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Australia – ASIC Consults On Changes To Holding Of Scheme Property And Other Assets.

26 January, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Regulatory & Compliance

 

The proposals in brief

 

  • ASIC has recently released a consultation paper proposing changes to Regulatory Guide 133 Managed investments: Scheme property arrangements and a draft updated RG 133.
  • The proposals include:
    • a requirement that custody assets are held on trust by the asset holder and that asset holders meet certain minimum standards including for organisational structure, staff capabilities, capacity and resources;
    • an expectation that due diligence enquiries should be made by a custodian pre-contract and on an ongoing basis in relation to its clients;
    • amendments to the content requirements for custody agreements including in relation to indemnities from asset holders or master custodians and in relation to reporting suspicion of failures to report breaches; and
    • modifications to ASIC Class Order 98/51 (which permits the use of omnibus accounts on certain conditions) to extend the relief to IDPS services and MDA services but also to impose additional conditions which will require additional supervision and compliance.
  • ASIC is also considering how the role of a custodian should be explained in PDSs and other marketing material available to retail clients and whether or not to extend the list of ‘special custody assets’ that a RE may hold without meeting relevant NTA requirements.
  • Submissions are due by 28 February 2013.

 

Background

 

ASIC recently released Consultation Paper 197 Holding scheme property and other assets (CP 197) seeking comments on proposed changes to Regulatory Guide 133Managed investments: Scheme property arrangements (RG 133). ASIC provided a draft of the updated RG 133 with CP 197.

 

ASIC has stated that the substantive proposed changes have arisen from a number of related matters including ASIC’s findings in Report 291 Custodial and depository services in Australia. For more information on Report 291, please see our article ‘ASIC’s report on custody and depository services has some important take outs for REs’. ASIC’s report on custody and depository services has some important take outs for REs’

 

ASIC also recently released a consultation paper proposing changes to the financial requirements for providers of custodial or depository services and REs of managed investment schemes and platform operators that hold scheme property or other property and assets. For more information, please see our article ‘ASIC consults on revised financial requirements for custodians and REs and platform operators holding assets’. ASIC consults on revised financial requirements for custodians and REs and platform operators holding assets

 

Who is affected by the proposed changes under CP 197?

 

CP 197 is relevant to:

 

  • REs of registered managed investment schemes holding scheme property and other assets;
  • licensed providers of custodial or depository services (licensed custody providers), including those who provide custody services merely incidentally (which may include trustees of unregistered schemes); 
  • MDA operators who are responsible to clients for holding assets under a MDA service; and
  • IDPS operators who are responsible to clients for holding assets under an IDPS.

 

Holding client assets

 

ASIC proposes to modify the Corporations Act in relation to ‘asset holders’, meaning holders of scheme property or other assets of a registered scheme, client assets of an IDPS, client portfolio assets of a MDA service or financial products or a beneficial interest in financial products under a custodial or depository service. 

 

ASIC’s proposal is to modify the Corporations Act by class order so that from 1 July 2014 asset holders would be required to:

 

  • hold the relevant assets on trust for their client and separately from their own assets or of any other scheme or person, subject to permitted omnibus arrangements, and
  • meet minimum standards for organisational structure, staff capabilities, capacity and resources and checks on clients.

 

Similar requirements already apply to REs under the Corporations Act and under RG 133 for REs holding scheme property or other assets. 

 

These proposed requirements and minimum standards would extend to incidental providers of custodial or depository services, which may include trustees of unregistered schemes. All relevant asset holders would need to review their arrangements and ensure that they have procedures in place to comply with the requirements.

 

Engaging another asset holder and client checks

 

ASIC proposes to state the following process and due diligence expectations, which ASIC considers are part of the obligations of an AFS licensee engaging another asset holder:


  • appropriate process: REs, licensed custody providers, MDA operators and IDPS operators should follow and document an appropriate process in selecting an appropriate asset holder, which is expected to address, among other things, compliance with minimum standards, competency, adequacy of financial, human and IT resources and risk management systems of the asset holder; and
  • due diligence: licensed custody providers should diligently consider what pre-contract and ongoing inquiries in relation to their clients are necessary at reasonable intervals to provide reasonable assurance that the asset holder’s activities will not be facilitating unlawful activities, which ASIC considers are part of an adequate risk management system which AFS licensees (other than certain bodies regulated by APRA) are required to have in place under the Corporations Act.

 

Agreement with third party asset holder

 

ASIC proposes to modify the existing requirements for agreements between a RE, MDA operator or a master custodian on the one hand and master custodian or asset holder on the other hand as follows:

 

  • the asset holder and any master custodian (as applicable) must indemnify the client against any loss or damage that arise from a failure to comply with the client agreement or to meet the prevailing standards of good practice for holding assets in the places where the assets are held; and
  • if it is not possible to obtain such an indemnity on reasonable commercial terms, the client seeking the indemnity (being an AFS licensee) must:
    • take all reasonable steps to negotiate the most favourable provision for the client, and
    • consider what additional protections it should reasonably have in place to manage the associated risks (eg requiring more frequent checks).

 

ASIC also considers that this indemnity should be required under an agreement between a licensed custody provider and retail client for the provision of a custodial or depository service.

 

If this proposal is implemented, custody agreements will need to be reviewed in order to identify any changes needed to comply with these requirements.

 

Reporting suspicious matters

 

ASIC also proposes to modify the Corporations Act by class order to require REs, licensed custody providers, MDA operators and IDPS operators to ensure that the agreement with any custodian they engage in connection with client assets obliges the asset holder to have adequate arrangements to ensure that the asset holder will report to ASIC within 10 business days if the asset holder suspects that the client may be in beach of:

 

  • section 912D, which relates to AFS licensees reporting significant breaches to ASIC, or 
  • section 60FC(1)(l), which relates to REs reporting certain breaches relating to the scheme to ASIC.

 

ASIC considers that, where these matters are not required to be reported to AUSTRAC under the anti-money laundering legislation, it is good practice for providers of custodial or depository services to foster a whistleblowing culture where misconduct or suspected misconduct is reported to ASIC under their risk management arrangements.

 

Relief from the requirement to hold assets separately

 

ASIC proposes to continue the relief provided under ASIC Class Order 98/51 Relief from the duty to separate assets of a managed investment scheme applicable to REs, with some amendments, to allow the use of omnibus accounts for:

 

  • assets of registered schemes, IDPS services and MDA services; and
  • financial products and beneficial interests in financial products held in the provision of a custodial or depository service by an AFS licensee where the client has consented in writing.

 

The conditions currently applicable to REs under this Class Order are that:

 

  • the RE ensures that the entity holding the relevant scheme property performs regular reconciliation procedures appropriate to the nature of the asset; and 
  • the RE reasonably considers that holding the scheme property separately from property of other schemes would not be in the best interest of members.

 

The proposed modifications to these conditions include that:

 

  • the RE, IDPS operator or MDA operator ensures the asset holder:
    • maintains adequate records showing the entitlement of the client in the account; 
    • is able to perform the administrative functions required in connection with holding such assets; and 
    • ensures that the account is always sufficient to meet the entitlement that the client and any other person has in relation to the account; and
  • the RE, IDPS operator or MDA operator must be of the opinion that the omnibus account does not expose its clients to unreasonable risk and is in the best interests of its clients in the circumstances. This opinion must be certified annually by the RE, IDPS operator or MDA operator.

 

Land used in primary production schemes

 

ASIC also proposes to modify the Corporations Act by class order to apply additional requirements to REs in relation to registered schemes involving primary production that include rights for use of land offered after 31 December 2013. 

 

Use of the term ‘custodian’

 

ASIC considers that product issuers and licensed custody providers should clearly describe the role of an asset holder in any product disclosure statement, financial services guide and other material available to retail clients, to ensure that clients are unlikely to be misled and to minimise the possibility of giving retail clients unwarranted reassurance because of the custodian’s appointment.

 

This position is not unexpected, given ASIC’s view, expressed in Report 291, that there is an ‘expectation gap’ between a custodian’s obligations and what the public expects of a custodian.

 

Special custody assets

 

ASIC is considering whether or not to extend the list of ‘special custody assets’ a RE may hold without meeting the relevant net tangible asset requirements in Regulatory Guide 166 Licensing: Financial requirements to include the following, subject to conditions:

 

  • derivatives under which the holder may be liable for future payments and margin accounts relating to those derivatives;
  • securities or interests in a managed investment scheme where the securities or interest or any associated contractual arrangements may give rise to a liability for the holder and it is not reasonably practicable to negotiate to make reasonably appropriate provisions for a holding by a person other than the RE; and
  • deposit-taking facilities with an Australian authorised deposit-taking institution (ADI) or a bank outside Australia regulated under Basel guidelines and money payable under the facility.

 

What is the proposed timetable for implementation?

 

ASIC has proposed that the changes to RG 133 come into force on 1 July 2014.

 

Submissions on CP 197 are due by 28 February 2013.

 

For further information, please contact:

 
Fiona Smedley, Partner, Herbert Smith Freehills
fiona.smedley@hsf.com
 
Matthew Farnsworth, Herbert Smith Freehills
matthew.farnsworth@hsf.com
 

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