Millions of consumers put at risk from wholesale investor test

CSLR managed investment scheme Sterling Income Trust wholesale investing

6 December 2023
| By Laura Dew |
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The Financial Advice Association Australia (FAAA) is concerned about consumers lacking the necessary knowledge to invest in managed investment schemes (MISs) being classified as wholesale investors.

Treasury opened a consultation into managed investment schemes in August to explore the appropriateness of the existing regulatory settings following several high-profile failures, such as Trio Capital and Sterling Income Trust.

In its submission to the consultation, the FAAA said these types of products present risks that are absent from other types, including a complex structure, liquidity issues, market risk, leverage and tax implications. 

One particular problem is the boundary between investors who are a retail client – who are protected by internal dispute resolutions schemes – and wholesale clients who are not. The wholesale client test has not been indexed since its introduction in 2012 and now includes a much larger volume of clients than originally intended, thanks to growth in residential property values and superannuation assets.

At the time of its implementation, only 1.9 per cent of the population could be classified as wholesale investors with net assets of $2.5 million or annual salary of $250,000, but this has since risen to 16 per cent, some 3.5 million people. If the test remains unchanged, this could reach 29 per cent by 2031.

“A primary concern to our members and their clients is the need to ensure a balanced approach to MIS regulation between protecting vulnerable consumers and the needs of genuine wholesale clients. 

“Of particular concern is the need to ensure that there are better protections for those on the boundary between retail and wholesale clients – such as those who are asset rich, cash poor, with  little capacity to lose money and who may not be financially sophisticated. This cohort is predominately made up of retirees and has been significantly impacted by past MIS misconduct and failures.

“The consumer protections that are now relinquished when a person signs up to be treated as a wholesale client are significant and can be life-changing if things go wrong. For some clients, it may absolutely be justified, appropriate and in their best interest to be treated as a wholesale client. For other less experienced consumers, it may be giving up too many protections. This is concerning.”

The FAAA recommended the net asset value and income test should be amended to exclude principal residence and increased to a $350,000 salary.

Even if a client did not meet the wholesale investor test, there is still a risk they could still invest in MISs by being classified as a “sophisticated investor” if the client provides their consent. The FAAA suggested changes should be made to require them to sign an enhanced consent document and make a declaration to state they have the knowledge and experience to be a sophisticated investor. 

“The FAAA would further suggest that consideration should be given to an obligation that would apply to providers not to treat a client as a wholesale client where there are reasonable grounds to question the evidence that has been provided by the client to demonstrate qualification with the sophisticated investor test, or if there are grounds to believe that the client does not understand the product(s) or the basis for being treated as a wholesale client.”

Consumer protection

It also highlighted MISs are beyond the scope of the Compensation Scheme of Last Resort (CSLR) which will come into force in April 2024, and the FAAA called for this to be changed to protect consumers in the event of an MIS failure. 

MISs should also be required to register with the Australian Financial Complaints Authority (AFCA) in the same way as retail advice licensees.

“The FAAA recommends AFCA’s jurisdiction should be expanded through a limited category to include wholesale MISs and wholesale only advice providers. AFCA’s jurisdiction over these providers should be limited to the consideration of complaints of inappropriate classification as a wholesale client. We acknowledge that this would require material changes to the core obligations for AFSLs with authorisations to provide services to wholesale clients only.”

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