Advisers currently using limited MDA arrangements and reviewing their investment management and portfolio administration options need to think carefully about the type of business they’re likely to be running in the future.
In the near future, it’s likely that ASIC will lift the requirements on advisory firms that use the 2004 “no action letter” to provide limited MDA arrangements.
There’s also mounting pressure on advisers to add greater value through improved portfolio management, in the prevailing volatile, low income environment.
Assuming ASIC removes the ability for an advisory firm to manage client portfolios under a limited MDA arrangement, there are three options for advisers who want to build an efficient, profitable and sustainable business.
Firstly, they can apply to ASIC for a licence authorisation to provide MDA services to retail investors, in which case they must satisfy the regulator’s competency, compliance and financial requirements. Alternatively, they can partner with an experienced, specialist MDA operator. Some believe a potential third option is to run client portfolios via a separately managed account (SMA) structure.
For those who plan to go down the SMA route and wish to continue managing portfolios, there are a number of potential shortcomings. This article examines the two key options available to advisers who want to provide an MDA service.
Option 1: Gain a licence authorisation to operate MDA services
Advisory practices that want to become an MDA operator must gain an AFS licence authorisation to operate MDA services for retail investors.
MDA operators are required to prove they have the competence, procedures and resources to provide MDA services.
Limited MDA arrangements that were previously provided through a regulated platform may need reworking. Regulated platforms providing custodial services to MDA operators will need to be engaged in a different way. This is particularly the case when it comes to contracting for custody and processes like managed fund trading where pooling provisions; which is the ability for each investor to meet minimum investment requirements in a PDS, need to be met.
That’s arguably the easy part.
Some advisory firms may look to implement their own administration arrangements or outsource to specialist managed account administrators. This may require new software providers and custodians, or alternatively, a specialist administrator who provides outsourced technology and administration solutions. That may sound simple but unfortunately for boutique MDA operators, the majority of custodians won’t deal with smaller MDA operators for commercial reasons. Furthermore, specialist administrators providing custodial services as part of their solution need to have $10 million in capital to provide a custodial arrangement and many don’t meet this requirement.
Then there’s professional indemnity insurance. Advisory firms looking to operate their own MDA arrangement can expect personal indemnity (PI) premiums to jump, assuming they can get cover at all.
ASIC believes MDA services need to be regulated in a similar way to RE arrangements given the risk to retail investors, which is why tougher licensing conditions apply to advisers who provide MDA services. PI insurers generally agree, particularly where a MDA operator is providing advice to clients, managing the client portfolio and undertaking administration in-house.
Finally, advisory firms need to also consider the additional regulatory and compliance obligations including ASIC’s proposed increased capital requirements.
Under the proposed changes, the capital requirement for MDA operators will increase to NTA of 0.5 per cent of FUA up to $5 million, even if administration and custody is outsourced.
Option 2: Partner with a licensed MDA operator and administrator
For the majority of small licensees and practices with limited MDA arrangements, this represents the most practical, low risk option because they can implement a compliant MDA service relatively quickly without a large capital outlay.
By partnering with a specialist MDA operator, advisory firms can outsource administration, custody and responsibility for the overarching compliance of the MDA structure while retaining responsibility and ownership of the strategic advice and portfolio management functions. Some providers build bespoke solutions for firms so that the solution is customised for the advisory firm.
This option enables advisers to focus on providing advice and managing portfolios without the need to meet onerous regulatory obligations, or continuously invest in costly systems and infrastructure.
Under this type of arrangement, an MDA operator typically appoints an advice business as a portfolio manager, under a formal investment management agreement.
Prior to appointment, advisory firms must demonstrate that there’s a strict governance framework in place, including documented policies and procedures and an experienced investment committee with independent members.
If any advisory firm manages their own portfolios, which will be the case under a limited MDA arrangement, advisers will seek to add value by ensuring clients don’t overpay for assets as far as possible, and conversely achieve the highest price possible when selling. To do that, they need the ability to take advantage of timely opportunities, manage money with discretion and execute trades efficiently, to better control the investment outcome, including the ability to move to a competitive cash solution when assets become overvalued.
Even if an advisory firm chooses to outsource all, or part of the, portfolio management function to a third party professional manager, asset consultant, broker or research house (as many do), they’re still responsible for setting the strategy, making sure it’s appropriate for the client, ensuring it’s properly implemented and electing to replace underperforming appointed parties.
Where a practice doesn’t have a formal investment framework, the right MDA provider can help them put one in place.
On Monday: A new white paper examines the possible impact of regulatory changes to managed discretionary accounts (MDAs) and provides tips on how to maximise practice efficiency, productivity and profitability.
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