Understanding the risk

ASIC has completed its review of unlisted property scheme disclosure, writes Greg Bell, and responsible entities need to check their current scheme’s adherence to the benchmarks and changes in disclosure principles:

The GFC highlighted a gap in the understanding by some investors of the risk/return nature of their investments. After a long period of sustained positive returns across the market, many “mum and dad” investors had become complacent to the point of ignorance regarding the potential risks within their investment portfolios.

This gap was particularly prevalent in unlisted property schemes, where a significant amount of time was spent by fund managers explaining risks to disgruntled investors that had already been outlined within the product disclosure statement (PDS).

In response to this issue, ASIC performed a review of over 260 unlisted property schemes and the adequacy of disclosure under the existing RG46. In preparing Unlisted property schemes – improving disclosure for retail investors (RG46), ASIC consulted with number of industry and professional bodies and fund managers. The Property Council was a major contributor and prepared a submission on the subject.

The results of the review and consultation process were released by ASIC in March 2012. The updated RG46 has significantly closed the gap on the clarity of potential risks and comparability between property schemes.

The existing RG46 required responsible entities to disclose information on eight disclosure principles in the PDS and then half-yearly, including:

1. Gearing ratio
2. Interest cover ratio
3. Scheme borrowings
4. Portfolio diversification
5. Valuation policy
6. Related party transactions
7. Distribution practices
8. Withdrawal arrangements.

The key changes to RG46, which will come into effect on November 1, 2012, will need to be addressed by responsible entities (REs) in their PDS and half-yearly disclosures to investors. These changes are:

• Introduction of six benchmarks (see Table 1)
• Amendments to seven existing disclosure principles (see Table 2)
• Removal of valuation policy disclosure principle (replaced by a valuation benchmark)
• Introduction of a new net tangible assets disclosure principle.

ASIC has adopted the ASX “if not, why not” approach to disclosure of the six benchmark requirements. If the scheme does not meet the requirements of a benchmark, then the RE will need to state that it does not comply with the requirement and provide an explanation as to how and why the RE deals with the underlying issue in an alternative way.

Originally, ASIC had proposed that a written policy for levels of gearing and interest cover would need to be at an individual asset level, not individual credit facility.

The Property Council submission argued successfully that it would be more relevant and efficient for REs to assess gearing and interest cover for properties at a loan facility level.

In addition, the Property Council submission suggested that distributions be paid from cash from operations rather than the ASIC’s original proposal, which would have used “realised income” as the benchmark for distributions. Cash from operations was considered a more tangible method of benchmarking distributions as there is no clear definition of realised income. The benchmark does not preclude a scheme from making distributions if there is no cash from operations; instead the benchmark allows a retail investor to understand the source of the distribution, for example, capital or cash from operations.

Under the valuation policy benchmark, REs will need to consider the costs and ability of adhering to the benchmark, particularly when the directors consider that there has been a significant movement in the property value on a regular basis. As was seen during the GFC, when there was a decline in property values over a sustained period of time, this could result in multiple independent valuations being required to meet the benchmark. In such circumstances, the REs may need to take a practical approach.

ASIC updated the disclosure principles in line with these six new benchmarks. Some of the notable changes are identified in Table 2.

The Property Council submission emphasised the need for consistency amongst development schemes on the key milestones in a development project:

• Settlement of land
• Planning approval
• Construction commencement
• Construction completion
• Sales settlement
• Project ends.

Net Tangible Asset (NTA) Disclosure Principle

One of the key recommendations in the Property Council’s submission was the need for closed-ended schemes to disclose the value of NTA per unit on a pre-tax basis.

NTA per unit was commonly applied to open-ended schemes, however this practice was being inconsistently applied to closed-ended schemes across the sector. The new requirement is intended to allow retail investors an appropriate comparison between schemes.

Action plan

Given the quantum of changes in the updated RG46, REs should review their current scheme’s adherence to the benchmarks and changes in disclosure principles as soon as possible and well before the November 1 implementation date.

ASIC will be performing reviews of unlisted property schemes for compliance with RG46 from this date. Typically, ASIC does not provide a list of who is selected for review or when the review occurs. If there is an issue with the disclosure, be prepared to receive a “please explain” letter.

Table 1: Six new benchmarks

Table 2: Amendments to seven existing Disclosure Principles

Greg Bell is senior manager – audit and assurance at BDO Australia