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Review creates challenges for super outcomes

The recently released Capability Review of the Australian Prudential Regulation Authority (APRA) made three recommendations that are specifically aimed at superannuation. These recommendations hold significant implications for how the industry might be regulated in future.

Recommendation 5.1 calls for the establishment of a dedicated Superannuation Division within APRA. This sensible proposal recognises that superannuation differs in fundamental ways from banking and insurance. Superannuation funds invest on behalf of members for uncertain outcomes, and fund trustees have a fiduciary duty to members. Banks and insurance companies make promises related to fixed amounts, and the duty of directors has (traditionally) been to the shareholders that provide the capital. Superannuation should be viewed through a dedicated lens.

Recommendations 5.2 and 5.3 are aimed at cementing member outcomes as a central focus for APRA. This will inevitably change the aspects that it pays attention to when regulating the industry.

The remainder of this article discusses some issues that arise from this shift in focus.

A move from financial stability to member outcomes

As a prudential regulator, APRA’s role is forward-looking and relates to how the financial industry operates and the potential implications. Its mandate spans a broad range of elements, with Section 8(2) of its governing act stating:

“APRA is to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality and, in balancing these objectives, is to promote financial system stability in Australia.”

Until recently, APRA pursued its mandate within superannuation by primarily addressing the financial stability of the funds themselves. The Review issues a loud shout for APRA to focus on member outcomes. This gives impetus to a shift that was already underway following the Hayne Royal Commission, both within APRA itself, and through the recent ‘member outcomes’ bill giving it power to take corrective action against funds that are not acting in members’ best interests.

The Review envisages APRA becoming a champion for members, backed up by the structure, resourcing and ethos to do so.

Previous mechanisms have been weak

The broad thrust of focusing on member outcomes is welcome. Although fund trustees have a fiduciary duty to act in the interests of members, the problem is that the mechanisms for ensuring that trustees are doing their jobs properly have been weak. The members themselves do not apply much pressure. Their main disciplining mechanism is through exercising fund choice, but most members lack the interest, knowledge or confidence to do so. Many just accept the default, often on trust.

Gatekeepers like corporate sponsors and financial advisers can exert some influence, but operate only in certain parts of the market. Research and consulting houses offer fund comparisons. However, none of these groups can be relied on to champion member interests in a comprehensive manner.

Having APRA on the look-out for member interests will provide both a valuable check on whether funds are doing what is best for their members, and a source of stimulus for change when required. The fact that funds know that APRA is watching will help ensure they stay in line.

Nevertheless, there are issues around implementation. Member outcomes are delivered at the product and service level. How deep does APRA go? At the top end, APRA could aim to satisfy itself that funds are giving deep consideration to member interests in designing their product offerings and ancillary services such as advice. At the bottom end, APRA might drill down to examine the products or services in some depth. It currently does this with MySuper authorisation.

Will APRA push at a product level?

The Review seems to be implying a deeper product-level focus. Recommendation 5.2 suggests that APRA: “publish objective benchmarks on product performance” and “collect product level data that facilitates accurate assessments of outcomes and comparability across funds”.

Will APRA not just place pressure on funds to adjust their governance structures, processes and behaviours, but also provide direction on product and service design?

How APRA might drill down into the product level in an efficient manner is an open question. What can they handle effectively? How can they avoid regulatory over-burden? How do they share the task with ASIC?

Finally, the APRA Review seems to place store in collecting product level data as a means to identify underperforming funds, and perhaps help drive competition by informing members. More product-level data is definitely needed.

However, past performance often contains more noise than signal. And making past performance the focal point of attention can drive dysfunctional behaviours such as return-chasing, short-termism and performance manipulation. We are starting to see dysfunctionalities from the focus on fees, such as funds passing over investments that may benefit members because they are more expensive. Once stipulated and monitored, a measure can become the target in itself.

APRA might be better off focusing on how funds approach the task of delivering value to members than concentrating on past member outcomes or the intricacies of product design. Why not let the funds work out what is best for their members, and concentrate on whether they are diligently pursuing their fiduciary duty in doing so?

 

Geoff Warren is an Associate Professor from the College of Business and Economics at The Australian National University.

 


 

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