Navigating turbulent times
Thank you for the opportunity to participate in a Trans-Tasman Business Circle event again.
This event has been rescheduled a few times due to COVID-19. Thankfully, we can finally meet in person. But just as the world appears to be pulling free from the grip of COVID, the Russian invasion of Ukraine has exacerbated a perfect storm of events: supply chain problems, soaring energy prices, surging inflation, rising interest rates, and falling asset values.
Former US President Franklin Delano Roosevelt remarked that smooth seas never made a skilled sailor. Superannuation trustees may be facing some rough seas ahead. The world in which asset values, and hence returns to members, are elevated by very low interest rates seems at an end. The focus on value for money will inevitably increase. And the performance of trustees is going to be subject to intensive scrutiny as more and more transparency is, quite rightly, demanded of the sector. Those that successfully navigate the coming few years will no doubt be amongst the better sailors.
But no matter how good the crew, rough seas can sink ships. So, as well as skilled sailors we need ships that are seaworthy. That’s where APRA has been focused for many years. Much of our agenda has been directed at improving frameworks for governance, risk management and operational resilience. Each is essential for successfully running a business come rain, hail or shine, and that trustees are focusing on what matters most – achieving the best possible retirement outcomes for their members.
We were asked to speak today about APRA’s latest priorities. To some extent, that’s easy because, while there are always some new developments to respond to, some things don’t change. If I leave you with one message today, it’s that even though the operating environment is rapidly shifting, one constant will be our focus on rectifying sub-standard practices and eradicating unacceptable product performance to drive improved member outcomes.
Setting the course
The past five years or so has seen a lot of scrutiny of the superannuation sector, and its regulators. The Royal Commission1 and Productivity Commission2 reports, which both landed in early 2019, shone a light on – to put it politely – the need to improve the way the industry served its members. Everyone had to do better.
Between them, the two reports led to substantial regulatory change, setting the industry on a new course. At their heart, the reforms had three core goals:
- producing higher standards of trustee behaviour;3
- driving out inefficiencies;4 and
- establishing much greater transparency.5
These components should be mutually reinforcing. But in case they aren’t, they also come with stronger powers for regulators. In APRA’s case, that includes the strengthened directions power, and penalties for best interests (now, best financial interests) breaches. These powers are important for making sure the higher standards of trustee behaviour – embodied in a relentless focus on members’ interests over all else – are not just aspirational.
My colleague Margaret Cole recently spoke about APRA’s more muscular approach to supervision and enforcement in superannuation. We are unapologetic about making use of our new powers – after all, Parliament didn’t give them to us only to have them gather dust. There’s a clear expectation they will be used to make sure members’ interests are always paramount.
Surveying the fleet
Having set a new course, what about the size and shape of the fleet?
It’s fair to say that if you were designing the superannuation industry from scratch, you wouldn’t give it the shape we have today. In an industry where size matters, there’s a long – and often underperforming – tail. Of the 145 APRA-regulated funds, 105 have less than $10 billion in funds under management, and 70 have less than $2 billion (that is, less than 1 per cent of the size of the very largest funds). Collectively, those 105 small funds – 72 per cent by number – manage only 8.5 per cent of assets.
In contrast, 17 large funds have more than $50 billion in funds under management each, collectively accounting for more than 70 per cent of assets.
This size difference matters. It has real impacts on the outcomes delivered to members. The analysis we published earlier this year demonstrated that trustees of the largest funds are leveraging their scale to reduce expenses and improve operating efficiency. They can lower fees and costs, access higher-yielding investments and better attract new members – a virtuous circle. Meanwhile, about half of sub-$10 billion funds face sustainability challenges with declining net cash flows and accounts. It’s hard to see how that is going to generate the best outcomes for their members.
In making this point, I want to be clear that APRA doesn’t blindly adopt a ‘big is good, small is bad’ approach. Our heatmaps show there are big funds that must do better, and there should be no free pass for them. Equally, there are small funds that are doing well for their members. But, overall, it’s difficult to get away from the fact that size, translating into economies of scale, helps deliver better member outcomes, and trustees that can’t compete on that basis need to think very hard about how (and whether) they can deliver in their members’ best financial interests, now and into the future.
Nowhere to hide
Importantly, there’s no longer anywhere for poorly performing funds to hide. Some of the most important and effective reforms in recent years have involved much greater transparency. Initiatives such as APRA’s heatmaps and the annual performance test have both drawn attention to under-performance, and created real consequences for those coming up short.
This is making a difference. Our MySuper heatmap, first published in 2019, substantially increased the transparency of performance, costs and fees. The power of this approach can be seen in the almost immediate drop in fees across the MySuper sector, cumulatively saving members millions of dollars. We ran a choice heatmap for the first time last year. Of the 220 odd under-performing options, around 120 are now closed or will soon be closed. This is good news for members, who will soon be in products or options with better performance history and lower fees and costs.
The statutory performance test has reinforced this approach, with serious consequences for those that fail. Thirteen MySuper products missed the mark in the first cycle: 10 of these have now exited or announced plans to exit soon. In due course, expanding the test to trustee-directed products will have a similar impact – more good news for members.
To state the obvious, this trend towards increased transparency is not going away. Trustees need to operate on the basis they are privileged to manage other people’s money, and they need to be completely open and transparent to show that privilege is warranted.
Performance is what counts
To recap, in the past five years alone, the superannuation industry has undergone tremendous change. Overall, these changes have produced a more efficient industry producing better outcomes for members. There is, however, still plenty of room for improvement.
Much in superannuation is, unfortunately, still debated through a particular competitive lens: industry versus retail funds; large versus small funds. We are indifferent to those distinctions. Our sole focus will continue to be on whether funds, regardless of their status, are delivering for their members.
The period ahead will test which trustees are best equipped to manage members’ money into the future. Inevitably, it will be trustees with robust business practices, operating within a clearly defined strategy that puts their members’ interests first, that will be best placed to navigate their way through some tricky times. Those that are unable to do so shouldn’t expect APRA to throw them a life buoy.
I’ve talked so far about some of the longer-term foundations for superannuation. I will now hand over to my colleague Suzanne Smith, who will highlight a few topical issues that are of particular interest at present.
Avoiding the rocks
In the time I have left, I’d like to drill into some of the areas Wayne touched on.
The first is the matter of consolidation. In the nearly 10 years since APRA incorporated superannuation into the prudential framework, the number of APRA-regulated funds has fallen from about 330 to 145 today. We know of at least 9 mergers that are either in progress or under serious consideration, so the number of trustees will continue to contract. We have begun seeing partnerships between some of country’s biggest and most successful funds, and even mergers that cross the barrier between the rival retail and industry sectors – something APRA welcomes.
Our analysis of sustainability trends suggests those funds joining forces to pool their resources, expertise and asset pools will realise savings they can pass on to members through lower fees and costs. Significantly, we have found that transactions (whether that be through a merger of business operations or successor fund transfer (SFT) of assets and members) involving larger funds deliver the greatest fee savings, especially in administration fees. As a result, the sustainability gap between the biggest and smallest vessels will only grow wider.
So where does that leave the long tail of small funds? To build on Wayne’s maritime metaphor, they’re “gonna need a bigger boat” if they wish to remain competitive, and the quickest way to achieve this is through a successor fund transfer – ideally with a large, well-performing fund.
Signing the deal, however, is only the first step in realising benefits for members. Depending on the nature of the transaction, we are observing funds facing difficulty due to what we refer to consolidation indigestion. This may manifest at the industry level at the point of transfer in a SFT, for example where an administrator has a backlog of transfers to process. Alternatively, it may be within an entity itself where the transaction results in a merger of businesses requiring integration of people, systems and processes to deliver the real advantages to members – the complexity of which should not be underestimated. This is more pronounced in scenarios where multiple transactions have been undertaken in quick succession. While these challenges are not insurmountable, the focus of trustees needs to remain firmly on translating the transaction into demonstrable financial benefits to their members.
Battening down the hatches
Another key area for APRA concerns investment governance.
As global economic conditions become more uncertain and volatility increases, appropriate and effective investment governance is essential to generate sustainable returns for members and foster innovation that will allow the industry to provide for retirees using their own accumulated wealth.
It is also essential, as we see the trend of insourcing investment management activities within superannuation funds continue, to the extent that some of the largest fund managers in Australia are the super funds themselves.
Next month, we will be releasing a refreshed investment governance prudential standard, updating a standard that has been in place since 2013. The refresh follows a review of unlisted asset valuation practices and transactions in the wake of COVID-inspired market volatility, which identified several areas for improvement, including how funds manage their liquidity and conduct stress testing of their investment strategy. These three areas are clearly relevant to boards and board investment committees, and it is here that the standard is being strengthened. The updated SPS 530 Investment Governance will take effect from the start of next year. We will be releasing new guidance on investment governance and valuation practices towards the end of the year to assist industry implement the new standard.
Seeking safe harbour
Finally, a few words about the new Retirement Income Covenant, which comes into effect next week.
A significant demographic shift is underway in superannuation that the industry is not fully equipped to deal with. An ever-growing number of members shift each year from the accumulation to the retirement phase, only to encounter a lack of accessible financial advice or suitable products to help manage their nest eggs for potentially decades to come. The Covenant aims to change that imbalance.
We released a joint letter with ASIC in March to support its introduction with a simple message to trustees of “just get on with it”. They are responsible for running their businesses and should not be waiting for regulators to tell them how to interpret the new legislative requirements. Importantly, though, it should not be viewed as a compliance exercise. The legislation requires trustees to understand the needs of their membership and think seriously about designing strategies to serve them well. Over coming months, we will undertake a thematic review of those strategies, and release the findings in due course, along with examples of better practice, to assist industry to continue to evolve and strengthen their role of supporting their members in this phase of their superannuation journey.
Running a tight ship
As every sailor knows, we can’t control the wind but we can direct the sails.
An environment that was already challenging for superannuation trustees through increased scrutiny and tougher regulatory requirements is becoming even more demanding as the global economy potentially encounters some rough seas. The best captains will already be taking steps to make sure their crew are skilled and their ships are sound, seaworthy and primed to weather any storms that may lie ahead.
As industry regulator, APRA is working to ensure trustees have a clear strategy to protect and promote the interests of their members. We expect them to constantly scan the horizon looking for potential threats and opportunities. High quality data is essential, and they should be closely studying their maps and instruments to ensure they are on the right course and, where necessary, change tack.
What they cannot do, and what APRA will not allow them to do, is remain afloat at any cost, if that cost is borne by members. Should it become clear that their vessel is too small or the conditions too rough, they should be prepared to move their members to another ship to ensure they reach the safe harbour of a financially secure retirement.
1The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry - Final Report
3 For example, the best financial interest duty (BFID), the reverse onus of proof and, in future, the Financial Accountability Regime.
4 For example, account consolidation, stapling, low balance protection.
5 For example, APRA heatmaps and the new annual performance test, as well as new disclosure and reporting requirements for investments and expenditure.