By Mark Bland, Partner and Geoffrey McCarthy, Special Counsel 

This fortnightly update is designed to help superannuation trustees track and manage regulatory change. We look ahead to forthcoming developments, look back at recent changes and then consider the impact on trustees. This edition’s spotlight is on the Federal Government’s “Your Future, Your Super” reforms package announced in its budget.

Key developments

• 6 October – Government announced Your Future, Your Super
• 6 October – APRA have commenced applying their new Supervisory Risk and Intensity (SRI) model
• 5 October – FASEA published a draft Financial Planners & Advisers Code of Ethics 2019 Guide for consultation.

Looking ahead

The House of Representatives is to sit on October 19 to 22 and 26 to 29.  Senate Budget Estimates hearings are to be held from 19 to 30 October with Treasury in the week from 26 October.

Looking back

15 October – APRA publishes a letter sent to trustees about the requirements for APRA approval for changes of controlling stakes. A person generally has a controlling stake if with their associates they have 15% of the voting power in the trustee.

14 October – The Payment Times Reporting Act was enacted which together with the Payment Times Reporting (Consequential Amendments) Act 2020 established a scheme under which requires enterprises with an annual total income of over $100 million must publicly report on their payment terms and practices in respect of a small business supplier.

14 October  – APRA’s Annual Report 2019/20 published.  The report discusses the use in supervision of APRA’s Heatmap noting that it continues to discuss underperformance with Trustees that are ‘red’.  APRA claims that significant fee reductions have come from its use of the Heatmap.

14 October – Senator Hume addressed the Association of Financial Advisers Virtual Conference.  She noted the timetable is now mid 2021 for legislation for FASEA Code disciplinary body.

12 October – APRA Deputy Chair Rowell gave a speech about alignment between APRA’s focus and “Your Future, Your Super”.  She supported the underperformance test proposals, noting alignment with APRA’s Heatmap and indicated the Heatmap publications application for 31 December 2020 may be affected.

7 October – ASIC publishes an article  stating that super funds benefit from strong protective whistleblower policies. The article refers to ASIC’s guidance RG 270 Whistleblowing policies and includes comments on what ASIC expects of Trustees including a positive and open environment to ensure an effective whistleblowing regime.

6 October – The Government announced in the budget a package of reforms to superannuation as discussed below, including:

• Stapling super accounts
• YourSuper comparison tool
• Superannuation accountability and transparency
• Annual performance tests.

6 October – APRA announced they have commenced applying their new Supervisory Risk and Intensity (SRI) model to replace PAIRS and SOARS to assess risk relating to prudentially regulated bodies.  The new model is more tailored by industry sector and in relation to superannuation will include cyber risk, operational resilience, governance, culture, remuneration and accountability and member outcomes.

5 October – FASEA published a draft Financial Planners & Advisers Code of Ethics 2019 Guide for consultation seeking comments by 2 November 2020. The draft guide provides an explanation of the intent and application of the Code’s values and standards and includes information in question and answer format.

1 October – APRA published FAQ 14 on whether personal contributions can be accepted from persons aged 65 to 74 on Jobkeeper.  APRA considers that Trustees can accept personal contributions in this situation.

On the horizon spotlight – Your Future, Your Super

In its 2020/21 budget, the Government announced its “Your Future, Your Super” reform package of proposals, with an aimed commencement date of July 2021. The four reforms are:

• Stapling super to the member
• YourSuper comparison tool
• Annual performance test
• Increased transparency and accountability.

APRA has said it will be working closely with the Government, ATO and ASIC on the detailed implementation plan for the Budget reforms. APRA will also be considering the changes that may be needed for its priorities and work plan, including potential changes to the MySuper Heatmap. Ms Rowell has said she considers APRA’s expanded data collection under the Super Data Transformation program will be critical to the implementation of the reforms. The new data collection standards are proposed to be effective from 1 July 2021 with reporting due in September 2021.

Stapling super accounts

This initiative implements a Royal Commission recommendation that a person should have only one default account. It also reflects recommendations of the Productivity Commission. Employers are to be required to pay SGC to an employee’s existing super account rather than the employer’s default fund if the employee has one and does not nominate a different fund.

Impact

The stapling of super accounts measures are unlikely to require changes to a trustee’s compliance arrangements however it will greatly impact its marketing strategies.

Funds who are existing default funds for industries which typically employ young people, such as retail and hospitality will be in a strong position, as will funds with effective marketing strategies to Millennials.

It is not clear how this will intersect with the Superannuation Choice reforms made in September 2020 which open up choice to employees under EBAs signed from 1 January 2021, in particular whether it only applies where an employee actually has the right to choose a fund.

YourSuper comparison tool

The Government will develop an interactive online comparison tool which will provide a table of MySuper products ranked by fees and investment returns, provide links to super fund websites to choose a MySuper product and show a member their current accounts to prompt a consolidation decision.

The YourSuper comparison tool will:

• Display a quarterly updated table of MySuper products ranked by fees and investment returns, with products that have not met the new higher performance standard clearly highlighted as underperforming.
• Link to the fund’s website when the individual can select a product from the table of MySuper products.
• Show the individual’s current superannuation accounts and allow them to select one of their existing superannuation accounts.
• Prompt to consider consolidating accounts if the individual has more than one fund.

The YourSuper comparison tool will be based on information that superannuation funds report to APRA and will be developed in consultation with the Treasury.

Impact

This is unlikely to require any changes to a trustee’s compliance procedures but is expected to accelerate the exercise of choice of funds and consolidation of accounts. High performing funds may co-opt the comparison tool as a marketing tactic.

Although references to fees appear not to be limited to investment fees and costs, the annual performance testing metric does appear to be limited to investment fees and costs.  Further if fees and costs that are effectively charged by a dollar amount or other measure not based uniformly on assets under management, it is not clear what assumption would be used to develop the disclosed amount and therefore the ranking.

Annual performance testing

To date the most controversial reform in announced in the “Your Future, Your Super” reforms in the Budget is the introduction of annual performance testing of some superannuation products.

The initiative follows Productivity Commission recommendations to take measures to deal with underperforming funds with priority to MySuper products. Accordingly, MySuper products will be subject to an annual performance test by 1 July 2021.

If a fund is “underperforming” against prescribed index benchmarks, the same as those used for the APRA MySuper Heatmap set out below, its Trustee will need to inform its members of this by 1 October 2021 and let members know about the YourSuper comparison tool.

“Underperforming” funds will be denoted as such on the YourSuper comparison tool. Funds that fail two consecutive “underperformance tests” will not be permitted to accept new members.

By 1 July 2022, annual performance tests will be extended to certain Choice superannuation accumulation products. The affected Choice products are ‘trustee directed products’ (TDP).  These are APRA regulated products where the trustee has control over the design and implementation of the investment strategy and the strategy covers more than one asset class.

Performance will be judged based on returns after tax and investment related fees, costs and taxes relative to a benchmark. The performance test will be based on the methodology used for APRA’s ‘Heatmap’. Products that underperform their net investment return benchmark by 0.5 percentage points per year over an eight-year period will be classified as underperforming. The indexes used, fee and tax rate assumptions used in the Heatmap for each asset class are as follows on Page 37, here.

Impact

The Government envisages the initiative will reduce the extent that members will be in poor performing products. As part of APRA’s supervision, trustees of funds that are underperforming and closed to new members will need to justify how they are meeting their obligations to existing members if they do not merge or improve their performance.

Any “underperforming” fund risks a run on the fund which could be extremely disadvantageous for remaining members. Members caught in shrinking funds may face higher costs and bear the impact of capital gains tax arising as affected assets are realized. Trustees of funds that are likely to be underperforming will need to be aggressively (but prudently) pursuing mergers as directors risk personal liability if remaining members suffer significant losses as a result of an increase in costs as the fund winds down.

The proposed measures have some important limitations that could influence the operation of funds and might at least to some degree detract from the achievement of the Government’s objective and have unintended consequences, discussed below.

Administration fees

Despite the Government’s references to fees and costs, the exclusion of administration fees creates an incentive to charge fees and costs as administration fees rather than investment fees and costs. These could mean that members are making decisions without considering their net returns, and in particular may conceal the impact on members with larger balances paying administration fees largely on a percentage basis.

The exclusion of administration fees puts this metric of “underperformance” out of sync with PDS and dashboards which are the current tools used to ensure consumers are able to compare funds. Members with low balances may be encouraged by the Comparison Tool to move to a funds with high administration fees but strong investment performance and as a result be worse off.

Index tracking

As the measures are based on indexes of traded financial products and assets, asset allocations which include other assets or which deviate from index weightings have a greater risk of varying from the index measure.  The proposals would involve particularly adverse consequences for products that are measured as underperforming.  As a result there will be an incentive to hold more assets in line with the relevant indexes.

This is particularly acute with such assets that are classified as “Other” and assets which have limited correlation with the specified indexes.  For example, investments in unlisted infrastructure vehicles in Australia may not be well correlated with the FTSE Developed Core Infrastructure Index hedged to AUD.  Private equity investments and unlisted property are unlikely to be well correlated. In addition, such assets may have long pay offs which mean in the short-term the measure of performance will be reduced by these investments and so may not be favoured by trustees concerned they may be considered underperforming in the early years.

There may also be cascading economic effects arising from trustees potentially being incentivized to more heavily weight their investments in indexes and out of unlisted infrastructure and private market investments. Although such investments represent only a portion of super investments, with superannuation assets in MySuper totaling $731 billion as at the end of the June 2020 quarter and likely to continue to grow, even reducing the small piece of that pie in such investments over coming years could have some impact on the cost of capital for such investments.  As the arrangements start to apply to TDP products, the impact would be more significant.

Some of these concerns might be alleviated by introducing separate absolute return comparators for unlisted infrastructure and private equity investments.  Conceivably measures could also accommodate a more appropriate measurement in light of their lumpy net returns rather than annually comparing returns with index benchmarks.

While for many products, the arrangements may incentivize index tracking and asset holding of assets in the index the impact of the measured outcome is not linear in terms of the pay off to the trustee or fund.

Incentives are not linear and may impact on risk

The proposal may have an impact on trustees of funds at risk of being considered underperforming to try to increase their performance measure through riskier investments including by taking an active management stance in search of alpha.  While this might be disadvantageous to the funds concerned, trustee might rationalize that it is in accord with their duties in light of the adverse impact on members of being in a fund that is publicly defined as underperforming.

There is also the possibility of there being a significant marketing premium for being the best or one of very top measured performance outcomes. Such funds may attract more choice investment and be more likely to be accepted as a successor fund.  This could incentivize more active or risky investments, since the benefit of a fund going from say the 70^th percentile to the 95^th, could exceed the disadvantage of going down to the 50^th percentile in ranking.  Again, trustee may rationalize that to do so is in the best interests of members in view of the potential to gain scale advantages.

New products

Particular issues will also arise for new products, where comparison would be affected by the increased variability of the shorter measured horizon.  This would create additional risk for non index tracking TDP products.  It may be considered not necessarily undesirable to discourage establishment of new products.

Accountability and transparency

Trustees will be subject to new obligations designed to reduce costs to give effect to a recommendation of the Productivity Commission. These measures include:

• Trustees will be required to comply with a new duty to act in the best financial interests of members.
• Trustees will have to establish that there was a reasonable basis to support their cost-incurring actions as being consistent with members’ best financial interests, which will not be subject to a materiality threshold.
• Trustees will need to provide members with key information regarding how they manage and spend their money in advance of Annual Members’ Meetings.
• Anti-avoidance provisions will apply to ensure payments from the superannuation fund to a third party (including an interposed or a related entity) do not undermine the intent of the change.
• A key area of focus is likely to be marketing and sponsorship arrangements.

It is not clear how the ‘anti-avoidance’ provisions will work. A recent use of this mechanism related to conflicted remuneration in the FoFA reforms to the Corporations Act. It prohibited any scheme for the “sole purpose or for a purpose (that is not incidental) of avoiding the application of any provision”.  This is different to the “sole or dominant purpose” formulation under tax laws and is potentially broader by catching something that has a purpose that is less than “dominant” but more than just “incidental”.

Impact

There is a question of how this new duty to act in the best financial interests will sit with the existing trustee duties to act in members’ best interests and to promote their financial interests as well as the sole purpose test.

Trustees will be required to implement greater measures of accountability of expenditure and greater levels of disclosure to members in Annual Members Meetings.

Reversing the onus of demonstrating compliance with this duty means that rather than the regulator having to prove a breach of this new obligation, trustees will have to prove that they are complying with it in expenditure down to the cent as there will be no materiality threshold.

Combined with the robust liability framework for directors, boards will be compelled to require a robust delegations framework, including reporting on use of such delegations as part of a Trustee’s business plans and expenditure management under APRA Prudential Standard SPS 515.

Many trustees spend money on advertising or contribute to collective bodies for advertising. The Your Future Your Super package includes a case study on advertising, indicating there may be a requirement for hard data in a Trustee’s basis for the advertising spend.

Similarly, a ‘reasonable basis’ will be required for sponsorships or payments to bodies affiliated with political parties (such as unions or employer associations) for promotion to members (employees or employers) and access to them at conferences.

More generally expenditure on providing clearer disclosures, customer service or good usability of websites, might require move evidence to be documented demonstrating that whatever its benefits in terms of making members more informed, more content and saving them time, such steps were in the member’s best financial interests, rather than more generally their best interests.

The extraordinary amount of additional work in demonstrating a reasonable basis, and providing relevant disclosures, will come at a cost, which itself may detract from the best financial interests of members.

While the initiative might be supported by the taxation benefits afforded to superannuation and the desire the benefits be used for its intended purpose, they sit oddly with indications of a more general recognition in the community that companies and their directors must consider a range of stakeholders, and not restrict their perspective only to what is in the best interests of company shareholders.

The requirement to document the justification for every cent that is spent will be challenging to trustees, which invest over a long time horizon. Trustees will need to have a clear strategy relating to environmental, social and governance considerations in investments and their operations so that executives make expenditure decisions with confidence. The politicisation of ESG considerations, with the Government criticising trustees for engagement with companies and global governments on climate change, is an interesting context for these changes.  Trustees will need to make decisions on whether it is their job to be ‘noisy’ and ‘belligerent’ on issues such as climate change.