The government’s indicated timeline of ‘early 2024’ for Treasury to deliver findings on the review of the regulatory framework for managed investment schemes has passed. An inquiry by the Parliamentary Joint Committee on Corporations and Financial Services into the wholesale investor test closed at the end of May 2024 and intends to report to the Parliament by the end of 2024. While calls continue to circulate for changes to the wealth tests in the Act (otherwise known as the wholesale investor test), the government has indicated that any action on these two reviews is not for this term of government. With an election next year looming, however, a new term of government will see this issue come onto the agenda.

The individual wealth test is the one most popularly used to categorise clients as wholesale. Clients categorised as wholesale clients under this test are also referred to as high-net-worth clients or (confusingly) sophisticated investors. However, the sophisticated investor test is a separate test in the Act. This article deals with the individual wealth test, where the monetary thresholds are set at $2.5 million in net assets, or gross income for each of the last two financial years of at least $250,000 per annum. The clients meeting this test are referred to as wholesale clients.

Why are there calls for changes?

The legislated definition of ‘wholesale investors’ has remained unchanged since 2002 when only 1.8% of the population qualified, estimated at ~12% in 2018 and is expected to rise to 43% in the next two decades if no changes are introduced. The growth in this designation has impacts for AFSL providers and for consumer protections.

The classification of wholesale investors has become increasingly relevant as more clients meet the criteria due to rising incomes and property values. While the Treasury report on the review of the regulatory framework for managed investment schemes (MISs) looked at the application of the wholesale investor test within the narrow prism of MISs, the calls for reforms surrounding the classification of wholesale clients generally are not going away. The inherent AFS licensee implications make it a critical issue for financial advisers to monitor and understand.

Why some advisers prefer “wholesale investors”

For clients, being classified as wholesale offers access to exclusive investment opportunities not typically available to retail investors, such as unlisted bonds, pre-IPO stocks, and venture capital. Advisers and wealth management institutions benefit from reduced compliance costs and the potential to work with wealthier clients more willing to pay fees.

This distinction is designed to provide greater consumer protection to retail clients, who are deemed to have lower financial literacy, through robust disclosure, dispute resolution, product design, and conduct requirements. However, these clients forfeit significant protections, including the right to certain disclosures, dispute resolution services, and compensation for adviser breaches. These distinctions leave room for potentially harmful oversights in advisers’ day-to-day operations, such as the distribution of Financial Services Guides (FSG) and communicating retail client rights not available to wholesale clients.

The simple act of providing a Financial Services Guide to a wholesale investor could have a significant financial and regulatory impact for the adviser and and/or the wealth management institution should a client and/or the regulator take matters further for an investment strategy ‘not performing’ or simply appearing to ‘educate’ a client about the investment vehicle.

Regulatory bodies including the Australian Securities & Investments Commission (ASIC), Australian Financial Complaints Authority (AFCA) and the Compensation Scheme of Last Resort (CSLR) are determined to ensure that advice given to clients does not cross the boundaries of retail and wholesale investors. The blurring of these lines will undoubtedly be amplified if and when legislation is passed that effectively reclassifies investors if measured only by the asset test should that be lifted from the current benchmark.

Net assets of $2.5 million or an annual income of $250,000 for the past two years, certified by an accountant.

ASIC and AFCA have highlighted concerns about advisers misclassifying clients as wholesale investors to bypass retail protections, leading to inappropriate risk exposures for financially unsavvy individuals. Proposals to address these risks include increasing and indexing asset thresholds; excluding non-investable assets like the family home; and requiring explicit opt-in mechanisms. Some advocate for knowledge-based assessments similar to Singapore's Customer Knowledge Assessment to ensure true financial sophistication.

The implications of wholesale clients transitioning to retail status are multifaceted and necessitate careful navigation of regulatory complexities, proactive client engagement, ongoing compliance considerations, and adherence to ASIC guidelines. As the industry adapts to the evolving regulatory landscape, collaboration, transparency, and a commitment to compliance will be instrumental in ensuring continued financial resilience and prosperity.

2025 Federal election

The reforms from Prime Minister Anthony Albanese’s Government intend to action recommendations of Hayne Royal Commission for review of the classification requirements — a topic front of mind for ASIC, AFCA and AFS licensees. Regulated entities should be alive to present remediation programs concerning record retention, signalling the current attention to these issues from the regulator. While the government has indicated that no changes will be made to the individual wealth tests prior to the Federal election in 2025, preparation for the real potential for change post the 2025 election is crucial for the implications for AFSL policies, procedures and compliance.

Key considerations

The terms "sophisticated investor" and "wholesale investor/client" are not synonymous, not just because of the confusion between the two tests, but also because the introduction of the FASEA Code of Ethics in 2020 added complexity, requiring advisers to assess clients' financial literacy beyond merely holding an accountant's certificate. According to the Code advisers have ethical expectations for client documentation and communication; however the current distinction between retail and wholesale clients convolutes expectations and adds unnecessary ethical complexity to adviser conduct. The key high level Ethical Standards include:

acting in the best interests of clients
avoiding conflicts of interest
ensuring that clients give informed consent and understand the advice they receive
ensuring that clients clearly agree to the fees they will pay
maintaining a high level of knowledge and skills.

For some products, even wholesale investors must be treated as retail clients. Self-Managed Super Funds (SMSFs) can meet the wholesale investor criteria if the trustees of the fund have net assets of $2.5 million or an annual income of $250,000. However, in multi-member funds, especially where control is equally shared, determining eligibility can be challenging.

Preparing for the future state

It’s imperative investment advisers and stockbrokers are aware of their current regulatory obligations and client-facing systems and processes as they prepare for upcoming regulatory changes in the medium term.

AFS licensees should prioritise internal operational and compliance consolidation to ensure they are equipped to respond effectively to this significant external framework reform that is anticipated post the 2025 federal election.

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