The two-year transitional period ending on March 11, 2004 will reveal how the Investment and Financial Services Association - IFSA member companies and other financial institutions faired. This report gives us an insight on the workings of the asset management companies in lieu of the new regulatory environment. It is imperative on the Pakistani asset management market to view this report as a learning tool in adopting the regulatory reforms, been pursued by the Securities and Exchange Commission of Pakistan - SECP.
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I. Country overview
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June 2003 $AUD millions
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i. Equity funds 217,632
ii. Bond funds 62,777
iii. Money market funds 144,793
iv. Other 218,521
v. Fund of funds 117,929
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Total in AUD (ex. FOF) 643,723
Total in USD 428,269
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The Australian managed investment industry is experiencing strong contributions, mainly due to the level of mandatory contributions required under the Australian superannuation guarantee system. The direction of fund flows over the past financial year can be broken into two phases.
The first phase, until March 2003, saw fund flows into money market, bond and property funds as general market conditions trended down.
Equity fund flows were down especially in the oversea fund area as were equity market returns over the nine-month period.
In the second phase of the year from March till June 2003 equity market started to rebound and have continued to strengthen post June. However equity market indices are basically where they were 12 months ago.
The Australian dollar appreciated by 18 percent relative to its US, increasing the US dollar value of funds under management by the same amount over a 12-month period.
Consequently the decline in funds under management has been negligible in 2003.
Equity markets and global economic conditions continue to rebound from March 2003 lows, with fund flows likely to be switch from defensive to growth orientated asset classes.
2. INTERNATIONAL INVESTMENT TRENDS
There has been a steady downward trend in overseas holdings, because of the overall equity market decline and a more risk adverse approach to investing in Australia.
3. LEGAL DEVELOPMENTS
MANAGED INVESTMENTS LEGISLATION: The Australian retail funds market remains regulated under the provisions of the Managed Investments Act. Under the act, funds managers take on the duties of the single responsible entity whereby they have heavy obligations, under statute law, to uphold unit holder rights. Hence trustee duties have been fused with manager duties.
The majority of managers use independent custodian services. Superannuation funds also are under the regulatory protection of the MIA as approximately 90 percent of these savings are invested in wholesale and retail MIA vehicles.
The MIA has also provided a model for a new prudential framework for superannuation funds.
A review of the MIA's first two years of operation has indicated that besides a few minor exceptions, the new regime is working in accordance with its original objectives.
Research on costs of managing MIA moneys reveals that there has been a reduction in costs following these reforms.
FINANCIAL SECTOR REFORM LEGISLATION: The Financial Sector Reform package commenced on 11 March 2002. Under it, financial institutions have harmonised disclosure and reporting obligations. Licensing of dealers and advisers in securities has been strengthened, as has the requirements for training individuals who give consumers financial advice.
The new arrangements entail far reaching changes in IFSA member companies and other financial institutions. The two-year transitional period ends 11 March 2004.
MASTER FUNDS: Australian funds mangers operate under a new set of provisions governing the sale and operation of 'wrap accounts' and master funds. These products offer a type of 'fund of fund' service but in many cases it is investors who decide on the asset allocation/fund allocation, hence they are referred to as 'Investor Directed Portfolio Services'.
IDPS products are popular because they allow investors access to a range of funds on the basis of wholesale fees and charges. Additionally, these accounts offer a fully integrated tax and member reporting facility.
IDPS products come under the FSR provisions and have the same income tax treatment as other retail funds, viz, investment income and capital gains are taxed in the hands of investors at the appropriate marginal rate of taxation.
TRACKING OF CASH TRANSACTIONS: Identification and reporting of cash transactions to prevent money laundering is a major issue. Currently, most investment management products do not come under the customer identification provisions.
Under a recent initiative, including the revised Financial Action Task Force revised 40 recommendations, there is the potential for many funds products to be required to comply with '100 point' test procedures under which investors who open a new account are required to undergo identification by the production of passport, driver's licence and birth certificates.
TAXATION: During the past three years there have been major reforms in Australia's taxation system. These reforms comprise lower rates of personal income tax, the abolition of wholesale sales tax and a broadly based taxed tax of 10 percent on goods and services.
In addition, rates of corporate taxation have been lowered in two steps from 39 cents to 30 cents in the dollar.
Efforts have been made to ensure that managed investments, wholesale and retail, continue their 'pass through' of income free of tax to the ultimate beneficiary, who pays tax at the appropriate rate. Because of this the capital gains tax impost on fund distributions has been reduced by 50 percent.
The industry succeeded in abolishing the 'cost base adjustment' that had resulted in the double taxation of certain capital gains on managed funds. This allows uniformity of treatment between direct and indirect investments.
SUPERANNUATION: Australian retail managed investment funds offered to employees who are accumulating a lump sum of retirement or drawing down funds whilst in retirement continue to grow despite two years of disappointing returns.
This growth has been fuelled by the compulsory superannuation payments employers make to their employee's superannuation accounts. Over the past decade these contributions have grown from 3 percent (July 1992) to 9 percent (from July 2002).
The Howard Government's ten-point plan on the superannuation front, further weakened the historical link between superannuation and employment. The changes in prospect include a number of interesting opportunities for funds managers offering retail and employer-sponsored superannuation, namely:
-- Matching government and employee contributions up to $1,000Aust for low and middle income earners;
-- Child superannuation accounts are available for Australians under the age of 18 years. Parents and others can make contributions up to a certain limit and the child would be able to convert these savings to normal superannuation on commencement of employment.
-- The lowering of the superannuation 'surcharge' (additional contributions tax on higher income earners) from 15 percent to 12.5 percent over the next three years with some prospects of a further lowering.
-- More flexible arrangements for the over 65 age group to allow them to continue to contribute to superannuation.
-- Choice and portability legislation to provide greater consumer sovereignty, which is likely to fail in the parliamentary process.
-- Social security and tax treatment of pension/income stream assets in growth (as opposed to fixed interest annuities) assets to be reviewed to provide enhanced benefits for retirees.
PRIVACY: The development of new technology and e-commerce has raised new issues about information privacy. Increasing use of the internet and other technology means that personal information may be very easily collected and transferred around the world.
The move in Australia to give greater privacy protection to personal information in the private sector is part of a world-wide trend. In December 2000, the Privacy Amendment Act 2000 was passed by the Federal Parliament with commencement one year later.
The new regime will apply to most private sector organisations. The National Privacy Principles (NNPs) in the Privacy Act set out how private sector organisations should collect, use, keep secure and disclose personal information.
A guideline to the NNP was developed to assist organisations to meet their obligations in the handling of personal information. IFSA has made substantial input into these guidelines to ensure a workable outcome.
II. DISTRIBUTIONS CHANNELS OF INVESTMENT FUNDS
With over 90 percent of retail business for funds managers coming from financial planners, the adviser/broker network continues to be the largest distribution channel. The larger Banks are also now owners of fund managers, as well as owners of large distribution channels.
Direct sales tend to be the province of over the counter superannuation and funds management service houses and low cost funds offerings advertised in the financial press and investor bulletins. Some web based selling has been successful, although the web is used more widely for information and administration activity.
Superannuation fund choice has not eventuated from a legislative perspective as yet, although it is occurring in the market, with company based funds choosing to outsource their super arrangements to master trusts. Investment choice continues to increase in popularity for all funds. This provides strong opportunities for master trusts, wholesale funds, and alternative style investments such as Socially Responsible Investments, Private Equity and Hedged products.
III. CORPORATE GOVERNANCE
RELEASE OF 4TH EDITION OF CORPORATE GOVERNANCE GUIDELINES: IFSA launched the 4th edition of its "Blue Book" - Corporate Governance: A Guide for Investment Managers and Companies on 10 December 2002. As part of the review process, IFSA held stakeholder meetings with many groups including the Australian Council of Superannuation Investors, Australian Institute of Superannuation Trustees, Australian Superannuation Funds Association, Australian Shareholders Association and the Australian Institute of Company Directors. The Blue Book is strongly supported by most of these associations.
The Blue Book is widely recognised by the investment community as setting best practice principles for corporate governance in Australia. It provides a benchmark by which domestic and international fund managers assess the governance of Australian companies.
Key guidelines for fund managers include:
-- Fund managers should establish direct contact with companies to discuss performance and corporate governance matters;
-- Fund managers should vote on all material issues where they have the authority to do so;
-- A corporate governance policy should be developed and include policies regarding voting; and
-- Fund managers should report to clients on its voting practices.
A recent IFSA study showed that funds managers vote on 92% of all resolutions of the companies in which they invest.
IV. FEE STRUCTURES
At the retail investment level there is a three-tier fee structure incorporating entry, ongoing and exit fees. Most funds have on-going fees set at between 1 percent and 2.5 percent of assets under management. Entry fees where they are used will be between zero and four percent. However, increasingly, brokers and planners are offering substantial rebates.
Exit fees, triggered when an investors leaves a fund before the passage of a certain specified time period are also used by some funds managers, especially where the front end fee is zero. Entry fees and on-going charges incorporate broker/agent commissions.
The drift to no-load funds has been muted because Australian investors prefer entry to managed funds on the advice of a licensed adviser, who is remunerated from the front end and/or ongoing management fee.
Under the FSR package of reforms all funds offering superannuation savings products will be required to articulate to investors certain details on their charging structures including a average expense ratio in percentage terms and the actual dollar costs of having $10,000Aust in the fund.
V. STRUCTURES AND TYPES OF INVESTMENT FUNDS
The most popular vehicle in the industry is an open-ended fund operated under the provisions of the Managed Investment Act (see section on regulation). Closed-ended funds are confined to a small number of property trusts that are listed on the Australian Stock Exchange but also operate under the MIA. Under taxation law both of these types of funds are required to distribute all of their income and capital gains. From time to time listed funds obtain new capital via special unit issues. However, a more popular method of raising additional funds to refurbish buildings etc is via debt-raising with selected institutions. Under ASX rules the level of gearing can be as high as 70 percent of unit holder equity.
VI. SELLING AND MARKETING OFFSHORE FUNDS
A small number of Australian funds managers offer investment products offshore. The most likely destinations for offshore marketing activities include Hong Kong, Singapore, New Zealand and Canada. The scope for offshore funds management will be limited until such time as there are significant changes in the international tax regime operated by Australian and certain overseas tax authorities.
Notwithstanding, the limits to offshore expansion, Australian funds managers invest a sizeable proportion of their Australian-sourced funds in offshore locations. Currently, about 20 percent of assets are invested offshore.
VII. VALUATION
IFSA's policy on fund valuation requires assets of unlisted funds to be valued on a market to market basis. In this regard well over 90 cent of unlisted funds have daily unit pricing based on prices in underlying debt and equity markets. The listed funds have real time pricing valuations based on the prevailing stock exchange quotations.
Less liquid assets in funds, for example real property are required to have at least an annual valuation.
VIII. DISCLOSURE
All public offer managed investments operate under a strict disclosure regime, regulated by the Australian securities regulator under the FSR reforms. Funds managers develop PDSs (Product Disclosure Statements) which form the basis for a customer entering into a contract to purchase an interest in a managed investment.
If investment and fund conditions change to the extent that they are materially different to the original disclosure, the fund is obliged to issue a supplementary disclosure document.
In addition, funds are required to issue an annual report and subject themselves to external audit process.
IX. DEVELOPMENT OF THE PENSION SYSTEM
Australia's pension funds are prudentially regulated and have to operate in accordance with legislative provisions restricting their freedom to operate in the same way as prospectus-based funds.
Employer sponsored funds, for example, must comply with equal employer - employee representation on their boards. Investment restrictions, for example, prevent the fund making certain loans to the employer-sponsor (five percent exposure limit), and funds are not allowed to gear their operations, other than by specified hedging arrangements.
With the exception for a small number of public sector schemes and an equally small number of private sector funds, underwritten by the employer, the majority of funds are accumulation type arrangements in which the investment risk is borne by the investors.
In Australia, private sector funds are fully funded, whereas a number of governments sponsored defined benefit schemes are unfunded (future generations of taxpayers fund pension entitlements).
Eighty percent of the industry's moneys have been sourced from pension funds.
X AND XI LIQUIDITY ISSUES AND HARDSHIP PROVISIONS
In the superannuation regime, liquidity is a matter for trustees to consider when formulating their investment and risk strategy. If a retirement fund experiences liquidity problems, the regulator can initiate procedures whereby an administrator will operate the fund with a view to restore its liquidity. In the event that the liquidity crisis is the result of theft or fraud, it is possible for the Government can take control of the fund and for the fund to receive the proceeds of a special levy on other funds to make up most of the liquidity shortfall.
This mechanism has not been used in relation to Australia pensions, although in the early 1990s it was used to assist an insurance fund which experienced liquidity difficulties.
Non-superannuation funds have different liquidity protection procedures based on disclosure. Central to these provisions is the scheme constitution and compliance plan both of which set out the investment and liquidity strategy. The great majority of schemes with illiquid assets (property trusts) are listed on the Australian stock exchange - an arrangement which gives investors liquidity.
Other schemes disclose their liquidity strategy via a prospectus document which needs to be reissued with appropriate amendments if circumstances change.
Importantly, Australian managed investments funds do not have mandatory 'buy back' arrangements under which the fund manager is obliged to purchase unit holder interests.
In the event that a fund does experience a liquidity difficulty, it is possible (if it is in the scheme constitution) for the manager to freeze assets and prevent unit holders redeeming their interests.
XII. DISPUTE RESOLUTION
Under the Managed Investment Act (1998) in Australia, responsible entities are required to join an external scheme for the handling of complaints. For this purpose, a national service has been established since 1991 to encourage and assists consumers and financial services providers to efficiently and effectively deal with complaints.
The Financial Industry Complaints Service (FICS) has been established as an independent body to help customers in the resolution of complaints relating to members of the financial services industry, including life insurance, superannuation, funds management, stock-broking, financial & investment advice, and sales of financial products.
The service operates through a process of investigation, negotiation, conciliation and arbitration. It is free of charge to the public and is approved by the regulator (ASIC) based on areas including accessibility, independence, fairness, accountability, efficiency and effectiveness.
The service has worked with ASIC and IFSA to promote awareness and improving complaints handling times. Since the Financial Services Reform Legislation became operative in March 2002, more financial services providers are required to provide access to external alternative dispute resolution schemes.
XIII. PERFORMANCE REPORTING
To ensure consistency and comparability amongst investment performance, the Australian Investment Performance Standard was developed in 1999 and has been widely adopted in the investment community.
As part of the IFSA Standards, the AIPS are a voluntary standard that aims to promote fair and consistent representation of investment performance to investors.
The goal is to achieve comparability of returns as well as demonstrating the industry's commitment to self-regulation. Consistent with the US and global standard, AIPS is a country version of the Global Investment Performance Standard.
Recently, the AIPS has been reviewed in consultation with the industry to ensure it remains consistent with the global standard.