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Cooper Review - a new model for super?

“Perhaps less idealistic than the members of the PJC that conducted the Ripoll Inquiry, the Panel does not seem to think that the disconnected or uninterested will become actively engaged through an education program or better disclosure; instead they say that these members need to be protected by more tailored regulation.
“At the same time, the actively engaged should not be subjected to paternalistic regulation. One size does not fit all and the Panel says that the superannuation system should cater for these different categories of members.”

The Panel charged with conducting the Super System Review has released its first Preliminary Report. The Report responds to the issues raised by the Panel in its Phase 1 Issues Paper on Governance. Like the Issues Paper, the Preliminary Report is internally focussed, primarily examining the superannuation fund, the trustee and the members.

The Report identifies some emerging themes, poses a new “architecture for super” and provides a preliminary response to some governance issues. In the main, the Panel has not expressed settled views or made specific recommendations, although they do dismiss some early proposals. They acknowledge that there is still a long way to go and invite comments in response to the paper.

Nevertheless, based on the views expressed in the Report, trustees can start to piece together likely changes for their business. With one exception, the broader funds management industry and other service providers will need to wait for the Panel’s next report to get a better sense of the broader impact of the Review. The exception is a radical proposal that at least some service providers should have a statutory fiduciary duty to members. It would have a significant and far-reaching impact on the industry more broadly. The Phase 2 Issues Paper on Operation and Efficiency did suggest some early themes around outsourcing, investments and fees which are also likely to have a more direct impact on the broader funds management industry.

Emerging themes

The paper identifies what the Panel refer to as “five emerging themes”:

  • super is special;
  • competition is not enough;
  • one size does not fit all;
  • members assume real risk; and
  • the review provides an opportunity to build a system for the future.

These themes underpin the key proposal in the Report that there be a new “architecture for super”.

Proposal for a new “architecture for super”

The Panel notes that members of superannuation funds have significantly different levels of engagement with their super. They range from the disconnected (whose super is often in an eligible rollover fund), to the uninterested (whose super is usually in the default option in an industry or retail fund) and then to the actively engaged (whose super is usually in a retail fund with multiple investment options or a self-managed fund).

Perhaps less idealistic than the members of the PJC that conducted the Ripoll Inquiry, the Panel does not seem to think that the disconnected or uninterested will become actively engaged through an education program or better disclosure; instead they say that these members need to be protected by more tailored regulation. At the same time, the actively engaged should not be subjected to paternalistic regulation. One size does not fit all and the Panel says that the superannuation system should cater for these different categories of members.

Based on these findings and these conclusions, the Panel recommends what it calls the “choice architecture” model.

The model classifies members into three main types: universal, choice and self-managed. Those who did not make an express choice would be placed in the universal category. If a member loses connection with their account, that account will be transferred to the disconnected category.”

The different needs of each class of member demand a different superannuation product and a different regulatory response.

The disconnected member

A disconnected member needs a low cost fund with a conservative investment strategy. This fund is called the “universal fund”. The trustee would likely be subject to highly prescriptive regulation. There would be little room for an exercise of discretion by the trustee and no room for an exercise of choice by the member. The disconnected member would require minimal information and disclosure.

The uninterested member (the “universal” member)

The uninterested or universal member needs a fund with a single diversified investment strategy (including a life-cycle strategy) with death and TPD cover. A default superannuation fund would need to cater to the universal member. The trustee of this kind of fund would likely have limited powers and, in the exercise of those powers, be subject to the full range of fiduciary duties. The Report says that for this category of member the need for advice would be limited because advice is “embedded” in the product. The implication appears to be that members will not need advice because the trustee will be looking after their best interests. The trustee will look more like the paternalistic trustee of a traditional corporate superannuation fund than the trustee of a retail mastertrust.

The engaged member (the “choice” and “self-managed” member)

The engaged member needs a fund with multiple investment and insurance options or their own self-managed fund. In the former case, the Report says that the trustee will have responsibility for a reasonable due diligence on investment and insurance options offered but limited liability for choices made by members. Effective disclosure is, the Report says, of paramount importance in this model since members will rely on that disclosure and advice when making investment and insurance decisions.

In many ways the proposal is merely a clear articulation of what the law currently provides. Although the Superannuation Industry (Supervision) Act 1993 (“SIS Act”) does not distinguish different classes of members or create different obligations for different categories of funds, the way in which a trustee exercises its discretions in equity and under the SIS Act turns on the interests of the members of the particular fund. For example, where those members have not exercised investment choice, the matters to be considered by the trustee in the exercise of its powers in establishing an investment strategy for the fund will be different than they would be if the members actively participated in the management of their superannuation by exercising investment choice.

In the latter case, the trustee is already provided a degree of protection from liability under section 52(4) of the SIS Act. The major difference between the current regime and that proposed for “choice architecture”, according to the report, “is the clearer distinction made between the ‘universal’ and ‘choice’ sectors”. It is an open question whether a disconnected member and a choice member could be members of the same superannuation fund.

Governance issues

The Panel says that super is not just another financial product since it has an overarching social policy objective. This purpose, together with the view that one size does not fit all, means that superannuation may, according to the Panel, need special rules in some areas. It also means that trustees should be subject to higher standards of governance.

The Panel says that “there should not be instances where the governance standards applicable to super funds fall below those applying to listed companies”. This has implications for the remuneration of directors and senior officers, for disclosure and related party transactions. It also has important ramifications for the trust model itself as well as the standards applicable to the trustee and the directors of the trustee.

Trust model

The Panel accepts the weight of the submissions that the trust model continues to provide the best investment vehicle for superannuation. However, in doing so it notes that the flexibility of the trust is a source of risk. In particular, trust law gives the settlor power to determine the terms of the trust. While there are some constraints under the SIS Act on that power, the strong implication in the Report is that they are not enough.

It is likely that the Panel will recommend some restriction on the provisions which can be included (and the fiduciary obligations which can be excluded) in a trust deed at least in respect of the disconnected member and the uninterested or universal member. In particular, provisions which require trustees to appoint a related party as a service provider or to invest in a related company are likely to be prohibited together with provisions which permit a trustee to act notwithstanding a conflict of interest. The question will be whether provisions of this nature can continue to be included in funds offered to engaged or choice members. This will likely depend on if, and how, the SIS Act is amended to impose specific fiduciary duties on trustees.

The fiduciary obligation

The Panel rejects the idea that trustees’ duties should be codified. However, it is likely that there will be a recommendation to impose specific fiduciary duties by statute; it is likely that these duties would change according to the nature of the fund. The report says:

the Panel supports amending the SIS Act so that it sets out clearly the trustee duties that arise with respect to ‘universal’ members and ‘choice’ members recognizing that these might differ in important respects”.

The different duties imposed on trustees would support the different needs of the different categories of members. However, in each case, the duty would modify or entrench the trustee’s existing and primary fiduciary obligation to act in the best interests of the fund members.

There is a more startling proposal suggested in the Report. It contains the following:

“.. market realities pose several challenges to a widespread application of the fiduciary principle to protect member interests. First, not all participants in the superannuation system are appropriately characterised as fiduciaries. Under current law, only the trustee of the fund is a fiduciary and has the consequent obligations to fund members. One of the fundamental issues facing the Review therefore is whether and to what extent fiduciary obligations ought to be imposed more broadly on service providers. The Panel is working towards a clarification of which participants in the system are ‘fiduciaries’ and the consequences that designation should attract in each case.

The suggestion is that any or all of a fund’s investment managers, administrators and fund managers could be required by statute to assume fiduciary duties towards the superannuation fund members. This would have a significant and far reaching impact for service providers.

Standards for trustees and directors

The Panel notes that neither trust law nor the SIS Act imposes a high standard of expertise on trustees or their directors. They also note the lack of performance measurement and accountability of trustees to members. While noting that these are matters for concern, the Panel does not suggest, at this stage, any radical change.

The Panel does appear to support the continuation of equal representation on trustee boards and to accept that elected directors may not meet the standard of knowledge and expertise which another director should satisfy. This shortcoming would be addressed by mandatory training after appointment. Likewise, there are similarly tentative suggestions for addressing shortcomings in the area of performance management (by having a standing committee charged with overseeing the performance of senior managers and the board) and accountability to members (disclosure and the mandatory provision of reasons in relation to complaints).

In the context of the Panel’s view that its Review is “an opportunity to position the superannuation system for the challenges of the next 15 years and beyond” and its forecasts about the size of the industry in 15 years ($3.2 trillion) and the average fund size in 15 years ($17.2 billion), these proposals seem timid.

We suspect there will be much more to come. One such proposal might be the specialist super court raised in the Phase 3 Issues Paper.

Phase 3 (Structure)

On the same day that the Panel released its preliminary report on Phase 1, it also released its consultation paper on Phase 3 (Structure). A large part of the consultation paper is devoted to SMSFs. Of the remaining matters canvassed in the paper, the following are worth noting:

Advice about super: In the wake of the Ripoll inquiry, the Panel has further postponed its consultation on getting and paying for advice about super. The Panel wants to think more about how advice would fit in with the proposed choice architectural model.

Collective pension schemes: The Panel asks whether there is room for collective pension schemes in the Australian superannuation system. These schemes pool risk between members and operate more like a defined benefit scheme, aiming at a certain level of annuity in retirement, but with investment risk ultimately borne by members. Younger members share in longevity risks faced by older members. In simple terms, collective pension schemes are something of a hybrid between defined benefit and defined contribution schemes.

Modern awards and default super: The Panel notes the concerns expressed about the process of nominating default superannuation funds in modern awards. Some concerns relate to default fund underperformance; others relate to the lack of transparency and competition in the nomination process. The Panel asks whether the current mechanism is the best mechanism or whether some other mechanism would be better.

A specialist superannuation court: The Panel queries whether (in contrast to the SCT and FOS) the AAT, Federal Court and Supreme Courts have sufficiently frequent exposure to superannuation issues to become expert and competent to resolve disputes. Specifically, the Panel asks whether there would be value in the creation of a specialist superannuation court. This question brings to mind the creation of the specialist Commonwealth Industrial Relations Court in the 1990’s, which was partly drawn from the Federal Court and ultimately folded back into it.

Risk sharing by smoothing investment returns: In its consultation paper on Phase 2 (Operation and Efficiency), the Panel looked in some detail at default superannuation and questions of investment approach and asset allocation. The Panel also questioned whether there has been an excessive focus on short term returns. The Panel returns to this theme in its latest consultation paper, asking whether default funds could be required or encouraged to have investment fluctuation reserves, to facilitate the smoothing of returns. The Panel asks how concerns about “free-riding” could be addressed.

Increased and better calibrated capital requirements: The Panel’s questions suggest a view that capital requirements are currently too narrowly applied (public offer only), too low ($5 million) and poorly calibrated (where a trustee relies on its custodian to satisfy the capital requirement, the requirement on the custodian does not vary depending on the number of trustees relying on it or the size of the funds).

Legacy products: Finally, the Panel asks whether legacy products are a problem in superannuation and, if so, whether measures are needed to address them above and beyond the successor fund transfer mechanism. Coincidentally, at the same time the Panel asked this question, another organ of government - Treasury - provided its answer in the form of its proposals paper on product rationalisation. Treasury has excluded superannuation from initial consideration of a product rationalisation mechanism, restricting its proposals to life insurance and managed funds. Treasury believes that legacy products are not as significant an issue in superannuation compared to other industries “due to the nature of the industry and the existing transfer provisions”.


  • John Edstein
    Consultant | Sydney
    T: +61 2 9296 2000
    M: +61 419 219 733

 Local contact(s)

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