Most of the reforms proposed for Collective Investment Schemes (CIS) in the June 2010 Securities Law Review will proceed. A small but significant exception is that employer (and other restricted offer) superannuation schemes will not now be required to close to new members as the price of retaining their current structures.
This Brief Counsel provides an overview of the key reform proposals and is a companion piece to our earlier commentary on the financial markets components of the review.
The four key reform directions are:
- requiring each CIS to have an external supervisor which is licensed under the Securities Trustees and Statutory Supervisors legislation and is responsible for manager oversight and custody of scheme assets
- providing for a special class of open ended investment company (OEIC) which is subject to the generic CIS regime and to the same basic requirements as other New Zealand companies, but has specialised rules relating to the issue and redemption of shares to allow investors to enter and exit efficiently
- requiring fund managers to be registered by the Financial Markets Authority (FMA) based on meeting a 'fit and proper person' test (the Treasury advised against this, arguing that sufficient protection is already provided through other legislation), and
- requiring future insurance contracts with an investment component, and any future employer or restricted-offer superannuation schemes, to comply with the CIS regime (existing arrangements will be exempt).
The only major changes from the June 2010 discussion document are the decision to impose a (relatively light-handed) licensing regime on fund managers and the pragmatism shown towards existing employer and restricted-offer superannuation schemes.
Proposed regulatory framework
Schemes will be free to adopt any legal form they wish but will be required to comply with a common set of substantive requirements. Key among these are that they have:
- a manager who is responsible for the management of the scheme, and
- an external supervisor, licensed under the Securities Trustees and Statutory Supervisors legislation, who is responsible for the oversight of the manager and the custody of scheme assets (though custodianship will be permitted to be outsourced).
Welcome relief for restricted superannuation schemes
Any new employer or other restricted-offer superannuation schemes will be covered by the regime.
Existing schemes, however, will be exempted provided they meet certain criteria. The June 2010 discussion document had contemplated exempting employer-based schemes only if they closed their doors to new members, but the Government has accepted the argument that this would be inappropriate as they require a certain level of membership to remain viable.
Instead, restricted schemes (i.e. those that are employer-based or restrict membership to a certain industry, profession or calling) will be required to have at least one independent trustee, approved by the FMA, who can demonstrate a degree of investment management skill and experience. We expect this will also mean having one independent director if the trustee is a company. This is the solution endorsed Chapman Tripp .
Restricted schemes will also be prevented from making investments of greater than 5% in any one asset or having total investments of greater than 5% in any employer related parties.
Multi-employer "master trust" schemes will be regulated in the same manner as all other CIS, with the fund manager becoming the issuer (as will be the case for KiwiSaver).
Duties of custodians
Each CIS will be required to place fund assets with an independent custodian. The external supervisor will be legally responsible for this role, but can contract out the performance of the custodial function to a third party if they choose.
Although licensing will not be necessary, Cabinet has decided that custodians must maintain a presence (an office or resident director or representative) in New Zealand, and keep all records of asset ownership in New Zealand. These requirements may create compliance issues for some overseas-based custodians.
Asset valuation and pricing errors and limit breaks
The FMA will prepare guidance on the appropriate process for valuing assets and how often valuations must be conducted. A CIS will be required to state whether it has complied with those guidelines in its PDS and by way of quarterly reporting. This will ensure that investors have accurate information to gauge performance and to ensure that accurate prices are applied at the point where investors are entering or exiting a CIS.
Managers will need to report to the supervisor of the scheme when a pricing error or limit break occurs, and the supervisor will be required to report this to the FMA if the error is 0.5% or more of the value of a unit or the value of the scheme. The manager will also have a duty to reimburse losses to current or former investors, as well as the scheme itself, unless it appears to the supervisor that the breach is of minimal significance (if the supervisor concludes that reimbursement or payment is inappropriate for this reason then it will be required to report that to the FMA).
Changes to constitutional documents
Material changes to constitutional documents will require the consent of a majority of investors.
Meetings and electronic voting
The provisions in the Unit Trusts Act will be extended to all CIS with the effect that:
- investors holding 10% of the value of the scheme's assets will be able to call a meeting, and
- resolutions at meetings will be passed provided the people who vote hold at least 25% by value of the scheme's assets and that they vote 75% by value in support of the resolution.
Electronic voting will be permitted, consistent with best practice overseas.
Where there has been a breach of duty by the fund manager, investors will be able to call a meeting and (provided the support threshold is met) remove the fund manager or direct the fund manager to take certain action.
Consistent with the existing whistleblower duties and protections in the Superannuation Schemes and KiwiSaver Acts, investment managers, actuaries or auditors will be required to disclose to the FMA any reasons they have to suspect that there is a serious problem with the CIS. Such disclosures will attract protection from liability if made in good faith.
Related party transactions
Disclosure of all related party transactions will be required. Fund managers will also be required to report to the external supervisor (and the supervisor will be required, in turn, to report to the FMA) any related party transaction which exceeds 10% of assets.
The Government decided against tighter regulation on the basis that this would be unduly burdensome (given that related-party dealing is an important feature of many business structures).
The idea is to encourage product innovation and facilitate greater share market participation by retail investors. OEICs will be run like a traditional company except that they:
- will be subject to the CIS regime, and
- will have specialised rules relating to the issue and redemption of shares to allow investors to enter and exit the market efficiently.
Regulation of fund managers and wrap-account providers
All fund managers (meaning their directors, senior managers and controlling owners) will have to be registered by the FMA.
The Cabinet Paper also proposes the regulation of non-pooled investment schemes, including wrap accounts, with the likelihood that there will be disclosure requirements imposed.
Details of what the FMA will take into account in determining eligibility will be set out in regulations but the Ministry of Economic Development has indicated that the 'fit and proper' person test will be less stringent than that applying to non-bank bank deposit takers and under the new insurance prudential supervision regime.
Insurance products and exchange-traded funds
Existing insurance contracts with an investment component will be exempted as most are legacy products and it is difficult to separate out the investment component. Further, the insurance/investment split is specific to the policy holder rather than generic.
Any new such contracts will be expected to comply with the CIS regime.
Exchange-traded funds are a relatively new product offering but are rapidly evolving. As these are becoming more complex and actively-managed, further work is required as to what disclosure requirements they should apply to them. These are expected to be addressed in the next report-back to Cabinet prior to 31 May 2011.
Our thanks to Jamie Hoyle and Emma Harding for writing this Brief Counsel.
The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.