3 options for LMDA arrangements

When it comes to replacing Limited MDA arrangements, advisory firms have three key options to consider if they hope to satisfy the changing demands of investors and the regulator, says David Heather.

Advisers currently using Limited MDA (LMDA) arrangements and reviewing their investment management and portfolio administration options need to think carefully about the type of business they’re likely to be running in the future.

In September 2016, ASIC announced it would remove the right for advisory firms that use the 2004 no action letter to provide LMDA arrangements.

There’s also mounting pressure on advisers to add greater value through improved portfolio management, in the prevailing volatile, low income environment.

Now that ASIC has removed the ability for an advisory firm to manage client portfolios under a LMDA arrangement, there are three options for advisers who want to build an efficient, profitable and sustainable business.

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David Heather 
Chief Executive Officer
Managedaccounts.com.au

Firstly, they can apply to ASIC for a licence authorisation to provide MDA services to retail investors, in which case they must satisfy the regulator’s competency, compliance and financial requirements.

Alternatively, they can partner with an experienced, specialist MDA provider.

What is a Limited MDA?

MDA arrangements for retail investors can, and do, exist where an adviser is not authorised to provide MDA services under their licence.

A large number of industry participants provide MDA services to retail clients using a ‘no action’ letter issued by ASIC in 2004. This provision allowed certain MDA arrangements to occur in regulated platforms if a licensee’s Financial Services Guide was amended and a contractual arrangement was implemented between the licensee and the client.

This is commonly referred to as a Limited MDA arrangement.

The no action letter came about because the Financial Services Council argued that unlike ‘full service’ MDAs, many advisers primarily used discretion to rebalance managed fund portfolios via a wrap platform, which took care of administration, custody and reporting. It successfully argued that it wasn’t clear whether they needed to be licensed or not.

Some believe a potential third option is to run client portfolios via a separately managed account (SMA) structure. For those who plan to go down the SMA route and wish to continue managing portfolios, there are a number of potential shortcomings.

A SMA may not suit advisers who want the ability to tailor client portfolios, use less liquid assets, access all corporate actions, exercise voting rights, use discretion when rebalancing client portfolios, and control execution through their brokers of choice.

On the other hand, SMAs may be an efficient way for advisers who have relatively unsophisticated clients to implement a standard portfolio for a large number of investors.

This article examines the two key options available to advisers who want to provide a MDA service.

Key consideration for gaining MDA Operator authorisation

  • AFSL authorisation requires Responsible Manager experience
  • MDA contracts, FSG and other compliance documents need to be developed
  • PI Insurance needs to recognise MDA services
  • Additional auditing
  • Custody arrangements need to be in place
  • Potential future capital obligations imposed by ASIC
  • Re-documenting the client
  • Need for a retail super solution


Option 1: Gain a licence authorisation to provide MDA services

Advisory practices that want to become an MDA provider must gain an AFS licence authorisation to provide MDA services for retail investors.

MDA providers are required to prove they have the competence, procedures and resources to provide MDA services.

LMDA arrangements that were previously provided through a regulated platform may need reworking. Regulated platforms providing custodial services to MDA providers will need to be engaged in a different way. This is particularly the case when it comes to contracting for custody and processes like managed fund trading where pooling provisions, which is the ability for each investor to meet minimum investment requirements in a PDS, need to be met.

That’s arguably the easy part.

Some advisory firms may look to implement their own administration arrangements or outsource to specialist managed account administrators. This may require new software providers and custodians, or alternatively a specialist administrator who provides outsourced technology and administration solutions.

That may sound simple but unfortunately for boutique MDA providers, the majority of custodians won’t deal with smaller MDA providers for commercial reasons. Furthermore, specialist administrators providing custodial services as part of their solution need to have $10 million in capital to provide a custodial arrangement and many don’t meet this requirement.

Then there’s professional indemnity insurance.

Advisory firms looking to provide their own MDA arrangement can expect PI premiums to jump, assuming they can get cover at all.

ASIC believes MDA services need to be regulated in a similar way to RE arrangements, given the risk to retail investors, which is why tougher licensing conditions apply to advisers who provide MDA services.

PI insurers generally agree, particularly where a MDA provider is providing advice to clients, managing the client portfolio and undertaking administration in-house.

Finally, advisory firms need to also consider the additional regulatory and compliance obligations, including ASIC’s proposed increased capital requirements.

ASIC announced it would continue to review the capital requirement for MDA providers, potentially increasing NTA of 0.5 per cent of FUA up to $5 million, even if administration and custody are outsourced.

The retail super dilemma

Some advisers believe they can run a limited MDA arrangement for retail super investors but the MDA structure is not recognised in super.

The trustee is king in super and it’s the trustee’s role to appoint an administrator, custodian, investment manager and adviser.

In order for advisers to manage retail super money with discretion, they need to be appointed as an investment manager by the super fund’s trustee and comply with APRA’s outsourcing rules. Effectively, they become a funds management firm.

That means advisers currently managing retail super money under a limited MDA arrangement should be issuing a record of advice (RoA) for every portfolio change.

Advisory firms can compliantly manage retail super assets with discretion by partnering with an MDA provider with a retail super solution.

Option 2: Partner with a licensed MDA provider and administrator

For the majority of small licensees and practices with LMDA arrangements, this represents the most practical, low risk option because they can implement a compliant MDA service relatively quickly without a large capital outlay.

By partnering with a specialist MDA provider, advisory firms can outsource administration, custody and responsibility for the overarching compliance of the MDA structure, while retaining responsibility and ownership of the strategic advice and portfolio management functions.

Some providers build bespoke solutions for firms, so that the solution is customised for the advisory firm.

This option enables advisers to focus on providing advice and managing portfolios without the need to meet onerous regulatory obligations or continuously invest in costly systems and infrastructure.

Under this type of arrangement, an MDA provider typically appoints an advice business as a portfolio manager, under a formal investment management agreement.

Prior to appointment, advisory firms must demonstrate that there’s a strict governance framework in place, including documented policies and procedures and an experienced investment committee with independent members.

If an advisory firm manages their own portfolios, which will be the case under a LMDA arrangement, advisers will seek to add value by ensuring clients don’t overpay for assets as far as possible, and conversely achieve the highest price possible when selling.

To do that, they need the ability to take advantage of timely opportunities, manage money with discretion and execute trades efficiently to better control the investment outcome, including the ability to move to a competitive cash solution when assets become overvalued.

Even if an advisory firm chooses to outsource all or part of the portfolio management function to a third party professional manager, asset consultant, broker or research house (as many do), they’re still responsible for setting the strategy, making sure it’s appropriate for the client, ensuring it’s properly implemented and electing to replace underperforming appointed parties.

Where a practice doesn’t have a formal investment framework, the right MDA provider can help them put one in place.

David Heather is Chief Executive Officer of Managedaccounts.com.au

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