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1.1 Managed investment schemes are schemes where an investor purchases
an interest in a fund which is managed by a professional manager to produce
a return for the investor. They encompass a wide range of investment products
and services including property, equities and cash management trusts as
well as smaller schemes such as ostrich farms and pine plantations. Approximately
$85 billion is invested in managed investment schemes at present and the
amount continues to grow by around $20 billion a year.
1.2 These schemes allow investors to diversify their investments over
a wider range of investment types than might otherwise be available and
allow them to have their funds professionally managed.
1.3 The Bill is not concerned with superannuation funds which are dealt
with under the Superannuation Industry (Supervision) Act 1993.
1.4 The Law currently requires a managed investment scheme to have both
a manager and a trustee. The manager is responsible for the day-to-day
operations and investment strategy of the scheme. The trustee is responsible
for distributing scheme income and ensuring that investments conform with
the trust deed. A trustee owes fiduciary obligations to scheme members
to supervise the management company on behalf of, and in the best interests
of, members.
1.5 During the late 1980's and early 1990's a number of events occurred
which made it apparent that the Law in respect of managed investment schemes
needed to be reviewed. In May 1991, the Law Reform Commission and the
Companies and Securities Advisory Committee were asked to examine and
report on the most efficient and effective legal framework for regulating
managed investment schemes. In 1993, those organisations tabled a report
entitled Collective Investments: Other Peoples Money (ALRC 65). The Report
was critical of the existing structure and recommended reform. The Review's
fundamental recommendation was that, for each scheme, there be a single
responsible entity in which the current responsibilities of both the trustees
and management company are combined and vested.
1.6 More recently the need for reform has been supported by the final
report of the Financial System Inquiry released on 9 April 1997. That
report recommended that:
The regulatory framework for public offer collective investments and
superannuation should be harmonised to the greatest possible extent
by:
making both types of products subject to a single consumer protection
regime (including disclosure rules) administered by the CFSC; and
bringing the structure of collective investments into line with that
for superannuation funds, by introducing a requirement for a single
responsible entity.
1.7 The Bill creates a new system for managing collective investment
schemes under which the requirement for a trustee is removed and each
scheme has a single responsible entity. The liability for any loss of
investors' funds through negligence or illegal activity will rest entirely
with that single responsible entity.
1.8 The Bill also imposes a range of measures aimed at protecting investors:
- Any member of the scheme who suffers loss or damage because of a breach
of its duties by the single responsible entity will have a right of
civil action against the responsible entity.
- The responsible entity will have a statutory duty to ensure that scheme
property is clearly identified and that scheme property is held separately
from the property of the responsible entity or of any other scheme.
- The scheme must be audited.
- Each scheme must have a compliance plan setting out the measures which
the responsible entity will apply in operating the scheme to ensure
compliance with the Law and the scheme's constitution and setting out
arrangements for ensuring that scheme property is identifiable and kept
separate from other property.
- A registered company auditor must be engaged to audit compliance with
the compliance plan.
- If the ASC believes that the compliance plan does not make adequate
provision for ensuring that the responsible entity complies with the
Law it may refuse to register the scheme.
- The ASC can issue guidelines which would require a scheme to have
specified custodial arrangements such as a separate custodian.
- The Bill also allows the ASC to declare that custodial arrangements
in relation to property of a scheme or class of schemes is to take a
particular form, such as the use of a separate custodian.
- The Bill requires that the responsible entity holds the scheme property
on trust for scheme member. The Bill thereby imposes trust-law obligations
on the responsible entity.
- All operators of a scheme will be required to hold a special licence
issued by the ASC and, in most cases, for the scheme to be registered
with the ASC.
- The responsible entity will be required to have either a board of
directors of whom at least half are independent directors, or a compliance
committee with at least half of the its membership being independent.
- The ASC will ensure a high level of compliance through its licensing,
registration and surveillance activities. The Bill also allows the ASC
to enter into legally binding undertaking with the responsible entity
of a scheme.
1.9 The Bill also provides for a 2 year transitional period for existing
schemes. The transitional arrangements allow either the existing management
company or the trustee to become the responsible entity.
1.10 During the course of its inquiry the Committee received submissions
from 54 parties and took evidence at two public hearings. List of the
submissions received and the witnesses who appeared before the Committee
are attached at Appendices I and II.
1.11 The evidence presented was often contradictory. The argument about
the merits, or otherwise, of the policy underlying the Bill was carried
on with considerable vigour. Unfortunately, the heated nature of the debate
did not always generate a similar amount of light.
1.12 Most of the submissions and witnesses before the Committee fell
into two groups. Those from the trustee industry were fundamentally opposed
to the scheme outlined in the Bill, while those from the fund management
industry generally supported the scheme. Both of these groups will be
affected financially by the changes proposed in the Bill. These two groups
frequently presented the Committee with diametrically opposed evidence.
1.13 The more impartial witnesses were generally supportive of the Bill.
Unfortunately little was heard directly from the people most effected
by the Bill, the small investors who put their savings in managed funds,
although organisations representing them gave evidence supporting the
Bill.
1.14 Because of the time constraints faced by the Committee, it has not
been possible to canvas in this Report all of the issues raised during
the Committee's inquiry. Some issues which were the subject of submissions
and discussion during the inquiry are, therefore, not discussed, or dealt
with only briefly, in this Report. Readers of the Report who are seeking
further information about the evidence presented to the Committee are
referred to the submissions and Hansards of the Committee's hearings.
1.15 In both submissions to the Committee and during public hearings,
concerns were expressed that removing the role of the trustee would considerably
reduce the level of protection for investors. Examples were given to the
Committee of occasions when an independent trustee had acted to enforce
compliance with the trust deed, to protect investors from unwise decisions
by fund managers and to recover losses which arose from the negligence
of previous trustees and fund managers.
1.16 Set against these benefits is the evidence of the failure of the
current arrangements in a number of cases, particularly the Aust-Wide
and Estate Mortgage funds. In general, there appear to be considerable
problems in clearly identifying the responsibilities of the two parties.
These problems were discussed in evidence to the Committee and the extent
of the problem, if any, was contested by some witnesses representing the
Trustees Association. In his submission to the Committee, Mr Ian Warner
outlined the problem in these terms:
In unit trusts the responsibility to the unit holders is divided between
the trustees and the management company but the dividing line is imprecise.
This imprecise dividing line has been handled in practice with give
and take and compromise between the trustee and the manager. The procedure
works effectively when the trust is running relatively smoothly but
causes great difficulty when the trustee and manager are precipitated
into determining just what is the dividing line when the trust runs
into financial difficulty, due to the influence of market conditions
such as a downturn in the property or equity markets, which in turn
exposes underlying shortcomings in either or both the trustee and the
manager. [1]
1.17 Mr Warner's preferred approach to these problems is to more accurately
delineate the dividing line between the duties of the two parties. The
Collective Investments Report also considered this problem but rejected
the idea of simply redefining the roles of the two parties.
The dual responsibility structure has led to confusion about what protection
is afforded to investors and may well be misleading as it does not emphasise
that the management company not only has responsibility for the management
of the commercial aspects of the scheme but for ensuring that its activities
comply with the law and the scheme's deed. The very fact of split responsibility
is a problem. [2]
Any such reworking will not overcome the inherent problems of divided
powers and responsibilities in a dual system, and the inevitable legal
complexity and uncertainty that this creates. [3]
1.18 The Committee was not persuaded that findings of the Report were
flawed or that there has been any significant change on this issue since
that Report was completed.
1.19 The evidence given to the Committee suggests that although some
investors may prefer the current two party structure, there is strong
support for clarifying the responsibility for the scheme by introducing
a single responsibility entity. The Committee noted that a range of investment
structures, including trustee common funds, already operate within a single
party structure.
1.20 As briefly outlined earlier, the new scheme involves a range of
measures which are aimed at providing a comprehensive scheme of protection.
In evidence to the Committee Mr Alan Cameron, Chairman of the Australian
Securities Commission, emphasised the integrated and flexible approach
that the Bill takes to regulating this industry. He said that the Bill
did not simply replace the trustee with supervision by the ASC:
what this Bill provides is an integrated approach to regulation,
and I have sought to tease out perhaps 14 elements of this integrated
approach in order to show that it is not just the ASC replacing the
trustee. [4]
this Bill takes an outcomes based approach to all of these requirements.
It does not specify how you achieve things; it specifies what the result
is to be. This is not unusual in current legislation. We see it as a
general trend to head in that direction. We see, for example, that the
United States SEC is heading in that direction in its most recent utterances
on custody. [5]
We have to ensure that whatever regime we come up with is appropriate
to all. It will not be a single regime of course but will permit a range
of remedies to be adopted, a range of procedures to be adopted, that
will match the needs and be more appropriate to all of those types of
schemes. [6]
1.21 The measures contained in the Bill are consistent with those which
have been applied successfully to other forms of collective investments
such as superannuation. Having considered the full scope of the provisions
contained in the Bill, the Committee is satisfied that these measures
will provide a level of protection at least equivalent to the current
arrangements.
1.22 It was argued before the Committee that the Bill should mandate
the use of an external custodian to hold scheme assets. It was put to
the Committee that this would increase investor protection by ensuring
that the assets were held separately from those of the scheme operator
and would be protected from any entanglements which might occur should
the scheme operator face financial difficulties.
1.23 While there was some sympathy within the Committee for this view,
the Committee was not persuaded that the Bill would benefit from such
an amendment. In reaching this conclusion the Committee took into account:
- the conclusion of the Collective Investments Report that a bare custodian
will provide little protection against misuse of scheme property because
it will be required to deal with the property as instructed by the scheme
operator; [7]
- that the Bill does not prevent the use of a separate custodian and
evidence to the Committee suggests that many schemes will choose to
do so;
- that the Bill allows the ASC to require the use of a separate custodian
where it considers that it is desirable because of the nature of the
scheme or because of concerns about its administration;
- that such a requirement may impose unnecessary costs on some schemes;
and
- that such a requirement would be unnecessarily rigid.
1.24 Evidence was presented to the Committee on whether the costs of
managing and administrating the new arrangements would fall and whether
the benefits of that fall would be passed on to investors. In its submission
to the Committee the Trustee Corporations Association [8]
said that there would be a significant increase in ongoing costs. The
Investment and Financial Services Association [9]
presented evidence that there would be significant cost savings.
1.25 The explanatory memorandum [10] to the
Bill identifies significant savings from the abolition of the two party
structure which are expected to exceed the additional costs of operating
the new structure. The Committee considers that the figures presented
in the explanatory memorandum are most likely to reflect the eventual
outcome. While there may be some individual instances where costs may
rise under the new structure, the Committee is satisfied that in the vast
majority of cases costs will fall.
1.26 Although there is no specific requirement that any fall in costs
be passed on to investors, the Committee notes that the managed funds
industry is very competitive and the Committee considers that it is reasonable
to assume that competitive pressures will force funds to pass any saving
on to investors.
1.27 During the Committee's public hearing on 24 March, Mr Tony Hartnell
brought to the Committee's attention the importance to Australia's economic
development of the more flexible structure contained in the Bill. He forcefully
put the view to the Committee that the current arrangements do not facilitate
the involvement of collective investment schemes in innovative investments
which carry a higher risk than most of the schemes currently operating.
In particular, he identified agricultural investment schemes and intellectual
property schemes such as in the entertainment, film and computer industries.
The trustee system, in my opinion has failed. They cannot be adequate
prudential regulators. Yes, there is a role for them in the sorts of investments
where you want to make sure that the number one touchstone of the investment
is security, and safety, and order, checking the dollars and making sure
that there are no leakages and making sure the MERs are right. There is
a very major role for trustees there, I am not trying to wipe trustees
out. But to go to the extent that I heard tonight, not one major exception
in managed collective investments should there be to the rule that you
should have trustees in there, is just counterproductive to the economic
development of the country. It stands in the way of innovation. [11]
1.28 Mr Hartnell expressed strong support for the Bill overall, although
he did indicate that there were some provisions with which he did not
agree where he would allow even greater flexibility than provided in the
Bill. In view of Mr Hartnell's considerable experience in the development
of corporate law and regulation, the Committee found his comments to be
very persuasive.
1.29 Concerns were raised during the Committee's hearings about the adequacy
of the ASC's resources to undertake its responsibilities under the Bill.
The Committee considers that the provision of adequate resources to the
ASC is a key element in the success of the new regulatory arrangements.
In response to questions from Committee members, Ms Jillian Segal said
that:
Obviously the ASC has considered the additional processes that it will
be putting in place and has made the government aware of its needs and
has put in its request for funds as part of the budgetary process. I can
only say that that is still in process. We await the announcement of the
budget like all of you do. We feel that we will be able to deliver. I
can only say that if resources are inadequate we will certainly be going
back to the government and letting them know. It is an annual process
and we think that certainly in the first year there will be resources.
If they are inadequate we will not be backward in coming forward. [12]
1.30 The Explanatory Memorandum to the Bill states that the review which
will be undertaken at the end of the transitional period will asses the
effectiveness of the administrative arrangements and regulatory requirements
of the new regime, and allow the resource implications of the new regime
for the ASC to be quantified. [13] In debate in the House of Representative it was
also noted that the Parliamentary Secretary to the Treasurer has given
verbal assurances that the ASC will receive adequate funding to fulfil
its role. [14]
1.31 Despite these assurances some Committee members remain concerned
that the ASC may not have adequate resources to carry out its role. The
Committee does not consider that these concerns justify delaying the passage
of the Bill. However, as a part of its normal role of monitoring the Australian
Securities Commission, the Committee will follow up this issue when the
new arrangements are being put into place. If the Committee becomes aware
of any deficiency in the resources available to the ASC to carry out its
role, the Committee will bring the matter to the attention of the Parliament.
1.32 Concern was expressed by some members of the Committee during hearings
that the ASC has yet to release a series of policy papers stating the
approach it will adopt to the detailed regulation of managed investments.
1.33 Of specific concern were the issues of the capital adequacy provisions
the ASC would insist upon in its deliberations on whether or not to licence
and register a single responsible entity, and the circumstances in which
the ASC would insist on a single responsible entity using a separate custodian.
1.34 The Committee is of the opinion that the ASC's treatment of capital
adequacy and the use of separate custodians should be given specific attention
in the review to be conducted by the ASC and Treasury at the end of the
proposed 2 year transition period.
1.35 The Committee is conducting its inquiry into the Managed Investments
Bill 1997, which significantly alters the regulation of managed investments
in Australia, in the context of a proposed, radical change to the structure
of the ASC which has, among its responsibilities, regulation of managed
investments.
1.36 The Committee is of the opinion that the Government should take
particular caution to ensure that the combination of these substantial
changes to both the managed investments regulations and the regulator
does not weaken actual investor protection and perceived investor protection.
1.37 After carefully considering all of the evidence presented to the
Committee the Committee has reached the following conclusions.
- The current division of responsibility between trustees and managers
reduces the effective accountability to investors of both and allows
both to attempt to shuffle the blame when something goes wrong.
- The range of measures in the Bill for the protection of investors
will provide an adequate replacement for the removal of the requirement
for a trustee provided that the ASC receives adequate resources.
- Investors will benefit from the clear identification of a single party
responsible for all of the activities and functions of the scheme. The
clear and unambiguous allocation of responsibility to a single party
will be made clear to both the responsible entity and the investor.
- The Bill will allow for a wider range of options in the management
structures of funds than the current arrangements and so facilitate
the involvement of managed funds in a wider variety of investment options.
- The new arrangements will generally result in a reduction in the costs
of managing collective investment schemes.
- There is a reasonable expectation that competition between fund managers
will result in any reduction in costs being passed on to investors.
- The Bill will not significantly affect the ability of Australian funds
to market their products overseas.
- The Bill will harmonise the regulatory framework for public offer
collective investments and superannuation by bringing the structure
of collective investments into line with that of superannuation funds.
- Allowing both the current structure and the proposed new structure
to operate concurrently would result in confusion and uncertainty among
investors, higher legal costs for investors taking recovery action,
higher regulatory costs for the ASC and higher compliance costs for
scheme operators dealing with schemes under both structures.
Subject to the tight time-frame for examination of the Bill, the Committee
recommends that the Bill be passed in its current form.
Senator Grant Chapman
Chairman
Footnotes
[1] Mr Ian Warner, Submission No 9, p 12.
[2] Collective Investments: Other People's Money;
The Law Reform Commission & The Companies and Securities Advisory
Committee, 1993, p 132.
[3] Collective Investments: Other People's Money;
The Law Reform Commission & The Companies and Securities Advisory
Committee, 1993, p 133.
[4] Mr Alan Cameron, Committee Hansard, 12 March
1998, p 57-58.
[5] Mr Alan Cameron, Committee Hansard, 12 March
1998, p 59.
[6] Mr Alan Cameron, Committee Hansard, 12 March
1998, p 60.
[7] Collective Investments: Other People's Money;
The Law Reform Commission & The Companies and Securities Advisory
Committee, 1993, p 85.
[8] Trustee Corporations Association of Australia,
Submission No 23, p 3.
[9] Investment and Financial Services Association
Ltd, Submission No 30, p 12.
[10] Managed Investments Bill 1997, Explanatory
Memorandum, p 5.
[11] Mr Tony Hartnell, Committee Hansard, 24
March 1998, p 131.
[12] Ms Jillian Segal, Committee Hansard, 24
March 1998, p 91.
[13] Explanatory Memorandum, Managed Investments
Bill 1997, p 4.
[14] House of Representatives, Hansard, 3 March
1998, p 170.
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