A review of potential changes to Australian sophisticated investor thresholds
In this post, I consolidate sentiment, research, and the original submissions to consider the impact of the proposed threshold revisions and possible alternatives.
Proposed changes to income and asset thresholds for sophisticated investors in Australia are raising concerns in the startup and entrepreneur support community The changes reported in the Australian Financial Review on 12 January 2024 are expected to result in a decrease in early-stage risk capital and an increase in inequality by limiting access to wealth-generating opportunities to those who already have substantial wealth.
These outcomes are highlighted by leaders in the Australian innovation ecosystem and supported by research. Research also points to alternative approaches in lieu of increased thresholds that could achieve the outcomes of investor protection while building capability and capacity in the Australian innovation ecosystem.
For those who wish to add their voice, there is a petition on Change.org to “Urge the Australian Government to reconsider Sophisticated Investor Test”.
Background
A review of the sophisticated investor test was highlighted in October 2022 as part of an overall inquiry into the managed investment sector. A subsequent review of the regulatory framework for managed investment schemes sought feedback from August to September 2023 on the appropriateness of existing regulatory settings for managed investment schemes. The consultation paper proposed 24 questions for consideration including the question around income and asset thresholds to be considered a sophisticated investor:
Should the financial thresholds for the net assets and/or gross income in the individual wealth test be increased? If so, increased to what value and why?
The current criterion for an investor to be classified as ‘sophisticated’ rather than ‘retail’ is for the investor to have $2.5 million in net assets or $250,000 in two-year consecutive gross income. The current lower threshold set in 2002 captured 1.9 percent of the Australian population but now encompasses 16 percent of the population. A 2021 research note by Associate Professor Ben Phillips at the ANU Centre for Social Research and Methods projects that, under the current 2002 thresholds, the qualifying population will increase to 29.1 per cent (6.78 million) of all adults by 2031 and 43.6 per cent (11.5 million) of all adults by 2041. The alleged revised thresholds are reported to increase to an amount in line with inflation, estimated at around $4.5 million in assets or $450,000 in income.
In addition to inflation, the increase has also been attributed to rising property values and the inclusion of the family home or superannuation, with some calling to exclude the family home as an asset as is seen in other countries like the UK and the US. This was mentioned by Cheryl Mack, founder of Aussie Angels - a platform that supports early-stage tech investing via syndicates and funds.
Cheryl notes further challenges with the proposed changes including an expected decrease in investment volume into early-stage technology companies, an increase in inequality by creating barriers to wealth accumulation opportunities for those who do not meet the criteria, and a negative impact on women who have lower wealth relative to men. Investor Alan Jones raises concerns about the proposed new thresholds being exclusionary, discriminatory, and ineffective with a likelihood of eliminating emerging smaller investment funds.
Investment syndicate Ten13 co-founder Stew Glenn echoes expectations about exclusion, inequality, and lowering of Australia’s global competitiveness. Steve Maarbani, CEO of crowdfunding platform VentureCrowd, expects a significant participation reduction in funding activity and a brain drain of investment and intellectual capital as investors gain their funding experience in other markets. The Head of Investments at the Regional Angel Investor Network Will Richards reinforces the issue of exclusion, particularly for technology early adopters who may wish to be both an investor as well as a customer. A recent opinion piece by UNSW Associate Professor of Finance Mark Humphery-Jenner highlights additional challenges including the elimination of opportunities in rural communities and indirect costs to founders from lack of access to angel investor mentorship and expertise.
The negative impacts of the change are highlighted in mainstream media and commentary from leaders in the innovation, investment, and startup industries. We can also see consequences and opportunities from research.
Research
Decrease in investor and investment quantity and volume
As highlighted by Professor Mark Humphery-Jenner, previous research from similar changes in other developed markets predicts a decrease in investment quantity and value as a result of the proposed change without a corresponding positive impact on investment quality or loss reduction. The United States government’s policy response to the 2008 financial crisis of the 2010 Dodd-Frank Act excluded personal residence when determining accredited investor criteria, eliminating 20% of households from the potential investor market. This had a disproportionate impact on regions and communities already disadvantaged in investor access and entrepreneur support.
As the author summarised:
“I show that cities more affected by the regulation change experienced a significantly larger decrease in local angel financing, entrepreneurial activity, innovation output, employment, and sales. I find that small business loans and second-lien mortgages became entrepreneurs’ partial substitutes for angel investment. My cost-benefit analysis suggests that the costs of protecting angel investors through the 2011 regulation change outweigh its benefits.”
The ecosystem metaphor is appropriate in innovation ecosystems in that everything operates in a balance. A change in one role (or species to use the ecologic comparison) will have an impact on others. Entrepreneurs follow the path of least resistance towards the highest value. Introducing barriers will result in both founders and risk capital pursuing alternative funding channels domestically at higher personal cost and in markets outside of Australia.
Make disclosure statements more readable
There is a presumption that increased wealth means that you will have a better understanding of financial disclosures and thereby make higher-quality investment decisions. This premise is backed up by research that finds that non-sophisticated investors are more conservative based on their lack of understanding and that institutional investors behave in a more sophisticated manner than the average layperson when considering bias in investment decisions.
However, the research also finds that more complex or less readable disclosures reward more sophisticated investors and create barriers for less sophisticated investors. While not a panacea, more readable disclosure statements and financial documentation can create more opportunities for less sophisticated investors. As noted by research:
The means of less-sophisticated non-professional investors (NPIs) using high-readability disclosures and more-sophisticated NPIs using low-readability disclosures are nearly identical on composite management credibility, management competence, and management trustworthiness. Taken together, these results provide further evidence that plain English disclosures compensate for a lack of task-specific knowledge, and increase credibility perceptions of management among less-sophisticated NPIs.
Leverage the intellectual capital in networks (syndicates, crowdfunding, teams)
Australia is experiencing an increasing trend towards investment syndicates, networks, and crowdfunding. Research shows that these models can benefit from leveraging collective wisdom and sharing knowledge and information. The platforms address challenges in information asymmetry and amplify the impact of high-performing investors. The performance of the models can depend on the reputation and specialised human capital of the lead investor and the strength of the relationship between investors. Syndicates also provide opportunities for risk sharing, portfolio diversification, and access to larger deals as well as encouraging investment by budget-constrainted lead investors through de-risking the investment.
Research highlights the value in inexperienced investors gaining experience through investors who have more experience. Investor communities can be close-knit but are welcoming to those who want to explore opportunities. There are also growing networks supporting investors in rural communities to access deals and experience from capital cities. Support for these models provides an opportunity for investors to gain the necessary experience towards consideration as a sophisticated investor.
Reinforcing systemic innovation ecosystem inequalities
Innovation and entrepreneurship create a conundrum for policy development. On the one hand, entrepreneurship supports economic diversification, business adaptability, individual self-efficacy, and can act as “a force for peace, equality, and expanded human welfare”. And yet increased innovation activity leads to inequality in contemporary capitalist societies. Unchecked by social protection systems, innovation and automation contribute to inequality.
The system is designed for the dominant actor in the system, supporting those who share a common gender, race, company type, and have greater access to support resources, networks and capital. I
n case you are wondering who this is, look no further than ChatGPT’s generated image of an “Australian sophisticated investor” - male, city-based, tech-enabled.
Investors are biased towards investing in founders with whom they feel comfortable and people feel comfortable with those with whom they have familiarity and commonality. Wealth is centralised by gender and race. Creating additional barriers to diverse representation in investors will only reinforce systemic inequality.
Questions and recommendation
A few questions are raised when reviewing the above commentary from leaders in the innovation space, past research, and submissions to the 2022 consultation outlined in the Appendix below.
First, we question whether wealth and income are adequate proxies for sophistication.
Research demonstrates that professional or sophisticated investors make better investment decisions. However, success is based on several factors including experience, environment, and opportunity. There are also many ways wealth can be accumulated such as through inheritance, high-earning professions, and realising windfalls from property or speculative opportunities that may be more indicative of luck than considered decisions.
There needs to be a pathway to gaining experience and sophistication that is not reliant on wealth and income. This can include formal training and evidence of past participation.
Second, we question the relevance of using population percentages of qualifying sophisticated investors.
Most articles highlight the percentage of the Australian population that can be considered sophisticated investors based on changes to inflation and wages. The media reports on the changes of 1.9 per cent to 16 per cent as some form of value judgment. And yet, what would be the impact if 80 per cent of the population could match the threshold to be a sophisticated investor?
A majority of the population being considered candidates for sophisticated investing would mature the market of advisers and regulations to both protect and take advantage of those investors. Using a comparison of obtaining a driving license, regulation focused on restricting the number of investors is like increasing the driving age to 30 or restricting access to freeways. There are additional license restrictions for driving certain types of high-performance vehicles or carrying a higher number of passengers where there is increased risk. These restrictions use criteria of experience and qualification rather than an arbitrary proxy such as age beyond a minimum requirement.
There is an opportunity to apply regulation to protect investors by improving the investment infrastructure and investor capability rather than a threshold that will reduce investor volume and capacity.
Third, we question appropriate regulation for investor protection and determining investment decisions.
Increased thresholds effectively tell investors where they can invest their funds. There is no end of investment opportunities for people to spend (or throw away) their money. Creating barriers that will have proven negative consequences on innovation capability and capacity will only divert those funds to other channels that may have as much if not greater risk.
Recommendation
I am by no means an expert in any particular facet of the conversation, as an experienced sophisticated investor, as a startup who has received funding, or as a policy maker. However, I have participated in each of these as an angel investor, as a founder of a few startups, and as a contributor to policy development. I am now a researcher whose vocation has settled on supporting the Australian innovation ecosystem.
The discussion above and recommendations below are more a synthesis of others’ views than my opinion. All are open to critique and feedback.
As others have noted, there are ways to improve the quality, capability, and capacity of investment without increasing thresholds that are guaranteed to embed inequality and reduce value and volume without significantly improving investor safety. Some of these ways include:
Embed certification programs to upskill investors
Leverage syndicates and crowdfunding for new investors to gain experience
Standardise investment instruments and make disclosure documents as plain language as possible
View any change through a lens of the whole community, by region, gender, age, race, ability, and nationality to consider unintended consequences.
Finally, as several in the consultation responses below noted, the significance of the change and its impact warrants additional discussion and review before making a decision. If it is not already underway, a transparent cost-benefit analysis would be helpful.
For those who wish to add their voice, there is a petition on Change.org to “Urge the Australian Government to reconsider Sophisticated Investor Test”.
Investment of risk capital has inherent risks, as the name suggests. If Australian investors are over-protected from experiencing that risk, the long-term impact on the resilience of our innovation ecosystem will be significant.
Personal context
For context, I hold a few roles related to the Australian innovation ecosystem. First, I am a Research Fellow (Innovation Ecosystems) with the Rural Economies Centre of Excellence at UniSQ where I build on my PhD research into the contribution of the innovation ecosystem on community resilience with a focus on rural economies. Second, I am CEO of a not-for-profit Startup Status that provides a technology platform to help map and measure the innovation ecosystem including policy impacts over time and across regions and areas of impact. Third, I am the Managing Director for the Global Entrepreneurship Network Australia focused on addressing systemic enablers and inhibitors to innovation and entrepreneurship.
Feedback and comments are always welcome as we work together to build the Australian innovation ecosystem.
Appendix - Consultation submissions
The excerpts below are from the 49 public submissions to the September 2023 consultation, grouped by those that propose to keep the current thresholds at the same or lower levels, and those that recommend the levels be increased. The theming is based on interpretation, with full comments relating to the question in the event the comments were misinterpreted.
Twenty-two of the submissions called for the thresholds to remain the same or be lowered, provided alternative conditions such as changing categories of investments. or recommended additional consultation.
Nine of the submissions proposed the thresholds increase but with conditions such as to account for CPI, to change for only one variable, or to adjust with a provision of other structural changes.
Eight of the submissions proposed an increase in the thresholds.
Remain, lower, conditions, or additional consultation
While an increase in house prices has been the major reason for the increase to 16% of all adults by 2021, this does not appear to me to be an alarming percentage, and has probably served to bring the eligible number more into line with reality… While an objective test is always more desirable than a subjective test for statistical analysis, there is an imperfect correlation between the net wealth or gross income of a person and their financial sophistication. - John Aldersley
The individual wealth test should continue to strike an appropriate balance between consumer protection, on the one hand, and certainty, on the other. - Allens
The current individual wealth test (particularly the net assets test) favours Generation Boomers and older. Whereas many of those within Gen Z and younger generations are not yet asset rich, but may still be sophisticated investors. Younger investors who self-educate and who are prepared to invest in wholesale products with a longer investment term and greater risk tolerance, ought not be penalised due to a structural deficiency in the Australian housing market. Therefore, a lower test with a consent requirement, may be more suitable to this category of investors. Further, any increase to the tests may exclude women and other minority groups from being able to invest in products that are more readily available to wholesale clients, such as early stage investing products. Surely this outcome is not desirable. Therefore, a lower test with a consent requirement, may be more suitable to these categories of investors. Finally, if any assets are to be excluded from the individual wealth test…, then AIMA supports a corresponding reduction to the current tests. - Alternative Investment Management Association (AIMA)
It cannot be assumed that all people who meet one of those criteria have knowledge or experience in respect of financial products. Nor can it be assumed that that class of person did not include numerous persons who were dependent on the accuracy of the marketing material the appellants chose to promulgate… There is a fallacy in equating wealth (however gained) with financial acumen. Successful athletes, actors and musicians are well known examples of wealthy individuals with poor investment acumen. The protections of retail investors ought to be extended to them, not carved out. - Angas Securities Limited
The Current threshold for individual wealth is $2.5million in net assets or gross income for each of the last two financial years of at least $250,000 per annum, should be retained. The average full-time annual earnings is $90,800 per annum2, with 1% of the population taking home earnings more than $253,0663 based on these figures and that we have stagnant wage growth the current threshold and net assets would preclude investors who should be intreated as retail clients and not wholesale. - The Association of Independently Owned Financial Professionals (AIOFP)
Asset and financial thresholds are meant to assist in protecting most consumers from being exposed to more complex and high-risk investments, however, AFCA has frequently seen these thresholds are a poor proxy for consumer understanding and they can also fail as a proxy for financial resilience. While investors who meet these tests may be able to sustain higher losses than other investors, this is not the same as being financial literate or losses being without significant impact, including in cases where a person attains money through inheritance, the sale of their home or release of superannuation and are making high impact financial decisions for the first time. For the purposes of the investor wealth test, it appears reasonable to exclude an individual’s superannuation and primary residence. This reflects the maturation of the Australian superannuation system and the significant growth in average Australian house values over time, and again appears to be consistent with the original underpinning policy objectives. From an AFCA complaints-handling perspective, it is the individual context in which client consent is sought and obtained that will determine whether a particular consumer genuinely understood the implications of and agreed to their classification. - Australian Financial Complaints Authority (AFCA)
We consider the current financial thresholds for the individual wealth tests are adequate. On the basis that high gross income is intended to correlate with an individual’s financial knowledge and experience, it follows that such an individual would limit gross income in their personal name, preferring to retain excess income in more tax effective company, trust or superannuation structures or salary sacrifice arrangements. As a consequence, we do not believe it necessarily follows that increasing the income test beyond $250,000 would have the desired effect of disqualifying inexperienced investors. - Australian Secure Capital Fund
ASX encourages standalone consultation on this issue to ensure that it is considered holistically and that feedback is sought from all affected stakeholders. ASX considers that a standalone consultation would enable Treasury to provide a more detailed and fulsome context for any proposed changes and to identify all possible impacts of reform in this space. - Australian Securities Exchange
The financial thresholds for the net assets and/or gross income in the individual wealth test should not be increased, subject to them being accompanied by an appropriate Suitability Process, as detailed below, having regard to the very significant changes in the financial services Regulatory Landscape over the last two decades. Also, it is felt that the investor can be more effectively protected by placing the responsibility on the financial services licensee rather than utilise levels of individual wealth to alone determine access to the wholesale sector of the market in financial products. 3. Should certain assets be excluded when determining an individual’s net assets for the purposes of the individual wealth test? If so, which assets and why? It is not necessary to exclude any of an individual’s net assets for the purpose of the wealth test, as the exclusion like the level of the individual’s net assets or gross income itself is too imprecise to qualify for access to the wholesale market in financial products and is not an appropriate substitute for assessing Suitability in accordance with the assessment criteria contained in the Corporations Act. - Bell Potter Securities Limited
The rationale for introducing financial thresholds in the product value test and the individual wealth test assumes that individuals who have the required value in assets or income have the knowledge or experience to understand and take on additional risks or the means to acquire professional advice.2 We would ask the Department to consider whether financial thresholds are sufficient or whether educational qualifications and ‘work experience’ should also be considered given the ra onale focuses on ‘knowledge or experience’. In addition, BoardRoom supports the restriction on the use of an Investor’s primary residence when calculating an investor’s ‘net assets’. This is not to say that the primary residence cannot be used, rather, it should not be the sole or primary asset relied upon by an investor during an asset test. - Boardroom Pty Limited
We suggest that any adjustments to net assets and gross income be: limited to a codified indexation regime; and periodically reviewed and adjusted by regulation as appropriate. If it is the case that assets and income increase in value over time at different rates, the Government may consider applying different rates of indexation which may reflect this differential. We do not agree with the potential exclusion of a person’s principal residence or superannuation balance for the purposes of the individual wealth related accountant certification category. This would substantially and unnecessarily reduce the universe of persons who should qualify as wholesale clients (and impacting legitimate access to a broad investment universe). Such a change would be substantially out of step with overseas peer regimes. In particular, although the UK rules exclude the principal residence and superannuation balance of a person relying on the UK equivalent category, the minimum net asset amount needed for a UK investor to qualify is £250,000 compared to the current $2.5 million Australian investor threshold. - Corrs’ Financial Sponsors Group
While there may be merit to increase the net assets and/or gross income in the individual wealth test, this is likely to result in many existing wholesale clients no longer meeting the thresholds when the accountant certificate is required to be renewed. This may force wholesale fund manager to exit the clients that no longer meet the thresholds, which may have a detrimental impact on these members investments. This is especially problematic if the fund is closed and/or illiquid. This change may trigger the need for the wholesale licensee to vary their licence to include retail clients or to apply for a Responsible Entity licence. The additional costs related to disclosure, training, dispute resolution, Professional Indemnity and general compliance requirements may make this unattractive. Excluding certain assets when assessing the net assets for the purposes of the individual wealth test may result in wholesale clients no longer meeting the threshold on renewal of the accountant certificate. - Paul Dortkamp and Margaret Sullivan, active members of the Independent Compliance Committee Member Forum (ICCMF)
As to the dollar amounts for those wealth measures, they should be determined having regard to the characteristics identified in paragraph 9. For example, if Treasury concludes that financial advice is realistically available to and used by a certain percentage of Australians, it could fix the thresholds by reference to the HILDA data having regard to this consideration. Another possible approach is to segment this client population into high net worth and “mass affluent”. Probably, high net worth households should be certified. The open question is whether some or all of the mass affluent should be too. - Professor Pamela Hanrahan Professor of Commercial Law and Regulation UNSW Business School
No, we don’t think the thresholds should be increased. However, we do advocate for changes that we believe would enable the test to be applied more simply and with more confidence. If the primary residence is excluded from the asset calculation (see question 3), then our view is that the overall threshold should be reduced to take this into account. Increasing the financial thresholds in the individual wealth test will have wideranging consequences that stretch well beyond the MIS framework. Any changes to the thresholds must be considered in this broader context. We would like to see data showing how many consumers who have been classified as wholesale clients have actually suffered loss as a result of that classification before proposing to change the test. - Kit Legal
Rather than implementing a limited consideration revision, we submit Treasury ought to undertake the exercise contemplated below in seeking to revise the financial thresholds for the individual wealth test, so that the new thresholds are appropriate in the current Australian landscape. The first step would be for Treasury to determine the proportion of Australians Treasury considers are sufficiently sophisticated such that they do not require the same level of protection as retail clients. The second step would be for Treasury to consider financial data around total earnings of Australians and their net assets, so that the corresponding value of gross income and net assets can be determined that would mean the same proportion of Australians are captured as those considered to be sophisticated pursuant to step 1. Treasury should also have regard to the disruption that would be caused by significantly increasing the financial thresholds, such that a far greater proportion of Australians would be treated as retail clients. A substantial revision would have a significant effect on the ability of product issuers to structure wholesale products and would reduce the level of innovation within the Australian financial services industry.16A significant revision of the financial thresholds would also reduce competition, noting the retail funds management space is highly concentrated.17 A significant revision would also require otherwise sophisticated Australians to invest in products that do afford protection as retail clients even if they do not require such protection, and such products may not necessarily aligning with their investment profile. - McMahon Clarke
Morgans does not support the changes to the wholesale client thresholds as proposed under Chapter 1 of the ‘Review of the regulatory framework for managed investment schemes’ consultation paper. • Morgans recommends the review of the wholesale client framework be separated out from the Managed Investment Scheme consultation as it should be subject to its own standalone consultation. This will enable appropriate participation by all relevant industry stakeholders and will ensure all possible consequential impacts are considered. We would not support changes where the unintended consequences could result in many advisers in the industry who have structured their business model as a wholesale-client-only model losing their client base and business. Advisers have already gone through substantial change due to the introduction of FASEA education requirements. The industry has suffered significant loss over the past few years in terms of advisers leaving the industry. Changing the wholesale client thresholds may result in advisers no longing being able to retain their wholesale-only business model and thus have no option but to leave the industry. We also believe wholesale clients themselves may suffer unintended consequences should the thresholds change. Wholesale clients are able to access wholesale client opportunities and products that retail clients cannot. Advisers have structured their businesses to meet the demands of clients in this respect. Changing the current regime may impact what products and strategies clients can invest in. Page 2 of 2 It may also result in clients having to sell out of their wholesale products, which could result in other complications such as incurring tax and other transactional costs. - Morgans Financial Limited
There is a moral question involved. Should financial resources be put towards protection of what would be wealthy people whose gross income is $250,000 or more in the last 2 income years or holding net assets of $2.5m. It is submitted that finite resources should be used in protecting non-wealthy investors rather than increasing the number of investors required to be protected. However, there is perhaps a reasonable argument that persons living in Sydney in particular have homes that would push them over the net asset threshold but really are not wealthy people. This issue could be resolved by excluding the investor’s main or principal place of residence from the net assets test. A person with net assets of $2.5m excluding the family home is wealth compared with most retail clients. With respect, they should be able to look after themselves without finite resources being applied for their protection. - Piper Alderman
The absence of any identified shortcomings in these tests does not warrant an increase in the threshold. Individuals seeking to be classified as wholesale investors (as opposed to a retail investor) are likely to have access to professional advice to support an informed decision- irrespective of the threshold test. As such, an increase to the current product value test or the thresholds for net assets and/or gross income is not supported as it is unlikely to add any additional protection. Furthermore, the inclusion or exclusion of certain income or assets needs to be balanced so that the full financial picture of the investor is understood. Increasing the thresholds would need to fully consider any unintended consequences, such as: • If a wholesale investor is not grandfathered and is subsequently deemed retail they may need to be redeemed out of a fund, this may not always be possible (e.g. funds with illiquid assets such as property funds) • If an investor is redeemed, they may be forced into a capital gains tax event • The Australian Financial Services Licence (AFSL) of the fund may also only have a wholesale license and may not be authorised to service retail investors • Investor equity and the ability to participate in future capital raisings so that their interests in a fund are not diluted. - Property Council Australia
We do not consider that there is sufficient evidence to suggest that, as a matter of public policy, the net assets and/or gross income in the individual wealth test be increased. If the thresholds are increased, fewer investors will be able to rely on the net assets and/or gross income to be classified as a wholesale client. This will have the following repercussions for investors and fund managers: • The smaller wholesale investor pool will decrease demand for wholesale fund products. • It is likely this will result in fewer wholesale fund managers and/or fewer products being introduced into the market. • The cost of the products issued will also likely increase because the fund manager will have fewer products across which to recover fixed costs and also from the impact of reduced competition. • For investors no longer able to be classified as wholesale, it is likely they will have to pay more to access retail products with a similar investment strategy and risk profile. • Note that for most wholesale products, the investment strategy and risk profile are similar to retail products, but the costs are higher due to increased regulatory compliance costs. A smaller wholesale investor pool may mean that small-to-medium wholesale fund managers are no longer able to operate as they cannot bear the additional regulatory compliance costs of having to offer their products to retail clients. These fund managers play an important role in the Australian economy and if they cease to operate there could be unintended broader economic impacts. We consider it to be in the interests of Australians as a whole, particularly natural persons (as opposed to institutional investors), to be able to access wholesale-only financial products because such products often allow investors to gain access to higher returns and asset classes which may not otherwise be available for retail-only products. Policy reforms should focus on wholesale investors (who are natural persons) being able to gain access to more affordable personal advice, rather than shutting off wholesale products to a greater number of Australians. Further, if the thresholds are to change, the PFA supports the ‘grandfathering’ of existing clients in existing financial products. That is, any new thresholds should apply for new acquisitions of new products, not past acquisitions of past products or new acquisitions of past products (e.g. through a rights issue or a distribution reinvestment). - Property Funds Association (PFA)
Greater clarity on how the asset and income tests are to apply to an SMSF would also be welcomed. While many funds will have a special purpose corporate trustee, some SMSFs still have two or more individual trustees. The application of the test differs, depending upon the SMSF trustee structure. The question remains whether it is appropriate to apply the tests at the trustee level or whether the tests should be based on the individual member’s interest in the fund. - SMSF Association
Without evidence of harm or a market failure, SIAA does not consider that there are sufficient grounds to introduce law reform. We note that was the view of most of the stakeholders who attended the Treasury roundtable on 14 September 2023 as well. Many of the managed investment schemes referred to in the Consultation Paper were sold to both wholesale and retail clients and pre-date the introduction of the DDO regime1. Client losses incurred in those schemes were not due to the wholesale investor test thresholds, but to the features and circumstances of the schemes themselves and the manner in which they were marketed. In the matter of the Trio Capital collapse, investors were the victims of fraud. We don’t consider that failures of these schemes should be used as a reason to change the wholesale client test either for managed investment schemes in particular, or more generally. The wholesale client test has application across financial services more broadly and is not confined to managed investment schemes… It is important to note that calls for change to the wholesale investor tests and asset thresholds are not coming from investors. Evidence that licensees are ‘pushing’ clients into becoming wholesale or systematically gaming the system has not been put forward. Opinion pieces that call for change say much about the fact that the thresholds have not changed since 2001, but provide no evidence of harm other than references to the failed management investment schemes noted earlier where the structure of the scheme was the problem or Mayfair, which resulted from misleading and deceptive conduct. We consider that clients would need to be surveyed to obtain their perspective on changes to the test. This is because any change to the wholesale client monetary thresholds would have a significant impact on clients, if the consequence of the change was that they would no longer be classified as wholesale. Such a change could disadvantage a significant cohort of Australian investors who have not been consulted on their views of whether such a change is welcomed by them. In the wholesale advice sector, the relationship between adviser and client is often closely fostered by the adviser and is based on trust developed over a number of years. Changes to the test could result in them losing access to their adviser of choice. - Stockbrokers and Investment Advisers Association (SIAA)
In UDIA National’s view these thresholds are well understood and are, in general, applied appropriately and consistently in an Australian context. As such, we don't see any significant need to increase the various thresholds or to complicate the tests by providing for the exclusion of certain assets. If such exclusions are deemed appropriate, they must be clearly defined and capable of sensible implementation. The desire to appropriately protect investors needs to balanced against the imposition of a prohibitive burden on the scheme promoter. - Urban Development Institute of Australia (UDIA)
Increase with caveates
The current values are not inappropriate, but it is a fault in the current legislation that there is no mechanism to adjust for inflation. Not to have such a mechanism diminishes the purpose and efficacy of the provision. In the case of Question 1, an adjustment for inflation could be on a biennial or longer basis and reflect CPI change over the period. I would be reluctant to consider greater than five years as CPI can increase sharply and lead to periodic distortions, but similarly in periods of low inflation one or two years is too short. In the case of Question 2, while CPI change is a simple method, it is imperfect for investors, issuers and advisers over shorter periods because of the effect of substantial market movements on investors' assets. For this reason alone, a period of longer than one or two years would be appropriate so as to allow some normalisation to occur. - Anonymous
Yes. In both instances. Current wage levels in many industries are significantly higher than in the 1990’s. Specific value increases are not something I feel competent to ascertain however if the category is to be retained, indexation to the national rate of inflation starting from inception of the income and asset tests should provide a more meaningful level of wealth. I am convinced however that the Wholesale Investor category set out in s761A of the Corporations Act is fundamentally flawed and allows many inappropriate investors to be fitted into a category where they are being denied proper disclosure and legal protection, both of which they in fact require and are due. In my opinion, the entire Wholesale Investor regime should be removed from the Law. I can see no real connection between a person’s wealth and their financial or investment sophistication or capacity to adequately assess the risks or potential benefits of investment proposals. Whilst I recognise that the original concept of the “Wholesale Investor” considered that they were investors who are “better informed and better able to assess the risks involved in financial transactions” therefore allowing them to participate in wholesale markets under a lighter touch regulatory regime because they are wealthy, I am certain that this assumption is wrong. However, that goal can be achieved with the current definitions of sophisticated and professional investor. The disconnect between implying the capacity to assess and analyse investment products is present because of some arbitrary wealth determination is fundamentally wrong and unnecessary. The best example I can imagine to support my view, is to consider the circumstances of a specialist medical surgeon and/or a non-finance based academic. In both circumstances, these example investors are very likely to earn in excess of the minimum amount to be categorised as a “wholesale investor” most likely will own in excess of the minimum net assets required and may also hold liquid assets in savings that allow a minimum initial investment of $500,000 as required. However, because their lives have been consumed in the learning of medicine or in attaining academic expertise in a chosen field, it is very possible that they have not acquired expertise in critically assessing an investment proposal. Obviously these type of investors must not be left to deal with investment decisions as if the principle of caveat emptor applied to them. They must be treated as retail investors due to their lack of investment sophistication. I have also often experienced managers of medium sized businesses who are not capable of analysing or assessing necessary parameters of investment offers despite their high level incomes and general business expertise. The wholesale investor category does not work and allows many investment offers to be made without proper disclosure and care as is required when dealing with vulnerable investors. Investors may proactively refuse to accept any advice about their investment intentions and rely solely on their own capabilities. They will however be unlikely to interact with any financial adviser when making their decisions. - Gavin Harrington
Increase the financial thresholds for the individual wealth test to either: • Increase to $5 million (including the family home) OR maintain at $2.5 million (exempt the family home) AND • Retain the gross income test at $250,000. • Improve the sophisticated investor test through regulatory guidance or a safe harbour. • Periodic review and no indexation. • Accompanying these changes should be a two-year transition and grandfathering of existing clients. - Financial Services Council
We consider that the qualified accountant’s certificate net assets and gross income tests remain justified by the policy reasons underpinning the FSR Bill. As with the product value test, we would support an increase to the financial threshold for the net assets test in line with CPI since 2001 or some other appropriate measure. We would caution against any significant increases to the financial threshold for the gross income tests, noting that $250,000 per annum remains a high wage in Australia. As with the product value test, we consider that there should be grandfathering to smooth the impact of these financial threshold changes and mitigate the disruption and inefficiency that would arise if existing investors were re-categorised as retail clients. We note that there is currently some confusion in the market as to: (a) how (if at all) the net assets and gross income tests should be applied to trustees; and (b) the meaning of control, particularly in the context of section 50AA of the Act. - Herbert Smith Freehills (HSF)
The current model tries to protect investors based on the definition of the skill of the investor (ie retail vs Professional Investor) and where the product is being distributed to (Design and Distribution Obligations (DDO) and Target Market Determination (TDD)). This approach has created significant red tape and puts the onus on the RE and allowed the investor to not take responsibility for their decisions and it does not assist most investors who need advice. We believe products should be split into Simple (short form offer documents (PDS/IM)) and Complex (long form PDS/IM) where, note simple wholesale products can still fall into the short form regime: Simple products = A managed investments scheme with no more than 5% of individual asset class and 25% in total in the asset classes of: shorting, derivatives (excluding FX hedging only), agricultural, property, illiquid, private equity, fund of funds and gearing. Complex products = All products that are not Simple products. No change is required in value if the model is changes to reflect the complex vs simple option, as this should ensure all investors are appropriately protected. - Harvey H Kalman
Our view is that raising the financial threshold for wholesale products could potentially limit access to sophisticated investment opportunities for smaller investors. By maintaining the current threshold, a diverse range of investors can continue to access products that may offer diversification benefits to their portfolios. We note that the current financial threshold test relies on set monetary values for net assets and gross income. However, these values can erode over time due to inflation. To address this, the thresholds could be adjusted periodically (for example, every 3 years) to account for changes in the cost of living and the purchasing power of money. The thresholds adjustments should be achieved by linking the financial thresholds to key economic indicators such as the consumer price index. This would automatically adjust the thresholds based on the prevailing economic conditions, ensuring that the test remains relevant and consistent over time. In conclusion, the financial threshold test for wholesale clients in Australia should remain as currently stated, with the potential to be adapted to take into account the impacts of inflation. - King Irving
Before considering the relevant monetary thresholds for the product value and individual wealth tests, the Committees submit that it may be worthwhile to consider whether these are appropriate tests in the first place, bearing in mind that the amount of funds a person has for investment will not necessarily be a reliable indication of their levels of education, knowledge, sophistication or financial literacy (as in some cases these factors may have had little bearing on how the person came to have the relevant quantum of funds available to invest). The Committees do not wish to propose specific net assets and/or gross income threshold amounts, as this is not strictly a legal issue. However, the Committees acknowledge that the proportion of the Australian population who meet the ‘wholesale client’ definition has increased significantly as a result of there being no indexation of the individual wealth test, coupled with increases in the value of real estate assets. Assuming that the wealth test will continue, then the Committees consider that, for future purposes, an uplift in the thresholds and ongoing indexation of the relevant net assets and gross income amounts would be appropriate. The Committees recognise that indexation of the dollar amounts could introduce complexity and uncertainty if adjustments were frequently made to align with changes in the national Consumer Price Index published by the Australian Bureau of Statistics (CPI). There could also be frequent inadvertent non-compliance. For simplicity, if indexation were adopted, the Committees suggest that: (a) the gross income threshold should be increased in $50,000 increments (e.g., where the threshold starts at $250,000 then, once CPI has increased by 20 per cent, the threshold moves to $300,000); and (b) the net assets threshold should be increased in $500,000 increments (e.g., where the threshold starts at $2.5 million then, once CPI has increased by 20 per cent, the threshold would move to $3 million). For ease of implementation and to limit any compliance burdens (e.g., to allow time for the accountant’s certificate templates to be updated), the Committees recommend that any changes to thresholds be introduced: (a) on not less than 12 months’ notice; and (b) to take effect at the beginning of a financial year (1 July). - Law Council of Australia
Incomes in Australia have not increased at any significant rate. A$250,000 for the past two years is still a very significant income and generally earnt in industries where the recipient has a degree of skill or knowledge that can be applied to assessing financial products for wholesale clients. The assets test is where clients have met wholesale criteria in the last 5 years in my view and is predominately a function of rising house prices. Putting a cap on the primary residence (wherever located) to A$1m would treat all investors equally and significantly reduce the number of persons qualifying as wholesale. If a restriction such as this was imposed the net assets test could stay at A$2.5m. - Stephen Smith
Our view is that better outcomes for investors are more likely to be achieved through investors becoming better educated about investment matters and as a consequence they will make better choices. We believe investors should educate themselves before investing, understand what they are investing in, seek appropriate advice and take responsibility for their choices. Increased regulation that provides too many safety nets for investors making poor choices will likely lead to poor outcomes. We are of the view that an “Accredited Investor “regime be established whereby if investors wish to invest in certain higher risk asset classes or investment strategies that they should be required to undertake a relevant course such as a RG 146 course and be accredited to invest in that asset class or investment strategy. ASIC would issue the investor with an accreditation number and when investing the investor provides proof that they are accredited. No dollar amount test can ensure that investors understand what they are investing in. All it can do is potentially minimize the impact of investment losses due to their other income or net assets. Should the thresholds be changed, we would suggest net assets of $2m excluding the primary residence and including their superannuation. The gross income amount of $250k per annum remains reasonable. - Vasco Trustees Group
Increase
We recommend that the financial thresholds for the product value and individual wealth tests used to classify wholesale clients should be increased to reflect inflation. The current financial thresholds have resulted in investors who may not have financial knowledge or experience, a high net worth by today's standards or a high-risk appetite accessing wholesale-only investments. This can present significant risks of harm. We also recommend introducing a statutory mechanism to periodically increase the thresholds over time, at least in line with inflation. Increasing the financial thresholds will better ensure that investors who are in substance retail clients are recognised as such and able to access the statutory protections that then apply. We do not consider that consent requirements are an effective means of ensuring that investors fully understand the consequences of being classified as a wholesale client. However, if consent requirements are introduced, they should be applied consistently across both the individual wealth and product value tests. - Australian Securities and Investments Commission
The financial thresholds for both the net assets and gross income tests should be increased, noting again neither threshold has been increased since implementation. The Joint Associations recommend that the net assets test should increase to $4 million to reflect the impact of increases in asset values, inflation and wages since the threshold was first introduced. It should also be indexed in line with AWOTE, but only increase in $250,000 increments. The gross income financial threshold should increase to $350,000 and indexed in line with AWOTE, but only increase in $25,000 increments. Both financial thresholds should have specific exclusions he wealth tests were originally included as high net wealth often accords with high financial literacy. However, correspondingly higher financial literacy likely results from actually dealing with financial products. High wealth in illiquid assets may not reflect a high level of comfort in financial assets by an individual. The individual’s principal place of residence should be excluded when determining their net assets for the purposes of the individual wealth test, as it is not an asset an individual should risk having to realise should their other investments fail. Further, for some individuals it may be their only significant asset and therefore arbitrarily inflate their financial wealth position or dealings with financial products. - Chartered Accountants Australia & New Zealand (CA ANZ), CPA Australia, the Institute of Public Accountants and the SMSF Association (the Joint Associations)
CHOICE supports adjusting the financial thresholds in the dollar-based tests to ensure that a relatively small proportion of people are eligible to be a wholesale client and that it is not widely accessible. - CHOICE Australian Consumers’ Association
At the very least, the thresholds for such classifications should be increased significantly. But a more fundamental and, I think, useful change would be to require that provision of such classification services could only be done by an entity which is not in anyway linked with the MIS either via contractual arrangements or by receiving commissions or fees from the MIS. I do not know whether there is any centralised database of individuals who have been accredited as being wholesale/sophisticated investors. If not, there may be merit in establishing such a regulatory (confidential) database (with compulsory reporting) such that the regulators can better identify over time what changes might be needed to the various thresholds and identify entities which may be inappropriately providing accreditation. - Kevin Davis Emeritus Professor of Finance, The University of Melbourne
There is merit in either increasing the net assets sum within the individual wealth test or removing the family home from the inclusion in the test. This would help to ensure that inappropriate assumptions are not made regarding the sophistication of an investor based on the growth in value of a passive asset that in all likelihood wasn’t purchased exclusively for investment purposes. - Equity Trustees
The FAAA recommends both the net asset value test and income tests be retained with the following amendments: • The Net Asset Value Test should: be increased and required to be indexed in line with AWOTE and increased in multiples of $5,000 increments every five years. o reflect the value of the Transfer Balance Cap (TBC), currently $1.9 million and associated indexation of this, applied to the individual (e.g. $1.9m); or doubled for a couple (e.g. $3.8m combined). This should be an alignment to the value and indexation of the TBC however, to avoid unintended consequences of government changes to the TPB on the wholesale test, it should not be formally tied to the TBC. to exclude the net asset value of the home (principal place of residence) - excluding the home is simple to do. Excluding the principal place of residence will not add complexity as it is exempt from CGT and a well-understood term by industry and consumers, which simplifies the classification for the purposes of the wholesale test. It also provides greater fairness in how the test is applied, considering the huge difference in house prices across the country. Excluding the principal place of residence from the wholesale test, removes the advantage some genuine wholesale clients have over others purely because of their location, as indicated by the ABS data above. • The Income Test should be: based on the individual’s income of the prior 2 years, based on the ATO’s income tax assessment of income o increased to $350,000. ndexed in line with AWOTE and increased in multiples of $5,000 increments every five years. The FAAA recommends the introduction of 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 to demonstrate qualification with the wholesale client wealth test, or if there are grounds to believe that the client does not understand the product(s) or the basis for being treated as wholesale. - Financial Advice Association Australia
We think that the individual wealth test should be similarly indexed such that the value is adjusted for CPI growth and reviewed every five years… Amending the threshold value of the individual wealth test as adjusted for CPI growth ensures a simple and effective means of ensuring that the individual wealth test is met by individuals with sufficient financial knowledge or means to obtain independent financial advice. Although some assets increase in value beyond CPI growth, we do not believe that there would be meaningful benefit gained by creating complex indexation to account for the real growth of an asset. This is further discussed below in relation to the primary residence. By increasing the threshold every five years, investors who are required to provide an accountant’s certificate every two years would understand the threshold requirement needed to continue to be classified as a wholesale client, and in the event that they do not have sufficient assets, this time frame would ensure that both the licensee and the individual have sufficient time to plan for the person to either divest their interests or cease receiving the financial service. - Hamilton Locke
Yes, recommend increase to net assets of $5 million and gross income to $400K per annum. - MSC Trustees (Melbourne Securities Corporation Ltd T/As MSC Trustees