The government’s review of managed investment schemes – will the proposed change to wholesale client thresholds impact your ability to fundraise?

19 September 2023

In Australia, the managed funds industry covers a wide range of arrangements and underlying assets, ranging from unlisted property schemes and mortgage funds to exchange traded funds. Furthermore, a single fund may cover multiple assets of different risk profiles. Currently, the Australian Securities and Investments Commission (ASIC) is the regulator responsible for administering the Corporations Act 2001 (Cth) (Act) and the Australian Securities and Investments Act 2001 (Cth), which set out the conduct and disclosure obligations of financial services providers including those who operate managed investment schemes. ASIC also exercises administrative powers in relation to Australian financial services licenses (AFSL) and disclosure, which is relevant as the trustee or responsible entity of a managed investment scheme (RE) may be required to hold an AFSL.

The Australian Government has released a consultation paper seeking feedback on the regulation of managed investment schemes in Australia (Paper).1 The Paper notes that in Australia, the total value of all assets held in managed investment schemes is approximately $2.7 trillion.2 Therefore, any review of the regulatory and legislative framework for managed investment schemes is significant and has the potential to impact the fundraising conducted by businesses across almost every industry sector.

Key areas of potential reform identified by Treasury include:

  1. whether the definition of a ‘wholesale client’ needs to be updated;
  2. introducing consent requirements for all wholesale clients;
  3. changing the process of replacing the responsible entity;
  4. minimum liquidity requirements and investor withdrawal rights; and
  5. limiting the type of investments that can be offered to retail clients.

These reforms may increase the compliance costs and time required to operate a scheme, and narrow the pool of investors for wholesale schemes, which may limit a scheme’s ability to attract investors.

Interested parties may make a submission to Treasury until Friday 29 September 2023. Please contact our firm if you require further information or assistance making a submission.

1. The definition of wholesale client

Current law

Persons who invest in a managed investment scheme may either be retail or wholesale clients. The Act provides that certain protections are granted to retail clients which are not granted to wholesale clients. These protections include receiving more fulsome disclosures and a product disclosure statement about any prospective investment. Schemes with retail clients may also have minimum financial requirements and may need to be registered with ASIC. Registered schemes are required to have stronger governance practices and accountability to their members.

A person is a wholesale client if they meet one of the following tests in sections 761G and 761GA of the Act:

Product value testIs satisfied when the price for the provision of a financial product or the value of the financial product to which the financial service is related equals or is greater than $500,000. 
Individual wealth testIs satisfied where the person has net assets of at least $2.5 million or a gross income of at least $250,000 per year in the last 2 financial years. Net assets include the value of a person's primary residence and their superannuation balance. This is evidenced by a certificate from a qualified accountant no more than 2 years before the offer is made.
Small business testIs satisfied where the financial product or service is provided for use in connection with a business that is not a small business.
Professional investor testIs satisfied if the client is a ‘professional investor’ as defined in section 9 of the Corporations Act.
Sophisticated investor testIs satisfied when a financial product or service is not being provided in connection with a business and the relevant entity is satisfied on reasonable grounds that the client has previous experience in using financial services and investing in financial products that allows the client to assess the merits, value, risks and information about the product or service.

Proposed reform

The financial thresholds contained in the product value and individual wealth tests have not been updated since their introduction in 2001. The Paper notes that in 2002 only 2% of Australian adults met the individual wealth thresholds, but this number rose to 16% by 2021. Therefore, an increasing number of individuals are classified as wholesale clients and do not receive the protections granted to retail clients.

The Paper also notes that in other jurisdictions a person’s primary residence or their entitlement under a pension are excluded from the calculation of their net assets.

The Paper questions whether the financial thresholds for the product value and individual wealth tests should be increased to more accurately capture individuals who have the knowledge or experience required to take on the risks of being a wholesale client, forgoing the protections of being a retail client. It also queries whether certain assets (presumably alluding to a person’s primary residence and / or superannuation balance) should be excluded in the calculation of that person’s net assets.

Impact on managed investment schemes

Any increase in the financial thresholds of the wholesale client tests, or the exclusion of certain assets from the calculation of a person’s net worth, will decrease the number of persons who are wholesale clients. This may decrease the number of investors eligible to invest in unregistered schemes and reduce the amount of funds that they have under management. This change will not impact retail funds.

2. Consent requirements for wholesale clients

Current law

If a scheme operator (licensee) relies on the ‘sophisticated investor test’ outlined above, it must provide the client with a written statement before or at the time when the product is provided. This statement must outline the reasons why the licensee is satisfied that the client has sufficient experience to assess the merits, value and risk of the product, and that the client can assess their own information needs and the adequacy of information given to it by the licensee.3

The client must also sign a written acknowledgement that they were not given a product disclosure statement (among other documents) and that the licensee does not have any other obligations to the client that it would have if the client were a retail client. The Paper refers to the requirement for a client to give this acknowledgement as a ‘consent requirement’.

Proposed reform

The Paper expresses concern that wholesale clients do not sufficiently understand the implications and risks of being classified as a wholesale client.

The Paper referenced previous reviews (including the Quality of Advice Review Final Report) that suggested that consent requirements should also be applied to wholesale clients who meet the net assets or gross income thresholds of the individual wealth test.

Impact on managed investment schemes

The introduction of a consent requirement for wholesale clients who meet the individual wealth tests, in addition to sophisticated investors, may significantly increase the compliance burden on schemes, particularly when onboarding new clients. The utility of such a requirement may be limited if the financial thresholds of these tests are increased, as the Paper suggests they may be.

3. Replacing a responsible entity

Voting requirements

The process by which members may replace a scheme’s RE depends on whether the scheme is a listed scheme. For listed schemes, the RE may be replaced by an ordinary resolution of the members present at a general meeting.4 However, changing the RE of an unlisted scheme requires an extraordinary resolution, a resolution passed by at least 50% of the total votes that may be cast by members entitled to vote, including those not present in-person or by proxy.5

Where an unlisted scheme has passive investors, or investments are made via a vehicle that does not easily facilitate voting, it may be difficult to meet the threshold to pass an extraordinary resolution. This may result in the entrenchment of an underperforming RE.

The Paper implies that this threshold is too high and that the voting requirements should be aligned to those of corporate collective investment vehicles, the corporate directors of which may be replaced by a resolution passed by at least 75% of the votes of members entitled to vote.

Impact on managed investment schemes

Lowering the threshold to replace a RE is arguably in the interests of investors and prospective or competitor REs, as an underperforming RE can be more easily removed.

However, this may present a challenge to incumbent REs, who may be more easily removed from their positions. This increased insecurity may be a distraction for incumbent REs, who may make shorter term investment decisions to keep investors happy at the expense of potentially more prudent longer-term decision making.

4. Liquidity requirements and investor withdrawal rights

A member’s right to withdraw from a registered scheme may be regulated by the scheme’s constitution and / or the Act, depending on whether the scheme is considered ‘liquid’. If a scheme is liquid, members may request to withdraw their investment at any time in accordance with the process contained the scheme’s constitution. For illiquid schemes, the RE must make a written withdrawal offer to all members, or to members of a particular class, specifying that an offer period is open.

Proposed reform

The Paper notes that the Act permits schemes to market themselves as ‘liquid’ if liquid assets account for at least 80 percent of the value of scheme property. Scheme property may be regarded as liquid assets if the RE reasonably expects that the property can be realised for its market value within the period specified in its scheme constitution. This period is not prescribed and may sometimes exceed one year as it is at the discretion of the RE. This contradicts the common understanding of liquidity, as investors may think that investing in a liquid scheme means that they can withdraw their funds within a matter of a few days.

The Paper notes that in other jurisdictions, similar schemes are considered illiquid if assets cannot be realised within 7 days, or if investors cannot redeem their units at least twice a month. Reform may include specifying liquid assets to include cash, bank bills, publicly traded securities or other assets that can be realised within 7 days.

Impact on managed investment schemes

Introducing clearer requirements for scheme liquidity may better align with the common understanding of the term. This may increase investor confidence in schemes and reduce misrepresentation or misunderstanding by investors of their withdrawal rights. Such a reform may also have a significant impact on the investment mix of registered schemes.

5. The type of investment that can be offered to retail clients

Provided that a RE has the appropriate AFSL authorisations, there are limited restrictions on the types of investments that a RE may offer to retail clients. Such investments may involve highly leveraged positions, short-selling, investment in derivatives or complex contractual arrangements with third parties.

Proposed reform

The Paper questions whether there should be a limit on the type of investments that a scheme can offer to retail clients, particularly where the investment is novel, illiquid or speculative. The Paper notes that other jurisdictions limit retail clients’ access to high risk investments. The Paper suggests that schemes should have reduced access to leverage, such as being limited to borrowing up to 10% of the value of the scheme property. Schemes may also be required to have a certain proportion of their investments be in liquid assets or be prohibited from directly investing in real property or other unregistered schemes.

The Paper also questions whether ASIC should have the power to refuse to register a scheme if it deems that the scheme would be inappropriate for investment by retail clients.

Impact on managed investment schemes

Reform in this area may limit the types of investment available to a registered scheme. A reduction in risky, complex or speculative investments may reduce the profitability of such schemes but will minimise risk for retail clients. This reform will likely not impact wholesale clients.

HWL Ebsworth Lawyers’ national corporate team have experienced professionals who can assist you in fundraising or making a submission to Treasury.

This article was written by Thomas Kim, Partner, Kenneth Lee, Special Counsel and Josh Hanegbi, Solicitor.

1Australian Treasury, ‘Review of the regulatory framework for managed investment schemes’ <>.
2Australian Treasury, ‘Consultation paper – Review of the regulatory framework for managed investment schemes’ (August 2023) p8 <>.
3Corporations Act 2001 (Cth) s761GA.
4ASIC Class Order 13/519.
5Corporations Act 2001 (Cth) s601FM.kenneth

Kenneth Lee

Special Counsel | Melbourne

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