<< Return to previous page | Parliamentary Joint Committee on Corporations and Financial Services

MANAGED INVESTMENTS BILL 1997
TABLE OF CONTENTS

MINORITY REPORT

Senator Andrew Murray

Australian Democrats

March 1998

1. INTRODUCTION

The Majority Report states that Approximately $85 billion is invested in managed investment schemes at present and the amount continues to grow by around $20 billion a year. By any measure that represents very large sums of money indeed, and exponential growth. Because of the financial scale affected, it is obvious therefore that the Managed Investments Bill 1997 (MIB) will touch the lives of all Australians in its impact, and not only the lives of millions of direct and indirect investors. It is legislation which must be examined with the utmost care, since it materially affects the capital needs, wealth preservation and wealth creation of Australia.

The Bill has had a long gestation period, and much has been written on the proposed new Single Responsible Entity (SRE) system. The legislative process was started by the Labor government as the Collective Investments Bill and has been adopted, with significant changes, by the Coalition as MIB. Managed investments have been the subject of recommendations from the Law Reform Commission and the Companies and Securities Advisory Committee via the 1993 report Collective Investments : Other Peoples Money (ALRC 65) and more recently from the 1997 report of the Financial System inquiry. Undoubtedly there is momentum for reform.

Nevertheless it is still an issue which polarises the main protagonists. The passions generated by so much money were apparent in the shower of documentation received, and by 54 submissions made despite the short notice of the inquiry.

The Majority Report at para 1.14 comments on the effect of time constraints on the quality of the Report. Without in any way criticising the Secretariat to the Committee, who have been put under great pressure by the timelines adopted for the inquiry, it does neither the Senate justice, nor the huge finances at stake justice, for the Secretariat and the Committee to be obliged to bring down a Report which consequently fails to adequately summarise and canvass all the issues raised, and to fail to do so in sufficient detail.

2. HAS A CASE BEEN MADE FOR CHANGING TO MIB?

2.1 Financial

Managed investment schemes are currently required to have both a manager and trustee. It is a prudential system, designed with checks and balances to minimise loss. This system has served Australia for decades. Trustees have been mandatory in the system since 1955 in Victoria, and 1961 for the Commonwealth.

How well does the present system operate? To repeat the Majority Report again, `$85 billion invested in managed investment schemes, and growing by $20 billion a year', would seem exceptionally successful. Returns to investors do not seem to be lower than acceptable levels.

On financial grounds, in the evidence before the Committee, the case has not been made that the present system fails Australia.

2.2 Investment losses and investor protection

Have there been `investment disasters'? Do a lot of people lose money under this system?

No system can be perfect or foolproof. It is true that over the decades there have been failures, the most notable of recent times being the Aust-Wide and Estate Mortgage funds collapse. Even in hearings held in camera little else emerged to be alarmed at. It is not an industry subject to unusual levels of fraud. In fact it appears on the whole to be well managed, protected, and self regulated, with the Australian Securities Commission (ASC) as regulator as a competent back-up to trustee or fund manager inadequacies.

A number of witnesses feared that MIB may not provide the same level of security as the present trustee system. Indeed the Trustee witnesses made the case that trustees had acted in the case of fund failures to recover more funds for investors than would be feasible under the proposed Bill.

Trustee witnesses to the Committee were of the view that the Bill would put investors at greater risk than before, since the system was changing from a tripartite one (Trustee-Fund Manager-Regulator) to a bipartite one (Fund Manager-Regulator). Fund Managers were either equivocal, or believed the new system would improve investor protection. The regulator, the ASC, could not be definite on the matter. The Australian Consumers Association (ACA), who have 200 000 members and subscribers, were unequivocal

Senator Murray So you think the view put to us by a section of the witnesses, that investors will be less protected, is wrong?

Ms Bun We do. [1]

Unfortunately, the ACA's opinion, while obviously well informed, was not in this instance based on consultation with its members or subscribers, particularly those who are also investors. [2]

It will be little comfort to those who are cautious of the full scale of these changes, if there is a significant weakening in investor security, and greater losses and risk as a result.

In a chilling prediction, Victorian Attorney General Jan Wade wrote in her submission [3]

There can be no doubt that under the proposed regime there will be greater likelihood of loss to investors and less likelihood that they will recover their losses.

The ASC does not replace trustees. It remains a regulator, and one which will always be limited by resources. It cannot be sued by disappointed investors. Instead of both fund managers and trustees capable of being sued by investors, only fund managers will remain. Liability now rests with one party only, not two. Whichever way you look at it, that is a lessening of investor ability to recover their money in the event of failure, negligence, or fraud.

In my view the case was not made, that present two party responsibility results in blame-shifting and confused responsibility. The pluses of wider responsibility (two deep pockets) and greater checks and balances anyway outweigh such criticism.

2.3 Costs

There are assertions that the MIB will result in increased costs, [4] and assertions that costs will fall. [5] The assertion that costs would be lower under the new system is advanced by the Investment and Financial Services Association (IFSA), which estimates an efficiency dividend annually of about $30 million for the entire industry. [6]

If there are cost savings there is no certainty that they will be passed on. [7]

KPMG, for the Trustee Corporations Association of Australia (TCA), estimated the transitional costs consequent to the new bill, to be between $56 and $66 million.

It is possible that costs could fall for the very big funds, under the MIB. For smaller funds costs will undoubtedly rise. [8] In that respect this is a measure prejudiced against the small business operator in this industry. The experienced business journalist Trevor Sykes had this to say

So MIB discriminates against small fund managers in two ways. First, it will lower costs of big fund managers and increase it for small ones. Second, in the absence of trustees, overseas investors will go for security by placing their funds with AMP and BT.

2.4 Competition

The witnessed advised that Australia has 22 statutory trustee companies, and that there are an estimated 500 scheme managers operating some 2000 schemes in Australia.

It is expected that MIB will result in market rationalisation. IFSA, described by Chanticleer (AFR 19 March 1998) as representing the big fund managers, believes that there will be fewer schemes, fewer trusts, fewer managers. [9] This certainly means less competitors. Given the apparent diversity of the industry at present, rationalisation does not yet represent the danger of an unacceptable level of oligopolisation. Nevertheless that danger, so real in much of Australian business life, may well become greater under MIB.

Rationalisation does not necessarily mean better competition.

The economist Dr Dwyer is of the opinion that the MIB runs the risk of forcing prudent Australian investors to invest offshore in better protected funds, in the better regulated markets. [10] This would advantage foreign competitors.

Senator Murray does this bill therefore advantage foreign countries and foreign companies at the expense of Australian investors, Australian companies, and Australian interests?

Dr Dwyer I think the answer is ultimately yes. We are putting ourselves in an inferior marketing position, if you want to look at it that way. [11]

Will the Bill significantly affect the ability of Australian funds to market their products overseas? Under the existing law we have no access to American markets, but US funds do have access to our markets. [12] As a large capital importer, our government obviously believes that it has to put up with this lack of reciprocity, (which lack also extends to other industries, such as agriculture and manufacturing).

The ASC presently approves schemes from Hong Kong, the UK, the USA, New Zealand, Guernsey, Jersey, and the Isle of Man, to operate in Australia. Australian schemes are known by the ASC to operate in New Zealand, but access to other countries (if any) would be negotiated directly between the fund and the foreign regulator. The ASC says it

does not expect that the passage of the Managed Investments Bill will alter the existing or potential access of Australian funds to foreign jurisdictions, or the access of foreign funds to Australia. [13]

Will the Bill significantly affect the willingness of foreigners to invest in Australian funds? Will they see investor protection reduced by the MIB?

With regard to international competitiveness, Dr Dwyer is of the opinion that we are on dangerous ground with the MIB

Here we are in Australia signing treaties, such as the World Trade Organisation, committing ourselves to free trade and financial services, while potentially implementing a regulatory regime that the Americans will be extremely fast to point out is substandard and below theirs.....once you suffer from a lack of confidence in your regulatory arrangements, then you are in trouble. [14]

2.5 Choice

The case for greater choice was undoubtedly made. It seems obvious that informed self sufficient innovative risk-takers should be able to opt for alternative products.

MIB does not, however, deliver choice. It is ironic that a Coalition government which makes much of the philosophy of choice, wishes to move from one mandatory trustee single-choice system to another mandatory SRE single-choice system.

Both the present mandatory system, and the MIB mandatory system, can be rightly criticised for interfering with the freedom of investors collectively to determine their own prudential requirements. All countries regulate securities. That is regarded as the price one pays for having secure investment systems which enjoy international and domestic approval. But limiting freedom should not mean no freedom or choice at all. And it should certainly not mean no consultation with investors, who surely have the right to make a choice.

3. A BIGGER PLACE FOR TRUSTEES IN MIB

In its pursuit of SRE's the government directly contradicts international practice. [15] The SRE is believed by some to be inconsistent with principles 2.1 and 2.3 of the International Organisation of Securities Commissions (IOSCO) for the regulation of liquid collective investments. The ASC on the other hand, believes that the Bill complies with IOSCO's intentions. [16] Out of 42 countries surveyed by KPMG in 1995, only two - the British Virgin Islands and the Netherlands Antilles - operated without the combination of Manager and Trustee/Custodian. [17] Australia clearly intends to go out on its own on this one.

To run against international opinion is not necessarily always wrong, but one would have to be absolutely sure that you were not in the process putting Australians' money at greater risk. The evidence before the Committee does not, in our opinion, give that comfort.

In an article in the AFR [18] Simon Hoyle reported international ratings agency Standard & Poor as raising concerns that the MIB would severely undermine the security of investors money. The article reported S&P as advocating in an SRE system at the very least the presence of an independent custodian to hold the funds assets separately. An independent custodian was a feature of Labor's proposed bill, and was one of the key provisions excised by the Coalition.

The Australian Democrats believe that in the event of a Trustee not being part of a scheme, the MIB should require an independent custodian, unless exempted by the ASC. The ASC would have the two years provided by the transitional period, to make exemption determinations.

SRE's are already a feature of Australian financial life - through banks, life insurance companies, and superannuation funds for instance, although each has different fiduciary and regulatory constraints. The Government has determined that all future new collective management investment schemes will be SRE's. The Australian Democrats do not propose to oppose that intention, although as is evident, we are fearful that it may expose some classes of investor to significantly greater risk.

The Government has also determined that all existing investment schemes will be SRE's, subject to a transitional period of two years. The Australian Democrats oppose that intention, unless the investors in those funds themselves want to change. We believe that investors in existing schemes should have a say in whether they move to an SRE environment or not.

There are also fund managers who oppose SRE's, as in the submission from Fidelity Investments (a USA subsidiary), who find Australian trustees a cheaper and better option than having to go `in-house' with all the consequent compliance and custodial duties. A number of smaller and medium sized Australian fund managers hold the same view, and presented evidence at the hearings. Indeed this MIB is characterised by its opponents as being designed for, and strongly favouring, `the big end of town.'

The Australian Democrats believe that the existing system can and should run parallel to the SRE system, if investors in existing funds wish that it do so. This means that in existing funds, where investors so choose, the requirement for a trustee should continue.

The Bill provides for a two year transitional period for existing schemes. The transitional arrangements allow either the existing management company or the trustee to become the responsible entity. The Government intends investors will move from one mandatory scheme to another mandatory scheme.

There is an amazing presumption here - that the Government can simply alter the security enjoyed by an investor without consulting them. It has not been established that the investors in each existing scheme want to change. Investors were largely unrepresented at the inquiry, and small investors in particular, were not represented.

The MIB permits the ASC to appoint a custodian, or the fund manager may voluntarily appoint one. There is however no provision for investors to make the appointment.

There will undoubtedly be investors who prefer the MIB proposal. There will also undoubtedly be investors who are more comfortable with the existing system. In a democracy, both should have a choice.

The Australian Democrats recommend that within the two year transitional period fund managers and trustees must separately devise the `for' and `against' cases for their particular scheme, have their case approved in a form acceptable to the ASC, and put it to the vote of investors in that fund. A simple majority should determine the outcome.

If, as the proponents of MIB argue, the case for SRE's are so overwhelming, then investors will surely plump for them. Especially when majors such as the AMP, Bankers Trust, Lend Lease, or Macquarie should be able to show investors that their capital, legal, and accounting resources may make it possible for them to do without a trustee.

Not giving investors a choice implies a fear by the proponents that investors may in fact disagree.

If they do, that is their right. It is after all, their money.

Trustees are independent from the managers of the funds, are presently licensed by the ASC and are paid from trust assets. They are in a fiduciary relationship with members of the fund scheme. They hold the legal title to trust assets as custodian, monitor compliance with the managers obligations under the trust deed, and take enforcement action on behalf of fund members where the manager is in breach of the trust deed.

If we are to return trustees to having a significant role under the MIB, then that role needs to be spelt out.

4. THE SINGLE RESPONSIBLE ENTITY

The MIB includes a number of measures to protect investors. Let us look at auditors, the compliance plan, and directors.

A registered company auditor must be engaged to audit compliance with the compliance plan. This is a sound and desirable practice. It is not one which guarantees independence however.

Auditors are recommended to shareholders by the Board, which may in turn have had them recommended by management.

Frequently the auditor is a related entity to other accounting and consulting services that contract to the company. This is a fundamentally flawed process, raising conflict of interest and independence problems.

Compliance plans are undoubtedly a good idea, but once again, we should be aware of the downside. The TCA had this to say

Because breach of the compliance plan will incur civil penalties under this Bill, responsible entities and their directors will have a strong incentive to make the plan a minimalist document. The ASC is saying so too. We say that compliance plans, as specified under the Bill, may well provide no effective protection for investors at all. [19]

The responsible entity will be required to have either a board of directors of whom at least half are external directors, or a compliance committee with at least half of its membership being independent. Once again, this is a sound and desirable practice. Despite the safeguards provided by proposed new section 601JA, independence is again not guaranteed. If the SRE selects, nominates, appoints or dismisses `independent' directors, they are not truly independent. If the SRE determines their remuneration, then they are not truly independent. Directors can only be truly independent if selected, nominated, appointed, dismissed or remunerated by a third party, operating at arms length, or by the investors themselves.

`Independent' directors are often anything but. If not recommended in the first place by the other directors in the `control group' they are supposed to be independent of, they can be subject to Board `capture' anyway, unless, as is fortunately sometimes the case, they are exceptional individuals.

Victorian Attorney General Jan Wade [20] confirmed this point

It seems naive to assert that these directors/compliance committee members will be able to resist powerful pressures such as peer pressure and institutional loyalty during their term of office.

SRE's do not have a solvency test, and rarely have a capital adequacy requirement beyond the $5 million required under SIS. [21] This is a serious problem. The TCA provided a schedule [22] with the equity of fund managers averaging a low $19.11 million, which as a percentage of funds under management, is a minuscule 0.45%. Banks by contrast have a minimum capital requirement of 8% of total deposits.

Reserve Bank rules prohibit banks from guaranteeing the performance or liabilities of a fund. Many of these funds have banks as parents or related entities. Insurance companies usually do not guarantee their funds.

It is obvious that capital adequacy rules must be introduced, to ensure that investors are adequately protected.

Without the added safeguards provided by a trustee, or in a more limited fashion by a custodian, a greater onus falls on the SRE, the fund manager. There is a maxim that `the higher the risk, the higher the return.' Undoubtedly different classes of investors have different needs - some are innovative risk-takers. Others are least-risk, much more cautious and safety conscious, others simply want a guaranteed return.

The difficulty is finding a way to `rate' the different investment products promoted by funds. There is no grading system, no Moody's system, available. At present the mandatory trustee role ensures certain safeguards, so that those uninformed investors have some protection. Under the SRE system, investors will still not necessarily be aware that some funds will be higher risk than others. Even strong proponents for the MIB, such as Bankers Trust adviser Mr Tony Hartnell, [23] recognise this as a problem

The weighting of the features that any fund may have, as against another fund, would be very difficult to put into some objective rating system.

The ASC does have the power to appoint a custodian, and would be well advised to do so where a particular fund is suspect in some way, or where a particular class of investors may need the extra protection that a custodian could bring. Either way, this power given to the ASC will require them to develop an appropriate rating system.

5. OTHER ISSUES

Legislation which generates such controversy and fears, and which potentially has such significant impact, will need reviewing after a time. Mr Rofe of the Australian Shareholder's Association (ASA) suggested that if a review was to be conducted, that it should not be earlier than five years. [24]

Amongst others, the TCA, IFSA, and ASA all recommended various substantive amendments to the Bill. These will be further considered by the Australian Democrats on their merits.

Senator Andrew Murray

March 1998

Footnotes

[1] Hansard 24 March 1998 CS 122

[2] Hansard 24 March 1998 CS 119-122

[3] Attorney General Of Victoria Submission No 49 p. 2

[4] Trustee Corporations Association of Australia Submission No 23 p. 3

[5] Investment and Financial Services Association Ltd Submission No 30 p. 12

[6] IFSA media release 8 March 1998

[7] Hansard 24 March 1998 CS 121-122

[8] March article by Trevor Sykes in the AFR Don't kill trustees, make them optional

[9] Hansard 12 March 1998 CS 50

[10] Dr Terry Dwyer Hansard 12 March 1998 CS 35

[11] Ibid

[12] Hansard 12 March 1998 CS 68-69

[13] ASC letter to the Committee 24 March 1998

[14] Hansard 12 March 1998 CS 29-30

[15] Arthur Robinson and Hedderwick Managed Investments Bill 1997 Analysis and Comments Melbourne 1998

[16] Hansard 12 March 1998 CS 63-64

[17] Trustee Corporations of Australia Supplementary Submission p. 20

[18] AFR 12 February 1998 Simon Hoyle Rethink managed funds revamp, says S&P p. 27

[19] Trustee Corporations Association of Australia Supplementary Submission p. 9

[20] Submission No 49 p. 1

[21] TCA Supplementary Submission p. 16

[22] Letter to the Committee 27 March 1998

[23] Hansard 24 March 1998 CS 138-139

[24] Hansard 12 March 1998 CS 87

Website feedback: web.senate@aph.gov.au
Last reviewed 23 April 2003 by the Senate Web Administrator
© Commonwealth of Australia
Parliament of Australia Web Site Privacy Statement
Images courtesy of AUSPIC