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Are there any restrictions on issuing debt securities?
The general position under the Corporations Act 2001 (Cth) is that debt securities may only be offered and sold in Australia if they are accompanied by a disclosure document prepared in accordance with the Corporations Act 2001 (Cth). Disclosure documents must be lodged with ASIC.
There are exceptions to the requirement to prepare a disclosure document which are outlined below.
The Corporations Act 2001 (Cth) also imposes a general prohibition on the advertising or publicity of offers of securities that require a disclosure document. There are further prohibitions on ‘hawking’ (i.e. unsolicited meetings or telephone calls).
If debt securities are listed on the Australian Securities Exchange, there are additional disclosure requirements and continuing obligations that will apply – these are contained in the Listing Rules of the Australian Securities Exchange.
What are common issuing methods and types of debt securities?
The debt securities market in Australia includes stand-alone bonds and bond programs (e.g. Medium-Term Note programs) issued by large corporations and financial institutions.
Bonds may be issued in wholesale and retail formats. Wholesale issues do not require a prospectus or other disclosure document, and are rarely listed.
Many different types of debt securities are offered in the Australia, including guaranteed and asset-backed securities, high yield bonds, covered bonds, hybrid securities (including convertible notes and preference shares), derivative securities and green bonds.
Parties that are not resident in Australia may issue ‘Kangaroo Bonds’ (i.e. bonds issued in Australian dollars). In many cases, these issues are driven by favorable Australian dollar terms in the cross-currency swap markets.
Wholesale debt securities can be cleared through Austraclear, the Australian domestic clearing system. In order to be eligible, the securities must be issued in Australian dollars.
What are the differences between offering debt securities to institutional / professional or other investors?
Offers of debt securities can generally be made to institutional/professional investors without a disclosure document. Offers of debt securities to retail investors require a disclosure document prepared in accordance with the Corporations Act 2001 (Cth).
When is it necessary to prepare a prospectus?
The general position under the Corporations Act 2001 (Cth) is that debt securities may only be offered and sold in Australia if they are accompanied by a disclosure document prepared in accordance with the Corporations Act 2001 (Cth).
Offers of debt securities can generally be made to institutional/professional investors without a disclosure document.
Offers of debt securities to retail investors will require a disclosure requirement, most commonly in the form of a prospectus.
Even where a prospectus is not required by law, an information memorandum is commonly used for marketing purposes.
What are the main exchanges available?
The Australian Securities Exchange is the main exchange in Australia.
Is there a private placement market?
It is certainly possible to issue bonds through private placement in Australia, although domestic demand for such bonds is generally lower than in the US and Europe, due in part to a relative lack of liquidity. Many corporate issuers prefer to issue bonds in overseas jurisdictions.
Are there any other notable risks or issues around issuing or investing in debt securities?
Issuing debt securities
Issuers are required to take responsibility for disclosure documents for debt securities. Liability may arise for breach of statute for statements that are misleading or deceptive, or omit any required information. In addition to the issuer, directors, underwriters, and other parties making statements in a defective disclosure document may also be liable for the damage arising from such defective disclosure.
Investing in debt securities
Debt security terms and conditions typically contain provisions which may permit their modification without the consent of all investors and confer significant discretions on the trustee, which depending on the terms of issue may be exercised with or without the consent of investors and without regard to the individual interests of particular investors. The conditions also provide for meetings of investors to consider matters affecting the investors interests. These provisions typically permit defined majorities to bind all investors including investors who did not attend and vote at the relevant meeting and investors who voted against the majority.
Are there any restrictions on establishing a fund?
The Australian funds management industry is mature and heavily regulated. An Australian hedge or debt fund is usually structured as a unit trust and would ordinarily fall within the definition of a ‘managed investment scheme’ in the Corporations Act 2001 (Cth). That Act imposes a wide range of obligations and requirements on the operators of managed investment schemes. Managed investment schemes are regulated by ASIC
Managed investment schemes
The following key restrictions apply when establishing a managed investment scheme:
- managed investment schemes, particularly those offered to ‘retail clients’ (as that term is defined in the Corporations Act 2001 (Cth)), are subject to relatively heavy regulatory requirements which may impose a significant compliance burden on the operators of such schemes;
- the operator of the managed investment scheme (which is called the 'Responsible Entity') must hold an Australian Financial Services License (AFSL) issued by ASIC (or be an authorized representative of another entity's AFSL) which authorizes it to act as the Responsible Entity of managed investment schemes;
- a managed investment scheme which is offered to retail clients must be registered with ASIC;
- if a managed investment scheme is structured as a unit trust (as is usually the case), general trust law will apply to the operation of the trust; and
- the offer of interests in a managed investment scheme to retail clients will require the preparation of a detailed disclosure document, the contents of which is heavily regulated.
Managed investment schemes may also be listed on the Australian Securities Exchange, provided that a range of regulatory requirements are met.
What are common fund structures?
As noted above, the most common fund structure in Australia is a unit trust, where each investor holds units representing a beneficial interest in the assets of the fund.
Unit trusts are usually managed so they can be treated as ‘flow through’ vehicles for tax purposes (similar to a partnership) so that the fund itself is not subject to taxation. Investors are taxed on their share of the net income and capital gains earned by the fund.
Certain units trusts that are managed investment schemes for Corporations Act 2001 (Cth) purposes may also qualify for tax concessions as a managed investment trust.
Collective investment vehicles
The Australian Government has been working on the introduction of an Australian collective investment vehicle (CIV) regime, which will introduce two alternatives to the current Australian unit trust structure. The new vehicles will be a corporate CIV and a limited partnership CIV, which will be similar to the equivalent structures which are commonly used in foreign jurisdictions.
The Australian Government is still conducting a consultation process (which began in 2017) with the most recent pieces of draft legislation outlining the proposed regime released in January 2019.
Asia Region Funds Passport
The Asia Region Funds Passport was implemented in Australia in 2018 with the Corporations Amendment (Asia Region Funds Passport) Act 2018 (Cth). It allows Australian fund managers to offer interests in qualifying funds to investors across multiple participating economies in the Asian region with limited additional regulatory requirements. Similarly, fund managers in other participating economies will be able to market their qualifying funds to Australian investors using the more streamlined regulatory process.
However, the uptake of the Asia Region Funds Passport will largely depend on how the corresponding tax reforms and the CIV regime will look once enacted by Parliament.
What are the differences between offering fund securities to professional / institutional or other investors?
Distinction between retail and wholesale investors
An investor is deemed to be a ‘wholesale’ investor for Australian law purposes where it has invested AUD500,000 or more in a particular fund. There are numerous other criteria for an investor to qualify as a ‘wholesale’ investor for Australian law purposes. For example, where an investor can produce a copy of a certificate given within the preceding two years by a qualified accountant that confirms that it has net assets of at least AUD2.5 million or has a gross income for each of the last two financial years of at least AUD250,000. Further, a person who has or controls gross assets of AUD10 million (including any assets held by an associate or under a trust that that person manages) is deemed to be a wholesale investor no matter what the size of its investment.
All investors that are not wholesale investors are considered to be retail investors.
Funds offered to retail investors must be registered with ASIC. The offer of interests in retail funds must be accompanied by a PDS, which must contain specific information as prescribed by the Corporations Act 2001 (Cth) (for example, information about the Responsible Entity, the fees and costs payable, the risks and benefits and significant characteristics of the fund). A PDS must also contain all other information that might reasonably be expected to influence the decision of a retail investor considering whether to invest in the fund.
Funds which are offered exclusively to wholesale investors do not need to be offered using a PDS. However, it is usual to provide another disclosure document, such as a private placement memorandum or information memorandum, when offering interests in such funds. Any such disclosure document must not be misleading or deceptive.
Are there any other notable risks or issues around establishing and investing in funds?
As noted above, in order to establish a fund in Australia, the operator of the fund must usually hold an AFSL (or be an authorized representative of an AFSL holder) with appropriate license authorizations.
In addition, where the fund is a managed investment scheme (which is usually the case for retail funds), a Responsible Entity must be appointed. In order for an entity to act as a Responsible Entity, it must:
- be an Australian public company;
- hold an AFSL (or be an authorized representative of another AFSL holder) authorizing it to provide the various financial services relevant to the operation of the fund; and
- either have a majority of directors who are external directors or have a compliance committee (to oversee the retail fund's compliance requirements) with a majority of 'external members'.
It is common for investment managers who do not satisfy the requirements for being a Responsible Entity to enter into an arrangement with an external or 'professional' Responsible Entity, which will operate the fund according to the investment strategy which the investment manager may set.
As mentioned, managed investment schemes may also qualify for tax concessions if they qualify as a “managed investment trust” under Australian tax laws. For a wholesale unit trust fund to qualify as a “managed investment trust”, the trust must be operated or managed by an AFSL licensee or by an authorised representative of such licensee.
Investing in funds
As noted above, most investment funds in Australia are structured as unit trusts. These funds are subject to the general law of trust. In addition, usually:
- The investors in a fund have no power to influence the fund's investment strategy, or any of the decisions or operations of the fund, solely by virtue of being a unit holder.
- The investors in the fund do not have a specific right to any particular assets of the trust.
- The investors in the fund will rank behind the fund's creditors in the event of insolvency.
- The fund operator will usually be entitled to an indemnity from the assets of the fund for any liabilities it may incur in performing its duties, and will usually limit its liability to the amount by which it is actually indemnified.
Are there any restrictions on marketing a fund?
The marketing of a fund in Australia will normally constitute providing 'financial product advice' and so will be a 'financial service' for the purposes of the Corporations Act 2001 (Cth). That Act provides that, generally, all providers of financial services must hold an AFSL (or be appointed as an authorized representative of another AFSL holder) with an authorization to provide the relevant financial service.
When offering interests in retail funds it is also generally necessary to prepare a PDS.
There are a number of very limited exemptions from the need to obtain an AFSL or to act under an authorization from another AFSL in order to market a fund in Australia. These exemptions generally only apply when the fund is marketed solely to wholesale investors. For example:
- Certain foreign financial services providers who are regulated in jurisdictions that ASIC considers to have a regulatory framework sufficiently similar to the Australian regime (such as the UK, US, Singapore, Hong Kong and Germany) may be eligible to apply for relief from licensing to enable them to market funds to Australian 'wholesale' investors2.
- An exemption applies where the marketing is done in Australia to a prospective investor which itself holds an AFSL and is not acting as a trustee or on behalf of another person (as Australian superannuation funds and Australian fund managers offer their products to their Australian investors through trusts, this limits the exemption to true proprietary investors which commonly do not have an AFSL as they are not usually required to hold one).
- An exemption applies where a prospective Australian investor makes enquiries of a foreign fund manager without any prior solicitation by the foreign fund manager, and the foreign fund manager does not during this time actively solicit persons in Australia in respect of the relevant fund (other than in response to the enquiry initiated by the Australian investor or by the Australian investor's agent).
2 ASIC is currently conducting a consultation process to formalise this exemption into a foreign financial services licence for foreign financial services providers. ASIC has proposed a prospective commencement date of 1 April 2020, however this is subject to the finalisation of the draft instruments proposed by ASIC.
Are there any restrictions on managing a fund?
Australian-domiciled funds will usually fall within the definition of 'managed investment scheme' in the Corporations Act 2001 (Cth). The Responsible Entity of a managed investment scheme (which is the operator of the fund) is typically required to hold an AFSL (or be an authorized representative of an AFSL holder) which authorizes it to provide the various financial services necessary to operate the fund, including a specific authorization to act as the Responsible Entity of a managed investment scheme.
As noted above an entity wishing to act as the Responsible Entity of a managed investment scheme must also:
- be an Australian public company; and
- either have a majority of directors who are external directors or have a compliance committee (to oversee the retail fund's compliance requirements) with a majority of 'external members'.
An investment manager which is not able to act as a Responsible Entity may enter into an arrangement with an external or ‘professional’ Responsible Entity, which will operate the fund according to the investment strategy which the investment manager may set. In those situations, from a strictly legal perspective, it is the Responsible Entity of a retail fund that engages the investment manager and is responsible for the acts of the investment manager, and the Responsible Entity will bear any liability for the mismanagement of the fund. Such external Responsible Entities will therefore typically charge a significant fee for their service.
If a managed investment scheme is to be offered to retail investors, it must be registered with ASIC and will be subject to a further layer of regulatory requirements. For example, a registered managed investment scheme must have a 'constitution' which is compliant with the Corporations Act 2001 (Cth) and must also maintain a 'compliance plan' which sets out the measures which the Responsible Entity must take to ensure compliance with the constitution and the Corporations Act 2001 (Cth).
The offer of interests in a managed investment scheme to retail investors will also generally require certain disclosure documents, including a PDS, to be prepared in accordance with the content requirements mandated by the Corporations Act 2001 (Cth) and by ASIC.
As mentioned, managed investment schemes may also qualify for tax concessions if they qualify as a “managed investment trust” under Australian tax laws. For a wholesale unit trust fund to qualify as a “managed investment trust”, the trust must be operated or managed by an AFSL licensee or by an authorised representative of such licensee. For a managed investment trust that seeks the 15% concessionally withholding tax rate for its fund payments, a substantial proportion of its investment activities must also be carried out in Australia.
Are there any restrictions on entering into derivatives contracts?
Unless an exemption or exclusion applies, a person issuing derivatives as part of its financial services business is deemed to be dealing in financial products, which requires an AFSL under the Corporations Act 2001 (Cth) and the Corporation Regulations 2001 (Cth). If a person issues derivatives without an AFSL, the counterparty would be entitled to rescind any agreements in relation to that product and the relevant agreements will be unenforceable. There are specific financial requirements for a person authorized to issue derivatives, which differ from requirements in relation to other financial products, which recognize the exposure of the licensee to counterparties arising from entering into derivatives.
For these purposes, a 'derivative' is broadly defined as an arrangement that has a future liability element and a derived value element, and is sufficiently wide to cover all commonly-regarded types of derivative contracts, including futures agreements and forwards, options, swaps and contracts for difference. Under the relevant legislation, certain arrangements are specifically excluded as derivatives including:
- arrangements for mandatory physical delivery of tangible property;
- a contract for the future provision of services; and
- anything that falls within one of the other categories of financial product (such as a security).
AFSL licensees have ongoing obligations under the Corporations Act 2001 (Cth) in terms of their conduct, including to:
- notify the ASIC of breaches or likely breaches of certain significant licensee obligations;
- quote their AFSL number in documents;
- comply with stipulated procedures when dealing with clients’ money; and
- keep financial records.
What are common types of derivatives?
Derivative contracts are entered into in Australia for a range of reasons including hedging, trading and speculation.
Derivatives may be traded over-the-counter or on an organized exchange.
All of the main types of derivative contract are widely used in Australia, including futures agreements and forwards, options, swaps (including credit default swaps) and contracts for difference. Underlying assets commonly include equities, fixed income instruments, commodities, foreign currencies and credit events.
The gross notional outstanding for interest rate derivatives in Australia is worth in excess of AUD10 trillion, the majority of which are denominated in AUD. There is also a sizeable FX swap market, with average daily turnover in excess of AUD100 billion.
Are there any other notable risks or issues around entering into derivatives contracts?
Since the global financial crisis in 2007-to-2008, and the G20 summit in 2009 the derivatives market has been subject to a significant amount of new regulation, and this has led to substantial compliance costs for market participants.
In January 2013, ASIC introduced the ASIC Derivative Transaction Rules (Reporting) 2013, together with the ASIC Derivative Trade Repository Rules 2013. Among other things, these Rules introduced mandatory reporting requirements for derivative transactions for the majority of derivatives users. These rules were subsequently softened by the ASIC Derivative Transactions Rules (Reporting) Amendment 2015 (no 1).
Other recent regulatory changes of note include the requirement for certain standardized over-the-counter derivative trades to be subject to clearing with a prescribed Central Clearing Counterparty, as implemented through the Corporations (Derivatives) Amendment Determination 2015 (No 1), and the requirement for reporting of certain trades to a licensed Trade Repository, as implemented through the Derivative Transaction Rules (Reporting) 2013 (both regulations have been subject to subsequent amendment).
The Prudential Standard CPS 226 (Margining and risk mitigation for non-centrally cleared derivatives), as published by the APRA in 2016, establishes the requirement for the posting and collection of variation and initial margin in transactions which include a covered entity (for example, deposit-taking institutions that are authorized under the Banking Act 1959 (Cth)).
In addition, it is important to note that the approach to market misconduct is generally the same for securities and for derivatives (including market manipulation and insider trading) although compensation orders for damages do not apply to derivatives.
Finally, the ATO has recently issued guidelines setting out risk factors applicable to cross-border related party derivatives.