Submissions - Ernst & Young
12 September 2001
Managed Investments Act Review
Attention: Mr Malcolm Turnbull
Dear Mr Turnbull
Managed Investments Act Review
The introduction of the Managed Investments Act heralded a new era in Australian Financial Services Reform with the removal of the two party manager/trustee system and the emergence of the Responsible Entity. Two years on from the required transition date you are undertaking a review of impact of this financial services reform and the benefit for fund managers and investors. We set out below our views, which have also been discussed with some of our clients below:
1. Investor Protection
There has been no identifiable change in the level of protection of unitholders' investments following the introduction of the Chapter 5C regime.
· Generally the security of investments is reflected in the nature of those investments , for example the share market is generally more risky than the cash or fixed interest markets.
· The other risk for investors is the size, experience and reputation of the manager. The variance in compliance cultures and practices is demonstrated because the significant compliance driver for large-scale operators is the risk to reputation, which in the operator's own risk management terms contributes to the development of a compliance culture.
For the large operators, compliance frameworks were developed prior to the introduction of the Managed Investments Act. The introduction of the legislation formalised the requirement for adequate compliance processes, and for some operators strengthened the investment review processes. Small operators appear to be less advanced in their approach to compliance.
2. Certainty of responsibilities
The introduction of a Single Responsible Entity for the operation of the investment scheme was aimed at providing greater certainty as to where the responsibilities, obligations and liabilities resided. The removal of the dual Manager/Trustee structure and replacement with the Single Responsible Entity concept has clearly made a difference in terms of a greater focus by operators on operational controls.
3. Rights of investors
It appears that investors perceive that there is little impact on their rights in relation to unitholdings in managed investment schemes. For most investors the level of awareness of the changes is considered minimal even though the rights of investors have improved under the Managed Investments Act.
4. Cost reductions to investors
The introduction of the Managed Investments Act was expected to create a short term cost spike for most scheme operators as they established and documented compliance frameworks and reviewed their operations. The removal of the trustee expense however was expected to provide cost reductions in the longer term.
In our experience most scheme operators have experienced additional costs, particularly in relation to higher than expected establishment costs. Any savings associated with the removal of the trustees appear to have been absorbed by the cost of appointing a custodian. Whilst some Management Expense Ratios have decreased, this appears to be due to the creation of economies of scale rather than the reduction in the costs of managing the investment schemes.
Overall the improvements introduced as a consequence of the Managed Investments Act have not translated into decreases in operating costs, and specifically the cost of compliance continues to impact on scheme operators' margins.
5. Compliance Awareness and Practice
Compliance as provided for in the Managed Investments Act is not an entirely new concept. However, the legislative requirement to have a formal compliance plan and thereby a review of scheme operations represented a significant amendment to the previous structure. In our view this legislative requirement has contributed to strengthen compliance practices, procedures and awareness amongst Responsible Entities and others involved in the managed investments industry.
For most entities there has been an increased focus on compliance. Specific benefits include the appointment of dedicated full time resources responsible for the development and supervision of the compliance frameworks, and an elevation of the seniority of compliance roles, with most compliance managers reporting directly to the board of the Responsible Entity.
The imposition of a formal audit of compliance plans has assisted in bringing a sharper focus and awareness of compliance responsibilities to all levels of scheme operators' businesses.
The challenge for compliance within the Managed Investments Act is to ensure that it remains proactive and does not degenerate into a checklist based or paper chasing exercise. Continued focus on the embedding of compliance obligations into the daily operations of scheme operators is required. This effort should be supplemented by ongoing review and analysis by the compliance committees, boards and compliance plan auditors.
6. Asset Diversity
The ability to diversify a portfolio has always been a key aspect of the managed investments industry. In general Chapter 5C caters for the diversity of schemes. However, the administration of the legislation by the Australian Securities and Investments Commission has not prevented the smaller agricultural schemes and solicitors mortgage schemes from collapsing.
The overall perception is that the regulation of schemes based on traditional financial investment products (for example property and securities) is functioning well under the regime. The smaller, more exotic end of the market however appears not to have transitioned well, as demonstrated in the results of ASIC's recent surveillance activity.
7. Improvements to the Managed Investments Act
In our experience constant legislative change is a major operational and organisational challenge. The flexibility of the current system which allows for changes to both compliance plans and constitutions is a positive factor and provides a mechanism to allow for necessary compliance changes arising in conjunction with new product offerings.
We note below some areas of the legislation and the operations of Responsible Entities which we believe require further consideration:
We note that the ASIC Information Release dated 6 April 2000 refers compliance plan auditors to Auditing Guidance Statement 1052 "Special Considerations in the Audit of Compliance Plans of Managed Investment Schemes" for guidance in relation to materiality. AGS 1052 in turn refers to AUS 810. All references in relation to materiality as described in the various materials available is a reference to financial statement materiality.
In our view ASIC should issue further guidelines concerning materiality in the audit of compliance plans. We believe that in accordance with the spirit of the Act, compliance should be seen as a practical addition to (and hopefully embedding into) business process to result in improved unitholder protection. We believe that materiality in the compliance plan audit and in the context of the Responsible Entity's reporting to the compliance committee and to ASIC should be examined and addressed from this perspective.
Any further consideration of materiality from a compliance plan audit viewpoint should be made in conjunction with the professional accounting bodies.
B) Contracts with Service Providers
Contracts with service providers often specify standards of performance under the contract. If the compliance plan requires compliance with the terms of the contract, than any breach in service standard also represents a technical breach of the compliance plan.
Our knowledge of the industry indicates that service providers will often make errors which their own processes detect and rectify. However, since every system has some inherent weakness, it is impractical to require that all breaches of services standards be recorded as breaches of the compliance plan. ASIC should consider providing further guidance in relation to breach reporting obligations of external service providers, and in particular whether there is an expectation that the service provider notify the Responsible Entity of all breaches of procedure and the rectification procedure undertaken, or to notify of significant material breaches only.
C) Compliance Committee Operation
There appears to be some misunderstanding amongst compliance committee members as to the extent of their duties and the extent to which they stretch into the operations of the Responsible Entity, if at all. It would be beneficial for ASIC to provide guidance to compliance committee members in a Policy Statement.
8. General Comments
Thank you for providing us with the opportunity to make a submission for the purposes of your review. If you would like to discuss any aspect of this submission, please contact me on 02 9248 4816.
Ernst & Young
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