Introduction and summary
The unlisted property fund industry is the latest to receive a new range of proposals aimed at improving disclosure to retail investors. ASIC has published its proposals in Consultation Paper 163: Unlisted property schemes: Update to RG 46 (CP 163) (released on 12 July 2011). This follows earlier proposals made by ASIC aimed at improving prospectus disclosure (Consultation Paper 155 Prospectus disclosure: Improving disclosure for retail investors (CP 155)). CP 163 sets out ASIC's proposed amendments to RG 146 Unlisted property schemes—improving disclosure for retail investors (RG 46).
An unlisted property scheme is defined in CP 163 as an unlisted managed investment scheme that has, or is likely to have, at least 50% of its non-cash assets in real property (not including infrastructure assets) and/or other unlisted property schemes.
Responsible entities of unlisted property schemes have been the subject of ongoing review by ASIC since the release of RG 46. CP 163 seeks to address issues ASIC has identified during its ongoing review. Specifically, ASIC has concerns regarding responsible entities' inadequate disclosures of:
- risks associated with the borrowing maturity profile and the extent of hedging;
- property development activities (timetables and funding);
- reasons for paying distributions from sources other than income, and the sustainability of doing this; and
- withdrawal rights and the risks associated with withdrawal arrangements promoted to investors.
ASIC was also concerned with the effectiveness of disclosure documents. ASIC found that several responsible entities had issued disclosure documents that incorrectly referenced other sections and documents, making it difficult for investors to adequately make comparisons between like products.
ASIC's proposals include:
- The introduction of disclosure benchmarks which responsible entities must address on an 'if not, why not' basis. The benchmarks address six key issues including: gearing policy; interest cover policy; interest capitalisation; valuation policy; related party transactions; and, distribution practices.
- Clarification and amendment to the existing disclosure principles to accord with the disclosure benchmarks and address some of the disclosure concerns ASIC has identified.
- Further guidance on how responsible entities can make their disclosures 'clear, concise and effective', by the introduction of an 'Investment Overview' like ASIC's proposed change to guidance on prospectus disclosure issued earlier this year.
ASIC has sought comment on its proposals (the deadline for submissions is 6 September 2011) with a view to releasing an updated RG 46 by December 2011 and requiring that responsible entities comply with the new guidance by 1 July 2012.
Benchmark disclosure
ASIC proposes to extend to unlisted property schemes its 'if not, why not' benchmark disclosure model used in Regulatory Guide 69 Debentures and unsecured notes: Improving disclosure for retail investors (RG 69) and Regulatory Guide 45 Mortgage schemes – improving disclosure for retail investors (RG 45). This model of disclosure provides concrete standards by which retail investors can assess financial products for which there are typically few external benchmarks. The benchmark disclosure model:
- identifies, for a particular financial product, the key risk areas potential investors should understand before making a decision to invest;
- sets a benchmark for how a product issuer should address these risks in establishing its business model and compliance procedures; and
- involves an issuer stating in the PDS and other disclosure whether it meets the benchmark, and if not, why not.
| Gearing policy |
The responsible entity maintains and applies a written policy that governs the level of gearing at an individual asset level. |
| Interest cover policy |
The responsible entity maintains and applies a written policy that governs the level of interest cover at an individual asset level. |
| Interest capitalisation |
The interest expense of the scheme is not capitalised. |
| Valuation policy |
The responsible entity maintains and applies a written valuation policy that requires:
- A valuer to be registered or licensed in the relevant state, territory or overseas jurisdiction in which the property is located, subscribe to a relevant industry code of conduct in the jurisdiction in which the property is located and be independent;
- procedures to be followed for dealing with any conflicts of interest;
- rotation and diversity of valuers; and
- for each property, an independent valuation to be obtained:
- before the property is purchased: for a development property, on an 'as is' and 'as if complete' basis; and or all other property, on an 'as is' basis; and
- within two months after the directors form a view that there is a likelihood that a decrease in value of the security property may have cased a material breach of a loan covenant.
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| Related party transactions |
- The responsible entity maintains and applies written policies on related party transactions, including the assessment and approval processes for such transactions and arrangements to manage conflicts of interest.
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| Distribution practices |
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The benchmarks set out above are in addition to the existing disclosure principles contained in RG 46 (which ASIC proposes to amend as set out below).
Amendments to Disclosure Principles in RG 46
ASIC proposes to amend RG 46 to clarify several issues and provide further guidance as to its expectations of responsible entities in applying the disclosure principles.
| Gearing ratio |
- Where the latest financial statements are not used to determine the gearing ratio, the responsible entity should disclose the source(s) and the date of the information used to calculate the ratio.
- When explaining what these ratios mean in practical terms, a responsible entity should ensure that the explanation addresses the risks associated with the level of gearing within the scheme.
- Where a responsible entity is unable to calculate the gearing ratio this should be disclosed with: reasons why the ratio cannot be calculated; explanation of the risks and impact of being unable to calculate the ratio; and, the steps being undertaken by the responsible entity to address these risks.
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| Interest cover ratio |
- Where a responsible entity does not base the interest cover ratio on the latest financial statements, it should disclose the source(s) of the information, and the date of the information, used to calculate the ratio.
- When explaining what this ratio means in practical terms, a responsible entity should ensure that this explanation addresses the relationship between the income received by the scheme and the amounts required to be paid under the terms of any relevant finance facility, and the ability of the scheme to meet its other financial obligations.
- Where a responsible entity is unable to calculate the interest cover ratio – for example, in a property development or in circumstances where the interest is capitalised – it should disclose the reasons why and provide an explanation of the arrangements it has entered into to meet the payment obligations related to the borrowed funds and the risks associated with these arrangements.
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| Scheme borrowing |
- Whether a scheme would breach any covenants in any credit facility if either the operating cash flow or the value of the asset(s) used as security for the facility were to fall by 10% or more.
- For each credit facility: the aggregate undrawn amount; the assets to which the facility relates; the loan-to-valuation and interest cover covenants under the terms of the facility; the interest rate of the facility; and whether the facility is hedged.
- Details of any terms within the facility that may be invoked as a result of investors exercising their rights under the constitution of the scheme.
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| Portfolio diversification |
- Whether the current assets of a scheme conform to the investment strategy of the responsible entity for the scheme, and an explanation of any significant variance from this strategy.
- The current value of the development and/or construction assets of a scheme as a percentage of the current value of the total assets of the scheme.
- In the case of a scheme involved in property development, for each significant development asset:
- the development timetable with key milestones;
- a description of the status of the development against the key milestones identified;
- a description of the nature of the funding arrangements for the development (including the sources of funding and repayment strategies where borrowing is used to fund the development);
- the total amounts of pre-sale and lease pre-commitments, where applicable;
- whether the loan-to-valuation ratio for the asset(s) under development exceeds 70% of the 'as is' valuation of the asset(s); and
- the risks associated with the property development activities being undertaken.
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| Valuations |
If the valuations benchmark is introduced, ASIC proposes to remove the valuations disclosure principle.
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| Related party transactions |
- The value of the financial benefit.
- The nature of the relationship (ie the identity of the related party and the nature of the arrangements between the parties, in addition to how the parties are related for the purposes of the Corporations Act or ASX Listing Rules - for group structures, the nature of these relationships should be disclosed for all group entities).
- Whether scheme member approval for the transaction has been sought and, if so, when (eg where member approval was obtained prior to the issue of interests in the scheme).
- Whether the arrangement is on arm's length terms, is reasonable remuneration, some other exception applies, or we have granted relief.
- The risks associated with the related party arrangement.
- The policies and procedures that the responsible entity has in place for entering into related party transactions, including how compliance with these policies and procedures is monitored.
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| Distribution practices |
- Whether the current or forecast distributions are sustainable over the next 12 months.
- If the current or forecast distributions are not solely sourced from realised income, the sources of funding and the reasons for making the distributions from these other sources.
- The impact of, and any risks associated with, the payment of distributions from the scheme from sources other than realised income.
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| Withdrawal arrangements |
- Whether the constitution of the scheme makes provision for investors to withdraw from the scheme and the circumstances in which investors are able to withdraw.
- Any significant risk factors that may affect the unit price at which a withdrawal will be made.
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Form of disclosure
ASIC proposes to provide additional guidance on how responsible entities can word and present PDSs and other disclosure documents in a 'clear, concise and effective' manner to help retail investors assess the offer and make informed investment decisions.
Clear, concise and effective
ASIC intends that RG 46 will be consistent with its guidance proposed in Consultation Paper 155 Prospectus disclosure: Improving disclosure for retail investors (CP 155), that is, a PDS will be clear, concise and effective if it helps retail investors make informed decisions because it:
(a) highlights key information;
(b) uses plain language;
(c) is as short as possible;
(d) explains complex information, including any technical terms; and
(e) is logically organised and easy to navigate.
ASIC also proposes to refer to the guidance in CP 155 on the use of communication tools that can help responsible entities to word and present PDS information in a clear, concise and effective manner.
Investment overview
ASIC proposes that an investment overview is included at the beginning of a document which highlights information key to the investor's decision to invest. This should contain disclosure of the benchmark and disclosure principle information. ASIC's stated aim is to 'change market practice' so that issuers provide retail investors with one balanced summary in the form of an investment overview.
ASIC has also stated that all disclosure and ongoing disclosure documents should be dated so as to allow investors to assess the currency of the data within such documents.
Comment
Some in the industry have endorsed ASIC's proposal because it would instil confidence in new and existing investors. However, ASIC's proposal has also been criticised because it makes the assumption that unsophisticated investors can understand and respond to quite subtle disclosures.
Most responsible entities as a matter of good practice (and arguably to comply with existing legal requirements) already make substantial disclosures in line with what ASIC has suggested (although not necessarily in the order and manner that ASIC proposes). However, the proposals are likely to impose an increased time and compliance cost burden on responsible entities to change disclosure processes and systems.