Publications

Publications

Publications / Financial Services

17 Nov 11
New financial requirements for responsible entities

Download PDF

Originally slated for a March 2011 release, ASIC has finally published its long awaited policy on the new financial requirements which will apply to responsible entities. McCullough Robertson partner, Tim Wiedman, summarises the new requirements and comments on the method of implementation chosen by ASIC. Links to practical examples showing  how the new obligations will apply to responsible entities are provided. The article also discusses other changes introduced by the new financial requirements.

The new financial requirements will apply from 1 November 2012 for both existing responsible entities and new responsible entities who obtain an AFSL between now and the commencement date.  Prior to 1 November 2012, the existing financial requirements will apply to all responsible entities. 

The new financial requirements represent a significant additional financial burden for many responsible entities.  Responsible entities should understand exactly how the new financial requirements will apply and determine a plan of action to ensure the requirements are met by 1 November 2012.

Cash needs requirement

Responsible entities, as with all Australian financial services licensees, are currently required to comply with the cash needs requirement.  For most responsible entities, this obligation essentially involves the preparation of a rolling three month cash flow forecast and maintenance of either a cash buffer or adequate financial resources.

From 1 November 2012, responsible entities will be subject to the following modified cash needs requirement obligation:

  • the responsible entity will need to prepare a cash flow projection covering at least the next 12 months
  • the directors of the responsible entity must, at least quarterly, approve the cash flow projection as satisfying ASIC’s requirements
  • the responsible entity’s calculations and assumptions underlying the projection must be documented and the responsible entity must record the reasons why the assumptions relied upon are appropriate
  • the cash flow projection will need to be updated when:
    • ceases to cover the next 12 months
    • there is a material change, or
    • the responsible entity suspects that an updated projection would indicate that the responsible entity is not meeting the ‘adequate resource’ requirements discussed at the next bullet, and
  • the responsible entity must demonstrate, based on the cash flow projection, that over the 12 month forecast period it will have access to sufficient resources to both:
    • meet its liabilities, and
    • comply with the cash or cash equivalent component of the liquidity requirement applying to the responsible entity (discussed below under the ‘Liquidity requirements’ heading).

The audit opinion required to be given by an auditor concerning the cash flow projection has also been modified in light the revised cash needs requirements. 

Net Tangible Assets (NTA) requirements

NTA requirement for responsible entities who ‘self-custody’ scheme assets

Responsible entities who ‘self-custody’ scheme assets (where those assets are not special custody assets or tier $500,000 class assets) will be required at all times to hold NTA at least the greater of:

  • $5 million, or
  • 10% of the average RE revenue of the responsible entity.

For a full explanation of the key concept of ‘average RE revenue’, click here.

The NTA requirement based on average RE revenue is uncapped.  Accordingly, responsible entities who ‘self-custody’ scheme assets will need to hold NTA of $5 million where the average RE revenue is $50 million or less. If the responsible entity’s average RE revenue exceeds $50 million the NTA requirement will be 10% of that amount with no upper limit.

NTA requirement for responsible entities where scheme assets are held either by a custodian or members, or are special custody assets or tier $500,000 class assets held by the responsible entity

Where the assets of all registered schemes operated by a responsible entity are:

  • held by members
  • held by a custodian that holds $5 million NTA or is an eligible custodian
  • are tier $500,000 class assets held by the responsible entity who has at least $500,000 NTA,  by an eligible custodian, or by a custodian or subcustodian where the custodian has at least $500,000 NTA, or
  • special custody assets held by the responsible entity, by an eligible custodian, or by a custodian who holds at least the same NTA as required by the responsible entity,

then the responsible entity must at all times hold NTA at least the greater of:

  • $150,000
  • 0.5% of the average value of scheme property of the registered schemes operated by the responsible entity, up to an amount of $5 million, or
  • 10% of average RE revenue of the responsible entity.

For a full explanation of the key concept of ‘average value of scheme property’, click here.

Therefore, the minimum NTA requirement has increased from $50,000 to $150,000 and, potentially, there is no maximum limit as the average RE revenue component is uncapped. 

In summary, if scheme assets are:

  • held by a custodian, by members or are special custody assets held by the responsible entity or custodian, the responsible entity’s NTA requirement will be:
    • $150,000 until either the average value of scheme property of all registered schemes exceeds $30 million or the average RE revenue exceeds $3 million
    • between $150,000 and $5 million, until average RE revenue exceeds $50 million
  • tier $500,000 class assets held by the licensee or custodian, the responsible entity’s minimum NTA requirement will be:
    • $500,000 until either the average value of scheme property of all registered schemes exceeds $100 million or average RE revenue exceeds $5 million, and
    • between $500,000 and $5 million, until average RE revenue exceeds $50 million.

For examples of the new NTA requirements compared to the existing NTA requirements for responsible entities with various arrangements for holding scheme property of their registered schemes, click here.

Liquidity requirements

ASIC’s new financial requirements include the introduction of liquidity requirements.  A responsible entity must hold the greater of:

  • $150,000, or
  • 50% of the lower NTA requirement,

in cash or cash equivalents.

In addition to these requirements, a responsible entity must hold liquid assets of an amount equal to the lower NTA requirement.

The lower NTA requirement is:

  • where the assets of the responsible entity’s registered schemes are held by a custodian or members, or are special custody assets or tier $500,000 class assets held by the responsible entity or custodian, the actual NTA required to be held by the responsible entity
  • where the assets of the responsible entity’s registered schemes comprise tier $500,000 class assets held by the responsible entity (who must have NTA of at least $500,000 to hold tier $500,000 class assets), the NTA requirement which would apply if the $500,000 NTA requirement for tier $500,000 class assets did not apply (i.e. the greater of $150,000, 0.5% of the average value of scheme property or 10% of average RE revenue), and
  • where the assets of the responsible entity’s registered schemes are held by the responsible entity (and are not special custody assets or tier $500,000 class assets), the NTA requirement which would apply if the responsible entity did not ‘self-custody’ (i.e. the greater of $150,000, 0.5% of the average value of scheme property or 10% of average RE revenue).

Cash or cash equivalents includes the following:

  • cash on hand, demand deposits and deposits with an Australian ADI that is available for immediate withdrawal
  • short-term, highly liquid investments readily convertible to known amounts of cash which are subject to an insignificant risk of changes in values (though no further guidance has been provided by ASIC, we expect interests in a cash management trust would meet this requirement)
  • the value of any eligible undertaking provided by an eligible provider (refer to ‘Other matters’ heading below), and
  • a commitment to provide cash from an eligible provider that can be drawn down within five business days and has a maturity of at least six months.

Liquid assets include:

  • cash and cash equivalents (other than the commitment to provide cash from an eligible provider discussed above)
  • assets the responsible entity can reasonably expect to realise for market value within six months.

Liquid assets must be free from encumbrances and, in the case of receivables, free from any right of set off.

The liquidity requirements are separate to the NTA requirement.  A responsible entity who meets the NTA requirement will not automatically satisfy their liquidity requirements and vice versa.  Practically, any cash or cash equivalent assets (other than the commitment to provide cash from an eligible provider discussed above) and liquid assets will count towards NTA. However, assets used for NTA purposes may not constitute cash or cash equivalent assets or liquid assets.

Currently, many responsible entities meet their NTA requirement by holding assets such as real estate, interests in non-liquid schemes and other ‘illiquid’ assets.  Moving forward, we expect responsible entities will satisfy their NTA requirements by holding cash and cash equivalent assets and liquid assets to ensure the assets supporting the NTA requirement also qualify for the liquidity requirements.

For a detailed summary of the liquidity requirements for responsible entities with different NTA requirements and scheme property holding arrangements, click here.

Other matters

Guarantee restrictions

ASIC’s proposed financial requirements, as set out in consultation paper 140, included restrictions on responsible entities providing guarantees and indemnities. A SIC did not proceed with this proposal.  However, the new financial requirements oblige responsible entities to exclude from NTA calculations the maximum liability which may arise under any guarantee provided by the responsible entity, except guarantees limited to scheme assets or which apply between members of a stapled group.

This is achieved by adding the value of such maximum potential liabilities to adjusted liabilities when calculating NTA (as NTA is equal to adjusted assets minus adjusted liabilities). Therefore, if a responsible entity had provided a personal guarantee of up to $5 million, $5 million would need to be added to adjusted liabilities in determining the NTA held by the responsible entity.  Essentially, for every $1 a responsible entity is potentially liable for under a guarantee the amount of assets it requires to meet its NTA requirement increases by $1.

For example, if a responsible entity’s NTA requirement was $5 million and the responsible entity had adjusted assets of $10 million and adjusted liabilities of $4 million, it would hold NTA of $6 million which is in excess of the minimum NTA required. If that responsible entity gave a personal guarantee to secure a debt of $3 million, its adjusted liabilities will increase to $7 million, its NTA will decrease to $3 million and it will cease to meet its NTA requirement.

Responsible entities will need to consider whether they have provided any guarantees, other than those limited to scheme assets or in favour of stapled group members, and obtain releases of any such guarantees prior to 1 November 2012. Otherwise, the potential liability secured by the guarantee will reduce the NTA deemed to be maintained by the responsible entity.

Eligible provider

In meeting its NTA and liquidity requirements, a responsible entity can provide an ‘eligible undertaking’ provided by an eligible provider.  Previously, eligible providers included entities whose shares are listed on a licensed Australian market or ASIC approved foreign exchange and had net assets of more than $50 million.  This enables a responsible entity with a listed parent who has significant net assets to rely on an eligible undertaking from the parent entity to meet its NTA requirements.

Under the new financial requirements, such entities will no longer be classified as an eligible provider.  Therefore, any responsible entity with an eligible undertaking from a listed parent will no longer be able to rely on this eligible undertaking to meet its NTA requirements (or to meet the new liquidity requirements) and will need to satisfy the NTA requirements in another way.

Implementation

One of the most interesting aspects of the new financial requirements is the method of implementation adopted by ASIC. The existing financial requirements for responsible entities are contained in the responsible entity’s AFSL conditions. Conversely, the new financial requirements are imposed by way of a class order which notionally inserts additional provisions in the Corporations Act. 

Traditionally, where ASIC wanted to change the AFSL conditions of licensees it has sent the varied conditions to each licensee requesting the licensee consent to the new conditions. An updated AFSL was issued upon receiving the licensee’s consent.

A responsible entity who complies with the requirements of the class order will be deemed to be complying with its AFSL conditions. Any responsible entities who obtain an AFSL post-1 November 2012 will not have the financial conditions imposed upon their AFSL, given the application of the class order.

We expect ASIC’s contention is that it is administratively efficient to utilise its regulatory power to impose the new financial requirements via class order rather than varying the AFSL of each responsible entity. That is, it is quicker and more cost-effective to impose the financial requirements by way of class order rather than sending revised AFSL conditions to each responsible entity and obtaining their consent to the amendments. 

However, the class order approach also provides ASIC with certainty that these requirements will apply to responsible entities without objection and removes the opportunity for responsible entities to challenge the imposition of revised financial requirements.

If ASIC introduced the new financial requirements through varying a responsible entity’s AFSL it would need to obtain their consent to the variation. The risk for ASIC is that any responsible entity who thought the variation was unreasonable and inappropriate could apply to the AAT to challenge the imposition of these new conditions.  The class order approach removes this risk for ASIC.

Prepare now to change

With just under 12 months before the new requirements come into effect, the time to prepare for the changes is now.  For many responsible entities there will be a significant financial and administrative burden involved in meeting these requirements.  It is a good idea to seek legal advice to ensure you understand the new requirements and how they affect your business and to help you implement an effective strategy in plenty of time.

In particular, responsible entities should:

  • calculate the new NTA requirement which will apply
  • determine whether this NTA requirement is currently satisfied and, if not, consider what needs to be done to ensure sufficient NTA is held
  • calculate the cash and cash equivalent and liquid assets the responsible entity will need to hold
  • determine whether sufficient cash and cash equivalents and liquid assets are currently held and, if not, consider what needs to be done to ensure the liquidity requirements are met, and
  • identify whether the responsible entity has given any guarantee which will have the effect of reducing the NTA it holds and arrange for the release of the guarantee (or a reduction in the amount secured).

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.

Download PDF

In this section

Contact

For enquiries please contact: