Australian and offshore investment managers will be directly impacted by Australian superannuation and other regulatory reforms that are proposed to take effect by 1 July 2013. The reforms will affect Australian retail and institutional investment patterns, the number of institutional clients, managers’ fees and distribution channels, the transparency of managers’ underlying positions and the content of investment management agreements. Investment managers should start planning now in order to respond to the reforms.
Fewer institutional investors and some investing in more conservative investments
Australia’s large superannuation funds make up the bulk of this country’s institutional investors. The number of large superannuation funds has been declining for many years as a result of consolidation and is forecasted to fall to 119 by 2025. The Stronger Super legislation, proposed to become law on 1 July 2013, is likely to encourage further consolidation by imposing more onerous duties on trustees. For example, trustees of funds offering a MySuper product will need to determine annually whether members investing in the product are financially disadvantaged in comparison to members of other funds who hold MySuper products, due to the trustee’s fund having an insufficient number of members or insufficient assets.
Each MySuper product must be invested in a single diversified investment strategy, which may be a lifecycle strategy.
The Stronger Super legislation will also require trustees of all large superannuation funds (i.e. trustees that are RSE licensees) to focus specifically on more factors relating to the fund’s investment strategy. New factors include costs that might be incurred in relation to the investments and whether reliable valuation information is available. Trustees will be required by statute to exercise due diligence in developing, offering and regularly reviewing each investment option of the fund. Further, under a proposed new Australian Prudential Regulation Authority (APRA) Investment Governance Prudential Standard, trustees must have an investment selection process that results in the trustee being satisfied that, among other things, it has sufficient understanding of how the investment will perform in a range of stress scenarios.
The proposed Stronger Super legislation, together with industry consolidation, might result in an overall reduction in the number of investment managers managing superannuation assets, as well as superannuation assets being invested more conservatively by managers who offer lower fees (see below). This has obvious consequences for asset classes that are more conservative (e.g. high quality bonds) or that have traditionally been charged higher fees (e.g. alternative investments).
Retail investors being encouraged to invest in more vanilla funds
Since the global financial crisis, investors have invested in more conservative investments. Government initiatives are encouraging this trend. For example, from 22 June 2012, “simple” registered managed investment schemes will require a short product disclosure statement, not exceeding eight pages. Non-simple schemes will still need to produce long product disclosure statements. For a number of types of non-simple schemes, the Australian Securities and Investments Commission (ASIC) expects even more information to be included in those documents than before (click here to read our alert “Regulatory ‘guides’ for retail offer documents – is ASIC overstepping the mark?”).
Products with longer offer documents might appear to involve more risk than products with shorter documents. Whether they do in reality is a different thing.
Further pressure on managers’ fees
A number of initiatives threaten to put further pressure on investment managers’ fees. These include:
- the Future of Financial Advice (FoFA) bans on monetary and non-monetary benefits given to platforms, distributors and advisers (discussed below). These bans place pressure on managers to reduce their fees by the amount they would otherwise have to pay. However, the FoFA reforms might result in managers having to spend more on marketing their brand and products, and so it might be difficult for managers to fully pass on the savings from ceasing to pay any banned benefits;
- the Stronger Super legislation, which will require all large superannuation funds to focus specifically the costs that might be incurred in relation to their investments; and
- performance fees for assets supporting MySuper products being regulated under Stronger Super. Trustees of large superannuation funds will need to ensure that any performance fee satisfies a number of criteria, including:
- the base fee, or any other fee payable, being set or adjusted so that the fee is lower than it would be if there was no performance fee;
- performance being measured by comparison with performance of investments of a similar kind; and
- performance being determined on an after-costs basis, and, where possible, an after-tax basis.
If a performance fee arrangement doesn’t meet the criteria, it can be paid only if the arrangement satisfies the general test of whether the arrangement promotes the financial interests of the members investing in the MySuper product.
Increases in regulatory capital
Managers that are responsible entities of registered schemes will be subject to stricter regulatory capital requirements from 1 November 2012. Responsible entities will need to have:
- sufficient financial resources to meet liabilities expected to be payable over the next 12 months, having regard to the responsible entity’s cash flows; and
- net tangible assets of at least 10% of average revenue (with no maximum), and, if the scheme does not have a custodian, to hold at least $5 million of net tangible assets.
Funds ceasing to pay commissions and other payments to financial distributors and advisers and being distributed differently
The FoFA legislation is proposed to become law on 1 July 2012, although most of its provisions will not come into effect until 1 July 2013 unless an affected entity elects to be bound early. It will introduce a number of bans relating to conflicted remuneration and other payments. FoFA is already reshaping the industry. Fund managers will need to review each benefit they give or receive (e.g. fee rebate, shelf-space fee and adviser commission) to ensure that the benefit will not be banned, or if it will, whether the benefit may be grandfathered. This includes intra-group benefits, non-monetary benefits (e.g. client entertainment) and business-to-business benefits. We expect that as a result of the FoFA reforms, fund managers will change the way they distribute funds and will look at alternate platforms such as the ASX AQUA II platform.
Disclosing details of assets invested in by superannuation funds and registered schemes
The Stronger Super proposals include a requirement for trustees of large superannuation funds to publish information to identify each of the financial products that the fund’s assets are invested in and the value of those assets on a six monthly basis. This requirement will also place obligations on custodians and others to provide information to the trustee to enable it to satisfy its reporting obligation. This obligation appears to override any confidentiality obligations. It is unclear at this stage how far these proposed obligations will go; it is hoped that this will be clarified in the final legislation.
Further, a Parliamentary Joint Committee report into the collapse of Trio Capital recommended the disclosure by registered schemes of scheme assets at an asset level. The Committee considered that disclosure would improve monitoring of schemes which would in turn assist in the earlier detection of fraud. It recommended that the Government release a consultation paper on the best mechanism for registered schemes to disclosure portfolio holdings.
Amendments to investment management agreements
Investment management agreements will need to ensure that any benefit given to a client with an Australian financial services licence complies with the FoFA bans on conflicted remuneration and is consistent with a manager’s disclosure obligations in relation to the underlying assets (see above). Where a client is the trustee of a large superannuation fund, the agreements will also need to:
- comply with the content requirements of the proposed new APRA Outsourcing Prudential Standard; and
- possibly comply with the performance fee restrictions where the assets managed include assets of MySuper products.
Existing investment management agreements may need amending before 1 July 2013 to comply with the above.
Finally, offshore investment managers should be aware that trustees of large superannuation funds will need to consult with APRA prior to entering into material outsourcing agreements so that APRA can be satisfied that the impact of the offshoring has been adequately addressed as part of the trustee’s risk management framework.
There are a number of regulatory reforms that will affect investment managers over the next 12 months. Some of the reforms will apply to investment managers directly, while others will be client initiated. Managers should consider how best they might respond to the reforms.