Material adverse clauses
Material adverse change clauses (MAC clauses) are frequently used in public and private company finance transactions. They are contractual attempts to allocate the risks to a lender arising from unexpected events that may significantly impact on a borrower's business and, consequently, its ability to repay the loan. Whether an event such as COVID-19 could be considered to result in a material adverse change (MAC) for a particular borrower would require an analysis of the financial impact of that event on the borrower, and an analysis of the particular MAC clause.
A sample definition of a MAC might be:
“a material adverse effect on:
(a) the business, operation, property, condition (financial or otherwise) or prospects of any Obligor;
(b) the ability of any Obligor to perform its obligations under the Finance Documents”
Depending on the transaction in question and the nature and form of the clause, MAC clauses may be structured:
- so as to result in a default, which triggers an obligation to repay the financial accommodation; or
- so as to entitle the lender to refuse to make the initial advance or further advances.
Reliance by a lender on a MAC clause can be difficult for lenders and create risk for the lender. MAC clauses are generally construed quite strictly because of the potential for damage that may result from calling a MAC event without proper justification, potentially resulting in a borrower being unable to meet its obligations for which the financing was required or even sending a borrower into insolvency.
What is "materially adverse", and when it is justified to call such an event, can vary greatly from borrower to borrower and will depend greatly on the circumstances in which each individual borrower finds itself.
By way of example, in Grupo Hotelero Urvasco SA v Carey Value Added SL  EWHC 1039, the English High Court held that in order to be "materially adverse", the change needs to "significantly" affect the borrower's ability to perform its obligations under the loan documents, in particular its ability to repay the loan. The Court emphasised "significantly", stating that any other interpretation may allow the lender to call a default or suspend lending when the borrower's financial condition does not fully justify it, propelling the borrower into insolvency.
What is "materially adverse", and when it is justified to call such an event, can vary greatly from borrower to borrower and will depend greatly on the circumstances in which each individual borrower finds itself. It also depends on the content of the MAC clause, which must be individually considered in each case. Looking at the above clause, for example, the word “prospects” is not always included. If it is included, then it would be easier for a lender to look to the impact of the event in future periods; without it, a lender would typically need to focus on the impact the event had already had. In each case though, a lender which had already advanced money might adopt the less risky position of waiting to see whether the actual outcome of the event is a breach of an obligation under the financing. A lender which only had a future commitment to lend money (for example for a transaction) might adopt a view that there had been a sufficient adverse change so as to warrant refusing to risk any new money with the borrower.
As an aside, it is worth noting that “force majeure” is not typically a defence for a borrower failing to satisfy its obligations or meet its financial covenants under its financing arrangements.
Council of Financial Regulators
Financial services organisations play a critical role in the economy and, consistent with that, the Council of Financial Regulators, with the Government, is working with the objective of ensuring that, notwithstanding COVID-19 related disruptions, financial markets are operating effectively and that credit is available to households and businesses.
Consistent with that, the CFR has indicated that:
- It is examining how the timing of regulatory initiatives might be adjusted to allow financial services organisations to concentrate on their business and assist customers. This is a welcome development, given the plethora of upcoming regulatory initiatives. Any such adjustments will need to look not just at the short term, but also the medium and longer term.
- ASIC and APRA have indicated a willingness to deal with problems financial services organisations may encounter in complying with the law due to the impact of COVID-19. They have indicated that they will, where warranted, provide relief or waivers from regulatory requirements including, for example, those on listed companies associated with secondary capital raisings, annual general meetings and audits.
- ASIC will work with financial institutions to further accelerate the payment of outstanding remediation to customers as soon as possible. Financial services organisations should give consideration as to how remediation may be able to be accelerated in these circumstances.
- There is an emphasis on the importance of a continuing supply of credit, particularly to small business. To that end, the Council of Financial Regulators will be discussing with lenders whether there are impediments to lending that financial regulators could help address.
The Australian Prudential Regulation Authority has:
- suspended the majority of its planned policy and supervision initiatives in response to the impact of COVID-19 (including its program to replace APRA’s Direct to APRA (D2A) data collection tool, which will be delayed for at least 6 months); and
- announced new commencement dates for six prudential and reporting standards that have been finalised but are yet to fully come into effect.
The decision is intended to allow APRA-regulated entities to dedicate time and resources to maintaining their operations and supporting customers, while also enabling APRA to intensify its focus on monitoring and responding to the impact of a rapidly changing environment on entities’ financial and operational capacity. There are also new commencement dates for six standards that have been finalised (but have not yet come into effect):
- CPS 226 Margining and risk mitigation for non-centrally cleared derivatives has been postponed by 1 year;
- CPS 234 Information Security (third-party arrangements transition provision) had an initial commencement date of 1 July 2020 but now six month extension to 1 January 2021 are available on a case-by-case basis;
- APS 220 Credit Risk Management has been postponed by 1 year;
- APS 222 Associations with Related Entities and related ARS 222.0 Exposures to Related Entities and ARS 222.2 Exposures to Related Entities – Step-in risk have been postponed by 1 year, but APRA says that in the interim, ADIs should not be actively increasing exposures to their overseas banking and insurance subsidiaries without prior consultation.
Changes to reporting obligations
On 1 April 2020, the three agencies APRA, the Reserve Bank of Australia and the Australian Bureau of Statistics announced changes to the reporting obligations of ADIs and RFCs. These changes are intended to balance the need for entities to dedicate time and resources to maintaining their operations and supporting customers, against the increased need for timely, accurate data for use in the rapidly changing environment.
Changes to due dates for quarterly reporting
In November 2019, APRA consulted on standardising the due dates for all quarterly reporting forms. APRA implemented this proposal on 1 April 2020 in the form of a temporary extension to reporting due dates, and expanded the proposal to cover all quarterly reporting by ADIs and RFCs. Forms that were previously due prior to the 35th calendar day will now be due on the 35th calendar day. Forms that were due after the 35th calendar day will continue to be due on the existing due date.
APRA, in consultation with the ABS and RBA, has decided to not grant any further blanket extensions to reporting due dates, nor to relax the governance requirements applying to reporting to APRA. APRA has stated that the data reported by ADIs and RFCs is essential for prudential supervision, for the monitoring of financial stability, the formulation of monetary policy, and to support Government policy and that the provision of timely, accurate information is vital, especially in this period of volatility.
Deferral of certain new reporting standards including for derivatives
Given the current operating environment, the agencies (APRA, RBA and ABS) have deferred the implementation of a proposed reporting standard relating to derivatives (Reporting Standard ARS 722.0), which would be used to collect quarterly data on the derivatives activity of ADIs and RFCs whose gross derivatives position is great than or equal to $1.5 billion.. This standard will apply to reporting periods ending on or after 31 March 2021. All ADIs and RFCs are exempt from reporting for periods prior to this date.
Continuation of certain parallel reporting for ADIs and RFCs
APRA stated it its letter of 20 March 2020 that it expects ADIs and RFCs to continue reporting the data that were required in:
- Reporting Standards ARS 331.0 Selected Revenues and Expenses (ARS 331.0);
- RRS 331.0 Selected Revenue and Expenses (RRS 331.0); and
- the ABS Quarterly Business Indicators Survey (QBIS).
The agencies (APRA, the RBA and ABS) had previously advised that the parallel run for these standards would end for the December 2019 quarter.
The agencies have revised their decision in order to maintain a consistent data source for the March and June 2020 quarters during the current period of uncertainty, and to capture the impact of COVID-19.
APRA will therefore temporarily reinstate ARS 331.0 and RRS 331.0, and require ADIs and RFCs to continue to report these forms for reporting periods ending on or before 30 June 2020. The due date will be extended to the 40th calendar day after the end of the reporting period, and APRA will accept this reporting on a best endeavours basis.
Reporting of QBIS will continue via the ABS. If required, data may be reported via telephone on 1800 642 149. The due date for QBIS reporting has been extended to 28 April 2020 and 28 July 2020, for March and June quarter reporting respectively.
Extension of timelines for notifications under BEAR
APRA has exercised power under the Banking Act 1959 to replace the 14 day period for notification of changes to accountability statements and maps with a 30 day period. The legislative instrument changing the period took effect from Monday 6 April 2020. Where changes to statements and maps occurred in the 14 day period prior to 31 March 2020, notification will be accepted by APRA as compliant if provided within 30 days of the change occurring.
New reporting standard for Government’s SME guarantee scheme
The Government has introduced the Coronavirus Small and Medium Enterprises Guarantee Scheme, which is designed to support up to $40 billion of lending to SMEs. Under the Scheme, the Government will guarantee 50% of new loans issued by eligible lenders.
In connection with this Scheme, APRA has released Reporting standard ARS 920.0 that must be completed weekly by all lenders that are approved under the scheme. APRA’s new reporting standard will support the scheme by providing data to Government on key metrics including number of loans approved, number of loans impaired, and number of guarantee claims made and paid. The first data collection is due on 1 May for information as at 17 April 2020.
Anti-money laundering and counter-terrorism financing
Compliance reports for 2019 were due to be submitted to AUSTRAC by 31 March 2020. AUSTRAC announced that it will be accepting compliance reports for 2019 until 30 June 2020, without risk of compliance action.
$15 Billion Structured Finance Support (COVID-19 Economic Response) Fund (SFSF)
The Structured Finance Support Fund's aim is to ensure continued access to funding markets impacted by the economic effects of COVID-19, and mitigate its impacts on competition in consumer and business lending markets. It will be in place for 12 months.
While ADIs and non-ADIs may receive investment, the intention is to support small lenders. To access the SFSF, smaller lenders need to access their finance through securitisation.
The focus will be to invest in securitised loans written by smaller lenders to support their ability to continue to issue new loans and obtain funding from markets at a competitive price. It is intended to support those lenders who don’t have access to the RBA's $90 billion fund – small ADIs who can't provide acceptable collateral required by the fund and non-ADIs.
Initial capacity of the fund will be $15 billion, which however may be increased, and it will be managed by the Australian Office of Financial Management (AOFM).
It will apply to all asset classes, not just RMBS, but the debt securities cannot be first loss securities. The AOFM will be able to purchase authorised debt securities that support a range of small business and consumer lending activities including credit cards, automobiles and personal loans.
AOFM must prioritise the following investments:
- those that provide support to smaller lenders that have lost access to reasonable price funding due to the economic effects of COVID-19;
- investments that maintain and encourage investment by the private sector in a securitisation market for smaller lenders;
- investments that are likely to promote competition in the securitisation market for smaller lenders;
- investments that are structured so they do not restrict renegotiation by small lenders and debtors of payment arrangements and allow smaller lenders to provide forbearance to debtors in respect of payments under contracts for credit;
- investments that do not adversely affect the capacity of small lenders to provide credit.
The AOFM will consider: an applicant's ability to access reasonably priced credit, investments that maintain and encourage investment by the private sector in the securitisation market for smaller lenders, and investments that are likely to promote competition in the securitisation market for smaller lenders.
The AOFM may invest in rated term securitisations in the primary market, and rated and unrated financing of securitisation warehouses. Therefore it is not limited to AAA investments only.
The AOFM will be permitted to directly invest in authorised debt securities, ie. a debt security that:
- is issued by a Trustee of a Trust of Body Corporate that is a special purpose vehicle;
- is in Australian dollars;
- relates to one of more amounts of credit;
- complies with requirements/restrictions prescribed by rules – ie. the Minister has the flexibility to change the types of investments permitted to be made;
- will allow direct investment in primary market securitisations and warehouse for finance of broad range of lending and mortgage, consumer and business lending. Not limited to residential mortgages and assets may include asset backed financing and SME lending (secured and unsecured) and consumer lending (including credit cards, cars and personal loans).
$90 Billion RBA Term Funding Facility
The RBA is establishing a $90 billion facility to ADIs, with the objectives of:
- reducing funding costs of ADIs, helping to reduce interest rates for borrowers;
- encouraging ADIs to support businesses by providing access to low cost funding. Whilst the scheme encourages lending to all business, the incentives are stronger for SMEs.
The facility has:
- a fixed interest rate of 25bps;
- a 3 year term;
- an aggregate limit of at least $90 billion across all participants;
- interest due at maturity.
There are restrictions on total initial drawings (Funding Allowance) – equal to 3% of a participant's total credit outstanding to Australian resident households and (non-related) businesses, measured as the average of the participant's total credit in the 3 months ending 31 January 2020. There is also an additional allowance designed to incentivise SME lending.
Funding will be available by way of repurchase transactions.
It will be open to all ADIs, but an ADI must be able to deliver eligible collateral to the RBA in order to use the facility, meaning it must be a member of the Reserve Bank information and Transfer System (RITS) and Austraclear. Eligible collateral will consist of all collateral currently eligible for the RBA's domestic market operations.
The facility is expected to begin taking drawdowns no later than 16 April 2020 and participants will be able to draw down the initial allowance until the end of September 2020 and an additional allowance by 31 January 2021.
In this regard, APRA has been contacting regional and smaller ADIs and recommending that they increase the size of their self-securitisations (repo securitisations), or that they put such structures in place to take advantage of the repurchase arrangements with the RBA.
Australian Business Securitisation Fund (ABSF)
The ABSF was established on 6 April 2019 and is administered by the AOFM. Originally it was to invest up to $2 billion in warehousing and the securitisation market, providing significant additional funding to smaller Banks and non-Bank lenders to on-lend to small business on low competitive terms.
Through the ABFS, the AOFM:
- funds new and existing warehouse facilities for SME loans alongside the private sector;
- buys and holds securitised SME loans in order to support segments of the market where there are identifiable gaps.
The AOFM called for proposals for the first round of ABS investments on 16 December 2019.
Short listed proponents of the first round were advised their proposals would be automatically considered for investment by the SFSF.
AOFM intended to announce a call for second round proposals prior to 1 July 2020. However it now intends to make an assessment of market conditions in early July 2020 before proceeding. SFSF has flexibility within its mandate to accommodate proposals that would be within the scope of ABSF.
Small Business Loan Guarantee Support Scheme
The Small Business Loan Guarantee Support Scheme is designed to support up to $40 billion of lending to SMEs. Under the Scheme, the Government will guarantee 50% of new loans issued by eligible lenders.
It is available for new loans to eligible lenders until 30 September 2020. The product can't be a credit card and a borrower can only access the Scheme via one lender.
Eligibility criteria include SMEs with a turnover of up to $50 million in the previous and likely in the current financial year, unsecured loans up to maximum of $250,000 per borrower (although can be a personal/director guarantee), up to 3 year term with 6 month repayment holiday to support up to $40 billion of lending to SMEs.
While a lender can submit an expression of interest at any time, the initial allocation may be made having regard to expressions of interest received by 1 April 2020.
It is open to bank and non-bank lenders but it is unlikely to be granted to lenders with less than $50 million in assets and/or limited SME lending experience.
Responsible lending relief for consumer loans used partly for small business
The National Consumer Credit Protection Amendment (COVID-19 Economic Response Package) Regulations 2020 temporarily exempt Australian credit licensees from certain responsible lending obligations in order to facilitate the flow of credit to small businesses.
The regulations provides relief in relation to loans predominantly for personal, domestic or household purposes, or to buy or refinance residential investment property (ie. a consumer loan) but where the loan is also partly to be used for business purposes. This is primarily an issue for smaller business (e.g. sole traders) where funds under a facility may be used for personal and business purposes. It effectively suspends the obligation to do a responsible lending assessment on the consumer loan (ie. incomings verses outgoings to check the loan is suitable), which would otherwise be required if the credit limit was increased or a new credit contract entered into. It also applies in relation to consumer leases.
Australian Bankers Association (ABA) Package for Small Business Relief
Under the package, certain Australian banks will defer loan repayments for small businesses affected by COVID-19 for 6 months.
Threshold for total business loan facilities that could be deferred is up to $10 million.
Borrowers such as commercial landlords can access financial support provided they agree not to terminate leases or evict current tenants for rent arrears due to COVID-19.
The banks have also agreed not to enforce business loans for non-financial breaches of loan contract.
The conditions are:
- borrowers must advise that their businesses have been affected by COVID-19;
- borrower must be current in terms of existing facilities in the 90 days prior;
- commercial property landlords must not terminate leases or evict current tenants for rent arrears as a result of COVID-19 during the 6 months repayment deferral period;
- interest is capitalised.
There is also relief for consumer borrowers (for home loans, consisting of repayment deferral between 3-6 months).
This has had wide publicity and borrowers are approaching other lenders not covered by it seeking same/similar relief.
The consequences for lenders (including whether the loans are in arrears and the impact, for example under any third part agreements) need to be considered.
For banks there is also the impact on capital – APRA (the prudential regulator) has indicated that for loans that were in order but where the borrower takes the deferral offer, these loans do not need to be treated as in arrears as a result of the deferral and do not need to be regarded as restructured.
Coronavirus SME Guarantee Scheme
The Coronavirus Small and Medium Enterprises (SME) Guarantee Scheme is designed to support up to $40 billion of lending to SMEs. Under the Scheme, the Government will guarantee 50% of new loans issued by eligible lenders.
It is available for new loans to eligible lenders until 30 September 2020 (in addition to other eligibility criteria). The product can't be a credit card and a borrower must be a SME (which is an entity as prescribed by the legislative rules made by the Minister) and each borrower can only access the Scheme via one lender.
Eligibility criteria for loans include that the loans are unsecured and up to maximum of $250,000 per borrower (although can be a personal/director guarantee), with an up to 3 year term.
While a lender can submit an expression of interest at any time, the initial allocation may be made having regard to expressions of interest received by 1 April 2020.
It is open to bank and non-bank lenders but it is unlikely to be granted to lenders with less than $50 million in assets and/or limited SME lending experience.
Reporting standard ARS 920.0 Australian Government Small and Medium Enterprise (SME) Guarantee Scheme must be completed weekly by all lenders that are approved under the scheme. APRA’s new reporting standard will support the scheme by providing data to Government on key metrics including number of loans approved, number of loans impaired, and number of guarantee claims made and paid. The first data collection is due on 1 May for information as at 17 April 2020.
A reporting form prepared by APRA is required to be provided by each participating lender in respect of each Scheme-backed loan (as set out in Schedules 1 and 2 of the Scheme Rules).
ASIC wrote to the funds management industry in mid-March 2020, reminding responsible entities of their various obligations, including the need to actively monitor redemption levels, review redemption terms, monitor the valuation of scheme property and actively assess the liquidity status of schemes. This letter was shortly followed by a joint letter from APRA and ASIC to superannuation trustees in early April 2020. The joint letter contains advice for superannuation trustees on how to manage the challenges they might face as a result of COVID-19, while at the same time continuing to meet their duties and obligations to members, many of which are set out in extensive APRA guidance. The result is that superannuation trustees will be put to the test: they must determine whether their liquidity management and asset allocations remain appropriate while having to consider matters such as appropriate valuations and member switches and withdrawals.
The joint letter notes that liquidity has been one of the primary areas of regulatory focus in recent weeks. The global sell-off in equities has resulted in many members switching their retirement savings into cash. Meanwhile, the recent announcement by the Government to allow some individuals early access of up to $20,000 of their superannuation savings has placed added liquidity stress on funds, particularly those funds whose membership comprises a large number of members employed on a part-time or casual basis. Further, funds are seeing an increase in compassionate payment and financial hardship applications, which continue to apply.
Adding to the liquidity issues faced by superannuation funds are those funds with a homogenous membership base heavily exposed to industries which are currently facing the biggest economic pressure and so have ceased receiving superannuation contributions (for example, hospitality or retail) and those superannuation funds that have a high level of concentration in unlisted assets such as infrastructure, property, private equity, structured credit and alternatives.
What superannuation trustees need to do
Unsurprisingly then, in their joint letter to industry, APRA and ASIC advised that liquidity must be a top priority for trustees. According to APRA and ASIC, superannuation trustees should be:
- undertaking regular and detailed liquidity stress-testing, ensuring that scenarios reflect changes in future net cash flows of the superannuation fund, member behaviour and market conditions;
- identifying areas where that could give rise to increased liquidity risk and addressing them, including increased member switching or deterioration in the liquidity profile of investments;
- determining whether liquidity issues could impact their liabilities or contractual arrangements, such as currency hedging programs, and reviewing their securities lending arrangements; and
- ensuring that valuations of unlisted and illiquid assets remain appropriate and considering whether any assets need to be revalued.
Liquidity is regularly a key concern for superannuation trustee and is not a new obligation (although COVID-19 has certainly put a spotlight on its importance, particularly when markets are not behaving as usual). For example, superannuation trustees are required to comply with the "investment covenant" in section 52(6) of the SIS Act, which requires superannuation trustees to formulate, review regularly and give effect to an investment strategy which has regard to, amongst other things, the liquidity of the investments covered by the strategy (in light of expected cash flow requirements in relation to the superannuation fund). This covenant is also supported by APRA Prudential Standard and Guide 530: Investment Governance which sets out APRA's expectations regarding a number of investment governance matters including liquidity management. In particular, SPG 530.168 notes that:
"APRA expects a prudent RSE licensee to have a substantial understanding of the liquidity of its investment options. In particular, APRA considers that a prudent RSE licensee would have an awareness of the potential for an investment option to become illiquid in adverse circumstances, how this might affect the value of the investment option and the RSE licensee’s ability to meet portability and benefit payments obligations in such circumstances. This would cover liquidity monitoring arrangements that assess the impact of market conditions or events on relevant liquidity positions."
APRA Prudential Practice Guide 233: Pandemic Planning also considers the impact of a pandemic on fund liquidity.
In terms of fund valuations, this is particularly interesting, in an environment where unlisted (illiquid) assets are not valued regularly and are often difficult to value. The impact of not having appropriate valuations however is significant, having regard to the fact that members could be switching, exiting or withdrawing and taking excess value with them (leaving remaining members with not enough value). The SIS Act caters for this, in that section 155 of the SIS Act imposes restrictions on a trustee from redeeming an interest in a superannuation fund, other than at a price that is fair and reasonable as between the redeeming member and the beneficiaries. This would likely mean that until a trustee has appropriate valuations, switches, exits and withdrawals would not be facilitated.
Superannuation trustees will also be concerned with ensuring compliance with APRA Prudent Guide 531: Valuation which specifically notes in respect of the valuation of unlisted investments, APRA expects superannuation trustees to consider whether there have been any material changes or other factors that may have caused or are causing the existing valuation of an unlisted investment to now be in appropriate, and undertake a valuation to determine a more appropriate value.
Communications with members
While superannuation trustees consider what action they need to take in the current COVID-19 environment, the joint letter reminded trustees of the need to communicate clearly with members. Both Regulators stated that the ability for trustees to respond promptly and accurately to members' questions should be a key operational focus for them and subject to ongoing monitoring and adjustment.
Beyond this however, trustees must be mindful of what representations they have made to members including in any Product Disclosure Statements (PDS), to ensure that the information in those documents remain up to date and appropriate. In particular, information contained in PDSs relating to risk disclosure, liquidity, asset allocation and fees should be carefully considered, and may be out of date following the impacts of COVID-19. In respect of the latter, an increase in transaction activity may lead to a material increase in fees and costs, including buy / sell spread which will need to be considered in the context of the current PDS disclosure (and may require updating / notification to members).
Managed investment funds
As a baseline, a PDS must be up to date at the time it is given and must not otherwise be "defective" under the Corporations Act 2001 (Cth). At this stage of COVID-19, some of the relevant sections that issuers should be focusing on, and possibly updating, include significant risks, underlying assumptions, liquidity and redemptions, asset allocations and fees and costs. Of course, issuers need to continually be mindful of how the changing landscape of COVID-19 may continue to impact the information provided to investors, as well as the impact it may have on scheme assets, and the responsible entity itself, and continually monitor and update investors as appropriate.
Of course, for any newly issued PDSs, or PDSs which are reissued during this period, careful consideration of how the product is likely to perform during a COVID-19 environment (having regard to the underlying assumptions made), and appropriate COVID-19 risk disclosure should, as a minimum, be considered and disclosed appropriately.
Examples of matters which may require updating
Significant risks disclosure
We envisage that issuers will need to carefully consider the current risk disclosure made to investors. If, for example, it is anticipated that a scheme's expected earnings will be affected as a result of COVID-19, or the scheme is not expected to perform the way it was intended, issuers should consider whether further risk disclosure is required for investors. For example, issuers of interests in property schemes may need to consider whether the inability of tenants to pay rent will impact the scheme earnings, equity based schemes may need to disclose valuation issues where the underlying stocks the schemes invest in have been suspended from trading and schemes that have a high exposure to the travel or retail industry would need to consider the impact on its earnings.
Issuers should also consider whether a specific COVID-19 risk disclosure should be made to investors which would be similar in nature to the "GFC disclosure" we saw in the previous economic global financial crisis. In this regard, we imagine a generic disclosure that COVID-19 is rapidly changing, it may have a significant impact on the way the scheme performs and the fact that at this stage, it is difficult to ascertain what the impact may be, may be appropriate.
Liquidity and withdrawals
A managed investment scheme that is "liquid" (for the purposes of the Act) may as a result of COVID-19, no longer be. This will impact a scheme's ability to continue to offer withdrawals from the scheme as well as any disclosure made in the PDS regarding the liquidity of the scheme and an investor's ability to withdraw. By way of background, a scheme is "liquid" if "liquid assets" account for at least 80% of the scheme property (where "liquid assets" are, broadly speaking, assets that the responsible entity reasonably expects can be realised for their market value within the period specified in the scheme's constitution for satisfying withdrawal requests (which may be 21 days or more or less, depending on the nature of the assets)).
The liquid nature of a scheme may be impacted by a number of items. For example, where it is believed that the number of withdrawals from a product are likely to increase as a result of COVID-19's market impact to such an extent as to impact the liquidity of the scheme, issuers should consider what changes ought to be made to liquidity references contained in its PDSs (particularly around how liquidity issues are managed, including suspension triggers). This was picked up recently in the letter ASIC sent to industry, where ASIC reminded responsible entities that they have a duty to continue to actively monitor the levels of withdrawals and applications and consider whether these are consistent with the liquidity of the underlying assets of the scheme. Of importance, ASIC reminded responsible entities that in assessing the liquidity of the scheme, it needed to consider both the short term and whether the scheme will remain liquid in the longer term to meet future withdrawal requests.
Of course, in circumstances where COVID-19 may have impacted the ability to value scheme assets or to realise scheme assets, this may have a similar impact on a scheme's liquidity. Such impact may also mean that unit pricing may be suspended (which will impact the ability to process withdrawal requests).
Issuers will also need to consider how withdrawals (and unit pricing) have been described in PDSs and whether there is any need to further update this disclosure so investors understand the risk that the scheme may need to suspend withdrawals (or the calculation of unit prices) in response to COVID-19 (subject of course to the scheme constitution providing an appropriate mechanism for such suspension). As an aside, responsible entities should consider whether ASIC's powers to grant hardship relief to investors where withdrawals have been suspended or a scheme otherwise becomes non-liquid is appropriate, which we discuss further below.
Fees and costs section
Given the current market volatility, it is not surprising that schemes are incurring significantly increased trading activity. This is also the case as issuers sell assets to fund liquidity for investors seeking to redeem their investment. This increase in activity may mean that schemes are bearing higher transactional and operational costs, which may impact the current buy / sell spread disclosure made to investors. Of course, if an issuer becomes aware that any fees or cost estimates (including the indirect cost ratio) disclosed in the PDS are no longer accurate, it will need to consider the materiality of such changes, how the amounts are described in the PDS (in particular, the buy / sell spread) and whether it is required to update the relevant amounts stated in the PDS.
Asset allocation statements
Issuers should also take care when altering asset allocations to offset exposure to riskier asset classes and only do so in line with the allocations specified in the PDS. If an issuer is required to make investments outside the specified allocation, then it should consider amending its PDS first (assuming of course, the PDS has not otherwise given it the flexibility to move outside the relevant allocations).
Issuers should also consider the impact that COVID-19 may have had (and may continue to have) on any assumptions made in terms of a product's performance. As such, to the extent that any underlying assumptions are now outdated or do not otherwise consider the impact of COVID-19 (or a pandemic generally), then to the extent issuers are able to reasonably estimate the impact, such economic forecasts (and other financial information) should be updated to take into account this impact.
Mechanisms for updating a PDS
Once an issuer has identified the information that needs to be updated, consideration will also need to be given as to the mechanism for updating the PDS.
The quality and nature of the update will need to be weighed against the criteria for updating a PDS via a website. Where the relevant updates include materially adverse information to investors, issuers will need to consider replacing the PDS or issuing a supplementary PDS. Of course, issuers of shorter PDSs will not be able to issue a supplementary PDS and will either need to issue a new shorter PDS or be comfortable that the updated information properly sits within the relevant incorporated by reference materials.
When issuing a supplementary PDS, issuers should also ensure that they can readily identify those applications that are made after the issued date of the supplementary PDS so as to be comfortable that the applicant has received the supplementary PDS.
In addition to updating PDSs, issuers may also need to issue a significant event notice (SEN) to product holders. A SEN should be issued where there has been a significant event affecting a matter, being a matter that would have been required to be disclosed in a PDS if the PDS had been prepared the day before the event occurred. The SEN must include all information that is reasonably necessary for a product holder to understand the nature and effect of the event. If the change is an increase in fees, then the SEN needs to be issued 30 days before the change takes place. Issuers should of course also consider their continuous disclosure obligations (as they apply to ED securities) where the SEN requirements do not apply to its products.
Additional requirements for listed funds
Responsible entities of listed registered schemes will also need to consider any additional disclosures to the market. Under ASX Listing Rule 3.1, once an entity becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the entity's share price, the entity must immediately disclose that information to the ASX.
ASIC relief for "frozen" funds
Responsible entities which find themselves in the position of suspending withdrawals or otherwise declaring a scheme as non-liquid should consider ASIC's powers to grant hardship relief to investors. A responsible entity may apply to ASIC seeking relief from the withdrawal provisions and equal treatment provisions under the Act to facilitate partial investor access to funds in cases of hardship. The criteria for hardship includes:
- severe financial hardship;
- unemployment; or
- compassionate grounds, which includes investors requiring access to funds in order to help pay for medical costs or funeral expenses.
ASIC can also provide relief to responsible entities of non-liquid schemes by allowing them to implement a 12-month "rolling" withdrawal offer. The "rolling" withdrawal offer generally will apply for one calendar year and apply to all withdrawal opportunities during that year.