Publications / Financial Services

2 Feb 12
New financial requirements for responsible entities - trips and traps

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Following on from our article in November last year explaining the new financial requirements for responsible entities which commence in November 2012, McCullough Robertson partner Tim Wiedman discusses some trips and traps responsible entities should consider in assessing the impact of the new financial requirements on their business and preparing to satisfy these new requirements.

In discussing and advising on the impact of the new responsible entity financial requirements with clients, three issues of concern or confusion have commonly arisen:

  • the impact of deeds of cross guarantee
  • the application of the average RE revenue concept, and
  • the use of bank guarantees to satisfy net tangible asset (NTA) and liquidity requirements.

Each of these issues is discussed in further detail below.

Deed of cross guarantee

What is a deed of cross guarantee

Where various entities in a corporate group (reporting entity) are each subject to the requirement to prepare and lodge a financial report, directors’ report and auditor’s report (Financial Report) (for example, they are a public company or large proprietary company), ASIC has granted class order relief to exempt those reporting entities from the requirement to prepare and lodge a Financial Report. 

In order to rely on the relief, the corporate group’s parent company must prepare and lodge a Financial Report covering the reporting entities and each company must meet various conditions. One of the conditions is each reporting entity relying on the relief and the parent company must enter into a deed of cross guarantee (Cross Guarantee) pursuant to which the parent company and each reporting entity guarantee each other’s liabilities.

Consequences for responsible entities

As explained in our previous article, from 1 November 2012, in calculating NTA responsible entities will be required to add 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) to their adjusted liabilities. Effectively, as NTA is equal to adjusted assets minus adjusted liabilities, for every $1 a responsible entity is potentially liable for under a guarantee, the assets it will require to meet its NTA requirement increase by $1. 

Where a responsible entity is the parent company and its subsidiaries include reporting entities, the responsible entity and those subsidiaries may have entered into a Cross Guarantee so the subsidiaries can rely on the ASIC relief and be exempt from the requirement to prepare and lodge their own Financial Report. 

In such circumstance, the liabilities of each subsidiary, who is a party to the Cross Guarantee, will need to be added to the responsible entity’s adjusted liabilities for the purposes of calculating its NTA under the new financial requirements. Consequently, this will likely have a significant adverse impact on the responsible entity’s NTA calculation and its ability to meet its NTA maintenance requirements.

Potential options for responsible entities

There are two options available for responsible entities to ensure the debts of their subsidiaries, who are a party to a Cross Guarantee with the responsible entity, are not required to be included as a liability for NTA calculation purposes:

  • the responsible entity be released from the Cross Guarantee, or
  • a new responsible entity is established to operate the registered scheme.

Each of these options is discussed below. 

Option 1 - revocation of Cross Guarantee

The responsible entity may revoke the Cross Guarantee by entering into a revocation deed with the other parties to the Cross Guarantee. Revocation of the Cross Guarantee will result in the responsible entity being released from all liabilities under the Cross Guarantee, specifically the obligation to guarantee its subsidiaries’ debts. 

However, the consequence of revocation is that any subsidiary of the responsible entity caught by the financial reporting requirements (such as a public company or large proprietary company) will no longer be able to rely on the relief and will need to prepare and lodge Financial Reports. 

Therefore, in addition to the responsible entity preparing and lodging a Financial Report covering the consolidated group as required by the Corporations Act, each of its subsidiaries, who are also subject to financial reporting requirements, will need to prepare and lodge a Financial Report.  This will increase the corporate group’s audit, accounting and ASIC lodgement fees but will also mean the responsible entity is not required to include its subsidiaries’ debts as a liability for NTA calculation purposes.

In addition to the requirement to enter into a deed of revocation, the revocation of the Cross Guarantee must occur in accordance with the procedures set out in the Cross Guarantee (and contained in ASIC Pro Forma 24). These requirements include, among other conditions, advertising the proposed revocation in a daily Australian newspaper and giving notice to each creditor. 

A responsible entity will need to ensure the revocation process is complete prior to 1 November 2012 but may also wish for the Cross Guarantee relief to apply for the financial year ending 30 June 2012, so that any subsidiary covered by the Cross Guarantee does not also have to prepare and lodge its own Financial Report for this financial year. This is possible, provided the responsible entity’s Financial Report for the current financial year is prepared, audited and lodged promptly after completion of the financial year. 

Option 2 - restructure

Where a responsible entity is a parent company of its corporate group (Current RE) and wishes to continue to rely on the relief provided in accordance with the Cross Guarantee, the responsible entity could consider establishing a new public company (New RE) which obtains its own AFSL and is appointed as responsible entity of the Current RE’s registered schemes. The New RE could be a wholly owned subsidiary of the Current RE as it would not be covered by the Cross Guarantee and therefore would not need to include the liabilities of other entities in the corporate group in its NTA calculation. 

It may also be possible to obtain relief from ASIC enabling the New RE to be appointed responsible entity of the registered schemes by notification to those members without convening a members’ meeting (though such relief will be subject to members having the right to request a meeting be held). Upon the New RE being appointed as responsible entity, the Current RE would cancel its AFSL (or vary its AFSL to remove the responsible entity authorisation) and cease to be subject to an NTA requirement.

As this alternative involves obtaining a new AFSL, obtaining ASIC relief, the resignation of the Current RE and appointment of the New RE, and the cancellation of an existing AFSL, responsible entities considering this approach should commence the process as soon as possible to ensure it is completed prior to the 1 November 2012 commencement date for the new responsible entity financial requirements.

Average RE revenue

As summarised in our previous article, the new NTA requirement for responsible entities requires a determination of ‘average RE revenue’. This is because the 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 or a custodian, is 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 a maximum of $5 million, or
  • 10% of average RE revenue of the responsible entity.  

Similarly, 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.

A common misconception in calculating average RE revenue is that it is limited to revenues generated from responsible entity activities, such as fees recovered from the registered schemes operated by the responsible entity. 

In calculating average RE revenue all revenue earned by the responsible entity, including revenue generated from non-responsible entity activities, must be included. For example, if a responsible entity earns revenue by way of dividends from wholly owned entities, fees for managing wholesale unregistered schemes, fees for providing property management services (to either related entities or third parties) and income from any other source (e.g. interest revenue), these amounts must be taken into account in calculating average RE revenue as well as responsible entity fees.

In addition, average RE revenue also includes payments out of scheme property to entities other than the responsible entity for activities which relate to fulfilling the responsible entity’s obligations under the Corporations Act. Therefore, average RE revenue includes amounts which are not revenues or income of the responsible entity but are amounts paid to other entities out of scheme property, regardless of whether those entities are related parties of the responsible entity or independent third parties. 

These payments include:

  • fees paid to a custodian
  • fees paid to asset managers, investment managers, property managers or similar service providers, and
  • fees paid to an entity for providing administration services for the scheme, such as unit pricing, registry or accounting services,

but exclude any audit fees paid to an auditor engaged to audit the scheme’s financial reports or its compliance plan. 

However, the obligation to include payments made from scheme property to entities other than the responsible entity applies only in connection with registered schemes operated by the responsible entity. Therefore, if the responsible entity operates wholesale unregistered schemes, any payments made from the scheme to another entity for providing management, administration or other services are not included in calculating average RE revenue.

Bank guarantee

Some responsible entities are currently satisfying their NTA requirement by way of an eligible undertaking provided by an entity (called an eligible provider), usually the responsible entity’s parent company, listed on ASX, NSX, BSX or an ASIC approved foreign exchange which has net assets of more than $50 million. 

An eligible undertaking is a financial commitment from the eligible provider to pay the amount of the commitment on written demand by the licensee and which is:

  • an enforceable and unqualified obligation, and
  • remains operative unless ASIC consents in writing to its cancellation.

Alternatively, a commitment which does not meet these requirements can be classified as an eligible undertaking where approved in writing by ASIC.

Under the new NTA requirements, a responsible entity will not be able to rely on an eligible undertaking provided by a listed entity with net assets of at least $50 million to meet its NTA requirement, as a listed entity with $50 million net assets no longer qualifies as an eligible provider. 

Consequently, some responsible entities in this position are looking to replace their current eligible undertaking, provided by their listed parent, with an eligible undertaking which satisfies the new requirements, such as a bank guarantee arranged by the parent company and provided in favour of the responsible entity (this is because an Australian bank is an eligible provider for NTA purposes).

However, responsible entities seeking to rely on a bank guarantee need to carefully consider the terms of the guarantee to ensure it meets the definition of an eligible undertaking. Specifically, bank guarantees generally terminate automatically upon the total amount under the guarantee being called. A bank guarantee provided on these terms will not meet the definition of an eligible undertaking as its termination or cessation is not subject to ASIC consenting in writing. 

Accordingly, a responsible entity will need to ensure the terms of a bank guarantee recognise that its termination or cessation is subject to ASIC’s consent. Alternatively, the responsible entity will need to apply to ASIC to have the bank guarantee approved as an eligible undertaking. 

In the event the responsible entity requires ASIC’s approval for a bank guarantee to be accepted as an eligible undertaking, the responsible entity should liaise with ASIC as soon as possible to ensure it can meet its NTA obligations by 1 November 2012.

Prepare now for change

The issues discussed above highlight the importance for responsible entities to immediately consider how the new financial requirements will impact them, assess whether they will be in a position to meet these requirements by 1 November 2012 and, if required, design and implement a plan to ensure compliance by 1 November 2012.


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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