Superannuation fund trustees will be seeking increased input and cooperation from their investment managers in order to comply with new regulatory requirements while hedge funds will need to consider their status under the refined definition of 'hedge fund'.
We have previously reported on some other aspects of these reforms and their potential impact on fund managers and this legal insight is an update on these earlier releases.
New Reporting Standards
Australia's prudential regulator, the Australian Prudential Regulation Authority (APRA) recently finalised a series of 35 new reporting standards which require superannuation fund trustees to submit detailed data on a quarterly or annual basis.
While some of the standards are related to internal trustee matters, many are concerned with fund investment and performance issues. We anticipate that investment managers will be asked to assist trustees compile and collate this information in the formats required by the regulator. For example, trustees will be required to report to APRA:
the investment fees and costs payable by the fund, including those fees built into the price of underlying products
the fund's asset allocation percentages, relative to the trustee's target allocation.
For some standards, APRA requires information for the period commencing 1 July 2013 while the remainder of the reporting standards are in respect of the period commencing 1 July 2014. In most cases, the reporting date is 28 days after the end of the reporting period (for quarterly reporting standards) or 31 days after the end of the reporting period (for annual reporting standards). APRA has granted very short extensions on the first reporting date for some of the reporting requirements.
Managers will need to build into their systems the capability to provide the information required by APRA and those managers who are unwilling or unable to provide the required information may find it difficult to keep their superannuation mandates.
Performance Fees for Investment Managers
The current reforms also restrict the circumstances in which superannuation funds can pay performance fees to their investment managers for arrangements entered into on or after 1 July 2013. These restrictions are strictest for funds which accept "default employer contributions", ie the mandatory contributions from employers on behalf of their employees to a fund selected by the employer. Default employer contributions make up the majority of contributions into superannuation funds in Australia. Funds accepting these contributions can only pay a performance fee to their investment manager where:
performance is measured against the performance of similar investments on an after cost basis
performance is measured over an 'appropriate' time period for the particular assets
there are disincentives for the investment manager for underperformance.
These restrictions are designed to align the interests of the investment manager with the employees whose money is being invested.
Refined 'Hedge Fund' Disclosures
The Australian Securities and Investments Commission (ASIC) has redefined the test for schemes that will be considered hedge funds for the purposes of some new hedge fund disclosure requirements and the requirement to comply with the shorter Product Disclosure Statement (PDS) regime. These new requirements are mandatory for funds which are offered to retail investors in Australia, while hedge funds, which are offered to wholesale investors, are 'encouraged' to comply.
Funds that fall within the revised definition of hedge fund will be required to comply with the disclosure obligations set out in Regulatory Guide 240: Hedge funds: Improving disclosure (RG 240) but will not be required to comply with the shorter PDS regime. Some funds that do not fall within the revised definition may be required to comply with the shorter PDS regime. The test for hedge funds has been redesigned to ensure that funds with more orthodox investment strategies are not inadvertently captured under the new definition, as was the case under the previous version.
The new material from ASIC makes it easier to determine whether a scheme falls within the definition of hedge fund and also introduces an anti-avoidance clause to ensure schemes are not structured for the sole purpose of avoiding being characterised as a hedge fund.
The amendments to the definition of hedge fund include:
Changes to the complexity of investment structure limb, which is triggered when a scheme invests through three or more vertically interposed entities (or two or more where at least one entity is offshore), where the responsible entity (RE) or an associate has the capacity to control either the disposal of products or two or more of the interposed entities. The amendments redefine 'interposed entity' to exclude registered schemes and certain foreign entities from being counted as interposed entities when determining whether the complexity of investment structure limb is triggered. The relevant foreign entities are those which are incorporated or registered in certain offshore jurisdictions and regulated by prescribed regulatory authorities (Prescribed Foreign Regulatory Authority). Prescribed Foreign Regulatory Authorities include the US Securities and Exchange Commission, the UK's Financial Conduct Authority and the Hong Kong Securities and Futures Commission.
Changes to the definition of 'derivative' and to the carve-outs from when this characteristic will be met, and clarification as to when the derivatives limb will be triggered.
Changes to the performance fee limb so that it is only triggered where there is a right to a performance fee and the RE has disclosed to investors that performance fees will be payable when certain conditions are satisfied.
RG 240 identifies a number of benchmarks and disclosure principles for hedge funds which include:
periodic reporting – whether the responsible entity (RE) of the hedge fund will provide periodic disclosure of certain key information on an annual and monthly basis
investment strategy – details of the investment strategy for the fund
investment manager –necessary information about the people responsible for managing the fund's investments
fund structure – an explanation of the investment structures, relationships between entities in the structure, fees payable to the RE and investment manager, jurisdiction of any offshore parties and the due diligence performed on underlying funds
valuation, location and custody of assets – the types of assets held, their location, how they are valued and custodial arrangements
liquidity – the fund's ability to realise its assets in a timely manner and the risks of illiquid assets
leverage – the maximum anticipated level of leverage of the fund (including leverage embedded in the assets of the fund)
derivatives – the purpose and types of derivatives used by the RE or investment manager and the associated risks
short selling – how short selling may be used as part of the investment strategy and of the associated risks and costs
withdrawals – the circumstances in which the RE allows withdrawals and how this might change.
The amendments take effect on 1 February 2014 and will result in many hedge funds, which are open to retail investors, having to address a range of additional issues in their disclosure documents.
The superannuation reforms will require effort from superannuation fund trustees and their investment managers if the new requirements are to be satisfied. In this regard, investment and reporting processes may need to be updated and agreements and mandates may need to be reviewed.
The hedge fund disclosure reforms should result in fewer 'false positives' in relation to classification as a hedge fund for disclosure purposes, ensuring that the disclosure requirements are aimed at the appropriate entities. Fund managers will need to consider whether they fall within the revised hedge fund test and update their disclosure documents accordingly.
K&L Gates' global presence positions us well to assist Australian superannuation funds and their global investment managers respond to these challenges.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.