in strictly ESG portfolios or to have an ESG class of units available for investors as part of a broader portfolio. ESG portfolios are those that take into account environment, social and governance factors in selecting the underlying investments. Environmental factors include use of renewable energy, carbon footprint size and efficient resource use and management. Social factors comprise of positions on human rights and the treatment of employees, namely with reference to the new modern slavery legislative framework. Governance factors incorporate regulatory and compliance records, as well as boards of directors of investee companies in relation to remuneration and appointments.
Subsection 1013D(1)(l) of the Corporations Act requires a product disclosure statement to set out the extent to which labour standards or environmental, social or ethical considerations are taken into account in the selection, retention or realisation of investments.
As the impacts of COVID-19 continue to be felt, it is likely that ESG investing will increase in line with the number of funds that pursue investment strategies and apply investment guidelines that take into account ESG factors.
High Court of Australia to consider the distinction between general and personal financial advice and the “efficiently, honestly and fairly” requirement in s 912A
Finally, a reminder of one of the most anticipated decisions in the financial services industry - Case No. S69/2020 - Westpac’s appeal to the High Court of Australia of ASIC v Westpac Securities Administration Limited  FCAFC 187..
The case considers whether Westpac’s conduct, under its campaign to have their customers roll over external superannuation accounts into Westpac Group superannuation accounts, constituted general or personal advice. In its decision, the Full Court of the Federal Court held that Westpac’s conduct constituted personal advice, not general advice, within the meaning of s 766B of the Corporations Act; this reversed the decision by Gleeson J at first instance. The distinction is significant; different regulatory obligations apply to a person providing personal advice and general advice. These differences include the obligation to act in the best interests of the client when providing personal advice, as well as the obligation to give a client a Statement of Advice.
The case also considers whether the Westpac AFS licensees complied with their obligation to do all things necessary to ensure that financial services were provided “efficiently, honestly and fairly” (s 912A(1)(a) of the Corporations Act), an issue that is likely to be of particular interest to the High Court and should provide instructive guidance and clarification on this requirement to all AFS licensees.