The imminent shift from MDAs to managed portfolios

It is widely known that ASIC’s rules which currently govern MDAs – arrangements that allow an MDA operator to manage a client’s portfolio on a discretionary basis, without the need to obtain the client’s authority each time a trade or change is made – will expire in mid-September.

Exactly what will replace them remains to be seen. However, it appears likely there will be two major changes. One of these probable changes involves a substantial increase in the capital requirements for groups that operate MDAs.

ASIC may align the rules that apply to MDA operators with the much stricter rules that apply to managed investment scheme operators. If an operator that is not providing custody and depository services has revenue above certain thresholds, it may be required to hold a minimum of $5 million in net tangible assets – effectively capital.

In contrast, the Financial Services Council has argued that, for an MDA operator that is not providing custody and depository services, the minimum capital should be between $150,000 and $2 million depending on the revenues and/or clients’ assets. This represents a significant increase in the capital that must be held by an MDA operator.

The other expected change, when ASIC finalises the new rules, is that limited MDAs will cease to exist.

Limited MDAs operate under a limited power of attorney from the client, and have been in existence since 2004. They have provided significant practice efficiencies by allowing advisers to regularly rebalance client portfolios (as opposed to a broader range of investment decisions enabled by an MDA) held on regulated platforms without the need to seek instructions from the clients each time by way of a Record of Advice or Statement of Advice.

However, limited MDAs have the disadvantage of not being clearly provided for in regulations; also, they potentially lack the necessary safeguards for clients.

Time for an alternative business model

The new rules will likely have serious implications for many existing operators of MDAs. Some 160 or so holders of Australian Financial Services Licences that operate MDAs will have to meet new capital requirements. Many may well struggle to do so.

Advice practices that rely heavily on limited MDAs for efficiency will be faced with rethinking their entire business model. If they do nothing, they may need to return to issuing a Record of Advice every time they look to rebalance a portfolio. This will reintroduce significant costs and inefficiencies previously removed from their business.

Fortunately, there is an attractive alternative for such groups: managed portfolios (also known as SMAs or managed accounts). Managed portfolios, which are accessed through a platform operating an investor-directed portfolio service, managed investment scheme, or superannuation structure, can deliver the benefits and efficiencies of an MDA or limited MDA. Moreover, they do so without the need for the adviser to hold an MDA operator’s licence and to comply with the corresponding capital requirement that is anticipated to be introduced by ASIC shortly.

Under this structure, the platform operator appoints a third-party portfolio manager to run managed portfolios, which clients can access through their platform account. Changes made by the portfolio manager will generate buy and sell trades within the client account which are automatically implemented without the need for a Record or Statement of Advice.

In essence, this type of arrangement gives the adviser all the advantages and efficiencies of limited MDAs. It also gives current MDA operators an alternative solution to continuing to operate their own MDA and becoming subject to onerous capital requirements.

Functionality and flexibility remain key

Advisers who move to managed portfolios can benefit from the flexibility and the functionality offered by the particular platform that they choose to work with.

Hub24’s platform, for instance, offers highly scalable but customised client outcomes, where advisers can set personal client preferences and dynamically manage tax outcomes without any manual intervention into the process, meaning optimised client outcomes and practice efficiency.

Nested managed portfolios are also available within Hub24’s platform, meaning portfolio managers can create ‘portfolios of portfolios’, leveraging to the fullest extent the cost-efficient and tax-effective trading within managed portfolios.

The benefits of managed portfolios – both to the adviser and to the end client – are substantial and are becoming better understood in Australia. In addition, the recent surge in growth will drive further benefits that flow from increased scale.

With the likely end of limited MDAs and the increased capital requirements of MDAs, the implementation of ASIC’s new regulatory approach could see the largest market shift to fully-implemented managed portfolios via platforms as advisers seek efficiencies in the delivery of superior client investment outcomes.

Jason Entwistle is director of strategic development at Hub24