Australia urged to make key ARFP changes

The Financial Services Council has sent recommendations to the Treasury advising ways to make the ARFP scheme viable, including on tax, commissions and allocation to Ucits funds.
Australia urged to make key ARFP changes

Australia’s Financial Services Council has urged its government to deliver key legislative and regulatory changes to make the pending ARFP passport scheme viable – including on taxation, commissions and allocation to Ucits funds.

The council – which acts for retail and wholesale fund houses, super funds, life insurers, advisory networks and trustee firms in Australia – sent its submission to the nation’s Treasury in support of the Asia Region Funds Passport (ARFP).

The purpose of the submission, which you can read in full here, was to highlight policy impediments in Australia to implementation of the regional scheme and to make recommendations on how it could be made commercially viable to maximise economic benefit.

The governments of Australia, Korea, New Zealand and Singapore agreed to establish a pilot for ARFP at the Apec finance ministers meeting in September 2013. Subsequently the Philippines and Thailand joined the consultation.

All participating countries will be required to make a similar submission to their governments with recommendations for effective implementation of ARFP.

In its document, which you can read here, the SFC argues the ARFP model needs to provide a viable structure for regional and global managers to participate.

If the scheme was too restrictive or not competitive with vehicles such as Ucits, it would flop, said the FSC. “Given the penetration of Ucits in Asia, if investment managers regard Ucits as a superior vehicle, ARFP will not be used,” it stated.

The council rejects a proposed rule compelling scheme operators to undertake certain delegated activities solely in the passport economies, saying it was inconsistent with commercial realities of international management.

“The rule would seemingly preclude a scheme operator from delegating a proportion of a product’s portfolio management to a non-member economy,” the FSC wrote. “This design feature presents a serious risk to the passport’s viability.”

It noted that scheme operators managing global equity or bond funds, for instance, would not be able to use ARFP as the management component for Europe or the Americas would be banned.

“As Ucits does not impose such restrictions, this design feature could hobble the passport’s prospects for scale and wide adoption,” it said, which would be especially problematic considering the popularity of global equity funds.

The council also pointed out that current ARFP rules allow master feeder structure but only where both the master and the feeder are passport funds. Australian trust structures investing 100% in Sicavs, for instance, would not therefore be allowed.

As a consequence, one of the FSC’s key recommendations is that the master feeder rule be extended to allow a limited allocation to Ucits funds.

On the question of fund registration, the council stressed that the ARFP model should try to avoid the same mistakes as Ucits, which have resulted in Ucits IV.

It argued for a streamlined process for registration in a fund’s host economy with limited restriction on ability to review an application.

Given compliance risks with distribution rules, among other, the SFC urges that a legal signoff in the host economy is provided with each application to confirm compliance. The host should then be able to register a fund within 21 days, barring public interest objections.

In another key sticking point, the council stated that taxation and regulatory structure reforms would also be required over the next 18 months, ahead of the scheme going live in January 2016.

It noted that the Australian government needed to establish an ARFP structure in the Corporations Act 2001 so that it is demarcated from other legal vehicles. This would enable a tax rate solely applicable to ARFP products.

“An ARFP structure would show our region that Australia is serious about addressing the widely held perception that Australia does not provide a level playing field for foreign investors and regularly changes the rules without warning,” the SFC said.

It also recommends a wider range of collective investment vehicles be made available in Australia, notably for non-resident investors who may not be familiar with unit trusts. Instead, it says any legal entity be eligible to elect into the new passport regime.

“By allowing such flexibility, Australian managers would be able to develop products that suited particular overseas jurisdictions,” noted the FSC. “This flexibility will be essential for Australian managers to fully capitalise on the opportunities that will arise through the ARFP.”

It recommends that Australia introduce an Investment Manager Regime (IMR) for non-resident investors to facilitate use of Australian investment managers.

It said non-resident investors should not be subject to Australian tax on non-Australian-sourced income and should be exempt from tax on profits on marketable securities whether they use an Australian manager or not. Also, investors should face the same tax outcomes for indirect investment through a collective investment vehicle as for direct investment.

The council stressed that the government strive for equality of taxation outcomes for foreign investors. It also supports a reduction of the managed investment trust withholding tax rate.

While this rate was cut to 7.5% in 2009, it was subsequently increased to 15% in 2012. The FSC pointed out that the rate was inconsistent with the withholding tax rate of 10% and therefore would encourage investment to be structured as debt rather than equity.

Moreover, it noted that while operators were prohibited from paying commissions in Australia, this was not applied consistently across Apec countries. This, it said, would put Australian funds at a disadvantage when distributing into Apec.

It recommended that passport fund operators be free both to choose whether to pay commissions for distribution of CIS funds, and to negotiate the rate of commission for the CIS fund and distribution channel concerned.

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