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Answers to questions on notice
Australian Securities and Investments Commission: answers to questions
taken on notice 21 June 2013, received 23 and 24 July 2013
Would the committee be able to receive, either in public or
in camera, a copy of the legal advice that ASIC has received which doubts the
likelihood of a successful prosecution against Mr Maher (formerly Gresham)?
The legal advice that was referred to by ASIC during its
hearing before the Committee was advice about whether ASIC was in a position to
seek orders preventing Mr Maher from travelling. ASIC has advice from Senior
Counsel that it does not have reasonable grounds for bringing such an application.
ASIC is not in a position to provide a copy of Senior
Counsel's legal advice to the Committee as we are concerned that to do so would
waive legal professional privilege. ASIC is very reluctant to waive privilege
in circumstances where we have an ongoing investigation of Mr Maher.
Does ASIC have a view as to whether Mr Maher has purchased
assets with the $2 million dollars that he received in undisclosed
commissions from recommending the ARP Growth Fund and PPST?
In responding to this question we are presuming that the
Committee is referring to approximately $2 million dollars in undisclosed
commissions that Mr Maher received for recommending certain investments for
As indicated previously, ASIC has not identified Mr Maher as
owning any assets of any substance that could be pursued to recover funds for
investors. In addition, ASIC is not aware of the liquidators of Trio Capital
Ltd (in liquidation) finding any such assets.
In its submission to the Trio
inquiry, ASIC noted that the assurance standards that are relevant to a
compliance plan audit do not have the force of law. ASIC suggested possible
reforms to improve the effectiveness of compliance plans, auditors and
committees. This included introducing an approval process for compliance plan
auditors and civil liability provision for compliance plan audits.
progress has ASIC made in this area and what feedback have you had from
Introducing an approval process for compliance plan auditors
and civil liability auditors is a policy matter for government.
We are consulting with the Auditing and Assurance Standards
Board (AUASB) concerning a possible update of its guidance for compliance plan
audits in GS 013 Special Considerations in the Audit of Compliance Plans of
Managed Investment Schemes (GS 013), which was issued in August 2009. We wrote
to the AUASB in November 2012 with the following matters:
(a) Form of revised pronouncement:
We recognise that the Board has issued
GS 013 as a guidance statement because it:
(i) is largely a restatement of the law and ASIC guidance; and
(ii) is underpinned by the auditing and assurance standards.
Should the revised pronouncement include
any additional requirements specific to compliance plan audits, the Board may
wish to consider issuing a standard. While a standard would not have the force
of law, it would be mandatory for members of The Institute of Chartered
Accountants in Australia, CPA Australia and the Institute of Public
Revised ASIC regulatory guide:
ASIC intends to issue a revised
regulatory guide RG 132 Managed Investments: Compliance Plans (RG 132) to
provide enhanced guidance as to our expectations for the content of compliance
plans. The revised RG 132 may also incorporate the guidance current in
regulatory guides RG 116 to 120. The Board should consider the revised RG 132
in developing its revised pronouncement.
The existing guidance on applying materiality in reporting by the
auditor of non-compliances with a compliance plan resides in an ASIC
Information Sheet. Recognising that reporting immaterial matters could detract
from the identification of material non-compliances, we intend to continue this
guidance but may include it in a regulatory guide.
(d) Other ASIC regulatory guides:
Since GS 013 was issued, ASIC has
issued a number of regulatory guides that are relevant to specific types of
registered schemes. The AUASB should consider the extent to which the following
regulatory guides impact on the role of the auditor and should be addressed in
an updated pronouncement, an updated GS 014 Auditing Mortgage Schemes or a
separate new pronouncement. These regulatory guides are:
(i) RG 46 unlisted property schemes—improving disclosure for retail
(ii) RG 45 mortgage schemes—improving disclosure for retail investors;
(iii) RG 231 infrastructure entities—improving disclosure for retail
(iv) RG 232 agribusiness managed investment schemes—improving disclosure for
retail investors; and
(v) RG 240 hedge funds—improving disclosure.
(e) ASIC audit firm inspection programme findings:
The Board should consider the extent to
which findings concerning compliance plan audits that have been identified in
ASIC’s inspection of audit firms indicate matters that could be addressed in a
revised pronouncement. These are outlined in our last public audit inspection
report (Report 317 Audit Inspection Program Report 2011–12). While the matters
identified by ASIC concern compliance by auditors with their existing
obligations, AUASB standards or guidance may assist auditors in better
understanding their obligations and conducting quality audits.
Some specific findings from our audit
firm inspections are:
Performing compliance testing only for selected schemes managed by a
single responsible entity without due regard to differences between schemes and
the controls operating for each scheme;
(ii) Failure by auditors of registered schemes relying on the report of an
auditor of a custodian to ensure that the report addresses relevant aspects of
compliance with the compliance plans of those schemes; and
(iii) Audit evidence not being obtained or insufficient documentation of audit
Under section 601HG(2) of the Corporations Act, the auditor
of an entity's compliance plan cannot be the auditor of that entity's financial
statements, although the auditors may work for the same audit firm. In its
submission to the Trio inquiry, KPMG stated that the requirement for different
persons to carry out the compliance audit and the audit of the financial
statements 'increases disaggregation in the oversight of the MIS'.
(a) What is ASIC's perspective on this?
(b) What does ASIC see as the risks that might arise if the same person were
permitted to carry out both types of audit?
The independence and objectivity of the auditor is an
important contributor to audit quality and market confidence in the
independence assurance provided by the auditor. Having a separate person within
a firm audit the compliance plan to the auditor of the financial report of the
responsible entity can only enhance the independence and objectivity of the
auditors. The risk and perception that the auditor may be less willing to raise
and report concerns in the compliance plan audit to avoid any impact on the
relationship with the responsible entity and fees from that entity is reduced.
At the time of the Trio inquiry, ASIC observed that Part
5C.4 of the Corporations Act:
- did not impose any qualitative standards by which a compliance
plan auditor must conduct their audit;
- did not make it an offence to conduct a poor-quality compliance
- only required the auditor to check compliance with the compliance
plan, not the compliance of the RE with the constitution of the MIS; and
unlike the assurance standards for an audit of financial
statements, the assurance standards for a compliance plan audit did not have
the force of law.
In your submission, ASIC provided a forward work plan which
identified regulatory options for improving the quality of compliance plan
(a) Can you outline your progress in each of the above areas since Trio?
(b) Since Trio, has there been a successful action against a compliance plan
We continue to review audits of compliance plans as a part
of our inspections of audit firms. There have been no successful actions
against a compliance plan auditor.
As a result of the compliance plan audit inspections
undertaken over the last year, has ASIC identified any further areas of
systemic concern across the industry?
In addition to the matters mentioned in response to question
3, our November 2012 letter stated that our public report on audit firm inspections
in the 18 months to 30 June 2012 identified the following concerns with
compliance plan audits for managed investment schemes conducted under s.601HG(1)
of the Corporations Act:
(a) Where functions such as custodial or investment administration or
back-office accounting are outsourced, auditors often choose to rely on a
report prepared by the auditor of the service organisation reporting on the
design, implementation and/or effectiveness of operating controls, or in
relation to specific assertions such as valuation and existence of investments.
(b) We found that auditors of compliance plans did not always obtain
sufficient and appropriate audit evidence on which to base their conclusions in
areas such as:
(i) whether the compliance plan continued to meet the requirements of Pt
5C.4 of the Corporations Act;
(ii) the adequacy of procedures for reporting and assessing breaches of the
(iii) the assessment of whether the service organisation auditor’s report
could be relied on in relation to outsourced functions, risk assessments
performed by the auditors, and the relationship to work performed on areas of
the compliance plan audit; and
(iv) the testing of specific areas, such as subsequent events up to the date
of issuing the compliance plan audit report, net tangible asset calculations
(for the responsible entity), and cash flow projections.
Many frauds are undiscovered for some time and may only come
to light because of a whistle-blower within the organisation. Directors are
often seen as the principal gatekeeper with responsibility for detecting fraud.
If the directors are in on the fraud, to what extent would ASIC expect a
compliance plan audit to detect fraud?
A compliance plan audit is not designed to identify fraud. It
might identify failure to apply controls which would have helped reduce the
risk that the fraud occurred and in this way attract attention to a fraud. If
incidentally to a compliance plan audit, the auditor has reason to suspect a
fraud that would constitute a contravention of the Corporations Act 2001,
the auditor may have an obligation to report the matter to ASIC under s.601HG
of that Act.
Given that a compliance plan auditor is only required to
ascertain the compliance of an RE with its compliance plan, could you clarify
for the committee who is actually responsible for ensuring that an RE adheres
to the constitution of the RE's MIS?
A compliance plan audit also covers whether the compliance
plan itself complies with the Act.
The responsibility for ensuring that a responsible entity
adheres to the constitution is with the directors of the responsible entity.
During the Trio inquiry, KPMG
suggested a need for greater oversight of managed investment schemes. KPMG
argued that one option would be to mandate a majority of truly independent
directors of the responsible entity which would remove the need for a
compliance committee. The second option is to strengthen the role of the
compliance committees and hold management accountable for acting on the
recommendations of the compliance committee.
(a) Could you comment on these two options?
The role of the compliance committee concerns the compliance
plan and compliance with that plan. The directors have a broader responsibility
in relation to the conduct of the overall scheme.
If there is a compliance committee with a majority of
independent members with appropriate capacity, powers and duties, it is unclear
on what basis there is a need for a majority of independent directors if the
objective of the arrangements is to promote compliance.
It would not be appropriate to require officers of the
responsible entity to be subject to direction by the compliance committee. Indeed
that would undermine the compliance committee’s capacity to provide independent
oversight. If management is unable to address concerns arising from monitoring
by the compliance committee, the compliance committee’s function is to report
the matter to ASIC.
In ASIC's submission to the Trio inquiry, you noted that a
MIS can be a complex product and yet there was no specific statutory requirement
for the RE of a MIS to disclose its scheme assets at the asset level. This
committee also recommended in its Trio report that the government release a
consultation paper on this issue, a recommendation that the government has
(a) Could ASIC update the committee on progress in this area, including
whether a consultation paper has been released?
On 1 July 2013 under the
Further MySuper bill, new arrangements come into force. The EM (pp. 39–40)
provides the following example:
An RSE licensee (ABC Super) invests assets of their fund
through a custodian. The custodian must invest as directed by ABC Super. The
custodian, at the direction of ABC Super, invests assets in a financial product
provided by Managed Investment scheme 1.
Managed Investment Scheme 1 makes investments into other
managed investment schemes. It is a fund of funds.
Managed Investment Scheme 1 invests in a financial product
offered by Managed Investment Scheme 2 by purchasing units in that scheme.
In this example, ABC Super must notify the custodian the
assets are those of ABC Super.
The custodian must then notify Managed Investment Scheme 1
that the assets invested are those of ABC Super as it is an investment in a
Managed Investment Scheme 1 must subsequently notify Managed
Investment Scheme 2 that it is investing assets derived from the assets of ABC
Super as it is investing in another financial product.
Managed Investment Scheme 2 will have an obligation to
provide information directly to ABC Super that is sufficient to identify its
financial product and the value of ABC Super’s investment.
The steps involved are set out in the Diagram.
(a) How will these arrangements improve the reporting of underlying asset
(b) What will these arrangements improve the reporting of underlying asset values?
The committee understands that reforms proposed in the
Further MySuper bill last year will be introduced via regulation and not
through the enactment of the bill. Treasury has begun to consult on the draft
regulations. One of the proposed changes revolved around the obligations that
were incurred when an MIS invested funds from a superannuation fund into a
second MIS. The committee understands that the second MIS would be required to
report back to the RSE trustee on its portfolio holdings.
Could you tell the committee whether that obligation would
apply if the second MIS was an unregistered overseas fund?
Answers to questions 10, 11 and 12
ASIC has not produced a consultation paper at this stage, in
relation to either managed investment scheme or superannuation funds portfolio
holdings disclosure. At present, we are waiting for settled legislation,
particularly with regards to portfolio holdings disclosure as part of the
Stronger Super reforms. We are currently providing feedback and assistance to
Treasury on the drafting of regulations in relation to portfolio holdings
disclosure. These regulations will give greater detail to the requirements in
section 1017BB of the Corporations Act 2001, as inserted by the Superannuation
Legislation Amendment (Further MySuper and Transparency Measures) Act 2012
(Tranche 3). The Explanatory Memorandum for Tranche 3 is quoted in the question
above. The timeframe for this aspect of the Stronger Super reforms has been
changed in the Superannuation Legislation Amendment (Service Providers and
Other Governance Measures) Act (Tranche 4) so that the first reporting date for
portfolio holdings disclosure is 90 days after 30 June 2014, as opposed to its
original timeframe of 90 days after 31 December 2013.
We may issue further consultation papers or regulatory
guidance after these regulations are settled. We anticipate that there may be
changes to these proposed regulations from original drafts that were circulated
publicly in May 2013, following industry feedback.
In terms of the reporting of asset values, there is a
proposed regulation that will enable ASIC to determine how assets should be
valued and described: see proposed regulation 7.9.07W. These arrangements may
help improve the reporting of underlying asset values as ASIC may be able to
impose a consistent methodology for asset valuation.
However, we see the primary function of portfolio holdings
disclosure to be increasing consumer awareness of the nature and types of
investments being made by trustees with their superannuation monies. This
enables people to better understand the risks associated with their investment
and to monitor how the fund complies with its stated investment strategy.
Greater transparency will also assist consumers to make more informed decisions
about their superannuation fund and whether an investment option is suitable.
In the current drafting of the portfolio holdings provisions
in Tranche 3, there are look-through arrangements that require managed
investment schemes that are invested in by trustees to report back to the
trustee as to where the money has ultimately been placed. There are
jurisdictional limitations where the fund invested in is offshore. ASIC cannot
insist on the offshore fund reporting to the trustee as to where the money has
been placed. However, it is expected that the trustee would report the initial
offshore investment to the extent that it is known to the trustee.
In the further regulations on portfolio holdings disclosure,
there may be changes to the look-through provisions that are detailed in the
We understand that the Government may be interested in
extending similar portfolio holdings requirements to managed investment schemes
following Trio. ASIC has consistently expressed its full support for this
position. We consider that the primary function of portfolio holdings
disclosure by superannuation funds, stated above, to apply equally to managed
Further, we remain fully supportive of industry initiatives
with regards to improvements in portfolio holdings disclosure.
In your submission to the Trio inquiry, ASIC stated that the
government might consider banning payments by issuers to research houses for
(a) What has caused ASIC to change its position in the recent regulatory
guide on research report providers?
(b) Does ASIC have greater concerns about particular types of business model
employed by research houses?
In our consultation paper, CP 171 Strengthening the
regulation of research report providers (including research houses) released in
November 2012, we consulted on whether conflicts of interest associated with
product issuers paying for research: (a) can be effectively and robustly
managed; or (b) should be avoided entirely.
We received 27 submissions in response to our CP. In
response to our questions on the conflicts associated with issuer pays
research, most respondents considered that this conflict could be managed with robust
processes and appropriate controls. Many also noted that that there was a range
of other business model conflicts that can have similarly adverse impacts on
the quality, integrity and reliability of the research. Some respondents also
noted that requiring avoidance of this conflict may have an adverse impact on
the availability of research in the current market.
On consideration of the issues and submissions, our updated
guidance requires providers who operate issuer pays business models to maintain
robust controls to ensure fee and contractual arrangements, relationship
management and /or ancillary business units are kept separate from the ratings
process and outcome. We also expect clear disclosures for users of research
that the research was commissioned and paid for by the issuer.
Our expectations of conflicts management for both direct and
indirect business model conflicts is set out in Table 5 of Regulatory Guide 79
Research report providers: Improving the quality of investment research (RG 79).
On releasing our updated guidance, we also committed to conducting targeted
surveillance of research report providers to assess compliance with our updated
guidance, measuring both broad compliance as well as discrete issues such as
conflicts management. We have given a clear signal to industry that if
standards do not improve, we will revisit the regulation of research report
providers to consider whether specific law reform is needed. Further, we have
also said to industry that if as an outcome of our surveillance activity,
conflicts of interest for example, are not being managed appropriately; we will
take regulatory action and if necessary, revisit the need to suggest law reform
in relation to this sector.
Different conflicts of
interest are present or can arise across the spectrum of business models
adopted by research providers. We recognise that the structure of a business
can increase or reduce the incidence of conflicts of interest and expect
research providers to consider the impact of conflicts in choosing their
business model. We expect each provider to consider real and perceived
conflicts of interest and where appropriate to manage the conflict with robust
controls. Where conflicts of interest cannot be managed, we expect providers to
avoid the conflict entirely. The effectiveness of these arrangements will be
the subject of ASIC's surveillance activity.
Does ASIC view research houses as providers of financial
advice or as providers of information?
RG79.25 sets out what we consider to be a research report. We
consider that a research report:
- is general advice that is in writing;
includes an express or implicit opinion or recommendation about a
named or readily identifiable investment product; and
- is intended to be, or could reasonably be regarded as being
intended to be, broadly distributed (whether directly or indirectly) to clients
(whether wholesale or retail) in Australia.
Some participants at the ASIC Annual Forum expressed a
desire to see research houses have more 'skin in the game' and face greater
accountability for the quality of their research.
(a) Does ASIC believe that research houses have enough 'skin in the game'
(b) Is ASIC comfortable with the level of accountability to which research
houses are currently subjected?
Research is prepared and distributed to retail and wholesale
clients and is an important input into the quality of financial advice retail
investors receive. It is a commercial imperative for research providers to
deliver research services that their clients can have confidence in. The
changes we have made to our policy to improve the quality of investment
research in RG 79, which comes into effect on 1 September 2013, are designed to
assist wholesale clients, such as advisory businesses, to do their own due
diligence on potential third party service providers such as research
providers. Where the service offering is not of good quality or where conflicts
of interest are not effectively managed, we expect purchasers of research
services to 'vote with their feet' and choose alternative providers who can
deliver quality, reliable services.
We have said to industry that if, as an outcome of our
surveillance activity, conflicts of interest, for example, are not being managed
appropriately, we will take regulatory action and if necessary, revisit the
need to suggest law reform in relation to this sector.
Research providers must hold an AFSL and comply with the
general licensing obligations including those relating to the management of
conflicts of interest and other obligations relating to the provision of
general advice, and a range of prohibitions, including those against misleading
and deceptive conduct, dishonest conduct and insider trading, for example.
Our policy settings in RG 79 update the regulatory framework
and are designed to improve the production of research and to increase the
sophistication of retail and wholesale clients in their level of reliance on
research reports. In releasing our updated guidance for research providers, we
clearly communicated our expectation that research providers needed to 'lift
Financial planners pay research houses for the time and
expertise that is involved in producing a research report into a fund or
(a) To what extent does ASIC then expect a financial planner to undertake
their own critical evaluation of a research report and what does ASIC think
this should involve?
Regulatory Guide 175 Licensing: Financial product advisers—Conduct
and disclosure RG 175.314 - 317 sets out our guidance for advice providers
using research reports. We expect advice providers to make inquiries and
research the products they give advice on. Where they use research, we expect
them to conduct due diligence on research report providers that they intend to
use and our updated guidance in RG 79 will help them to do this. We consider
the due diligence will need to consider the business model, conflicts of
interest associated with that service provider, how it selects products for
rating, the methodology it employs and its spread of ratings. This will help
the advice provider to form a view about the service provider and the extent to
which the adviser can rely on the research. Regardless of their use of third
party service providers such as research providers, the advice provider remains
responsible to the client for the advice they give.
In its submission to the Trio inquiry, the Financial
Planning Association (FPA) noted a conflict between the commercial interest of
some licensees and the best interests of a financial planner's clients. The FPA
recommended a statutory best interest duty 'for the consumer as a whole' to
apply to all licensees and not just those dealing directly with retail clients.
(a) Could ASIC comment on this proposal?
(b) Does ASIC have any concerns that even after the FOFA reforms concerning
'client best interest' and 'conflicted remuneration' are in place, that when a
financial institution creates financial products and also controls a financial
advice network, the situation could still arise where the sales target of the
financial institution conflicts with the financial adviser's best interest
obligation to their client?
Under the Corporations Act, licensees must do all things
necessary to ensure that the financial services covered by their license are
provided efficiently, honestly and fairly. Licensees are also subject to
obligations under the ASIC Act including: implied warranties as to due care and
skill and fitness for purpose. The desirability of law reform to impose further
or more explicit obligations on product manufacturers to take account of the
needs of consumers as a whole is a matter for Government.
Section 961J requires that if a provider knows, or
reasonably ought to know, that there is a conflict between the interests of the
client and the interests of the provider or an associate or representative, the
provider must give priority to the client's interests when giving advice. This
obligation applies to advisers working for an advice network that is controlled
by a financial institution. Regulatory Guide 175 states that in order to comply
with this obligation, an advice provider must not over service clients to
generate more remuneration for themselves or related parties where the level of
service is not commensurate with the client's needs.
In its submission to the Trio inquiry, the Financial
Planning Association (FPA) welcomed the 'best interest duty' and the banning of
commissions under the FOFA reforms. However, the FPA noted that product reform
is not being addressed, including in the area of potentially misleading claims
being made about products.
(a) Is ASIC considering ways to enhance the responsibility of product
providers and fund managers in developing products for retail investors?; and
(b) What consultation has ASIC undertaken in this area, what has been the
industry response, and is ASIC considering anything more than appealing to the
best interests of product providers and fund managers?
Answer not yet supplied.
Does ASIC have an expectation that a custodian would
communicate with an auditor when preparing net asset value calculations for an
Given that the requirements faced
by a custodian appear to be primarily around the holding of sufficient assets,
to what extent does ASIC view custodians as critical gatekeepers in the system
as compared to the role played by auditors, research houses and trustees?
Answers to question 19 and 20
A custodian may or may not be engaged to prepare net asset
value calculation for an RE. If a custodian does undertake an engagement to
prepare net asset valuations, the custodian would not routinely consult with an
auditor, whether the auditor of the RE, of the managed investment scheme or of
the compliance plan for the managed investment scheme, in performing such
calculations. On the other hand in performing an audit, an auditor may seek
information from the custodian concerning the assets held, and the systems that
the custodian uses to hold assets and in performing any calculation functions
where it is relevant to the subject matter of the relevant audit.
In ASIC Report 291 ASIC stated that 'We consider custodians
to be gatekeepers within the financial services industry, with responsibility
in the product chain for the safe keeping of client assets'. It is not possible
to assess whether a custodian is more or less 'critical' compared with
auditors, research houses and even trustees or responsible entities - they all
have a significant but distinct role to play. Custodians play an important
operational role in the day-to-day activities of the finance industry and in
keeping assets in custody. They are generally only engaged to act on authorised
instructions of the RE. The role of a custodian does not include any investment
management or other discretionary decision making powers in relation to those
What checks would ASIC expect a trustee to undertake to
ensure that the data being incorporated into the net asset valuation
calculations by a custodian are robust and correct and how would this work in
In the context of portfolio holdings disclosure, it is the
trustee that needs to be confident that the information they are disclosing on
their website is accurate and does not contain misleading statements. The
trustee needs to undertake whatever checks it considers appropriate to be
satisfied that the information it obtains from its custodian is accurate.
In a superannuation context, APRA has some oversight of
trustees and their relationship with material outsourced service providers,
which may include custodians. For example, APRA may scrutinise the level of
review that the trustee engages in with its service providers.
We note that as a result of Stronger Super reforms and
changes to reserve requirements, an increasing number of trustees may opt not
to have a custodian at all.
Could you explain what you aim to achieve with consultation
paper No. 204 into the risk management systems of responsible entities?
Currently, under the Australian financial services licence
regime, licensees including responsible entities (REs) are required to comply
with a general requirement to ‘maintain adequate risk management systems unless
the licensee is regulated by APRA’ (s912A(1)(h) of the Corporations Act (the
Consultation paper 204 Risk management systems of
responsible entities (CP 204) outlines our proposals to strengthen risk
management systems in a way that fleshes out what is adequate and what is good
practice in a more applied context and aims to help REs to better identify and
manage the risks they face in the operation of schemes including strategic,
governance, operational, investment and liquidity risks.
We propose these changes in CP 204 on the basis of the
findings from ASIC's 2011–12 review of the risk management systems of a
selected group of REs. The review found that the risk management systems vary
significantly in sophistication with REs. For example, we have concerns that
the non-APRA-regulated REs tended to have less comprehensive and sophisticated
risk management systems.
CP 204 proposed to enhance the general risk management
obligation in s912A(1)(h) by way of a class order to subject REs to targeted
requirements in relation to their risk management systems, supported by
industry specific guidance for the managed funds sector to supplement our
existing guidance in Regulatory Guide 104 Licensing: Meeting the general
obligations. The consultation ended in May 2013. Responses received were
generally supportive of the proposals in CP 204. ASIC is in the process of
finalising the proposed class order and regulatory guidance.
BT Financial Group: answers to questions taken on notice 21 June 2013, received
12 July 2013
The FOFA reforms place a statutory onus on financial
planners and advisers to put the best interests of their clients first and to
avoid conflicted remuneration. However, there is a concern that when a financial
institution creates financial products and also controls a financial advice
network, a situation could still arise where the commercial interests of the
licensee conflicts with the financial adviser's best interest obligation to
BT Financial Group is the wealth management arm of the
Westpac Group and in addition to other bodies is regulated by the Australian
Prudential Regulatory Authority (APRA) and the Australian Securities and
Investment Commission (ASIC).
BT Financial Group takes its responsibilities as a
gatekeeper and a financial services provider seriously.
We place customers at the centre of everything we do, which
includes acting in their best interests when providing financial advice.
As part of the recent Future of Financial Advice (FOFA)
reforms, which we support, we have implemented new ‘best interests’
requirements to further support planners in demonstrating they have met their
best interests obligations to customers.
We have strong and well-established risk management and
governance frameworks. These establish clear protocols for how we operate as a
business, including the products we offer to our customers whether through our
Approved Product Lists or otherwise. We accept that conflicts of interest may
arise from time to time in the normal course of business. However, we are
confident that we have appropriate processes and protocols in place for
managing any such conflicts.
- Our advisers are not restricted to recommending our products, and
they can and do advise on and recommend other products to our customers.
- We are continually improving our products to ensure they meet the
needs of our customers.
- We have strong controls in place to ensure that our advisers only
recommend products when it is in the best interests of our customers. Our
advisers are required to place customer interests above their own and above
those of the BT Financial Group and the Westpac Group, and there are
consequences for our advisers if they do not do this.
The committee understands that BT Financial Group makes
financial products and also employs advisers to sell those products. Can you
comment on whether BT Financial Group's financial planners and financial
advisers are subject to sales targets, and if so, could this create tension for
your financial advisers in meeting the best interests of their clients?
We do not employ advisers to sell products. We employ
advisers to provide financial advice and to help meet the financial needs of
We believe in the value of financial advice and we provide
quality advice to customers in a strong and sustainable model.
We do not impose product sales targets on any of our
In the adviser channels we own (i.e. Securitor and BT
Select) we work with financial adviser practices by helping them to attract and
service customers but we do not specify sales or revenue targets for these
practices or their financial advisers.
The salaried adviser channels (e.g. Westpac Financial
Planning and St.George Financial Planning) have revenue targets, and planners
participate in a bonus scheme. All revenue (initial and ongoing), and all asset
categories or products (i.e. managed funds, direct equities, etc.), are treated
equally under this scheme. Salaried advisers are only eligible to participate
in the bonus scheme if they have met certain requirements within a particular
period (including feedback from customers and meeting compliance requirements).
There are no sales targets relating to particular products, Westpac Group
products or asset classes.
We take our responsibilities seriously in supporting quality
advice to customers. We require planners and management to comply with the law
as well as applicable regulations and company policies. In particular, we
require our planners to comply with best interest obligations and consequences
of failing to comply are serious and can include withholding or cancelling a
planner’s bonus, performance management and, potentially, termination. We carry
out regular auditing of planners. We also assess and review our obligations,
key controls, including our monitoring system, at least annually.
Does BT Financial Group take
any responsibility for managing the conflict of interest that may exist for its
financial advisers between the 'best interest' duty to their clients and a
perceived or real need for the financial advisers to promote the financial
products of the Group within which they work?
We accept that conflicts of
interest may arise from time to time in the normal course of business. However,
we are confident that we have appropriate processes and protocols in place for
managing any such conflicts.
Specifically, we take our responsibility for both the
construction of the Approved Product List (APL) and providing an appropriate
framework for meeting best interests requirements extremely seriously.
Our Advice business’ internal research team follows robust
processes and established protocols to create APLs to ensure customers gain
access to quality products. These protocols include an ongoing benchmarking
process to compare products against peers in the market to determine their
suitability for inclusion on the list. Members of the research team are not
incentivised to recommend that any particular product or asset class be placed
on an APL. These research criteria, including the benchmarking process, is
applied consistently to all products whether internally or externally sourced.
All decisions on APLs are made independent of product issuers, and the
decision-making process has appropriate controls and oversight.
Planners are ultimately responsible for determining what
products are appropriate for their customers’ circumstances. We support our
planners in order to meet this obligation, and have trained the planners to
understand our process to establish the APL and their responsibilities to
ensure they have separately considered any product they are considering
recommending in light of the customers’ needs and objectives.
Through our internal research team, clear guidance is
provided to support our planners on what products may or may not be appropriate
for particular needs and circumstances. We do not impose product sales targets
on any of our financial advisers.
Planners are required to place customers interests first and
in priority to their own or those of the organisation. We will continue to
embed the FOFA driven changes through continued training, support, monitoring
Any failure to demonstrate compliance with the best
interests obligations will result in significant consequences under our
policies, which can include withholding or cancelling a planner’s bonus,
performance management and, potentially termination. In addition, planners may
be subject to additional controls including increased monitoring and
supervision, mandated para-planning and vetting.
If BT Financial Group does not rely solely on the financial
adviser complying with the new FOFA reforms, what protocols does BT Financial
Group have in place to avoid or manage this conflict should it arise?
We provide support in order to assist the planner in meeting
these obligations, including through robust processes in order to set the APLs
and other policies, training and monitoring activities. The planner is
ultimately responsible for complying with the new best interests FOFA reforms
as discussed above.
We have a number of protocols in place. These include:
- conduct and behavioural standards incorporated into employment
contracts, and performance and reward schemes;
- strong and well-established risk and governance framework;
- well-developed, robust and regular assessment of licensee and
general obligations and the control effectiveness in ensuring compliance;
- a strong risk culture predicated on the three lines of defence
strategy independently assessed as effective with a high degree of management
- embedded compliance objectives in management Job Descriptions and
‘Scorecards’ with defined measures;
- a range of practical controls to ensure the right planners are
recruited, planners are adequately trained and accredited (beyond current
industry requirements), supervised and monitored. This is further supported by
a range of policies and consequences framework where standards are not adhered
- a range of tools, systems and reports that support planners, and
management in managing against new, and existing obligations in the provision
Does BT Financial Group have
an internal research house function? If so, can you comment on the cost of high
quality qualitative research from research houses relative to the cost of BT
Financial Group conducting the same quality of research in-house?
BT Financial Group is supported by two key in-house research
teams, focusing on Advice and Fund Manager Governance.
The Advice in-house research team is responsible for the
review of investments to formulate an Approved Products List which provides
guidance to financial planners when providing advice to customers.
The team undertakes a formal research process to identify
best of breed investment opportunities across all asset classes and product
types. Investments are reviewed and monitored on a regular basis. We note that
the in-house research team is required to assess internally and externally
sourced products in the same way in its research assessment.
The Advice in-house research teams have access to external
research resources including Zenith Investment Partners, Chant West, JP Morgan,
Bloomberg and Morningstar as inputs into the research process.
For the Advice business, external research is also used to
supplement broader investment choice for our external adviser networks.
(b) Fund Manager Governance
The Fund Manager Governance
in-house research team is responsible for monitoring and oversight of all
investments across our platform, superannuation and investment businesses.
The team provides analysis and recommendations in relation
to selecting investment options and appointing fund managers, as well as
oversight and monitoring of investment options, for the platforms,
superannuation and investment businesses.
As well as undertaking its own due diligence on investment
managers, the team has access to external research resources including Lonsec,
Zenith Investment Partners, Chant West, van Eyk and Morningstar as inputs into
the research process.
One of the key functions of both in-house research teams is
to support the delivery of quality outcomes to clients. We believe an in-house
research function allows greater support that is tailored to the needs of our
financial planning network and allows better oversight of the quality of the
Is BT Financial Group a dual regulated entity offering both
Responsible Entity and Registrable Superannuation Entity services? Are there
advantages in being licensed to act as a Responsible Entity and as a Registered
Superannuation Trustee, and if so, what are they?
BT Financial Group is a holding company and is not a
regulated entity. However, there are some entities within its group that are
dual regulated entities operating as a Responsible Entity (RE) of a number of
managed investment schemes and as a Registrable Superannuation Entity (RSE)
licensee, as trustee of a number of public offer superannuation funds.
An RE and RSE licensee are both trustees with statutory and
fiduciary duties to hold and invest assets for the benefit of beneficiaries.
While there are some differences between the duties of an RE and RSE, they are
not as significant as their similarities. The Stronger Super reforms that have
amended the duties of RSE licensees and their directors are very closely
modelled on those that apply to REs.
By combining the roles of RE and RSE licensee in a single
company and Board, the beneficiaries of the company’s managed investment
schemes and superannuation funds benefit from:
- the specialist expertise of trustee directors appointed for their
relevant knowledge and skills;
- risk management and conflicts management systems directed to the
roles and duties of trustees; and
- specialist advisers including in-house counsel, who specialise in
Given that a compliance plan auditor is only required to
ascertain the compliance of a Responsible Entity with its compliance plan,
could you clarify for the committee who is actually responsible for ensuring
that a Responsible Entity adheres to the constitution of the Responsible
Entity's managed investment scheme?
The compliance plan of a
registered scheme must set out adequate measures that the responsible entity is
to apply in operating the scheme to ensure compliance with the Corporations Act
and the scheme's constitution.
The Board of a Responsible Entity is responsible for
ensuring that the scheme’s constitution is complied with. BT Financial Group’s
compliance and governance framework is designed to assist the Boards of each
company that acts as an RE to oversee the company’s compliance with all of its
legal obligations, including complying with the terms of a scheme’s
A paper just published in the Journal of Economic
Perspectives by veteran American economist, Burton G. Malkiel,
indicates that over the last 30 years, passively-held index funds have
substantially out-performed the average active fund manager. He also observes
that the amount of under-performance is well approximated by the difference in
the fees charged by the two types of funds. Mr Malkiel acknowledges that some
active management is required for market efficiency because it ensures that
information is properly reflected in securities prices. However, he found that
'the number of active managers and the costs they impose far exceed what is
required to make our stock markets reasonably efficient.
(a) Can you comment on the rationale for the higher fees for asset
management charged by fund managers when the evidence gathered by Malkiel for
the last three decades indicates that a passive investment would have brought
greater returns for the investor?
What is ‘active management’?
Active portfolio management is the process of applying
research and skill in order to deliver superior results over an index based
passive exposure. Investment managers that apply an active strategy will tend
to charge a higher fee than passively managed strategies but the true measure
of success is the return generated for clients after taking into account the
Active management can be considered at the asset allocation
level as well as at the sector level. Setting strategic asset allocations for
an extended period and having strategies passively rebalance does not take into
account the ever changing nature of markets and investor behaviour. Active
management at this level is synonymous to risk management and is imperative to
maximising the probability of meeting return objectives for investors over the
medium and longer term.
At a sector level, in many markets, the degree of overall
alpha (excess return above a benchmark) available to all managers and investors
will tend toward zero over time. But there will always be winners and losers
and the success of a variety of strategies will vary greatly according to the
market environment, risk appetite and return drivers over the period being
measured. In Australian equities over the last 10 years, 1st quartile managers
have delivered more than 1.2% above the index after taking fees into account
(Mercers data to end May 2013).
Active management can increase returns
It is our view that an active approach can enhance risk
adjusted returns. Alpha opportunities exist as markets are not always
efficient, and this provides the potential for pricing anomalies which can be
exploited. Skilful managers can extract alpha even after their costs are
deducted. Some managers have unique insight and can exploit opportunities in
different market conditions. Our approach identifies these managers and invests
with them, employing a disciplined and repeatable process through qualitative
manager research. We also change managers to suit the forecast market
An active approach can support a higher return objective for
long term investors than a passive approach would allow. Their investments can
be evaluated against an absolute return target, expressed as a return of a
certain level over inflation (or 'CPI+'). Over time, a passive strategy will
require a higher degree of market risk for longer in order to achieve the same
result as a well-managed active strategy.
Economies go through cycles that favour different investment
approaches at different times. Active management allows the risks associated
with these cycles to be mitigated while the opportunities presented by these
cycles can be exploited. Different investing styles (such as 'value' or
'growth' investing within equities) add value at different times and an active
strategy can tilt a portfolio in favour of an outperforming style. A passive
approach does not allow for this.
Active management can mitigate risks
In a GFC-like event, a passive approach will not engage in
downside risk management which can lead to a higher degree of capital erosion.
In fact, passive strategies that follow an index will tend to invest in the
companies that go bankrupt and in the bonds that will default.
Past performance over the last 10 or 30 years is not
necessarily indicative of future trends and outcomes. There is no guarantee
that the investing environment is the same, and indeed there are indications
that we may currently be going into a different environment. Passive investing
cannot provide the downside risk management that is only possible with active
Investments need to be managed through the cycle and this
can be achieved using active asset allocation. This involves tilting a
portfolio by holding more in asset classes likely to outperform and holding
less in asset classes likely to underperform. Our process reflects our
long-term views on asset classes in our Strategic Asset Allocation (SAA). Risks
to this view from volatility and turbulence are then mitigated through our
medium-term Dynamic Asset Allocation (DAA) and our short-term Tactical Asset
Passive management has its own issues
There are problems with passive management and viewing this approach
as a 'base case' or starting position for investment is flawed. Most benchmarks
that are tracked in a passive strategy are weighted by market capitalisation.
This means that more of the portfolio is held in securities that are worth
more, while less of the portfolio is held in securities that are worth less.
This is somewhat arbitrary and is not necessarily an appropriate basis for
structuring a portfolio.
The main issue with using market capitalisation as the only
source of information is that as a price of a security relative to others increases,
the passive approach will invest more in that stock. This effectively embeds a
momentum process into the stock selection, emphasising past winners in the
portfolio and ignoring value opportunities. It equates to buying stocks after
they have become more expensive and selling them after they have become
Modern portfolio theory suggests that once targeted returns
are reached, gains should be crystallised through the sale of outperforming
assets. This is not possible with a passive approach, where in fact the
opposite occurs. When tracking a market capitalisation-weighted index,
investors are forced to hold more of stocks that have increased in value and
less of stocks that have decreased in value.
It is also our view that market capitalisation is not the
only relevant measure of the future return generating capacity of a stock. A
passive process assumes stock prices are always a reflection of true value. It
ignores diversification across sectors and size and can lead to undiversified
portfolios of assets. Additionally, the composition of indices changes over
time. This introduces risks to the portfolio that could otherwise be addressed
through active management.
Finally, a passive approach cannot consider the outcomes
required by the investor. For example, in the S&P/ASX 200, there is
presently a large overweight tilt to bank stocks. A passive investor will
therefore have a corresponding large overweight allocation to this sector. This
is a risk that passive investing cannot address.
Case study – Standish Mellon International Fixed Interest
We have invested in Standish Mellon’s International Fixed
Interest strategy since October 2005, providing almost 10 years of data and
offering an observable outcome of active management over a passive benchmark.
Since inception to May 2013, the Standish mandate has returned 10.24% net
(after fees) annualised while the Barclays Global Aggregate (Hedged to AUD) has
returned 7.69%. The active approach has outperformed by 2.55% annualised over
this period. This outperformance is significant and justifies taking an active
During this time, the bond market has gone through
significant shifts, and by employing an active approach Standish has been able
to accommodate these shifts, mitigate the risks and add alpha to the fund. A
passive approach through this environment has not been able to deliver the same
Investment theory and technical considerations
A passive investment strategy seeks only to earn the
benchmark or market return, known as beta. An active investment strategy
receives the same beta, plus the excess return of the manager, known as alpha.
By definition, alpha is uncorrelated to beta. This means that the
outperformance or underperformance of a manager does not depend on whether the
overall market is going up or down. This makes alpha a valuable and efficient
source of return.
By examining risk-adjusted returns using an Information
Ratio, it can be demonstrated that an active approach can deliver higher
returns per unit of risk than a passive approach. Looking at a Sortino ratio
can show similar information and additionally identify the downside protection
offered by a strategy.
'The Fundamental Law of Active Management', developed by
Grinold and Kahn, states that a manager’s information ratio is a function of
the information coefficient and the breadth of investments. This means that the
risk-adjusted returns that a manager delivers above a benchmark can be
explained by the manager’s level of skill and the number of investment
decisions it makes. In other words, to achieve a good result, an active manager
needs to be good at picking stocks and also ensure the portfolio is
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