ASIC has issued a class order which permits the exercise of discretion by responsible entities of registered managed investment schemes (registered schemes) when making pricing decisions.

The new class order relief is contained in Class Order [CO 05/1236], which varies Class Order [CO 05/26] Constitutional provisions about the consideration to acquire interests. The details of the changes to Class Order [CO 05/26] are set out in the attachment to this information release.

The relief allows a scheme constitution to provide a formula or method for determining the issue price and/or withdrawal amount that gives the responsible entity discretion to determine a matter or factor that forms part of the issue price and/or the withdrawal amount. ASIC has executed the class order to ensure that the operation of section 601GA of the Corporations Act 2001 (the Act) does not unreasonably restrict responsible entities in setting the issue price and/or the withdrawal amount.

‘ASIC recognises that there is a desire for greater commercial flexibility for responsible entities to ensure that the practical operation of pricing provisions is efficient, fair and in the best interests of scheme members. ASIC considers that the relief now contained in Class Order [CO 05/26] strikes an appropriate balance between regulatory, commercial and consumer needs,’ Director of Applications, Advice and Licensing, Mr John Price said.

‘The conditions of the relief are intended to make the responsible entity’s discretion transparent and to put in place adequate safeguards to ensure that the responsible entity acts reasonably in the exercise of any discretion. ASIC understands that the documentation conditions are consistent with current widespread practice in the funds management industry,’ Mr Price said.

Class Order [CO 05/26] modifies the application of section 601GA of the Act to responsible entities of registered schemes. Paragraph 601GA(1)(a) requires the constitution of a registered scheme to make adequate provision for the consideration to acquire an interest in the scheme (issue price). Subsection 601GA(4) provides that, if members have a right to withdraw from the registered scheme, the constitution must specify that right and set out adequate procedures for dealing with withdrawal requests, including the amount (withdrawal amount) to be paid to members withdrawing interests from the scheme.

In ASIC’s view, the policy underlying section 601GA requires the issue price or withdrawal amount to be set out in the constitution in a way that enables decisions made on unit prices to be objectively tested. This means the responsible entity or a third party has limited scope for the exercise of discretion in determining the issue price or withdrawal amount.

The relief is effective from the date the class order is recorded on the Federal Register of Legislative Instruments (FRLI) in electronic form. The FRLI may be accessed at www.frli.gov.au. Compliance with the conditions of the relief is not required until 1 May 2006 to allow responsible entities time to review their current practices.

The relief provided in [CO 05/1236] will not affect registered schemes that include fixed issue prices and/or withdrawal amounts in the scheme’s constitution.

The attachment provides further detail about ASIC’s class order.

End of release

Download copies of:

• Class Order [CO 05/1236] with associated Explanatory statement and Regulation impact statement
• Class Order [CO 05/26] Constitutional provisions about the consideration to acquire interests

ATTACHMENT TO IR [05-66]: ASIC RELIEF FACILITATES PRICING DISCRETIONS BY RESPONSIBLE ENTITIES

Background

Section 601GA of the Corporations Act 2001 (the Act) requires the constitution of a registered scheme to:

1. make ‘adequate provision’ for the consideration to acquire an interest (issue price); and
2. where members have a right to withdraw from the scheme, set out ‘adequate procedures’ for making and dealing with withdrawal requests, including the amount (withdrawal amount) to be paid to members withdrawing interests from the scheme.

In Policy Statement 134 Managed investment schemes: Constitutions [PS 134], ASIC states that it interprets the expression ‘adequate’ to mean that it must be possible to objectively test the determination of the issue price and the withdrawal amount from the terms of the constitution. ASIC considers that if a provision of a scheme’s constitution allows the responsible entity to influence any aspect of the issue price or the withdrawal amount, then the constitution does not comply with s601GA.

Policy review

In October 2004, ASIC released a Consultation Paper Proposed class order relief from section 601GA for constitutions of registered managed investment schemesseeking submissions about proposed clarification of ASIC’s policy on s601GA. ASIC particularly sought submissions about s601GA and transaction costs, entry and exit fees, and valuing interests. ASIC considered the submissions it received in response to the Consultation Paper and undertook further consultation with the Investment and Financial Services Association (IFSA) about the form of clarifying relief in arriving at what is now its class order relief. This process highlighted the demand to develop a more general policy applying to a broader range of discretions where those discretions were capable of affecting the determination of the issue price or withdrawal amount for a scheme.

In the interim period while it considered its policy development, ASIC made temporary relief from s601GA available to responsible entities for constitutions that permitted the use of discretions to determine aspects of the issue price and/or the withdrawal amount. This temporary relief has been superseded by the changes to Class Order [CO 05/26] announced today. See Instrument [05/1269].

Transition

ASIC understands that the documentation conditions of the class order relief are consistent with current industry practice, but as practices may be slightly different across schemes, ASIC has given responsible entities until 1 May 2006 to comply with these conditions. This will allow time for responsible entities to check their practices against the class order conditions and make any necessary changes.

Explanation of the modifications to s601GA in the class order

[CO 05/1236] has been issued to clarify ASIC’s policy about how issue prices and

withdrawal amounts may be determined. Some scheme constitutions specify a formula or method for determining the issue price, rather than a set dollar amount. Where that 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, ASIC’s view has been that the constitution may not comply with s601GA. Under the class order relief, ASIC is clarifying its policy to allow a formula or method set out in the constitution to permit the responsible entity to exercise discretion to influence an aspect of the issue price or the withdrawal amount.

Conditions of relief

The responsible entity must meet certain requirements set out in the class order to obtain the benefit of this relief. ASIC understands these requirements to be consistent with current widespread industry practice. A responsible entity must:

1. act reasonably in exercising the discretion;
2. exercise the discretion in a way that is consistent with ordinary commercial practice unless it is impracticable to do so;
3. 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;
4. retain the documents that are relevant to each discretion for seven years; and
5. provide a copy, upon request and at no charge, of any documented policy or written explanation referred to in paragraph (c) to:
   1. any member of the scheme; and
   2. a person who has received or should have received the Product Disclosure Statement for an interest in the scheme.

Policy on the exercise of the discretion

The class order allows the responsible entity to develop a policy on how it will exercise its discretion (documented policy). Having a policy will ensure that:

1. issue prices and withdrawal amounts are calculated and applied consistently and equitably; and
2. the formula or method used is reviewed at appropriate periods.

If the responsible entity exercises discretion and does not have a policy or departs from its documented policy, it must document why the exercise of discretion or the departure from its documented policy was reasonable in the particular circumstances.

Nature of discretions

The nature of the discretions that the class order permits the responsible entity to exercise are limited to those that affect the pricing of interests in the scheme. The requirements of the class order will not apply to discretions that affect the structure and operation of a scheme and which are not contemplated by the policy underlying s601GA, including investment decisions, distributions, consolidations, or amendments to the scheme constitution.

The type of discretions that the class order applies to include discretions allowing the responsible entity to:

1. estimate an allowance for transaction costs;
2. select a valuation method;
3. determine entry/exit (application/withdrawal/switching) fees;
4. determine the total net asset value of the scheme, where this is to be used in valuing an interest;
5. allocate assets/liabilities/revenue/expenses between classes;
6. round off the issue price or withdrawal amount;
7. determine 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
8. determine the time at which asset values and liabilities will be calculated.

The exercise of any of these discretions will be subject to the general duties of the responsible entity under s601FC, including the obligations to act reasonably and in the best interests of scheme members.

A practical example of a discretion contemplated by this relief is where, in the case of the issue price, the constitution states that interests are to be issued on the basis of the net asset value of scheme property divided by the number of interests, adjusted for transaction costs (i.e. the ‘formula’ that will be used by the responsible entity). The constitution may allow the responsible entity to exercise discretion to estimate an amount for the transaction costs, to choose the valuation method used to value scheme property and/or to determine the frequency at which valuations are conducted and at which the issue price is recalculated. This example is not exhaustive. The discretions that are included in the constitution concerning any formula or method may vary depending on the kind of scheme.

Estimates of transaction costs

Where a scheme constitution allows the responsible entity to ‘estimate’ transaction costs, the way in which transaction costs are estimated may vary depending on the kind of scheme. The responsible entity should apply a sound and reasonable process that is consistent with ordinary commercial practice (unless it is not practicable to adhere to that practice). This process should be documented so that the responsible entity can explain why the estimation process is appropriate.

A responsible entity may use the same transaction costs estimate for a period of time; however, estimates should be adjusted as soon as information on the actual position becomes available. The responsible entity should also review estimates periodically and update them if there have been any significant changes that affect the reasonableness of the estimate or the methodology used to determine the estimate.

Overlap with relief currently provided in [CO 05/26]

[CO 05/26] currently provides conditional relief from s601GA to allow the responsible entity of a scheme to set the issue price of interests in some circumstances. Under s601GAA, the responsible entity may issue interests at a discount to the issue price that normally applies under the constitution for:

1. placements of quoted interests;
2. pro rata rights issues;
3. interest purchase plans;
4. distribution reinvestment plans;
5. schemes involving no or limited pooling;
6. forfeited interests; and
7. negotiated fee agreements with wholesale clients.

The additional relief from s601GA granted in [CO 05/1236] will only affect this existing relief to the extent that the scheme constitution allows the responsible entity to exercise discretion in working out the issue price against which a discount is to be applied (starting price). Where there is discretion about the determination of the starting price, the responsible entity must comply with s601GAB. Once the starting price has been determined, the responsible entity's determination under s601GAA of the discount to be applied to the starting price is not subject to the s601GAB requirements.

Schemes that will not be affected

The relief in [CO 05/1236] will not apply to schemes where the responsible entity does not have any discretion about how the issue price, or the withdrawal amount, is determined, as the case may be. In general, listed schemes will not be affected, as where interests are bought and sold at ‘market price’, the issue price and withdrawal amount can be objectively determined. However, to the extent that a responsible entity of a listed scheme has discretion about how the ‘market price’ will be calculated, s601GAB will apply.

Unlisted registered schemes that have a fixed issue price in the scheme’s constitution also will not be affected. In addition, the relief will not apply to fixed term schemes that do not allow members to withdraw from the scheme until a specified term has expired, as the withdrawal amount will only be calculated once the scheme has been wound up. Schemes involving the management of a single asset or enterprise often have the characteristics described in the examples above.

For further background, refer to:

• Information Release [05-34]:ASIC extends interim relief for certain managed investment scheme constitutions
• Information Release [05-15]:ASIC further extends interim relief for managed investment scheme constitutions
• Information Release [04-77]: ASIC extends interim relief for managed investment scheme constitutions
• Information Release [04-31]: ASIC announces interim position on transaction costs for managed investment scheme constitutions