Current regulatory review of Australia's investment landscape

Co-authored by Annie Xiao, Solicitor

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Current regulatory review of Australia's investment landscape

Current regulatory review of Australia's investment landscape

Co-authored by Annie Xiao, Solicitor

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February 28, 2024

The long-standing ‘wholesale’ investor test is under review

The ‘wholesale’ investor test in Australia is currently up for review. In response to many and varying public views, the Assistant Treasurer and Minister for Financial Services, Minister Stephen Jones has made it clear on 6 February 2024 that “no decisions have [yet] been made”.¹ While this test has remained unchanged since its inception in 2001, it has been subject to review several times over the past two decades.

It is important to note that the current review of the distinction between ‘wholesale’ and ‘retail’ clients under Australian law is part of a broader review of the regulations applying to managed investment schemes (MIS) – the Review of the Regulatory Framework for Managed Investment Schemes (MIS Review).² And the question as to how a ‘wholesale' client should be determined appears to be the most publicly contested aspect.

Treasury has been provided with differing views on the ‘wholesale’ investor test, with 80 submissions received. Some of the most vocal have informed the Australian press with the Australian Financial Review (AFR) recently reporting that it understands the ‘regulators’ are proposing to raise the sophisticated and ‘wholesale’ investor net-asset threshold from AU$2.5 million to AU$4.5 million.³ This is based on ASIC’s public submission recommending increasing the individual wealth threshold to account for inflation since 2001. Lucy Dean of the AFR also reported in January 2024 that increasing the individual wealth test thresholds “will lead to fewer innovative companies because it will knock out many of the so-called angel investors who support start-ups, venture capitalists warn.⁴ This is consistent with the submission from Archangel Ventures (Archangel) who argue that Australia’s individual wealth tests are already too restrictive, especially compared to the US.⁵Archangel’s submission highlights that Australia’s individual wealth test threshold is 66% higher than the US (although the US test does exclude the family home) and that there is also no requirement for an accountant certificate to be provided when calculating the individual income threshold.

The Financial Services Council (FSC), Australia’s peak body representing the investment funds industry has expressed the view that a ‘fine-tuning’ of the ‘wholesale’ investor test is a necessary consumer protection requirement.

As noted by FSC CEO, Blake Briggs, “[w]hen the [‘wholesale’ investor test] thresholds were first introduced in 2001, only 1.5 percent of households were captured under the current AU$2.5 million asset threshold. Today, it’s increased to 11.7 percent.⁶ FSC’s analysis provides that if the current thresholds are left unchanged, current trends would dictate that by 2033 more than one in five mum and dad investors could cease to have consumer protections afforded to ‘retail’ investors if they were to be treated as a sophisticated ‘wholesale’ investor. As such, FSC has proposed to raise the individual wealth asset test to AU$5 million (including the family home).⁷

The Financial Advice Association Australia (FAAA) has also raised significant concern over the fact that the current thresholds have not kept up with the economic environment as they have not been indexed since their commencement. The result of this is a much broader group of consumers meeting the threshold to be classified as a ‘wholesale’ client as the test includes residential property and income (which have risen considerably over time).⁸ To account for this, FAAA has proposed that the net asset value test and income test should be increased and that the family home should be excluded when determining an individual’s net assets (see Table 1 below). The FAAA further comments on the need to balance the protection of vulnerable consumers and the needs of genuine ‘wholesale’ clients, as well as better consumer protections such as dispute resolution schemes for those consumers who fall between the boundaries of the ‘retail’ and ‘wholesale’ client definitions (including a recommendation for AFCA to have a role in complaints where a client considers they have been inappropriately classified as a wholesale client).

In relation to the product value test, the FAAA suggests that it should remain at the current level of AU$500,000 and be indexed every 5 years based on AWOTE.⁹ The FAAA explains that AU$500,000 is a considerable amount of money to invest in one product, and an increase of the threshold amount would impact the ability of genuine ‘wholesale’ clients to appropriately diversify their investment portfolio, which therefore increases risk for the client.

Notably, the Law Council of Australia has submitted that there should be a standalone consultation process for the ‘wholesale’ investor test given its broader application and its wider impact on financial product issuers and the duties and disclosure obligations.¹⁰

Given the public debate, it is difficult to predict the final position. If thresholds are increased (see Table 1 below) as indicated by various parties, this will have significant implications for wholesale investment managers. The availability of their investment products will be restricted for investors who currently classify as ‘wholesale’ investors and who would, subject to the increased thresholds, be classified as ‘retail’ investors resulting in many investors not being able to access interests in wholesale fund products, for example, in property, venture capital and private equity.

Table 1: Comparative thresholds for the current and proposed ‘wholesale’ investor test


Test Type	Current threshold under Corporations Act	FSC's proposal	FAAA's proposal
Individual wealth test: net asset test	AU$2.5 million (including the family home)	Increase to AU$5 million (including the family home) OR maintain at AU$2.5 million (exempt the family home)	Reflect value of Transfer Balance Cap (TBC): - AU$1.9 million for individual - AU$3.8 million for couple AND exclude net asset value of family home AND index to AWOTE with increases every five years to the nearest AU$5,000 e.g. If AWOTE increases by 10% from 2025 to 2030 then net asset test threshold to increase by 10% (i.e. AU$1.9 million to AU$2.09 million for individuals).
Individual wealth test: gross income test	AU$250,000 per year in the last two years	Remain at AU$250,000	Increase to AU$350,000 AND index to AWOTE with increases every five years to the nearest AU$5,000
Product value test	Investments / financial products value in excess of AU$500,000	Remain at AU$500,000	Remain at AU$500,000 AND index every 5 years based on AWOTE

A number of submissions have argued for the grandfathering of existing ‘wholesale’ client investments to preserve the status quo, however there are limited details at this stage as to what transitional relief (if any) may be available for investors and investment managers.

25 year-old regulatory framework for managed investment schemes under review

The review of Australia’s ‘wholesale’ investor test is one element of the MIS Review announced by Treasury on 4 August 2023.

This current MIS Review is focused on the efficacy of the regulations applicable to registered managed investment schemes under Chapter 5C and Chapter 7 of the Corporations Act, and whether the consumer protections which apply to ‘retail’ clients in a registered MIS are adequate and appropriate. The ‘wholesale’ investor test debate is included as a part of this review, as it is determinative of which investors have the benefit of these consumer protections.

The regulatory framework for MISs has undergone a number of reviews and inquiries since its inception in Australia in 2001. This includes two reports by CAMAC, six Parliamentary reviews and inquiries, and two Senate inquiries, with the latter two reports following a number of significant scheme failures including the Sterling Income Trust (SIT), Trio Capital and Timbercorp. While ASIC has implemented stricter disclosure guidance for MISs since collapses during the Global Financial Crisis and successive Federal Governments have implemented some legislative changes from the above reviews to develop the regulatory framework (including the Design and Distribution Obligations (DDO) regime implemented in 2021), the MIS Review is the first full review of the regulatory framework in recent years.

It is well known that the catalyst for the current review was the collapse of the SIT and Sterling Group, a failed retail managed investment scheme which had a devastating impact on their primarily elderly investors. The losses were predominately caused by product and organisational complexity, mis-priced products and a fall in the residential property market. In announcing the MIS Review in March 2023, the Minister said Treasury intends to ensure strong investor protections across the financial sector, extending the review beyond schemes involved in real estate (such as the SIT and Sterling Group) and involving the broader MIS regulatory framework.¹¹

The Australian MIS industry is quite significant. In June 2022, there were 420 responsible entities operating a total of 3,656 registered schemes with ASIC, which had a total value of assets held by these registered schemes of about AU$1.8 trillion.¹² This compares to the aggregate market capitalisation of domestic companies listed on the ASX of AU$3.1 trillion and the assets of Australia’s Big 4 Banks of approximately AU$4.4 trillion.¹³

Importantly, Australia’s managed funds industry has grown from AU$2.5 trillion in 2014 to AU$4.6 trillion in 2023.¹⁴ This has been driven by exponential growth in the superannuation sector, which has seen funds under management of Australia’s superannuation funds increase from AU$1.8 trillion in 2014 to AU$3.6 trillion in 2023, and is expected to grow to over AU$9 trillion by 2040.¹⁶

MISs in Australia vary in structure (with the predominant form being unit trusts), features and asset class including cash management trusts, property schemes, equities schemes, credit schemes, exchange traded funds, agricultural schemes, and time-sharing schemes. The law allows flexibility for the fundamental features of each MIS to facilitate diversification of investments.

The MIS Review contains 24 groups of questions interrogating the following key regulatory aspects of the operation and governance of MISs in Australia, including:

‘Wholesale’ client thresholds – whether the current thresholds that determine whether an investor is a ‘retail’ or ‘wholesale’ client remain appropriate (see section 1 above);
Suitability of scheme investments – whether certain MISs should be marketed and sold to ‘retail’ investors;
Scheme governance and the role of the responsible entity – whether the governance, compliance and risk management frameworks for MISs are appropriate;
Right to replace the responsible entity – whether ‘investor rights’ for people who invest in MISs are appropriate;
Right to withdraw from a scheme – liquidity requirements for MISs;
Winding up insolvent schemes – whether an insolvency regime is required for MISs; and
Commonwealth and state regulation of real property investments – the interaction between Commonwealth and State laws when regulating real estate investments by MISs including issues relating to the failed SIT and Sterling Group.

In the FSC’s submission for the MIS Review, it submitted in relation to item 2 above, that there is no need for further conditions or restrictions on certain investment products when marketed and sold to ‘retail’ investors as the DDO regime already establishes a consumer-first approach to product design and distribution, and that ASIC is equipped with a range of regulatory tools such as the Product Intervention Powers to intervene on non-compliant products.¹⁷FSC also considers that currently there are no indications that the DDO is failing. We are aware this view has been expressed more broadly across the MIS industry, as organisations wish to be given the opportunity to fully embed the DDO requirements into their operational and governance frameworks before being subject to further regulation.

The consultation period for the MIS Review opened on 4 August 2023 and closed on 29 September 2023, and the 80 submissions from key industry players are indicative of the interest in the regime and its efficacy. We expect Treasury’s response may come in March 2024 with unsurprisingly, most focus to be on the ‘wholesale’ investor test. We await Treasury’s response with anticipation, and we will keep you updated on the latest regulatory updates as they come through.