ASIC has introduced new financial requirements for responsible entities of managed investment schemes. The measures include many (but not all) of ASIC's proposals in its 2010 consultation paper.
This alert outlines some of the key new requirements that will apply to responsible entities, which will be effective from November 2012. Responsible entities will need to start to plan for the new (generally, higher) financial requirements as well as put in place appropriate processes in order to meet the associated reporting requirements.
1. Cash flow projection for at least 12 months
It is proposed that a responsible entity must prepare a projection of its cash flows over at least 12 months based on the responsible entity's reasonable estimate of what it is likely to happen over the period.
The aim is to further encourage responsible entities to plan their financial resource requirements on an ongoing basis. The current three month projection period is considered too short as it is unlikely to provide directors with the opportunity to identify potential cash flow risks at a sufficiently early stage to allow them to take corrective action.
Responsible entities will be required to be able to demonstrate, based on the cash flow projection, that over the 12 month projection period it will have:
- access to sufficient resources to meet its liabilities; and
- sufficient resources to comply with the cash or cash equivalents component of its net tangible assets (NTA) requirement (see below).
The projections need to be approved at least quarterly by the directors and must be updated in certain circumstances including when there is a 'material change'.
2. Net tangible assets (NTA)
The proposed new measures require that a responsible entity must at all times hold minimum NTA of the greatest of:
- $150,000; and
- an amount of up to $5million, being 0.5 per cent of the average value of scheme property operated by the responsible entity; and
- 10 per cent of the average RE revenue of the responsible entity (with no maximum).
The proposed changes reflect ASIC's view that the current minimum NTA requirements, which start at $50,000 (depending on the circumstances), do not provide a responsible entity of any size with a sufficient buffer to meet its compliance requirements.
Average value of scheme property and average RE revenue
The base amount of scheme property applied to calculate the required NTA will potentially become a more fluid figure. 'Average value of scheme property' will require the responsible entity to apply the greater of the actual current value and an adjusted amount. The adjusted amount, broadly speaking, is derived from averaging the actual monthly value of scheme property for up to the last two preceding financial years (starting from when the RE is first authorised to operate a registered scheme) and the monthly forecast value of the scheme property for the remainder of that financial year.
ASIC also states that the inclusion of a revenue based test in the proposed NTA requirement is a better indicator of a responsible entity's overall operating risk. The reference to 'average RE revenue' includes payments out of scheme property that relate to fulfilling a responsible entity's obligations, even if some of those obligations are outsourced to a separate management or custodial entity. There is an exception for audit costs covering statutory audit requirements. The stated aim is to ensure that responsible entities maintain NTA that cover all aspects of scheme operations. Broadly, the average RE revenue is to be calculated by the responsible entity by reference to the actual RE revenue over certain previous financial years and the forecast RE revenue for the remainder of that current financial year. Note, for the second financial year and going forward, responsible entities do not take into account their revenue for the first financial year.
Liquid assets and cash or cash equivalents
The NTA would be required to be in the form of 'liquid assets' (extending to assets that can be realised for market value within a six month period). The purpose of this is to enable responsible entities to have access to liquid assets to address short-term to medium-term issues. Half of the required NTA would need to be in the form of 'cash or cash equivalents', subject to a minimum of $150,000. The intention here is to ensure that responsible entities have adequate cash reserves to address immediate and unexpected expenses.
The NTA requirement that would apply if a responsible entity has custody of scheme assets would become the greater of $5million and 10 per cent of average RE revenue (explained above).
Adjusted liabilities and eligible undertakings
There are arrangements that responsible entities have entered into that would need to be reviewed in light of the amended definitions of 'adjusted liabilities' and 'eligible provider' categories, otherwise responsible entities risk inadvertently breaching the minimum NTA requirements.
3. Audit opinion
The responsible entity must lodge with ASIC a report by a registered company auditor, for each financial year of the responsible entity and any other period that ASIC directs. Among other assurances, the opinion must state that for every part of the period for which the responsible entity was authorised to operate a registered scheme, it complied with certain provisions regarding the cash needs requirements and NTA requirements. This would need to include an opinion relating to the reasonableness of the assumptions underlying the 12 month cash flow projections.
What proposals were rejected?
ASIC did not adopt certain of the proposals in its original consultation paper. In particular, it originally proposed to prohibit responsible entities from providing certain guarantees and indemnities. The majority of respondents disagreed because, amongst other reasons, the nature of operations of a responsible entity requires the provision of certain guarantees and indemnities in the ordinary course.
What does this mean for responsible entities next year?
The proposed reforms are to commence on 1 November 2012. Entities that will have difficulty meeting this deadline should consider applying to ASIC for an extension.
In the meantime, it is important that responsible entities review their current financial resources and ensure that they meet the revised requirements above. It may be the case that restructuring or recapitalisation will be needed to ensure that responsible entities are in compliance with the new reforms.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.