The Financial Services Council has suggested a more pragmatic approach to prohibiting related-party investments as the government looks at clamping down on the type of conflicted arrangements that were part of the $1 billion Shield and First Guardian collapse.
The government announced a consultation into managed investment schemes (MISs) last month which included suggestions to improve oversight of super switching, the collection of more data on MISs by ASIC, and a prohibition on related-party arrangements.
The consultation was launched in response to criticism there wasn’t sufficient oversight of MISs in the aftermath of the Shield and First Guardian collapse. ASIC acted against the funds over concerns investor money was being misused on high-risk investments, pet projects of the directors and personal expenses, and much of the investor money may not be recoverable, according to liquidators.
In its submission to the consultation, the FSC said the related party transaction framework should preserve legitimate and investor beneficial arrangements, rather than adopting a blanket prohibition with limited exceptions that would unnecessarily capture legitimate commercial practices.
The FSC said clear and comprehensive disclosure of all related party transactions in product disclosure and ongoing reporting should be required, as well as the introduction of a clearly defined prohibition targeting high-risk and self-dealing related party arrangements.
The council said that a targeted prohibition could capture arrangements such as related-party lending that lack independent valuations, circular transaction structures designed to obscure asset values or inflate performance, revenue sharing or conflicted distribution arrangements, and structures that effectively transfer control of scheme assets to conflicted distribution or advisory entities.
“These examples demonstrate the types of conflicted conduct that should be prohibited, rather than constituting an exhaustive or open-ended regulatory list,” the FSC said.
“As a foundational safeguard, the law should require responsible entities to clearly disclose all related-party transactions in product disclosure documentation and ongoing disclosure materials.”
The government consultation suggested creating a mandatory alerts regime for super trustees to improve ASIC’s visibility of “problematic” super switching behaviour, which the FSC supported.
The FSC said ASIC should be equipped with the data and intelligence it needs to effectively implement risk-calibrated registration of MISs as well as detect high-risk super switching activity.
“The FSC recommends that, if the policy objective is to improve ASIC’s visibility of potential high-risk super switching, Treasury consider pursuing an enhanced periodic data reporting model via APRA rather than a mandatory alerts regime,” the FSC submission said.
ASIC said in a submission to parliament this month that it didn’t have the capability to effectively monitor all MISs. The FSC said it supported a structured initial and recurrent data collection framework where it is designed to support risk-based registration and supervisory calibration.
“Data collection should enable ASIC to identify emerging conduct and fund-level risks and allocate supervisory resources proportionately across the sector,” the FSC said.
“However, expanded data collection powers should be clearly linked to defined regulatory objectives. Data collection should not operate as a blanket reporting expansion, but as a mechanism to support tiered supervision, early risk identification and targeted engagement.”
It said ASIC must be properly resourced to handle the collection and analysis of the data provided, but its current information gathering portals “do not demonstrate the kind of reliability that would support imposing increased information sharing burdens on industry”.
Indemnity protection
The FSC also published its submission into the government’s review into professional indemnity (PI) insurance and the Compensation Scheme of Last Resort.
The consultation sought feedback on what changes could be made to enable the CSLR to more effectively recover funds from a licensee under external administration or their PI insurer.
The FSC said that before considering any regulatory intervention, Treasury should assess the drivers of loss that lead to unpaid AFCA determinations.
Furthermore, any reforms to PI insurance should consider market capacity and the response from insurers to avoid market destabilisation.
The council recommended that oversight of the adequacy of PI insurance coverage should be carried out as part of an AFSL’s annual audit requirements and there could be obligations introduced that would prevent cancellation of policies so as to allow a greater period of time for claims to be made.
The FSC also suggests Treasury should investigate the possibility of increasing the priority given to the CSLR operator’s creditor claims in liquidation.
The FSC argued that ASIC has legal powers under section 915H of the Corporations Act to require an AFSL to hold PI insurance for the same length of time as the regulator requires the licensee to maintain AFCA membership after its licence is cancelled.
