Black Holes in the Wholesale Universe – The risks of wholesale funds

Article written by InvestNow

In April this year another obscure subterranean fund surfaced into public view as a likely ponzi scheme.

As further details came to light, it emerged that Penrich Capital, operating from a Christchurch base had sunk investor assets into a Cayman Islands-domiciled fund, allegedly valued at about $400 million.

The Serious Fraud Office (SFO) is currently investigating the firm, headed by Kelly Tonkin, but investors in the Penrich Global Macro Fund face the strong prospect that their money has all-but disappeared into the Caribbean.

While Penrich attracted clients from across the world, a significant number of local investors – including an elite Auckland girls’ college – have been caught up in the scandal.

Unfortunately, investors in the Penrich fund will have to fight on without much help from the NZ investment sector regulator, the Financial Markets Authority (FMA), to get to the bottom of the mystery. 

Like many other investments in the NZ market, the Penrich fund was structured as a wholesale offer, exempting it from the strict disclosure and investor protection rules applying to retail products as defined in the Financial Markets Conduct Act (FMC).

What’s the big deal anyway?

The FMC brought much-needed clarity to the NZ investment market when the law came into force for fund managers in 2016.

Under FMC, only licensed managed investment schemes (MIS) providers can offer products to retail clients. And all MIS-issued products come with comprehensive disclosure requirements (with all documents published on the Disclose website, for example), regular reporting obligations, strong governance rules and ongoing oversight from the FMA.

Wholesale funds, however, can simply carry a disclaimer that the FMC rules don’t apply.

The FMA itself noted in a 2019 report: “Wholesale funds and their custodial arrangements are not regulated (other than being subject to the fair dealing provisions of the FMC Act) in New Zealand. As such, the FMA has very little sense of the size, structure, practices or risks in this sector.”

Black holes, grey areas and red flags

By the regulator’s own admission, then, wholesale funds have created a huge black hole at the centre of the NZ regulatory universe.

Undoubtedly, the wholesale FMC exemption is useful for truly sophisticated, professional investors to streamline market processes.

But current NZ law allows a much wider population of investors to shelter under the wholesale umbrella – you only have to be a bit rich. In fact, there are four ways to qualify as a ‘wholesale investor’, namely as an:

  • investment business – such as MIS managers;
  • investment activity – defined as owing, or dealing in financial products worth at least $1 million during the last two years;
  • large investor – with net assets, or turnover, of $5 million or more during the last two year; and.
  • eligible investor – or a person with self-declared experience in buying and selling financial products.

The ‘eligible investor’ option, in particular, opens up a murky grey area in the law, allowing almost anyone into the wholesale arena – although there are supposed to be some safeguards where a lawyer, registered accountant or authorised financial adviser signs off on the declaration.

As the Penrich case (and the many others before it) shows, while entering the wholesale world is relatively easy, it’s not always so simple to leave.

Even before falling into the SFO investigation, Penrich had waved a few red flags for investors. In 2015, for instance, the fund was cited for asset valuation problems by a retirement scheme that had invested in Penrich. The Cayman Islands domicile of the Penrich product might be considered another early warning signal for investors.

Or perhaps the wholesale fund designation should serve as a giant red flag for most individual NZ investors.

All funds on the InvestNow platform are retail products, offered by NZ-based MIS providers or Australian-regulated managers (which share retail compliance rules across the Tasman).

InvestNow general manager, Mike Heath, said retail investors deserve the highest level of protection available under the law.

“We want all the products on InvestNow to be ship-shape,” Heath said. “Otherwise, investors remain vulnerable to Caribbean-based pirates and other wholesale losses.” 

Some helpful resources:

Black Holes in the Wholesale Universe – The risks of wholesale funds

Article written by InvestNow

In April this year another obscure subterranean fund surfaced into public view as a likely ponzi scheme.

As further details came to light, it emerged that Penrich Capital, operating from a Christchurch base had sunk investor assets into a Cayman Islands-domiciled fund, allegedly valued at about $400 million.

The Serious Fraud Office (SFO) is currently investigating the firm, headed by Kelly Tonkin, but investors in the Penrich Global Macro Fund face the strong prospect that their money has all-but disappeared into the Caribbean.

While Penrich attracted clients from across the world, a significant number of local investors – including an elite Auckland girls’ college – have been caught up in the scandal.

Unfortunately, investors in the Penrich fund will have to fight on without much help from the NZ investment sector regulator, the Financial Markets Authority (FMA), to get to the bottom of the mystery. 

Like many other investments in the NZ market, the Penrich fund was structured as a wholesale offer, exempting it from the strict disclosure and investor protection rules applying to retail products as defined in the Financial Markets Conduct Act (FMC).

What’s the big deal anyway?

The FMC brought much-needed clarity to the NZ investment market when the law came into force for fund managers in 2016.

Under FMC, only licensed managed investment schemes (MIS) providers can offer products to retail clients. And all MIS-issued products come with comprehensive disclosure requirements (with all documents published on the Disclose website, for example), regular reporting obligations, strong governance rules and ongoing oversight from the FMA.

Wholesale funds, however, can simply carry a disclaimer that the FMC rules don’t apply.

The FMA itself noted in a 2019 report: “Wholesale funds and their custodial arrangements are not regulated (other than being subject to the fair dealing provisions of the FMC Act) in New Zealand. As such, the FMA has very little sense of the size, structure, practices or risks in this sector.”

Black holes, grey areas and red flags

By the regulator’s own admission, then, wholesale funds have created a huge black hole at the centre of the NZ regulatory universe.

Undoubtedly, the wholesale FMC exemption is useful for truly sophisticated, professional investors to streamline market processes.

But current NZ law allows a much wider population of investors to shelter under the wholesale umbrella – you only have to be a bit rich. In fact, there are four ways to qualify as a ‘wholesale investor’, namely as an:

  • investment business – such as MIS managers;
  • investment activity – defined as owing, or dealing in financial products worth at least $1 million during the last two years;
  • large investor – with net assets, or turnover, of $5 million or more during the last two year; and.
  • eligible investor – or a person with self-declared experience in buying and selling financial products.

The ‘eligible investor’ option, in particular, opens up a murky grey area in the law, allowing almost anyone into the wholesale arena – although there are supposed to be some safeguards where a lawyer, registered accountant or authorised financial adviser signs off on the declaration.

As the Penrich case (and the many others before it) shows, while entering the wholesale world is relatively easy, it’s not always so simple to leave.

Even before falling into the SFO investigation, Penrich had waved a few red flags for investors. In 2015, for instance, the fund was cited for asset valuation problems by a retirement scheme that had invested in Penrich. The Cayman Islands domicile of the Penrich product might be considered another early warning signal for investors.

Or perhaps the wholesale fund designation should serve as a giant red flag for most individual NZ investors.

All funds on the InvestNow platform are retail products, offered by NZ-based MIS providers or Australian-regulated managers (which share retail compliance rules across the Tasman).

InvestNow general manager, Mike Heath, said retail investors deserve the highest level of protection available under the law.

“We want all the products on InvestNow to be ship-shape,” Heath said. “Otherwise, investors remain vulnerable to Caribbean-based pirates and other wholesale losses.” 

Some helpful resources:

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