01 April 2020

Australian Investment Funds – Monitoring COVID-19 Impacts

This article was written by Jim Boynton, John Sullivan, Daniel Natale and Kai-Chen Lamb.

As COVID-19 evolves it will have a significant impact on investment funds and their trustees and managers, both directly and indirectly through the broader market, people and economic effects. While there is uncertainty about how the pandemic will develop, many relevant legal issues can be anticipated and planned for now.

We have outlined some matters for trustees and managers to consider. Several initial considerations relate to liquidity. It is also important for trustees to consider the broader implications, such as impacts on assets in which their funds are invested and impacts on the trustee or manager itself.

Trustees and managers should actively monitor the position of their funds and be familiar with their trust deeds and their legal obligations. They should also monitor regulatory developments applicable to their investments, their funds and their investors.

This update primarily focusses on wholesale unlisted funds. There are some additional or different considerations for listed funds and for retail funds.

  1. Do I understand the impacts for the fund and the trustee or manager?

    Take steps to assess the potential impacts of COVID-19 on the fund’s investments, financial position, performance, liquidity and operations, and on the trustee or manager.

    Consider what risks arise directly and indirectly from the pandemic and assess how they can be mitigated. For many funds, there will be direct impacts, such as adverse effects on fund investments (e.g. through closures and government restrictions). There will also be indirect impacts, such as through volatility in financial and investment markets, reduced liquidity of the fund or its investors, or uncertainty in asset values.

    Assess and monitor all aspects of the fund’s liquidity position, given its critical importance. This would include assessing cashflow from and the needs of investments, the banks’ financing position, the fund’s distribution and redemption needs, and its equity commitments.

    Consider also how the crisis might impact on the trustee or manager’s ability to perform its role.

  2. Monitor regulatory developments

    Monitor regulatory developments applicable to the fund, fund investments and investors. These include matters such as closures and government restrictions, stimulus measures, as well as regulatory changes proposed in response to the pandemic.

    A selection of recent Australian regulatory developments is below.

    Subject

    Summary

    ASIC guidance to trustees who are financial services licensees

    ASIC has reminded responsible entities in the current environment to:

    • be aware of their legal obligations and duties to members; and

    • actively monitor scheme liquidity and notify ASIC if any scheme becomes non-liquid or they suspend redemptions (see 6.2 below).

    Leases


    • States and Territories in Australia are to put in place a six-month moratorium on evictions of tenants undergoing financial distress.

    • Legislation passed in New South Wales and Tasmania will enable regulations to be made in relation to temporary relief for tenants and restrictions on landlords’ enforcement rights in particular circumstances.

    We expect similar measures to be introduced across other States and Territories.

    Foreign investment review framework


    Recently announced temporary changes to the FIRB regime have:

    • reduced the monetary screening thresholds for all foreign investments to $0; and
    • extended the timeframe for reviewing applications from 30 days to up to six months.  

    Insolvency regime

    The Federal Government has announced temporary relief for financially distressed businesses as part of a COVID-19 related stimulus package, which will have flow-on effects for the insolvency, corporate governance and directors’ duties regimes.

    Temporary early access to superannuation

    The Federal Government has announced measures to enable individuals affected by COVID-19 to apply for early release of payments from their super fund.



  3. Should we notify investors generally?

    Consider updating investors on the impacts of the COVID-19 outbreak for the fund.

    Investors in registered schemes might need to be notified under the significant event or continuous disclosure provisions of the Corporations Act.  Investors in wholesale funds may need to be notified under the trust deed reporting provisions or it might be necessary to update information memoranda, pitch books and other materials currently in use to avoid misleading and deceptive conduct allegations. Even if investors are not required to be notified, consider whether the circumstances or the trustee’s general duties as an AFS licensee (or good investor relations) warrant notification.

    If the trustee needs to take certain actions (e.g. suspending redemptions or winding up a fund), the trust deed might require investors to be notified before the trustee can do so.
     

  4. Should we supplement or withdraw the offer document?

    Consider supplementing or withdrawing the fund’s offer document if, as a result of market changes or other impacts or the trustee’s actions in response, the offer document is no longer accurate or no longer satisfies any prescribed content requirements.

    Consider if the risk disclosures merit updating in view of potential impacts such as those above, or if stated targets or investment guidelines may no longer be achievable.

  5. Should we revalue the fund’s assets or change the buy/sell spread?

    Most trust deeds will give the trustee discretion to revalue the assets.  Revaluations will impact unit prices.  Registered scheme assets must be valued at regular intervals appropriate to the nature of the assets.  Consider whether it is in the best interests of investors to revalue the assets and whether the value of any assets should be decreased or cannot be determined.

    Not being able to value an asset (or significant uncertainty as to valuations) might be a ground for suspension of redemptions (see below).

    Even where issuances and redemptions are suspended, any obligation to publish periodic net asset value (NAV) or unit price calculations can expose a responsible entity to potential liability where there are significant errors. This is especially the case where super funds or other funds of funds are invested and are using periodic unit price/NAV information to value issue and exit prices for their own funds. Consider whether publishing unit prices/NAV calculations can and should be suspended (or whether an appropriate disclaimer should be included with any such information).

    Consider if the costs of acquiring or disposing of assets have changed and, if so, whether the unit buy/sell spread and the unit pricing policy should change.

  6. Can or must we suspend pricing or processing applications and redemptions?

    6.1 Power to suspend or impose a gate on redemptions

    The circumstances in which unit pricing or processing applications and redemptions may be suspended very much depend on the particular trust deed.  Any power must be exercised in the best interests of investors.

    Before exercising this power, carefully consider the position of applications and redemption requests received.

    If the unit price is suspended, that often means all issues and redemptions are suspended. So while there may be a pause on redemptions, further capital may not be drawn either.

    Some funds will have gates, queuing mechanisms or other requirements for redemptions, and the trustee may have a range of powers to consider exercising, as well as suspension powers. In some cases, redemptions may be at the trustee’s discretion, which must be exercised in the best interests of investors.

    6.2 Cease processing redemptions if registered scheme has become illiquid

    If the fund is a registered managed investment scheme and is not liquid, withdrawals can only be made in accordance with a withdrawal offer made by the responsible entity.  We are aware that ASIC is monitoring fund liquidity carefully and has recently sent a letter to registered schemes requesting that they notify ASIC if they make a determination that the scheme is illiquid and/or to suspend redemptions.

    6.3 Tax considerations for processing redemptions

    If significant redemptions must be processed, trustees should also ensure that they manage the redemptions appropriately from a tax perspective to ensure continuing investors are not disadvantaged.  This includes potential lot management considerations when determining which assets should be realised in order to fund the redemption, as well as management of the fund tax distribution position, taking into account both the tax position of the fund going forward and the position with respect to any existing distributions that have been undertaken.

    Consideration should be given as to whether any significant redemption provisions in the trust deed can be used (and whether the redemptions can qualify as a significant redemption), or whether it is necessary to strike a distribution period. 

    6.4 Processing applications

    If applications are not suspended but there is significant uncertainty in unit pricing, consider if it is desirable to delay processing applications or drawdown until market volatility subsides.
     

  7. What if I need or wish to retain distributable cashflow in the fund?

    If the fund is facing liquidity challenges, the trustee and the manager may also wish to consider options available under the trust deed to conserve cash.  Typically, while trust deeds allow the trustee to make provisions or reserves for liabilities, they may also have distribution provisions that limit the amount which may be retained in the fund.

    For example, under some older trust deeds, trustees may need to distribute at least the fund’s income each year, but these deeds may also be drafted to provide the trustee with certain powers to distribute less than the taxable income for a particular year. These trust deeds may also contain provisions that allow trustees to require re-investment of distributions. Consideration could be given to whether it is appropriate for those powers to be exercised in the current circumstances.

    Funds that are eligible for, and have elected into, the “attribution managed investment trust” or AMIT regime may have greater flexibility to defer or accumulate income if there is insufficient cash to pay the full distribution. The AMIT regime also provides the advantage of giving investors an automatic cost base uplift in the event that the taxable components attributed to an investor exceeds the amount distributed.

    However, regardless of which strategy is adopted, these cash management strategies have the potential to generate “dry income” (i.e. income on which the investor must pay tax but receives no cash).  The possibility of this, taking into account the expected tax profile of investors, should be considered in determining the distribution strategy for the fund in this environment.

  8. What if an investor wishes to revoke its commitment or defaults?

    Certain investors may have increased need for liquidity, which may cause them to seek to revisit their commitment or potentially to default on their commitment if further drawdowns are made.

    Typically, commitments to most unlisted funds are irrevocable and there will be sanctions the trustee may apply to an investor who defaults. Trustees need to consider their response to such events having regard to the best interests of investors.

  9. What if the trustee is also a unitholder?

    Additional care must be exercised by a trustee that is also a unitholder.  Generally, it must act in the best interests of the unitholders of each fund and also not make use of information acquired in its capacity as trustee of one fund to gain an improper advantage for another fund (or breach insider information laws).

  10. Should or can we wind up the fund?

    The circumstances in which a fund can be terminated depends on the trust deed.  Any power must be exercised in the best interests of investors.
     

  11. What if I need to have a unitholder meeting?

    Most unlisted funds do not have a mandated annual general meeting, so they do not face the same issue as listed companies in needing to meet a statutory timetable for their AGM.  However, some funds may need to have unitholder meetings in the near term as part of their response to the crisis or otherwise (e.g. if there are trust deed changes or important actions the trustee needs to take that require unitholder approval).

    Trustees may wish to review their trust deeds to ascertain to what extent meetings can be held virtually. Under many trust deeds there will be a need for a primary physical meeting but proxy voting can be used to alleviate the numbers attending in person. It may be possible for certain aspects (e.g. Q&A) to be conducted by phone or video conferencing to supplement the physical meeting.

If you would like to discuss the matters raised, please contact the authors or your usual contact in our Funds or Tax teams. KWM has a team of specialists who are closely monitoring and working with clients to respond to the developments arising from COVID-19. For more information, please see our insights hub here.

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