1. Compliance with key AFS licence conditions including net tangible assets (NTA), base level financial requirements, professional indemnity insurance, external dispute resolution scheme membership and key persons

Our reviews identified examples such as:

• failure to meet NTA as a result of including assets such as related party loans that should be excluded for the purposes of calculating NTA

• inadequate level of professional indemnity insurance considering the nature of the responsible entity's (RE's) business

• inappropriate or unsubstantiated assumptions used for the purposes of preparing cash flow forecasts

• undocumented financial or other support arrangements resulting in some uncertainty in respect of the arrangements and an inability of the RE to monitor these arrangements, and

• the RE failing to advise ASIC of a change of key persons or that a key person was no longer engaged by the RE meaning the RE may not meet its expertise or competence requirements.

ASIC Guidance

An explanation of the financial requirements for REs is contained in Regulatory Guide 166 Licensing: Financial requirements (RG 166).

Substantial changes to the financial requirements for REs relating to preparation of cash flow projections and NTA calculations will commence on 1 November 2012. These changes are outlined in updated versions of RG 166 and Pro Forma 209 Australian financial services licence conditions (PF 209) and will be implemented through Class Order [CO 11/1140]. ASIC encourages all REs to become familiar with the new requirements and address any compliance issues prior to 1 November 2012.

Establishing and maintaining compliance measures that ensure, as far as is reasonably practicable, that the RE meets financial services laws is a condition of the AFS Licence. The general obligations imposed on all licensees under s912A of the Corproations Act 2001 (Corporations Act) are explained in Regulatory Guide 104 Licensing Meeting the general obligations (RG 104). This guide addresses ASIC’s view that a licensee must have adequate compliance measures in order for the licensee to comply with its licensing obligations.

2. Inappropriate compliance arrangements for the nature, scale and complexity of the REs business and insufficient resources to undertake the compliance function

Our reviews identified examples such as:

• compliance plans frequently did not address the requirements of ASIC regulatory guidance, for example Regulatory Guide 165 Licensing: Internal and external dispute resolution (RG 165), Regulatory Guide 198 Unlisted disclosing entities: Continuous disclosure obligations (RG 198) and Regulatory Guide 46 Unlisted property schemes – improving disclosure for retail investors (RG 46)

• failure to lodge scheme and RE financial statements and scheme compliance plan audit reports within statutory time frames

• failure to review and update compliance plans on an ongoing basis

• failure to comply with internal processes and procedures including crucial areas of related party transactions, conflicts of interest, breach identification and recording, complaints handling and property valuations

• lack of succession planning in respect of compliance resourcing particularly where key compliance staff have dual or competing roles

• some REs did not place high importance on the compliance function nor saw it as part of their day-to-day processes, resulting in insufficient compliance resources being employed, and

• a number of compliance plans did not reflect the structures or procedures within the RE's operations, particularly where there had been recent restructuring;

ASIC Guidance

The purpose of a compliance plan is to describe how the RE will make sure that it is complying with the Corporations Act and the scheme constitution. We therefore consider that a compliance plan should list the key processes, systems and structures that the responsible entity will apply.

ASIC Regulatory Guide 132 Managed investment schemes – compliance plans (RG 132) gives REs guidance on how to prepare a compliance plan for a managed investment scheme and the level of detail required in a compliance plan. Australian Standard AS 3806-2006

Compliance programs

is also helpful to assist licensees in formulating their compliance measures and assists in setting good industry practice.

RG 104 addresses the importance of having effective compliance measures and adequate resources to ensure the RE can comply with its obligations under the Corporations Act. We expect REs to document their compliance measures, fully implement them and monitor and report on their use and regularly review the effectiveness of these measures and ensure they are up-to-date. In ASIC’s view, failure to do this will make it more difficult to comply with the general obligations and to demonstrate compliance with them.

We expect responsibility for overseeing the RE's compliance measures and reporting to the governing body (including having ready access to the governing body) will be allocated to a director or senior manager. In addition, REs need to ensure that the area responsible for compliance is independent enough to do its job properly, has adequate staff, resources and systems and has access to relevant records.

3. Poor risk management systems and plans

Our reviews identified examples such as:

• risk management processes did not consider the potential risks associated with the RE being unable to continue to operate the scheme

• specific risks concerning the ongoing operation of the scheme were not identified in some circumstances

• risk management plans inconsistent with compliance plans and not reviewed for adequacy at least on an annual basis or more frequently depending upon the circumstances

• the risks associated with other entities providing financial support was not identified or addressed, and

• where the RE had insufficient compliance resources, we noticed the risk management plans did not appear to have a properly documented analysis of their risk system and in some cases were fragmented and out of date.

ASIC Guidance

An AFS licensee’s risk management systems will depend on the nature, scale and complexity of its business and risk profile.

Regulatory Guide 104 (RG 104) clearly outlines ASIC’s expectation that the RE's risk management system will be based on a structured and systematic process that takes into account the RE’s obligations under the Corporations Act; identifies and evaluates the risks faced by the RE’s business, focuses on risks that adversely affect consumers or market integrity; establishes and maintains controls designed to manage or mitigate those risks; and fully implements and monitors those controls to ensure they are effective.

In addition we expect that the RE’s risk management systems will normally need to address the risk that its financial resources will not be adequate.

AS/NZS ISO 31000:2009 Risk management –Principals and guidelines produced by Standards Australia can also assist in providing principals and guidance for managing any form of risk in a systematic, transparent and creditable manner within any scope or context.

4. Insufficient measures to control and monitor the release of information to investors

Our reviews identified examples such as:

• a number of compliance plans did not have adequate measures to address the disclosure guidance in RG 46 and RG 198

• persons responsible for monitoring continuous disclosure did not have access to the necessary information for disclosure purposes resulting in a dilution of accountability for continuous disclosure, and

• in some instances, no cross-checking of information was performed before information was released.

ASIC Guidance

Compliance plans play a key role in protecting investors and promoting their interests. ASIC expects compliance plans to contain adequate procedures to ensure that the RE is meeting its obligations in relation to disclosure. This aspect is discussed in more detail in RG 46 and the importance of effective compliance measures is addressed in RG 104.

5. Inadequate controls to manage related party transactions

Our reviews identified situations where there was a lack of information to support why related party transactions were in the best interests of scheme members; or to demonstrate effective controls were in place to ensure related party transactions were formally approved and monitored to ensure any conflicts were managed.

ASIC Guidance

Controls surrounding related parties are important to address the risk that the interests of a related party may influence the decision-making of directors to the detriment of the interests of members. ASIC has provided guidance in Regulatory Guide 76 Related party transactions (RG 76) in order to promote better disclosure and governance for related party transactions. This regulatory guide also applies to registered managed investment schemes.

Equally important are the controls surrounding managing of conflicts of interest. Regulatory Guide 181 Managing conflicts of interest (RG 181) provides guidance for controlling, avoiding and disclosing conflicts of interests in order for REs to comply with their statutory obligation to manage conflicts of interest.

Outcomes from ASIC’s reviews

ASIC has required the REs involved to address our concerns. In response to the more serious deficiencies, those REs have sought external advice including appointing independent consultants to assist them in meeting their obligations and in one case ASIC, has suspended the AFS licence.

As a result of these reviews, ASIC has obtained:

• compliance with AFS licence conditions

• commitment from REs to ensure compliance functions are adequately resourced

• improvements in the quality of the RE’s compliance arrangements and compliance plans

• inclusion of arrangements into risk management processes that address the risks of the RE not being able to meet its obligations and a greater consistency between the compliance plans and risk management plans

• increased focus from REs on risks of operation of schemes including financial and administrative support from related parties, and

• improvements in continuous disclosure processes.