As the super industry grows and becomes ever more complex and systemically important, a single metric, bright line backward-looking test with major consequences of failure is not fit for purpose. Unfortunately, the recent consultation on the YFYS performance test only focuses on modifying the existing test without changing its essential nature. 

A total restructure of performance assessment in super is needed. A better model would be a government authority that is empowered to assess all sectors of the system through considering a body of evidence and making determinations where fund offerings are deemed sub-standard. Our full submission that floats this idea and addresses the options proposed by Treasury is found here.

Current consultation is too narrow in scope. More ambition is needed.

The main options floated in the recent Treasury consultation amount to tweaks on a single test of past performance aimed at easing constraints on investing in ‘nation-building’ assets, reducing benchmark-hugging, and broadening the test’s application.

Tinkering in this way seems at odds with the expansive intent of the Annual Superannuation Performance Test – design options consultation of March 2024, and the Treasurer’s comment that “any changes must be enduring to set the test up for long-term stability” (covered here). Without major reform we expect that, in time, it will become necessary for the test to be reviewed yet again.

While we see merit in the implied aims and some of the proposed options, we do not consider them to be the major reforms that will place the test on a sustainable footing. And it will inevitably leave some sectors untouched. More ambition is needed.

Structure of the test is the main issue

We have three issues with the structure of the existing test:

1. A backward-looking bright line test with existential implications sits at the foundation of the unintended consequences. Funds are incentivised to manage the test to avoid failure at all costs, and this is driving industry behaviour. Constraints on investing and benchmark-hugging that policymakers are trying to address arise from this feature.   

• Use of a single metric is fraught. Funds will manage to the metric, whatever it is, and all metrics have issues. Changing the metric only changes the nature of the problems that arise.

• Most importantly, the current test regime is not built for the future. It does not cope with industry growth and evolving practices. Nor does it account for the fact that differing sectors require differing assessment approaches.

Case for a government authority to oversee assessment

Our preferred approach would be to replace the bright line test regime with a government authority that is empowered and resourced to assess performance and then make determinations. It could be mandated to expand testing across the super system in due course.

We envisage that the authority would determine how performance is to be assessed, ideally by drawing on quantitative and qualitative assessment techniques with latitude to interpret the evidence.

This approach offers a number of benefits:

• Forward-looking – The authority could introduce a forward-looking assessment that accounts for the current state and not just the past state as reflected in observed returns. For instance, changes in investment philosophy and processes, fund governance, resourcing including staffing, and so on all matter for future member outcomes and could be considered.

• ‘Fairer’ assessment – Considering and interpreting the available evidence around performance within the context that it was delivered should produce a fairer assessment. The curse of a single metric would be removed.

• Capacity to update the process as required – The authority can update its assessment process as the super system evolves through time. For instance, it can account for changes in markets and industry practices.

• Extracting from the political process – Assigning responsibility to an authority would convert performance testing from a legislative instrument to an assessment regime that sits outside of the policy review process, which currently involves engagement through Treasury and inevitable lobbying that hampers change and results in inertia.

Mechanism for extending assessment to other areas

Our YFYS submission led us to reflect on extension of performance testing to other areas, including externally directed products, separately managed accounts, single sector products and retirement. We are largely unconvinced that expansion of the existing test to these areas is warranted, in a large part because it is unsuitable for other contexts.

An authority mandated to undertake assessment across the super system could be a mechanism for extending assessment into other areas. The authority could design assessment to fit the situation, coupled with the discretion to interpret the findings given the circumstances. We even wonder whether it could be the vehicle to facilitate assessment in retirement, which is needed to get the industry moving and ensure minimum standards.

APRA or a new entity?

APRA would be the most logical candidate to undertake the role. If APRA was considered unsuitable, or hesitant to move beyond a pure prudential focus into product assessment, then a separate independent entity could be established.

One important benefit of APRA as the responsible authority is that undertaking detailed assessment would inform other aspects of their industry engagement activities and consideration of systemic implications.

No panacea, but much better

Establishing an authority to undertake performance assessment is, of course, no panacea. There are many issues with allowing scope for interpretation, including opening up opportunities for regulatory capture and potentially appeals of determinations. Nevertheless, it would be far superior to a bright line test based on a single backward-looking metric.

Government needs to lead the conversation

This is the fourth review of the YFYS test. Our sense is that the current consultation reflects Treasury attempting to thread the needle with palatable options that balance the political pressures created by strong and disparate lobbying efforts from a range of stakeholders. This is a difficult environment in which to craft consumer protections while furthering good economic outcomes.

We have reached the point where change requires strong government leadership.

Robust action is needed to establish an assessment framework that takes Australia forward. We call on government to start a bigger discussion around the very nature of the super performance test.

The Conexus Institute is a not-for-profit think-tank philanthropically funeded by Conexus Financial, the publisher of Investment Magazine.