The Financial System Inquiry (Murray Inquiry) Committee handed down its Interim Report on 15 July (Report). The Inquiry is the first financial system inquiry since the 1997 Wallis Report, and clearly much has changed in the financial services landscape over that time.
What is abundantly clear is that much of the Report’s 460 pages are directly relevant to APRA-regulated superannuation funds (Funds). Added to this, we take the view that the Murray Inquiry actually provides the opportunity for Funds to take charge of their destiny, especially in respect of retirement product development and the growth of self-managed superannuation funds (SMSF), both of which the Inquiry had a focus on.
overview
The Inquiry noted that Australia has the fourth largest pool of superannuation assets in the world with assets forecast to exceed those of the banking sector by the early 2030s, reinforcing the importance and effect of the superannuation sector in funding economic activity. One challenge ahead might be that funds will allocate a higher proportion of their assets
to overseas investments because of the reduced capacity for the Australian market to absorb those funds, and therefore impacting on Australia’s balance of payments.
Currently, around 30% of assets are held in the retirement phase, but this is expected to increase to more than 40% over the next 30 years having the following effects:
•itislielythtageterpoportionftotalassetswillbeinvested deensivel,suchasinGovernmentandcorportebonds,witholder superannuantslielytopeeryieldovercapitalappecition;
•deensiveoverlayswillinceasinglybeusedtopotectmembers againstsignificantfallsinassetvalues.Thiswillequiegeterdepthin derivtivemaretsandincludebalancesheetguaranteesfbansand insuers,whichwillequiethemtoexpandtheircapitalbases;and
•theewillbeinceasinginteestinpoductsthtpotectagainstlongevity riskinceasingthedemandorfiedincomeassetsthtcouldalso stimultedemandorsecuritisedassets,whichisanimportantfunding souceorsmallerlenders.
Further, Funds could engage in direct lending to households and businesses
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
in direct competition with the banking sector, which has already occurred in other economies, such as the United Kingdom. This would require superannuation funds to develop credit assessment capabilities and would have implications for how funds might be regulated.
Additionally, consolidation in the superannuation market will be accompanied by a shift to more illiquid assets as the cash flows for large funds become larger and more predictable.
From a taxation perspective, the Inquiry noted that:
•thelagenumberfindividualswithverylagesuperannutionbalances suggeststhesuperannutionsystemisbeinginceasinglyusedorta- benefitpurposes;and
•agowingpoportionfund-heldAustralianequities(andtheefectf efundableimputtionceditsandta-feeetiementbenefits),
may erode the Government’s revenue collection abilities at the same time as expenditure pressures are increasing.
fees and costs
The Inquiry found that the operating costs of Australia’s superannuation funds are among the highest in the OECD, with estimates that fees have consumed more than a quarter of returns since 2004. These issues are not unique to Australia, and the Inquiry stipulated that fees should not be
considered in isolation and that, ultimately, superannuation funds should be judged on their after-fee return for a given risk profile.
In general, competition has led to feature-rich, but more costly, superannuation products, in part reflecting that many consumers are not fee sensitive.
Further the benefits of increased scale over the past decade have been largely offset by higher fund expenses from:
•ashifttowadsinvestinginhighe-costassetclasses;
•substantialgowthinmemberengagementservices;
•investmentinmodernadministrtionpltorms;
•activeinvestmentmanagement(leadingtotransactioncostsand managementees)byfunds;and
•highdemandorliquidityfomsuperannutionfunds,drivenby:
-themandtory theeday inte-fundportability equiement;
-theneedtomaebenefitpayments;
-theneedtomaintaintagetassetalloctionswithinafund;
-theneedtocovermaginsoncurencyhedgingpositions;and
-memberinvestmentswitching.
The Inquiry considered the following issues in respect of Funds’ high fees:
•whetherundsaeecessivelyocusedondeliveringshort-termeturns, andtowhtextentmoetailoringfassetalloctiontomembers (liecycleinvestments)wouldpoducenetbenefitsormembers;
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
•intoducingmoecompetitionineltiontodefaultemployer contributionsthoughchangingawads.TheGovernmentiscurently consideringpolicyoptionsonthisissue;
•theChileanmodelinwhichsuperannutioncontributionsfall new members aeplacedinthesamedefaultfund.Defaultfundmanagement isauctionedonthebasisfees,cetingstongercompetitionbetween fundsordefaultfundsttus.Howeve,theInquirynotedthtthismodel raisesanumberfotherpolicyissuesthtwouldneedtobeconsideed beoebeingcontempltedorAustralia,suchasthenumberfdefault funds,concentrtionrisk,assetalloctionandegultoryequiements;
•whetherundsshouldhveaccesstoaliquidityfacilityttheReserve BankfAustralia(RBA)thtwouldpovideeliableaccesstoliquidity duringtimesfstessandinceaseund’scapacitiestoinvestorthe longterm.TheInquirynotedthttoaccesstheRBAliquidityfacilit, undswouldneedtoholdepo-eligibleassets,whichtendtobehighly liquid.Itistheeoeunclearhowaccesstosuchafacilitywouldeduce unds’holdingsfliquidassets.TheInquiryalsonotedthtunds
can compete indirectly for liquidity at the RBA through an entity that already participates in the open market operations of the RBA, as long as the fund has eligible assets to exchange with the entity. Alternatively, Funds can participate directly in open market operations by becoming a member of the RBA’s Information and Transfer System (RITS) and holding their liquid assets in Austraclear. The Inquiry was not convinced that access to a liquidity facility at the RBA would overcome the concerns raised; and
•whetheraprinciples-basedappoachtoportabilitytransersmaybe moeefectivethanthecurentpescriptiveappoach.
The Inquiry is seeking submissions in respect of fees including whether:
•MySuperpovides(orislielytopovide)sufficientcompetitivepessues toensuelowereesandhigherfte-eeeturns,orwhetheritshould bechanged,includingwhetherauctioningdefaultfundsttusshouldbe consideed;
•thethee-dayportabilityruleshouldbeamended;
•theecenttendfgeterverticalintegrtioninthewealth managementandsuperannutionsectorsiseducingcompetitionand contributing to higherees;
•theeaenetbenefitsintailoringassetalloctiontomembersand/or pojectingetiementincomesonsuperannutionsttements;
•undshveanundueocusonshort-termeturnsandhowmightitbe addessed;
•theeisatendawayfomactiveassetmanagementwithinassetclasses;
•undspriceswitchingpoperly;and
•superannution’struststructueisacost-efectivevehicle.
thomson geer comment
It is clear that the high costs of extra regulatory compliance resulting from implementing MySuper and Stronger Super has made it difficult for Trustees to pass on cost savings to members.
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
role of boards
The Inquiry noted concerns that APRA’s requirements have become too prescriptive and do not delineate appropriately between the role of Boards and management. Many industry participants believe the requirements imply an excessive level of managerial ownership by the Board and, in some cases, overstate the Board’s influence. Submissions argued that this diminishes Boards’ abilities to focus on governance and strategic direction, hampering their capacity to perform their core functions.
According to APRA, its standards do not require Boards to micro-manage the organisation. Instead, they aim to ensure Boards implement appropriate policies and frameworks, particularly relating to risk, and are satisfied that these policies are effective. Correspondence is often addressed to Boards, but with the intention of ensuring that they are aware of APRA’s concerns and ensure that management addresses them.
The Inquiry is seeking submissions in respect of issues including whether:
•theeshouldbeaeviewfprudentialequiementsonBoadstoensue theydonotdrawBoadsintoopertionalmtters;and
•Regultorsshouldcontinuetoclarifytheirexpecttionsontheolef Boads.
thomson geer comment
We are aware of APRA Prudential Reviews and interviews with Boards that appear to expect the Board to be intimately aware of all operational issues affecting their Funds. This appears to contradict APRA’s statements, above.
We therefore recommend that further clarity of APRA’s expectations of Fund Boards occurs.
retireMent products
The Inquiry clearly focussed on the fact that the retirement phase of superannuation will become a greater issue over time. Of special note was that the superannuation drawdown phase provides limited choice for managing risk in retirement.
The ageing population is expected to contribute to a deterioration of the Government’s fiscal position, resulting in a net cost to Government of 3% of GDP by 2050. Additionally, the structure of retirement income products may also affect the allocation of funding in the economy and productivity growth. As the stock of superannuation assets in the retirement phase increases, demand for defensive assets such as fixed income products can be expected to increase.
lump sums
The Inquiry noted that Australia may have a “lump sum culture” predominantly for the reason of extinguishing debt, and the Inquiry noted that the number of households entering retirement with debt, particularly a mortgage, is increasing.
Further on average, around one-third of superannuation assets are withdrawn by the time an individual reaches the Age Pension eligibility age. Around one-quarter of people with a superannuation balance at age 55 have depleted their balance by age 70.
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
annuities and pensions
The Inquiry noted a range of behavioural biases have been found to discourage people from purchasing products with longevity protection:
•annuitiesaepeceivedtoberiskygamblesrtherthaninsurance;
•individualsundeestimtetheirlieexpectancy;
•etieeswanttheflexibilitytomeetuoeseencashequiementsand levetheiresidualassetsasabequest;
•individualsundervaluefutueconsumptioneltivetocurent consumption;
•annuitiesaenotpeceivedtodelivervalueormoney;and
•annuitiesestrictaperson’seligibilitytoeceivetheAgePension.
potential retirement products
The Inquiry noted a range of potential options available to the Government, including:
•equiringthtpartfanindividual’saccumultedsuperannution benefitsbediectedintoadefaultnon-commutableincome steam thtpovidespotectionagainstifltionandlongevityrisk,unlessthe individualopts-out;and
•mandtingthtallorpartfsuperannutionbenefitsbemovedinto anon-commutableincomesteamthtpovidespotectionagainst ifltionandlongevityrisk.
Such options would need to accommodate for members with adverse financial or health-related circumstances. In the UK, for example “enhanced” or “impaired” annuities, which pay higher incomes for the same purchase price, are available to people with certain medical conditions that lower their life expectancies.
regulatory and other barriers
Products such as Deferred lifetime annuities (DLA) (where income payments are delayed for a set amount of time) or group self-annuitisation (participants contribute funds to a pool that is invested in financial assets
and regular payments from the pool are made to surviving members) do not meet the standards set out in the SIS Regulations. In practice, if a product cannot qualify for a tax exemption, the market for that product is unlikely to develop.
The Age Pension assets test and income test (through deeming an income on assets) apply to DLAs, even during the deferral period, and therefore an exemption during the deferral period would be required.
Providers of new retirement income products must deal with multiple Government bodies for approvals, including the ATO, APRA, ASIC and the Department of Social Services.
Providers of guaranteed retirement income products, especially long-dated or whole-of-life products, are exposed to interest rate, investment and longevity risk. Mitigating these risks requires using more capital, obtaining reinsurance, or managing them in financial markets, for example, by taking offsetting positions in bond or derivative markets.
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
The Inquiry is seeking submission in respect of policy options or other alternatives including:
•impovingthepovisionffinancialadviceandemovingimpediments topoductdevelopment;
•povidingpolicyincentivestoencourageetieestopuchaseetiement incomepoducts;
•intoducingadefaultoptionorhowindividualstaetheiretiement benefitsormandtingtheusefparticularetiementincomepoducts;
•econsidertheAgePensionmeans-testsinespectfcertainetiement poducts;and
•issuinglonge-dtedGovernmentbonds,includingifltion-lined bonds,tosupportthedevelopmentfetiementincomepoducts.
The Inquiry is seeking submissions in respect of issues including whether:
•poductsincludingdeeredlietimeannuities,goupselfannuitistion aeelevantorAustralianetiees;
•theprivtesectorwouldbeabletomanagelongevityriskiftheeisa lageinceaseintheuseflongevity-potectedpoducts;
•Governmentshouldinceaseitspovisionflongevityinsuranceand howwouldinstitutionalarrangementsbeestablishedtoensuethey weestableandnotsubjecttopoliticalintereence;and
•egultionsimpedethedevelopmentfpoductstohelpetieeseverse mortgagetheirhomes.
thomson geer comment
We have had “Simpler Super” and “Stronger Super”. It will only be a matter of time before we have “Older Super”. Retirement product development is the next looming challenge for Funds, and some may argue that SMSFs are perceived as providing retirees with better retirement options. Funds should consider the issues raised by the Inquiry and make relevant submissions because retirement is likely to expose superannuation funds to (growing) member leakage for two reasons:
-
retirees taking out lump sums; and/or
-
retirees seeking independent financial advice (triggered by their impending retirement) and moving their superannuation into an alternative superannuation fund (most likely a SMSF) that offers more flexibility.
self-Managed superannuation funds
size
The Inquiry noted that the number of APRA-regulated funds (excluding small APRA funds) fell from more than 4,700 to 299 since 1997, and the number
of SMSFs has grown rapidly to the point where SMSFs currently account for around one-third of total superannuation assets, or $559 billion. SMSFs now make up the largest segment of the superannuation system in terms of the number of entities and the size of funds under management.
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
reasons for establishing an sMsf
The majority of SMSF establishments derive from accounting and financial advice, in circumstances where the quality of that advice varies., to the extent the SMSF Professionals’ Association of Australia (SPAA) noted improvements to the current financial advice environment is warranted.
One major reason for SMSF establishment has been to establish tax effective vehicles, though the Inquiry appeared to take the view that tax treatment
of all superannuation funds is the same, although in practice SMSFs may achieve better tax outcomes (during retirement phase).
The Inquiry noted that the Tax White Paper could examine the tax outcomes of SMSFs and other Funds and measures to ensure that SMSF establishment is not motivated purely by tax outcomes.
borrowings
The estimated number of SMSFs using geared products grew by more than 11% to 38,000 over the year to April 2014. Total borrowings in 2012 were over $6.2 billion.
The Inquiry noted that the general lack of leverage in the superannuation system is a major protection for the financial system and the ability to borrow directly may, over time, erode this strength and create new risks and vulnerabilities for the superannuation and financial systems.
The Inquiry also took the view that some evidence suggested that borrowing is often associated with poor financial advice and often poor advice resulted in members establishing SMSFs as a specific part of a geared investment strategy. This Inquiry shares the Super System Review Panel’s view that leverage should not be a core focus of any superannuation fund (including SMSFs) and is inconsistent with Australia’s retirement income policy.
The Inquiry is seeking submissions in respect of .
•estoringthegeneralpohibitionondiectleveragefsuperannution fundsonapospectivebasis;
•whethertheInquirybeconcernedaboutthehighopertingexpensesf manySMSs;and
•whethertheeshouldbeanylimittionsontheestablishmentfSMSs.
thomson geer comment
The Report failed to mention or identify that many SMSF members receive an immediate tax benefit if they hold business real property that they operate a business out of. In these circumstances, the immediate tax- benefit to the member is that the rent paid to the SMSF is deducted from the business’ assessable income, resulting in a lower taxation liability to the business.
In our experience, the ability of SMSFs to hold a member’s business real property so the member’s business can obtain an immediate tax-benefit, is often a very powerful reason for members to establish SMSFs.
Members of Funds cannot access this benefit, because Funds do not hold their members’ business real properties.
From a commercial perspective, if SMSF leverage encourages members to establish SMSFs, Funds should consider leverage as an exposure to member leakage.
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
We recommend that Funds consider these issues and make submission to the Inquiry, noting that even though ASFA may make submissions, it represents both Funds and SMSFs.
investMents
The Inquiry noted (briefly) that Investments in infrastructure are viewed by some as being illiquid and that infrastructure investment could be facilitated by developing liquid, tradeable claims on infrastructure projects which could provide greater scope for investors, including superannuation funds, to invest in infrastructure.
The Inquiry seeks further information on what are the impediments to the development of liquid, tradeable claims on infrastructure projects.
advisers
The Inquiry noted that the competence of advisers varies widely in an environment in which consumers find it difficult to gauge the differences.
Stakeholders raised concerns about the adequacy of SMSF advice, in particular that some consumers are advised to establish SMSFs where it is not cost-effective or appropriate for their needs.
Some submissions argued that some of the conduct currently regulated as general advice could more accurately be described as “sales information”, “advertising” or “guidance”. The aim of this relabelling would be to give consumers a clearer indication of what is involved.
The Inquiry is seeking submissions in respect of the policy options or other alternatives including:
•impovingthecurentdisclosueequiementsusingmechanismsto enhanceconsumerunderstanding,includinglayeeddisclosue,risk pfiledisclosueandonlinecompartors;
•emovingdisclosueequiementsththvepoveninefectiveand facilittenewwaysfpovidingiormtiontoconsumers,including usingtechnologyandelectonicdelivery;
•subjectingpoductissuerstoarangefpoductdesignequiementsto pomotepovisionfsuitablepoductstoconsumers;
•povidingASICwithadditionalpowerssuchas:
-poductinterventionpowerstopescribemaretingterminologyor complexormoeriskypoducts;and
-powerstotemporarilybanpoductswheetheeissignificant lielihoodfdetrimenttoconsumers;
•raisingminimumeductionandcompetencystandadsorpersonal (includingSMSF)adviceandintoduceantionalexamintionor financialadvisers;
•intoducinganenhancedpublicegisterffinancialadvisers(andtheir employees)whichincludesaecodfeachadviser’scedentialsand curentsttusintheindustry;
•enhancingASIC’spowertoincludebanningindividualsfommanaginga financialservicesbusiness(asdistinctfompovidingafinancialservice); and
|
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
•enaminggeneraladviceas“sales”or“poductiormtion”and mandtethtthetermadvice’canonlybeusedineltiontopersonal advice.
privacy
The Inquiry briefly touched upon Privacy Law and is seeking submissions in respect of the following policy options or other alternatives:
•eviewingandassessingthenewprivacyequiementstwoyearsfter implementtiontoconsiderwhethertheirimpactsappopritelybalance financialsystemefficiencyandprivacypotections;and
•eviewingecod-eepingandprivacyequiementsthtimpacton coss-boder iormtionflowsandexploeoptionsorimpoving coss-bodermutualegultoryecognitionintheseaeas.
penalties and further regulation
penalties
The Inquiry noted that on a comparison, Australia’s penalty regime enforceable by ASIC under the Corporations Act provided for considerably lower civil penalties (including in respect of disclosure and inappropriate advice) than Canada, Hong Kong and the United Kingdom (which included uncapped civil penalties).
Accordingly, the Inquiry is seeking submissions as to whether it should review the Corporations Act’s penalty regime.
thomson geer comment
Funds may wish to consider this issue.
providers of scale
Additionally, the Inquiry considered whether certain service providers outside the regulatory perimeter are of such scale and potential influence that service disruption or failure would affect regulated institutions such that there may be a case for considering direct regulation. Two potential direct regulation cases include administrators and technology service providers
of scale, that the Inquiry considered extending AFSL requirements to (in our view administrators usually are licenced, or at least authorised under an AFSL).
prudential regulation of funds
The Inquiry noted the differences between the regulation of APRA- regulated superannuation funds and ASIC-regulated managed investment schemes (MIS) with differences lying predominantly in the intensity of the requirements applying to governance and risk management and the intensity of supervision applied in respect of these standards. Differences also exist in the requirements for financial resources, reserving and liquidity.
The Report states that Funds are subject to heavier prudential regulation than MIS, and states that applying prudential regulation to Funds is likely to impose additional costs, whilst acknowledging the benefits of this regulation especially when superannuation is integral to retirement income policy.
The Inquiry is seeking submissions on whether there is a strong case for change including whether to align regulation of APRA-regulated
superannuation trustees and funds with responsible entities and registered management investment schemes.
Advice | TrAnsAcTions | dispuTes
Domestic & Cross Border
thomson geer comment
The Inquiry is inviting submissions, which are due on Tuesday 26 August 2014.
We highly recommend that Fund trustees, and their service providers, carefully consider the Report’s contents and whether submissions should be made. Submissions made will aid Funds in:
-
seeking to clarity or improvements to the current regulatory environment;
-
seeking to enhance the retirement product offerings that will help to retain retired members; and
-
seeking a more level-playing field when competing with SMSF advisers. If you would like us to assist, please do not hesitate to contact us.
written by:
Mark Abramovich | Partner | +61 3 9641 8627 | [email protected]
Luke Hooper | Senior Associate | +61 3 9641 8767 | [email protected]
For further information, please click here to contact our national Superannuation team or contact our
office directly:
sydney
Level 25
1 O’Connell Street
Sydney NSW 2000
+61 2 8248 5800
Melbourne
Level 39
Rialto South Tower 525 Collins Street
Melbourne VIC 3000
+61 3 8080 3500
Melbourne
Level 20
385 Bourke Street
Melbourne VIC 3000
+61 3 9670 6123
brisbane
Level 16 Waterfront Place, 1 Eagle Street
Brisbane QLD 4000
+61 7 3338 7500
|
adelaide
Level 7
19 Gouger Street
Adelaide SA 5000
+61 8 8236 1300
This Alert is produced by Thomson Geer. It is intended to provide general information in summary form on legal topics, current at the time of publication. The contents do not constitute legal advice and should not be relied upon as such. Formal legal advice should be sought in particular matters. Liability limited by a scheme approved under Professional Standards Legislation.