Transition to the FMC Act – shrinking pool of those in need of a licensed auditor?

A quick note, somewhat on the hoof.

One of the issues that I am wrestling with is the implications of various entities being a FMC reporting entity. Many people simply don’t seem to be able to work through either the tests or understand the implications – in terms of a major uptick in their compliance burden.

You are probably aware of the recent exemption for smaller DIMS licensees (given the size and nature of their businesses). This gives certain providers of discretionary investment management services (“DIMS”), who are licensed to provide DIMS under Part 6 of the FMC Act, a concessionary treatment according to whether a DIMS licensee falls into one of two levels. The levels are based on the amount of retail funds under management (“FUM”) under the DIMS provided by the DIMS licensee. Retail FUM is calculated at the start of the provider’s financial year. The exemptions are in two-tiers:

• Exemptions for Level 1 licensees (licensees with less than $100m retail FUM): Level 1 licensees are exempted from certain financial reporting requirements under the FMC Act relating to accounting records, the preparation of financial statements that comply with generally accepted accounting practice (GAAP), and the audit and lodgement of those statements. These DIMS licensees are still required to keep certain accounting records and to meet any company or tax financial reporting obligations that would apply to the DIMS licensee if it were not an FMC reporting entity.
• Exemptions for Level 2 licensees – (licensees with between $100m and $250m retail FUM): Level 2 licensees are exempted from the requirement under the FMC Act to have financial statements audited by a licensed auditor. The DIMS licensees are still required to comply with any company or other audit requirements that would apply to the DIMS licensee if it were not an FMC reporting entity.

However, it seems likely that a number of other vehicles that will be a non-restricted and registered managed investment scheme (“MIS”) – are thinking that they have a good chase for similar treatment.

This is particularly the case for closed-end funds – no new investment and typically invested in one asset or asset class. Under the FMC Act, a non-restricted and registered managed investment scheme (“MIS”) must have a licensed manager – by the close of transitional period for the FMC Act (1 December 2016). In general terms, a MIS pools money from a number of investors, who rely on the investment expertise of the scheme manager. The definition in the FMC Act is broad and includes collective investment schemes, and most schemes involving participatory securities under the Securities Act 1978 (which includes various syndicate structures).

There are a number of implications of licensing for MIS (which is not the purposes of this note) and governance is a big issue, at least in the minds of the good folk at the FMA who have generated a 48-page license application guide! Much of the licensing process (and particularly the discussions about Governance) is a bureaucrat’s dream and, I think, divorced from the reality of running a small closed-end syndicate. As a high-level sample, the FMA will seek to be satisfied that you have:

“… a high-level body responsible for overseeing compliance with your market services licensee obligations – and ensuring appropriate risk management.”

Equally in abstract, this is stated as requiring certain ‘minimum standards’, which are described by the FMA as requiring:

1. You have a clear reporting and governance framework covering all key aspects of your business (or proposed business) including compliance obligations and key risks of the business.
2. You have an ‘oversight body’ responsible for overseeing compliance – it should not be solely the responsibility of risk, compliance or internal audit functions.
3. You have appropriate arrangements to ensure your oversight body and other senior managers and directors get timely, and sufficient, high quality governance and management information to allow for proper oversight and decision making.
4. Your oversight body considers the adequacy and robustness of its governance and compliance arrangements at least annually.
5. Your constitution does not have any provision which allows your directors to act contrary to the best interests of the licensed business when they are exercising their powers or performing their duties. This also applies to directors of related bodies under your licence.
6. Related bodies– your oversight body is able to direct and oversee the provision of market services by any related body authorised under your licence (authorised body)

As a result, I think as we get closer to the end of next year, many of these entities (either on an industry basis or on a case-by-case basis) will be lobbying the FMA to show why they should be treated in a similar fashion to a small MIS – and have reduced financial reporting obligations and, particularly, not need a licensed auditor.