Reforms that will significantly change the super industry 14 min read
If anyone was worried the superannuation regulatory reform agenda for 2021 was not busy enough, you needn't be – the Government has introduced the Treasury Laws Amendment (Your Future, Your Super) Bill 2021 into the House of Representatives. The Bill proposes a number of reforms that will significantly alter the shape of the industry. And while there have been a number of changes since the exposure draft materials released late last year (discussed here), they're not necessarily improvements.
As a refresher, the 'Your Future, Your Super' package includes three key reforms:
- introduce a new annual test for 'underperformance' of products (with dire consequences for failing that test in two consecutive years);
- amend the current best interests test applying to the conduct of trustees and directors to a 'best financial interests' test, with trustees 'enjoying' a special reversed burden of proof; and
- require employers to make contributions for new employees from 1 July 2021 onwards to each employee's 'stapled fund'.
There's also a surprise bonus (of sorts) in the Bill that was not in the exposure draft materials – the removal of the '5%' exception to the portfolio holdings disclosure requirements.
Below is our round up of the Bill, how it compares to the exposure draft and what this all means for the super industry.
A new Part 6A – Annual performance assessments is proposed to be introduced into the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act). The key amendments would be to:
- require APRA to conduct an annual performance test each financial year on MySuper products and certain other products to be specified in regulations (which the EM suggests will include products where the trustee has control of the investment strategy), starting on or after 1 July 2021 for MySuper products and on or after 1 July 2022 for any prescribed products;
- allow the regulations to specify requirements or other considerations in respect of the detail of the performance test (meaning the detail on arguably the most important aspect of the regime is deferred to regulations, which have not yet been released);
- require trustees to notify beneficiaries who hold a product of a 'fail' determination of that product within 28 days after receiving notification from APRA;
- where a 'fail' determination is received from APRA for a second consecutive financial year, prohibit trustees issuing an interest in that product (ie this will apply to new members to the fund, whether default members or otherwise, and existing members moving to the product), unless and until APRA lifts the prohibition;
- introduce more trustee covenants to bolster the above obligations – being covenants for the trustee to meet its requirements where it fails its annual performance assessment once or on two consecutive occasions, and to require a trustee to have regard to APRA's latest annual performance test for a product in making its own determinations for the purposes of its annual outcomes assessment for the same product; and
- provide APRA with (i) discretion to combine the performance tests for two separate products in circumstances specified in regulations (which the EM suggests would act as an anti-avoidance measure to prevent trustees from creating 'new' but substantially similar products to avoid consecutive tests) and (ii) the power to make prudential standards in relation to 'resolution' planning – that is, the process by which APRA may manage or respond to a trustee, fund or connected entity of a trustee being unable (or being considered likely to be or become unable) to meet its obligations or suspending payment (or being considered likely to suspend payment).
Key changes since the exposure draft include:
- More subject matter for regulations: Although the precise content of the performance test is still to be specified, regulations may:
- specify requirements based on a comparison of the actual return of a product for a period with a benchmark return for the product (or a class of products) for that period; and
- specify different methods and assumptions (eg relating to fee or tax rates) for APRA to rely upon in conducting its performance tests, although APRA would have some discretion to depart from the specified assumptions where certain conditions are met.
- Underperformance test results to be publicly available: APRA is to publish the test results on its website.
- Notification to members of 'fail' assessment: APRA or ASIC may provide trustees with an extension from the 28-day notice period, although the EM notes this would be for 'very limited circumstances' such as if the fund was undertaking a successor fund transfer. It also goes into a surprising amount of detail (particularly given much more important matters have been left to regulations) to specify the form of notice to members (eg it may be sent by 'pre-paid post or by courier').
- YourSuper comparison tool: The EM explains that APRA would provide data and ranking information to the ATO (based on the formulas set out in regulations) and the ATO would use that information to build and maintain the YourSuper comparison tool to allow beneficiaries to compare fees and performance information between products.
- Protection for employers: The Bill includes amendments to protect employers from breach of their obligations where they are unable to contribute to a fund for employees as a result of a product being closed due to failing the performance test (and could therefore be liable for a superannuation guarantee charge under the Superannuation Guarantee (Administration) Act 1992 (Cth)). In short, the Bill is trying to fix a problem it is creating and, in doing so, will create work for employers and expose their employees to the risk that their superannuation contributions will not be paid or will be delayed.
The introduction of a performance test which (if failed in two consecutive years) would prevent trustees accepting members into MySuper and other products will understandably make trustees nervous. It wouldn't be a shock if such a failure was a death-knell to the relevant product, or even an entire fund (particularly if the relevant product is its MySuper product).
As a result, trustees may well be incentivised to adopt investment approaches that track whatever benchmarks are chosen by APRA. This could significantly shape their investment decisions (eg a move away from riskier assets that are likely to perform better in the long term, but are more likely to underperform over a two-year period). However, the precise consequences for trustees and the industry as a whole will depend on exactly what the performance test in the regulations looks like.
This highlights a recurring theme in the Bill – a lot of the important detail is left to regulations. What detail there is in the Bill as to the scope of the regulation-making powers for the performance test points to difficulties in devising it – eg mechanics around the use of assumptions. In short, the industry will be rightly apprehensive about what they know, and what they don't yet know, about the 'Your Future, Your Super' reforms.
The Bill proposes to substitute the existing best interests duties of trustees and directors in sections 52 and 52A of the SIS Act to act in the 'best financial interests' of beneficiaries of the fund. That is, s52(2)(c) will contain the following covenant by trustees (the changes made by the Bill are italicised and a similar covenant by directors would be inserted into s52A): 'to perform the trustee's duties and exercise the trustee's powers in the best financial interests of the beneficiaries, including complying with any requirements prescribed by the regulations for the purposes of this paragraph'. In short – the obligation at the heart of a trustee's duty will no longer make sense – what does 'including' mean here? What if the prescribed requirements are not in the best financial interests of beneficiaries? Is compliance with the prescribed requirements intended as an exception to the general duty, or is it the case that Parliament thinks Treasury, or a regulator, is better able to decide what is in the best financial interests of beneficiaries of a fund than its trustee?
The new best financial interests duties would apply on or after 1 July 2021:
- in respect of payments to a third party 'by, or on behalf of, the fund';
- in relation to the performance of duties or the exercise or powers by trustees and directors; and
- with a reversed evidential burden of proof (in respect of the trustee, but not directors) such that a trustee would need to adduce evidence to contend that it complied with the best financial interests duty in the event that an alleged breach is pursued by a regulator.
In addition, the Bill seeks to amend the SIS Act to:
- prohibit a trustee from making certain payments or investments prescribed by the regulations; and
- introduce a strict liability offence if a trustee contravenes an operating standard that relates to a record-keeping obligation.
The key changes to the proposed best financial interests duty are as follows.
- Scope for additional requirements: the proposal to allow for regulations to be made that prescribe additional requirements that, if contravened, would constitute a breach of the best financial interests duty is new. All we know so far is that the regulation-making power is broad, intended to have a deterrent effect and intended to provide an ability to impose requirements where there is an increased risk of trustees avoiding their best financial interests duty (eg through corporate structures or schemes or otherwise). At least the reversed burden of proof won't apply to such requirements.
- Narrowed application: there has been some narrowing of the application of the new duty since the exposure draft such that the reversed burden of proof, new record-keeping offences and obligation not to make certain payments or investments prescribed by the regulations would only apply in respect of trustees (as described above) and not to directors (as was additionally contemplated in the exposure draft legislation). This will be of (some) comfort to directors, although it doesn't fundamentally address industry concerns.
- Clarification of application to contracts: the Bill contemplates that the best financial interests duties would apply to decisions to renew or vary a contract on or after 1 July 2021 (as well as the exercise of powers or performance of duties under any such renewed or varied contract) – but will not apply in relation to the performance of a contract entered into before 1 July 2021.
The proposed new best financial interests duty in sections 52 and 52A is not, in general terms, inconsistent with how the courts have interpreted the existing best interests duty. However, it does a lot of damage to a duty which is able to adjust to the matter at hand – noting that not all decisions of a trustee affect members' financial interests (where examples might include a decision to retire and appoint a new trustee or director) and it demonstrates a desire by Parliament to strengthen and focus the minds of trustees on members' financial interests to the exclusion of anything else.
Of more practical concern for trustees (and directors) are the following:
- The proposal to reverse the burden of proof, which runs counter to the 'presumption of innocence' that trustees (and people generally) are accustomed to operating under. It is likely to create somewhat of an administrative headache for trustees, who will feel pressure to create more extensive documentary trails in respect of their decision making (and, perhaps ironically, incur additional costs to the fund in doing so).
- The extremely broad regulation-making powers, which allow the specification of additional requirements that would constitute a breach of the best financial interests duty or prohibit certain payments and investments. As with the performance test discussed above, leaving such matters to regulations creates significant uncertainty for trustees and directors.
The portfolio holdings disclosure requirements in the Corporations Act 2001 (Cth) are due to commence on 31 December 2021 (after many deferrals). Broadly speaking, these require trustees to disclose on their website sufficient information to identify – subject to certain exceptions – each investment, its value and weighting and the total value and weighting of all disclosable items.
One of those exceptions was up to 5% (by number of disclosable items) of investment items (other than derivatives) for each investment option (ie on an investment-option-by-investment-option basis) if:
- those investment items are commercially sensitive; and
- making information publicly available about those items would be detrimental to the interests of members.
The Bill proposes to remove this exception.
This proposal was not in the exposure draft materials.
The (somewhat arbitrary) 5% concession was originally introduced in an attempt to address industry concerns that public disclosure of investment holdings would foreclose certain investment opportunities for superannuation funds (particularly in the unlisted and alternative asset space).
The EM explains the amendment as intended to 'increas[e] transparency in the superannuation system and empowe[r] members to make fully informed decisions about their retirement savings'. That may be so, but there is an obvious tension if trustees are forced to disclose commercially sensitive items when doing so would have a detrimental effect on, say, the value of fund assets. We can only hope that the regulations to be made to support the portfolio holdings disclosure regime may mitigate this (eg in the level of the detail required to be disclosed).
Finally, the 'stapling' reform seeks to limit the creation of multiple superannuation accounts for people who don't choose a super fund when they change jobs. Employees will be 'stapled' to a single fund which will follow them when they change jobs.
The primary amendments are to the Superannuation Guarantee (Administration) Act 1992 (Cth) (and apply to employers and the Commissioner of Taxation) such that:
- an employer will satisfy its superannuation guarantee charge obligations by making a contribution for an employee to the employee's 'stapled fund', if:
- the employee has not chosen a fund;
- the employer has requested the Commissioner of Taxation to identify whether the employee has a 'stapled fund'; and
- the Commissioner has notified the employer that the employee has a 'stapled fund'; and
- prohibit an employer satisfying the choice of fund rules (and superannuation guarantee charge obligations) by making contributions to the employer's default fund (or a fund specified in a workplace determination or an enterprise agreement made before 1 January 2021) if an employee has a 'stapled fund'.
If passed, these changes will apply in respect of an employee's employment that starts on or after 1 July 2021.
The definition of 'stapled fund' will be prescribed by regulations – which have not been released (as discussed below).
The Bill has introduced some changes that were not contemplated in the exposure draft – these include:
- an ability for tax agents to make stapling requests to the Commissioner on behalf of employers;
- discretion for the Commissioner to reduce (including to nil) an employer's individual superannuation guarantee shortfall where the stapled fund did not accept contributions from the employer and the employer therefore made a late contribution; and
- an amendment to the Superannuation Act 2005 (Cth) to ensure that Australian Public Service employers are required to comply with the new stapling rules.
Unfortunately, the Bill and its EM do not shed too much further light on the scope of the regulations beyond what we had already been told in the exposure draft materials (ie that they will cover matters 'of a machinery nature').
Given employers will need to comply with the new stapling rules, if passed, for employees who start on or after 1 July 2021, it would be good to see the regulations that will determine what exactly a 'stapled fund' is soon. However, we can be fairly certain that a 'stapled fund' will be defined in some way by reference to an existing fund of the employee – and it's reasonable to assume there will be some funds that are stapled to many more members than others. For example, a fund that has the bulk of its membership join upon first entry into the workplace or as part of opening their first bank account may do well out of the new stapling rules.
Whether this is good or bad news for retirement savings may depend on the performance of the stapled fund – perhaps the regulations will require the Commissioner to have regard to APRA's annual performance tests. And as we've previously mentioned, it may also depend on whether the member loses any administration fee discount that has been negotiated by their employer, but which ceases to apply to their account when they change jobs. Either way, if this proposal is passed, it is likely to significantly change the shape of the industry.