Publications / Financial Services

5 Mar 14
ASIC imposes additional obligations on responsible entities for holding and custody of scheme assets

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ASIC has recently released class order 13/1409 (CO 13/1409), imposing minimum standards on responsible entities for holding and dealing with scheme assets.  Effectively, ASIC has sought to impose specific requirements on responsible entities rather than continuing to rely on them to appropriately apply the more general obligations which currently exist. This is a clear indication that ASIC considers the current practices for holding scheme assets are inadequate.

Partner, Tim Wiedman, summarises the standards advised by CO 13/1409 and the consequences for responsible entities.

The Corporations Act requires responsible entities to ensure the assets of a registered scheme are clearly identified as scheme assets are held separately from the responsible entity’s assets and the assets of any other schemes.  A responsible entity’s Australian financial services licence (AFSL) also imposes obligations on it to meet the requirements set out in ASIC Regulatory Guide 133 for the holding of scheme assets and to ensure, where scheme assets are held by a custodian, the custody agreement meets certain requirements.

CO 13/1409 contains two broad obligations:

  • requiring a responsible entity who is a ‘self-custodian’ (where they hold the assets of their registered scheme) to meet, or a responsible entity who appoints a custodian to hold scheme assets to ensure the custodian meets, certain minimum standards for holding scheme assets, and
  • for a responsible entity who has a custodian, requiring the custody agreement between the responsible entity and custodian to address certain matters.

Further details of these minimum standards and custody agreement requirements are summarised below.

Minimum standards for holding scheme assets
The minimum standards for holding and dealing with scheme assets require a responsible entity to:

  • do all things necessary to ensure a custodian holds scheme assets on trust (with some exemptions for assets located outside Australia), unless the assets are held by the responsible entity or scheme members
  • have reasonable procedures for giving instructions to:
    • the custodian, or
    • custodial staff (where a responsible entity is a ‘self-custodian’) in relation to scheme assets
  • do all things necessary to ensure the custodian identifies scheme assets as held on behalf of the responsible entity and holds those assets separately from assets in which the responsible entity or custodian has an interest
  • do all things necessary to ensure the custodian or, where the responsible entity is a ‘self-custodian’, the responsible entity:
    • has an organisational structure which supports the requirements for holding scheme assets
    • segregates custodial staff from persons performing other functions (such as investment or trading functions) in a way that minimises conflicts of interest which may exist
    • has a documented policy approved by, or with the authority of, its directors or equivalent, designed to ensure custodial staff are not influenced because of a potential conflict of interest to act other than in accordance with their duties
    • undertakes reasonable checks to detect and document any attempt to inappropriately influence custodial staff, and take reasonable action in the event this happens, and
    • structures its business so that custodial staff can report to the directors or compliance committee and the duties of custodial staff and their managers do not extend to other functions (such as investment or other decisions which may result in the transfer or disposal of scheme assets) that may create conflicts of interests
  • ensure its custodial staff (where the responsible entity is a ‘self-custodian’) or take reasonable steps to ensure the custodian’s custodial staff (where the responsible entity has a custodian): have the knowledge and skills necessary to perform their duties properly; appropriate ongoing training and educational programs are provided to custodial staff; custodial staff have the necessary time and authority to perform their duties; and that custodial staff are appropriately resourced
  • document and implement a reasonable process to monitor and assess an appointed custodian’s performance of its obligations and to ensure the custodian documents and implements a reasonable process to monitor and assess any sub custodian
  • ensure it keeps records of scheme assets in a way that enables the holding of those assets to be conveniently and properly audited by the scheme auditor and that any custodian or sub custodian keeps such records in relation to scheme assets held by it, and
  • document and implement a reasonable process for determining if it should ‘self-custody’ and hold scheme assets or engage a custodian, addressing potential conflicts of interest and any other considerations relevant to the best interests of members.

Further, where a responsible entity changes custodian, appoints a custodian to hold assets previously held by the responsible entity or holds scheme assets previously held by a custodian, the responsible entity must obtain a report from a person unrelated to the responsible entity or custodian confirming all assets have been identified and transferred, unless it reasonably believes it is not in the best interests of members to do so.

A responsible entity who meets the requirements set out above is deemed to comply with the AFSL condition requiring it to comply with the obligations of Regulatory Guide 133 regarding arrangements for holding scheme assets.

Custody agreement requirements
Where a responsible entity appoints a custodian, the responsible entity must ensure it has a written custody agreement containing provisions:

  • specifying reasonable rights for the ongoing review and monitoring of the custodian and any sub custodian by the responsible entity and the standards against which their performance will be assessed
  • requiring the custodian to certify at least every 13 months that it believes it and each sub custodian have met, and have no reason to believe that they will not continue to meet:
    • the terms of the custody agreement, and
    • the requirement for the responsible entity to do all things necessary to ensure the scheme asset holding standards are met by the custodian or sub custodian, other than as disclosed to the responsible entity or that the custodian reasonably believes are trivial
  • requiring the custodian to acknowledge to the responsible entity on request that scheme assets are held for the responsible entity
  • specifying how instructions will be given by the responsible entity to the custodian
  • preventing the custodian from taking or granting any security interest or encumbrance over scheme assets, unless it is in accordance with the custody agreement and does not cover unpaid custodian fees
  • specifying how the custodian will maintain records of scheme assets and transactions regarding those assets
  • specifying procedures for the reconciliation of information the custodian is given on the existence and quantity of scheme assets against the custodian’s records, and for reporting any exceptions
  • requiring the custodian to provide all reasonable access and assistance to the responsible entity and scheme auditors
  • requiring the custodian to provide written notice of, and contact information for, any other person appointed by the custodian to hold the scheme assets (for example, a sub custodian)
  • enabling the responsible entity to terminate the agreement without payment (other than for accrued fees and expenses or reasonable expenses involved in the transfer of scheme assets to the responsible entity or new custodian) and without limiting any right to damages under the custody agreement, if the responsible entity has reasonable grounds believe the custodian is in breach of the agreement due to an act or omission of the custodian (or sub custodian) resulting in the responsible entity failing to comply with the minimum scheme asset holding standards of CO 13/1409
  • requiring scheme assets be transferred to the responsible entity (or as it directs) within a reasonable period after termination of the custody agreement
  • requiring the custodian to notify material or systemic breaches of the custody agreement to the responsible entity’s board or compliance committee
  • specifying the terms on which the custodian is authorised to engage a sub custodian or other person to hold scheme assets, which must:
    • where the sub-custodian or asset holder is a related body corporate of the custodian, require the custodian be liable to the responsible entity for the acts or omissions of that related body corporate, and
    • otherwise, be contained in a written agreement which meets the requirements specified in CO 13/1409.
  • requiring the custodian to establish and maintain business continuity arrangements
  • preventing the custodian from disclosing any confidential information relating to the scheme, other than to ASIC, which is required by law or as directed by the responsible entity
  • requiring the custodian to establish and maintain adequate arrangements to ensure it will report to ASIC within ten business days if it suspects the responsible entity has breached its obligations under the Corporations Act to report breaches to ASIC
  • for reasonable liability and does not include provisions that exclude the liability of the custodian for direct loss (except in circumstances which the responsible entity considers to be reasonable), and
  • for, if appropriate, reasonable indemnity in relation to losses suffered by the responsible entity due to the custodian’s acts and omissions.

Also, the custody agreement must not contain provisions that require the custodian to disclose to the responsible entity that it has communicated with ASIC concerning suspected contraventions of the financial services laws.

Further, the responsible entity must do all things necessary to ensure the custodian has a written agreement with any sub custodian or other person it engages to hold scheme assets which addresses the requirements set out above.

A responsible entity whose custody agreement satisfies these requirements is deemed to comply with the AFSL condition requiring a custody agreement to address the matters listed in that condition.

A responsible entity who was authorised to operate registered schemes prior to 2 January 2014 (existing responsible entity) must:

  • comply with the minimum standards for holding scheme assets by 2 January 2015, and
  • ensure that any custody agreement meets the requirements listed above by 1 November 2015.

New responsible entities, being licensees who are first authorised to operate a registered scheme on or after 2 January 2014, must comply with both the minimum standards for holding scheme assets and the custody agreement requirements from the date ASIC issues an AFSL authorising them to be a responsible entity.

Implications for existing responsible entities
Compliance with CO 13/1409 will require existing responsible entities:

  • to develop or update and implement various policies regarding the holding of scheme assets
  • who ‘self-custody’, to ensure their organisational structure and operations meet ASIC’s scheme asset holding standards
  • who have a custodian, to take all steps reasonably necessary to ensure the custodian meets ASIC’s standards for holding scheme assets, and
  • who have a custodian, to ensure the custody agreement meets the requirements summarised above (requiring the custodian to ensure any agreement with a sub custodian also meets these requirements), by the relevant deadline.

Therefore, existing responsible entities who ‘self-custody’ should review their organisational structure and processes and update or implement policies as necessary to ensure they meet the minimum scheme asset holdings standards by 2 January 2015.

Existing responsible entities who have a custodian should also review their operations and processes to ensure they have the policies and procedures in place which meet ASIC’s requirements for holding scheme assets, and liaise with their custodian to confirm their structure and policies are consistent with requirements, by 2 January 2015.  Further, the responsible entities must also review their custody agreements and identify any deficiencies or non-compliance with ASIC’s new requirements and being liaising with their custodian with a view to revising or replacing the custody agreement prior to the 1 November 2015 deadline.

Relevantly, ASIC also recently issued class order 13/1410 (CO 13/1410) which requires custodians who hold an AFSL to provide custodial services to:

  • meet the same standards for holding scheme assets when providing services to responsible entities, as applying to responsible entities under CO 13/1409, and
  • require agreements with sub-custodians to contain provisions similar to those which CO 13/1409 requires a responsible entity to include in its custody agreement.

The deadline for compliance with CO 13/1410 for licensed custodians is the same as applying to responsible entities under CO 13/1409, namely custodians who were licensed before 2 January 2014 have until 2 January 2015 to meet the scheme asset holding standards and until 1 November 2015 to ensure their agreements with sub-custodians or nominees meet ASIC’s requirements.  Any entity which becomes authorised under its AFSL to provide custodial services after 2 January 2014 will need to comply with the scheme asset holding standards and sub-custody agreement requirements from that date.

Therefore, existing responsible entities and custodians will be working toward meeting similar requirements within the same timeframes and this should foster a timely and co-operative transition to compliance with these obligations by the applicable deadlines. 

Practical issues for new responsible entities
While CO 13/1409 provides an appropriate transition period to enable existing responsible entities to work with their custodian (if applicable) to achieve compliance, it does pose considerable problems for new responsible entities entering the market, who need to appoint a custodian, which will be the vast majority of new responsible entities given the high net tangible asset requirement typically applying to those who ‘self-custody’. 

The difficulty for new responsible entities will be locating custodians who currently have:

  • the appropriate organisational structure, policies and procedures to enable the responsible entity to discharge its obligation to appoint a custodian who meets ASIC’s minimum scheme asset holding standards, and
  • a custody agreement (and agreements with sub-custodians) which meet ASIC’s requirements.

As existing custodians are also subject to a transitional period, we understand that a number of custodians, particularly those with global operations, do not currently (and are not required to) meet the minimum scheme asset holding standards and their standard ‘custody agreement’ does not address all the CO 13/1409 requirements.

Though this does not pose any issues for a custodian’s relationship with existing responsible entities, a custodian who does not currently meet the minimum scheme asset holding requirements and whose custody agreement does not satisfy ASIC’s requirements cannot be appointed by a new responsible entity.  That is, they are effectively ‘closed for business’ to new responsible entities and will remain so until their operations and custody agreements are updated to satisfy the CO 13/1409 requirements.  

However, we understand some of the local Australian custodians are rapidly reviewing their structures, revising custody agreements and implementing the policies and procedures necessary to meet the requirements of CO 13/1409, to enable them to be appointed by new responsible entities and therefore gain a ‘first mover’ advantage over their custodian competitors.

Consequently, during this update process, new responsible entities may experience delays in establishing their funds management business if they cannot source a custodian who will enable them to comply with CO 13/1409 (as ASIC will not grant an AFSL until the responsible entity demonstrates they have appointed a custodian who meet these requirements, unless the responsible entity is a ‘self-custodian’) or may experience limited choice in potential custodians.

How can we assist?
Our experienced team of funds management specialists can assist you with understanding how the requirements of CO 13/1409 will affect your business and reviewing or preparing policies and procedures in light of the new minimum standards for holding scheme assets.

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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