Chapter 2The wholesale investor and client tests
Introduction
2.1This chapter examines stakeholder views on the wholesale investor and client test thresholds, with reference to the matters set out in the inquiry’s terms of reference.
2.2As noted in Chapter 1, the committee’s decision to inquire into the wholesale client and investor tests arose from the Australian Government’s 2023 review of the regulatory framework for managed investment schemes (the MIS review).
2.3The MIS review followed a number of previous reviews and inquiries which considered the effectiveness of the distinction between wholesale and retail investors. The MIS review posed the following questions for consideration by stakeholders:
Should the financial threshold for the product value test be increased? If so, increased to what value and why?
Should the financial thresholds for the net assets and/or gross income in the individual wealth test be increased? If so, increased to what value and why?
Should certain assets be excluded when determining an individual’s net assets for the purposes of the individual wealth test? If so, which assets and why?
If consent requirements were to be introduced:
How could these be designed to ensure investors understand the consequences of being considered a wholesale client?
Should the same consent requirements be introduced for each wholesale client test (or revised in the case of the sophisticated investor test) in Chapter 7 of the Corporations Act? If not, why not?
2.4The submissions to the MIS review demonstrated a broad consensus as to the importance of the wholesale and retail client distinction. For example, the Financial Advice Association of Australia (FAAA) submission to the MIS review observed that the distinction operates as:
…[a] barrier to protect retail clients while providing regulatory relief for clients with the appropriate level of financial knowledge and skills or capacity to incur financial loss that may come from high-risk complex investments.
2.5However, submitters to the MIS review offered a broad range of views in relation to the questions posed for consideration by stakeholders. Accordingly, in light of the importance of the wholesale investor and client tests, on 20 March 2024, the committee commenced its own inquiry into the wholesale investor and client tests to ensure that the submissions, evidence and views of stakeholders will be available to inform future government consideration of the operation of the wholesale investor and client tests.
Background
Purpose of the wholesale investor and client tests
2.6The distinction between wholesale and retail investors was inserted into the Corporations Act 2001 (Corporations Act) in response to the 1997 Wallis inquiry, which called for ‘specialist regulation to protect retail consumers of financial products and financial services, aimed at ensuring that consumers have adequate information, are treated fairly and have adequate avenues for redress’.
2.7The wholesale investor and client tests therefore put into effect the policy rationale of differentiating between wholesale investors, who are typically better financially resourced and informed and able to participate in more risky but potentially more lucrative financial products and markets, and retail investors, who are typically less well financially resourced and informed and therefore require a greater level of protection.
2.8As explained by the Australian Law Reform Commission, the introduction of greater consumer protections for retail investors reflects:
…a recognition of the inherent limits on the ability of [some] individuals to understand and appropriately account for risk when making financial decisions and the increased range and complexity of financial products that are now being offered to retail clients such as derivatives and exchange traded funds.
2.9In general terms, protections for retail investors can include:
information disclosure obligations, such as product disclosure statements;
the prohibition of conflicted remuneration and the imposition of best-interests obligations in the provision of financial product advice;
financial product design and distribution obligations and Australian Securities and Investments Commission (ASIC) powers to make product intervention orders; and
additional professional and ethical standards for providers of personal advice to retail clients.
The wholesale investor and client tests in the Corporations Act
2.10The wholesale investor and client tests operate in relation to the following parts of the Corporations Act:
the wholesale investor test in relation to offers of securities under s.708 of Chapter 6D (Fundraising);
the wholesale client test in relation to financial products and services under ss761G and 761GA of Chapter 7 (Financial services and markets), which regulates financial services and markets to promote informed decisions by, and the provision of suitable products to, consumers of financial products and services; and
the wholesale/retail client distinction in relation to the regulatory framework for managed investment schemes (MIS) under Chapter 5C (Managed investment schemes), which imposes certain governance and compliance requirements on the operation of registered MIS and requires MIS to be registered if being offered to retail clients.
Description of the wholesale investor and client tests
2.11Individuals that can qualify as a wholesale investor or wholesale client must obtain a certificate from a qualified accountant certifying that they meet the prescribed criteria under the Corporations Act. A person holding such a certificate is then qualified as:
a wholesale investor (aka sophisticated investor) for the purposes of Chapter 6D in relation to offers of securities; or
a wholesale client for the purposes of Chapter 7 in relation to financial products.
2.12As set out below, the wholesale investor and client tests in Chapters 6D and 7 of the Corporations Act each have a product value test and a separate individual wealth test. The individual wealth test is comprised of two parts: the assets test and the income test.
2.13In addition to the product value and individual wealth tests, individuals may qualify separately as a wholesale investor or client if they satisfy the sophisticated investor test (SIT).
Wholesale investor test for investors in securities (s.708, Chapter 6D)
2.14The wholesale investor test in Chapter 6D applies to investors in securities. The test determines whether a regulated disclosure document such as a prospectus must be provided to the investor.
2.15To qualify as a wholesale investor a person must satisfy one of the following three tests:
Product value test: the minimum amount payable for the securities is at least $500,000;or that amount plus other amounts previously paid for securities of the same class held by the person is at least $500,000.
Individual wealth test: the person has net assets of at least $2.5 million or a gross income for each of the previous two financial years of at least $250,000 a year (net assets and gross income include the net assets and gross income of a company or trust controlled by the person).
Sophisticated investor test: a person may also qualify as a wholesale investor if an Australian Financial Services licensee (AFS licensee) is satisfied on reasonable grounds that the person has experience in investing in securities that allows them to assess, and inform themselves about the merit, value and risks of, the securities being offered. The AFS licensee must give the person written reasons for being satisfied as to these matters; and the investor must sign a written acknowledgement that the licensee has not given them a disclosure document in relation to the offer.
Wholesale client test for financial products and services (ss 761G and 761GA, Chapter 7)
2.16The wholesale client test in Chapter 7 of the Corporations Act applies to the provision of financial products such as interests in managed investment schemes; general insurance and some superannuation products; non-cash payment facilities; derivatives; other products that satisfy the general financial product definition in sections 763A–763E; and securities (other than the Chapter 6D securities discussed above). The test is relevant to disclosure and a range of other statutory requirements, with these protections applying to retail clients and not to wholesale clients.
2.17To qualify as a wholesale client a person must satisfy one of the following three tests:
Product value test: a person is a wholesale client if the price of the financial product, or the value of the financial product to which a financial service relates, is $500,000 or more.
Individual wealth test: a person is a wholesale client if they have net assets of at least $2.5 million or gross income of at least $250,000 per year for the last two financial years.
Sophisticated investor test: a person may also qualify as a wholesale client if an AFS licensee is satisfied on reasonable grounds that the person has experience in using financial services and investing in financial products that allows them to assess, and inform themselves about the merit, value and risks of, the product or service. The AFS licensee must give the person written reasons for being satisfied as to these matters; and the client must sign a written acknowledgement that, among other things, the licensee does not have the obligations that it would otherwise have if the client was a retail investor under Chapter 7.
Wholesale and retail clients in relation to MIS (Chapter 5C)
2.18As noted above, Chapter 5C of the Corporations Act (Managed investment schemes) imposes certain governance and compliance requirements on the operation of registered MIS and requires MIS to be registered if being offered to retail clients.
2.19The ASIC submission noted that the additional protections for MIS retail clients include:
the requirement to register the scheme with ASIC;
specific obligations in relation to the content of the MIS compliance plan and constitution of the scheme, along with restrictions on the ability of the MIS operator to amend the constitution;
statutory fiduciary duties imposed on the responsible MIS entity as well as its directors and officers;
obligations in relation to the management of liquidity by the scheme;
and
financial reporting and compliance plan audit obligations.
Support for increasing the test thresholds
2.20As noted above, the MIS review invited stakeholders to consider the appropriateness of the current financial thresholds for the wholesale investor and client tests.
2.21The government’s consultation paper on the MIS review invited consideration of the relevant thresholds for the wholesale client and investor tests as follows:
Given that the current thresholds have not been adjusted since they were introduced, and more Australians are [now] eligible to be classified as a wholesale client, it is important to consider the appropriateness of these thresholds in today’s environment and whether they continue to provide an adequate benchmark for determining when a client might be a wholesale client.
2.22As noted above, the consultation sought feedback on the specific question of whether the thresholds for the product value and wealth elements of the wholesale and client investor tests should be increased, and several submissions to the review, including from ASIC, indicated support for raising the thresholds. The ASIC submission to the MIS review recommended increasing these test thresholds on the basis that:
The current financial thresholds have resulted in investors who may not have financial knowledge or experience, a high net worth by today's standards or a high-risk appetite accessing wholesale-only investments. This can present significant risks of harm.
2.23Similarly, the Financial Services Council submission to the MIS review noted the key role of the ‘distinction between retail and wholesale clients’ and stated:
It is clear the existing thresholds should be changed to deliver a more sustainable regulatory framework capable of withstanding changing wealth patterns more reflective of consumers a whole. This can be achieved in different ways each carrying with it consequences for consumers misaligned from the overall intent of ensuring the wholesale and retail classifications reflect the expectations and capacity of the consumers they were designed to protect.
2.24The question of whether to increase the test thresholds was a prominent issue raised in the submissions to the committee’s inquiry into the wholesale investor and client tests. A number of inquiry participants indicated their support for increasing the test thresholds, as set out below.
Justification for increasing the test thresholds
Greater proportion of people meeting test thresholds
2.25The primary justification that has been advanced for increasing the wholesale investor and client test thresholds is based on concerns about the greater proportion of people that can qualify as wholesale investors or clients, compared to when the tests were first introduced into the Corporations Act in 2001.
2.26Specifically, since being introduced, the individual wealth and product value tests have not been indexed or otherwise been adjusted and have therefore remained at: $2.5 million for the assets test; $250,000 per year for the last two financial years for the income test; and $500,000 or more for the product value test threshold.
2.27The proportion of the population that can qualify as wholesale investors and clients has therefore expanded significantly because:
in relation to the assets test, the growth in asset values (particularly real estate assets) has allowed more people to meet the $2.5 million threshold;
in relation to the income test, the growth in incomes over time has allowed more people to meet the $250,000 threshold; and
in relation to the product value test, the growth in individual liquid assets or wealth over time has increased the number of people able to make a single investment in a financial product or service of $500,000 or more.
2.28The ASIC submission noted:
The…thresholds used in the wholesale tests have not been updated in more than two decades. During this period, the proportion of Australian adults who satisfy the individual wealth tests has grown materially.
2.29ASIC and a number of other submitters pointed to research, including by the Australian National University, indicating that ‘as at 2002, the proportion of adults that met the individual wealth tests to be considered [as a] wholesale [investor or client] was 1.9%. This was predicted to grow to 16.2% by 2021 and projected to increase to 43.6% by 2041’.On such projections, approximately 18% of Australians can qualify as wholesale investors or clients in 2024.
2.30With relatively more individuals able to qualify as wholesale investors or clients, and therefore to invest without the greater protections afforded to retail clients, inquiry participants in favour of increasing the thresholds were concerned that more Australians are investing with fewer consumer protections. The ASIC submission concluded, for example, that the policy intent of the tests to protect clients with lower financial literacy and resources has been undermined’.
2.31Similarly, the submission of Hamilton Locke, a law firm practising in the field of financial services, commented:
If the…[current test thresholds] do not keep up with the changing economic conditions of today, there is a risk that those that genuinely require protections as retail clients will not have access to such protections. As a result, the regime is also shifting away from its original rationale for the differential treatment of wholesale investors/clients. Generally, wholesale investors/clients are presumed to be “better informed and better able to assess the risks involved in financial transactions”, or “possess the means to acquire appropriate advice”, and therefore do not warrant the same protections as retail clients. However, given the number of Australians qualifying as wholesale investors/clients relative to their purchasing power in the current climate, this is not necessarily the case.
2.32CPA Australia also noted that test thresholds have never been increased; and supported increasing them on the basis that they ‘are crucial in ensuring that the regulatory framework remains robust and reflective of the current economic environment’.
2.33The FAAA submission also considered that the fact that ‘the threshold tests have not kept pace with the economic environment…[has] placed more vulnerable consumers at greater risk of being mis-classified as a wholesale client’. Similarly, the Ord Minnett submission noted:
…the monetary limits which apply to wholesale investors have not changed, notwithstanding there has been a fourfold increase in the value of residential property in that time.
Many investors who fall within the definition of 'wholesale' investor as set out in the Corporations Act, are not financially 'literate' or indeed sophisticated.
2.34Ord Minnett noted that affording wholesale investor status to inappropriately experienced investors allows them to participate in riskier investments ‘without the full disclosure mandated under the Corporations Act for retail clients’; and that ‘[s]uch clients may also find their right to recovery compromised given that the Australian Financial Complaints Authority has discretion to exclude claims from wholesale Investors’.
2.35Further, in his appearance before the committee, Mr Karl Morris AO, the Chief Executive Officer and Managing Director of Ord Minnett, observed that an unintended consequence of the implementation of professional standards for retail advisers in 2019 had been, in effect, to create an incentive for financial services providers to ‘classify as many of their clients as wholesale as possible’, or to deal exclusively with wholesale clients, leading to a two-tier system of financial advice:
…[Wholesale] firms are not allowed to deal with retail [clients]. When I was a young stockbroker, if I had a wealthy client and a poor client, they got exactly the same advice. I had the same education, I had the same research, I had the same everything. So I treated—and we do as a firm—every client exactly the same. If you are working for a wholesale-only firm you cannot deal with retail clients. The burden of dealing with those retail clients then comes across to us. We recently had well over $1 billion worth of assets transferred from a major investment bank to us because they no longer wanted to advise those retail clients; they just transferred it to Ord Minnett.
2.36Mr Morris considered that the creation of an environment in which financial advisors were subject to vastly different levels of regulation depending on whether they dealt with retail investors or with wholesale investors only had therfore, in practice, reduced the opportunities for retail investors to obtain investment advice.
2.37ANGAS Securities, a company operating as the responsible entity for three MIS comprising a total of 3,000 Australian investors, also supported increases to the test thresholds. It submitted that, while registered MIS and ‘other compliant and licensed operatives can provide protections for retail investors’, wholesale investor ‘carve outs’ provide ‘scope for unregistered and often disreputable operators to dilute these protections or eliminate them altogether’.
Evidence of harm arising from current test thresholds
Examples cited by ASIC
2.38The ASIC submission stated that, although it had only ‘very limited oversight and regulatory powers in respect of financial products offered to wholesale clients and wholesale investors, under the current test thresholds it had nevertheless ‘observed numerous instances of serious harm suffered by investors who are not financially sophisticated or considered wealthy by today’s standards, after entering wholesale-only investments.’ Its submission stated:
In these situations, investors did not understand the risks of the relevant investment, were vulnerable or did not have the financial resources to weather the financial loss.
2.39ASIC noted that situations in which wholesale investors had suffered significant financial losses included ‘significant collapses of a number of registered [MIS]’ and a ‘range of wholesale scheme collapses’; and cited the following two examples:
(a)the LM Managed Performance Fund where more than AUD 400 million was invested by over 4,500 members (based locally and overseas); and
(b)the Equititrust Premium Fund where approximately AUD 56.7 million remained owing to members when administrators were appointed.
2.40In addition, ASIC stated that it had identified a number of instances of misuse of the wholesale investor and client tests, involving certain entities misclassifying retail investors as wholesale investors, or ‘other misuses’. The ASIC submission stated:
We have seen instances of the accountant’s certificate mechanism being misused, including in the fundraising context where trust or company structures have been used to enable the inappropriate certification of investors as sophisticated investors, and instances where accountant’s certificates have been forged.
2.41The ASIC submission cited the following matters as specific examples:
the matter of Oztures Trading Pty Ltd, in which retail clients ‘invested in complex derivatives…[were] incorrectly classified as wholesale clients’;
the matter of Kwickie International Ltd, in which ‘a small number of accountants acted as trustees for trusts set up for the apparent sole purpose of enabling their clients to be classified as wholesale investors’, enabling the clients to receive offers for shares without a prospectus being provided;
the matter of Guvera Group, in which clients ‘invested in Guvera through a private investment company in some cases were classified as wholesale investors through use of trust and company structures, to avoid treatment as retail clients’;
the matter of former financial adviser Ezzat-Daniel Nesseim, who was sentenced for criminal offending, and was also permanently banned from providing financial services, in relation to conduct including use of three forged wholesale client certificates.
2.42ASIC considered that matters such as these involving the misclassification of retail investors as wholesale investors, and other ‘misuse of the wholesale tests, meant that ‘these investors were not afforded the important additional protections that apply to retail clients’.
2.43On the basis of these concerns, ASIC submitted:
Increasing the financial thresholds will not prevent all harm resulting from products marketed or sold, or financial advice given, to clients who should be treated as retail clients…[but] should help mitigate harms, as it will better ensure that investors who are in essence retail clients are recognised as such and benefit from the statutory protections applicable to retail clients.
2.44A number of inquiry participants considered that the examples cited by ASIC did not demonstrate problems arising from the setting of the current test thresholds, and therefore were not relevant to the question of whether the test thresholds should be increase. These views are discussed below from paragraph 2.87.
Suggestions as to how to increase the test thresholds
2.45Proponents of increasing the test thresholds had a wide range of suggestions as to how the increases should be effected.
2.46However, broadly speaking, proponents’ suggestions were based on the general notion of restoring the thresholds to the level they would have reached had they been subject to indexation since their introduction; and providing for some mechanism by which the thresholds can be increased over time to account for the effects of inflation.
2.47The following section sets out ASIC’s recommended increases to the test thresholds as well as the recommendations of other inquiry participants.
ASIC
2.48ASIC recommended increasing the test thresholds ‘to account for inflation since their introduction to the Corporations Act’. The ASIC submission stated that, ‘if adjusted to account for inflation based on…[Consumer Price Index (CPI)] increases from 2021 to 2024, the thresholds would increase as follows’:
product value test threshold—from $500,000 to approximately $922,000; and
individual wealth tests:
assets test threshold—from $2.5 million to approximately $4.61 million; and
income test threshold—from $250,000 to approximately $461,000.
Ongoing indexation of test thresholds
2.49In addition to a one-off increase to the test thresholds to account for inflation since 2001, ASIC recommended that ‘a legislative mechanism be introduced to facilitate periodic increases to the thresholds over time [to] ensure the thresholds at least keep pace with inflation and remain up to date.’
Chartered Accountants Australia and New Zealand, CPA Australia, Institute of Public Accountants, and Self Managed Super Fund (SMSF) Association
2.50The joint submission from the Chartered Accountants Australia and New Zealand, CPA Australia, Institute of Public Accountants, and Self Managed Super Fund (SMSF) Association (the Joint Associations) recommended broadly similar increases to the thresholds, as follows:
product value test threshold—from $500,000 to $1 million; and
individual wealth tests:
assets test threshold—from $2.5 million to $4 million; and
income test threshold—from $250,000 to $350,000.
Ongoing indexation of test thresholds
2.51The Joint Associations also supported indexation of the product value, assets and income test thresholds, in line with AWOTE upon reaching set increments of $100,000 (product value threshold) $250,000 (assets threshold) and $25,000 (income threshold).
Financial Advice Association Australia
2.52The Financial Advice Association Australia (FAAA) recommended the threshold levels be set as follows:
product value test threshold—to remain at $500,000 on the basis that this is already ‘a large amount of money to invest in one product, even for genuine wholesale clients...[and that if this is increased it will] impact the ability of genuine wholesale clients to appropriately diversify their investment portfolio’.
individual wealth tests:
assets test threshold—to be set at $2 million for an individual and $4million for a couple, but with the family home excluded from the assets pool; and
income test threshold—to be increased from $250,000 to $450,000 in line with inflation since 2001.
Ongoing indexation of test thresholds
2.53The FAAA also supported indexation of their recommended product value, assets and income test thresholds, in line with AWOTE in multiples of $5,000 increments every five years.
Financial Services Council
2.54The Financial Services Council (FSC) recommended the threshold levels be set as follows:
product value test threshold—to remain at $500,000 on the basis that, despite the increase in the proportion of individual’s able to meet this threshold, it is ‘unlikely that an individual would invest $500,000…at a single point in time if they were not already a high net worth individual’;
individual wealth tests:
assets test threshold—to be increased from $2.5 million to at least $5 million including the family home; or alternatively to remain at $2.5 million but with the family home excluded from the assets pool;
income test threshold—to be maintained at $250,000 on the basis that ‘it continues to cover less than 1% of the population’.
Periodic review of test thresholds
2.55The FSC submission noted that it did not support ‘automatic periodic indexation’ of the test thresholds as this would create ‘uncertainty and cost for the industry’ by creating the need for ‘ongoing adjustments to compliance systems’. However, the FSC stated that it ‘would be open to a legislative mechanism for periodic consideration of increases to the thresholds (for example, every five years) as part of a statutory review of the appropriateness of the thresholds undertaken by the Minister’.
Exclusion of the family home from the assets test
2.56The assets test threshold currently includes all assets in a person’s name, including their primary residence (aka family home) and, as noted above, the significant increases to real estate values in Australia since the test was introduced have allowed relatively more Australians to qualify as wholesale investors or clients.
Support for excluding the family home
2.57A number of inquiry submitters therefore indicated a preference for removing the family home, and potentially other non-financial assets, from the assets test, either with or without suggesting related adjustment of the test threshold.
2.58This preference was based on a number of grounds but generally reflected views that the family home is not a financial asset; and home ownership and home values are not reliable indicators of, or proxies for, an individual’s knowledge or experience in relation to investing. The Australian Information Industry Association (AIIA) submission, for example, observed:
[While]…it is common for properties to be inherited and a source of generational wealth…[owning] a property in itself does not equate [to] financial literacy and competency…
2.59As noted above, the FAAA recommended maintaining the current assets test threshold of $500,000 but with the exclusion of the family home from the assets pool. The FAAA recommended this on the following grounds:
equity and fairness: simply due to large differences in property values across Australia, the test ‘may exclude genuine wholesale clients with a lower property value but capture vulnerable consumers whose property value has substantially increased’;
risk to unsophisticated clients: due to growth in house prices over time, unsophisticated clients become able to qualify, and therefore be misclassified, as wholesale investors; and
stability of the assets test: due to ‘the variability and continuous growth in property values, excluding the home from the net asset value test offers greater stability and assurance that the test will remain fit for purpose over the longer term.
2.60Sydney Angels Incorporated also supported the removal of the family home from the assets test, but in conjunction with: lowering of the test threshold to $1.5 million; allowing joint assets of spouses to be considered; and grandfathering of existing arrangements otherwise affected by any changes. Sydney Angels Incorporated submitted that this approach would ‘more closely align with the policy intent of the wholesale investor test which is based on a consumer’s knowledge, financial capacity and risk appetite for making financial decisions’; and better align Australia’s regulatory settings with overseas jurisdictions.
2.61Mr Peter M Milford submitted that the exclusion of the family home from the wholesale investor and clients tests is the ‘only change’ that is needed to the current arrangements. Mr Milford considered that this would remove the issue of people qualifying as wholesale investors or clients simply due to increasing property values; make the treatment of the family home more consistent across financial regulations; and remove the current bias in the test arising from relatively higher property values in Sydney and Melbourne.
Opposition to excluding the family home
2.62Other inquiry participants opposed the exclusion of the family home from the assets test on a range of grounds.
2.63Some submissions raised concerns that the removing the family home from the assets pool would be discriminatory or disadvantageous to certain groups. Quintessential, for example, suggested that, because the family home often represents a significant portion of an individual’s wealth, excluding it from the assets test would distort an individual’s ‘true financial position and place homeowners at a disadvantage for having acquired a house rather than…[invest in] another type of asset’.
2.64Aussie Angels warned that excluding the family home could have a detrimental and disproportionate impact on women, given that women are more likely to receive the family home in a divorce.
2.65The Alternative Investment Management Association (AIMA) opposed the removal of the family home from the assets test, pointing to the practical difficulty of determining exactly what liabilities should be excluded where certain assets are removed from a net assets-based test. Further, AIMA noted that this would lead to uncertainty as an investor’s status as a wholesale or retail client could fluctuate ‘based on their ‘acquisitions and disposals of’ excluded classes of assets. The AIMA submission explained:
For example, if the family home is excluded from the wealth test, an investor might be a retail client, but then they could become a wholesale client under the wealth test temporarily if they were to sell that property and live in a rented premises for a period of time, before purchasing another property (and potentially becoming a retail client again).
2.66AIMA was also concerned that excluding the family home from the assets test ‘could inadvertently encourage the wrong behaviours, such as excessive borrowing against those excluded assets, including things like the family home, putting these assets at risk’. The AIMA submission explained:
For example, an owner of a $6 million mortgage free property would not be classified as a wholesale client if the asset is excluded from the individual wealth test, but could borrow $3 million against that property to invest in financial products (leaving net equity of $3 million in the family home) and be characterized as a wholesale client.
Ongoing indexation or periodic review of the test thresholds
2.67As outlined above, submissions from inquiry participants included a range of recommendations in relation to ongoing indexation or periodic review of the test thresholds to account for the effects of inflation, whether or not preceded by an initial one-off increase to account for inflation and asset growth since 2001.
2.68As noted above, for example, ASIC considered that, following on-off increases to the thresholds to account for inflation since 2001, ‘a statutory mechanism should be introduced to facilitate periodic increases to the financial thresholds over time’; whereas the FSC preferred the introduction of a process for periodic review of the thresholds to allow for regular consideration of their appropriateness.
2.69The Law Council of Australia (LCA), while noting that indexation of the test thresholds could be introduced ‘to prevent unintentional ‘wholesale creep’, observed that indexation could also introduce ‘complexity and uncertainty if…[it occurred frequently] to align with changes in the…[CPI]’, potentially leading to ‘inadvertent non-compliance’. The LCA submission explained:
For instance, if accountant’s certificate templates are not updated to reflect the new threshold amounts (due to insufficient attention to detail or awareness of regulatory change – which is not infrequently a cause of breaches), the potential exists for an investor to be above the previous threshold but below the new adjusted threshold. If an outdated template is used, then an investor might be incorrectly characterised as wholesale and not given the intended regulatory protection.
2.70Accordingly, the LCA suggested the following approach to indexation could be adopted, with changes to thresholds taking effect with at least six months’ notice and at the beginning of a financial year:
the product value threshold be increased in $100,000 increments (e.g. where the threshold starts at $500,000, and once CPI has increased by 20%, the threshold moves to $600,000);
the gross income threshold be increased in $50,000 increments (e.g. where the threshold starts at $250,000, and once CPI has increased by 20%, the threshold moves to $300,000); and
the net assets threshold be increased in $500,000 increments (e.g. where the threshold starts at $2.5 million, and once CPI has increased by 20%, the threshold would move to $3 million).
Opposition to increasing the test thresholds
2.71Many inquiry participants raised significant concerns about the effectiveness and impacts of increasing the wholesale investor and client test thresholds, as set out below.
Greater proportion of people meeting test thresholds
2.72As noted above, the primary justification advanced for increasing the wholesale investor and client test thresholds is based on concerns about the greater proportion of people that can qualify as wholesale investors or clients, compared to when the tests were first introduced into the Corporations Act in 2001.
2.73Proponents of raising the test thresholds pointed to the approximately 15% increase in the proportion of Australian that can qualify as a wholesale investor or client today as raising a concern that individuals without the necessary knowledge and experience are being allowed to access wholesale markets.
2.74However, this concern was rejected by opponents of raising the thresholds on a number of grounds.
Proportion of sophisticated investors in Australia
2.75Some inquiry participants contended that the original setting of the thresholds at a level to qualify approximately 2% of the population as wholesale investors of investors should itself be questioned or substantiated. Arcana Capital Pty Ltd, for example, submitted that the idea that only 2% of Australians had the required financial literacy or sophistication to invest in wholesale investments in the early 2000s should be challenged.
2.76Similarly, MARQ Trustees submitted that, as the increase in eligibility to qualify as a wholesale investor ‘does not in itself provide a substantive basis for change’, ‘it would be more beneficial’ for any changes to the test thresholds to be explained by reference to ‘the rationale for setting the original thresholds’.
2.77Hall & Wilcox argued that, rather than increasing the test thresholds simply on the basis of the observed effect of inflation, ‘the Committee should seek to identify the current proportion of Australians that are ‘sophisticated’ so that the financial thresholds can appropriately be set.’ The Hall & Wilcox submission listed a number of factors as suggesting that ‘more Australians are [financially] sophisticated now than was the case when the current financial thresholds were set.’ These included:
tertiary education: in 2022, 28.8 per cent of males and 35.2 per cent of females obtained a tertiary qualification, whereas in 2002 only 17.8 per cent of the population had a university education, suggesting that more Australians today are capable of doing their own investment-related research and analysis;
access to information: the expansion of the internet has made information more accessible, which means that ‘people are better positioned now…[than] when the financial thresholds were first set to assess and compare products, source their own information [and research]…and understand the risks and merits of particular financial products;
access to advice: recent estimates suggest that approximately 10 percent of Australians today have access to financial advice, which is likely more than was the case in 2002;
increased ownership of financial affairs: many Australians today ‘actively manage their superannuation savings through self-managed superannuation funds (SMSFs) and through that management have acquired considerable levels of financial literacy.’
2.78The Aussie Angels submission pointed to many of the same factors to argue:
The historical reasons for these test thresholds do not apply in the same way they did 20 years ago. The economic environment has changed, Australians are more educated, there is more access to information, and simply trying to limit access to certain products will not be an effective strategy for protecting consumers. The evidence [in fact] suggests that only a very few investors need further protections while the vast majority need better access to more choices.
2.79The SIAA considered that it is appropriate for more Australians to qualify wholesale investors because the ‘current net worth of Australian households is 380 per cent higher than it was in 1989, despite the adult population, at 12.25 million, being only 70.5 per cent higher.’
2.80One Investment Group submitted that the implementation of compulsory superannuation in 1992 has also enabled Australians to become more financially literate and experienced.
Effectiveness of existing consumer protections for investors
2.81Several inquiry participants considered that the increase in wholesale investor and client eligibility has occurred alongside increased consumer protections in Australia’s regulatory environment.
2.82Aussie Angels, for example, noted:
There have been significant reforms and regulatory developments governing the regulation of financial products over the past ten years including; updated guidance on risk management systems for responsible entities (REs) (ASIC RG 259), strengthening of AFSL requirements with a focus on a wider range of persons as ‘fit and proper persons’ (ASIC Info Sheet 240), enhanced breach reporting requirements (ASIC RG 78), providing ASIC with product intervention powers (PIPs) and most notably, the introduction of the Design and Distribution Obligations (DDO) which has introduced significant product governance obligations with a consumer centric focus across the lifecycle of an investment product.
2.83Herbert Smith Freehills observed that, while retail investors have additional consumer protections, wholesale markets are still subject to regulation and consumer protections, including through misleading and deceptive conduct laws and conditions on financial services licenses. Similarly, Arcana Capital Pty Ltd rejected of the notion that wholesale markets are inherently riskier.
Voluntary assumption of risk as wholesale investor or client
2.84Some opponents of increasing the test thresholds also noted that, while more Australians can meet the test thresholds, participating as a wholesale investor or client is a deliberate and voluntary assumption of risk by individuals.
2.85The SIAA, for example, noted that classification as a wholesale investor or client involves an individual actively seeking and maintaining wholesale investor or client status:
Investors do not automatically become wholesale clients by virtue of their wealth or income; they must actively request this classification by obtaining a certificate from an accountant which must be renewed every two years...
2.86Similarly, Bayley Stuart Investment Management Pty Ltd observed that it is not the case that ‘once a person meets the wholesale thresholds they are forced to be treated as a wholesale client’ and that, regardless of wealth or assets, an individual can continue to invest with the greater protections of a retail investor or client if they choose.
Evidence of harm arising from current test thresholds
2.87Opponents of increasing the test thresholds widely considered that there is a lack of evidence that the current setting of the test thresholds is leading to significant harm to investors.
Examples cited by ASIC
2.88In this regard, many submitters and witnesses questioned the relevance of the few examples of investor harm cited in the ASIC submission, and examples cited in other submissions to the inquiry.
2.89For example, AIMA, in response to questions on notice from the committee, provided the following comment on the following two examples cited in the ASIC submission, which both involved collapses of wholesale investment schemes:
the LM Managed Performance Fund where more than AUD 400 million was invested by over 4,500 members (based locally and overseas); and
the Equititrust Premium Fund where approximately AUD 56.7 million remained owing to members when administrators were appointed.
2.90The AIMA submission stated:
We observe that these collapses both occurred +10 years ago and involved AFS licensees who were also authorised to operated registered managed investment schemes and so their businesses…[were] subject to the highest regulatory standards. ASIC’s submissions do not focus on the more significant retail scheme collapses within these corporate groups. Further, in the case of the Equititrust Premium Fund, the number of impacted members is relatively low (38 unitholders).
2.91Mr Adrian Bunter, Committee Member, Sydney Angels Incorporated, offered a similar assessment of the ASIC examples, concluding:
Increasing the financial thresholds for the wholesale investor criteria would not have prevented the relevant breaches by the respective parties in each of those cases [cited by ASIC]…I would argue that those examples do not reasonably support the need to increase the thresholds, but identify other matters that need to be addressed in relation to regulating financial services.
2.92In relation to examples of investor harm cited in other submissions, AIMA noted that case studies cited by AFCA ‘concerning the misclassification of various SMSFs as wholesale clients’ did not in fact demonstrate ‘harm caused by the current wholesale client tests’. Rather, these cases involved potential failures by financial firms to properly assess clients against the existing test thresholds and/or potential misleading or deceptive conduct.
2.93More generally, Aussie Angels observed that, in fact, ‘the many failures of financial products that led to significant investor losses over the last 10-15 years were primarily retail products’ rather than wholesale products.
2.94Given the lack of substantial evidence of harm to investors, opponents of increasing the current test thresholds, such as the Australian Financial Markets Association (AFMA), emphasised ‘that there is a lack of demonstrated connection to the specific consumer harm resulting from these thresholds, which result[s] in a lack of clarity as to where and how [the proposed] threshold increases across the tests will materially uplift protection for consumers’.
2.95The Property Council of Australia concluded that, without ‘evidence of harm or market failure’, ‘no case has been made to increase the thresholds to artificially limit the number of investors who qualify under the wholesale client tests’.
2.96DrDavid Millhouse argued:
In some respects, the present debate has missed the point…[because investor] losses are not because of the present typology of ‘wholesale’ or other categories of investor. The common causal factors are other deficiencies in the regulatory architecture. Therefore, regulatory change to ‘wholesale investor’ typology does not necessarily translate into a less risky financial products and services environment for any investor.
Lack of consultation in relation to increasing the test thresholds
2.97In addition to questioning the lack of evidence to justify increasing the test thresholds, a number of submitters and witnesses noted the need for consultation with stakeholders over any changes to the wholesale investor and client tests, and, specifically, that no consultation had taken place to support the recommendations made by ASIC to increase the current test thresholds.
2.98In its appearance before the committee, ASIC confirmed that, in formulating its own submission and recommendation to increases the test thresholds, it had not undertaken any formal stakeholder consultation. The ASIC submission acknowledged that consultation with relevant stakeholders, including industry and consumer representatives, would be desirable given that any proposed ‘changes to the tests would represent a material change to the regulatory setting for financial services and markets’.
2.99Several submitters were also of the strong view that, due to the potentially wide-ranging consequences of increasing the test thresholds (see below from paragraph 2.105), it is imperative that consultation is undertaken to ensure the views of stakeholders are taken into account and to better understand the potential impacts of any changes. For example, the SIAA submitted:
While there may be stakeholders arguing for changes to the wholesale investor thresholds, the cohort that would be most impacted—the wholesale investors themselves—have not been asked if they would be happy to lose their wholesale classification. No change should be made without consultation with wholesale investors, in order to understand the impact on them and their investments.
2.100The ASX submitted that the broad range of consequential impacts on a range of markets and sectors ‘requires careful and balanced consideration’ and that any ‘specific proposals for change should be subject to their own consultation once they have been identified’.
2.101Similarly, Aussie Angels considered that any recommended increases to the thresholds ‘must undergo thorough consultation, impact assessments, and considerate adjustments to maintain a balance between investor access and consumer protection’.
2.102Kit Legal submitted that any changes should be informed by research, including the collection of data on losses suffered by the wholesale clients and how those losses may be avoided in future.
2.103The evidence of some of inquiry participants suggested that increasing the thresholds may be significantly out of step with the views and preference of investor communities. M8 Ventures, for example, cited a research poll which indicated that, of those surveyed:
52 per cent believe there should be no limitations on who can invest in startups; and
56 per cent would support lowering the financial thresholds for wholesale investors.
2.104Similarly, Aussie Angels advised the committee:
None of the 1,700-plus wholesale investors in our community have told us that they need or want further protections. On the flipside, hundreds of the retail investors in our network have persistently reached out to us asking how they can qualify.’
Potentially negative impacts of increasing the test thresholds
2.105Opponents of increasing the wholesale investor and client test thresholds raised concerns in relation to potentially negative impacts on Australia’s investment ecosystem and communities.
General impacts
2.106A number of inquiry participants noted that, as the intent of increasing the test thresholds is to reduce the available pool of wholesale investors and clients, this would broadly impact Australia’s investment industry.
2.107AIMA, for example, observed that increasing the thresholds would ‘risk forcing investors to be overly concentrated into a smaller number of investments’, with less diversification resulting in poorer investment outcomes.
2.108The submission of Hall & Wilcox urged the committee to ‘have close regard’ to the likely ‘disruption and issues’ that the change would bring about. Hall & Wilcox considered that decreasing the number of Australians that are able to be treated as wholesale clients would:
have a significant effect on the ability of product issuers to structure wholesale products;
reduce the level of innovation within the Australian financial services industry; and
reduce competition, noting the retail funds management space is [already] highly concentrated.
2.109PAC Partners, a ‘research led wholesale capital markets provider’, also commented on the specific impacts increasing the test thresholds:
Should these proposed changes take effect, they will have a detrimental effect on the Australian financial markets that operate wholesale client bases only. As PAC Partners are primarily an Equity Capital Markets (ECM) house, the proposed changes will significantly reduce the distribution base and may lead to a potential reduction in market participation.
2.110Aussie Angels observed that the impacts of increasing the test thresholds would occur at a time when Australia is moving away from heavy reliance on mining towards investing in ‘more sustainable’ industries such as technology. Reducing the pool of wholesale investors would, in effect, ‘be putting more barriers in place for innovation at this crucial time’.
2.111Marquette Properties, a specialist wholesale investment manager for commercial property syndicates, submitted that increasing the test thresholds ‘would dramatically alter how we operate and service our investor base, as well as our existing investors’ current holdings’.
Impact on foreign investment
2.112Some inquiry participants argued that increasing the test thresholds could impact negatively on levels of foreign investment in Australia.
2.113Aussie Angels and Sydney Angles Incorporated submitted that making it more difficult to participate in start-ups and venture capital in Australia would likely deter foreign investors from such investments.
2.114Sydney Angels Incorporated noted that, in addition to losing foreign investment, reducing the potential pool of wholesale investors by raising the test thresholds could also encourage Australian investors move to offshore investments.
2.115Similarly, Morgans Financial Limited argued that, because Australia’s current thresholds are competitive with the United Kingdom (UK) and the United States (US), raising the barrier to wholesale investments in Australia could see investors favour overseas markets and, ultimately, reduce Australia’s international economic competitiveness.
2.116The AIIA were also concerned about potential impacts on Australia’s international competitiveness, advising that increasing the test thresholds could reduce availability of private funding and make ‘it harder for Australian tech companies to secure the capital that they need to grow and compete globally, potentially forcing them to seek funding offshore’. The TechCouncil agreed, stating:
…if we can’t attract local investment into our start-ups and our entrepreneurs, they will and do go overseas, and if we can’t attract local investment, it is very difficult to attract international investment as well, and this goes to a much broader ecosystem point.
Impact on angel and venture capital investment
2.117The committee heard that increasing the test thresholds could also impact on angel investors and venture capital groups investing in new businesses and start-ups, as these are often smaller or private investors making early-stage non-monetary and financial investments.
2.118While acknowledging the importance of protecting retail consumers from ‘unscrupulous promoters of complex financial products with high fees and opaque risks’, Dale Advisers warned that increasing the test thresholds ‘to achieve policy objectives in these areas should avoid causing collateral damage in other areas, in particular the startup ecosystem and all its various types of supports and investors’.
2.119The SIAA contended that increasing the thresholds ‘would shrink the pool of investors able to participate in offerings, both listed and unlisted’ and would ‘particularly impact smaller entities listing on the ASX, and the ability of early-stage start-ups to attract capital through private equity, venture capital and angel investors’.
2.120Similarly, Giant Leap submitted that ‘restricting access to wholesale investor status may impede early-stage investment, essential for fostering innovation and driving productivity gains’. The submission of Flying Fox, a venture that ‘manages an investment syndicate for wholesale investors interested in high-growth, early stage technology companies, submitted that this ‘important niche of startup investment…is likely to be deeply impacted’ by increasing the test thresholds:
Any change to these tests would likely have adverse outcomes for the Australian startup ecosystem, reducing capital and talent pools.
2.121Angel Investors advised that increasing the test thresholds could potentially reduce the number of angel investors by 50 to 80 per cent. This would ‘decimate the provision of investment capital at the earliest stage for start-up companies’ and, in turn, ‘have a devastating long-term impact on the wider venture capital ecosystem, innovation and long-term employment creation’.
2.122Mr Jordan Green AM also pointed to the significant long-term impacts of increasing the test thresholds:
…the bulk of economic growth and the bulk of job growth in Western economies, for some time now, according to the International Labour As a result, the AIIA argued that there would be an increased reliance on government funding and programs (such as the Industry Growth Program) to fill the gaps, which ‘risks distorting the market and increasing the burden on public resources’.
Impact on specific groups of investors
2.123Inquiry participants were also concerned about the potentially negative consequences of increasing the test thresholds for specific groups of investors including women, minority groups, regional areas and younger people, as investing opportunities for these groups would be curtailed.
Women investors
2.124Mr James Cameron, Partner, Airtree, observed that women as a group would likely be disproportionately impacted by an overall reduction in wholesale investors due to increasing the test thresholds, particularly in relation to angel and start-up investors:
…the impact on angel investors…[of] these potential increases in the thresholds…would disproportionately impact women as a group…
2.125Mr Cameron noted that removing a significant number of women from the potential pool of angel investors for start-up companies would ‘likely have a knock-on effect on the number of women founders and entrepreneurs that get founded’. He noted that ‘there is a very large funding gap between’ the male and female founders and entrepreneurs, and that having more women investors in the investment ecosystem ‘increases the likelihood that women founders will get funded’.
2.126Similarly, the Australian Investment Council submitted that increasing the test thresholds would limit the opportunities for women as investors, fund managers and founders seeking access to capital.
2.127Some submitters noted that limiting opportunities for women founders would compound existing gender disparities in Australia’s investment industry, with First Nations X citing a 2020 report by LaunchVic indicating that only 22 per cent of Victorian startups are founded by women.
2.128Airtree highlighted that these disparities could be addressed by fostering more rather than less participation by women in angel and start-up investing. DrHumphery-Jenner concurred, stating that having more female investors would provide greater access to funding for female entrepreneurs ‘through debiasing and ensuring a debiasing of male investors’.
Young investors
2.129Submitters and witnesses also observed that increasing the test thresholds raises concerns over intergenerational inequality due to potential impacts on young investors.
2.130The SIAA noted that, while older Australians have had the opportunity to generate wealth under the current thresholds, the higher thresholds would likely exclude many young Australians from the more lucrative wholesale markets in what amounts to a ‘moving [of the] goalposts’.
2.131Dr Mark Humphery-Jenner agreed, submitting that ‘depriving young individuals of the ability to invest…[will] exacerbate inequality’.
Industry-specific investors
2.132Halo Funds Management (HFM) provided an example of how increasing the test thresholds could impact on industry-specific investment funds. HFM is the investment manager of the Succession Capped Interest Fund, which was established in 2019 ‘with the objective of offering innovative ways to finance the ownership of retail pharmacies’ by pharmacists. The HFM submission explained:
Only a qualified pharmacist can own a pharmacy in Australia. So the Fund was established with a loan product targeted at the needs of young pharmacists looking to attain ownership and an investment product designed to offer divesting owners an opportunity to continue investing in an industry which they understand while diversifying their risk.
2.133HFM was concerned that increasing the test thresholds:
…might severely limit the number of pharmacists who are able to invest in the Fund, thereby depriving aspiring owners of the opportunity to acquire and reducing the pool of capital which is available to established owners looking to divest.
2.134Similarly, the submission of Pepperstone Group Limited (PGL), a ‘global issuer of margin foreign exchange contract and contracts-for-difference’ (CFDs), noted that investment in CFD products was currently already subject to significant ASIC-imposed restrictions and ‘leverage changes’ that had led ‘many experienced retail investors to seek wholesale status’. PGL was therefore concerned that further restricting access to wholesale investor and client status ‘would ‘undoubtedly [negatively] affect…[their] business and industry’:
Should product restrictions become overly burdensome or costly on clients, it will simply drive more clients to access products offshore in unrestricted and unregulated jurisdictions where they will not have access to the protections and supervision provided by Australian law.
2.135Natgen, a property fund manager managing commercial properties and developments for investors throughout Australia, submitted:
Increasing the thresholds for the gross income and the net asset tests is likely to significantly decrease the pool of individuals eligible to be classified as wholesale clients within the client base of…[Natgen] and across the investor community in general.
2.136The Medical Technology Association of Australia, a national association representing manufacturers and suppliers of medical technology, submitted that increasing the test thresholds ‘risks shrinking the already shallow pool of private investment (either via venture capital funds or directly as angel investors) into medical technology commercialisation’:
The implication is a reduced number of feasible projects suitable for funding by the National Reconstruction Fund and an over reliance on grant programs to commercialise Australia’s world class medical device technologies.
Other groups of investors
2.137Dr Elena Kelareva, Startup Founder and Executive Director of GippsTech, argued that the ‘reduction in startup funding that would be caused by…[increasing the test thresholds] would be particularly harmful to rural and regional founders, as they already face greater barriers to investment compared to urban founders’.
2.138Some inquiry participants noted more generally that increasing the test thresholds would tend to advantage wealthier investors and disadvantage retail, smaller and individual investors.
Minimising impacts on investors currently qualified as wholesale investors
2.139Given the potential impacts of increasing the test thresholds on the groups of investors outlined above, some inquiry participants called for the grandfathering of existing thresholds for those currently qualified as wholesale investors or clients, if the increase to the test thresholds was to occur.
Grandfathering and transitional arrangements for existing thresholds
2.140Many inquiry participants noted that increasing the thresholds would impact negatively on investors who would cease to qualify as wholesale investors or clients under higher thresholds, which could lead to unfairness and uncertainty in investor markets.
2.141Many submissions therefore argued, whether or not they supported increasing the test thresholds, that if the thresholds were to be increased there would need to be grandfathering and transitional arrangements to preserve the wholesale investor or client status of individuals who had qualified under the current thresholds.
2.142Morgans Financial Limited, for example, suggested that a failure to implement grandfathering arrangements ‘could cause clients to suddenly become ineligible for products which they currently own or services which they are presently receiving, and force a sudden requirement to exit or change positions, which may cause taxation or other financial implications’.
2.143The LCA supported grandfathering and transitional arrangements so that ‘individuals who met the net assets test on or before the date the law changed could continue to be treated as wholesale clients for the remaining duration of their existing accountant’s certificate’. The LCA argued that grandfathering ‘would also enable a transition period for the introduction of the new test [thresholds] of 24 months, as has been used for previous legislative reforms impacting the financial services industry’ and would ‘minimise the negative impact and potential disruptions for affected product users’.
2.144The Property Funds Association submitted that grandfathering provisions must be central to any increases to the thresholds to ‘ensure forced redemptions do not lead to a market-wide failure and severe outcomes for investors’. The Property Funds Association further added that it is essential to allow time for fund managers and advisors to ‘retrain, requalify, alter their licences or possibly wind up’.
2.145The FSC noted that two years would be an appropriate transition period but was concerned that if grandfathering were only temporary it would ‘not address the issues created for investors currently classified as wholesale investors who may lose this status if new test thresholds are introduced’.
Concerns about ongoing indexation of test thresholds
2.146As noted above, a number of the proponents of increasing the test thresholds also proposed some form of ongoing indexation of the thresholds to account for the effects of inflation over time.
2.147However, inquiry participants identified several concerns about indexation of the thresholds, including the arbitrary nature of indexation, distortion of investment decisions, and difficulty with compliance.
2.148The Property Council of Australia, for example, strongly opposed indexing the thresholds, arguing that ‘choice, competition, and a variety of financial products for consumers should be considered more important than maintaining arbitrary parity with either inflation or another index’.
2.149The Property Council of Australia also cautioned that, because inflation is a forecast measure, indexation of the thresholds ‘would add uncertainty and distort investment decisions, increasing complexity for consumers’.
2.150Sydney Angels Incorporated indicated that the ongoing periodic changes to the thresholds from indexation would lead to challenges for investors and financial service providers in determining whether investors satisfy the tests at a given point in time. Sydney Angels Incorporated submitted accordingly that the thresholds should be periodically reviewed rather than be subject to indexation.
Comparisons with overseas jurisdictions
2.151Inquiry participants raised concerns that that increasing the test thresholds would put Australia out of line with current thresholds in comparable overseas jurisdictions.
2.152AIMA, for example, noted, while there are some differences, Australia’s current test thresholds are broadly in line with overseas jurisdictions:
Australia is not [currently] out of step with international markets with our wholesale tests. While there is some divergence in terms of the numbers used to meet income tests or the assets test, almost all comparable jurisdictions do use one such test or more. For jurisdictions that do adopt an income test, some tests are lower than ours—for example, Canada and the United Kingdom. Some jurisdictions include or exclude some assets from the tests, but the overall impression is that Australia is not out of step.
2.153The Australian Investment Council submission noted that, generally in respect of the process undertaken to review test comparable test thresholds in overseas jurisdictions:
In reviewing these comparative jurisdictions [of Europe, the United Kingdom, the United States, Singapore and Hong Kong], key points to note are:
In all of the other jurisdictions there is no pre-determined or automatic increases in financial/qualifying thresholds based on indexation or other methodology
Any proposed changes to the financial/qualifying thresholds across jurisdictions are carefully considered and typically subject to public consultation prior to implementation.
2.154Attention was also drawn to the US, where the financial thresholds have remained at the level they were originally set in 1982 and 1988, despite being reviewed every four years. Arcana Capital Pty Ltd highlighted that an attempt to raise these thresholds in 2022 by the US Securities and Exchange Commission was unsuccessful due to concerns regarding unintended consequences.
Reversal of the UK increases to test thresholds
2.155A number of submitters and witnesses pointed to the recent experience of the UK increasing its own wholesale investor and client tests as offering particularly pertinent lessons for Australia.
2.156In 2023, to account for inflation, the UK adjusted a number of the thresholds for its wholesale investor and client tests by increasing the thresholds for its income (high net worth) test from £100,000 to £170,000 and assets test from £250,000 to £430,000, respectively.
2.157However, due to the negative impact of the increases on the investment funding of start-up companies and early-stage venture capital funds, the UK government reversed the changes only five months after implementation.
2.158AIMA Australia noted that the reasons for the UK reversing the threshold increases also included their negative impacts on seed investment, the venture capital industry, and new fund manager incubation.
Other proposals for reform
2.159Separate to issues concerning the test thresholds, inquiry participants suggested several other reforms related to the operation of the wholesale investor and client tests, including:
the sophisticated investor test;
the accountant’s certificate for wholesale investors; and
the class order for business introduction services.
Sophisticated investor test
2.160Under the sophisticated investor test (SIT) for either a wholesale investor or a wholesale client, a person may qualify as a wholesale investor or client if an Australian Financial Service (AFS) licensee is satisfied on reasonable grounds that the person has experience in using financial services and investing in financial products that allows them to assess, and inform themselves about the merit, value and risks of, the product or service.
2.161While some inquiry participants argued that the SIT should be abolished on the basis that it is scarcely used and subjective, others argued that a SIT-style test should be the sole way to distinguish between wholesale and retail clients.
Subjective character of the sophisticated investor test
2.162Australia, along with relevant overseas jurisdictions such as the US and the UK, uses objective and subjective tests to classify wholesale investors; and Aussie Angels noted that the rationale for providing the subjective SIT test as an alternative to the threshold-based product value and individual wealth tests is to ensure that the arbitrary test thresholds do not exclude people who should have access to wholesale investing opportunities.
2.163However, inquiry participants broadly recognised that, on its current formulation, the SIT is a largely subjective test, and that AFS licensees are reluctant to rely on the SIT due to its subjectivity. Interactive Brokers Australia Pty Ltd, for example, noted:
…[the] subjective wholesale investor/client test…is rarely used as it lacks the objectivity of the other wholesale investor/client tests and is subject to legal challenge by clients or disputes at the Australian Financial Complaints Authority (AFCA).
2.164The subjective character of the SIT also increases the potential for conflicts of interest given it would generally be in the interests of an AFS product issuer for an investor to be classed as a sophisticated investor and therefore be able to be sold wholesale investment products and services.[159]
2.165ASIC indicated it was concerned that the subjective nature of the tests ‘may be open to abuse, particularly in relation to complex and novel product offerings’ by AFS licensees.
2.166The committee also heard that the SIT is difficult for AFS licensees to implement at scale and exposes them to compliance risks.
Support for knowledge- and experience-based tests
2.167Notwithstanding concerns about the subjective character of the current SIT, a significant number of inquiry participants argued that, fundamentally, the current wholesale tests based on assets, income and product value are a poor proxy for financial literacy, and that these tests should be replaced by financial literacy or product knowledge tests like the SIT.
2.168SIT-style tests based on education and investment experience were regarded as more accurately identifying whether an investor should have access to wholesale markets.
2.169The Australian Shareholders’ Association, for example, supported a test based on skills and knowledge rather than financial thresholds. The submission of 360Certainty Pty Limited and Avenir Capital Pty Ltd (360Certainty) observed that ‘[w]ealth or income does not necessarily correlate with financial literacy’, and therefore recommended ‘more fundamental change’ than the proposed increases to the test thresholds:
In relation to consumers that may qualify as wholesale, we would recommend moving away from the current value-based test, net asset / income test, and the sophisticated investor tests, and to replace these with a financial literacy test.
2.170Similarly, the FAAA considered that the current wholesale and investor client tests are insufficient to protect vulnerable consumers ‘from inappropriately being misclassified as a wholesale client’ on the basis that they ‘do not adequately reflect the person’s levels of debt, tolerance to risk, capacity to lose capital, or experience and capability to understand financial matters’. However, the FAAA argued that a financial literacy or capability test to qualify a person as a wholesale client or investor should apply in addition to the existing assets, income and product value tests.
2.171In a similar vein, Morgans Financial Limited supported ‘mandatory knowledge testing for wholesale investors, alongside the existing asset or income framework, provided that the certainty and objectivity of the current tests remain for the industry’.
2.172The submission of Mr Bruce Gleeson, an individual investor, noted that the current wholesale investor and client tests effectively exclude retail investors from the more profitable investments that are available to those who can qualify as wholesale investors or clients. Mr Gleeson therefore called for the existing test that ‘discriminates between investors according to their wealth’ to be replaced with a ‘new financial literacy test’.
2.173Similarly, the submission of Wilson Asset Management (WAM), the investment manager for eight listed investment companies investing more than $5 billion on behalf of more than 130,000 retail investors, pointed to the ‘inequities of the [current] wealth-based’ tests:
…the use of wealth as a crude tool to judge investment sophistication is an anachronism in modern Australia and the proposal from ASIC would unfairly exclude a large number of educated individuals from being able to participate in capital raisings in its current form.
2.174WAM therefore recommended that the government ‘enhance’ the current arrangement, which discriminates between investors according to their wealth by:
…adding a new test of financial literacy to enable those with the relevant experience and qualifications to qualify for the test and not be excluded simply because of their wealth. This is particularly pertinent to companies that are not-listed and therefore pose greater risks for investors. For investors who fall outside of the threshold, there should be recognition of education and experience as an indication of investment sophistication. The latter will capture those who, for example, are in the profession but do not meet the income or asset tests.
2.175In contrast to views supporting knowledge-based tests for qualifying as a wholesale investor or client, the SIAA submitted that their members would be unwilling to undertake a knowledge test and that such a test would be difficult to implement across the industry.
Potential reform of the sophisticated investor test
2.176Some inquiry participants suggested reforming the SIT to remove its subjective character by introducing objective criteria, such as knowledge, training, education and relevant experience.[171]
2.177Aussie Angels, for example, suggested that a revised SIT could identify specific examples of previous experience and professional training that could meet the new criteria for knowledge, training and education.
2.178The FSC submitted that a SIT based on objective criteria would ‘encourage licensees to support section 761GA free from the fear of liability of incorrectly classifying investors’; and would ‘enhance capital flow to wholesale investment products from appropriately experienced investors’.
2.179Other suggested reforms to address potential conflicts of interest and other process and governance issues in relation to the SIT included limiting the use of the SIT to ‘AFS [licence] holders who are independent of the product issuer’, and clarifying the process that should occur if a client challenges the wholesale status of an investment.
2.180The Property Council of Australia also proposed introducing safe-harbour provisions to provide AFS licensees with protection from liability where certain objective SIT criteria were met by the person applying as a wholesale investor or client (such as the objective training or education elements above).
Accountant’s certificate for wholesale investors
2.181A qualified accountant certifies that a person satisfies the individual wealth tests under sections 708(8)(c) and 761G(7)(c) of the Corporations Act by providing a certificate confirming the person’s income or assets.
2.182As set out below, number of inquiry participants recommended changes to the current arrangements governing accountant’s certificates.
Introduction of penalties for misuse
2.183As set out above, ASIC indicated that it had identified examples of the accountant’s certificate being misused to facilitate fundraising, with company or trust structures having been used for inappropriate certification of wholesale investors.
2.184ASIC therefore recommended introducing penalties and sanctions for misuse of the accountant’s certificate for classifying wholesale investors and clients.
2.185However, the Joint Associations did not support ASIC’s proposal, warning that if penalties were implemented there would need to be significant reforms to the law around accountant’s certificates to ensure that ‘accountants, product providers, financial advisers and investors can easily understand an accountants’ obligations and responsibilities’.
Abolishing the requirement for an accountant’s certificate
2.186The Joint Associations were concerned about an apparent increased reliance on accountant’s certificates and argued that accountant’s certificates were no longer fit for purpose and should be abolished.
2.187Ms Cheryl Mack, Chief Executive Officer, Aussie Angels, observed that the requirement for an accountant’s certificate may act as a barrier for some overseas investors, particularly if they are required to find an Australian accountant to issue a certificate.
2.188In terms of alternative approaches, the committee heard that, in the US, the UK, and Canada, accountant’s certificates are not required as wholesale investors are allowed to access wholesale markets on the basis of self-declaration.
2.189In New Zealand, wholesale investors can self-certify if overseen by a lawyer, accountant or financial adviser.
2.190However, Herbert Smith Freehills did not support proposals to abolish the requirement for an accountant’s certificate. It argued that the certificate provides a clear statement as to ‘whether the investor has been confirmed to meet the net assets or gross income test, or not, and…is an efficient, binary test which provides certainty of outcome for product issuers and investors alike’.
2.191MARQ Trustees observed that individual accountants can choose whether or not to provide accountant’s certificates for wholesale investors if they have concerns.
2.192ASIC noted concerns about self-certification approaches on the basis that a ‘client may lack the experience to carry out the assessment required of their individual income and assets (particularly, if more complex joint financial arrangements exist)’, and the potential for a client to be subject to undue influence from a product issuer or another party to acquire a financial product or service.
Transferring certification requirements to advisers or product issuers
2.193The Joint Associations argued that, rather than accountants, the financial adviser or product issuer should be responsible for assessing or ensuring that a client is qualified to invest in wholesale markets. This argument was based on ‘a perception that the holding of an accountant’s certificate removes risk for the advisor or product provider and, instead, shifts that risk to accountants’.
2.194However, the FAAA opposed this recommendation on the basis that transferring the accountant certificate requirement to financial advisers ‘may increase consumer risk’ by removing a ‘separate additional professional consideration’ of a client’s circumstances. Similarly, the SIAA submitted that its members ‘consider that it is important that the accountant’s certificate is provided by an accountant who is independent of the financial services licensee’.
2.195The FAAA also noted that financial advisers have no or very restricted access to Government and other information, which limits their ability to verify client information. The FAAA considered that, should the accountant certificate requirement be transferred, financial advisers would need to be provided with access to the Australian Tax Office Portal ‘to enable them to view the client income information to be verified for certification.
2.196ASIC was also concerned by the Joint Associations’ proposal on the basis that conflicts of interest could arise due to advisers or product issuers having a financial interest in the client acquiring a particular financial product or service; and because the client would not have the benefit of an independent review of their circumstances by an accountant.
ASIC Corporations Instrument (Business Introduction) Instrument 2022/805
2.197ASIC Corporations Instrument (Business Introduction) Instrument 2022/805 (ASIC Instrument 2022/805) provides conditional relief to those involved in business introduction services from the financial product disclosure, anti-hawking and advertising requirements in the Corporations Act 2001. The instrument will lapse on 1 April 2025.
2.198The relief provided by ASIC Instrument 2022/805 allows angel groups to provide non-financial advice information to investors about interests in a registered MIS through brochures, bulletins, meetings and web platforms.
2.199ASIC indicated that ‘at this stage’ it did not intend to extend the relief provided by ASIC Instrument 2022/805 once it expires. However, it noted the government’s intention to undertake a review of the instrument prior to its expiry.
2.200However, Sydney Angels Incorporated were concerned that the expiry of ASIC Instrument 2022/805 would ‘potentially make it impossible for the majority of angel investor groups to operate in Australia’, noting that it is relied on for angel investor meetings where startups make pitches without needing to hold an AFS licence (AFSL). Sydney Angels Incorporated noted that securing a licence ‘would be an expensive and unnecessary compliance burden for associations of volunteer members that operate on not-for-profit principles’.
2.201Similarly, Mr Jordan Green AM noted that the class order is broadly relied on by angel investors in the private company investment sector, and was concerned that, if the relief is not maintained, those providing business introduction or matching services would require a financial services license. Mr Green recommended that the government should:
Provide certainty for Angel groups to operate under a self-organised, self-regulated regime that recognises they are not financial service providers and, as such, are exempt from licensing requirements.
2.202Dale Advisers also supported maintaining the relief provided by ASIC Instrument 2022/805, citing concerns about the costs of obtaining a financial services licence and the increased challenges for startups to find investors.
Committee view
The wholesale investor and client tests
2.203The committee notes that the wholesale investor and client tests play an important policy role in Australia’s investment markets. The tests ensure that only people with the appropriate level of resources, knowledge and skill are able to invest in wholesale markets, which may involve more complex and riskier investments and are subject to fewer consumer protections; and that participants in retail markets are provided with appropriate consumer protections.
2.204The operation and effectiveness of the wholesale client and investor tests have been considered in connection with a number of reviews and consultations since 2011. Most recently, in 2023, submissions to the review of the regulatory framework for managed investment schemes (the MIS review) from investment industry stakeholders revealed a broad range of views in relation to the operation of the wholesale investor and client tests.
2.205Accordingly, in light of their important function, the committee commenced its own inquiry to provide the opportunity for broad consideration and stakeholder engagement in relation to the operation of the wholesale investor and client tests.
Increasing the test thresholds
2.206The current wholesale investor and client tests in the Corporations Act each have a product value test and a separate individual wealth test. The individual wealth test is comprised of two parts: the assets test and the income test, which have prescribed financial thresholds which investors must satisfy to qualify as wholesale investors or clients.
2.207The committee notes that a number of prominent submissions to the 2023 MIS review recommended increasing the wholesale investor and client test thresholds, including the submission of ASIC, and the ASIC submission to the committee’s inquiry reiterated this recommendation. This question of whether to increase the financial thresholds for the tests was raised in a significant number of the submissions received by the committee, with many inquiry participants responding directly to ASIC’s submissions and recommendations in relation to increasing the thresholds.
Greater proportion of people meeting test thresholds
2.208The committee heard from ASIC and other proponents of increasing the test thresholds that the justification for the increase is to account for the growth in the value of assets and incomes over time, which has meant that significantly more Australians can qualify as wholesale investors or clients today (approximately 18%) than when the tests were first introduced (approximately 2%).
2.209The committee notes in this regard that the case for increasing the wholesale investor and client test thresholds is based almost wholly on the observed effects of inflation having increased the potential pool of wholesale investors and clients over time. However, while this increase may raise a prima facie case for change, the committee considers that there is a lack of evidence showing that this increase to the potential pool of wholesale investors has in fact led to any significant or systematic harm to particular classes of investors, or to the Australian investment industry more generally. Put simply, the committee considers that proponents for increasing the test thresholds have not identified any specific mischief which would be addressed by increasing the potential pool of wholesale investors in Australia.
Lack of evidence of harm arising from current test thresholds
Examples cited by ASIC
2.210In this regard, during the inquiry, the committee was not persuaded by the examples of investor harm identified by ASIC and other submitters as having been caused by the current settings of the test thresholds.
2.211First, the fact that so few examples were able to be cited did not provide sufficient evidence of significant or systemic harm arising from the current settings of the test thresholds per se. The committee considers that the paucity of examples in fact tends to support the view that the current test thresholds settings remain appropriate, notwithstanding the greater proportion of people meeting the test thresholds (see paragraph 2.216 below).
2.212Second, legitimate questions were raised regarding the relevance and extent to which the few examples cited actually demonstrated problems with the current test threshold settings. The committee considers that the examples provided were not in fact related to problems arising from inexperienced or unsophisticated investors being incorrectly classified due to the effect of inflation on the test thresholds and suffering losses in connection with wholesale investments. In fact, these examples merely demonstrate a number of individual instances of incorrect and fraudulent classification of investors, in many cases involving retail rather than wholesale investors.
2.213The committee notes that increasing the test thresholds would have no impact on deliberately fraudulent misclassification of investors or on the regulation and effectiveness of consumer protections in the retail investment market.
2.214Similarly, the committee was not persuaded by prima facie arguments that, relative to when the tests were first introduced, simply because the proportion of Australians that can qualify as wholesale investors has increased due to inflation there must therefore be a cohort of wholesale investors who are vulnerable and therefore unqualified to participate in wholesale markets.
2.215The committee notes that this proposition is not supported by any analysis based on the reasons for setting the test thresholds at their original levels in 2001, and inquiry participants pointed to a number of considerations supporting the view that the proportion of Australians able to qualify as wholesale investors or clients in 2024 is appropriate, notwithstanding the growth in that cohort due to the effects of inflation.
2.216These considerations include the increased financial sophistication of Australians due to higher levels of tertiary education, better access to information and financial advice and increased individual net worth and involvement in management of personal financial affairs.
Potentially negative impacts of increasing the test thresholds
2.217In this regard, the evidence to the inquiry suggested some significant negative impacts that could arise from increasing the test thresholds, and that a high level of caution in relation to increasing the test thresholds is desirable.
2.218Inquiry participants were concerned that, by reducing the pool of available wholesale investors and clients, increasing the test thresholds would generally increase the risk to investors by reducing their ability to diversify and reduce levels of innovation and competition in Australia’s financial services industry.
2.219More particularly, the committee heard that increasing the test thresholds would be disruptive to established funds and investors, to the extent that significant numbers of investors currently operating as wholesale investors would be reclassified as retail investors. Reducing the pool of available wholesale investors and clients would also impact negatively on foreign investment; angel and venture capital investment; other specific groups such as women and young investors; and on specific investor groups.
2.220The committee notes that proponents of increasing the test thresholds generally proposed some form of ongoing indexation to account for the effects of inflation over time, and inquiry participants also raised significant practical concerns about the potential for indexation to increase complexity for investors, leading to distortion of investment decisions and inadvertent noncompliance.
2.221The committee considers that that these significant potential negative impacts of raising the test thresholds were demonstrated by the example of a similar proposal in the UK, which was implemented and, subsequently, quickly reversed in 2023. This example from a comparable jurisdiction shows that particular concerns about the impact of raising the test thresholds on angel and capital investors deserve serious attention before any such changes are introduced in Australia.
2.222A number of inquiry participants raised the UK experience in pointing to the need for meaningful consultation with industry if a government in future determines to proceed with increasing the test thresholds. The committee strongly agrees with industry stakeholders on the need for extensive consultation should any such proposal be pursued in future.
2.223In this regard, the committee notes the evidence of ASIC that it did not, despite recommending that the test thresholds be increased, conduct any external consultation to consider stakeholders’ views on the potential harms and benefits to industry of increasing the test thresholds. The committee considers that, as the chief regulatory body for Australia’s financial system, it is incumbent on ASIC to ensure that its significant policy recommendations are underpinned by appropriate research, including meaningful consultation with industry stakeholders.
2.224The committee considers that, while a case for raising the test thresholds has not been established at this time, the inquiry has demonstrated a need for consideration as to the most appropriate mechanism for periodically reviewing the operation of the wholesale investor and client tests, including the settings of the relevant thresholds.
2.225Given the potential impacts of any change to the wholesale investor and client tests on Australia’s investment industry, the committee considers that any such mechanism should include a mandatory requirement for industry engagement and consultation.
2.226That the government consider establishing a mechanism for periodic review of the operation of the wholesale investor and client tests; and that any such mechanism include mandatory requirements for engagement and consultation with Australia's investment industry.
Sophisticated investor test
2.227The committee notes that there was significant stakeholder interest in reform of the sophisticated investor test (SIT), on the basis that it could provide a robust alternative to the wholesale investor and client tests based on product value and individual income and assets thresholds.
2.228The committee heard that the SIT is currently underutilised as an alternative means of qualifying for access to wholesale investment products and services. This is because its subjective character means that AFS licensees are reluctant to qualify investors using the SIT as they may be liable if the SIT is found to have been wrongly issued. Equally, the subjective character of the SIT means that it may increase the potential for conflicts of interest where an issuer has a financial interest in an investor qualifying as a wholesale investor or client.
2.229The committee accepts the view that it is important that a knowledge- and experience-based test is available, as an alternative to product value and individual income and assets tests, for individuals to be able to qualify as wholesale investors and clients in Australia. As long as they are based on reasonably objective criteria, the committee notes that SIT-style tests can provide a more accurate assessment of a person’s capacity to participate in financial markets as a wholesale investor and client.
2.230The committee therefore considers that the Corporations Act 2001 should be amended to introduce objective criteria to the SIT. This will ensure that potential wholesale investors are not unfairly or arbitrarily excluded from wholesale markets, and thereby promote participation in, and the flow of capital to, Australia’s wholesale markets.
2.231Given the potential importance of a revised SIT to the wholesale-retail client distinction, the committee considers that the government should ensure that the proposed amendments to the Corporations Act 2001 are subject to consultation prior to being introduced to the parliament.
2.232That, subject to a period of stakeholder consultation, the government amend the Corporations Act 2001 to remove the subjective elements of the sophisticated investor test and introduce objective criteria relating to the knowledge and experience of the investor.
Other proposals for reform
2.233The committee notes that the inquiry received a range of other suggestions for reforms that were broadly related to the inquiry’s terms of reference.
2.234These proposals included suggestions concerning the current requirements for accountant’s certificates for wholesale investors and clients, and the operation of the current legislative instrument relating to business introduction services, which is due to expire on 1 April 2025.
2.235The committee did not reach any conclusive view or recommendations on these matters. However, the committee acknowledges that the issues identified raise significant policy considerations for government, and therefore encourages the government to consider whether there is a need for a broader review of the legislation regulating wholesale and retail investors and the financial markets more broadly. The committee considers that any such review could build on significant previous inquiries, such as the Australian Law Reform Commission’s Review of the legislative framework for corporations and financial services regulation and the Quality of Advice Review, and the independent 2022 Quality of advice review, conducted by Michelle Levy.
Senator Deborah O’Neill
Chair
Labor Senator for New South Wales