Retail vs Wholesale Clients – Regulatory Concerns and Responses

While there have been some changes to the wholesale client eligibility criteria since the FSR regime commenced in 2004, there has been little recent appetite from regulators or the Government for a more fundamental reassessment of the distinction between wholesale and retail clients. Accordingly, the eligibility tests remain essentially the same as originally enacted in 2004.

This article looks at the regulatory issues and concerns which have arisen with the current legal definitions of wholesale and retail clients under the Corporations Act 2001 (the “Act”).

The distinction between wholesale and retail clients

Under the Act a person is either a wholesale client or a retail client in relation to a particular financial product or service.

Retail clients are considered by the law as less financially literate than their wholesale counterparts. While a basic level of regulation does apply to wholesale clients, the law requires financial services providers to meet a wide range of prescriptive disclosure, dispute resolution, training, product design and conduct requirements when dealing with retail clients that do not apply to wholesale clients.

The relevant provisions of the Act start from the position that clients should be treated as retail clients. If the advice relates to personal, motor vehicle and domestic types of insurance and superannuation products then this is always the case. For other products it is possible for the client to be treated as wholesale if they meet one of the eligibility tests – although some tests do not apply to all products and services.

There are five eligibility tests under which clients may be treated as wholesale (under sections 708 and 761G of the Act).  In short, this covers:

• Product Value – the product being invested in or advised on has a value exceeding $500,000;
• Individual Wealth – a person owning net assets of $2.5 million or having a gross annual income of over $250,000 shown over two financial years, as certified by an accountant;
• Professional Investors – a range of institutional investors with specific attributes;
• Large Businesses – having more than 20 employees – or more than 100 employees if the business is or includes the manufacture of goods; and
• Sophisticated Investors – persons that an AFSL holder has determined to be experienced in using financial services.

Concerns with the current distinction

The continuing increase in retail client regulation over recent years (such as the FOFA reforms, adviser professional standards, target market determinations and ASIC’s product intervention powers) together with the increasing ease with which clients can meet the wholesale client eligibility tests has led many financial services businesses to adopt, or consider moving to, wholesale only business models. Consequently, more and more clients are being provided with financial services without the benefit of the consumer protections that are provided for under the Act.

The Australian wholesale client system regards wealth as a proxy for financial literacy. This leads to some clients with low levels of financial literacy being treated as wholesale clients and, therefore, not receiving the enhanced regulatory protections which apply under the Act.

Set out below are some of the perceived problems with the current law:

• It allows some clients to be treated as wholesale without them having an appropriate (or any) level of financial literacy.
• There is not always a positive correlation between wealth and financial literacy. For example, a person may exceed the individual wealth thresholds simply by the receipt of a windfall gain such as an inheritance or winning a lottery.
• With increased earnings, escalating property values, increased superannuation holdings and the effect of inflation, the individual wealth thresholds are becoming increasingly accessible to a range of clients who would not have been considered to be “wealthy” in 2004.
• There is no mechanism for the periodic review of the product value or individual wealth dollar thresholds (the product value test threshold can be traced back to 1991).
• Tests based on quantification of wealth exclude clients who have the requisite level of financial literacy but not the requisite wealth (a good example being a FASEA compliant financial adviser).
• In most cases a client can be treated as wholesale without requiring their consent – or even knowledge.
• The eligibility tests are difficult to apply where assets are jointly owned (which commonly occurs in domestic relationships).
• A reluctance by AFSL holders to use the sophisticated investor test because of its subjective nature – with the resulting issues of conflict of interest, uncertainty and room for error in judgment which creates fear of later liability.
• Some of the eligibility tests have a business use criteria attached to them. In some tests this requires the product or service to be connected to a business use while in others it requires a non-business use. There is no guidance in the legislation as to what constitutes business use – which creates further uncertainty.

Regulatory uncertainty for SMSF clients

That said, it should also be noted that, where a financial service ‘relates to a superannuation product’, a trustee of an SMSF will be classified as a retail client unless the SMSF holds net assets of at least $10 million at the time the service is provided.  Accordingly, the meaning of the expression ‘relates to a superannuation product’ has become a key area of uncertainty when treating the trustee of an SMSF as a wholesale client.

In August 2014, ASIC issued Media Release 14-191MR which set out the following ‘no action’ position:

‘….where the trustee of an existing superannuation fund receives advice about how to invest the fund’s assets, ASIC will not take action if the person providing the advice determines whether the trustee is a wholesale client based on the general test mentioned above (e.g. if the trustee has net assets of at least $2.5 million), rather than applying the higher $10 million net asset test.  ASIC will adopt a similar approach to a trustee who subscribes for financial products on behalf of an existing fund.’

Following ASIC Media Release 14-191MR, it was generally accepted in the financial services industry that all of the wholesale client eligibility tests were available to an SMSF where the advice related to the investment of the SMSF’s assets (that is, the advice ‘relates to’ underlying securities, derivatives or real property, etc. – and not to superannuation itself).

However, AFCA has taken a narrower view of what ‘relates to a superannuation product’ means.  AFCA’s view appears to be that a financial service will ‘relate to a superannuation product’ (including an SMSF) where there is a connection between the financial service and the superannuation product.  AFCA has stated that the words ‘relates to’ have an extremely wide meaning and that ‘the phrase can refer to a direct or indirect connection between two subjects’.

AFCA’s position appears to be that, where financial services are provided to an SMSF that does not have at least $10 million in net assets at the time the financial services are provided, the individual wealth and sophisticated investor tests are inapplicable and the SMSF will be a retail client on the basis that the financial services provided to the SMSF ‘relate to a superannuation product’.

The different approaches taken by ASIC and AFCA in relation to this issue are, obviously problematic for advisers and product issuers dealing with wholesale clients.  In the absence of a Court decision on this point or legislative intervention, the ‘safe harbour’ position would be to treat SMSF clients as retail clients when providing them with financial services.

Regulatory responses

The Government issued an Options Paper on wholesale client eligibility in 2011. However, no particular action has resulted from it.

Somewhat surprisingly, there was no consideration of wholesale client issues at the Financial Services Royal Commission held in 2018. The topic didn’t appear to come up during the public hearings and was not mentioned in either the Interim Report or the Final Report.

Introducing indexation for the individual wealth and product value dollar thresholds would seem to be a fairly obvious regulatory response. However, doing so does not address the issues that arise from using wealth as a proxy for financial literacy.

Although they appear to have no current appetite to change the existing eligibility rules, the Government and ASIC have both taken steps in recent years to either restrict or modify the full application of the wholesale client rules in relation to particular products.

A particular regulatory focus has been in relation to restricting the use of the “sophisticated investor” eligibility test – it presently cannot be used for a number of financial products. The regulators seem to be increasingly wary of this test as it is presently worded. They appear to have two concerns with the concept:

• that product issuers are “exploiting” the test to “circumvent” the retail client protections; and
• that sophisticated investors are not regarded as having requisite knowledge of “complex” financial services.

The first concern is not without some foundation as the eligibility decision can be a self-serving one for the AFSL holder making the assessment. As to the second concern, the same criticism can be made of the product value and individual wealth tests.

There are also indications that, rather than providing a wide ranging regulatory exemption for wholesale clients, a basic level of regulation might apply in the future to wholesale clients with “additional protections” applying to retail clients. This approach can be seen in the crowd-sourced equity funding rules.

Alternatively, the regulators might require that a client who is otherwise eligible to be treated as wholesale must:

• initiate a request to be treated as wholesale; or
• only be treated as wholesale with their prior, informed consent.

Just because you can doesn’t mean you should

It should also be noted that ASIC has also been increasingly invoking the “efficiently, honestly and fairly” AFS licence condition to impose an ethical overlay over the conduct of financial services businesses.

It is certainly possible that ASIC might invoke that licence condition against an AFSL holder who was perceived to be “exploiting” the eligibility tests to classify financially illiterate clients as wholesale.

In effect, ASIC would be taking the view that just because you can classify a client as wholesale doesn’t necessarily mean that you should.

Practical measures to take in relation to wholesale clients

If you presently have a wholesale client model or are considering moving to one we recommend that you:

• contact us to obtain legal advice on whether and how wholesale client eligibility applies to your products and services – the legislative provisions are complicated, not easy to find and involve many exclusions and exceptions;
• be careful in how you assess and evidence wholesale client eligibility and make sure that you implement controls to ensure that it is maintained (for example, accountant’s certificates need to be renewed every 2 years);
• carefully consider whether it is appropriate to treat individual investors as wholesale clients based purely on their level of wealth – some assessment of a client’s level of financial literacy would also appear to be prudent.

Require further assistance?

Holley Nethercote Lawyers are well experienced in assisting with all aspects of wholesale client issues.

Author: David Court (Partner).

This article was written in 2020, reviewed and updated in 2025.