When establishing a new private equity fund, investors and fund managers require a robust understanding of the governing legal and regulatory framework. This can be challenging given the complexity of legal, regulatory and compliance requirements. Throughout this two-part series, we cover the fundamentals of private equity fund formation in Australia. This is the second of a two-part series in which we outline the key regulators, registration and licensing requirements for different funds, and the restrictions on offers and the sale of fund interests.
If you would like to understand what fund structures are available for private equity investment and how they may impact your investment strategy, you can read more here.
Who are the principal regulatory bodies?
ASIC has authority over private equity funds including MITs, AMITs, and CCIVs within Australia. The Australian financial services licencing regime provides that fund operators and managers that hold an Australian financial services licence (AFSL) must prepare and lodge audited accounts available to the public, comply with compliance standards under the Corporations Act and hold adequate financial capital at all times.
In addition to the financial capital requirements, a licensed entity must also have organisational capacity and relevant experience with dealing in and advising on securities to which the AFSL relates. These requirements set out detailed tests that need to be satisfied by the persons responsible for the day-to-day management and operation of the relevant fund.
Industry Innovation and Science Australia (IISA), the Department of Industry, Science, Energy and Resources and the Australian Taxation Office (ATO) jointly administer the VCLP and ESVCLP regimes.
The Australian Tax Office is another key regulator in the private equity space, investors and fund managers can access attractive tax benefits under the Income Tax Assessment Act 1997 (Cth) and Income Tax Assessment Act 1936 (Cth) (Tax Laws) where they meet the requirements.
What registration and licensing is required to set up a PE fund?
Managed investment schemes
The requirements for private equity funds will differ depending on the type of investor they are targeting. Funds for institutional and wholesale investors have limited registration requirements compared to those targeting retail investors. In recent months, ASIC has contemplated raising the financial threshold to be considered a wholesale or sophisticated investor. However, the proposal is currently on hold. If this does go ahead, this could impact the disclosure obligations a fund has when raising capital from investors who will no longer be considered sophisticated investors. You can read more about the anticipated changes here.
Those operating a registered managed investment scheme must hold an AFSL to operate the scheme.
An AFSL has conditions attached that must be complied with. This includes having sufficient organisational capacity, and technological and financial resources to run the fund. There is also a minimum standard that each responsible manager operating under the AFSL must have knowledge and experience that is relevant to the securities that they are in dealing in and advising on.
An AFSL holder must satisfy the financial condition that the scheme operator has at least $10 million or 10 percent of its average revenue in net tangible assets (whichever is greater), unless for each registered scheme, the scheme assets are held by a licensed custodian who has the financial resources to do so, or another prescribed exception applies such as being an ‘incidental provider’. These conditions involve extensive tests that need to be satisfied by those involved in the everyday management and operation of the scheme.
Unless otherwise relying on applicable licensing exemption, AFSL authorisations are also required to take certain actions such as issuing and redeeming interests in the scheme, investing in scheme assets, and to give financial product advice about the scheme.
Consequences of conducting a financial services business in Australia without proper authorisations are severe and obtaining an AFSL from ASIC can take several months so it is worth planning early if a licence is required (and an exemption from the requirement to otherwise hold an AFSL cannot be relied on (for example, acting as an authorised representative on another licensed entity’s AFSL)).
CCIVs
The CCIVs corporate director must hold an AFSL to operate the business and conduct its affairs. Both wholesale and retail CCIVs and their sub-funds must be registered with ASIC. Along with the AFSL requirements, retail CCIVs must comply with stronger regulatory requirements than its wholesale counterpart.
What are the key regulatory differences between a CCIV and a registered managed investment scheme?
The key regulatory differences between CCIVs and managed investment schemes (MIS) structured as a unit trust are:
| Wholesale CCIV | Managed investment schemes (unregistered) | Retail CCIV | Managed investment schemes (registered) | |
| Legal personality | Yes – company | No, rely on the trustee to conduct commercial affairs on their behalf | Yes – company | No, rely on the trustee to conduct commercial affairs on their behalf |
| Financial product | Share | An interest within the MIS (e.g. unit) | Share | An interest within the MIS (e.g. unit) |
| Sub-funds required | Yes | No, currently create multiple classes of units to create a similar effect of sub-funds but risk cross-class liability. | Yes | No, currently create multiple classes of units to create a similar effect of sub-funds but risk cross-class liability. |
| Segregation of assets and liabilities | Yes, separated by each sub-fund | No absolute segregation | Yes, separated by each sub-fund | No absolute segregation |
| Fund operator | Corporate director which must be a public company | Trustee | Corporate director which must be a public company | Responsible entity, which must be a public company acting as the trustee |
| Prescribed constitution requirements and rules about its modification | No | No | Yes, ASIC can direct the corporate director to modify the constitution | Yes |
| Constitution legal status | Statutory contract between the CCIV, the corporate director, and each member. | Trust deed (constitution) between the trustee and the beneficiaries (unit holders) | Statutory contract between the CCIV, the corporate director, and each member. | Trust deed (constitution) between the trustee (responsible entity) and the beneficiaries (unit holders) |
| Compliance committee and plan required | No compliance plan or committee required. | No compliance plan or committee required. | No compliance committee required, but at least half of the directors within the designated corporate director must be external directors. A compliance plan is required. | Yes, a compliance committee is required where less than half of the responsible entity’s directors are external directors. A compliance plan is required. |
| ASFL required | Yes | Generally yes, unless an exemption applies. | Yes | Yes |
| Issue price rules | No | No | No | Yes |
| Dividend distribution and redemptions – solvency test required | Yes, distributed and redeemed based on solvency test. | No test applies for dividends and redemption. | Yes, distributed and redeemed based on solvency test. | No test applies for dividends and redemption. |
| Related party transactions | Related party transaction rules do not apply. | Related party transaction rules do not apply. | Related party transaction rules apply. | Related party transaction rules apply. |
Limited partnerships
Those wanting to establish an incorporated limited partnership must register with their State or Territory and meet the requirements under the relevant State or Territory partnership legislation. VCLPs and ESCVLPs must also meet the requirements under the Venture Capital Act 2002 (Cth) to be registered with the IISA to enjoy the tax benefits given to these structures.
Foreign investment
A foreign investor may be subject to Australian foreign investment legislation and be required to obtain approval from the Foreign Investment Review Board (FIRB) to invest into an Australian private equity fund. The recent increases to Australia’s foreign investment fee regime signal that foreign investors must be aware of incoming government measures that may impact potential investment opportunities, you can read our latest alert here.
What are the legal and regulatory restrictions on offers and sales of private equity fund interests?
As a starting point, an AFSL is required where the manager of a private equity fund would like to give financial product advice or issue financial products to Australian investors. Depending on the circumstances, ASIC can provide an exemption to this requirement.
The Corporations Act allows the manager of a private equity fund to make offers without disclosure of key information about the fund including fees, benefits, and risks of investing, to issue interests to wholesale, institutional, and professional investors. As mentioned above, it will be important to consider whether your targeted investors will still meet the ‘sophisticated investor’ threshold, and the implications of this if the changes go ahead. Where the manager of a private equity fund would like to make an offer to retail investors, a prospectus or product disclosure statement is required to be issued and registered with ASIC.
It remains best practice to give an information memorandum regardless of the ASIC requirements to investors which will cover similar content to a prospectus or PDS. As discussed above, retail CCIVs also have more thorough disclosure requirements than its wholesale counterparts. Additionally, when dealing with retail investments, the fund will need to be registered and the fund manager must meet additional licensing and financial requirements.
Other laws that must be complied with when offering interests in private equity funds include:
- restrictions on issuing or selling financial products, such as interests in a managed investment scheme, on an unsolicited basis;
- the treatment and use of confidential or personal information;
- identity verification under anti-money laundering legislation; and
- restrictions on conduct of banking and insurance businesses, including an overall prohibition against engaging in misleading or deceptive conduct in providing financial services or relating to a financial product.
What does this all mean?
As a part of fund formation, there must be careful consideration of what legal, licencing, and regulatory requirements must be fulfilled. Once established, each fund will have its own set of ongoing compliance and reporting requirements, and when making business and strategy decisions, funds will have to ensure that they act accordingly. ASIC can take enforcement action over improper conduct, not meeting disclosure obligations, and misadministration of the fund.
Next steps
We act for both new and established funds management, venture capital and private equity firms across Australia. Our corporate advisory and tax teams can help you establish your new fund.
If you would like an overview of the available types of fund structures, you can read our article here. When you are preparing to establish your fund, please get in touch with us if you would like to discuss a suitable fund structure that will work to your advantage. We can also help you understand your regulatory and compliance obligations under Australian law, including registration and AFSL requirements, tax treatment, and foreign investment strategies into Australia.