Are you a responsible entity of a fund that is concerned about liquidity during the COVID-19 pandemic? Are you concerned that you are in breach of the financial requirements of your Australian financial services license? Do you need to update your disclosures to reflect the current market environment? Do you have a query about the requirements of the Corporations Act or ASIC regulation?
Investor reactions to the COVID-19 pandemic have driven significant downturns in global and domestic markets across many asset classes. ASIC has recently written to responsible entities reminding them of their liquidity requirements in the current market environment.
Internationally, a number of high-profile asset managers, including Aviva Investors, Kames Capital and Janus Henderson, have suspended dealing in their property funds, citing liquidity concerns, the safeguarding of investor assets and difficulty valuing assets (reported here).
Domestically, we will potentially see a similar approach taken with fund managers looking to suspend redemptions in some sectors of the unlisted funds market – that was a significant feature of the 2008 global financial crisis.
This article is designed to assist responsible entities in managing their liquidity during this challenging time. We have set out some tools and strategies that responsible entities may consider when faced with these challenges.
Managing liquidity
The effect of the COVID-19 pandemic on the economic environment increases the risk that responsible entities will not have adequate financial resources to meet their financial obligations and needs, including redemptions, distributions and expenses.
Funds that have invested in assets that are not easily traded on a financial market, such as property or mortgage schemes, may experience challenges around liquidity. For some landlords, income streams are under threat as occupiers fail to generate sufficient revenue to make rental payments and, in extreme cases, sustain their businesses.
The management of liquidity should be considered at both the responsible entity level and the scheme level.
Responsible entity level
At the responsible entity level, there should be liquidity risk management processes in place to continually assess compliance with the financial requirements under their Australian financial service license. The financial requirements that are relevant to liquidity include, but are not limited to:
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standard solvency and positive net assets;
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cash needs;
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audit requirements;
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net tangible assets, including requirements for holding at least 50% of the NTA requirement in liquid assets; and
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specific requirements for financial products and services offered.[1]
Responsible entities should forecast their income and continually monitor their ability to meet their financial requirements. If their financial requirements are no longer met, it is likely that a responsible entity will be required to lodge a breach report with ASIC and possibly cease dealing in their funds.
Scheme level
At the scheme level, acting in the best interests of members, the responsible entity is required to manage the objectives of both the scheme and members’ expectations for redemptions. Responsible entities need to closely monitor the amount of redemptions and the applications that are being made by members.
ASIC has identified a number of tools that can be used to manage liquidity at the scheme level, including but not limited to:
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redemption fees;
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suspension of withdrawal requests;
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placing a limit on the amount of redemptions;
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in specie transfer;
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swing pricing;
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minimum or maximum limits on withdrawals; or
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satisfying withdrawals on a partial or staggered basis.[2]
Liquidity and illiquidity
Responsible entities should be assessing whether their funds remain liquid or become illiquid. If a fund becomes illiquid, the responsible entity must determine whether there should be a suspension of member related cashflows to protect members.
If the responsible entity intends to suspend redemptions, the constitution must give it the power to do so. ASIC has provided guidance on what type of restrictions that should be stated in the constitution. Any decision to restrict dealing with withdrawal requests must be exercised in a manner consistent with the responsible entity’s duties.[3]
Unit pricing
When faced with significant market volatility, responsible entities may be unable to value the scheme assets or calculate the unit price with any certainty. If the responsible entity cannot accurately value the fund’s assets, it may be permitted to suspend unit pricing and therefore a suspension of withdrawal requests.
If the responsible entity intends to suspend unit pricing, the constitution and unit pricing policy must give it the power to do so. This power should also be disclosed in the fund disclosure documents.
Transaction costs
The current environment may require some funds to incur more costs than typically arise, including those from liquidating assets to make redemption payments. In such circumstances, in order to act in members best interests of members, the responsible entity may determine that transaction costs (ie. the buy/sell spread) should be increased.
If the responsible entity intends to increase the transaction costs, it should ensure that its terms are consistent with the PDS, the constitution and the unit pricing policy.
Disclosures
It is important that responsible entities ensure that fund product disclosure statements (PDS) are up to date. As a result of the market turbulence caused by the COVID-19 pandemic, a number of responsible entities have reviewed fund PDSs and updated their disclosures. Particular focus has been placed on disclosure regarding risk, unit pricing and redemptions.
Responsible entities of simple managed investment schemes that have shorter PDSs need to be monitor scheme assets for the strict requirement to have at least 80% of their investments able to be sold within 10 days at market value.[4] If the threshold is breached, then the scheme is no longer a simple managed investment scheme and the responsible entity is required to cease dealing in the fund until a full PDS is issued.
Notifying ASIC
If a responsible entity determines that a scheme is to be suspended or deems it illiquid, then it should notify ASIC immediately.
Hardship relief
Under the Corporations Act, a responsible entity must treat all members equally and are unable to make exceptions on suspended withdrawal requests. However, during the 2008 financial crisis ASIC provided relief to allow responsible entities with non-liquid funds to return some capital to certain members experiencing financial hardship. ASIC has indicated to responsible entities that it will consider providing this hardship relief to responsible entities on a case-by-case basis.[5]
How we can assist
As the spread of COVID-19 and government response continues to evolve, Hamilton Locke has analysed the recent developments and how they might affect responsible entities. We can assist fund managers that are seeking advice on licensing requirements or breaches, liquidity risk management, updating their PDSs, applications for relief, considering trustee duties or other Corporations Act requirements.
Please contact Brendan Ivers, Justin Gross or Samuel Jones for more information.
Sources 1. ASIC Regulatory Guide 166 Licensing: Financial requirements 2. Regulatory Guide 259: Risk management systems of responsible entities 3. Regulatory Guide 134: Funds management: Constitutions 4. Information Sheet 133: Shorter PDS regime -Superannuation managed investment schemes and margin lending 5. Regulatory Guide 136: Funds management: Discretionary powers
