APRA to force mergers for funds deemed ‘underperforming’

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Comment by Greg Bright

They have given big super funds sufficient, and reasonably clear, warning over the past couple of years but APRA last week finally said it was calling in the trustees of a number of super funds to question them on their governance, past performance and likely future performance. If they don’t stack up, the regulator will demand they transfer their assets to another fund.

The APRA note, issued last Thursday (August 31), signed by Helen Rowell, deputy chair, says: “APRA will soon write to each of the RSE licensees of RSEs identified as a result of APRA’s assessment to request their respective Boards to meet with APRA to discuss our assessment.

“These RSE licensees will be required to develop a robust and implementable strategy to address identified weaknesses within a reasonably short period and to engage more regularly with APRA to monitor the implementation of that strategy. Where it is clear that a particular product or RSE is unlikely to be able to continue to operate in the best interests of its members, APRA expects the relevant RSE licensee to act to ensure a timely and well-managed transfer of members to another suitable product or RSE, either within the RSE licensee’s own operations or those of another RSE licensee.”

So there you have it. APRA last wrote to super funds, on August 11, outlining a new suite of governance standards and upcoming discussions. The regulator is now, effectively, indicating it that it will move beyond a supervisory role and will attempt to restructure the big super fund sector according to its inhouse policy settings. Let’s see how history judges this.

An ‘RSE’ (registrable superannuation entity) is an APRA-regulated super fund. There are 139 of them, most of which are well-known in the industry. There are also another 2,000-odd small ones – with five or fewer members that have external trustees – which are remnants of a previous regulatory environment. Of the 139, roughly, depending on various definitions, 37 are retail/commercial funds, 26 are corporate not-for-profits and 62 are industry or government not-for-profits. There are 14 ‘other’ under this publication’s calculations.

The industry chatter has it that there could be between 15-20 big super funds which are caught in this net and forced to find a new home for their members. There are several important issues at stake here, the main one being: does APRA actually know what is in the best interests of members? Here are some of the issues:

  • APRA, through the implementation of MySuper and other regulatory actions which favour the reduction in headline costs, rather than after-fee and after-tax returns, notwithstanding the regulator’s claims to the contrary, could be leading millions of members into a market bubble. APRA, for instance, makes no assessment of opportunity costs, which fund managers think about all the time.

To its credit, APRA at least admits its statistics are dodgy: “APRA recommends that users of the statistics exercise caution in analysing and interpreting the reports, particularly while the annual superannuation data collection is still relatively new. It will take some time for the information reported to APRA to reach an appropriate level of quality and consistency,” it said in February.

  • APRA’s returns data significantly lags the industry’s estimates. For instance, the annual “fund level superannuation statistics” for the year to June 2016, were published on February 1 this year. In the current passive versus active debate, an increasing number of managers are sticking their necks out and calling equity and bond markets to be fully-to-over priced (see related report on Pyrford’s view this edition). Short-term performance will inevitably suffer until the selling wave hits but long-term performance may benefit substantially.
  • APRA has, for several years, warned smaller super funds that they should consider merging with another fund or funds to obtain better scale. There is actually zero evidence that this would benefit members. Certainly, APRA has never provided any. Various private researchers, such as Rainmaker and Chant West, have questioned it from time to time. Administration fees, which for whatever reason seem to be a focus in the scale discussion, are a tiny part of overall costs. It’s all about the investment costs. Every investment professional knows size is normally a disadvantage in investments.

With respect to its determination criteria in the upcoming discussions with errant funds, APRA says:

“APRA’s assessment considers both an RSE’s historical member outcomes, as well as key indicators for future sustainability. It also incorporates APRA’s supervisory knowledge of the

unique characteristics of each RSE and RSE licensee, including APRA’s assessment of the adequacy of governance and risk management frameworks, strategic and business planning practices and business operations.

“The metrics for APRA’s assessment of historical outcomes and future sustainability include:

  • net returns, on an absolute basis and relative to risk/return targets;
  • costs per member for MySuper products;
  • cost of insurance cover;
  • administration and operating expenses as a percentage of average net assets (operating cost ratio);
  • net cash flows as a percentage of average net assets (net cash flow ratio);
  • net member benefit outflow ratio;
  • net rollovers as a percentage of average net assets (net rollover ratio);
  • trends in membership base; and
  • active member ratio.”

Most big super funds were formed in the 1980s, with the advent, in 1986, of Award Super, the precursor to the Superannuation Guarantee. Some corporate and a few industry funds date back a lot further than that. APRA was formed 10 years after Award Super and three years after the introduction of the SG, in July 1996, after a carve out from the Reserve Bank of Australia.

The RBA was given specific responsibility to oversee and administer monetary policy – mainly inflation and, therefore, interest rates – while the new APRA was given regulatory control of the banks, other financial institutions, and superannuation. Well, at least the RBA has done its job.

The continuing scandals among the banks, particularly the CBA, question the quality of oversight by APRA, mainly, but also ASIC, the consumer’s regulator.

With respect to super, here’s an idea. Given the super industry is always searching for the better alignment of interests between client and service provider, perhaps APRA should participate in this good-governance aim. Perhaps APRA staff should be forced out of the public service pension system and into the real world that they oversee. Would they consequently change their policy settings? After all, the industry provides most of the funding for APRA’s annual budget.

And, while they’re at it. How about introducing some good governance at APRA, too. Like having some merit-based independent directors, representing both gender and ethnic diversity? And proper industry representation. (See APRA organisation chart)

It’s time the industry questions what it’s paying for with APRA.

My main point is this: APRA should concentrate on overseeing and regulating the industry’s legislation. It should not get involved in matters beyond its capabilities, such as the structure of the super industry. And it should certainly not interfere in investment strategies.

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