Ross Jones, Deputy Chairman - Senate Standing Committee on Economics, Canberra
I would like to follow the Chairman’s general comments with brief opening comments on the superannuation industry, given that it is an area of particular interest at the moment.
Firstly, the superannuation industry is going through a major reform process. The Stronger Super reforms will have a significant impact on funds and regulators over the next 12 months, prior to the introduction of MySuper on 1 July 2013. As part of this process APRA is intended to have standards-making powers for superannuation, powers that it has in the other industries it supervises. At present APRA has greater supervisory powers over a small credit union than a multi-billion dollar superannuation fund. We are planning on the basis that the relevant legislation to give APRA standards-making powers in superannuation will be passed by Parliament this year. We have draft prudential standards on a range of topics, such as risk management, audit, governance, fit and proper, conflicts of interest and investment governance, out for consultation at the moment, with the expectation that an enhanced supervisory framework for superannuation will be in place by 1 July 2013.
The second issue I want to address is confidence in the superannuation system. Confidence in the system has been affected by the low returns and increased volatility in those returns since the global financial crisis hit. Confidence has also been impacted by the losses associated with the fraud in Trio Capital.
In the years since the financial crisis began, investment returns have been low. The annual average rate of return (2002-2007) was 9.8 per cent and volatility was 6.8 per cent. The average return (2006-2011) was 1.8 per cent and volatility 11.4 per cent. There is now a greater focus by fund members on their superannuation.
One other factor impacting on the confidence in the industry has been the collapse of Trio Capital and the associated fraud in investment schemes.
The Australian superannuation sector is highly safe. Over the past decade, Australian Superannuation funds under management have grown from around $500 billion to around $1.3 trillion of which around $800 billion is supervised by APRA. In that time there has been one fraud, of around $55 million in the APRA-regulated sector. I would emphasise also that the fraud did not occur in an APRA-regulated entity, but in an offshore hedge fund, beyond the reach of Australia’s regulators.
However, there is little doubt that the collapse of Trio has diminished confidence. The Parliamentary Joint Committee on Corporations and Financial Services reported on the collapse of Trio on 16 May and I would like to comment on its findings and recommendations.
Trio Capital was an APRA licenced superannuation fund trustee. It was also the responsible entity for a range of ASIC-regulated managed investment schemes, including Astarra Strategic Fund, (ASF) where most of identified losses occurred. The ASF was a hedge ‘fund of funds’ with funds invested overseas.
The Inquiry made two specific recommendations related to APRA. The first is that APRA cooperate with other agencies to pursue criminal investigations, and where possible, criminal sanctions against key figures responsible for defrauding Trio investors. APRA will of course cooperate in every way it can, however APRA’s powers are limited to areas within its mandate.
Under the Superannuation Industry (Supervision) Act 1993 (SIS Act) APRA can pursue the imposition of civil or criminal penalties and make disqualification orders for persons responsible for breaches of the SIS Act. The parties responsible for compliance with the SIS Act were the trustee (Trio Capital - now in liquidation), its directors (the subject of a series of enforceable undertakings and continuing investigation by APRA) and the investment managers (variously in liquidation and in the case of Mr. Shawn Richards, subject to ASIC’s criminal processes). Other individuals named in the Trio Report are not within APRA’s prudential remit, as their conduct related to products not regulated by APRA.
The second recommendation was that APRA conduct an internal assessment of the adequacy and timeliness of checks to monitor superannuation vehicle ownership. This process has begun. We have conducted a review of our supervision after the collapse of Trio and will further investigate. The Parliamentary Joint Committee (PJC) also commented that APRA must review ‘trigger points’ in events leading to Trio’s collapse. APRA will follow up the recommendation including some specific advice on fraud identification from other agencies. We will also consider if there is a need for additional legislation.
APRA’s prudential supervision has not been based on the premise that fund owners, trustees and employees are engaged in fraudulent activity. In its supervision of superannuation APRA acts as a third line of defence after trustees and auditors. As a first line of defence, the organisation’s management has ownership, responsibility and accountability for assessing, controlling and mitigating risks. In APRA’s view the trustees of Trio failed to act in members’ interests.
APRA’s focus is on governance of funds, the fitness and propriety of responsible persons, and investment policy. Supervision based on assumptions that governance failures are indicative of fraud would require considerably more intrusive supervision and stronger regulatory powers. It may be possible to reduce the risk of fraud by certain types and locations of investment. However, such an approach is not without cost as highly regulated investment schedules may lead to overly low risk investments that do not generate adequate long-term retirement savings. Further, such an approach would require a considerably larger resource commitment by APRA that would be funded by the superannuation industry.
Short of a highly prescriptive approach, APRA has nonetheless been warning about the dangers in this area. In 2003 APRA alerted all trustees advising them of risks associated with investments in opaque hedge funds. The response to this advice was generally negative, with hedge fund managers cristising APRA and even an AFR editorial stating that APRA had ‘strayed outside their prudential remit’.
APRA has also issued several publications to assist trustees in meeting their obligations to prevent fraud.
A particularly relevant question is whether a fraud like Trio could occur again. While there can be no guarantees, a number of policy and regulatory changes have been enacted since Trio was established that should further reduce the likelihood of such an event being repeated.
In 2004, the Government enacted the Superannuation Safety Amendment Act 2004 following recommendations from the Superannuation Working Group, an advisory body it had established a few years earlier. The major changes in the prudential supervision regime were:
- trustees were required to be licensed by APRA by 30 June 2006 if they wished to remain as trustees of APRA-regulated superannuation entities;
- a mandatory risk management framework was introduced for both the trustee and the funds under trusteeship; and
- new operating standards covering fitness and propriety, adequacy of resourcing and outsourcing came into effect.
The Superannuation Working Group had also recommended that APRA be given a prudential standards-making power. This recommendation was not accepted by the Government at that time.
The new risk management and operating requirements were imposed on the Trio group when it applied for a licence but were probably inadequate. APRA’s prudential reviews of Trio focused on conflicts of interest and independence of trustee directors from the promoters of the fund. At no stage until Trio collapsed did the trustees or auditors raise any concerns with APRA about the soundness of the fund’s investments. If they had, APRA’s focus would obviously have changed.
The Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill, passed by the House of Representatives on 23 May 2012 will give APRA a greater ability to deal with issues of poor trustee governance.
APRA will have a greater ability to act on Trio-type situations where the fund invests in a related-party managed investment scheme. Such action will make the Trio model more difficult to sustain in practice.
However it would appear that Self Managed Superannuation Fund (SMSF) trustees and financial planners who did have access to investment returns from the Astarra fund did not identify peculiarities in the returns. It was an independent whistleblower who highlighted that the pattern returns was highly implausible.
I would like to make one final point, and that is that it would appear that self managed superannuation fund trustees and financial planners did not behave in the same way as the APRA-regulated funds. The impact of the Trio fraud has actually been made much larger by the failure of some self managed funds to have adequate and appropriate risk diversification. If we look at the average exposure per member in an APRA-regulated fund, the average exposure is around $11,000. There are around 6,000 people in APRA regulated funds who were affected by the impact of Trio. Six thousand people and around $55 million. There are 600 people in non-APRA regulated funds for about an equivalent amount. In other words, the material provided to the Parliamentary Joint Committee suggests that the asset concentration by certain SMSFs in the Astarra Strategic Fund led to losses that are considerably greater than would have occurred in the APRA-regulated environment. I think this probably suggests that investors were considerably more exposed in the self-managed sector than prudent diversification would warrant. It would appear that the self-managed superannuation fund trustees and their financial planners probably would have responded a little more carefully.
Without going any further, I will leave it there and be happy to take questions.