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Thursday, 12 December 2002
Page: 7825


Senator CHAPMAN (9:58 AM) —I present the report of the Parliamentary Joint Committee on Corporations and Financial Services on the review of the Managed Investments Act 1998, together with the Hansard record of proceedings and documents presented to the committee.

Ordered that the report be printed.


Senator CHAPMAN —I move:

That the Senate take note of the report.

In deference to the Manager of Government Business in the Senate and to Senate colleagues who want to progress with the legislation in the Senate today and finish at a reasonable hour, I seek leave to incorporate my tabling statement in Hansard.

Leave granted.

The statement read as follows—

The managed investments sector saw dynamic growth during the nineties. Since the introduction of the Managed Investments Act on 1 July 1998, the assets held in managed investment schemes has almost doubled to $175 billion. This is a substantial figure and serves to emphasise how important it is for the 3 million Australians who have invested in managed investments schemes that regulation of this sector is appropriate and effective. We need to ensure that investors' interests are properly protected, and also that domestic and overseas confidence in the integrity of our financial markets is maintained.

The Committee was concerned that Mr Malcolm Turnbull's Review of the Managed Investments Act 1998 did not appear to examine in any depth the fundamental elements of the single responsible entity arrangements introduced by the Act. This may have been due to the relatively tight timeframe—4 months—within which the Review was undertaken in the latter half of last year.

In any event, the Committee thought that proposals for mandatory third-party custodianship and proposals for change should be more closely examined, along with specific governance issues relating to board and audit independence.

On 6 April 2002, the Committee advertised its terms of reference and called for submissions. The terms of reference focussed on the findings of Mr Turnbull's Review and sought comments on:

1. whether the current arrangements adequately protected investors' interests given the quite significant corporate collapses over the past two years and the questions they raise about corporate governance issues;

2. global best practice in investor protection of managed funds;

3. whether section 1325 of the Corporations Act, in providing for actions against parties other than the responsible entity, was inconsistent with the emphasis on the RE's liability under the Managed Investments Act;

4. the pros and cons of allowing for the appointment of an external compliance entity for compliance purposes; and

5. fees and costs in the managed investments sector.

Altogether the Committee received 12 submissions plus 2 supplementary submissions. The Committee is grateful to those who invested the time and effort to make sometimes very detailed submissions.

The Committee held public hearings in Sydney on 11 and 12 July 2002 and 7 August 2002. The Committee thanks those who so generously made themselves available at these hearings.

The Turnbull Review didn't consider the effect of September 11 on the performance of the managed funds sector in Australia and whether this had put MIA regulation to the test. While evidence to the Committee was that the response by the managed funds sector to September 11 had been timely and effective—possibly more so than under the previous regime—the Committee's overall conclusion was that the stresses exerted were not of sufficient magnitude to provide a litmus test of the regime's efficacy.

Probably the most controversial issues were those concerning:

1. the compliance framework and whether the MIA had made sufficient provision to ensure the independence of those undertaking the compliance monitoring function;

2. costs and fees under the MIA; and

3. whether the single responsible entity or (single RE) structure should allow for mandatory third-party custodianship of scheme assets.

Independence of in-house compliance monitors

The Committee was encouraged to hear that the MIA had engendered a strong compliance culture within the managed investments industry. However, some witnesses referred to technical and systemic problems with the regulatory framework which they said had reduced the effectiveness of in-house and external compliance monitoring. The most serious allegations concerned the independence and qualifications of compliance monitors—whether on the RE's board or on a separate compliance committee.

The Committee heard evidence that has caused it to seriously doubt that the MIA has made proper provision to ensure the independence of compliance monitors. Merely to require a compliance monitor to be an `external' director or member, without more, does not guarantee that that person will be `independent'.

The Committee consequently has made recommendations to ensure that compliance monitors will be more independent. Apart from correcting more technical anomalies in the legislation, the recommendations are designed to keep a check on the RE's powers to appoint and remove compliance monitors by making the process more transparent and removing opportunities for the arbitrary exercise of these powers. In particular, the Committee has recommended that the RE should disclose all appointments, retirements and removals of compliance monitors to ASIC within a limited timeframe and to all investors on an annual basis. Reasons for removals and resignations should be given. ASIC is also to be given powers to remove compliance monitors who are not performing or otherwise where it would be inappropriate for them to continue in the role.

External corporate compliance entities

The Committee heard proposals for the appointment of an external corporate compliance entity either to conduct the compliance monitoring itself or to act as an external member on a compliance committee. It was argued that corporate compliance entities would be more likely to maintain their independence and also provide expertise where this was hard to come by.

Some said that outsourcing compliance monitoring to an external entity was undesirable because it would encourage REs to delegate their responsibility for ensuring compliance. The Committee decided that this possibility could be kept in check by allowing a corporate compliance entity to act only as one member of a compliance committee and not as the committee itself. The Committee believes this arrangement will not only provide schemes with well-resourced and qualified candidates but will also enlarge the pool of potential candidates.

Qualifications and expertise of compliance committee members

In the United States, the United Kingdom, Canada and Australia moves are afoot to improve corporate governance standards. The Committee was particularly interested in the emphasis given by the Sarbanes-Oxley Act of 2002 in the United States on the need for a company's auditing compliance monitors to have the necessary expertise to properly perform their role.

The Committee believes more should be done to set minimum standards of competency and integrity for compliance committee members. We have therefore recommended that the compliance plan of a registered scheme should be required to set out minimum standards of competency and integrity for compliance monitors and that these standards should be disclosed to investors annually. In addition, ASIC should develop model minimum standards, in consultation with industry for use by the industry.

Compliance plan auditor

The Committee did not hear a great deal of evidence on the independence of external compliance monitoring per se. Of the evidence presented, the major issue was whether merely prohibiting the same auditor from auditing both the scheme's financial statements and the compliance plan was a sufficient guarantee of independence.

The possibility of allowing professionals other than accountants to undertake compliance plan auditing was also raised.

In its assessment of auditor independence issues, the Committee was able to draw on the findings of several studies, among them, Professor Ian Ramsay's report, Independence of Australian Company Auditors: Review of Current Australian Requirements and Proposals for Reform, ASIC's auditor independence survey concluded in December 2001, CLERP 9's issues paper, the Joint Committee of Public Accounts and Audit's Review of Independent Auditing by Registered Company Auditors, and a recent Ernst & Young review of Australia's top 200 companies.

All of these indicated that additional measures were needed to improve auditor independence. Interestingly, the Ernst & Young study indicated that more than 25 per cent of the 200 companies surveyed would not meet the basic independence and expertise requirements for audit committees under United States law and the listing rules of the New York Stock Exchange. This is not merely academic. There are very real practical regulatory implications for Australian companies with securities registered under US law or those planning to branch out into overseas markets.

In the light of these reports and the evidence presented, the Committee concluded that there was a need for additional measures to ensure the independence of the compliance plan auditor. These involved the introduction of new reporting requirements concerning the management of independence issues and to guard against any attempts to corrupt the integrity of an audit.

The Committee considers that the overall integrity of compliance monitoring would benefit from the extension of qualified privilege and whistleblower protection to employees of REs and, where the application of the legislation may be uncertain, to employees of compliance plan auditors.

The Committee sees merit in allowing individuals other than registered company auditors to conduct compliance plan audits. This is provided of course that they have the qualifications and experience to equip them for the task.

The Committee has not made recommendations regarding audit partner or audit firm rotation but awaits with interest CLERP 9's conclusions in this regard. In the meantime, the Committee encourages industry initiatives to develop best practice audit standards for performance audits.

ASIC made a number of proposals to clarify the existing law about compliance plan audits which the Committee supports. In addition, the Committee believes that greater transparency in reporting should be encouraged and endorses ASIC's proposal for compliance plan auditors to report to scheme members on an annual basis.

Costs and fees

Much of the evidence to the inquiry reflected a strong polarisation of views regarding the effect of the new regime on costs and industry structure. However, the Committee was not able to properly test this evidence given the absence of reliable, independent quantitative data.

While some of the data presented indicated a downward trend in MERs, there was no hard evidence that this had translated into lower fees to investors or whether the downward trend could be attributed either wholly or in part to the changes introduced by the MIA.

Given the absence of any reliable, independent data on the subject, the Committee felt it was ill-equipped to draw any conclusions. The Committee would be particularly interested in information about the MIA's impact on costs and fees, competition and overseas investment in the industry.

The Committee has consequently recommended that a costs/benefit analysis be undertaken to determine the MIA's impact:

· on fees and costs;

· on competition within the industry; and

· on the level of consumer understanding of this area.

The Committee notes that better disclosure by managed funds to enable an investor to compare fees, will promote competition within the industry. The Committee therefore commends ASIC's recent initiatives to improve disclosure of fees within the managed funds industry.

The single responsible entity structure

Mr David Knott, Chairman, ASIC, when commenting on the spate of recent corporate failures in Australia, suggested that one contributing factor had been a growing complacency towards corporate governance. This, he proposed, had been nurtured by sustained economic growth during the `90s and Australia's `remarkable' survival of the Asian financial crisis so that corporate governance `lost momentum as an effective program for corporate risk management'.

There is no doubt that the corporate collapses in the US and Australia have shaken market confidence and focussed attention on corporate governance, particularly with regard to the independence of company directors and auditors.

The United States has already made significant changes to its corporate governance regime in the Sarbanes-Oxley Act of 2002. In Australia, the Government has commenced the process of corporate governance reform, particularly in the area of auditor independence, with its CLERP 9 issues paper released in September 2002.

Against this background, questions raised about corporate governance and, in particular, the effectiveness of internal and external compliance monitoring and self-regulation under the MIA take on an added resonance.

The Committee notes that the MIA's regulatory framework was devised following several years of sustained buoyancy and confidence in Australia's financial markets. The framework places considerable confidence in the independence and integrity of its compliance monitors which, in view of HIH, One-Tel, Harris Scarfe and the corporate debacles in the United States, may have been misplaced.

Evidence presented to the Committee has raised concerns that the key investor-protection elements under the MIA may not be delivering the level of protection that investors are entitled to expect and, indeed, which is needed to maintain confidence in the managed funds sector among domestic and overseas investors.

The Committee has made recommendations about licensing requirements for REs, specifically, that ASIC review NTA and insurance requirements for REs. In this regard, the Committee's main objective is to ensure that an RE has a sufficient financial buffer to enable it to ride out the consequences of poor investment decisions or otherwise to guard against the risk of a disorderly wind-up if the business fails.

The Committee is also concerned about start-up and on-going costs imposed on managed funds by the MIA and whether they have translated into lower fees for investors. Tied in with this is the effect of the MIA on market structure and competition which ultimately has an impact on investor protection.

Although important, these matters should not divert attention from the fundamental objective of the MIA—to ensure that scheme property will be protected in the event of a scheme's collapse or an RE's malfeasance.

As a start, it is essential that in-house and external compliance monitors have the requisite degree of independence to enable them to carry out their role so that conflicts of interest are promptly identified and successfully managed before they threaten the viability of a fund.

On the basis of the evidence heard during its inquiry, the Committee questions whether the Act makes adequate provision for the independence of the key players in the compliance framework— the RE's board, the compliance committee, and the compliance plan auditor.

Indeed, the Committee's recommendations put forward in earlier chapters of this report reflect the Committee's concern and seek to strengthen the independence of the compliance framework.

In the United States, the United Kingdom and Canada, scheme property must be held by an independent custodian.

There is no question that, in not requiring mandatory third-party custodianship of scheme property, Australia has chosen to deviate from what some consider to be global best practice. Australia has therefore broken new ground.

Clearly there are two distinct schools of thought on the new MIA regime. Those belonging to the old school hold serious doubts about the wisdom of dispensing with a mandatory third-party custodian. They believe that a third-party custodian of scheme property is crucial to protect investors' interests and strongly advocate a return to the dual-party structure. They point to global best practice and suggest that Australia is out of step with the major financial centres of the world where an independent custodian is a minimum standard.

Those belonging to the new school are convinced that the safeguards built into the new regime, such as the statutory duties imposed on the RE, the rigorous compliance obligations and ASIC's surveillance role, offer sound investor protection. They see great strength in having a single responsible entity which is designed to provide clear accountability and cost savings.

The Committee understands the concerns of those looking to return to the old dual-party structure with a trustee and a fund manager. It appreciates that there is no precedent for the RE system. Further, the Committee acknowledges that the new arrangements for protecting investor interests have yet to be genuinely tested by market conditions—that it is still early days and some sectors of the business community harbour lingering uncertainty about the soundness of the MIA.

However, the evidence presented to the Turnbull Review and the Committee's current inquiry, has failed to establish a convincing case that the MIA's regulatory framework would benefit from the imposition of mandatory third-party custodianship or any other major structural changes. The Committee is satisfied that the framework currently in place, together with the measures recommended by the Committee to ensure that conflicts of interest are properly managed, is delivering a high standard of protection to investors in managed funds.

The Committee consequently does not intend to make any recommendations regarding structural changes to the regulatory framework. Having said this, the Committee stresses that there are areas of concern with the MIA's management of conflicts of interest. The Committee therefore strongly urges the adoption of its recommendations to deal with these.

However, in acknowledgment of the arguments put in favour of optional third-party custodianship, the Committee believes that the current provisions of the Act in this regard should be monitored by ASIC.

The Committee recommends that the current provisions of the Managed Investments Act 1998 relating to third-party custodianship, should be monitored by ASIC with regular reports being made to the Parliamentary Joint Committee on Corporations and Financial Services with particular regard to:

· the number of entities opting into third-party custodianship; and

· providing some qualitative comparative analysis of the performance of those entities with, and those without, third-party custodians.

The Committee further recommends that on the basis of these reports, the Committee should regularly review the efficacy of the current opt-in provisions in the Act compared with an alternative opt-out provision regarding optional third-party custodianship.


Senator CHAPMAN —I seek leave to continue my remarks later.

Leave granted; debate adjourned.