Since the Global Financial Crisis (‘GFC’) hit in 2007, Australia has experienced debt market turbulence flowing from the US sub-prime crisis, together with successive interest rate increases and a cyclical softening in property markets. Mortgage schemes were not immune to the crisis with some schemes experiencing financial stress under these economic conditions, evidenced by a decrease in fund inflows and extensions of withdrawal periods or suspensions of withdrawals.

With large construction loans defaulting and the Government guaranteeing cash deposits at banks, credit unions and building societies, mortgage scheme investors wanted their money back. Pooled Mortgage Schemes were the hardest hit due to their offering of daily or monthly liquidity despite the fact that the Schemes were lent to property developers to be repaid over several years.

Large Pooled Schemes such as MFS Limited, City Pacific Mortgage Fund and LM First Mortgage Income Fund were unable to survive the impact of the GFC and have since collapsed. In 2012, Banksia Securities went into liquidation while holding $650 million on behalf of approximately 3000 investors. In fact, since 2007, one-third of all unlisted mortgage funds earmarked as "unrated" by a major agency have collapsed.

CONTRIBUTORY MORTGAGE SCHEME v POOLED MORTGAGE SCHEME

Since the collapse of the large pooled mortgage schemes, those who survived have come to realise the problems associated with pooling large amounts of investor’s money into the one fund. The Australian Securities and Investment Commission (‘ASIC’) describes the key difference between a pooled mortgage scheme and a contributory mortgage scheme as 'for pooled mortgage schemes, all investors’ investments and returns are linked collectively with a pool of mortgages, whereas for contributory mortgage schemes each investor’s investment and return is linked with the performance of a particular mortgage'.

Similar mortgage funds holding billions of dollars of ordinary investor funds have collapsed in recent years.

A CLOSER LOOK AT CONTRIBUTORY MORTGAGE SCHEMES

Generally, a contributory mortgage scheme is comprised of multiple sub-schemes. Members of the scheme invest in individual sub-schemes rather than the scheme as a whole. The scheme Product Disclosure Statement discloses generic information about all sub-schemes. Specific information, relating to each individual sub-scheme, is disclosed in Sub-Scheme Product Disclosure Statements for each sub-scheme (‘SPDS’).

Each sub-scheme derives its income by investing in a particular mortgage investment. A particular mortgage investment involves a single loan to a specific borrower (or group of co-borrowers) secured over real property. Thus, when members invest in a sub-scheme, they are investing in a mortgage investment and the SPDS discloses information specific to that mortgage investment. The result is that Investor’s contributions to a particular Mortgage Investment are quarantined within sub-schemes so that investors in each Sub-Scheme do not have recourse to the property held in other sub-schemes.

Contributory mortgage schemes provide the opportunity for the investor to take control of their investments and invest only in the particular sub-scheme that is appealing to them. They may decide they only want to invest in the Sydney market or perhaps South East Queensland. They may decide to invest in loans that have a Loan to Value Ratio of less than 60%. They may decide to stay away from construction loans. Whatever their investing strategy, the contributory mortgage scheme structure allows them to maintain control over their investments. With some schemes offering returns of up to 8% per annum, contributory mortgage schemes are attractive to savvy investors and those with self-managed super funds.

CURRENT REGULATION OF MORTGAGE SCHEMES

The offer of interests in mortgage schemes is regulated under the Corporations Act 2001 (Cth). Schemes must be registered with ASIC as a Managed Investment Scheme and be operated by a responsible entity which has adopted a scheme constitution and compliance plan. The responsible entity also must satisfy the requirements to hold an Australian Financial Services Licence (‘AFSL’) which includes having available adequate financial resources to provide the financial services covered by the AFSL.

Of particular importance is the mandatory Compliance Plan. The compliance plan for a scheme plays a key role in the range of measures designed to protect scheme members. Under the Corporations Act, a compliance plan must set out adequate measures that a responsible entity will apply to ensure that it complies with the Law and the scheme constitution: s601HA A Scheme’s Compliance Plan should list the key processes, systems and structures that the responsible entity will apply including the processes, systems and structures by which a responsible entity will continuously review how it is complying with its obligations under the Law and the scheme constitution.

A Compliance Committee with at least two external members oversees the Scheme’s compliance with the Compliance Plan and any significant breaches must be reported to ASIC. There are serious consequences for breaching a scheme’s Compliance Plan and from experience, ASIC will not register a founding compliance plan until they are satisfied that it adequately covers all areas required by the legislation.

WHAT MEASURES HAVE ASIC PUT IN PLACE TO AVOID THE LOSSES SUFFERED DURING THE GFC?

As large pooled mortgage schemes starting collapsing, ASIC focused their attention on the mortgage scheme market in general and they concluded that one of the major shortcomings was that the funds were failing to adequately disclose information to their investors.

Following consultation, ASIC released Regulatory Guide 45: Mortgage schemes: Improving Disclosure for Retail Investors (‘RG 45’). RG 45 aims to increase the level of disclosure to retail investors, by requiring schemes to provide retail investors with the information they need to make an informed investment decision.  At a minimum, disclosure against the benchmarks and the provision of the information in the disclosure principles is required.

Contributory mortgage funds increase the level of disclosure to investors by providing a SPDS with all of the information necessary to enable the investor to make an informed decision regarding their investment.

THE FUTURE OF CONTRIBUTORY MORTGAGE FUNDS

In the wake of the collapse of the pooled mortgage scheme market, the contributory mortgage scheme is rising in its place. Providing investors with a new alternative to the old way of thinking where their life savings were handed over to a large scheme to lend as they pleased, contributory mortgage schemes are giving back the control to the investor and allowing them to make their own investment decisions and ultimately keep control of their money.