Updated MDA Regulation Will Foster Certainty and Growth
Introduction: The Australian Securities & Investments Commission (ASIC) announced updated regulation in relation to Managed Discretionary Accounts (MDAs) on 29 September 2016. This update has been foreshadowed for some time and follows an extensive industry consultation process undertaken by ASIC, including the issue of a consultation paper (CP 200) in March 2013 and consideration of industry feedback to the proposals included in that paper.
We don’t propose to discuss the legal minutiae of the changes here, but will identify key themes and issues that caught our attention.
The headlines & timetable: ASIC has issued a new legislative instrument governing MDAs (ASIC Corporations (Managed Discretionary Account Services) Instrument 2016/968) and an extensive revision to Regulatory Guide 179 (RG 179). As widely anticipated, limited MDAs relying on ASIC’s no action position are to end, with existing LMDA operators having until 1 October 2018 to transition to an alternative solution for their clients. Our reading is that this transitional arrangement applies to both old and new clients of existing LMDA operators, provided they first relied on the no action position before 1 October 2016. No one will be able to start issuing LMDAs after 1 October 2016 if they had not previously relied on the no action position before that date.
The future options for LMDA operators post 1 October 2018 include applying for MDA provider authorisation under their AFSL. ASIC will recognise experience gained operating a LMDA but this does not automatically guarantee authorisation will be granted. Full MDA operators authorised before 1 October 2016 have until 1 October 2017 to comply with ACI 2016/968, with the old instrument CO 04/194 continuing to apply until then (or they can opt in early). MDA providers authorised after 1 October 2016 must comply with ACI 2016/968 from the date they are authorised.
ASIC is NOT imposing the regulatory capital requirements on MDA providers it foreshadowed it might in its consultation paper, but will review these requirements over the next 2 years. For sake of clarity, MDAs continue to be a retail concept (the MDA regulation does not apply to wholesale investors), and the new legislative instrument and regulatory guide do not apply to managed accounts offered through a registered scheme, such as a Separately Managed Account issued under a product disclosure statement (PDS).
The language: Under the new instrument MDA operators become known as MDA “providers”, reflecting the different ways MDAs can be run and that certain functions can be outsourced. ASIC has clearly stated that if you contract with a client to provide an MDA they will treat you as the issuer of a financial product (RG 179.16), though both ACI 2016/968 and RG 179 typically refer to MDAs as MDA services – regulation requires they be offered and reviewed with advice, and combined with their discretionary nature and flexibility of form, this makes them a service, not a product. This is an important cultural issue for an industry used to dealing in investment products. ASIC has clearly set out the defining features of an MDA (RG 179.1) but has not sought to provide clarity around other managed account terminology such as SMA, IMA and UMA, though it confirms that registered schemes are NOT MDAs.
Important themes – Recognising diversity: There has been a sense that ASIC was playing catch up with managed account regulation, and some proposals in Consultation Paper 200 suggested a lack of appreciation of the different ways MDAs were being structured. ACI 2016/968 and RG 179 comprehensively address this, with a 10 page chapter on “MDA services with different arrangements” covering: MDA with an external MDA custodian; MDA with an external MDA adviser; MDA with external administration support; MDA where the client holds legal title to portfolio assets; MDA on a regulated platform; and market participants providing an MDA to family members. This is welcome guidance that will help the industry develop with increased confidence.
Transparency and accountability: RG 179 applies not only to MDA providers but also agents of MDA providers and those that enter into a direct contract with the MDA client, such as an MDA custodian or external MDA adviser. Providers are responsible for the actions of their agents as if they are their own, including compensating clients for loss caused by an act or omission of the agent. MDA providers must also include information about outsourcing arrangements in their FSG, including naming the entities involved and how they will be monitored.
Clarification of certain compliance obligations: ASIC has confirmed MDA fees are product fees and do not form part of the ongoing fee arrangement disclosed in a Fee Disclosure Statement (RG 179.117), and has clarified treatment where MDA and advice fees are bundled. On best interest duty, RG 179 explicitly states the obligation on MDA providers to act in the client’s best interest when providing MDA services is separate and additional to that of advisers providing personal advice (RG 179.62), extending to all activities undertaken in providing the MDA; an example of a potential breach is excessive transacting relative to client objectives. The new regulation also addresses the “no pooling” provision that seemed at odds with bulk transacting and platform custodial accounts, confirming bulk transacting and typical platform pooling are accepted (RG 179.36–38, RG 179.192–194).
Outstanding questions and issues – Responsibility for the work of external MDA advisers: Notwithstanding the clarity provided, we feel the water has been muddied on responsibility for advice provided by external MDA advisers. An MDA has an external MDA adviser if someone other than the MDA provider contracts directly with a client to prepare and review an investment program included in the MDA contract (RG 179.167); that adviser must hold an AFS licence authorised to give financial product advice to retail clients (RG 179.169). The regulatory guide states this arrangement is designed to ensure clients understand someone other than the MDA provider is directly responsible for the suitability of the investment program (RG 179.172), and that the MDA provider does not need an AFS licence authorisation for general advice contained in offer documents in that case.
However, RG 179.174 then says an MDA provider must review the SOA given in relation to that investment program before entering into the MDA contract, and not enter into it if they have reason to believe the MDA is not appropriate – while RG 179.175 clarifies ASIC does not expect a comprehensive review, and that by forming this view the MDA provider does not endorse the investment program. Taken as a whole, this puts the MDA provider in the position of having to second guess the work of the external MDA adviser, notwithstanding they may not have the competencies or licence to review personal advice – this does not seem logical to us, will likely lead to disputes, slow service down, increase costs, and create ambiguity around responsibility for advice that will be unsettling to professional indemnity insurers.
How will ASIC assess MDA provider applications from LMDA operators? Obtaining authorisation to operate an MDA has been extremely difficult in the past 3 years, reflecting ASIC’s concern that discretionary portfolio management should require specialist skills and resources. RG 179.191 states ASIC will take into consideration experience gained under the no-action position, to the extent it is equivalent to the proposed MDA business, but RG 179.53 confirms ASIC will also consider whether the applicant has the capacity to provide the MDA efficiently, honestly and fairly, and in compliance with ACI 2016/968. Our counsel to LMDA operators is not to take authorisation for granted – seek it early so there is time to take alternative action if denied.
Are MDAs more or less attractive under revised regulation? Our simple answer is that the updated regulation makes them relatively more attractive than before, not because of material change, but because of the greater certainty ASIC has delivered around the flexibility the MDA regime supports, including: running one managed account service over multiple platforms; having more say in how new services or technologies are integrated; having greater control over investment selection; and outsourcing different elements of the service to different providers. For some businesses this will be attractive, while for others the benefits of registered schemes will make them the more attractive option.
Required authorisations to advise on MDAs: RG 179.209 notes that a person making recommendations or statements of opinion about investing in an MDA is providing financial product advice and must hold an appropriate authorisation. The regulatory guide does not spell out precisely what that authorisation is, and we will be querying ASIC on this.
The Verdict: Overall, ASIC have done a good job with their review of MDA regulation. Through consultation with the industry they have developed a more detailed understanding of the level of innovation occurring around MDAs, and have sought to support this by clarifying how regulation will be applied under various models, taken a common sense approach to consistency between registered and unregistered schemes, and been transparent in their reasoning. In our view ASIC deserves significant credit for this. While our overall views are positive, there are one or two issues we will seek clarity on from ASIC, and further issues will emerge as licensees ready themselves to be compliant with ACI 2016/968.
What should practitioners do? For LMDA users: although the 2 year transition timeframe seems generous compared to the 12 months given to full MDA providers, there is good reason to start work now. LMDA users need to: understand and assess options for transitioning away from LMDA (becoming an authorised MDA provider, becoming an external MDA adviser to an MDA provider, becoming licensed to a dealer who is an MDA provider, setting up a private label or standard managed account service as a registered scheme, or setting up your own range of unit trusts); potentially apply for MDA provider authorisation early enough to still have time for alternative steps if denied; review vendors of relevant services; design the new managed account service within the confines of the chosen execution method; set up new procedures and documentation; make adjustments to practice management systems; undergo due diligence on investment management processes; train staff; and promote and execute the updated service with each investor. Ideally this should occur alongside a broader strategic review addressing questions such as: what are the key competencies and competitive strengths of my business? How do I create value for my clients and is it consistent with my core skills? What can be done to enhance value delivery and the overall service experience? Am I happy with how operational and compliance risk is managed? Am I outsourcing the right things? Is my pricing strategy appropriate? Am I maximising the value of my practice? Once the workload is considered, and remembering the 1 October 2018 deadline, 2 years is not long. LMDA users requiring expert assistance are invited to contact Brett Sanders of Philo Consulting for a no obligation discussion.
For full MDA operators: existing operators are relieved not to face regulatory capital requirements, but there is still much detail to manage. It is not always clear what is a new requirement, versus a clarification requiring action, versus simply a new way of saying the same thing – the full implications often only become clear at implementation. MDA operators will need to carry out a thorough audit of key documents and processes, including at minimum: FSG; investment program templates; MDA contract; SOA template; operational and compliance procedures (onboarding, fee disclosure statements, annual investor statement and audit report); annual review of the MDA contract and investment program; advice policy manual; compliance policies/manual; and staff training materials. For some, clarifications provided via RG 179 may prompt a review of service structure (for example whether to use external administration support or an external MDA custodian). The impact of these changes from a client’s perspective is likely to be modest for businesses retaining their current service structure.
For those yet to decide on their managed account offering: organisations that want to offer managed account services but have not yet done so have the same options listed above. There is no regulatory deadline to meet, but the service must be compliant from the day it launches. Our general advice is to start with the needs of your customer base and the strengths and weaknesses of your business and work back from there. The decisions made around the design of your managed account service are some of the biggest decisions a financial planning firm will make and will be lived with for years to come. If you require expert assistance please do not hesitate to contact Brett Sanders of Philo Consulting.
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