CCIV: Trustees win; custodians lose

There are going to be a lot of winners with the new CCIV regime. Lawyers advising foreign clients come to mind, as they may now be able to avoid having to explain the 500 year history of trust law to clients originating from outside of the Commonwealth.

Client:             “so a trust can’t borrow, sue or be sued and the unitholders do not have limited liability….?”…

Lawyer:           “Yes, it started in the 14th century in the Court of Chancery…”

The draft bill paves a way for Australian fund managers to provide a more familiar structure to foreign clients with products registered in Australia. There should be a net export benefit for Australia’s funds management market, to the extent that exporters haven’t already figured out ways to circumvent Australia’s complicated regime. For example, its quite common for an Australian fund manager to register a fund in Ireland to sell into lucrative Taiwanese, Singaporean and Hong Kong markets.

However, the draft bill released by Government will be met with a collective groan by the custodians in the country. To understand this, rewind the clock to 1998 (or 1993 to be precise). 1998 was the year the Government decided to “go it alone” globally speaking and introduce the single responsible entity regime (which was proposed in 1993). The single responsible entity regime – pushed on by the banks and major wealth companies – did away with nuisance trustees who were responsible for providing oversight of fund managers.

At the time, there was little sympathy for trustees, who had managed to preside over what was the last recession in Australia led by falling property prices and collapsing property funds (Estate Mortgage for example toppled Burns Philp Trustees). The legislators of the day thought trustees were so useless, there was no need for them. But in killing off an industry, the government decided the best party for the job of supervising and monitoring fund managers was the fund managers themselves. A Royal Commission may one day opine on this point.

Meanwhile, the trustees of the day turned their attention to the newly created role of custodian to put a tourniquet on their losses. The custodian was to be an entity of financial substance to safeguard the assets of Australia’s funds management sector. Most trustees of the time that were solvent used the capital on their balance sheet to support fund managers who didn’t have the spare capital to be their own custodian.

However, since 1998, the role of custodian was largely minimised contractually. The custodian function became very simple; to be recorded as the legal owner of the assets of a trust (including bank accounts) and to act on instructions of the fund manager. Custodians became document signing, asset registration, price collection and payment businesses with no ultimate responsibility to the end investors. There are some very good custodians, but so minimal is their role that ASIC even went so far as to suggest the expression “custodian” potentially created an “expectation gap” in respect of the actual function.

That gets us to August 2017 and, under the CCIV bill, the role of custodian is transplanted by an entity to be known as a “depository”. Unlike today’s custodians, a depository will be required to discharge best interest and fiduciary duties. In particular, (a) to exercise the degree of care and diligence that a reasonable person would exercise in the depositary’s position; and (b) to act in the best interests of the CCIV.

These are significant changes that mean that if the CCIV structure is adopted, custodians who wish to participate as depositories will have to start exercising best interest duties on behalf of the CCIV. There will have to be wide-scale changes to processes and procedures to ensure representatives of the depository are considering the ultimate impact of decisions on the CCIV investors. Furthermore, you could expect that in the event of scheme collapses or malfeasance, a depository’s insurance policy will attract the attention of plaintiffs.

Another potential result is that custodians will stay as they are and professional trustees will act as the appointed depository to a CCIV. The depository will be able to rely on the delegation powers drafted into the new regime to sub-delegate traditional custodial duties to traditional custodians.

The depository is more trustee than a custodian. After a 20 years pause, it would appear the phoenix has risen from the ashes. It will be interesting to see how custodians and their peak bodies react to a best interest duty.