The Asia Region Funds Passport begins to take shape

In brief

It's been a busy few months for the development of the Asia Region Funds Passport. In late August, the Federal Government released exposure draft legislation to accommodate the introduction of the Passport in Australia. Once implemented, the Passport will allow fund managers from participating economies to market and sell interests in qualifying funds to retail investors in other passport jurisdictions within a streamlined regulatory framework. Partner Penny Nikoloudis, Senior Associate Rebecca Sheehy and Associate Mai Go report on the proposed multilateral regulatory framework for the Passport and some of the issues arising from the exposure draft legislation.

Once the Passport regime is implemented, qualifying Australian collective investment schemes (Australian Passport Funds) may market their funds to investors in other participating economies in the Asian region with limited additional regulatory requirements.
Similarly, qualifying collective investment schemes in other participating economies (Foreign Passport Funds) may market their funds to Australian investors using the more streamlined regulatory process, which should increase competition and choice for Australian investors.
All funds participating in the Passport regime (Passport Funds) must comply with a combination of home and host economy regulations, as well as the overriding Passport Rules that are set out in the Memorandum of Cooperation on the Establishment and Implementation of the Asia Region Funds Passport (the MOC).
Current Passport economies are Australia, Japan, South Korea, New Zealand and Thailand.

The proposed regulatory framework

The development of an Asia Region Funds Passport was one of the recommendations of the Johnson Report in 2009. The rationale was that improving market access for Australian fund managers overseas and, in turn, for offshore fund managers in Australia, should allow for a number of benefits for both fund operators and investors in Australia and the Asian region.

On 30 June 2016, the MOC signed by Australia, Japan, South Korea, New Zealand and Thailand came into effect. Broadly speaking, the MOC provides for a regulatory framework that looks like this:

'Passport Rules'	All Passport Funds must satisfy a set of common rules, which are contained in Annexure 3 of the MOC and known as the 'Passport Rules' (see below for an overview of these rules).
'Home Economy'	The 'Home Economy' is the country where the Passport Fund is first registered or approved. The Home Economy is responsible for registering a local fund as a Passport Fund. The Passport Fund must comply with the laws and regulations of its Home Economy that apply to it by virtue of its establishment in that jurisdiction (eg related party transactions, duties of operators, etc). In practice, a Passport Fund may need to comply with both the Passport Rules and the Home Economy Rules on certain matters (eg custody arrangements, risk management, valuation, etc).
'Host Economy'	The 'Host Economy' is the country in which the Passport Fund is marketed. Before offering interests in a Host Economy, the Passport Fund must apply to the Host Economy for entry into that country in accordance with the entry process that the Host Economy has implemented. In addition, the Host Economy may choose to apply laws and regulations to Passport Funds offered in its economy on the following 'investor-facing' matters: disclosure and annual and periodic reporting to members in the Host Economy, including member requests for information; distribution and provision of financial services in the Host Economy in relation to interests in the Passport Fund (eg licensing requirements, advertising, payment of commissions, etc); member complaints; restrictions on the labelling of a Passport Fund as an exchange-traded fund, index fund, capital guaranteed fund, money market fund or feeder fund; anti-money laundering and counter-terrorism; appointing a local representative or agent in the Host Economy or requiring the Passport Fund or its operator to register as a foreign company; and the exercise of any information gathering, surveillance, enforcement or administrative power relating to compliance with any of the matters above. Again, these requirements may overlap with the Passport Rules, in which case both sets of rules need to be satisfied by the Passport Fund. In July this year, the Passport Joint Committee issued guidance on the five Host Economies' laws and regulations relating to the above matters in order to assist fund managers in making an initial assessment of the requirements that will apply in each jurisdiction under the Passport.

'Passport Rules'

All Passport Funds must satisfy a set of common rules, which are contained in Annexure 3 of the MOC and known as the 'Passport Rules' (see below for an overview of these rules).

'Home Economy'

The 'Home Economy' is the country where the Passport Fund is first registered or approved. The Home Economy is responsible for registering a local fund as a Passport Fund. The Passport Fund must comply with the laws and regulations of its Home Economy that apply to it by virtue of its establishment in that jurisdiction (eg related party transactions, duties of operators, etc).

In practice, a Passport Fund may need to comply with both the Passport Rules and the Home Economy Rules on certain matters (eg custody arrangements, risk management, valuation, etc).

'Host Economy'

The 'Host Economy' is the country in which the Passport Fund is marketed. Before offering interests in a Host Economy, the Passport Fund must apply to the Host Economy for entry into that country in accordance with the entry process that the Host Economy has implemented.

In addition, the Host Economy may choose to apply laws and regulations to Passport Funds offered in its economy on the following 'investor-facing' matters:

disclosure and annual and periodic reporting to members in the Host Economy, including member requests for information;
distribution and provision of financial services in the Host Economy in relation to interests in the Passport Fund (eg licensing requirements, advertising, payment of commissions, etc);
member complaints;
restrictions on the labelling of a Passport Fund as an exchange-traded fund, index fund, capital guaranteed fund, money market fund or feeder fund;
anti-money laundering and counter-terrorism;
appointing a local representative or agent in the Host Economy or requiring the Passport Fund or its operator to register as a foreign company; and
the exercise of any information gathering, surveillance, enforcement or administrative power relating to compliance with any of the matters above.

Again, these requirements may overlap with the Passport Rules, in which case both sets of rules need to be satisfied by the Passport Fund.

In July this year, the Passport Joint Committee issued guidance on the five Host Economies' laws and regulations relating to the above matters in order to assist fund managers in making an initial assessment of the requirements that will apply in each jurisdiction under the Passport.

This three-tiered, overlapping matrix of legal and regulatory requirements is one aspect of the Passport that we expect will present implementation challenges. However, as we noted in our Unravelled article of 5 April 2016, unlike the European Union, the Asia region does not have a superimposing regulatory body like ESMA, which is able to issue directives that participating economies are obliged to adopt in their legislation.

Eligibility requirements for passport funds – the 'Passport Rules'

To qualify as a Passport Fund, a fund must satisfy the following 'Passport Rules':

Requirement	Annexure 3 of MOC
Fund operator	Qualifying fund operators from Australia, Japan, South Korea, New Zealand and Thailand. Manages (itself or with its related parties) funds of at least US$500 million FUM. Officers and employees have requisite experience and qualifications (as specified in the Passport Rules). Meets the required 'organisational arrangements' test. Meets the required 'track record' test (five years' relevant experience). Meets the specified 'good standing' test. Capital requirement of minimum US$1 million + 0.1 per cent FUM (capped at US$20 million). Meets specified requirements regarding delegation of functions. Principal place of business is in a Home Economy.
Fund/sub-fund	Any entity that is a regulated collective investment scheme (CIS) or a sub-fund of a regulated CIS in its Home Economy (in Australia, this is currently a registered managed investment scheme, and it is proposed that it will include a corporate collective investment vehicle (CCIV) when the legislation relating to CCIVs is introduced, which is likely to be after the Passport regime has been implemented – on CCIVs, see our article on 25 August 2017). Mandatory custodian (in Australia, this can be the responsible entity) and requirements relating to the holding of assets. Independent oversight (in Australia, this may be by the external directors of the responsible entity or the compliance committee of the scheme). Interests in a Passport Fund must be offered in Home Economy.
Investment restrictions	Liquid assets only: currency, deposits, depository receipts over gold, transferable securities and money market instruments. Can only hold assets issued in an IOSCO jurisdiction. Restrictions on making deposits. Restrictions on using derivatives. Restriction on securities lending arrangements. No short-selling. Mandatory diversification – restrictions on portfolio acquisition. Cannot lend money or act as guarantor. Restrictions on borrowing.
Other requirements	Restrictions on performance fees. Members' redemption rights. Financial reporting and auditing requirements. Annual review of the operation of the Passport Fund. Breach reporting requirements to home and host regulators.

The Passport Rules must be incorporated into domestic legislation (in substantially the same form as Annexure 3 of the MOC) in order to take effect. While the exposure draft legislation establishes a mechanism for incorporating the Passport Rules into Australian law by way of legislative instrument, that instrument has not yet been released.

Key features of the exposure draft legislation

On 25 August 2017, the Australian Government released exposure draft legislation, in the form of a proposed new Chapter 8A of the Corporations Act, to implement the following aspects of the Passport framework:

The process for registering an Australian fund (registered scheme) as a Passport Fund (see 'Home Economy' under 'Background' above).
The process for approving entry into Australia by Foreign Passport Funds (see 'Host Economy' under 'Background' above):
- Under the draft legislation, Foreign Passport Funds wishing to offer interests in Australia must:
  - be registered as a foreign company in Australia; and
  - lodge with ASIC a notice of intention to offer interests in Australia, together with a copy of a product disclosure statement (PDS) that complies with the PDS requirements of the Corporations Act.
- ASIC will use a streamlined mutual recognition process to consider the application and generally will have 21 days to make a decision as to whether the fund should be refused entry. ASIC may reject an application if, among other things, it is of the opinion that the fund will not comply with corporations legislation, the ASIC Act, laws of the Home Economy of the fund, or if it is of the opinion that it is not in the public interest to approve the fund as a Foreign Passport Fund.
Additional matters that Australia is authorised to regulate as a Host Economy (see 'Host Economy' under 'Background' above). The exposure draft legislation covers the following matters:
- members' rights to certain records;
- ASIC's compliance and enforcement powers; and
- ASIC's exemption and modification powers.
As noted above, a mechanism for incorporating the Passport Rules into Australian law.

The draft legislation envisages that the existing PDS, disclosure, advertising, licensing, FoFA and other requirements that currently apply to registered managed investment schemes will apply in the same way to Foreign Passport Funds that are marketed in Australia. It does so by including a 'note' under the current section 9 definition of 'managed investment scheme' that 'a notified foreign passport fund is taken to be a managed investment scheme for the purposes of this Act'.

Potential issues with the exposure draft legislation

There are a number of areas of concern in the exposure draft legislation which we think need to be considered further:

Timing of application process for Australian Passport Funds: In the current draft, ASIC is not required to process an application to register an Australian fund as a Passport Fund within any specified period of time. As many fund operators will require a level of certainty to organise offering timelines and marketing trips, the lack of a defined consideration period will cause uncertainty and administrative difficulties. In our view, a consideration period of 21 days should be applied for consistency with applications for Foreign Passport Funds.
Registration as foreign company: The requirement for a foreign Passport Fund to be registered as a foreign company in Australia is, in our view, unnecessary given the information ASIC will have as part of the application process by the foreign fund. To require a separate application to register as a foreign company is not only administratively burdensome, but the associated disclosure obligations could limit the attractiveness of Australia as a market.
Requirement to provide PDS: Because the short-PDS regime is not available to Foreign Passport Funds, significant time and expense may have to be incurred by Foreign Passport Funds to prepare a long-form PDS that complies with Australia's disclosure obligations. As there appears to be no harmonisation of the disclosure laws across participating economies, fund operators will need to prepare separate disclosure documents in each jurisdiction in which they wish to market. This may act as a significant deterrent to an offshore fund considering passporting to Australia. A potential method of addressing this issue is to allow Foreign Passport Funds to prepare the necessary documentation required to comply with the disclosure obligations in their Home Economy, and a supplement (or 'wrapper') for each relevant Host Economy that ensures the document as a whole addresses the disclosure requirements of the Host Economy.

These and other matters were raised in our submission to Treasury on the draft legislation.

What's is next?

Submissions on the exposure draft legislation closed on 25 September 2017.

Under the MOC (which is not legally binding), the five original Passport economies agreed to 'endeavour to implement' the Passport arrangements by way of domestic legislation within 18 months of signing the MOC (that is, by 31 December 2017). Activation of the Passport will occur after any two participating economies complete this implementation.

In its latest media release on 13 October, the Passport Joint Committee indicated that, while the participating economies have been undertaking considerable work and consultation to finalise the legal and regulatory requirements necessary to implement the Passport, it expected that the Passport would commence 'in the first half of 2018'. We think that timing is more realistic, given the significant volume of work that remains to be undertaken.

Most importantly, in order for the Passport to have any chance of success, the tax laws in each of the participating economies need to be harmonised to achieve tax neutrality between Passport Funds of the participating economies.

In Australia specifically, the industry (led by the Financial Services Council) has been pushing for a non-resident withholding tax rate of zero for Australian Passport Funds to ensure that they are able to compete effectively with Foreign Passport Funds. Previous proposals for targeted reductions in Australian withholding tax rates have met mixed success and any agreement by the Australian Government to such a proposal is likely to depend on an assessment that the broader benefits to Australia of the Passport regime outweigh the perceived cost to the revenue as modelled by the Federal Treasury.

With the spotlight now firmly on tax, we can expect to hear much more on the Passport over the coming months.

The Asia Region Funds Passport begins to take shape

In brief

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