Tougher oversight flagged by ASIC for investment vehicles: what you need to know about proposed changes to ''wholesale clients''

Fund managers and investors should be keenly aware of new rules proposed to further regulate participation in investment and fundraising activities in Australia.

In September 2023, in response to a consultation paper released by Treasury, ASIC published its review of the rules applying to ‘managed investment schemes’ under Chapter 5C of the Corporations Act (Act). Managed investment schemes are commonly set up as unit trusts and include a diverse range of investment funds, such as property or exchange traded funds, with a broad spectrum of risk profiles.

ASIC has recommended that the 'product value’, ‘net asset’ and ‘gross income’ tests for wholesale investors – usually larger and more institutional investors – be tightened by significantly raising the financial thresholds. By doing so, ASIC is effectively requiring that the consumer protections afforded to smaller investors (known as ‘retail clients’), such as the right to receive the Product Disclosure Statements, be extended to a broader category of investors. Among other recommendations made by ASIC, the changes serve ASIC’s objective of maintaining trust and stability in the financial system.

Critically, ASIC went beyond the scope of enquiry set by Treasury to suggest that the same thresholds for investors to qualify as ‘sophisticated’ for the purposes of companies raising capital under Chapter 6D of the Act also be raised. While this sensibly maintains alignment between the wholesale and sophisticated investor tests, this proposal will limit the pool of investors who can receive securities without disclosure documentation such as a prospectus.

Given that the recommendations are broadly expected to be adopted (at least in part), this article will outline ASIC’s proposals and provide recommendations to readers to ensure that they are prepared if the changes become law.

What kind of investors are there?

The rules which apply in respect of fundraising under Chapter 6D of the Act and managed investment schemes under Chapter 5C / Chapter 7 of the Act differ depending on whether the investment is offered to sophisticated or non-sophisticated investors (in the case of fundraising) or wholesale or retail investors (in the case of managed investment schemes).

Currently, an investor will be a sophisticated or wholesale investor (as applicable) if at least one of the following tests are satisfied:  [1]

• product value test – the value of the financial product or securities being acquired by the investor is at least $500,000;
• net assets test – the net assets of the investor are at least $2.5 million; and
• gross income test – the gross income of the investor is at least $250,000 per year for the last two financial years.

Sophisticated and wholesale investors may access a wider range of securities and financial products, which may have a higher level of risk, than non-sophisticated and retail investors. However, as sophisticated and wholesale investors are typically larger and more experienced, they do not have access to the legal safeguards designed to protect other investors. These safeguards include:

• in respect of managed investment schemes, design and distribution obligations which require retail managed investment scheme managers to take reasonable steps to ensure that the distribution of their products are consistent with their nominated target market to protect vulnerable investors trading in volatile products;
• in respect of managed investment schemes, an obligation of the ‘responsible entity’ (the entity managing the fund, such as a trustee) to operate the scheme as a registered scheme, and meet heightened disclosure obligations such as issuing a product disclosure statement (PDS) to retail investors as well as obligations to generally act in the best interests of members under Chapter 5C of the Act; and
• in respect of fundraising, the requirement to issue disclosure documentation such as a prospectus to potential investors.
   

What has ASIC proposed?

ASIC has proposed to both increase the thresholds for the product, net assets and gross income tests and index these amounts annually to account for future inflation. Given that the thresholds have not changed since 2001, ‘bracket creep’ has become a factor as the thresholds have become easier to satisfy over time. This is especially the case as the family home, which typically comprises the most valuable portion of an individual’s assets, is included in the net assets test. Accordingly, a higher percentage of people satisfy the ‘wholesale client’ and ‘sophisticated investor’ tests.
In ASIC's view, bracket creep is causing some investors to be unwittingly classified as wholesale investors and lose protections otherwise offered to unsophisticated and retail investors. In fact, an ANU study has shown that only 1.9% of adults were sophisticated or wholesale investors in 2002, but this number increased to 16% in 2021 and is expected to grow to 29% by 2031 if left unchecked.

However, if ASIC’s proposal is adopted, it is unclear how sophisticated and wholesale investors will be treated if they subsequently become retail investors. In particular, there is uncertainty whether:

• there will be any grandfathering provisions, which will enable such investors to remain in wholesale schemes if they consent; and
• if there are no grandfathering provisions, whether an investor’s forced redemption of their investment will trigger a CGT event generating an unexpected tax liability.

Furthermore, while some commentators openly support these measures as a prudent step to ensuring investor safety, others have cautioned that tightening the thresholds will stifle investment and create further deadweight loss in the financial sector.

Nonetheless, even if the thresholds are increased, savvy smaller investors may have respite that they may still be able to access investment opportunities that are otherwise marketed to sophisticated and wholesale investors only. For example, if an offer of securities or financial products is made by a body holding a financial services licence and if that body is satisfied on reasonable grounds that an investor’s previous experience in investing is sufficient to enable them to make informed decisions, then the investor may still be allowed to invest in these opportunities that are otherwise off limits. [2]

What other changes has ASIC flagged?

Among other things, ASIC also proposed the following changes:

• hanging the rules governing when a scheme is considered liquid or illiquid;
• automating the registration of managed investment schemes;
• making it easier to replace responsible entities for unlisted schemes; and
• introducing a tailored insolvency regime, as a scheme specific regime would simplify the process and would aim to give investors a better outcome.
   

What does this mean for participants in the investment sector?

Companies raising capital, scheme managers and investors alike should closely monitor whether ASIC’s recommendations are adopted and become law. In particular, companies raising capital and scheme managers should be aware of the potential impact of updated thresholds and consider making representations to industry bodies, regulators and parliament to ensure all implications of such a change are examined. 

Sophisticated and wholesale investors that are at risk of becoming reclassified as non-sophisticated and retail investors respectively should be aware of any transitionary rules when they are released and if grandfathering options are available. These investors may also consider applying to a licenced financial services body directly if they are experienced in investing and wish to continue to invest in securities or schemes otherwise only available to their counterparts.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask to speak to a member of the Commercial team.

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[1] See for example, section 708(8) and section 761G(7) of the Corporations Act 2001(Cth). As with all such provisions, there are notable exceptions to these general rules.

[2] See section 708(1) and section 761GA of the Corporations Act 2001(Cth)