The superannuation sector's adversity and opportunities

2019 and 2020 represented a perfect storm for the superannuation industry, which – all things considered – it has weathered well.

Following the Financial Services Royal Commission (FSRC), the industry has had to come to grips with reinvigorated and energised regulators responding to the challenges and referrals announced by Commissioner Hayne. This comes with the extensive and aggressive use of the full armoury of compulsory information-gathering powers including:

  • Production of documents
  • Directions to provide information
  • Requirements to undergo an examination to answer questions and/or provide reasonable assistance to the regulator.

This is quite often on extremely short time frames and demands considerable resources of the organisation.

To date, a number of cases have already been brought by ASIC, APRA and AUSTRAC with mixed results, with more in the process of being prepared. In this new paradigm, regulators appear to have reset their risk profile for litigation, and are more likely to bring actions. That is not to say that regulators are happy to accept a loss (as can be seen by ASIC's appeal of the Federal Court's Westpac decision at first instance). Rather, they have taken on board the FSRC's 'why not litigate?' recommendation as a guiding principal, while still evaluating the likelihood of success, but fully accepting of the risk that they might not be successful.

New regulatory reforms for superannuation funds

Superannuation funds have also had to contend with a stream of regulatory reforms that have either been enacted, published for consultation or otherwise announced – many of which fell out of the FSRC. These reforms include:

  • Ending the grandfathering of the conflicted remuneration provisions effective from 1 January 2021 and, in addition to the FSRC’s recommendation, requiring that any grandfathered conflicted remuneration at this date be rebated to clients;
  • Prohibiting RSE licensees from assuming any obligations other than those arising from or in the course of its performance of their duties as the trustee of the superannuation fund;
  • Prohibiting the deduction of any advice fees (other than intra fund advice) from MySuper accounts;
  • Limiting the ability to deduct advice fee (other than for intra fund advice) from non-MySuper accounts;
  • Prohibiting unsolicited selling (i.e. hawking) of superannuation and insurance products;
  • Ensuring superannuation fund members only have one default account (for new members entering the system);
  • Prohibiting RSE licensees (and their associates) from 'treating employers' where the act may reasonably be understood by the employer to have a substantial purpose of having the employer nominate the fund as a default fund or having one or more employees of the recipient apply or agree to become members of the fund;
  • Introducing civil penalties for breach of covenants and like obligations;
  • Requiring anyone seeking to acquire greater than a 15% controlling stake in an RSE licensee to apply to APRA for approval; and
  • Requiring superannuation funds for the first time to hold annual members' meetings with strict penalties for failing to hold them, for officers failing to attend or answer questions asked of them.

Introducing FAR – the Financial Accountability Regime

However, the most far reaching reform so far announced is yet to be enacted - the recommendation to extend the Banking Executive Accountability Regime to all RSE licensees (to be known as the Financial Accountability Regime or FAR). While this reform is yet to be legislated, the consultation paper published by APRA in February this year would indicate this will require trustees to fundamentally look at the governance model, decision making processes, culture and HR policies of their organisations. As a result, a number of superannuation funds have commenced work on implementing the proposals in the absence of the legislation. 

Financial impacts of COVID-19

Like many others in the Australian economy, superannuation funds have also had to contend with the financial impacts of the COVID-19 pandemic.

Like in any downturn, superannuation funds cannot currently rely on the same level of inflows typically due to:

  • Lower voluntary member contributions resulting from lower consumer confidence and disposable income;
  • Lower returns on investments, dividend yields and, as is the case presently, record low interest rates;
  • Reduced SG contributions due to the COVID-19 social distancing restrictions, business shut downs and redundancies; and
  • Reduced business cash flow and in some cases, employer insolvencies and defaults.

These liquidity pressures are more acutely felt by super funds which have a high volume of members who are employed in industries hardest hit by the COVID-19 social distancing restrictions such as tourism, hospitality, aviation, retail, building, entertainment and the arts.

In response to the needs of those financially affected by unemployment as a result of the pandemic, the financial hardship rules were extended to allow members to access up to $10,000 in each of the 2019/20 and 2020/21 financial years (ie. up to $20,000 in total). According to Treasury, this is anticipated to result in 2.6 million people across the Australian workforce receiving a total of $42 billion in superannuation.

While this measure released cash to assist individuals affected and was welcomed by the broader economy, by definition, it added to the liquidity pressures on those funds most affected by the COVID-19 social distancing restrictions.

Even the fall in the Australian dollar has added to liquidity pressure on super funds as they are forced to provide more collateral to cover hedges.

“For some funds, the combination of these factors represent a 'perfect storm'.”    

In response, most affected super funds are reconsidering their how, and how often, they value their unlisted assets. In March of this year, one of Australia's largest super funds announced the one-off re-valuation of its entire unlisted asset portfolio. Investment managers are also being asked by their super fund clients to conduct ad hoc and more frequent valuations.

In some cases, we have seen super funds affected by the COVID-19 social distancing restrictions redeeming major holdings in unlisted assets - for example, HostPlus is reported to have requested to withdraw $1.4 billion from the Industry Super Property Trust (ISPT). The increased pressure on underlying managers to liquidate assets for which there may be a restricted market (such as in property) has in turn resulted in a significant widening of buy/sell spreads on certain asset sectors.

However, where there is adversity, there is often also opportunity.

In this case, there is opportunity for funds that have the available liquidity to invest in quality assets that may not have otherwise become available. For example, we have also seen an increase in the market for distressed or illiquid assets by more liquid funds that are using their liquidity to take advantage of price 'dislocations'. It is reported that in some cases, super funds with greater liquidity have approached less liquid funds or their underlying managers, offering to purchase their interests in unlisted distressed or illiquid assets.

In addition, one of the measures that the Commonwealth and State governments may use to help kick start the economy is through infrastructure projects. Unlisted infrastructure assets offer stable long term returns that match the longer-term investment profiles of super funds. Ironically, these infrastructure assets are likely to be on offer at a time when the House of Representatives Standing Committee on Economics is scrutinising the extent to which super funds are exposed to unlisted assets.

Mega funds: a fresh round of mergers

While most funds will weather the storm, for some industry funds, the current regulatory and economic environment has demonstrated the need to merge into or to create a larger fund in the interests of their members. The rest of 2020 and 2021 are likely to see a fresh round of super fund mergers. In some instances, these mergers will create 'mega funds' such as the recent merger of First State Super and Vic Super to result in a $125 billion fund known as Aware Super or the potential merger of QSuper and Sunsuper which would be the largest super fund in Australia with $195 billion.

The post-FSRC period has also seen the continued divestiture by the banking sector of life insurance and wealth businesses, initially acquired about 20 years ago.

In 2016, NAB sold 80% of its interest in MLC Life to Nippon Life for $2.4 billion. In the midst of the FSRC, on 2 May 2018, NAB announced that following a review of its operations, it would exit the Advice, Platform and Superannuation and Asset Management business operating under the 'MLC' brand via demerger, IPO or trade sale.

In late 2018, ANZ entered into agreements for the sale of its interest in OnePath Life to Zurich for $2.85 billion and the sale of its interest in the OnePath Wealth business to IOOF for $850 million. However, due to the intervening FSRC, it was not until early 2020 that these sales could be completed.

In late 2019, CBA announced that it had entered into an agreement to divest its interest in CommInsure Life to AIA Group Limited for approximately $2.375 billion and, in May 2020, that it had entered into an agreement to sell 55% of its stake in Colonial First State to global investment firm KKR for approximately $3.3 billion.

In May 2020, Westpac has announced a strategic review of its wealth business which is assumed to include consideration of spinning off that business.

On 31 August 2020, NAB announced that it has entered into an agreement to sell 100% of its interest in MLC Wealth to IOOF for a purchase price of $1.440 billion. Taking into account its existing funds under management and the purchase of the OnePath wealth business earlier this year, IOOF will potentially be the largest retail superannuation provider in Australia.

Before being acquired by the major banks, these wealth businesses were either financial institutions in their own right or owned by other large financial institutions. These divestitures will mark the first time that these businesses will be owned by a range of diverse organisations including private equity firms. Only time will tell how will these businesses interact with each other and how will they compete with the emerging 'mega funds' within the industry fund sector.

Contact

Maged Girgis

Wealth Management Sector Leader

Maged Girgis is one of the country's most-respected financial services lawyers with over 28 years’ experience specialising financial services law advising life insurance and superannuation fund clients.

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