I want to start by acknowledging the Traditional Owners, the Dharug and Gundungurra people and by paying my respects to Elders past and present.

It’s really good to be back at the Researcher Forum to talk about some of ASIC’s priorities.

Before doing so, I just want to [inaudible] at another event a few weeks ago.

I was speaking to a room of financial literacy educators, and I made the observation that when it comes to financial decisions, people making those decisions are always at a disadvantage.

They always know less about the products and the risks involved than the people on the other side of the transaction.

And that’s true across financial services, but it’s particularly true when it comes to investments, which is why the topics that we’re discussing today are so important.

Even the most sophisticated of investors are reliant on the expertise – and the integrity - of others when making major investment decisions.

And advisers, researchers, advice licensees, fund managers all play a role, either directly or indirectly, in influencing how investors choose to invest their money and in the outcomes that they ultimately enjoy.

So, it’s important, as the theme of today’s forum suggests, that we have ‘world-class’ investment governance and research in Australia.

That what ASIC expects and in pursuing this expectation, our key focus, of course is on minimising the risk of harm to consumers and investors, and you’ll see this reflected across our priorities.

There are two in particular that I’d like to talk about today, and they’re both enforcement priorities – some that we are backing up with serious action through the courts.

The first of those is holding those responsible for the Shield and First Guardian collapses to account.

And the second is to crack down on poor practice in private credit.

Pursuing accountability for Shield and First Guardian

Let’s start with Shield and First Guardian – partly because they’re collectively one of our biggest things that ASIC is working on right now - and that will be the case for some time - and partly because they’ve got implications for everybody working in the advice and investment ecosystem.

If you wonder why it’s relevant to you, the numbers should make it clear.

With more than 11,000 investors impacted and close to $1 billion of retirement savings put at risk, it’s the most egregious example of consumer harm that I have seen in my time at ASIC.

And the people affected are Australians who were trying to do the right thing by their retirement savings but were instead lured into switching their super into high-risk investments.

People like Gary, who’s in his early 60s, looking forward to retirement^[1].

He was aware that his existing super fund wasn’t performing as well as it had been, and with that knowledge, he was contacted by a comparison site, which put him on to a financial adviser who set him up with a self-managed super fund and invested all his funds into First Guardian.

As things stand today, he stands to lose almost $700,000.

Or Juan^[2], a 41-year old at risk of losing his entire super, after being convinced to roll all his savings into First Guardian.

These are shocking stories, and unfortunately there are thousands like them.

Each of them involves financial losses, but each of them also involves a very human cost.

And there is a long chain of participants involved:

• Lead generators, including data brokers and telemarketers
• Financial advisers, and financial advice firms
• Superannuation trustees like Macquarie, Equity Trustees, Diversa and Netwealth
• Research houses
• Auditors
• And of course, the fund operators themselves.

We believe all hold some degree of culpability.

Now ASIC has been very clear that our first priority in these matters has been to preserve assets so that they can be recovered for investors while our investigations are continuing.

And in our work so far, we’ve:

• issued stop orders to prevent ongoing harm
• obtained asset-freezing orders
• sought the appointment of receivers and liquidators
• obtained travel restraint orders
• cancelled financial services licenses
• and banned financial advisers.

We’ve, of course, commenced proceedings against Macquarie, Equity Trustees, Interprac Financial Planning, and SQM Research.

In a significant win for some investors, Macquarie has committed to repaying investors 100% of the net cash they invested in Shield through Macquarie’s wrap platform.

Importantly for those in the room today, our action against SQM Research is the first we have taken against a research house.

It is our view that SQM Research prepared reports containing misleading representations and its processes fell short of expected standards when it published “favourable” ratings for Shield.

More generally though, it’s our view that research houses should serve as gatekeepers against poor quality investments or unsuitable products.

They need to do all things necessary to go about their work efficiently, honestly and fairly. And they need to avoid issuing ratings or commentary that can’t be justified by evidence.

In addition to the proceedings I have already mentioned, we are also seeking leave to commence proceedings against MWL Financial Services, a former MWL director and Imperial Capital Group – a lead generator – for allegedly operating a scheme resulting in hundreds of clients investing superannuation into Shield.

So all up, at this point in time, we have 10 separate Federal Court proceedings against 18 defendants, and there is more to come.

As I mentioned, holding those responsible for the collapse of the Shield and First Guardian Master Funds to account is one of our enforcement priorities - and our investigations are ongoing.

While this has all got quite some time to play out, there are some lessons to be learned now. 

I mentioned at the outset that Australians are dependent on the chain of financial experts behind their investments - advisers, research houses, investment platforms, superannuation trustees and advice licensees.

When every part of the chain fulfils its role – with its multiple layers of knowledge, expertise, duties and obligations – the system works exactly as it should.

Investors can be confident that they will be offered products that are safe, and appropriate for them and their financial goals.

But when there are failures in that chain – far too often it is investors who pay the price.

The failures involved in Shield and First Guardian have highlighted some potential regulatory gaps across that chain.

These include:

• the regulation of lead generators, whose activities may not be adequately captured by the anti-hawking provisions
• the super switching process
• the obligations of super trustees who provide platform products;
• and the regulation of managed investment schemes, which ASIC has previously identified as a priority for reform.

We welcome the Government’s commitment to exploring sensible reforms that can better protect consumers in the future, and we’re committed to working with the Government to identify what would be most effective, based on what we’ve learned during our investigations to date.

Improving practices in private credit

I’ll now move on to private credit.  

In talking about this topic, I want to say that ASIC recognises that private credit – done well – plays an important role in the financial system.

It’s an important source of funding for sectors that are under-served by the traditional banking sector, and it provides diversification and choice for borrowers and investors alike.

According to one estimate, private credit in Australia is now valued at more than $200 billion^[3] and while that amount is not systemically important, the same source estimates that it’s grown 500 per cent[4] in the past 10 years.

And with increasing investment in private credit via superannuation, that growth seems likely to continue.

That’s why it’s important that we are alert [inaudible] to the potential risks.

In terms of those risks, a significant one is that in Australia, we have a high concentration of private credit lending to the property sector, including loans to higher risk development and construction.

Over time, this could amplify the system-wide vulnerability related to residential property identified by APRA in last month’s system-wide stress test.  

Private credit at current volumes is untested in a stress scenario and we’re already seeing a wide variance in practices across the sector which is why ASIC is taking an interest.

A lack of transparency across the sector is a key concern.

Australia lags behind peer regulators and peer countries in terms of the data that we as a regulator have access to.

We have neither the breadth, depth, or frequency of data needed to monitor and supervise retail and wholesale funds confidently. 

Countries like Singapore, Canada, and the UK with similar regulatory frameworks have greater access to more reliable and recurrent data on private markets, including private credit.

And given that our domestic private credit growth outstrips that seen in many of these countries, we’d like to see this data gap addressed to enable ASIC to more confidently supervise funds.

As you would know, earlier this year, we undertook a surveillance of 28 retail and wholesale private credit funds to understand how fund managers are managing the risks that underpin investor confidence and market operation, and we released the findings of that surveillance a few weeks ago.

We did observe a range of practices, including some better practices, but we also identified some areas of concern.

Key areas for improvement include governance and transparency; fees and interest rates; valuation methodologies; liquidity; and credit management.

I’ll just focus on three today that may be relevant to many in the room because they’re key to how researchers understand and evaluate private credit funds.

They are:

• The use of terminology
• Fee and interest disclosure; and
• Valuations

Terminology

Starting with terminology.

We found market-wide inconsistencies in terminology that make it really hard for investors to compare the nature and risks of private credit funds.

Fund operators and investment managers defined and applied terms such as ‘default’ and ‘investment grade’ differently - so simple terms like ‘default’ – a range of definitions.

Such inconsistent use of terms makes it hard for investors to meaningfully understand what they’re investing in or compare loan default or arrears levels across funds.

There are also variabilities in how funds describe their underlying assets.

Some funds primarily categorised their assets using terms that describe the ranking or seniority of the security – for example ‘first mortgage’ and ‘mezzanine’.

Other funds categorised their assets with reference to direct lending, securitised loans or the use of funding – for example ‘commercial real estate development’.

Concerningly, we found that asset descriptions sometimes failed to include clear information that would help investors understand the risks of the assets held by a fund.

For example, a failure to disclose that loans will fund higher-risk real estate construction and development. Or that the fund primarily invests in unsecured loans.

Again, this inconsistency makes it difficult for investors and advisers to accurately compare funds and make informed choices about what products they are investing in and the risks associated with them.

The adoption of consistent industry terminology -- or at least a clear explanation of key terms -- would be an important step towards greater transparency for investors, and we welcome some of the industry commitments to work on that issue. 

Fee and interest disclosure

Transparency was also an issue when it came to fee and interest disclosure.

Of the 28 funds we reviewed, only four published information about the interest rates or range of interest rates charged to borrowers.

If these rates are disclosed, investors are better able to judge the riskiness of the investment.

Conversely, where borrowers pay fees on top of interest that are not disclosed, this masks a clear signal about the level of risk involved in the lending.

In our review, only two retail funds quantified the interest earned from their assets and borrower fees and disclosed the retained amounts as part of their wider management fee in the product disclosure statement.

Only one wholesale fund passed on to investors the full economic benefits of interest earned from its assets and income earned from borrower fees.

To enable investors to better assess the true cost of investing in a fund, fund managers and trustees should disclose all revenue they earn in connection with their funds.

Clear and effective disclosure to investors enables them to understand what they are paying for, directly and indirectly, and to better judge whether they are being appropriately compensated for the associated risk.

Valuations

And the final area of private credit that I wanted to touch on is valuations, which is pretty core to the whole thing.

Investors obviously rely on fair valuations to assess performance and make informed investment decisions.

Private assets in particular are subject to heightened valuation risks, due to infrequent trading and limited opportunities for price discovery.

Many of the private credit funds that we looked at were open-ended funds, with regular monthly or quarterly redemption periods.

And for open-ended funds in times of stress, failure to adjust valuations in a timely manner could allow some fund members to exit at a higher price, at the expense of the remaining investors.

Some of the poor valuation practices we observed involved infrequent valuations, incomplete or absent valuation policies, insufficient independence [inaudible] and inconsistent approaches to valuing collateral.

Where valuations are not accurate, reliable, timely or comparable, this raises serious questions about the ability of investors – and indeed researchers – to assess the performance of a fund.

So having touched on those three areas in a bit more detail [inaudible] our report outlines ten guiding principles for private credit ‘done well’ – what we think that looks like in Australia.

They cover areas like terminology, fee disclosure and valuations – those three areas, as well as other areas like design and distribution, organisational capability, liquidity and governance.

Now each of these principles [inaudible] is grounded in the law. And we will be monitoring how well private credit funds adhere to them.

I mentioned earlier, this is an enforcement priority and in line with that, as you would know, we’ve already issued stop orders on several target market determinations and one PDS due to poor disclosure and distribution.

And in instances of more egregious conduct, we may take more serious action, and we have commenced some enforcement investigations in this area.

Looking ahead, we also announced the second phase of our private credit surveillance.

On the retail side, this surveillance will look at disclosures of fees and margins, and the distribution practices of private credit funds to retail investors, with a specific focus on the adviser channel. 

We want to understand how retail private credit funds are distributed and, when distributed through advisers, to test the quality of the advice that they provide.

On the wholesale side, there are plans to look at fees, margin structures and conflicts of interest in the management of wholesale private credit funds, with a particular focus on real estate lending.

Through that ongoing program of work, which will hopefully be complemented by industry standards, we hope that private credit will be increasingly done well in Australia, with benefits to individual investors and the broader economy.

Conclusion

I mentioned at the start that ASIC is focussed on minimising harm to consumers and investors.  That’s a responsibility that we all share.

Whatever role you play in the investment ecosystem, you can help to ensure that consumers who engage in investing, within or outside superannuation, are presented with products that are safe, appropriate, and aligned with their best interests.

And when that occurs, it doesn’t only mean better outcomes for individuals. It’s fundamental to building and maintaining trust in the system overall.

 

[1] First Guardian, Shield superannuation disasters expose deep flaws in Australia's $4.3 trillion retirement system - ABC News

[2] First Guardian collapse leaves thousands at risk of losing super as ASIC freezes director assets - ABC News

[3] REP 814 Private credit in Australia

[4] REP 823 Advancing Australia’s evolving capital markets: Discussion paper response report | ASIC

Editor's Note:

This speech was re-published on 3 December as checked against delivery.