Monday 24 October 2016

How the new rules will affect advisers

The Australian Securities and Investments Commission (ASIC) has recently changed the rules governing Managed Discretionary Accounts (MDAs) in Class Order 2016/968 and updated its guidance in Regulatory Guide 179 Managed Discretionary Accounts (RG 179).

After a three-year wait, advisers who offer MDAs or are thinking of doing so, now have clear direction.

“The new requirements are balanced. They take into account the need to protect clients’ interests and at the same time recognise the variety of ways in which MDA services are offered,” says Claire Wivell Plater, managing director of The Fold Legal, a specialist law firm that advises clients on financial services regulation. She’s pleased ASIC has taken industry concerns into account in the design of the changes.

New licensing requirements for ‘limited’ MDA providers are the most significant change. Advisers who have been operating managing discretionary accounts within a regulated platform without holding a specific licence authorisation will need to apply for one.

“The good news is there's a two year transition period for this. During this time, although advisers will need to demonstrate they have the required relevant skills, experience and training, ASIC will recognise experience gained from operating an MDA within a platform. That's very important, because it provides continuity for advisers and their clients,” she adds.

Practical implications

Wivell Plater warns advisers the process for applying for an authorisation to offer clients MDAs is rigorous and involved. Aside from applying for the license, advisers will need to demonstrate they can comply with the MDA requirements.

To do this, they will need to carefully document their MDA policies and procedures and review their disclosure documents to ensure they comply with the new requirements. “ASIC’s new approach is to ask for copies of some of these materials so they can form their own view about the likelihood of compliance. So advisers need to be ready,” she says.

The changes also mean advice practices that offer MDAs will need to ensure they have robust practices to manage actual and potential conflicts of interest.

Additional disclosures will be required in financial services guides (FSG), and MDA contracts and investment programs will require new content. “Because the FSG disclosures are detailed and complex, our suggestion to clients is to have two FSGs, a standard FSG that covers their non-MDA services and a supplementary MDA FSG. The supplementary document can be given to clients when advisers know they’re likely to recommend an MDA service,” she says.

The changes also mean advice practices that offer MDAs will need to ensure they have robust practices to manage actual and potential conflicts of interest. Wivell Plater suggests appropriately managing conflict of interest risk involves a number of considerations.

Most importantly, advisers must ensure any decisions to recommend an MDA service are made objectively following an assessment of whether an MDA is appropriate for the client. Providing an in-house service such as an MDA service can generate more income for advisers who generally charge additional fees for managing clients’ investments on a discretionary basis.

Therefore, under the best interests duty, the onus is on advisers not to recommend an MDA unless there is an additional benefit for the client. This needs to be assessed objectively.

Wivell Plater says ASIC’s guidance on managing conflicts of interest is practical and helpful. ASIC suggests MDA operators appoint an independent investment committee to make investment decisions, and that these decisions are approved by a compliance officer before being implemented. Systems should be established to create alerts if the investment committee's parameters are breached.

“The investment parameters should be set out in an investment policy which can be used as a governance mechanism. The policy could establish rules for, for example, acceptable asset allocations, trading frequencies and the use of unlimited recourse financial instruments.”

Avoiding conflicts

Another ASIC recommendation is for advisers to flag potentially conflicted transactions and subject these to an additional level of approval.

Wivell Plater explains the regulator expects advice practices to have information barriers that insulate advisers who make discretionary investment decisions from information that could give rise to conflicts.

“So if there is an in-house benefit from an investment, the idea is to ensure advisers aren't aware of it, so they can’t unduly promote an investment that's in the licensee’s interests,” she explains.

The new requirements will require more focus on custodial arrangements.

According to Wivell Plater, ASIC also expects practices to have arrangements to automatically suspend their discretionary authority in certain circumstances. This would include unexpected events such as significant market dislocations.

Additionally, ASIC has said advisers must obtain specific client consent before trading unlimited recourse products such as contracts-for-difference on a discretionary basis. Wivell Plater says this won’t affect most practices.

“It takes expertise to trade these instruments on a discretionary basis. Advisers who do this need to make the client aware of the risks in the FSG and MDA contract and get their specific consent,” she notes.

ASIC has decided not to introduce any new financial requirements for practices that offer MDAs. It was considering introducing a net tangible assets condition similar to those that apply to managed investment schemes and custodians, but has decided to defer this until after the impact of the other MDA changes can be assessed, i.e. for at least 2 years.

On top of this, MDA operators are still required to have $5 million in insurance cover.

Industry impact

According to Wivell Plater, the changes are likely to be a positive for platforms.

 “Over the past few years, in response to heightened demand for MDAs, a number of platforms have created bulk trading facilities so practices can implement a bulk change across all clients’ portfolios with one rolled up trade. This avoids having to go into each client's portfolio individually to effect the change. These platforms are well placed to assist advisers to operate MDAs,” she adds.

Start preparing for the new regime now because the changes impact almost every aspect of MDA services.

Some platforms also offer investment committees and model portfolios. So advisers who don't have the capacity to establish their own investment committees can work with the platform’s capabilities.

On the other hand, the new requirements will require more focus on custodial arrangements. MDA providers who delegate custody must ensure the custodian and their sub-custodians satisfy rigorous standards when holding clients’ assets on trusts; most particularly, holding them separately from other property and keeping meticulous records of ownership.

“That will require written agreements about what the custodian can and cannot do,” says Wivell Plater.

The agreement must give MDA providers the right to review, monitor and give instructions to the custodian and any sub custodian. It must prevent custodians from taking security interests such as a mortgage or lien over clients’ assets, even to secure payment of their fees. And custodians must agree to be liable to the MDA provider and clients about any losses that might be caused by the custodian's acts or omissions.

The custodian must also certify at least once every 13 months it has met the agreement’s terms and minimum standards. This means advisers must have much more robust selection, contracting and monitoring obligations in relation to an external custodian. However this really just brings the custodial requirements for MDAs in line with other custodial arrangements.

All the new requirements must be in place on or before 1 October 2017, other than licence variations for limited MDA operators, which have until 1 October 2018 to apply for an MDA authorisation.

Wivell Plater’s message to MDA providers is to start preparing for the new regime now because the changes impact almost every aspect of MDA services.

And for limited MDA operators who will need to vary their licences, while two years seems like a long time, it can take many months to get an application through.

“Limited MDA variations are new, and our experience has been that novel applications take even longer than usual. So it would be advisable to start soon,” Wivell Plater says.

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