A GUIDE TO PUBLIC INVESTMENT FUNDS

Regulatory Framework for Public Investment Funds in Australia

This is the second article in CNM Legal’s four-part series: A Guide to Public Investment Funds. The series provides an overview of registration, regulation, marketing and tax treatment of public investment funds in Australia. This article will discuss the regulatory framework for public investment funds in Australia, focusing on the main areas of regulation, the registration process and additional regulatory restrictions and requirements.

What are the main areas of regulation imposed on public funds?

Governance

Governance within the financial sector entails adherence to strict regulatory measures overseen by ASIC, the regulatory authority responsible for the majority of the financial services sector.

As outlined previously, a registered ‘managed investment scheme’ (‘MIS’) must have a compliant constitution, a suitable compliance plan, a public company as the ‘responsible entity’ (‘RE’), auditors for both the fund and its compliance plan, and, if less than half of the RE board comprises external members, a compliance committee. The fund’s constitution delineates operational rules that the RE must abide by, encompassing specific provisions detailed earlier.

Under the Corporations Act 2001 (Cth) (‘Corporations Act’), most actions concerning registered funds are regulated, including amendments to the fund constitution, the removal and substitution of the RE, member meetings, financial reporting, fund dissolution, member withdrawals, and ongoing reporting and disclosure requirements.

The compliance plan for the fund must outline measures for ensuring compliance with the fund’s constitution and the Corporations Act. The RE, in executing its powers and duties, is bound by various obligations, encompassing general duties to act honestly, with due care and skill, and in the best interests of members, as well as compliance obligations ensuring adherence to the fund’s constitution and the compliance plan.

Moreover, the RE must ensure proper management, valuation, and preservation of fund property, as well as reporting any breaches to ASIC. Directors of the RE are also mandated to prioritize member interests, acting honestly and with due care, while ensuring compliance with relevant regulations.

Breaches of these obligations may lead to civil penalties, including compensation orders if loss or damage to fund property occurs. Employees of the RE are similarly bound by these duties.

The compliance committee, appointed by the RE, monitors compliance with the fund’s compliance plan, reporting breaches to the RE and ASIC as necessary. Additionally, the committee evaluates the adequacy of the compliance plan and may commission independent professional advice.

A compliance plan auditor, appointed by the RE, conducts annual audits of compliance with the compliance plan, reporting to the RE and ASIC if non-compliance persists.

Additional authorization or registration requirements may apply to specific fund types, such as conditions for operating primary production schemes or registration under state partnership legislation for limited partnerships. Furthermore, funds listed on the ASX must adhere to ASX Listing Rules and regulations from both ASIC and ASX.

Selection of investment adviser, and review and approval of investment advisory agreement

While there are no explicit requirements outlined for the selection of fund investment advisers, the general duties of the RE, as discussed earlier, influence the process of selecting, reviewing, and approving investment advisers. These duties include acting honestly, with due care and skill, and in the best interests of fund members.

Furthermore, certain types of funds, such as superannuation funds and specific government funds, may have particular requirements regarding the appointment of advisers. These requirements are tailored to the unique nature and objectives of these funds, ensuring that appointed advisers meet specific criteria relevant to their operation and purpose.

Capital structure

While there are no specific capital structure requirements for a fund itself, the RE or a corporate director of a ‘corporate collective investment vehicle’ (‘CCIV’) must adhere to the capital requirements stipulated by its Australian financial services licence (‘AFSL’). These requirements typically mandate that the RE maintains solvency with positive net assets, forecasts at least 12 months’ worth of cash-flow needs for its operations, holds professional indemnity insurance, and sustains a prescribed level of ‘net tangible assets’ (‘NTA’).

In cases where fund assets are held by a custodian meeting financial prerequisites, the mandated NTA comprises cash or cash equivalents valued at the greater of:

A$150,000;
5 percent of the average fund value; or
10 percent of the average RE revenue.

Conversely, if fund assets are not held by a compliant custodian, the requisite NTA amounts to the greater of:

A$10 million; or
10 percent of the RE’s average revenue.

These provisions ensure that the RE possesses adequate financial resources to safeguard the interests of investors and fulfil regulatory obligations.

Limits on portfolio investments

While there are no specific limitations imposed on fund portfolio investments, all holdings must be consistent with the permitted investments outlined in the fund’s constitution. Typically, fund constitutions include expansive investment powers to provide flexibility in portfolio management.

Conflicts of interest

The RE is obligated to prioritize the best interests of the fund members over its own interests, as outlined above.

Strict regulations govern related party transactions involving a registered fund’s RE. Any related party transaction, whether originating from or potentially jeopardizing fund assets, is prohibited unless conducted at arm’s length, under less favourable terms for the related party, or with prior approval from a meeting of fund investors. Moreover, according to general trust law, related party transactions must be clearly authorized by the fund’s constitution.

Advisers are held to a standard of acting in the best interest of their clients and are subject to limitations on conflicted remuneration, as discussed below.

Market conduct regulations, including restrictions on short-selling, prohibitions against insider trading, and measures to prevent market manipulation, also impact the activities of the fund’s RE and managers. Compliance with these regulations is essential to ensure the integrity and fairness of market operations.

Reporting and recordkeeping

In addition to the offer disclosure requirements outlined below, ongoing and periodic reporting obligations are applicable to registered funds.

The RE of a registered fund is required to:

Provide investors with confirmation of transactions regarding their investments and withdrawals, along with a balance, value, and transaction report for each reporting period, which may span up to one year.
Notify members or issue a notice of any material change or significant event concerning the fund and comply with continuous disclosure obligations if the fund is classified as a ‘disclosing entity,’ typically applicable when there are at least 100 members or if the fund is listed.
Submit reports to ASIC regarding the fund, including reports of significant breaches, annual audit reports for the fund, the RE, the RE’s AFSL, and the fund compliance plan. Additionally, the RE must notify ASIC of any changes in officers, ‘responsible managers,’ and ‘key persons’ listed on the RE’s AFSL, provide notices regarding the status of PDS usage, and furnish any other information requested by ASIC.

In addition, the Corporations Act contains the design and distribution requirements for financial products aimed at retail clients, commonly referred to as the design and distribution obligations (‘DDO Regime’). Under the DDO Regime, an RE (or a corporate director of a CCIV) is obligated to notify ASIC in writing if there has been a ‘significant dealing’ in a fund interest concerning a retail client that deviates from the Target Market Determination (‘TMD’). This notification must be furnished within 10 business days of the RE becoming aware of the significant dealing. ASIC may also require an RE to provide additional information regarding the distribution of a fund interest or maintain records mandated by the DDO Regime.

Furthermore, corporate directors of CCIVs and REs are required to file specific reports with the Australian Transaction Reports and Analysis Centre (‘AUSTRAC’) or the Australian Taxation Office (‘ATO’) for the purpose of anti-money laundering and counter-terrorism, including suspicious matter reports.

Other

Registered funds are subject to various legislative frameworks governing privacy, anti-money laundering (‘AML’), and taxation, which encompass income tax (including capital gains tax), goods and services tax (‘GST’), and stamp duty regulations.

Moreover, listed funds must adhere to the Listing Rules in addition to statutory and common law requirements. General trust law holds particular significance for registered funds, as stipulated by the Corporations Act, wherein fund property is held in trust for the benefit of fund members. Consequently, registered funds inherently involve a statutory trust arrangement.

Compliance with these legal frameworks is imperative for registered funds to ensure the protection of investor interests, maintain regulatory compliance, and uphold the integrity of financial markets.

What does the registration process involve for investment advisers that advise on public funds?

Individuals or entities conducting financial services activities in Australia typically require an AFSL issued by ASIC under the Corporations Act.

To obtain a standard AFSL, applicants must satisfy criteria related to capital adequacy, operational capability, educational qualifications, and industry experience. The application process involves submitting documentation to ASIC, including details of responsible managers possessing requisite education and practical expertise. Additionally, applicants must provide police and bankruptcy checks or nominated responsible managers, along with evidence demonstrating operational proficiency to deliver the requested financial services.

Upon obtaining an AFSL, license holders are bound by obligations outlined in the Corporations Act. These obligations entail:

Conducting business operations efficiently, honestly, and fairly.
Maintaining organizational competence.
Ensuring representatives adhere to regulatory compliance, possess competency, and receive adequate training.
Maintaining sufficient financial, technological, and human resources to deliver financial services.
Establishing risk management, conflict resolution, dispute resolution, and compensation mechanisms for retail clients.
Adhering to financial services laws and the terms outlined in the AFSL.

Compliance with these obligations is essential for AFSL holders to uphold regulatory standards, protect consumer interests, and foster trust within the financial services industry.

In addition to the limitations imposed by an AFSL holder’s licence, advisers face specific restrictions when promoting funds. These limitations will be discussed in detail in the next release of CNM Legal’s A Guide to Public Investment Funds: Marketing of Public Investment Funds in Australia.

Are there any requirements or restrictions for public funds investing in digital currencies?

There is currently no regulatory or statutory requirements or restrictions for funds regarding investments in digital currencies.

Are there additional requirements for exchange-traded funds?

Exchange-traded funds (‘ETFs’) are obligated to adhere to the applicable rules of the exchange on which they are listed. For instance, ETFs listed on the ASX must comply with the AQUA Rules. Issuers of ETFs must satisfy various criteria set forth by the exchange.

Information Sheet 230 provides detailed guidance on the criteria that ASIC, as the regulator of market operators, expects exchanges to consider and impose on ETF issuers. This criteria encompass matters such as transparency of portfolio holdings, liquidity, and market-making arrangements.