Asia Region Funds Passport - what's in store for 2014?

In brief

At the recent APEC conference in Bali, the finance ministers of Australia, New Zealand, Singapore and South Korea signed a formal Statement of Intent on the establishment of the Asia Region Funds Passport, which will allow fund managers based in participating countries to market and sell certain managed funds to retail investors in other passport jurisdictions within a streamlined regulatory framework. Partner Penny Nikoloudis and Lawyers Matthew Symmons and Lisa Wu report on the key aspects of the Passport, the timetable for its establishment, which Australian funds may qualify, and the potential changes to Australian legislation.

Background

The agreement to proceed with the ARF Passport follows on from the Australian Financial Centre Forum, which was established in September 2008 to report on the policy settings needed to develop Australia as a leading regional financial centre. The Forum's report (known as the Johnson Report) recommended that Australia explore the concept of developing an ARF Passport. In order to determine whether there was sufficient interest, the Federal Government introduced the development of the concept as an exploratory policy initiative within the APEC Finance Ministers' Process.

While the signing of the Statement of Intent on 20 September 2013 did not, of itself, establish the ARF Passport, the finance ministers of the Initial Members published a framework document that sets out the initial guiding principles and basic arrangements for it. The next step for the Initial Members is to jointly issue a consultation document, which they will each then use to consult publicly within their own economies during the first half of 2014 on the rules needed to implement the scheme ahead of its scheduled commencement in January 2016.

In consulting publicly, the Initial Members have agreed to explore adjusting some of their domestic policy settings that, if left unchanged, could have a negative impact on the initial operation and appeal of the ARF Passport. In particular, the tax regimes in each jurisdiction are complex, and represent a significant challenge to the establishment and efficient operation of the ARF Passport – eg Australian policymakers will need to consider whether, and to what extent, the existing withholding tax rates will apply to residents of other ARF Passport economies that invest into Australian-domiciled Passport funds.

It is the signatories' objective that the ARF Passport will, over time, become a more inclusive regional scheme. The Statement of Intent confirms that the signatories will work with other APEC economies to take account of their views in the development of the detailed rules and to facilitate their readiness to participate in the future. It is anticipated that the two economies most ready to sign on, given their developed regulatory frameworks, are Japan and Taiwan.

In addition, we note that the ARF Passport is one of three current initiatives of note aimed at improving the cross-border distribution of managed funds in Asia – the others being the mutual recognition process involving Hong Kong and China, and the ASEAN collective investment scheme framework. As such, the ultimate success of the ARF Passport may depend on whether its development is aligned to these other initiatives so as to develop a more meaningful and larger region of co-operation.

The European experience

The ARF Passport is modelled on the Undertaking for Collective Investments Transferable Securities (UCITS), which was implemented more than 25 years ago with the objective of establishing a single market for funds management services across the European Union.

The UCITS funds experienced a relatively slow uptake at first, due to, among other factors, certain EU member nations imposing additional regulatory requirements to protect local asset managers. Nevertheless, UCITS funds have since gained worldwide recognition, and have been at the heart of the development of the European funds industry for the past two decades, with more than 35,000 UCITS-compliant funds holding assets in excess of €6 trillion.

Some commentators have observed that the absence of an Asian collective investment scheme has been one of the key drivers for the success of UCITS. Indeed, several European operators have established UCITS funds specifically for seeking money from Asian investors. It has been reported that Asia has represented up to 40 per cent of total net sales into UCITS funds in recent times.¹ To this end, while Asia is home to approximately 60 per cent of the world's population, its funds under management represents only 13 per cent of the global funds under management, in contrast to Europe, which accounts for less than approximately 13 per cent of the world's population and more than 30 per cent of global funds under management.²

So, while the UCITS framework can serve as a model for the ARF Passport, it is likely to be a key competitor going forward.

Timeline

The Statement of Intent provides for the following milestones for implementation:

Which Australian funds will qualify as eligible funds?

Unlike the Australian approach, where ASIC concentrates on ensuring adequate disclosure is made in relation to funds that are to be offered to retail investors, many Asian jurisdictions require that their funds meet particular investment criteria or limitations (such as investment concentration limits or gearing prohibitions) before they can be authorised for public offer. This latter approach is reflected in the framework document, which indicates that for a fund to be offered under the ARF Passport regime, it will need to satisfy a number of criteria, including the following. It:

• is a registered managed investment scheme under Chapter 5C of the Corporations Act 2001 (Cth);
• only makes limited use of derivatives;
• may only borrow or obtain finance in limited circumstances and limited amounts;
• does not engage in short-selling; and
• provides reasonable redemption rights for investors.

We note that some of these criteria resemble those applied when determining whether an Australian fund is a 'hedge fund' for the purposes of ASIC Class Order [CO 12/749] (as recently modified by ASIC Class Order [CO 13/1128]) and it would therefore appear that Australian hedge funds will not be eligible to participate in the ARF Passport regime.

Similarly, the reference to 'reasonable redemption rights' resembles the tests used to determine whether an Australian fund is a 'simple managed investment scheme' that may issue shorter eight-page PDSs for the purposes of Part 7.9 Div 4.2C of the Corporations Regulations 2001 (Cth). As such, while no detail has been provided at this stage, it is possible that in order to be eligible to participate in the ARF Passport regime, an Australian fund will need to be a simple managed investment scheme; thereby excluding funds with substantially illiquid assets, such as unlisted property funds. To this end, we note that ASIC has recently confirmed that the operation of the mFund Settlement Service (previously known as the ASX Managed Fund Service) will initially be limited to the issue and redemption of interests in simple managed investment schemes, despite industry submissions requesting that its scope be expanded to cover all unlisted registered managed investment schemes currently available to retail investors.

Consequential changes

Not only will new Australian legislation need to be enacted to establish the ARF Passport in Australia, consequential changes are anticipated to Australia's laws, regulatory framework for managed funds, and the taxation regime. In particular, it will interesting to see:

• how ASIC's role is expanded to authorise the distribution of non-Australian funds and the related disclosure documentation;
• whether lawmakers and ASIC will determine eligibility for the ARF Passport by reference to the existing 'hedge fund' and 'simple managed investment scheme' definitions or whether a new sub-category will be created;
• what measures will be implemented to streamline the offering on non-Australian funds – eg whether there will be standard application forms across ARF Passport economies;
• whether Australian retail investors will be able to access non-Australian funds through platform and IDPS services;
• what impact the ARF Passport will have on existing mutual recognition arrangements with Hong Kong, New Zealand, the UK, the US and Germany; and
• as mentioned above, what changes will be made to the taxation of non-resident investors to create a level playing field between Australian and non-Australian participants in the ARF Passport.

With the public consultation process scheduled to commence in early 2014, we expect there to be significant progress on the ARF Passport initiative over the coming months.

If you have any questions in relation to the impact of the ARF Passport, please feel free to contact us.