In November 2009, Jeremy Cooper, the then head of the Government’s Super System Enquiry, expressed strong views about how superannuation trustees invest.

He questioned their reliance on investment managers and pointed to the Canadian pension schemes who were bidding for Transurban at the time as a better model. He said that trustees should be dictating terms and fee levels with investment managers and asked “shouldn’t it be the person with the cheque book” who dictates the terms. Superannuation trustees, he said, should “start acting as if they are at the top of the food chain”. [1]

The Cooper Review’s recommendations

However, beyond a recommendation that trustees should be solely responsible for investing fund assets, the final report of the Super System Review, released on 30 June 2010, was largely silent on how a trustee should exercise its investment powers. Instead, it recommended that trustees be required to take account of costs, tax and the availability of valuation information in developing and implementing an investment strategy, that they focus on after tax returns and that a “performance fee standard” be developed by the Australian Prudential Regulation Authority (APRA).

The Government’s response - “Stronger Super”

The Government’s response, “Stronger Super”, released in December 2010, was also silent, stating only that: “As investment decisions are rightly a matter for trustees, the Government will not require superannuation fund trustees to make particular investments, including infrastructure.” [2]

However, the very real question is whether the Government and APRA will achieve indirectly what the Government has not done directly. Contrary to the Government’s decision not to dictate how trustees exercise their investment powers nor to prescribe specific investments, will key recommendations in fact cause trustees to make more passive and conservative investment decisions? Rather than following the model of the Canadian pension schemes espoused by Jeremy Cooper, will Australian superannuation funds increasingly choose to invest in low cost index funds?

Three key recommendations

In this context three recommendations are key: the recommendation to introduce MySuper, the recommendations grouped together under the “Governance” heading intended to heighten the duties of trustees and their directors, and the recommendation to give APRA a standards making power. The Government gave its strong support to MySuper, its in principle support to many of the governance recommendations and accepted, in the face of fierce opposition, the recommendation that APRA be given a “general standards making power in relation to superannuation (including prudential matters) in order to address the recommendations in this report and to drive efficiencies in the industry”.[3] Although the Government’s response refers to APRA’s powers to issue “prudential standards”, it is not clear that the Government intends to restrict APRA’s standards making power by using the word “prudential”.

These recommendations do not go directly to trustees’ powers of investment. However, separately and together they may well influence the exercise of those powers.

MySuper

MySuper is intended to provide a low-cost, simple product with a single investment strategy to members. Trustees will have a “specific duty to deliver value for money as measured by long term net returns” .[4] This duty was not recommended by the Cooper committee. It is noteworthy because it will convert the existing duty of a trustee to apply a proper process in exercising its investment powers to a duty to provide members with a certain outcome when it exercises its investment powers. Compliance with the duty will be scrutinised and “enforced” by APRA as well as ratings agencies.

This duty, together with the emphasis on lowering costs and fees for members, is likely to influence how trustees invest. Currently, trustees are not exposed to liability or penalty for an investment decision which ultimately provides a poor return to members if they have undertaken proper process in making the investment. If the new duty is adopted, the same circumstances may well give rise to an action by members and the imposition of penalties by APRA - the trustee may, as a matter of fact, not have delivered value for money notwithstanding that it acted properly in deciding to make the investment.

Governance

The Cooper Review recommendations included proposed new duties for trustees and directors of trustees intended to ensure that trustees exercise their powers in the best interests of members and without a conflict of interest or duties. These were given “in principle” support by Government.

There is significant resistance to these recommendations. Equity and the Superannuation Industry (Supervision) Act (SIS) already impose high standards on trustees when they exercise trust powers and SIS, the Corporations Act and the common law already impose high standards on directors of trustees. There is a real question as to how the additional duties would further the interests of members. One very real prospect is that they will promote more conservative and more risk averse decision-making, particularly investment decisions. This may well not serve the interests of members.

APRA

Finally, there is the APRA standards making power.

APRA sees this power as an important means of being able to tailor the rules which apply to trustees. It is unclear how prescriptive the standards will be and how far their subject matter will extend. We know that there will be a performance fee standard and very likely a standard for managing conflicts. It is also very clear that APRA considers that greater regulation and closer oversight of industry participants is in the interests of members.

It is also likely that APRA has views about what are proper investments for superannuation funds. Could APRA exercise its standards making power in such a way as to promote investments in certain classes of assets and inhibit or even prohibit investments in certain classes of assets or assets which do not satisfy particular criteria? If it does, how far could those standards go before investment decisions are made by APRA rather than, as recommended by the Cooper Review and endorsed by Government, by trustees?

The next steps

The Government formed a peak consultative group to make recommendations about the implementation of Stronger Super. That group is supported by several working groups, including a MySuper group and a governance group. The consultative group is due to provide its report to the Government. In the meantime, Treasury may be already preparing draft legislation and APRA is rumoured to have started working on draft standards.

We are promised exposure draft legislation at the end of the year.

In the meantime, the recommendations and the Government’s response point to a new paternalism and very little appetite for risk. Both are likely to make it difficult for superannuation trustees to reconcile the merits of increased active and direct investment by funds, promoted by Jeremy Cooper in 2009, with the requirements imposed by MySuper, heightened trustee and directors’ duties and APRA standards.