10 Nov 2011

New financial requirement for responsible entities

by Matthew Daley, Matt Anderson

The net tangible assets requirement has been significantly increased.

Following some high-profile collapses of responsible entities of managed investment schemes in the wake of the global financial crisis, ASIC has been reviewing the financial requirements which apply to responsible entities. ASIC has now finalised new requirements, in the first major change to this part of the regime since the managed investment laws were introduced a decade ago.

ASIC says that the increased compliance costs on responsible entities are outweighed by the benefits to investors and managed investments sector.

What are the new financial requirements for responsible entities?

Under the changes implemented through ASIC Class Order 11/1140 and outlined in Regulatory Guide 166 Licensing: Financial requirements and Pro Forma 209 Australian financial services licence conditions, responsible entities will have new requirements for net tangible asset capital, liquidity and reporting.

Cash-flow projections

Responsible entities must prepare 12-month cash-flow projections which must be approved at least quarterly by directors, and reviewed annually by auditors. This is a change from the current three-month period.

A responsible entity would be required to demonstrate, based on the cash flow forecast, that over the projection period it will have:

  • access to sufficient resources to meet its liabilities; and
  • sufficient resources to comply with the cash or cash equivalents component of its net tangible asset requirement.

It would be allowed to include the value of any eligible undertaking provided by an eligible provider as part of its cash balance.

Net tangible asset (NTA) capital requirements

Currently responsible entities must hold a minimum of $50,000 and 0.5% of funds under management. This is being increased – they will now have to hold the greater of:

  • $150,000
  • 0.5% of the average value of scheme property (capped at $5 million), or
  • 10% of the average RE revenue (uncapped).

However, where a responsible entity has not engaged an eligible custodian to hold the scheme assets or where the scheme assets are not of a prescribed nature (being "Tier $500,00 class assets" or "special custody assets") then it must hold the greater of:

  • $5 million, or
  • 10% of the average responsible entity gross revenue (uncapped).

"RE revenue" includes the responsible entities revenue for accounting purposes and to the extent not otherwise captured, payments out of scheme property that relate to fulfilling a responsible entity’s obligations under the Corporations Act, even if some of those obligations are outsourced to other entities. The average gross revenue is calculated by reference to the previous 24 months and a forecast for the next 12 months.

Excluded from the NTA are:

  • potential liability under any personal guarantees provided by the responsible entity; and
  • parent entity eligible undertakings.

New NTA liquidity requirement

Currently there is nothing preventing a responsible entity from using non-liquid assets to satisfy its NTA requirement. To ensure that the NTA can be drawn on quickly to fulfil a responsible entity's obligations to members, the greater of $150,000 or at least 50% of its minimum NTA requirement will have to be held as cash or cash equivalents.

"Cash or cash equivalents" are:

  • cash on hand, demand deposits and money deposited with an ADI that is available for immediate withdrawal;
  • short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value; and
  • the value of any eligible undertakings provided by an eligible provider.

The balance of its minimum NTA requirement must held as liquid assets, meaning they:

  • can reasonably be expected to be realised for its market value within six months; and
  • are free from encumbrances and, in the case of receivables, free from any right of set-off.

Reporting on NTA requirement

A responsible entity will have to report its NTA requirement, actual NTA, average value of scheme property, average gross revenue and cash or cash equivalents as at the end of each financial year.

What's prompted the changes?

ASIC says the changes are intended to boost investor confidence and stability in the managed investment sector, and have been prompted by a combination of factors.

The first is the change in the managed investment sector since the minimum financial resource requirements were introduced in 2002. The amount of assets under management has increased, as has the number of schemes, and schemes now have differ in size, complexity and nature.

The second factor is that familiar issue in our sector, the global financial crisis. As investor inflows dried up, outflows increased, and fees earned by responsible entities suffered accordingly. Those with low capital bases and/or illiquid assets were particularly exposed. If they then collapsed, there were not enough assets to meet the costs of administrators and other professional service providers engaged to wind down or transition assets. This, says ASIC, "contributed to a loss of investors’ funds and a corresponding, but harder to measure, loss of investor confidence in the managed investment industry."

The transition period

Responsible entities will have to meet these new requirements in November 2012. ASIC says it is open to an extended transition period of 12 months to 1 November 2013, but this is on a case-by-case basis, and only when a responsible entity can demonstrate extenuating circumstances.

It will also consider granting temporary relief from some or all of the new financial resource requirements when the new NTA requirement is unreasonably burdensome, having regard to the circumstances of a particular responsible entity.

Responsible entities will of course need to carefully consider how they will meet the new requirements before November 2012 and in particular those responsible entities which have a significant revenue base may need to consider whether steps might be taken to reduce that revenue base, for example, by shifting non-scheme related revenue activities to another group entity.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.