Further FMA consultation – managed investment schemes

Further FMA consultation – managed investment schemes

Introduction

Amongst the usual last-minute deluge of last minute discussion papers, omnibus bills containing small but important legislative changes (more on this later) and consultation documents that landed at the tail-end of last year were three quite significant consultation papers from the FMA.

Each has a short deadline for submissions, with the FMA’s timeline for expected response being “March” – and expected outcomes that will be required (typically in the form of licensing, governance and disclosure matters under the FMC Act) by the end of November 2016. When you consider that the timeline for licensing by the FMA is expected to be 3 months (assuming few hiccups) – the signals are that this will be a testing last stretch to full implementation of the FMC Act for some.

The three consultation papers related to:

• Forestry scheme issues and exemption proposals: In which the FMA seeks submissions on possible exemptions to address some issues faced by forestry schemes under the FMC Act.

• Property schemes – proposed exemptions: Most existing property syndicates or schemes will be a ‘managed investment scheme’ under the FMC Act and the FMA is seeking submissions on possible exemptions to address some of the issues faced by existing property syndicates or schemes in meeting certain of their compliance obligations.

• Designation of certain investment companies: The FMA is consulting on proposed class designation for shares in certain types of investment companies as managed investment products – which will result in the company being a ‘managed investment scheme’ for the purposes of the FMC Act. As a result, the investment company would be subject to the licensing, disclosure and governance requirements for a managed investment scheme under the FMC Act.

The deadline for submissions on all three consultation papers is 19 February 2016.

Observations

Having spent quite a lot of time already this year on the permutations arising out of the proposals for forestry and property schemes consultation papers (and the difficulties posed by the narrow windows proposed in relation to closed end funds and those in wind-down mode – as well as the practical difficulties posed by some of the custodial arrangements mooted) I would also counsel interested parties to consider the likelihood that there will be few work-rounds.

Specifically, the proposed designation under the FMC Act whereby certain types of shares are to be being treated as managed investment products in a managed investment scheme (MIS) – rather than as equity securities in a company reduces the scope for some syndicates seeking to restructure as a company.

An MIS is required to have a licensed manager and an independent (licensed) supervisor. Scheme assets must be held by the independently – and there are statutory duties for both the manager and supervisor of the MIS.

Most MIS will be a form of ‘managed fund’ (which will typically be on continuous issue and involve very liquid/saleable assets) – but others will be closed and have assets that are not readily saleable, such as forestry, kiwifruit and dairy syndicates and some forms of property fund. Each have different disclosure and governance requirements under the FMC Act.

The FMA has been concerned to ensure that some investment vehicles that are structured as a company (which should not, by definition, be an MIS) should in fact be treated as an MIS – for better investor protection reasons. Typically:

• Investing in a MIS does not provide an investor with any direct control over the MIS (and as a result, the licensing and governance requirements of the FMC Act are designed to provide investors with protection)
• Investing in shares in a company usually provides an investor with an ownership stake and voting rights (e.g. the right to appoint/remove directors) and scope to hold the directors and management to account.

As a result, the FMA points to a substance over form issue (looking at the economic substance of the structure – to determine whether something structured as an offer of shares in a company should be treated, in substance, as an MIS – to give investors the same protections).

This will result in a class designation test that designates a vehicle structured as a company (i.e. an offer of shares) to be managed investment products (in an MIS) where the offeror is an ‘investment company’ and any one of the following applies:

• the shares offered do not confer key voting rights
• there is an entrenched manager or other costly service provider
• the company has the word ‘fund’ in its name.

(Companies that have shares quoted on a licensed market (i.e. a stock exchange) or which will be quoted on a licensed market are proposed to be excluded from the proposed designation).

The FMA proposes that, for a company to be caught by the class designation, its main purpose must be that of investment. The FMA refers to three broad categories of investment companies being used for collective investment purposes:

• a collective investment in financial products (e.g. shares)
• a collective investment in multiple assets (e.g. a portfolio of commercial properties or businesses)
• a collective investment in a single asset (e.g. a commercial property).

The FMA’s view of an “entrenched” manager or service provider – are those where there is a service arrangement with a value of 5% or more of the company’s total revenue; and either:

• the arrangement extends for a period longer than 3 years and cannot be terminated at the election of the company without reasonable notice; or
• the termination of the arrangement would result in the company being obliged to pay compensation in excess of what it would have been required to pay over the life of the arrangement.

As a result – whilst the FMA has not reached a firm view on the entrenchment issue and states that there may be circumstances where an entrenched manager or significant service provider provides value for investors that is proportionate to the value received by the manager or service provider under the arrangement (and the FMA is seeking views on when it might be appropriate for shares in such an investment company not to be designated) – it seems clear that the writing is on the wall for forestry, and other similar, funds where there is such an entrenched manager. In those cases, it seems highly likely that (even if structured as a company rather than, say, a limited partnership) the company will be subject to a designation and subject to the licensing, disclosure and governance requirements of an MIS.

Further information

If you would like more information about any of the matters discussed in this note, please contact me.