The uncertainty of when an SMSF meets ASIC’s ‘wholesale’ or ‘sophisticated investor’ test was covered in a previous Cuffelinks article: ‘When does an SMSF qualify as a ‘wholesale’ investor?’. My experience is that the lack of clarity is also hampering much-needed philanthropic efforts, even as Australia strives to improve its performance in this socially-critical sector.
Private Ancillary Funds (PAFs) combine gift-giving with tax efficiency and are becoming increasingly popular in Australia. A more detailed descriptions of PAFs can be found here on the Cuffelinks’ website. Their benefits include:
- a mechanism for inter-generational giving (the whole family becomes involved in philanthropy from an early age) and creating a family legacy
- an amount removed from a donor’s other assets with the sole purpose of supporting philanthropic causes, within a tax-exempt structure
- a more sophisticated and controlled approach to philanthropy with tax advantages.
Since setting up our family PAF, over the last seven or eight years, my original expectations have been exceeded. Our children, while still young, have become involved in donation decisions, we have been able to provide multi-year support to philanthropic causes and we believe our decision-making around how and when we give has improved significantly.
Indeed our involvement in the PAF community was a key determinant in my decision to join The Benevolent Society where one of my roles was in developing the Social Benefit Bond issue in late 2013 with our partners, Commonwealth Bank and Westpac.
Social Benefit Bonds are one form of impact investing and a powerful way of harnessing money for worthwhile causes. At the moment our investment policy is for up to 20% of our PAF’s investments to be impact investments.
However, in my involvement both as a PAF founder and with the Social Benefit Bond, a real impediment to the level of impact investing has been the application of the ‘wholesale’ investor tests under the Australian regulatory regime.
Regulation of financial investment products requires that an offer of investment products to ‘retail’ investors must be made under a ‘retail disclosure document’. These have stringent content requirements, particularly for a new product, and also involves the directors (among others) assuming an increased level of potential statutory liability. A ‘retail’ offer will generally involve:
- significant increases in legal and auditor costs
- establishment of formal due diligence and board sub-committees
- a more precise and longer timetable
- the issuer having an Australian Financial Services License (AFSL) that permits relevant interactions with ‘retail’ investors (for which more onerous regulatory requirements apply) or the availability of an exemption
- the participation of a larger number of small investors with the resultant additional costs.
To date, the two NSW Social Benefit Bonds projects chose to undertake ‘excluded offers’, also known as ‘wholesale only’ offers, for which the above matters are not (or are lesser) considerations. I expect most future issues will do the same.
In general, to participate in a ‘wholesale’ offer, an investor will need to meet the defined requirements for being a ‘sophisticated investor’ or a ‘professional investor’ under the Corporations Act.
PAFs and the wholesale investor tests
Cuffelinks has previously highlighted issues for Social Benefit Bonds conducted as ‘wholesale only’ offerings, made under an information memorandum.
One of The Benevolent Society’s closest supporters wanted to invest via an SMSF and, despite this person being a senior manager in financial services, the book-runners found it difficult to accept due to the regulatory uncertainty that the SMSF would satisfy the ‘wholesale investor’ tests. This uncertainty is due to a statement by ASIC that, for the purposes of sections 761G(6)(b) and (7) of the Corporations Act, the phrase ‘relate to’ should be given a broad meaning. Any financial service provided to an SMSF may ‘relate to’ a superannuation product and would therefore be a ‘retail’ offering unless the SMSF itself held more than $10 million in net assets. The provision of these services to such a ‘retail’ investor would have required significant additional costs described above.
Unfortunately, the issue is similar for the PAF community. Our PAF has been involved in transactions where all of the following have been adopted:
- providing a certificate from a qualified accountant that in my personal capacity I am a sophisticated investor
- acceptance that our PAF can be a sophisticated investor as long as all trustees are sophisticated investors
- a complete prohibition on any PAF being considered to be a sophisticated investor unless it meets either of the $2.5 million in net assets or $250,000 of gross annual income tests.
These differing approaches are resting on different interpretations of sections 708(8) or 761G(7) of the Corporations Act. In particular, under section 708(8)(d), a ‘sophisticated investor’ is designated to include “a company or trust that is controlled by a person who [themselves] meets the requirements [of being a sophisticated investor]”.
ASIC has not been able to provide clear guidelines on what ‘control’ means for these purposes and accordingly, the different approaches are driven by the degree of conservatism in each organisation.
ASIC needs to take a ‘substance over form’ approach. If our trustees supplied a minute from a meeting of our PAF that identified me as the Investment Officer (who is ultimately responsible for the investments our PAF makes) and I was able to prove via a qualified accountant’s certificate that I am personally a sophisticated investor, this should meet the intent of the legislation.
It is disappointing that in recent impact investing transactions, some PAF and SMSF investors have been turned away from participating simply because of a lack of clarity. From a government policy perspective, state and federal, impact investing should be supported for the development of private sector funding strategies to reduce the burden on taxpayers of funding social and environmental projects.
Steve Hawkins is an investment banker at Fort Street Advisors, Chairman of The Benevolent Society Business Advisory Council and founder of a family PAF.