Skip to content.

Home

Allens Arthur Robinson

Funds Management - Real Estate & Superannuation

Focus: Funds Management – February 2006

Transaction costs and other pricing discretions: ASIC issues class order relief

In brief: After almost two years of industry consultation, ASIC has issued class order relief allowing responsible entities to exercise limited discretions when calculating unit prices. Responsible entities have until 1 May 2006 to implement procedures enabling them to comply with the conditions of the relief. Senior Associate Penny Nikoloudis examines the impact of the class order on both unlisted and listed schemes.

Background to Class Order 05/1236

Issued on 21 December 2005, Class Order 05/1236 represents one of the most significant policy developments in the regulation of managed investment schemes in recent years. The release of the Class Order is the culmination of almost two years of industry consultation, including an Australian Securities & Investments Commission (ASIC) consultation paper issued in October 2004, and three extensions to ASIC's interim relief and 'no-action' position during the consultation period.

ASIC's interpretation of section 601GA

Central to the Class Order are the following two provisions of the Corporations Act 2001 (the Act) and ASIC's somewhat controversial interpretation of them:

  • paragraph 601GA(1)(a) requires the constitution of a registered scheme to make 'adequate provision' for the consideration that is to be paid to acquire an interest in the scheme; and
  • subsection 601GA(4) provides that if members of the scheme have a right to withdraw, the constitution must specify that right and set out 'adequate procedures' for making and dealing with withdrawal requests.

Since the introduction of the Managed Investments Act in 1998, ASIC has interpreted the expression 'adequate' to mean that it must be possible to objectively test the determination of the issue and redemption price from the terms of the constitution. In other words, the constitution must specify an 'independently verifiable' issue and redemption price. ASIC considers that if a provision in a scheme's constitution allows the responsible entity to exercise any discretion that may influence any aspect of the issue or redemption price, then the constitution does not comply with s601GA.

This strict interpretation of s601GA has restricted the ability of responsible entities to issue scheme interests at a discount (or premium) to the price specified in the scheme's constitution. To facilitate fundraising activities by managed investment schemes, particularly listed schemes, ASIC has, since 1998, issued class order relief allowing responsible entities to issue units at a discount (or premium) in specified circumstances (Class Order 98/52, which was replaced by Class Order 05/26 – see AAR's Focus: Funds Management, May 2005.

Return to top

Transaction costs and other standard pricing discretions

As reported in AAR's Focus: Funds Management, May 2004, since 2004, ASIC has applied its interpretation of s601GA even more strictly. In particular, ASIC adopted a practice of rejecting scheme constitutions that contained 'standard' pricing provisions, on the basis that those provisions allowed responsible entities to exercise discretions, which prevented issue and redemption prices from being 'independently verifiable'. Most notably, ASIC focused on 'transaction costs'. In ASIC's view, the responsible entity's ability to estimate the expenses for the transaction costs component of the issue or redemption price meant that the prices were not 'independently verifiable' and, therefore, the provisions did not comply with the Act.

In July 2004, ASIC announced its temporary policy position as follows:

  • in relation to new schemes, ASIC was prepared to grant 'pro forma' interim relief, on a case-by-case basis, on the condition that the relevant product disclosure statement (PDS) contain sufficient disclosure about how the responsible entity would exercise its discretions; and
  • in relation to existing schemes, ASIC took a 'no action' position.

This temporary relief has been superseded by the introduction of Class Order 05/1236.

Return to top

What types of pricing discretions are covered by Class Order 05/1236?

Class Order 05/1236, which amends Class Order 05/26, provides conditional relief in relation to limited discretions that are commonly exercised by responsible entities in calculating issue and redemption prices.

The Class Order applies where a scheme constitution specifies a formula or method for determining the unit price, rather than a set dollar amount. Where the formula or method allows the responsible entity to exercise discretion about any matter that affects the value of a factor included in the formula, or that is an aspect of the method, the Class Order provides relief from s601GA, so long as certain conditions are satisfied.

ASIC has identified the following types of common discretions that would be covered by the Class Order:

  • estimating an allowance in transaction costs;
  • selecting a valuation method;
  • determining entry or exit (application/withdrawal/switching) fees;
  • determining the total net asset value of the scheme, where this is to be used in valuing an interest;
  • allocating assets, liabilities, revenue and expenses between classes;
  • rounding off the issue price or withdrawal amount;
  • determining a time at which the issue price will be determined, where applications received before that time will be issued at one price and applications received after that time will be issued at a later price; and
  • determining the time at which asset values and liabilities will be calculated.

These are discretions that affect the pricing of interests in a scheme and, therefore, in the absence of ASIC relief, would contravene s601GA. By contrast, ASIC has confirmed that the Class Order is not intended to apply to other types of discretions that may properly be exercised by the responsible entity in relation to the structure and operation of a scheme, including investment decisions, distributions, consolidations, amendments to the scheme constitution, and so on. Relief is not required in relation to those types of discretions.

Is there a transitional period?

ASIC has given responsible entities until 1 May 2006 to comply with the conditions of the Class Order. ASIC considers that this allows sufficient time for responsible entities to check their practices against the Class Order conditions and make any necessary changes. As discussed below, the Investment and Financial Services Association (IFSA) has sought an extension to this transitional period.

Return to top

What are the conditions of relief?

To obtain the benefit of the Class Order relief, the responsible entity must satisfy certain conditions that, according to ASIC, are consistent with current industry practice.

The conditions require the responsible entity to:

  • act reasonably in exercising the discretion;
  • exercise the discretion in a way that is consistent with ordinary commercial practice, unless it is impracticable to do so;
  • either exercise its discretion in accordance with a current documented policy, or provide a written explanation explaining how the discretion was exercised and why such exercise was reasonable;
  • retain the documents that are relevant to each discretion for seven years;
  • inform all members on or before the first date when the responsible entity sends a communication to all members after 1 May 2006 that they may obtain copies of the documented policies and written explanations at no charge; and
  • provide a copy, upon request and at no charge, of any documented policy or written explanation to any member of the scheme or any person who has received (or should have received) the scheme's PDS.

The Class Order specifies the matters that need to be covered in the documented policy and written explanation. Depending on the nature of the pricing discretions that may be exercised by a responsible entity, the preparation of these documents may be a difficult and time-consuming exercise.

The scheme's PDS must also include statements to the effect that copies of the documented policy or written explanation are available from the responsible entity at no charge. This condition applies only to PDSs prepared (as opposed to 'issued') on or after 1 May 2006.

Return to top

What about listed schemes?

During the consultation period, the issues relating to pricing discretions were considered mainly in the context of unlisted schemes. This is because interests in listed schemes are generally acquired or disposed of at the prevailing 'independently verifiable' market price, or at a discount to the market price in accordance with the fundraising exceptions specified in Class Order 05/26.

However, ASIC Class Order 05/1236 expressly applies to both unlisted and listed schemes.

When will the Class Order apply to listed schemes?

According to ASIC's information release issued with the Class Order, listed schemes will not generally need to rely on the Class Order relief because, where interests are bought and sold at 'market price', the issue price and withdrawal amount can be objectively ascertained. However, the information release goes on to say that, to the extent that a responsible entity of a listed scheme has discretion about how the market price will be calculated, the Class Order will apply. For example, many scheme constitutions contain a definition of 'market price' that allows the responsible entity to choose between two (or more) alternative tests. The Class Order will apply to the discretion exercised by the responsible entity in choosing the relevant test.

This raises the question about how Class Order 05/1236 is intended to operate in conjunction with the existing fundraising relief in Class Order 05/26, which allows the responsible entity (typically of a listed scheme) to issue units at a discount (or premium) to the 'market price' in specified circumstances. According to ASIC's information release, the requirements of Class Order 05/1236 do not apply to the discretion exercised by the responsible entity in applying the discount (or premium). However, Class Order 05/1236 does apply to the extent that the responsible entity exercises any discretion in calculating the market price (ie the 'starting price') against which the discount (or premium) is to be applied.

While this intention is explained in the information release (which does not have the force of law), it is not clearly reflected in the Class Order itself (which has the effect of modifying the Act). The drafting of the Class Order, particularly the interaction between the new 'pricing discretions' relief and the existing 'fundraising' relief, is most confusing. For example:

  • s601GAB(11) of the Class Order does not clearly distinguish between discretions relating to the 'starting price' and discretions relating to the discount (or premium); and
  • subsection 601GAB(2)(b) of the Class Order may be interpreted as requiring constitutions for listed schemes to specify a maximum discount in relation to each of the fundraising circumstances currently covered by Class Order 05/26 (which, at least in relation to interest purchase plans and negotiated fees, was not previously a requirement of Class Order 05/26). This may mean that existing constitutions for listed schemes may need to be modified.

Given the significance of these matters, urgent clarification from ASIC is required.

Return to top

Some concerns

In addition to the uncertainty surrounding the application of the Class Order to listed schemes (as discussed above), the drafting of the instrument and the policy position taken by ASIC give rise to a number of practical concerns.

On behalf of its members, IFSA has made submissions to ASIC highlighting the following key concerns and, where applicable, seeking appropriate modifications to the Class Order to address these matters:

  • The broad scope of the Class Order. The Class Order refers to 'each discretion' that is relevant, directly or indirectly, to carrying out unit price calculations. This is very broad scope, and could potentially include discretions that affect the structure and operation of a scheme. While the information release confirms that the Class Order is intended to apply only to unit pricing discretions, this is not clearly reflected in the Class Order itself.
  • Compliance costs. The costs of implementing pricing discretion policies, and ongoing compliance costs, will impose an unreasonable burden on responsible entities (and scheme members) and should not be underestimated.
  • Unrealistic deadline. The proposed commencement date (1 May 2006) should be delayed by at least 12 months.

Return to top

What steps need to be taken before 1 May 2006?

To qualify for relief under Class Order 05/1236, responsible entities will need to complete the following steps before 1 May 2006:

  • undertake a detailed analysis of the pricing provisions in each scheme constitution and identify any discretions that may be exercised by the responsible entity, which may affect the pricing calculation;
  • consider whether any amendments need to be made to the pricing provisions of the scheme's constitution in light of the Class Order (particularly in relation to listed schemes);
  • prepare a documented policy for each discretion that has been identified, addressing the matters specified in the Class Order;
  • implement and document procedures to ensure ongoing compliance with the conditions of the Class Order;
  • at the first communication to members after 1 May 2006, inform members that they may, at no charge, obtain copies of the responsible entity's documented policies relating to pricing discretions; and
  • at the first rollover of the scheme's PDS after 30 April 2006, incorporate into the PDS the statements required by the Class Order.

Return to top

More information?

For more information, please see the following:

Return to top

For further information, please contact:

Return to top

Tweet or bookmark with
Tweet this article

What are these?

 

Recent Funds Management - Real Estate & Superannuation publications