Legal News & Analysis – Asia Pacific – Singapore – Capital Markets

 

The Monetary Authority of Singapore (“MAS”) has issued a Consultation Paper on Proposals to Enhance Regulatory Safeguards for Investors in the Capital Markets. The changes proposed cover the following areas:

 

• Extending the capital markets products regulatory regime to include new products;
• Requiring product issuers to provide and disclose complexity-risk ratings; and
• Amending the regulatory criteria for Accredited Investors (“AIs”), Institutional Investors (“IIs”), and Expert Investors.

The last day for feedback is 1 September 2014. This Update looks at the changes proposed

 

Extending the Capital Markets Products Regulatory Regime to Cover Additional Products

 

In the last few years, a number of non-conventional products have been offered to consumers as alternative investments. As these products exhibit the same characteristics as regulated capital markets products, the MAS proposes to extend to them the current regulatory safeguards available to investors in capital markets. The products which it proposes to include are:

 

• Buy-back arrangements involving the exchange of precious metals; and
• Investment schemes which have the elements of a regulated collective investment scheme but do not pool investors’ contributions.

 

Buy-Back Arrangements Involving The Exchange Of Precious Metals

 

The buy-back arrangements that are proposed to be included involve:

 

• Party A purchasing precious metals of gold, silver, or platinum from Party B for an agreed sum of money or money’s worth;
• Party B being under an obligation to purchase the asset back from Party A at a future time; and
• The purpose or effect of the arrangement is to enable Party A to receive a financial benefit from Party B.

 

The MAS’ intention is to regulate buy-back arrangements which are in effect capital raising arrangements. Accordingly, a key element that will need to be established is the right for Party A (i.e., the investor) to receive a financial benefit from Party B (i.e., the issuer) as part of the arrangement. The right to receipt of a financial benefit must be agreed upon at the point in time that the parties enter into the arrangement, although the actual amount received may vary according to pre-determined factors.

 

The MAS considers there to be a financial benefit where the effective re-purchase price that Party B agreed to pay for the buyback at the time the arrangement is entered into is higher than the initial purchase price that Party A paid for the asset.

 

Conversely, trading contracts, storage contracts, consignment arrangements, and sale and lease-back arrangements are some examples of commercial transactions for which the MAS considers there to be no financial benefit as either no financial benefit is guaranteed under the transaction, or any benefit that Party A derives relates to the use or consumption of the asset under the arrangements (as opposed to purely investment purposes).

 

Collectively Managed Investment Schemes

 

Under the Securities and Futures Act (“SFA”), collective investment schemes (“CIS”) are arrangements in respect of any property, whether securities or futures, commodities, or real estate, that exhibit all of the following characteristics:

 

• Participants have no day-to-day control over the management of the property;
• The property is managed as a whole by or on behalf of the scheme operator;
• The participants’ contributions are pooled;
• The profits or income of the scheme from which payments are to be made to the participants are pooled; and
• The purpose or effect of the arrangement is to enable participants to participate in profits arising from the scheme property.

 

In the last few years, there have been a number of arrangements offered to retail investors that fall out of the statutory definition of a CIS as the investors are offered direct interests in the underlying physical assets instead of having their contributions pooled. However, in all other respects, the arrangements have the same characteristics as a traditional CIS, in particular, the schemes are collectively managed and the right to profits is on a pooled basis. As such, the MAS has proposed that the CIS regulatory framework should be extended to such schemes.

 

The Consultation Paper sets out the following examples of such collectively-managed investment schemes in the context of real-estate:

 

• Land investment schemes: These are arrangements in which investors are offered fractional interests in undeveloped land, and are required to use the scheme operator’s services in obtaining planning permission for or disposing of the land as a whole (or both).
• Investment in land for forestry or harvesting purposes: Under such an arrangement, investors acquire fractional interests in a plantation plot, or individual trees on the plantation plot. The scheme operator is entrusted with day-to-day control over management of the forestry or harvesting operations for the entire plot of land, and investors receive rights to participate in profits arising from the forestry or harvesting operations in respect of the scheme property.
• Buy-to-let schemes: These are arrangements in which investors are offered units (through fractional interests or a room in a block of apartments) in real estate, on the basis that the investor will be entitled to participate in rental income generated from the scheme operator’s management of the properties as a whole.

 

In addition, the MAS will consider promulgating specific rules in the Code on Collective Investment Schemes (“CIS Code”) for some collectively-managed investment schemes that have characteristics that are largely similar to those in schemes already authorised by the MAS for retail offer. The CIS Code is intended to ensure that collective investment schemes which are offered to retail investors are subject to appropriate safeguards including safeguards against liquidity, valuation, and custody risk. Including such collectively-managed investment schemes in the CIS Code will allow the MAS to authorise them for retail offer. Currently under consideration are schemes that invest solely in gold, silver, and platinum. Operators of such schemes who wish to offer these products to retail investors will have to obtain a Capital Markets Services licence for fund management. The MAS has stated that it will separately consult on the details of these proposed changes to the fund management regime.

Proposed Framework For Complexity-Risk Ratings

 

The MAS proposes requiring all investment products (capital markets products, structured deposits, and participating whole life and endowment policies and investment-linked policies) to be rated for complexity and risk, and for these ratings to be disclosed to investors. Products not covered by this proposal include term life policies, non-participating whole life and endowment policies, and annuities.

Complexity Ratings

The proposed complexity rating will be determined based on the following factors:

 

• Number of structural layers: This factor is intended to capture the number of structural layers in a product that determines its payoff as well as the number of layers that are interposed between the investor and the underlying asset. For example, a fund-of-funds product will have three layers, in that there are two fund management levels between the end-investor and the underlying asset.
• Extensiveness of derivatives usage: This refers to the number of types of derivatives that are inherent in a product. When counting the number of derivatives used, it is the type used that is relevant for this purpose. For example, a product only using simple interest rate swaps (regardless of the number of swaps employed) is deemed to use only one type of swap
• Known valuation models: Valuation models may be classified as publicly available, proprietary, or generic:
  • Publicly available: The valuation models are well-known and inputs for the models are readily available (e.g. priceearning valuation models for common shares).
  • Proprietary: The issuer provides prices based on its own proprietary valuation model. Prices are not publicly available but can only be provided by the market-maker. For example, credit default obligations where there is a lack of established valuation models that calibrate bankruptcy risk accurately.
  • Generic: The valuation of the product is clearly not reliant on publicly available models, but is also not reliant entirely on proprietary models (e.g., options, which require the use of slightly more sophisticated, yet commonly available, models like the Black-Scholes option pricing model).
• Number of return outcomes: This refers to the number of potential scenarios that can determine the final return outcome of the investment product. For example, the only outcome in an investment in ordinary shares is the sale price. On the other hand, options may have two outcomes depending on whether the option is exercised or not.

 

Each of these factors will yield a score as shown in the table below:

 

Factor		Low	Medium	High
Number of structural layers	Threshold	One Layer	Two Layers	Above Two Layers
	Score	1	3	5
Usage of derivatives	Threshold	None	Up To Two	Above Two
	Score	1	3	5
Known valuation models	Threshold	Publicly Available	Generic	Proprietary
	Score	1	2	3
Number of return outcome scenarios	Threshold	One	Two	More Than Two
	Score	1	3	5

 

The total score will determine the complexity rating, which is
proposed to be assigned as follows:

 

• Low: 4 – 5;
• Medium: 6 – 7;
• High: 8 – 14; and
• Very high: 15 – 18.

 

Risk Ratings

 

The MAS proposes to use a simple pre-determined “bucket based” approach to risk rating, based on the likelihood that an investor would lose some or all, or even more than his principal investment amount. On one end of the spectrum would be a “low” risk rating where an investor is deemed unlikely to suffer losses to his principal. A “high” risk rating on the other end of the spectrum is where investors in such products may lose more than the investment amount

The Consultation Paper proposes the following risk ratings to be assigned and provides examples of the types of products that would receive such a rating:

 

• Low: Examples include:
  • Singapore dollar structured deposits (excluding Dual Currency Instruments (“DCIs”)) and par-endowments by MAS-licensed banks / insurers;
  • Singapore dollar bonds issued by the Singapore Government and statutory boards, including Singapore Government Securities; and
  • Singapore dollar AAA-rated corporate bonds.
• Medium: Examples include:
  • Investment-grade debt securities, or debt securities guaranteed by investment-grade entity. The Consultation Paper explains that a debt security would be considered as investment-grade, if it has a minimum long-term rating of BBB- by Fitch, Baa3 by Moody’s, or BBB- by Standard and Poor’s, or is fully guaranteed by an entity that has an investment-grade credit rating; and
  • Non-concentrated, non-leveraged, and non-synthetic Real Estate Investment Trusts (“REITs”)/CIS/Investment- Linked Policy (“ILP”) subfunds. Funds can be considered as “non-concentrated” if they satisfy the following criteria:
    • For an equity or debt fund, in addition to complying with the spread of investments limits as set out in Appendix 1 of the CIS Code, its investments are not concentrated on a single sector in a single country;
    • For property funds (including REITS), its investments are not concentrated in a single country; and
    • For commodity or foreign currency funds, its investment exposure is not limited to a single class of commodity or currency respectively
• High: Examples include:
  • Single equities (e.g., share in a company);
  • Business trusts;
  • Unrated and non-investment grade debt securities;
  • Concentrated, leveraged, or synthetic REITs/CIS/ILP
  • sub-funds;
  • DCIs; and
  • Bought options.
• Very high: Examples include:
  • Written options;
  • Leveraged FX trading;
  • Contracts-for-differences; and
  • Futures.

Complexity-Risk Rating

Each investment product will be plotted against two dimensions: its complexity rating and its risk rating. The Consultation Paper provides the following 4×4 matrix as an example of how products will be treated under the proposed complexity-risk ratings framework:

 

(Click to enlarge)

 

 

The MAS also seeks views on whether historical price volatility (or credit rating in the case of debentures) should be used alongside the complexity-ratings framework.

Production And Disclosure Of Ratings

 

The MAS proposes that product issuers be required to rate the products issued and for the ratings to be disclosed in product offering documents for new and ongoing offers of investments to retail investors. In addition, issuers who seek to have their products listed on an approved exchange will be required to inform it of the rating. The exchange will indicate this information on its trading platform accordingly. Intermediaries will similarly be required to ensure this information is made available to investors transacting in listed products through them.

Refinement Of Investor Classes

Opt-In Procedure For AI Status

 

Currently, a person who meets the requirements to be an AI is automatically accorded AI status. As such, issuers and intermediaries dealing with him are exempted from various regulatory requirements. As not all non-retail investors are necessarily better informed or require less regulatory protection than retail investors, the MAS has proposed to modify the regulatory framework for AIs such that persons who meet the AI requirements must expressly opt-in writing to be treated as an AI.

The proposed opt-in process is as follows:

 

• The financial institution will provide a written notification to all clients, including new and existing clients, who are assessed by the financial institution to be eligible to be AIs, of their initial classification as retail investors (for new clients) or AIs (for existing AI clients), their right to request for AI status, and a clear written description and warning of the regulatory safeguards that may be disapplied if they opt-in to AI status.
• Alternatively, an investor eligible for AI status could, of his own accord, approach a financial institution to indicate that he wishes to be classified as an AI.
• If the investor wishes to opt-in to AI status, he must confirm this in writing to the financial institution and acknowledge that he understands and accepts the consequent reduction in regulatory safeguards. This confirmation should be in a separate document from the letter notifying him of his status.

 

The MAS proposes a two-year transitional period to migrate existing AI clients to the opt-in regime. During this transitional period, financial institutions would be allowed to continue to treat their existing AI clients as AIs. Existing AI clients may, however, choose to be re-classified as retail investors.

 

AI status will be held on a per financial institution basis. As such, an investor can choose to be treated as an AI in one organisation and as a retail investor in another. An AI client would be able to change his classification to non-AI status at any time by making a request in writing to the relevant financial institution.

Changes To The Definitions of AIs, IIs, and EIs

 

The current definition of an AI includes an individual whose net personal assets exceed SGD 2m. The MAS proposes to modify this criterion such that net equity in an individual’s primary residence can only contribute up to SGD 1m of the minimum net assets threshold of SGD 2m.

The following additional persons will also be eligible to opt to be AIs:

 

• Any individual, who holds a joint account at a financial institution with an individual who is an AI, but only in respect of transactions entered into with or through the financial institution, using the joint account;
• Any corporation (and not just one that is an investment holding company) that is wholly-owned by AIs; and
• Any trustee of any trust in which all the beneficiaries are AIs.

 

The definition of II is proposed to be extended to include:

 

• Entities organised in foreign jurisdictions, carrying out financial services activities similar to those for which MAS licences are granted, and that are authorised, licensed, and/or regulated in one or more foreign jurisdictions; and
• All central governments and central governmental agencies of foreign states, supranational governmental organisations, and sovereign wealth funds.

In addition, while the existing definition includes all statutory bodies, the definition is proposed to be amended to include only statutory boards. Accordingly, town councils and other entities incorporated under specific Acts of Parliament are proposed to be removed from the definition.

 

The Expert Investors class of investors is proposed to be removed from the regulatory framework of the SFA and the Financial Advisers Act.

Finally, the regulatory framework for exemptions available for dealings with AIs and IIs will be regularised. These will be amended such that any existing exemptions available for dealings with AIs that do not apply to IIs will be amended to apply also for dealings with IIs.

 

 

For further information, please contact:

 

Choon Yuen Hui, Partner, WongPartnership
[email protected]

 

Elaine Chan, Partner, WongPartnership
[email protected]

Gail Ong, Partner, WongPartnership
[email protected]

Chee Shan Long, Partner, WongPartnership
[email protected]

Kah Keong Low, Partner, WongPartnership
[email protected]

 

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