Australian Institutional Investor Roundtable
A speech by Deputy Chair Karen Chester, to the Australian Institutional Investor Roundtable hosted by Standards Board for Alternative Investments (SBAI), Thursday 22 April 2021.
Check against delivery
Today I’ve been asked to provide you with a regulatory update of what matters to ASIC for investors for 2021–22.
But before I start, let me (with apologies to Rodgers and Hammerstein) begin at the “very beginning – a very good place to start”. By outlining the macro-market dynamics at play in the here and now.
Consistently low interest rates and the ongoing hunt for yield have (by necessity) inflated risk appetite among investors (be they retail or wholesale) and entities.
Running in-tandem with elevated risk and risky behaviour, is accelerated business change. 2020 being the year of uncertainty – a Rubik’s Cube – when we had to pivot like a game of Twister.
2020 resulted in all of us getting better at living with change and uncertainty, whether we wanted to or not.
Perhaps the best thing we gained from the trials of 2020 was the ability to do things differently. And with that came enhanced risk appetites – as individuals, and collectively as organisations.
I’m sure we all watched US markets back in February and the ‘Reddit army’ with both trepidation and fascination.
And while the risk in Australia of a ‘GameStop moment’ is remote, it is symptomatic of a shift in risk mindset that is happening globally among consumers becoming investors. And this we are not immune to.
Another issue in the ‘here and now’ is that of fees and costs – specifically, the evidence of excessive and unwarranted fees in the super system.
A 2018 Productivity Commission report found that while reported fees had trended down, a long tail of high-fee products remained entrenched, mostly in retail funds. It also found that compelling cost savings from realised scale were not systematically passed on to members as lower fees or higher returns.
We’re also working on a report with Deloitte Access Economics on competition in managed funds. This work is relevant to institutional investors because it’s examining the correlation between fees charged by MIS’s and the performance achieved. I’ll talk more on this later.
While ASIC continues to get on with implementing regulatory action to support economic recovery, consumer and investor protection remain top-of-mind.
It’s in this context that I put to you three questions. These are the three tests that frame ASIC’s regulatory priorities in 2021:
- As investors move up the risk curve in the hunt for yield, how are you evaluating the impact of your product disclosure and governance practices on those consumers?
- With Australia’s superannuation system under more scrutiny than ever before, how can you live up to your stakeholders’ expectations and deliver value? And by ‘value’ I mean ‘perform well over time and at lower cost’, and ‘signs of healthy competition’.
- How well are you prepared for the real and growing threats posed by operational risks – particularly cyber?
Disclosure and governance
To the first question. As investors move up the risk curve in the hunt for yield, how are you evaluating the impact of your product disclosure and governance practices on those consumers?
In asking this question, I’m referring to institutional investors’ position as the provider of underlying wholesale products.
I want to show you how ASIC’s work links back to you upstream. And I’ll use ESG investment (in a broad sense) as the framework for our discussion.
Risk management and disclosure
First to risk management and disclosure as it relates to climate change. We’re seeing high levels of engagement by the private sector on sustainable finance, climate risk management, and overall commitment to ESG initiatives. Seventy-eight percent of the ASX100 acknowledge climate change as a financial risk to their business.
Close to 60% of Australia’s Top-100 companies are following the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). There are about 40 listed asset managers that have publicly committed to supporting the TCFD’s recommendations.
ASIC has conducted a number of surveillance exercises on the climate change-related disclosure practices of large listed companies. We will continue to focus on this area as practices in our market develop.
We’re also working with other local regulators, including the climate-risk working group of the Council of Financial Regulators.
ASIC is also working with the IOSCO Sustainability Taskforce on its greenwashing project. And greenwashing leads me to the ‘broader church’ – indeed, the foundation stone – the issue of product labelling.
ASIC’s 2020 true-to-label project concluded that fund managers must do more to ensure product names (and marketing) align with underlying assets.
In other words, the product must do what it says on the tin. Because managed investment products are not prudentially regulated or government guaranteed, it’s a must-have that consumers are not misled around the sustainability of a particular product. Not to mention its level of risk or return.
As part of our true-to-label review, ASIC sought corrective action from 13 responsible entities where we identified significant concerns. Altogether, ASIC dealt with 30 funds from about 20 responsible entities; protecting consumers investing over $10 billion across these funds. We continue to monitor the outcomes and consider appropriate regulatory action, including enforcement action where necessary.
Product labelling then leads us into product advertising.
Here I’ll highlight ASIC’s ‘trifecta’ Federal Court wins against Mayfair 101 and Mr Mawhinney alongside (the other bookend matter) of our current civil penalty proceedings against La Trobe Financial.
Mayfair marketed the risks, returns and liquidity of some of its fund products in ways that were false, misleading or deceptive. Its products were deliberately targeted to attract wholesale investors who were not sophisticated investors.
This case illustrates why marketing must be true-to-label, regardless of whether the customers are retail or wholesale, or a bit of both.
ASIC’s win against Mayfair was a wake-up call for how funds promote their products, and how they use search engine advertising and sponsored links. It bolstered our true-to-label work and set a precedent that ASIC will use in future cases to defend consumers.
This is particularly important during the post-COVID economic recovery period, as more inexperienced investors flood into the market, and classify themselves (or are classified by others) as wholesale rather than retail investors.
The key thresholds here – that the investor has net assets of at least $2.5 million; income of at least $250,000; and/or is investing at least $500,000 – have not changed since 2001.
For example, think of a retired farmer in Mildura where Australian house prices and super balances have deemed said farmer a wholesale investor. These thresholds are not and have not been indexed.
While this is a policy issue – because unsophisticated (quasi-retail) clients are currently deemed wholesale in Australia – it does mean we have to be more hands-on and interventionist in the wholesale market than most of our regulatory peers.
I also mentioned our current case against La Trobe Financial. We’re alleging La Trobe marketed its funds in ways that were misleading or deceptive, or likely to mislead or deceive.
The Mayfair case, along with our current matter against La Trobe, illustrate ASIC’s standpoint that marketing and product suitability are not the exclusive concern of the retail market. We will continue our work to extend the legal principles protecting consumers from misleading and deceptive marketing.
Not only do issuers need to ensure their product ads and websites represent their product risk, return and liquidity truthfully, they also must ensure their advertising methods – including domain names, meta-title tags, and Google Ads – do so as well.
This is an emerging area of law, and while ASIC does not directly regulate Google advertising, we do ask you to take heed.
Design and distribution obligations
All of these issues – advertising, labelling and disclosure – bring us back to the incoming design and distribution obligations.
DDOs are (for me at least) the jewel in our recalibrated legislative crown.
As Jane Austen puts it in Sense & Sensibility, “I do not want syllables where actions have spoken so plainly”. The actions product issuers take to address these obligations will speak to ASIC louder than words.
Product issuers with retail investors in their client base will need to comply with DDOs from 5 October.
We see benefits in issuers taking a broader approach to DDOs.
We understand there are difficulties, in practice, of distinguishing between a retail investor, and a vulnerable unsophisticated wholesale investor, even though they may be treated very differently under the current legislative settings.
As well, the general obligation of AFS licence holders under section 912A of the Corporations Act to ‘do all things necessary’ to ensure the financial services covered by the licence are provided ‘efficiently, honestly and fairly’, still applies to financial services delivered to wholesale investors of this kind.
So yes – DDOs are a massive step-change for industry. However, we see the potential benefit of ensuring that suitable products – the right products – are sold to the right end-investor.
Now to governance practices. Superannuation fund governance was highlighted during the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry; and continues to be a focus for APRA. And we’ve determined that the timing is right for a review of responsible entity (RE) governance.
Why? Because we want to ensure REs are fulfilling their duty to act in the best interests of their members.
The same goes for any RE members connected to superannuation funds, which also have a duty to protect investors’ interests. Not to mention the fact that as at March 2019, Australia’s managed funds (or mutual funds) were worth $2.9 trillion dollars – around 150% of Australia’s GDP.
ASIC is currently reviewing the governance practices of 10 REs of managed investment schemes to evaluate the quality and effectiveness of their governance structures, processes and policies. We’re asking questions about Board governance practices, compliance committee practices, and how REs engage with and rely on third-party service providers.
The review will provide us with a clearer understanding of current industry practice (for example, Board composition and the number of independent chairs and directors). It will also help us identify where REs may not be meeting their obligations.
We plan to publish a report later this year to highlight our observations and any areas of concern. The report will identify the cohort of REs surveyed, and we are expecting to identify REs where their conduct has been exemplary – or concerning.
While the focus is on retail schemes, there are likely to be findings relevant to the investment management sector as a whole – for example, robust oversight of service providers, particularly where they are related companies.
I note there have been expressions of concern among some REs about whether the review will lead to new standards from ASIC or law reform from Government. All I’ll say is that law reform is solely a matter for Government. And at any rate, it’s far too early to know what the findings of the review might be.
I’d like to now turn your attention to my second question: With Australia’s superannuation system under more scrutiny than ever before, how can you live up to your stakeholders’ expectations and deliver value?
On 1 January 2021, the Government introduced reforms to improve ASIC’s effectiveness as the conduct regulator for superannuation, and to increase ASIC’s consumer protection powers. These reforms enable ASIC to more effectively regulate superannuation trustee conduct without detracting from or duplicating APRA’s role as prudential regulator.
Effectively, ASIC co-regulates with APRA the obligations of super trustees under the SIS Act where consumer protection, market integrity, disclosure or record-keeping are concerned.
ASIC now has greater consumer protection powers under the Corporations Act and ASIC Act. We can take action in relation to a broader range of conduct by superannuation trustees.
We remain focused on protecting consumers’ interests – we want to see super funds operate in a way that is fair to members and promotes confidence in the superannuation system.
We want to see trustees go beyond compliance by placing members’ interests first. As trustees or the providers of investment services to super funds, we ask you to consider issues around value, transparency, fees and costs.
I mentioned earlier our engagement with Deloitte Access Economics on the MIS competition review.
The Interim Report did not find significant evidence to suggest that competition is not effective in the managed funds industry. However, it has identified areas where concerns have been raised, or where outcomes might be improved. While the final report is due to be delivered to ASIC in the coming months, the interim report notes that:
- Fees charged by Australian funds are low by global standards. Analysis of the PDS management fee for nearly 6,000 funds undertaken for this report found that management fees declined from an average of 90 basis points (bps) in 2014 to 87bps in 2020.
- During consultation, fund managers generally identified fees as an important source of competition, and some indicated that they are price takers rather than price makers.
- The majority of fund managers also noted that retail investors closely scrutinise fees and are placing increasing priority on fees and performance.
- Retail managed funds generally charge higher fees than wholesale managed funds. This is consistent with the higher bargaining power of wholesale investors compared to retail investors.
To my third and final question for you this evening. How well are you prepared for the real and growing threats posed by operational risks – particularly cyber?
Cyber risk has been a ‘known known’ for well over 20 years. But in today’s world of reliance on networked digital systems and working from home at scale, threats are now at your digital doorstep. It’s arguably the new frontier of both national defence and market integrity, and the battlefield is asymmetrical – an attacker only has to win once.
The impact of cyber risk is insidious. It can have a multiplier effect on individual businesses, markets and ultimately – investors. While technology promises greater efficiency and productivity, it has also expanded the attack surface for threat actors from low-level cyber criminals to state-backed advanced persistent threats.
This shift in surface exposure and the number of risks is only going to grow. This is why we’re not just raising awareness of cyber resilience and helping regulated entities prepare for self-assessments.
We’re also taking decisive, deterrence-based enforcement action, as evidenced by ASIC’s August 2020 case against RI Advice Group under section 912A of the Corporations Act.
This is the first action ASIC has taken against a licensee in respect of cyber security and cyber resilience. And it definitely won’t be the last. We will ensure regulatory incentives for cyber resilience remain in open play.
It’s in this context that I ask you to consider your operational security – are your systems, policies and processes up to scratch? Where are your weakest links and what are you doing about them?
For super trustees, the starting point is APRA’s Prudential Standard CPS 234 on Information Security.
This standard aims to ensure APRA-regulated entities take measures to be resilient against information security incidents (including cyber-attacks) by maintaining an information security capability commensurate with vulnerabilities and threats.
We only need to look back to 16 November last year and the ASX’s cash equity market trading outage. This incident highlighted that many firms were not prepared for an outage of that scale, and as such could not cut over to Chi-X in time to continue trading.
Participants’ duties to their clients – including the obligation to take reasonable steps to obtain best execution – do not fall away where there has been a market outage or disruption.
I’d like to thank SBAI for inviting me to speak this evening.
I look forward to continuing ASIC’s engagement with the SBAI as we both get going on our 2021 work program.
 Productivity Commission, Superannuation: Assessing Efficiency and Competitiveness, No. 91, December 2018.
 KPMG media release, ASX100 companies ahead of global firms in acknowledging climate risks, 20 November 2020.