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ISSUE 08FEBRUARY 2014

Asia Region Funds Passport - update

New customer due diligence requirements

When is scheme land not scheme property?

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HEDGE FUNDS – DISCLOSURE OR EXPOSURE

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From the editorWelcome to the first edition of Fundamental for 2014.

A range of activity looks set to make this year an exciting and challenging one for the funds management industry, including:

• an encouraging up-tick in the establishment of new funds and deals being done by our clients

• ramped up regulatory activity by the Australian Securities and Investments Commission (ASIC)

• a number of recent court decisions imposing higher duties on fund managers and the directors of fund managers.

Also, the change of Government has brought with it a number of new inquiries relating to the funds management industry, most notably the ‘Son of Wallis’ Financial System Inquiry. McMahon Clarke is working with a number of industry bodies in preparing submissions to those inquiries and advocating for the funds management industry.

In this edition we feature:

• the Asian Region Funds Passport which will allow Australian fund managers to distribute interests in their managed funds, across multiple regional borders

• ASIC’s increased obligations for REs of hedge funds and ‘funds of hedge funds’

• issues to consider when holding a meeting of the members of a managed investment scheme

• new customer due diligence requirements.

From the editor

Asia Region Funds Passport – update

Meetings of managed investment scheme members

New customer due diligence requirements

Hedge funds – disclosure or exposure

Enhancing privacy

When is scheme land not scheme property?

Are you an ordinary resident?

Snapshot

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Contents

Brendan Ivers

Partner, Funds Management

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We welcome two new members to our funds management team, Kristy McCluskey and Elliott Stumm, as well as Wayne Penning (partner) in the firm’s expanding capital markets practice focusing on equity and debt raisings, private equity and capital management strategies. Wayne is joined by associate Andrew Williams and lawyer Laura Steele who will work closely with our corporate advisory, real estate and funds management teams.

Also, we’re very proud to announce that the Chambers Asia-Pacific 2014 Guide has again ranked McMahon Clarke as a ‘leading firm’ in investment funds Australia-wide, and two of our senior lawyers have been singled out as leaders in that field. This is an excellent result, particularly for a firm of our size, and reflects the quality and complexity of our work.

We hope you enjoy Fundamental, our guide to the issues affecting the funds management sector. As always, we welcome your feedback and suggestions.

Best regards

Asia Region Funds Passport – UpdateAustralian fund managers are set to take advantage of the ever increasing wealth among the middle class in Asia, with the move by the Australian Government to formalise and implement the Asian Region Funds Passport (Passport). Andrew Shearer-Smith says the Passport will allow Australian fund managers to distribute interests in their managed funds, across multiple regional borders.

On 20 September 2013, the finance ministers attending the Asia-Pacific Economic Cooperation summit signed a cross-border agreement for the distribution of managed funds in the Asia-Pacific region. The participating countries are Australia, New Zealand, South Korea and Singapore.

A key advantage for Australian fund managers is that the Passport will enable the sale of managed funds to participating countries and the management of Asian money in Australia, under Australian regulations.

The finer details about how the Passport will be regulated and implemented are set for public consultation early this year. It is anticipated not all types of managed funds will be able to access the benefits of the Passport and there will be some restrictions, such as—

• eligible asset classes• liquidity requirements• registration (or licensing) arrangements• limitations around the use of leverage.

It appears only simple managed investment schemes (eg bond funds, cash funds and equities funds) will be able to access the Passport arrangements.

It is envisaged a pilot program will be implemented around January 2016.

We will keep a close eye on this important development for the funds management sector and keep you up-to-date with developments.

Andrew Shearer-Smith

Consultant, Funds Management

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Meetings of managed investment scheme membersMany issues can arise when holding a meeting of the members of a managed investment scheme. Here senior associate Brit Ibanez highlights some of the issues to consider when preparing for a meeting.

THE ACT OR THE CONSTITUTION?The primary sources of rules about the conduct of meetings are the Corporations Act (Act) and the scheme’s constitution. Both sources should be checked as the constitution may modify the Act.

WHO CALLED THE MEETING?There are three ways to call a meeting of members:

• the responsible entity (RE) can call a meeting • the members can ask the RE to call a meeting,

or • the members can call a meeting themselves.

If the RE is asked to call the meeting, then the RE must pay for the cost of the meeting and, importantly, can appoint the chair for the meeting. The position of chair can be crucial in contested meeting scenarios.

ORDINARY, SPECIAL OR EXTRAORDINARY RESOLUTION?The Act provides that members can call meetings to vote on special or extraordinary resolutions only (unless the scheme is listed). It does not contemplate the members of a managed investment scheme calling a meeting to vote on ordinary resolutions. However, the Act is silent about the nature of the resolution if the RE calls the meeting.

WHAT SHOULD THE AUDITOR RECEIVE?In a contested meeting scenario, there can be a huge volume of material. The RE must give the auditor of the scheme and the auditor of the scheme compliance plan all the communications relating to the meeting that the members of the scheme receive.

Brit Ibanez

Senior Associate, Litigation & Risk Management

PROXIESWill a third party be appointed to manage the proxy vote? Companies such as Boardroom, Link and Computershare can be engaged to manage scheme meetings. Alternatively, the RE must manage the proxy process. That process needs to be transparent and capable of validation. For example, a consistent rule should be applied to accepting or denying proxies.

VOTING AT THE MEETINGA special or extraordinary resolution must be decided on a poll. However, any other resolution put to the vote at a meeting of scheme members must be decided on a show of hands unless a poll is demanded.

DEMANDING A POLLDoes the constitution restrict the demand of a poll on a resolution for the election of the chair or the adjournment of a meeting? These are the only two resolutions where the Act specifically provides that a constitution may provide that no poll may be demanded. A poll may be demanded by:

• at least five members present entitled to vote on the resolution

• the members present with at least five percent of the votes that may be cast on the resolution, or

• the chair.

Meetings of managed investment schemes can run smoothly, but can also create difficult questions of law and procedure. We are experienced in advising on all types of meetings and can assist with any questions.

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New customer due diligence requirementsFollowing the release of a discussion paper and consideration of submissions, the Australian Transaction Reports and Analysis Centre (AUSTRAC) has prepared draft Anti-Money Laundering and Counter-Terrorism Financing (AML/CTF) rules relating to customer due diligence (CDD). In this article graduate Elliott Stumm analyses the draft rules and the potential impact for fund managers.

BENEFICIAL OWNER The draft rules redefine beneficial owner to mean any individual who owns or controls (directly or indirectly) the customer. Control is broadly defined and captures, for example, arrangements and understandings whether or not they have legal or equitable force. This is far broader than the current definition, which provides that a beneficial owner is an individual who owns more than 25 percent of the issued capital in the company.

A reporting entity’s AML/CTF program must be amended to require a reporting entity to consider the customer’s money laundering and terrorism-financing (ML/TF) risk, including risks related to—

• beneficial owners of the customer• whether the customer, or any beneficial owner

of the customer, is a politically exposed person• the source of funds and source of wealth of

the customer and each beneficial owner of the customer

• whether, on taking reasonable measures, the reporting entity will be able to adequately understand the business or occupation of the customer, and

• the control structures of the customer.

The draft rules require AML/CTF programs to be designed to enable the reporting entity to understand the nature of the business or occupation of each customer and the control structures of non-individual customers.

Further, the AML/CTF program must enable the reporting entity to identify significant changes in ML/TF risk arising from changes in the nature of the business, occupation, control structure, or beneficial ownership of any customer, in addition to those risks previously required to be identified. Additionally, appropriate systems and controls must be included to determine in what

circumstances any beneficial owner information should be collected, updated or verified for ongoing CDD purposes, and must undertake reasonable measures to keep, update and review the documents, data or information.

ENHANCED CUSTOMER DUE DILIGENCE PROGRAM The draft rules bring about changes to the enhanced CDD program requirements. The draft rules modify the current range of measures the reporting entity must undertake when the enhanced CDD program is triggered to include reference to a customer’s beneficial owners.

Further, the enhanced CDD program is triggered when a designated service is provided to a customer who is, or has a beneficial owner that is, a foreign politically exposed person. When this is the case, a more detailed analysis of the customer’s know-your-client information (KYC) and beneficial ownership information must be undertaken to identify the source of the customer’s and each beneficial owner’s wealth and funds, and senior management approval must be sought with respect to continuing the business relationship with a customer, or whether a transaction or service should be processed or provided.

SETTLORSUnder the draft rules, AML/CTF programs are required to include a procedure for collecting the full name of the settlor of a trust as part of the minimum KYC information of a customer acting as trustee. This is required except where the material asset contribution to the trust by the settlor is less than $10,000, or where the settlor is deceased. This change is premised on the idea that the identity of the settlor may indicate the true beneficial owner.

Please contact us if you have any questions about the draft rules and what this will mean for your business, in particular any potential changes that may be required to your AML/CTF program.

Elliott Stumm

Graduate, Funds Management

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Brendan Ivers

Partner Funds Management

The Australian Securities and Investments Commission’s (ASIC’s) Regulatory Guide RG240 (RG240) introduces greater disclosure obligations for responsible entities (REs) of hedge funds and ‘funds of hedge funds’ which means an increased risk of non-compliance. In this article partner Brendan Ivers explains that from 1 February 2014 it is important to ensure the benchmarks and principles contained in RG240 are met for both new and established funds.

HEDGE FUNDS – DISCLOSURE OR EXPOSURE

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Strict adherence to disclosure obligations is of critical importance to the introduction and continuation of investments.

Application of RG240

RG240 is directed at REs of hedge funds issuing a product disclosure statement (PDS). However, RG240 is encouraged to be a benchmark for offers to wholesale investors, as well as issuers of investment opportunities undertaking strategies normally associated with hedge funds.

RG240 defines a hedge fund as a registered managed investment scheme that—

• is promoted by the RE as being a ‘hedge fund’, or

• exhibits two or more hedge fund characteristics, such as a complex investment strategy or structure, the use of leverage, and the use of short selling.

Even if a hedge fund meets the definition of a ‘simple managed investment scheme’, disclosure against the benchmarks and application of the principles in RG240 is expected.

Timing for implementing improved disclosure

From 1 February this year, all new and existing REs need to disclose against the benchmarks and apply the disclosure principles contained in RG240.

For PDSs issued for existing funds, the relevant disclosure information should be contained on a website referred to in the PDS. Alternatively, the existing PDS may be supplemented so it reflects the new standards.

Further, any material changes to the benchmark or disclosure principle information should be explained on an ongoing basis. The ongoing disclosure obligations of REs of hedge funds include—

• continuous disclosure • periodic statements, and• notification of any material change to a matter

that would be required to be specified in a PDS.

Benchmarks and disclosure principles for hedge funds

RG240 outlines benchmarks and disclosure principles which should be highlighted in PDS material relating to hedge funds. ASIC considers each benchmark and disclosure principle to address a key risk area that potential investors ought to understand before making an investment decision.

For example, benchmarks are set in relation to the disclosure of valuation of assets and the periodic reporting of certain key information. The disclosure principles relate to matters such as the hedge fund’s investment strategy, investment manager, structure, liquidity, and leverage.

Significance of RG240 for your business

Strict adherence to disclosure obligations is of critical importance to the introduction and continuation of investments. Failing to disclose according to the standards exposes the fund to unnecessary regulatory and legal risk.

Given the greater disclosure obligations placed on REs of hedge funds, it is important all REs of hedge funds consider and seek advice, as it is likely these obligations will impact all hedge funds, not just those requiring a PDS.

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Allana Agnew

Associate, Litigation & Risk Management

Enhancing privacySubstantial changes to Australian privacy laws, which are due to commence in March 2014, will impact on any organisation which collects or holds personal information about an individual. This includes responsible entities and trustees issuing offer documents and collecting personal information from applicants.

Associate Allana Agnew sums up how the Federal Government’s new Privacy Amendment (Enhancing Privacy Protection) Act (Act) changes the privacy laws and what steps organisations will need to take to comply.

SIGNIFICANT CHANGESHere’s a summary of the most significant changes:

1. The current National Privacy Principles and Information Privacy Principles are consolidated into a single set of Australian Privacy Principles (APPs), and apply equally to the private and public sectors.

2. Organisations must take reasonable steps to implement appropriate practices, procedures and systems to comply with the APPs and have adequate enquiry and complaint-handling systems in place. An organisation must have a policy for the management of personal information which includes how the entity collects and holds personal information and, if the personal information is likely to be disclosed to a foreign entity, the countries where the foreign entities are located.

3. Where possible, before collecting personal information about an individual, the individual must be notified of a number of matters, such as—

• the identity and contact details of the organisation

• if the personal information will be collected from someone other than the individual, then the fact this information will be obtained from a third party and the circumstances as to how that information will be (or has been) collected, and

• the reason the personal information is being collected and the consequences to the individual if the information is not collected.

4. An Australian organisation which discloses personal information to a foreign recipient must take reasonable steps to ensure the foreign recipient does not breach the APPs. The Australian organisation will be liable for any breach by the foreign recipient and its only recourse is to sue under contract.

5. Credit providers and fund managers will have greater information available to allow for a proper assessment of credit worthiness and risk as credit reporting agencies are permitted to record additional data about an individual. This includes account opening and closing dates; types of credit accounts opened; current limits on each active credit account; and repayment history information.

6. The Information Commission has greater enforcement powers and functions, such as the power to accept enforceable undertakings; an ability to pursue civil penalties of up to $1.1 million for serious or repeated breaches; and the power to undertake privacy performance assessments.

NEXT STEPS FOR FUND MANAGERSHere are some important next steps for fund managers and any entity which collects personal information from individuals:

• Review current privacy policies, notices and consents dealing with collecting and using personal information. If a privacy policy is not in place, then a policy should be prepared together with a standard notice to individuals setting out the information prescribed in the APPs.

• Appoint a Privacy Officer to review the privacy policy and procedures and ensure compliance with the Act. The Privacy Officer should report to the board regularly and identify any deficiencies in compliance and remedial action taken to rectify the deficiency. These records will be a useful resource if any assessment of the organisation’s compliance with the Act is undertaken by the Information Commissioner.

• Review offer documents and accompanying application forms to ensure investors are made aware of the organisation’s privacy policy about the collection, use, and holding of personal information.

McMahon Clarke can assist with the review of privacy policies and procedures to ensure compliance with the amendments to the Act.

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When is scheme land not scheme property? A primary role of a responsible entity (RE) of a managed investment scheme is to keep scheme property separate from the RE’s property and the property of other schemes. However, this division can become blurred where property, apparently owned by the RE in its own right, is used by it for the benefit of the scheme.

The Supreme Court of Victoria recently considered this issue when the landowning RE is removed (Willmott Forests Ltd v Primary Securities Ltd). Here litigation and risk management partner Kristy Dorney discusses the implications.

Kristy Dorney

Partner, Litigation & Risk Management

constitution. It also became entitled to exercise the rights Willmott had previously exercised as RE to discharge those obligations. This included the right to access the land at any time.

• Under the terms of the lease agreements between Willmott and investors, Willmott was obliged to give consent to assignments of leases and not to unreasonably withhold that consent. This would enable Primary to continue to operate the scheme, including the transfer of interests of investors where required.

The court was satisfied Willmott was bound to continue to allow the land to be used for the scheme for the balance of the life of the scheme and that Primary was entitled to exercise certain rights in relation to the land which had previously been exercised by Willmott in its capacity as RE.

CONCLUSIONThe Willmott case is an important reminder to REs to consider the appropriate structure for their scheme, including whether the RE will hold title to scheme land in its capacity as RE or in its personal capacity. The implications for the RE, if removed as RE for the scheme, can be far reaching as this case demonstrates.

FACTS Willmott Forests Ltd was the RE for a registered forestry scheme. The scheme’s constitution provided Willmott would be engaged by investors to plant, manage and harvest trees and lease the land to the investors. To that end, Willmott and the investors entered into a lease agreement for part of the land which was registered in Willmott’s name.

Willmott also had use of land adjoining the leased land which was also registered in Willmott’s name but not leased to the investors or to the scheme.

Willmott was removed as RE by resolution of the investors and replaced by Primary Securities Ltd (Primary). Liquidators subsequently appointed to Willmott argued the land was owned by Willmott in its own right and was not scheme property.

RIGHTS, LIABILITIES AND OBLIGATIONSThe court accepted the liquidator’s arguments that the land was the property of the RE and not scheme property, and then considered the implications for the scheme and Primary as the new RE. The court noted Willmott had been acting, with respect to the land, in a dual role as owner and RE. It found the rights, liabilities and obligations Willmott exercised in its capacity as RE passed to Primary by operation of the stautiry novation provisions of the Corporations Act (Act). It noted as follows:

• When Willmott undertook work on the land pursuant to the project agreements, it was doing so in its capacity as RE.

• Under the Act, when Primary replaced Willmott as RE, it took over the obligations of Willmott under the various agreements and the

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Are you an ordinary resident? Failure to comply with the requirement in the Corporations Act for at least one director of a proprietary company, and at least two directors of a public company, to ordinarily reside in Australia may result in a penalty notice or prosecution by the Australian Securities and Investments Commission (ASIC). Lawyer Kristy McCluskey warns directors to take care when portraying themselves as being ordinarily resident in Australia.

ORDINARY RESIDENCEThe term ‘ordinarily reside’ is not defined in the Act and ASIC has not provided any guidance on what criteria must be fulfilled for a director to satisfy this requirement.

While the concept of ‘ordinary residence’ has been considered in numerous cases, it has not been considered in many cases relating to the Corporations Act requirement. Where this requirement has been considered, the director’s failure to reside in Australia was relatively obvious (eg having an American address for service) and the court has not been required to delve any deeper into the issue of residency requirements.

Ordinary residence has mostly been considered by the court for the purpose of revenue laws and bankruptcy. Accordingly, it is useful to consider these lwas when attempting to establish what a director may need to demonstrate when attempting to establish Australian residency.

FOREIGN ACQUISITIONS AND TAKEOVERS ACTThe application of the Foreign Acquisitions and Takeovers Act (FATA) to the question of residency is particularly useful, given its relevance to foreign investment, commercial transactions and national policy, all of which play a role in the successful directorship of Australian companies.

FATA provisions deal, in part, with natural persons who are not Australian citizens, yet are ordinarily resident in Australia at a particular time. The person is considered to be ordinarily resident if—

• they have actually been in Australia during 200 or more days in the prior 12 months, and

• at the time in question, either—• the person is in Australia, and their

continued presence in Australia is not subject to any time limitation imposed by law, or

• the person is not in Australia but, immediately before their most recent departure from Australia, their continued presence in Australia was not subject to any legal limitation.

Kristy McCluskey

Lawyer, Funds Management

BANKRUPTCY ACTThe Bankruptcy Act (Bankruptcy Act) allows for a debtor to have their possessions forcibly taken in order to pay their debts or satisfy other claims, such as where a director is held personally liable for the debts of their company. However, the person must be personally present or ordinarily resident in Australia. The Bankruptcy Act does not define the term ‘ordinarily resident but, unlike the Corporations Act, it has been reviewed extensively by the court. These cases have led to the adoption of the following criteria when establishing residency:

• The degree of permanence of the person’s residence in Australia (rather than a place where the individual stays only casually).

• Where the ordinary course of the person’s life regularly occurs.

• Whether the person has a dwelling in Australia.• If the person has left Australia, how long they

intend to spend outside Australia.• Whether there are employment arrangements

creating a link between the person and Australia.

DUAL RESIDENCYIt is also useful to note that an individual can be ordinarily resident in more than one country at the same time. Some people regularly or customarily live in more than one place, each of which has an element of permanence about it and is not merely a place of casual or intermittent resort. This may be especially applicable to a director whose company maintains business and international networks across several countries.

CONCLUSIONIn summary, whether a director is ordinarily resident is a matter of fact and degree. However, a director should give careful consideration to the above factors when portraying themselves as being ordinarily resident in Australia.

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McMahon Clarke again ranked as leaders in investment funds The Chambers Asia-Pacific 2014 Guide has again ranked McMahon Clarke as a ‘leading firm’ in investment funds Australia-wide, and singled out partner Brendan Ivers and consultant Andrew Shearer-Smith as leaders in that field.

McMahon Clarke managing partner Sean McMahon says this independent and objective recognition is an excellent result, particularly for a firm of our size, and reflects the quality and complexity of our work.

Covering the entire Asia-Pacific region and more than 30 specialist practice areas, Chambers Asia-Pacific ranks the leading law firms and lawyers across the region. For the current Asia-Pacific directory, researchers carried out thousands of interviews with lawyers and clients. The qualities on which the independent and objective rankings are based include legal ability, professional conduct, client service, commercial awareness, diligence, and commitment to the client.

IPD Australia – Asset market seminarMcMahon Clarke and IPD Australia are hosting an asset market update seminar on 28 February 2014 at the Brisbane Hilton Hotel. Please contact us for further details.

1262 Charlotte St Brisbane Q 4000 GPO Box 1279 Brisbane Q 4001 T 07 3831 8999 F 07 3831 1121 www.mcmahonclarke.com

Focus on capital markets We are delighted to announce that Wayne Penning has joined McMahon Clarke as a partner to head the firm’s Capital Markets team focusing on equity and debt raisings, private equity, and capital management strategies. We also welcome associate Andrew Williams and lawyer Laura Steele to our Capital Markets team.

Wayne, together with partner Langton Clarke (head of Corporate Advisory) will spearhead the firm’s corporate and commercial practice and will work closely with the firm’s Real Estate and Funds Management teams.

Wayne and his team are well recognised throughout the corporate community and offer strategic and detailed knowledge of the heightened regulatory, compliance and structural challenges in today’s marketplace. This will be an important asset to our clients moving forward.

The addition of Wayne and his team complements our well recognised corporate and commercial platform

and further strengthens our experience in working with our clients in mergers and acquisitions, capital raising and regulatory issues generally.

Snapshot (cont’d)

Wayne Penning

Partner

Andrew Williams

Associate

Kristy McCluskey

Lawyer

Laura Steele

Lawyer

Elliott Stumm

Graduate

Funds management team expandsOur Funds Management team continues to expand with the addition of lawyer Kristy McCluskey, who offers strong corporate advisory and private equity experience, and graduate Elliott Stumm. These new appointments confirm our ongoing strategy to develop exceptional people with deep industry knowledge.