The latest round of legislation aimed at overhauling the system has been a challenging period for super funds which have been focused on launching low-cost default MySuper products, overhauling back office transactions through the SuperStream measures, while also improving governance and disclosure.

Three-quarters of super fund chief executives recently surveyed by the Financial Services Council (FSC) said the Stronger Super regulations were having a big impact on their businesses. While many have backed the ultimate goals of the regulation, they have also voiced concerns about its unintended consequences – repercussions which the industry is continuing to absorb.

Fees

MySuper was designed to not only be a simple default super product, but a costeffective one. However, the regulatory burden has pushed up costs. Funds are being forced to absorb extra compliance, custodial and administration costs, as well as go through a lengthy MySuper application process and overhaul a number of internal processes.

John Brogden, chief executive of theFinancial Service Council, estimates the cost to super funds of Stronger Super implementation at $1.5 billion. AMP has said it will add 4 basis points to its Signature Super administration fee for five years beginning November 1, 2013. MLC has warned of a small fee increase to recoup some of the expenses that the new legislation has entailed as well.

Neil Cassidy, chief executive of Tasplan, says he remains sceptical about the benefits of MySuper.

“The costs have been far greater than we anticipated,” he says. “It’s going to take a long time to recoup back what we’ve had to put into getting this MySuper license.”

Industry funds have largely absorbed the extra costs through their reserves, the extent of which will only be revealed in their 2012-13 annual reports which have yet to be released.

Deloitte partner, consulting, Russell Mason, estimates doubledigit cost increases and predicts a rise in administration fees.

“You could see expenses going up across the board by 10 per cent. That would not be unreasonable, on top of any inflationary costs that might be there.”

Asset allocations

The drive to lower costs is affecting asset allocations, with higher priced asset classes such as private equity and absolute return funds coming under scrutiny.

“It’s a bit strange in some ways because the legislation doesn’t say you have to have a low-fee product,” Frontier Advisors director of consulting Fiona Trafford-Walker says.

“It basically just has to a be a product that is right for your members but this is a noteworthy change in terms of our client base – fees just have to be lower… it is leading to views on asset allocation towards cheaper asset classes and away from more expensive ones.”

Some funds are leaning towards appointing passive-enhanced equity managers whereas, in the past, they would have been more likely to appoint an active manager. It is a view also shared by the fund manager bosses surveyed by the Financial Services Council, that believes MySuper will reduce the extent of active management.

“That’s something we worry about because we think about net returns and net returns are the most important thing,” Trafford-Walker says.

Some of the biggest shifts to low fees have been amongst retail funds which have adopted indexed portfolios. This is putting the role of private equity and hedge funds under debate. The standard 2 per cent base fee and 20 per cent performance fee can add 15 to 20 basis points to a fund’s management expense ratio – a large amount for a small proportion of the portfolio when investment costs are paramount.

Nonetheless, the best private equity and absolute return managers are not cutting fees despite the pressure from local trustees. Such funds can rely on demand from offshore, where the fee debate has not been so strong.

The role of illiquid assets such as private equity in boosting industry fund returns over retail funds is well documented. Martin Scott, head of Australia at private equity firm Partners Group, which manages about $3 billion on behalf of local super funds, is concerned that funds will lose out.

This happened before just after the global financial crisis. “Essentially for a period of one year, most funds were on hold to illiquid investments,” he says. “This had an interesting impact with some funds choosing to sell into the secondary market. From a members’ investment point of view, these funds would have been far better to hold the investments to maturity.

“Most investors have now returned to the illiquid asset classes and are rebuilding their portfolios. We even saw many first time institutional investors enter the private equity asset class looking to benefit from others selling. Some of the best investments made over the last 10 years were done exactly when the regulations were being discussed – unfortunately it pushed many to the side lines and they missed some of the greatest opportunities to invest we have seen for a very long time.”

Partners Group, as with other fund managers, has been affected by super funds’ increased portfolio reporting requirements. It is another area of concern over practical implementation, which is intended to provide useful information to investors but may reveal confidential transactions or upcoming deals.

ASIC will require super funds to disclose their underlying investments by July 1, 2014 (as recommended by the Super System Review) although the exact disclosure is still being debated.

“To me, it doesn’t make any sense to provide total transparency on every single investment in every single manager because you’re going to have thousands and thousands of line items when most people just want to know the material holdings,” Trafford-Walker says.

Jim Boynton, partner at King and Wood Mallesons, says offshore managers are particularly concerned.

“The portfolio reporting requirements have caused some offshore managers to reconsider whether they will manage Australian superannuation money. Several closely guard details of their underlying portfolios. Others have been asked by super funds to bear the burden of the additional reporting and other obligations that are really the trustee’s. This increases the cost of doing business and might result in costs being passed on to members.”

Another component of the MySuper legislation requires a fund to receive approval from APRA whenever it outsources a function or service to an overseas-based external provider. Trafford- Walker says that it also applies to the appointment of any overseas-based fund manager, which could potentially take weeks to approve.

“That’s going to delay appointments – you may miss opportunities because of the extra time you’ll need to allow APRA to look at all the material. I don’t think APRA is going to look and saying that’s a good or a bad manager, they’re just going to say did you follow the right process.”

The compliance load – and the interpretation of the legislation – is an ongoing issue for many funds. “We have got a situation at the moment because of MySuper,” Greg Nolan, general manager investments, CareSuper, says.

“We have got to renew a contract with a provider which is going to cost us money and time and we are reviewing the provider in the next six months and apparently we cannot get an exemption. What we have got to do will take a month, it will cost us money and time and it might all be redundant in a month or two. Those sorts of things really frustrate people.”

The opportunity cost

As Stronger Super has become the overarching focal point for the industry, it has necessarily come at the expense of a number of other areas. The FSC’s CEO report, which surveyed 55 chief executives, found that the reforms, and associated regulatory burden, had diverted resources, including their best staff, to compliance-related projects instead of long-term growth-focused projects.

Deloitte’s Mason says post-retirement products, smartphone apps, and improving member analytics which would allow more focused targeting of services, have all been delayed.

“I’ve seen a lot of trustees say ‘We want to do this, but we either don’t have the budget or we can’t focus on two major things at once – we’ll have to put that on the back burner until after January 1, 2014, when we’ve bedded down MySuper and seen how our members react to that,” he says.

The regulatory burden, particularly the back office-focused SuperStream reforms, has resulted in a substantial increase in information technology budgets. Almost two-thirds of chief executives surveyed in the FSC report said they expected to increase IT budgets over the next two years, with more than onequarter of those doing so as a result of the new regulations. Fund managers also said they also were finding it difficult to discuss new innovations or directions with super clients because they are tied-up with regulatory concerns.

The original Super System Review, which led to the reforms was implicitly supportive of the ongoing trend towards consolidation across the industry, with the benefits of scale expected to deliver lower fees and larger retirement balances.

But while consolidation is still expected, the implementation process has diverted attention away from potential mergers between funds in the short term. “The focus on mergers went away because the main aim was to get your own MySuper license and a merger could be a distraction to that,” according to Tasplan’s Cassidy, who also said the $2-billion fund still receives approaches from other funds.

The number of large APRA-regulated funds fell by 6.6 per cent in 2012-13 from 348 to 325. That was a considerably slower pace of consolidation than the 9.8 per cent and 9.4 per cent posted in the preceding two financial years, although the corporate fund sector continues to show the greatest pace of outsourcing.

The human cost

The uncertainty regarding the Stronger Super legislation and the tight time frame to implement the bulk of the changes has been all-consuming for those within the industry.

Cassidy says the 12-month deadline to implement MySuper was unnecessarily short and was all-consuming. “Sleepless nights – I don’t know how many times I lay awake at night thinking why am I doing this? What’s next and why is it happening? It put a lot of pressure on personnel and at the end, fingers crossed, it does meet expectations, but I just think there are some doubts in relation to it. Time will tell.”

Implementation has been delayed a number of times as the industry struggled to adapt and pushed for clarification.

The Association of Superannuation Funds of Australia (ASFA) chief executive, Pauline Vamos, says there are still 39 significant issues which require clarification.

“Funds and providers have to go ahead whether or not the legislation is finalised, whether or not the policy just doesn’t work, whether or not a clarification has been provided,” she says. Vamos oversaw the significant Financial Services Reform Act while a director at the Australian Securities and Investments Commission. “So what happens when finally it has been resolved, you have to sometimes wind back what has been put in place.”

Vamos says ASFA has called on the regulators and government to take a pragmatic approach to implementing the Stronger Super legislation. “Everybody involved in the implementation side of Stronger Super – and I speak to a lot of them – is frantic, absolutely frantic. Fatigue, when you’ve been frantic for so long, does set in.”

CareSuper’s Nolan says the stress has also pushed people from the industry. “I know one guy who left 18 months ago, and one of the reasons he quit was he said he just could not go through with MySuper. He was in the industry for a long time. He was working on compliance with a fund. He retired. Burnout is a major thing here.”

One comment on “The unintended consequences of regulation”
  1. Through the haze of all of this, a sleeping timebomb for the industry is the start of the compulsion for employers to conform to electronic data standards @ 1st July 2015

    Talk about frantic. At a time when the industry is still embedding rollovers and MySuper, they face 8 months to change the behavours, technology and processes of employers, with regulations and details still yet to be finalised.
    Rollovers was between 200 odd funds, Contributions is between 800,000+ employers and 500,000+ funds, so is 8 months to get ready enough for the industry?

    Every member wants an efficient system to drive down costs and increase returns, but at cost?

    The definition of crazy…. repeating the past, expecting different results.

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