House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Employment and Workplace Relations and Minister for Financial Services and Superannuation, the Hon Bill Shorten MP)

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Stronger Super

On 16 December 2010, the Assistant Treasurer and Minister for Financial Services and Superannuation, the Hon Bill Shorten MP (the Minister), announced the Stronger Super reforms.

Stronger Super represents the Government's response to the review into the governance, efficiency, structure and operation of Australia's superannuation system, the Super System Review (the Review).

To provide input on the design and implementation of the Stronger Super reforms, the Government undertook extensive consultations with industry, employer and consumer groups. The Government announced its decisions on the key design aspects of the Stronger Super reforms on 21 September 2011 (the Minister's media release number 131/2011).

This Bill is the second tranche of legislation implementing the Government's MySuper and governance reforms as part of Stronger Super. The first tranche of legislation was introduced to the Parliament on 3 November 2011 as the Superannuation Legislation Amendment (MySuper Core Provisions) Bill 2012 (the MySuper Core Provisions Bill).

This Bill implements the next stage of the reforms. The Bill introduces the power for the Australian Prudential Regulation Authority (APRA) to make prudential standards, amends section 52 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) to expand the duties for registrable superannuation entity (RSE) licensees, applies new trustee duties to RSE licensees of an RSE that offers a MySuper product and applies duties to the directors of corporate trustees.

Date of effect: The provisions introducing the prudential standards-making power will apply from the day after Royal Assent. Duties for trustees and directors of RSEs, and trustees and directors of RSEs offering MySuper products will apply from 1 July 2013.

Proposal announced : On 16 December 2010, the Minister announced the Stronger Super reforms. On 21 September 2011, the Minister announced the Government's decisions on the key design aspects of the Stronger Super reforms.

Financial impact : This Bill has no significant financial impact on Commonwealth expenditure or revenue.

Summary of regulation impact statement

Impact: The regulation impact statement (RIS) for Stronger Super implementation can be found at http://ris.finance.gov.au. The relevant sections of the RIS covered in this Bill are governance of superannuation (including the section in the appendix) and subsections 2.1 and 2.2 of the insurance appendix. A RIS exemption was granted for the remainder of the Stronger Super reforms, which will be subject to a post-implementation review.

Measures to be contained in subsequent tranches of legislation

The MySuper and governance reforms will be implemented in several tranches of legislation. This Bill is the second tranche.

Further reforms that are not contained in this Bill that will be addressed by subsequent tranches of legislation include:

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further requirements in respect of insurance;

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allowing defined benefit funds and schemes to continue to be a default superannuation product;

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rules for the charging of financial advice deducted from member accounts and charging for intra-fund advice;

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arrangements for the transition of member accounts from existing default superannuation products to MySuper products;

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trustee duties for eligible rollover fund licensees that will be similar to the specific trustee duties in relation to MySuper products;

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prohibition on deduction of commissions from MySuper member accounts;

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rules for the payment of performance-based fees by RSE licensees to investment managers in relation to the assets of a MySuper product;

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limitation of certain fees to cost-recovery;

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a rule for the fair and reasonable allocation of costs between each MySuper product and each choice product within a fund;

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additional governance measures (relating to selection of service providers, not preventing directors of trustees from voting other than in certain limited circumstances, increasing the time limits for which members can lodge complaints to the Superannuation Complaints Tribunal in relation to total and permanent disability (TPD) insurance claims, requiring trustees to provide members with reasons for decisions in respect to formal complaints and providing APRA with the administrative power to impose fines);

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enhanced data collection and data publication powers for APRA;

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additional disclosure requirements in relation to MySuper and choice products;

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consequential amendments to deal with the nomination of superannuation funds in modern awards and enterprise agreements;

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consequential amendments to the Corporations Act 2001 (Corporations Act) to ensure the necessary obligations of that Act apply to MySuper products;

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ensuring APRA has the ability to determine prudential standards to facilitate the transition process;

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consequential amendments to move requirements for fitness and propriety, actuaries and auditors from the legislation to prudential standards; and

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amendments to the Corporations Act so that RSE licensees that are also responsible entities of managed investment schemes are no longer exempt from the Corporations Act requirements to have available adequate financial resources.

Chapter 1 Trustee obligations

Outline of chapter

1.1 Schedule 1 to this Bill amends the SIS Act to enhance the obligations of superannuation trustees and directors, both in relation to MySuper products and more generally.

1.2 This chapter explains:

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obligations that relate specifically to MySuper trustees; and

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heightened requirements for trustees and directors of RSEs more generally.

Context of amendments

1.3 Australia has adopted a trust structure for governance of superannuation funds. Trustees have fiduciary and statutory obligations to manage the assets of the trust on behalf of its beneficiaries, and in the beneficiaries' best interests.

1.4 The Review noted that to ensure a consistently high standard of governance across the superannuation industry, it is important that trustees' duties are clearly understood, are set at an appropriately high level, and are sufficiently robust to accommodate developments in the size, structure and practices of the superannuation industry.

1.5 The Review recommended heightened duties for trustees as well as applying some duties to individual directors of corporate trustees.

1.6 The Review also recommended specific duties that should apply to trustees of MySuper products, noting that default members generally delegate all aspects of their superannuation to the trustee.

1.7 This Bill implements the Government's response to the Review's recommendations in relation to trustee obligations, including the enhanced trustee obligations for MySuper products referred to in the MySuper Core Provisions Bill.

Summary of new law

1.8 Schedule 1 implements the changes to trustee duties, including in relation to trustees of MySuper products and directors of corporate trustees.

1.9 Additional duties for MySuper trustees include to:

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promote the financial interests of MySuper beneficiaries, in particular returns to those beneficiaries (after the deduction of fees, costs and taxes);

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annually assess sufficiency of scale; and

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include in their investment strategy an investment return target and level of risk for MySuper members.

1.10 Additional duties for trustees of RSEs include to:

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give priority to the interests of beneficiaries where conflicts arise;

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exercise the same degree of care, skill and diligence as a prudent superannuation trustee;

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have regard to valuation information, expected tax consequences and costs in their investment strategies, and offer a range of options sufficient to allow members to choose a diversified asset mix. A related change clarifies that trustees must comply with relevant covenants and MySuper duties in order to be able to claim a defence against an action for loss or damage;

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have an insurance strategy and meet additional duties in relation to insurance;

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formulate, regularly review and give effect to a risk management strategy; and

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maintain and manage financial resources to cover operational risk.

1.11 Schedule 1 also sets out the duties that apply to individual directors of corporate trustees.

1.12 With a couple of minor exceptions these additional obligations will not apply to SMSFs. The existing covenants that apply to SMSFs will continue to apply under new sections.

Comparison of key features of new law and current law

Detailed explanation of new law

Obligations in respect of MySuper products

Obligations for trustees that offer a MySuper product

Enhanced trustee obligations

1.13 New enhanced trustee obligations will apply to a trustee of an RSE that has been authorised by APRA to offer a MySuper product. These are duties that a trustee will owe to members of a MySuper product, as these members rely on the trustee to make judgments about managing their superannuation. [Schedule 1, item 9, section 29VN ]

1.14 Enhanced trustee obligations for MySuper products means the obligations imposed by the covenants in section 52, as enhanced by obligations imposed under section 29VN and any covenant prescribed under new section 54A that are specified in the regulations as forming part of the enhanced trustee obligations. Enhanced director obligations means the obligations imposed by the covenants under section 29VO and any covenant prescribed under new section 54A that are specified in the regulations as forming part of the enhanced director obligations. APRA must be satisfied that a trustee will comply with the enhanced trustee obligations and that individual directors of corporate trustees will comply with the enhanced director obligations to authorise an RSE licensee to offer a MySuper product. The enhanced trustee obligations for trustees of an RSE that offers a MySuper product relate to financial interests, scale, and targeted investment return and risk. [Schedule 1, item 2, subsection 10(1)]

Financial interests

1.15 A trustee must promote the financial interests of members of a MySuper product. In particular, the most significant component of the financial interests of beneficiaries of the fund that hold the MySuper product will be returns to those beneficiaries (after the deduction of fees, costs and taxes). Returns to beneficiaries (after the deduction of fees, costs and taxes) are those amounts placed into member accounts through an increase in their unit price or credited to their account, which are a result of investing the member's balance. [Schedule 1, item 9, paragraph 29VN(a)]

1.16 This requirement heightens the obligations trustees owe to members of a MySuper product reflecting that members of a MySuper product have effectively delegated the responsibility for making decisions regarding their superannuation to the trustee. This requires a trustee to make informed judgments regarding the MySuper product, for example in relation to the composition of assets in the investment strategy, so that it secures the best financial outcome for these beneficiaries. [Schedule 1, item 9, paragraph 29VN(a)]

1.17 While this will lift the standard required of trustees, it is not a requirement that trustees generate certain level of returns. Sustained low returns may indicate a failure to promote the financial interests of beneficiaries, but low returns, on their own, will not necessarily involve a breach of this obligation. The obligation does not imply that members of a MySuper product should be given preference over other members of the fund, for example, by the trustee in allocating investment returns, or in any other way. [Schedule 1, item 9, paragraph 29VN(a)]

1.18 The obligation to promote the financial interests of beneficiaries who hold the MySuper product is not limited to a particular period. The trustee must promote the financial interests of beneficiaries over the period they hold, or are expected to hold, an interest in the MySuper product. As most members would be expected to remain in the MySuper product for a considerable period, it will be generally appropriate for trustees to aim to manage returns to those beneficiaries (after the deduction of fees, costs and taxes) over the longer term. [Schedule 1, item 9, paragraph 29VN(a)]

1.19 Furthermore, the obligation to promote the financial interests of beneficiaries necessarily includes consideration of the level of investment risk appropriate for these members, recognising that different groups of members may have a different risk tolerance and there is a trade-off between investment return and investment risk. [Schedule 1, item 9, paragraph 29VN(a)]

1.20 To be clear, this requirement does not prevent trustees from offering advice, insurance or services to members that do not directly improve returns to those beneficiaries (after the deduction of fees, costs and taxes). However, the trustee must consider whether the benefits of offering the advice or service is appropriate having regard to the impact on members' returns. For example, financial advice (including intra-fund advice) to members on contributions may not directly promote returns to beneficiaries (after the deduction of fees, costs and taxes), however, offering this financial advice may be in the financial interests of members. [Schedule 1, item 9, paragraph 29VN(a)]

Annual determination of scale

1.21 Trustees will have a new obligation to make a single, annual determination whether the financial interests of beneficiaries that hold the MySuper product are disadvantaged compared to beneficiaries that hold a MySuper product in other funds due to insufficient scale in terms of members or assets. [Schedule 1, item 9, paragraph 29VN(b)]

1.22 With regard to administrative scale, a trustee's determination must deal with the sufficiency of both the number of members in the MySuper product and the number of members of the fund as a whole. [Schedule 1, item 9, subparagraphs 29VN(b)(i ) and ( ii)]

1.23 Certain administrative requirements will only be relevant to members of a MySuper product. For example, the trustee must comply with fee rules that limit the types of fees that may be charged to members of a MySuper product. Administrative systems to ensure a trustee complies with these rules will have costs that will be spread among members of the MySuper product only. Therefore, a relevant consideration for trustees is whether the number of beneficiaries is sufficient to ensure those costs for each member are not so high as to place the financial interests of those beneficiaries that hold the MySuper product at a disadvantage compared to beneficiaries of other RSEs that hold a MySuper product. [Schedule 1, item 9, subparagraph 29VN(b)(i)]

1.24 However, most administrative requirements will be common to all members of a fund. A trustee must determine whether there is a sufficient number of beneficiaries of the fund to ensure that the financial interests of members of its MySuper product are not disadvantaged compared to members of other funds that hold a MySuper product. [Schedule 1, item 9, subparagraph 29VN(b)(ii)]

1.25 With regard to investment scale, a trustee's determination must consider the sufficiency of assets that are relevant to the investment for the MySuper product, which includes the effect of scale on costs and investment opportunities. [Schedule 1, item 9, subparagraphs 29VN(b)(iii ) and ( iv ))]

1.26 In making this determination, a MySuper trustee can have regard to the value of the assets of the MySuper product in its own right, but may also have regard to the extent to which the MySuper assets are pooled with other assets of the fund, or the extent to which those assets might be pooled with the assets of other funds, for investment purposes. [Schedule 1, item 9, subparagraphs 29VN(b)(iii ) and ( iv ))]

1.27 The details of the trustee's determination of these scale matters must be included in the investment strategy for the MySuper product. It will be incumbent upon a trustee that determines that assets or members are insufficient to take appropriate action to rectify the insufficiency so they continue to meet their general obligation to promote the financial interests of beneficiaries. APRA will provide prudential guidance on processes trustees could adopt to form a determination and relevant considerations for trustees in rectifying insufficient scale. [Schedule 1, item 9, paragraphs 29VN(a ) and ( c)]

Target investment return and level of risk for a MySuper product

1.28 Trustees of RSEs that offer a MySuper product will also be required to include in their investment strategy an investment return target for the assets of the fund that are attributed to the MySuper product. The target must be expressed as the expected return over a rolling period of 10 years, updated each year. [Schedule 1, item 9, paragraph 29VN(d)]

1.29 Trustees that offer a MySuper product will also be required to determine a level of investment risk that is appropriate for members of a MySuper product. In determining the risk appetite for the investment of its MySuper assets, a trustee may consider the age of members as well as other relevant factors. [Schedule 1, item 9, paragraph 29VN(d)]

1.30 A trustee's obligation to consider the investment return target and level of risk for a MySuper product must be done in parallel reflecting the inherent trade-off between a target investment return and related investment risk.

1.31 A trustee will have to clearly articulate and justify the investment return target and level of risk they have adopted for the MySuper product. This will have to be included in the investment strategy of the fund and the MySuper product. [Schedule 1, item 9, paragraph 29VN(d)]

Obligations for directors of corporate trustees of funds that offer a MySuper product

1.32 Each director of a corporate trustee of an RSE that offers a MySuper product must exercise a reasonable degree of care and diligence for the purposes of ensuring the corporate trustee carries out its aforementioned obligations. [Schedule 1, item 9, subsection 29VO(1)]

1.33 A reasonable degree of care and diligence refers to the degree of care and diligence a superannuation entity director would exercise in the corporate trustee's circumstances. A superannuation entity director is a person whose profession, business or employment is or includes acting as director of a corporate trustee of a superannuation entity and investing money on behalf of beneficiaries of the superannuation entity. [Schedule 1, item 9, subsections 29VO(2 ) and ( 3)]

1.34 Paragraph 29T(1)(h) of the MySuper Core Provisions Bill states APRA must be satisfied that an RSE licensee is likely to comply with the enhanced trustee obligations for MySuper products in order to authorise the RSE licensee to offer a MySuper product. Reflecting the introduction of these duties for directors of MySuper products, APRA must also be satisfied that directors of the RSE licensees are likely to comply with section 29VO. [Schedule 1, item 7, paragraph 29T(1)(ha)]

1.35 Paragraph 29U(2)(c) of the MySuper Core Provisions Bill states APRA may cancel an authority to offer a MySuper product if it is no longer satisfied that an RSE licensee is likely to comply with the enhanced trustee obligations for MySuper products. Reflecting the introduction of these duties for directors of MySuper products, APRA can also cancel an authority to offer a MySuper product if it is no longer satisfied that directors of the RSE licensees are likely to comply with section 29VO (whether because of failure to do so or any other reason). [Schedule 1, item 8, paragraph 29U(2)(ca)]

Contravention of trustee or director obligations in relation to MySuper products

1.36 A person must not contravene their obligations under sections 29VN or 29VO. While a contravention of these obligations is not an offence, and contravention does not result in the invalidity of the transaction, a person who suffers loss or damage as a result of another person contravening its obligations may recover the amount of the loss or damage by way of action against that other person or against any person involved in the contravention. An action of this kind may be begun any time within six years after the day on which the cause of action arose. [Schedule 1, item 9, section 29VP ]

1.37 This section allows action to be taken in respect of loss or damage as a result of a person contravening MySuper obligations equivalent to that applying to contravention of other trustee duties. [Schedule 1, item 9, section 29VP ]

1.38 The defence under revised subsection 55(5) applies to an action for loss or damage brought under section 29VP. [Schedule 1, item 15, subsection 55(7)]

Governing rules void if inconsistent with MySuper obligations

1.39 A provision of the governing rules of an RSE offering a MySuper product is void to the extent it is inconsistent with the obligations that apply to a trustee or director of the RSE under sections 29VN and 29VO respectively. This ensures that these obligations have effect over any governing rules that would otherwise limit their effectiveness. [Schedule 1, item 9, section 29VQ ]

Governing rules of superannuation entities

1.40 Trustees are currently subject to the duties imposed by the covenants included in subsection 52(2) of the SIS Act. These covenants are automatically taken to be incorporated into the governing rules of all superannuation funds.

1.41 This Bill introduces separate sections for the covenants relating to trustees and those relating to the individuals who are directors of corporate trustees. This Bill also separately identifies the covenants relating to RSEs and SMSFs.

1.42 Specifically:

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section 52 contains the covenants to be included in the governing rules for trustees of RSEs, including general covenants, and those relating to investment, insurance and risk;

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new section 52A contains the covenants to be included in the governing rules for directors of corporate trustees of RSEs;

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new section 52B contains the covenants to be included in the governing rules of SMSFs; and

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new section 52C contains the covenants to be included in the governing rules for directors of corporate trustees of SMSFs.

1.43 To avoid doubt, section 51A is inserted to ensure the covenants are cumulative in effect. Each covenant that is referred to in sections 52, 52A, 52B, 52C to 53 (or prescribed under section 54A), and each obligation referred to in sections 29VN and 29VO, that applies to a trustee of a superannuation entity, or a director of a corporate trustee of a superannuation entity, will apply in addition to every other covenant or obligation referred to in those sections that applies to the trustee or director. For example, the obligations that apply to trustees that offer a MySuper product are in addition to each covenant that applies to a trustee of an RSE. [Schedule 1, item 11, section 51A ]

1.44 Existing sections 53 and 54, which relate to approved deposit funds, are retained.

Covenants for registrable superannuation entities

General covenants

1.45 The new subsection 52(1) effectively replicates the existing provision, and ensures that where the governing rules of an RSE do not contain covenants to the effect of those set out in subsection 52(2), the governing rules are taken to contain covenants to that effect. [Schedule 1, item 12, subsection 52(1)]

1.46 Subsection 52(2) creates new duties for trustees in relation to conflicts of interests and duties and giving priority to beneficiaries and acting fairly. It also heightens existing requirements in relation to the degree of care, skill and diligence required of trustees. The overall effect of these changes, which are explained in further detail below, will be to hold trustees to a higher standard. [Schedule 1, item 12, subsection 52(2)]

1.47 The remaining covenants in existing subsection 52(2) are retained:

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to act honestly in all matters concerning the entity (existing paragraph 52(2)(a)); [Schedule 1, item 12, paragraph 52(2)(a)]

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to perform the trustee's duties and exercise the trustee's powers in the best interests of beneficiaries (existing paragraph 52(2)(c)); [Schedule 1, item 12, paragraph 52(2)(c)]

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to keep the money and other assets of the entity separate (existing paragraph 52(2)(d)); [Schedule 1, item 12, paragraph 52(2)(g)]

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not to enter into any contract (or do anything else) that would prevent the trustee from (or hinder the trustee in) properly performing or exercising its functions and powers (existing paragraph 52(2)(e)); [Schedule 1, item 12, paragraph 52(2)(h)]

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this does not prevent the trustee from engaging or authorising persons to do acts or things on behalf of the trustee (existing subsection 52(3)); [Schedule 1, item 12, subsection 52(5)]

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if there are any reserves of the entity - to formulate, review regularly and give effect to a strategy for their prudential management (existing (52(2)(g)); and [Schedule 1, item 12, paragraph 52(2)(i)]

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to allow a beneficiary access to any prescribed information or any prescribed documents (existing paragraph 52(2)(h)). [Schedule 1, item 12, paragraph 52(2)(j)]

1.48 Changes to requirements in relation to the investment strategy (existing paragraph 52(2)(f)) and requirements in relation to reserves (existing paragraph 52(2)(g)) are detailed below.

1.49 New section 54A (reflecting existing subsections 52(5) to (7)) enables the regulations to prescribe a covenant to be included in the governing rules of a superannuation entity. Covenants prescribed by regulation may elaborate, or supplement or otherwise deal with any aspect of a matter in a covenant or other provision in the Act, but must be capable of operating concurrently with the covenants and the Act. [Schedule 1, item 13, section 54A ]

Conflicts of interests and duties

1.50 Conflicts can occur between the duties the trustee has to beneficiaries, and the duties it has to others. Other conflicts can also exist, including between the interests of beneficiaries and the interests of the trustee or an associate of the trustee.

1.51 The general law requires trustees to avoid conflicts of duties and interest, subject to certain exceptions that allow the trustee to act despite the conflict, for example by authorisation under the fund's governing rules. Where a conflict exists, and general law allows the trustee to proceed despite the conflict, there will be a number of additional requirements that must be met. [Schedule 1, item 12, paragraph 52(2)(d)]

1.52 The first is a requirement for trustees to give priority to the duties to and interests of beneficiaries over the duties to and interests of the trustee to other persons. [Schedule 1, item 12, subparagraph 52(2)(d)(i)]

1.53 The second requirement is that the trustee must ensure their duties to beneficiaries are met despite the conflict. The duty to beneficiaries includes, but should not be limited to, the duties to act in the best interests of beneficiaries and to exercise the relevant degree of care and diligence. [Schedule 1, item 12, subparagraph 52(2)(d)(ii)]

1.54 Thirdly, the interests of beneficiaries must not be adversely affected by the conflict. [Schedule 1, item 12, subparagraph 52(2)(d)(iii)]

1.55 Fourthly, the trustee must comply with any prudential standards in relation to conflicts that are developed by APRA. [Schedule 1, item 12, subparagraph 52(2)(d)(iv)]

1.56 The duty to give priority to beneficiaries will override any conflicting duty an executive officer or employee of the trustee has under Part 2D.1 of the Corporations Act or Division 4 of Part 3 of the Commonwealth Authorities and Companies Act 1997. [Schedule 1, item 12, subsection 52(4)]

1.57 The new provisions are not intended to limit transactions with related parties where the transactions are in the best interests of beneficiaries and permitted under the general law. [Schedule 1, item 12, paragraph 52(2)(d)]

1.58 In addition to applying to trustees of APRA-regulated superannuation funds, these changes will apply to trustees of approved deposit funds, pooled superannuation trusts and small APRA funds, and each member of a group of individual trustees.

1.59 The changes, however, will not apply to the trustees of SMSFs.

Duty to act fairly

1.60 New covenants are being introduced to require trustees to act fairly in dealing with classes of beneficiaries within the entity and with beneficiaries within a class. [Schedule 1, item 12, paragraphs 52(2)(e ) and ( f)]

Standard of care, skill and diligence

1.61 The existing law requires trustees to exercise the same degree of care, skill and diligence, in managing the fund, as an ordinary prudent person would exercise.

1.62 The Bill brings this requirement into line with the existing State and Territory trustee legislation applying to professional trustees. [Schedule 1, item 12, paragraph 52(2)(b)]

1.63 The term 'superannuation trustee' will be introduced into the legislation reflecting these requirements. 'Superannuation trustee' is defined as a person whose profession, business or employment is or includes acting as a trustee of a superannuation entity and investing money on behalf of beneficiaries of a superannuation entity. [Schedule 1, item 12, subsection 52(3)]

1.64 In relation to all matters affecting the entity, trustees will be required to exercise the same degree of care, skill and diligence as a prudent superannuation trustee would exercise in relation to an entity of which it is trustee and on behalf of the beneficiaries of which it makes investments. [Schedule 1, item 12, paragraph 52(2)(b)]

1.65 This change will not apply to the trustees of SMSFs.

Investment strategy

1.66 Reflecting the changing nature and variety of investment options offered since the introduction of member choice, and the many ways in which these options are provided, trustees will be required to exercise greater scrutiny and diligence at the investment option level.

1.67 Trustees will have a responsibility to consider the appropriateness of investment options (including individual investments) and whether they should be offered to members. When formulating and giving effect to investment strategies, trustees will be required to consider not only the whole of the fund (as is required under the existing paragraph 52(2)(f)), but a strategy will be required for each investment option. [Schedule 1, item 12, paragraph 52(6)(a)]

1.68 Additional investment covenants that trustees will be required to have regard to, as detailed below, are the availability of valuation information, expected taxation consequences, and expected costs. [Schedule 1, item 12, subparagraphs 52(6)(a)(iv ), ( vi ) and ( vii)]

1.69 The existing requirements applying to the whole of the fund investment strategy will also apply to strategies for individual investment options. These are to consider:

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the risk involved in making, holding and realising, and the likely return from the investments covered by the strategy, having regard to the RSE's objectives and its expected cash flow requirements (existing subparagraph 52(2)(f)(i)); [Schedule 1, item 12, subparagraph 52(6)(a)(i)]

•

the composition of the investments covered by the strategy, including the extent to which the investments are diverse or involve the RSE in being exposed to risks from inadequate diversification (existing subparagraph 52(2)(f)(ii)); [Schedule 1, item 12, subparagraph 52(6)(a)(ii)]

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the liquidity of the investments covered by the strategy, having regard to the expected cash flow requirements in relation to the RSE (existing subparagraph 52(2)(f)(iii)); and [Schedule 1, item 12, subparagraph 52(6)(a)(iii)]

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the ability of the RSE to discharge its existing and prospective liabilities (existing subparagraph 52(2)(f)(iv)). [Schedule 1, item 12, subparagraph 52(6)(a)(v)]

1.70 While a trustee will be required to consider diversification in developing an investment strategy, this will not prevent a trustee from offering investment options that are undiversified, on the basis that the trustee has formed the view it would be appropriate for their members to be able to choose that investment option. [Schedule 1, item 12, subparagraph 52(6)(a)(ii)]

1.71 The investment covenants are also clarified to ensure that trustees are required to review their investment strategies regularly. [Schedule 1, item 12, paragraph 52(6)(a)]

1.72 Trustees will be required to have regard to the costs that might be incurred by the RSE in relation to investments covered by the strategy. In examining this, trustees will need to consider whether the costs are justifiable in delivering the best deal for members. [Schedule 1, item 12, subparagraph 52(6)(a)(vii)]

1.73 Trustees will need to have regard to the expected taxation consequences of an investment strategy, in light of the circumstances of the fund. [Schedule 1, item 12, subparagraph 52(6)(a)(vi)]

1.74 Trustees must consider whether reliable valuation information is available in relation to the investments covered by the strategy. This will ensure trustees consider and make arrangements for the regular valuation of all assets, in particular direct or unlisted investments that may be difficult to value. [Schedule 1, item 12, subparagraph 52(6)(a)(iv)]

1.75 As is the case with the existing paragraph 52(2)(f), the new subsection 52(6) highlights considerations that are required in relation to the investment strategy. It is not designed to be an exhaustive list. [Schedule 1, item 12, subparagraph 52(6)(a)(viii)]

1.76 In determining its prudential standard and associated guidance material, APRA will provide further detail on its expectations regarding requirements for investment strategies.

Appropriate due diligence in the selection and monitoring of investment options made available to members

1.77 The Review recommended that trustees should be subject to new express duties in selecting and monitoring options.

1.78 The Bill introduces a new requirement to exercise due diligence in developing, offering and reviewing regularly each investment option. [Schedule 1, item 12, paragraph 52(6)(b)]

1.79 APRA's prudential standard and associated guidance material will provide further detail on its expectations in relation to due diligence.

Defence to an action for loss or damage

1.80 Currently, under subsection 55(5), trustees can claim a defence against an action for loss or damage in relation to an investment if the investment was made in accordance with the investment strategy covenant in paragraph 52(2)(f).

1.81 Subsection 55(5) is being amended so that trustees must satisfy all of the covenants in sections 52, 52A, 52B, 52C, 53 and 54A and the obligations in sections 29VN and 29VO where they are relevant to the investment (rather than just paragraph 52(2)(f)) before relying upon this provision as a defence to an action for loss or damage in relation to the making of an investment. [Schedule 1, item 14, subsection 55(5)]

1.82 The change recognises the interdependency between the covenants. For example, where a trustee has acted dishonestly and in a conflicted manner, it would be unreasonable to have a defence for investment loss where it had otherwise complied with the investment covenant. The changes are not, however, intended to prevent trustees from accessing the defence in cases where a covenant or duty is not relevant to the particular loss as a result of making an investment. [Schedule 1, item 14, subsection 55(5)]

1.83 This change will apply to SMSFs to the extent that a covenant or proposed covenant applies to SMSFs. [Schedule 1, item 14, subsection 55(5)]

1.84 Subsection 55(6) is also being amended so that trustees must satisfy all of the covenants in sections 52, 52A, 52B, 52C, 53 and 54A and the obligations in sections 29VN and 29VO where they are relevant to the management of reserves (rather than just paragraph 52(2)(g)) before relying upon this provision as a defence to an action for loss or damage. [Schedule 1, item 14, subsection 55(6)]

1.85 As with the change to subsection 55(5), this change will apply to SMSFs to the extent that a covenant or proposed covenant applies to SMSFs. [Schedule 1, item 14, subsection 55(6)]

Diversification

1.86 In formulating the fund level investment strategy, trustees decide the type and number of options they offer to members.

1.87 Trustees will have to offer investment options which will allow a member to obtain a diversified asset mix if they choose. [Schedule 1, item 12, paragraph 52(6)(c)]

1.88 If a member chooses to be undiversified, the trustee has no obligation to assess the appropriateness for that member of the investment strategy chosen by the member beyond the aforementioned requirement to formulate and give effect to an investment strategy in respect of each investment choice option. [Schedule 1, item 12, paragraph 52(6)(c)]

1.89 Trustees that offer a MySuper product will meet this requirement without considering the composition of any other investment options as members will be able to choose the single, diversified investment strategy of the MySuper product. [Schedule 1, item 12, paragraph 52(6)(c)]

1.90 Paragraph 58(2)(d) is being amended to clarify that it is permissible for a beneficiary to give a trustee directions to take up, dispose of, or alter the amount invested in an investment option. [Schedule 1, item 19, paragraph 58(2)(d)]

1.91 These changes will allow trustees to provide investment options in a responsible and appropriate manner, and allow members to choose investments appropriate to their individual needs. For some members, maximising their retirement income will involve consideration of investments across their entire asset portfolio, rather than just across their superannuation assets.

Insurance strategy

1.92 Recognising that insurance can be a significant cost to superannuation members and, therefore, impact on retirement incomes, a new duty will be introduced requiring each trustee of an RSE to formulate, review regularly and give effect to an insurance strategy for the benefit of beneficiaries of that RSE. [Schedule 1, item 12, paragraph 52(7)(a)]

1.93 This strategy will be required to include provisions to address each of the following matters:

•

the kinds of insurance to be offered to, or acquired for the benefit of, beneficiaries; [Schedule 1, item 12, subparagraph 52(7)(a)(i)]

-

Later tranches of legislation will limit the types of insurance that can be offered within superannuation to life, TPD and income protection insurance;

•

the level or levels of insurance cover to be offered to beneficiaries, taking into account the costs and the policy terms of each arrangement; [Schedule 1, item 12, subparagraph 52(7)(a)(ii)]

-

Later tranches of legislation will require trustees of RSEs to offer (or acquire for the benefit of members) a minimum level of default life and TPD insurance (which members may be able to opt-out of);

•

the basis for the decision to offer or acquire insurance of those kinds, with cover at that level or levels, having regard to the demographic composition (such as the average age of the members, account balance, expected time to retirement and the risk of making a claim) of the beneficiaries of the entity; [Schedule 1, item 12, subparagraph ZZX2(7)(a)(iii)]

-

This recognises the importance of demographic composition in deciding on an appropriate insurance offering, while not limiting the factors trustees can have regard to in determining insurance offered; and

•

the method by which the insurer (or insurers) is determined, taking into account the policy terms in respect to the financial interests of members. [Schedule 1, item 12, subparagraph 52(7)(a)(iv)]

1.94 In some circumstances, an insurance strategy will cover insurance arrangements transferred under a successor fund transfer and, consequently, may not be able to be reduced. Similarly, some public sector schemes may have insurance benefits determined by legislation and cannot be altered as a result of an insurance strategy. However, in these circumstances, there will still be a requirement for the trustee to have an insurance strategy in relation to the insurance for these members. The strategy will have to outline any limits imposed on a trustee in the insurance that can be offered to members in these circumstances. [Schedule 1, item 12, paragraph 52(7)(a)]

Insurance duties

1.95 Each trustee of an RSE will be required to consider the cost to all members when offering insurance of a particular kind or level and should only offer insurance of a particular kind or level if the cost of the insurance does not inappropriately erode the retirement income of beneficiaries. This recognises the importance of trustees balancing the needs of members with respect to insurance cover offered and retirement incomes. [Schedule 1, item 12, paragraphs 52(7)(b ) and ( c)]

1.96 The duty of a trustee to consider the impact of the cost of the insurance offered on the retirement income of beneficiaries will apply at the level of the entire membership of an RSE. In designing insurance offerings, the duty requires the trustee to consider the trade-off between the insurance cover provided and the retirement incomes of members. Therefore, it does not apply to the circumstances of individual members. [Schedule 1, item 12, paragraphs 52(7)(b ) and ( c)]

1.97 Furthermore, it will not restrict trustees from offering a strategy for groups of members that have particular insurance needs, such as an insurance-only superannuation account. [Schedule 1, item 12, paragraphs 52(7)(b ) and ( c)]

1.98 Each trustee of an RSE will be required to do everything that is reasonable to pursue an insurance claim on behalf of one or more of its beneficiaries, if the claim has a reasonable prospect of success. Trustees should consider the likely costs and benefits (with respect to all affected members of the RSE) of pursuing an insurance claim in determining whether it is reasonable to pursue a potentially successful claim. [Schedule 1, item 12, paragraph 52(7)(d)]

Operational risk

1.99 Operational risk is the risk that a superannuation fund may suffer loss due to inadequate or failed internal processes, people and systems or from external events. It does not include the investment or market risk that superannuation fund investments are subject to. Examples of operational risk include: miscalculation of member benefits such as unit pricing errors; inadequate trustee insurance; damage to member records; computer or software failure; fraud, negligence or misconduct; and loss of key staff.

1.100 Currently, trustees of public offer entities must hold net tangible assets and/or the benefit of an approved guarantee to a total value of at least $5 million, or invest through a custodian and comply with APRA's written requirements in relation to that. There are no capital requirements for the trustees of non-public offer superannuation funds. Trustees may also be required to hold an Australian Financial Services Licence (AFSL) issued by the Australian Securities and Investments Commission (ASIC). However, as bodies regulated by APRA, they are required to meet only the operating standard in relation to the adequacy of resources imposed under the SIS Regulations, while being exempt from any further requirement to have available adequate financial resources that applies to holders of an AFSL.

1.101 The Review found that these existing trustee capital requirements are not sufficient to protect members adequately from the impact of operational risk. In particular, the Review found that the trustee capital requirements are too low relative to the operational risks faced by many superannuation funds, are not calibrated to reflect these risks, and do not take into account the fact that some trustees may manage several RSEs and may also manage non-superannuation managed investment schemes. The Review was also concerned that the existing capital requirements only apply to public offer superannuation funds and found drawbacks to the guarantee and custody alternatives by which trustees can satisfy the capital requirements.

1.102 To address these problems, the current trustee capital requirements in the SIS Act will be replaced with a new requirement to maintain and manage financial resources to cover operational risk that will apply to all superannuation entities regulated by APRA. [Schedule 1, item 12, paragraph 52(8)(b)]

1.103 It is intended that a later tranche of legislation will amend the Corporations Act so that RSE licensees which also manage non-superannuation managed investment schemes are no longer exempt from the Corporations Act requirements to have available adequate financial resources.

1.104 These changes will provide current RSE members with enhanced protection from losses due to operational risk. They will reduce the chances of a particular cohort of members, who happen to be members of the RSE when an operational risk related loss is identified, bearing an unfair proportion of the loss. This is because the reserve or capital used to meet the loss will have been built up over time. The changes may also promote members' confidence in the superannuation system and lead to an improved focus on risk management by RSE licensees. [Schedule 1, item 12, paragraph 52(8)(b)]

Replacement of the current trustee capital requirements with a requirement for financial resources to cover operational risk

1.105 RSE licensees will be required, in respect of each RSE under their trusteeship, to maintain and manage in accordance with the prudential standards financial resources to cover the operational risk of the RSE. The financial resources will be able to be held as capital of the licensee, a reserve of the RSE, or both. [Schedule 1, item 12, paragraph 52(8)(b)]

1.106 Existing section 29DA of the SIS Act, which contains the existing capital requirements for superannuation fund trustees, will be repealed. Existing paragraph 29D(1)(g) and subsection 29E(3) of the SIS Act will also be amended to remove references to the existing capital requirements. [Schedule 1, item 4, paragraph 29D(1)(g ); item 5, section 29DA and item 6, subsection 29E(3)]

1.107 It is also intended that existing regulation 3A.04 of the SIS Regulations will be repealed. This regulation contains the detailed rules supporting the capital requirements in existing section 29DA of the SIS Act.

1.108 Details of the requirement for financial resources to cover operational risk will be contained in a prudential standard determined by APRA. It is envisaged that the standard will contain transitional arrangements that allow RSE licensees to meet the requirement within a suitable timeframe. It is also intended that the standard will require RSE licensees to formulate and give effect to a strategy for prudentially managing the financial resources held to cover operational risk.

1.109 SMSFs will not be subject to the requirement for financial resources to cover operational risk.

RSE governing rules must not prohibit the maintenance of an operational risk reserve

1.110 Section 115 of the SIS Act will be amended to ensure that RSE licensees are able to maintain operational risk reserves within RSEs under their trusteeship. Currently, existing section 115 does not provide RSE licensees with this power in cases where the governing rules prohibit it. [Schedule 1, item 20, section 115 ]

1.111 It is envisaged that RSE licensees will be able to meet the requirement for financial resources to cover operational risk by maintaining operational risk reserves within the RSEs under their trusteeship. It is, therefore, necessary to ensure that RSE licensees have the power to maintain operational risk reserves with RSEs. [Schedule 1, item 20, section 115 ]

Restriction on recouping operational risk losses from RSE assets

1.112 Where the financial resources maintained to cover the operational risk of an RSE are held as capital by the RSE licensee and are drawn upon by the licensee, the licensee will be prohibited from indemnifying itself from the assets of the RSE to the extent of this draw-down of its capital. This will involve amending section 56 of the SIS Act. [Schedule 1, item 18, paragraph 56(2A)(a ); item 16, subsection 56(1 ); and item 17, paragraph 56(1)(b)]

1.113 Section 56 of the SIS Act currently permits an RSE licensee to indemnify itself from the assets of the RSE, except in cases involving dishonesty or insufficient care and diligence by the licensee or where the licensee is liable for a monetary penalty under a civil order. Without the amendment, this would mean that, where an RSE licensee meets operational risk losses from its capital held for this purpose, the licensee could then immediately recoup these expenses from the RSE itself (if the governing rules permitted this). This would defeat the purpose of maintaining financial resources to cover operational risk, which is designed to protect current RSE members from bearing the full cost of an operational risk loss.

1.114 The amendment is not intended to prohibit licensees from replenishing their capital through fees charged to RSE members over time. In determining its prudential standard and associated guidance material APRA will set out its expectations for how financial resources held to cover operational risk (whether maintained as licensee capital or as reserves) should be replenished once they have been used to meet operational risk losses. [Schedule 1, item 18, paragraph 56(2A)(a)]

1.115 In addition, an RSE licensee must exhaust all the financial resources maintained for the purpose of covering the operational risk of an RSE (whether these resources are held as capital of the licensee or reserves of the RSE) before being indemnified from the other assets of the RSE for the costs of operational risk. This will ensure that the financial resources are drawn upon when required and that the ability of the licensee to indemnify itself is not employed to bypass the operational risk reserve and/or operational risk capital and use other resources of the RSE first in order to meet an operational risk loss. [Schedule 1, item 18, paragraph 56(2A)(b)]

Risk management strategy

1.116 A new duty is being introduced which will require each trustee of an RSE to develop, implement, and regularly review a risk management strategy. The risk management strategy is to cover the trustee's actions as they relate to the exercise of powers, or the performance of duties and functions, as trustee of the entity, and the risks which arise from the operation of the entity. [Schedule 1, item 12, paragraph 52(8)(a)]

1.117 With the introduction of this new risk management duty (new paragraph 52(8)(a)), existing provisions in the SIS Act which impose conditions on an RSE licence to the effect that the RSE licensee have a compliant risk management strategy (paragraph 29D(1)(e) and paragraph 29E(1)(c)), and a risk management plan for each RSE of which it is a licensee (paragraph 29E(1)(e)), are to be repealed. Notes referring to requirements to have a risk management strategy and risk management plan (subsection 29A(2) of the SIS Act), are also repealed. [Schedule 2, items 14 and 15, subsection 29A(2 ); item 21, paragraph 29D(1)(e ); and item 22, paragraphs 29E(1)(c ) and ( e)]

1.118 As a consequence of the above changes, the detailed requirements relating to the existing risk management strategy licence condition (Division 8 of Part 2A of the SIS Act) and the risk management plan licence condition (Division 5 of Part 2B of the SIS Act), are also to be repealed. It is intended that APRA will define comprehensive requirements, including similar requirements to those set out in Division 8 of Part 2A and Division 5 of Part 2B, in prudential standards. [Schedule 2, item 25, Division 8 of Part 2A ; and Schedule 2, item 33, Division 5 of Part 2B ]

1.119 It is also intended that existing Division 4.1A of the SIS Regulations will be repealed. This Division contains further detailed rules regarding the content of risk management strategies and plans.

1.120 Consequential amendments will repeal the offence provisions relating to non-compliance with a direction from APRA to modify a risk management strategy (section 29JC of the SIS Act) or a risk management plan (Division 6 of Part 2B of the SIS Act). References to these directions from APRA being reviewable decisions are also repealed (subsection 10(1) of the SIS Act). [Schedule 2, items 7 and 8, subsection 10(1 ); item 26, section 29JC ; item 27, section 29JD and item 33, Division 6 of Part 2B)]

1.121 Miscellaneous consequential amendments will remove references to:

•

a risk management strategy in the context of an application to APRA for an RSE licence;

•

a risk management plan in the context of an RSE licensee applying to APRA for registration of an RSE; and

•

a risk management plan in the context of APRA registering an RSE.

[Schedule 2, items 16 to 19, section 29C ; items 28 to 31, section 29L and item 32, paragraph 29M(1)(d)]

1.122 The requirement that the approved form, which is given by an approved auditor to the RSE licensee, must include statements relating to the RSE's risk management plan and risk management strategy (paragraph 35C(5)(d) of the SIS Act), is also to be repealed. [Schedule 2, items 35 and 36, paragraphs 35C(5)(c ) and ( d)]

Covenants for directors of corporate trustees of registrable superannuation entities

1.123 The Review noted there are difficulties for trustees and directors of corporate trustees in understanding what is expected of them, and as industry consolidates, conflicts of interest and duty arise more regularly.

1.124 Section 52A clarifies the duties that apply to individuals who are directors of corporate trustees of RSEs, and achieves the intent of the Review's recommendations in this area. [Schedule 1, item 12, section 52A ]

1.125 New subsection 52A(2) reflects many of the covenants in the new subsection 52(2), but with a focus on the individuals who are directors of corporate trustees of RSEs. [Schedule 1, item 12, subsection 52A(2)]

1.126 Where the governing rules of an RSE do not contain covenants to the effect of those set out in subsection 52A(2), the governing rules are taken to contain covenants to that effect. [Schedule 1, item 12, subsection 52A(1)]

1.127 As is the case in the new section 52 for trustees, section 52A includes duties for the directors of corporate trustees of RSEs in relation to conflict and giving priority to beneficiaries. [Schedule 1, item 12 , paragraph 52A(2)(d)]

1.128 As is the case for trustees under new subsection 52(4), the duty of a director of a corporate trustee of an RSE to give priority to their duties to (and the interests of) beneficiaries overrides any conflicting duty an executive officer or employee of the corporate trustee has under Part 2D.1 of the Corporations Act or under Division 4 of Part 3 of the Commonwealth Authorities and Companies Act 1997. [Schedule 1, item 12, subsection 52A(3)]

1.129 Requirements in relation to the degree of care, skill and diligence required of directors of corporate trustees are included in section 52A. [Schedule 1, item 12, paragraph 52A(2)(b)]

1.130 A new term, 'superannuation entity director', is introduced into the legislation. This is a person whose profession, business or employment is (or includes) acting as a director of a corporate trustee of a superannuation entity, and investing money on behalf of beneficiaries of the superannuation entity. [Schedule 1, item 3, subsection 10(1 ) and item 9, subsection 29VO(3)]

1.131 The term superannuation entity director is used in section 52A in relation to the director of a corporate trustee of an RSE and in section 29VO in respect of an additional obligation the director of a corporate trustee has in relation to a MySuper product.

1.132 Each director of a corporate trustee is required to exercise the same degree of care, skill and diligence that a prudent superannuation entity director would exercise in relation to the entity where he or she is a director of the trustee and that trustee makes investments on behalf of the beneficiaries of the entity. [Schedule 1, item 12, paragraph 52A(2)(b ) and item 9, subsection 29VO(3)]

1.133 The required standard of care, skill and diligence is an objective standard. Care and diligence go to the way in which the director applies himself or herself to their functions. The level of skill required does not necessarily require particular qualifications, and new directors will not be expected to have the level of skill and knowledge of an experienced director immediately. It is not intended that each director will have the same skills but rather that each understand the business of the trustee and its regulatory framework and be in a position to contribute to meetings of the trustee. APRA will provide further guidance on these matters. [Schedule 1, item 12, paragraph 52A(2)(b ) and item 9, subsection 29VO(3)]

1.134 A number of other covenants in subsection 52(2) will apply to the directors of corporate trustees of RSEs:

•

to act honestly in all matters concerning the entity (cf. existing paragraph 52(2)(a)); [Schedule 1, item 12, paragraph 52A(2)(a)]

•

to perform their duties and exercise their powers in the best interests of beneficiaries (cf. existing paragraph 52(2)(c)); and [Schedule 1, item 12, paragraph 52A(2)(c)]

•

not to enter into any contract (or do anything else) that would prevent the director or trustee from (or hinder the director or trustee in) properly performing or exercising their functions and powers (cf. existing paragraph 52(2)(e)). [Schedule 1, item 12, paragraph 52A(2)(e)]

1.135 Paragraph 52A(2)(f), which reflects the existing subsection 52(8), contains the requirement for the individual to exercise a reasonable degree of care and diligence for the purposes of ensuring the corporate trustee carries out the covenants referred to in section 52. [Schedule 1, item 12, paragraph 52A(2)(f)]

1.136 The reference to a reasonable degree of care and diligence in paragraph 52A(2)(f), reflects the existing subsection 52(9), except it applies a standard of degree of care and diligence a superannuation entity director would exercise in the trustee's circumstances. [Schedule 1, item 12, subsection 52A(5)]

1.137 The covenants in subsection 52(2) will operate as if the director of the corporate trustee of the RSE was a party to the governing rules (existing subsection 52(8) of the SIS Act). [Schedule 1, item 12, subsection 52A(6)]

1.138 The duties in new section 52A apply to directors of RSE licensees where the RSE licensee is acting as trustee of the RSE (that is, the duties apply in relation to the performance of the RSE licensee's functions in that capacity). In the case of dual regulated entities (where a corporation is both an RSE licensee regulated by APRA and a responsible entity of a managed investment scheme regulated by ASIC), it is not intended that these duties apply to a director of the RSE licensee in its capacity as a director of a responsible entity. [Schedule 1, item 12, section 52A ]

1.139 The overall effect of these changes is to strengthen the covenants that apply to individuals, and to hold those individuals who are directors of corporate trustees of RSEs to a higher standard.

1.140 Existing subsection 55(3) of the SIS Act enables members to sue for loss or damage in certain circumstances where a covenant has been breached.

1.141 The duties in new section 52A will not apply to each person who is a member of a group of individual trustees. However, the trustee duties in section 52 apply to each individual trustee. [Schedule 1, item 12, section 52 ]

Covenants for self-managed superannuation funds

1.142 As a consequence of introducing separate covenants for trustees of RSEs and directors of RSEs, the existing section 52 covenants applying to SMSFs are moved to a separate section to aid the readability of the SIS Act, in particular for SMSF trustees.

1.143 Schedule 1 to this Bill inserts new section 52B to maintain the existing covenants to be included in the governing rules of SMSFs. There are some small changes to the wording of the SMSF trustee covenants reflecting equivalent improvements made to the interpretation of the general covenants, in particular:

•

the insertion of 'review regularly' in respect of the investment strategy of the fund; [Schedule 1, item 12, paragraph 52B(2)(f)]

•

the insertion of 'review regularly' in respect of the reserves of the fund; and [Schedule 1, item 12, paragraph 52B(2)(g)]

•

the insertion of 'to perform the trustee's duties' replacing 'to ensure that the trustee's duties and powers are performed'. [Schedule 1, item 12, paragraph 52B(2)(c)]

1.144 Schedule 1 to this Bill inserts new section 52C to maintain the existing covenants to be included in the governing rules of SMSFs relating to directors. There are no changes to the content of these covenants. [Schedule 1, item 12, section 52C ]

Application provisions

1.145 All new duties for trustees and directors will apply from 1 July 2013. It is also expected that prudential standards relating to these matters will have effect from 1 July 2013.

Chapter 2 Prudential standards

Outline of chapter

2.1 Schedule 2 to this Bill amends the SIS Act to give APRA the power to issue prudential standards in relation to prudential matters in superannuation. This chapter explains the new arrangements for prudential standards.

Context of amendments

2.2 As the prudential regulator for RSE licensees, APRA primarily relies on the supervisory powers given to it under the SIS Act and accompanying SIS regulations.

2.3 Currently, APRA's role includes the enforcement of a range of requirements found in the SIS Act and SIS regulations. However, making changes to these standards in response to changes within the superannuation industry can involve significant time lags. While APRA can issue guidance material on expected standards, these are not legally binding.

2.4 Recognising the need for greater flexibility and adaptability in respect of legally enforceable standards, the Review recommended APRA be given a standards-making power in relation to superannuation.

2.5 Prudential standards, determined and drafted by APRA, are designed to improve the clarity and certainty of prudential regulation by providing additional detail on the prudential matters set out in the enabling legislation. Prudential standards are legislative instruments within the meaning of the Legislative Instruments Act 2003 (LI Act), and are therefore disallowable by Parliament, subject to scrutiny by the Standing Committee on Regulations and Ordinances and to appropriate consultation with industry as part of their development and ongoing revision.

2.6 As Australia's financial system prudential regulator, APRA already has the power to issue prudential standards in relation to authorised deposit-taking institutions, life insurance companies and general insurance companies, but not for superannuation funds. Prudential standards-making powers across the other parts of the financial system have been successful in providing APRA with the flexibility to effectively adapt to industry developments and the ability to provide regulated entities with clearer and more tailored legal requirements.

Summary of new law

2.7 Schedule 2 of this Bill amends the SIS Act to give APRA the power to issue prudential standards in relation to prudential matters in superannuation to be complied with by RSE licensees.

Comparison of key features of new law and current law

Detailed explanation of new law

Prudential standards requirements

2.8 APRA will be given the power to issue prudential standards in relation to superannuation prudential matters. The legislative framework for these powers will be similar to the frameworks for prudential standards for the other prudentially-regulated industries.

2.9 APRA may determine prudential standards relating to prudential matters. The standards must be complied with by RSE licensees of RSEs or their connected entities, a specified class of RSE licensees or their connected entities, one or more specified RSE licensees or one or more specified connected entities. [Schedule 2, item 1, subsection 34C(1)]

2.10 'Connected entities' are subsidiaries, as defined in the Corporations Act, or other entities as prescribed in regulations. Extending the application of prudential standards to connected entities aims to ensure compliance with prudential standards cannot be avoided through arrangements with related entities. [Schedule 2, item 4, subsection 10(1)]

2.11 Prudential standards may impose different requirements to be complied with by different classes of RSE licensees or connected entities, in different situations or in respect of different activities. This allows APRA to have one prudential standard for a given topic covering different requirements. [Schedule 2, item 1, subsection 34C(2)]

2.12 A prudential standard may require each RSE licensee of an RSE, each RSE of a specified class of RSE licensee, a specified RSE licensee or each of two or more specified RSE licensees to ensure its (or their) connected entities satisfy particular requirements. This will enable APRA to ensure RSE licensees are responsible for their connected entities complying with particular requirements in prudential standards. [Schedule 2, item 1, subsection 34C(3)]

2.13 APRA may exercise powers and discretions under the prudential standards, including but not limited to discretions to approve, impose, adjust or exclude specific prudential requirements in relation to particular or specified RSE licensees or connected entities. This will allow APRA to flexibly or quickly respond to situations where such discretion is necessary. For example, this may cover situations involving transitional arrangements relating to the operational risk reserve. [Schedule 2, item 1, subsection 34C(5)]

Content of prudential standards - prudential matters

2.14 Consistent with APRA's powers in the other prudentially-regulated sectors, APRA will be able to determine prudential standards in relation to prudential matters. The definition of prudential matters, which is described further in the paragraphs that follow, includes elements from the definitions applying to banking and general insurance but recognises that different considerations apply to superannuation, which has accumulation funds (where liabilities reflect the investment gains and losses) and defined benefit funds (where there will be defined liabilities). The definition complements APRA's prudential regulation of superannuation, both existing and agreed to as part of the Government's Stronger Super reforms.

2.15 The prudential matters for which APRA can determine prudential standards are matters relating to:

•

the conduct by an RSE licensee of an RSE of the affairs of the RSE or a connected entity in such a way as to protect the interests or meet the reasonable expectations of the beneficiaries of the RSE; [Schedule 2, item 1, paragraph 34C(4)(a)]

•

the conduct by a connected entity of an RSE licensee of an RSE of the affairs of a connected entity in such a way as to protect the interests or meet the reasonable expectations of the beneficiaries of the RSE; [Schedule 2, item 1, paragraph 34C(4)(b)]

•

the conduct by an RSE licensee of an RSE of the affairs of the RSE licensee in such a way as to keep itself in a sound financial position or not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(c)]

•

the conduct by an RSE licensee of an RSE of the affairs of the RSE in such a way as not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(d)]

•

the conduct by a connected entity of its affairs in such a way as to keep itself in a sound financial position or not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(e)]

•

the conduct by an RSE licensee of an RSE, or a connected entity, of any of its affairs that are relevant to the RSE with integrity, prudence and professional skill; [Schedule 2, item 1, paragraph 34C(4)(f)]

•

matters relating to appointment of auditors and actuaries; and [Schedule 2, item 1, paragraph 34C(4)(g)]

•

the conduct of audits and actuarial investigations. [Schedule 2, item 1, paragraph 34C(4)(h)]

2.16 The inclusion of conduct by an RSE licensee of the affairs of the RSE or a connected entity in such a way as to protect the interests of beneficiaries in this definition recognises that prudential matters in relation to superannuation include issues related to operating in a way that ensures that the interests of beneficiaries are not adversely affected. It also recognises that the nature of these interests may vary depending on the type of fund (accumulation or defined benefit) or product (for example, choice or MySuper).

2.17 Prudential matters also include conduct by an RSE licensee of the affairs of the RSE or a connected entity in such a way as to meet the reasonable expectations of beneficiaries. This makes it clear that prudential standards are not restricted to issues addressing potential adverse or detrimental impacts on the interests of beneficiaries but can also cover issues involving the advancement of beneficiaries' interests. This will allow APRA to make prudential standards that ensure the conduct of RSE licensees meets beneficiaries' reasonable expectations in relation to all aspects of their superannuation interest (for example, expectations related to investments, the generation of retirement benefits and other product features), consistent with existing standards and covenants under the SIS Act.

2.18 For example, in an accumulation fund, a member's entitlement will be dependent on net investment returns, rather than being a specified dollar amount or sum referable to a formula. In this context, it is appropriate for prudential standards to go beyond simply protecting the value of member contributions but also to cover investing contributions to generate additional retirement benefits.

2.19 Prudential matters also include matters relating to appointment of auditors and the conduct of audits. This is primarily to move APRA's existing prudential regulation in relation to auditors and audits from the SIS Act and SIS Regulations into prudential standards, providing greater flexibility and adaptability for these.

2.20 Prudential matters also include matters relating to appointment of actuaries and the conduct of actuarial investigations. This will allow APRA to determine standards in relation to existing circumstances where the actuarial investigations are required (that is, for defined benefit funds).

2.21 The remainder of the definition of prudential matters is consistent with the definitions applying to the other prudentially-regulated sectors. These aspects seek to minimise the risk of an RSE licensee acting in a way that would undermine its own sound financial position, the financial soundness or stability of an RSE for which it is trustee or that of Australia's financial system. While these risks are arguably lower in the context of superannuation than they are in the banking sector for example (given the nature of accumulation funds, and the way superannuation funds interact with the wider system), the superannuation system is an integral part of Australia's financial system and must be effectively regulated to minimise risk.

2.22 While APRA will determine the content and coverage of its prudential standards, prudential standards are expected to cover issues such as: governance, fitness and propriety, conflicts of interest, outsourcing, risk management, investment governance, insurance, business continuity management, audit, operational risk financial requirement and defined benefit funding and solvency.

2.23 Later tranches of legislation will ensure that APRA has the necessary power to determine prudential standards to facilitate the transition process to MySuper.

Revocation or variation of prudential standards and legislative instruments rules

2.24 APRA may, in writing, vary or revoke a standard. This allows APRA to flexibly adapt or retract standards in response to changing circumstances. [Schedule 2, item 1, subsection 34C(6)]

2.25 A standard made in relation to one or more specified RSE licensees (or connected entities) or an instrument varying a standard applying to one or more specified RSE licensees (or connected entities) comes into force from the later of:

•

the day on which APRA gives a copy of the standard or variation to the RSE licensee (or connected entity) to which the standard applies; and

•

if APRA includes with the copy of the standard or variation given to the RSE licensee (or connected entity) notice that the standard or variation will come into force on a later day-on that later day. [Schedule 2, item 1, subsection 34C(7)]

2.26 The revocation of a standard made in relation to one or more specified RSE licensees (or connected entities) comes into force on the later of:

•

the day on which APRA gives notice of the revocation to the RSE licensee (or connected entity) to which the standard relates; and

•

the day specified in that notice as the day on which the revocation comes into force. [Schedule 2, item 1, subsection 34C(8)]

2.27 Subsections 34C(7) and (8) ensure any changes to the standards that apply to specified RSE licensees or connected entities can only come into force on or after the day in which notice of the change is given to the affected entity. [Schedule 2, item 1, subsections 34C(7 ) and ( 8)]

2.28 A standard made in relation to one or more specified RSE licensees (or connected entities), or an instrument varying or revoking a standard or applying to one or more specified RSE licensees (or connected entities) is not a legislative instrument. [Schedule 2, item 1, subsection 34C(9)]

2.29 As entity-specific prudential standards are not legislative instruments, in contrast with prudential standards applying to all or a class of entities, they are not subject to the processes for tabling, disallowance and registration in the LI Act. They are more in the nature of an administrative instrument and for that reason it is appropriate that they be merits reviewable under section 344 of the SIS Act.

2.30 Accordingly, a decision to determine, vary or revoke a prudential standard referred to in new paragraph 34C(1)(e) or (f) (that is, relating to one or more specified entities) is a reviewable decision subject to reconsideration by APRA upon written request and further review by the Administrative Appeals Tribunal under section 344 of the SIS Act. [Schedule 2, item 9, paragraph 10(1)(doc)]

2.31 Section 344 of the SIS Act sets out a procedure for merits review of decisions listed in the definition of 'reviewable decision' in section 10 of the Act. Under that process a person who is affected by and dissatisfied with a reviewable decision of the Regulator may, within 21 days of receiving notice of the decision, request the Regulator to reconsider the decision, giving reasons for the request. The Regulator must then reconsider the decision before the end of 60 days after the day on which the Regulator received the request. If the Regulator confirms or only varies the decision then the person affected by the decision may seek further review in the Administrative Appeals Tribunal.

2.32 Otherwise, any other instrument (prudential standard) made under new section 34C is a legislative instrument for the purposes of the LI Act. APRA must comply with the LI Act requirements in determining a prudential standard, including requirements relating to consultation with those likely to be affected by the proposed prudential standard. [Schedule 2, item 1, subsection 34C(10)]

Relationship between prudential standards and other law

2.33 To avoid any confusion due to potential conflict between prudential standards and other law, a prudential standard may be determined that elaborates, supplements or otherwise deals with any aspect of a prudential matter to which a covenant in sections 52 to 53 or prescribed under section 54A of the SIS Act relates, or a prudential matter to which a provision of the SIS Act or the SIS Regulations relates. However, a prudential standard is of no effect to the extent that it conflicts with the SIS Act or the SIS Regulations. [Schedule 2, item 1, subsections 34D(1 ) and ( 2)]

2.34 To ensure there is no conflict between a prudential standard and operating standards made under Part 3 of the SIS Act, the SIS Regulations will be amended to remove aspects of operating standards that would conflict with prudential standards.

2.35 To ensure there is no conflict between a condition imposed on an RSE licence and prudential standards, new subsection 29EA(2A) has been inserted to give preference to a licence condition over anything in prudential standards. [Schedule 2, item 23, subsection 29EA(2A)]

Notification of prudential standards

2.36 If APRA determines or varies a prudential standard applying to one or more specified RSE licensees or one or more specified connected entities (under new paragraph 34C(1)(e) or (f)), APRA must give a copy of the standard or variation to the affected entity. This ensures APRA gives appropriate notice to affected entities. [Schedule 2, item 1, subsection 34E(1)]

2.37 If APRA revokes a prudential standard applying to one or more specified RSE licensees or one or more specified connected entities (under new paragraph 34C(1)(e) or (f)), APRA must give notice to the affected entity. This also ensures APRA gives appropriate notice to affected entities. [Schedule 2, item 1, subsection 34E(2)]

Compliance with prudential standards

2.38 RSE licensees will have a direct obligation to comply with prudential standards determined by APRA. Including 'prudential standards' in the definition of RSE licensee law ensures licensees are required to comply with prudential standards as a condition of their licence. Consequently, the existing rules for compliance and potential consequences associated with failure to comply with licence conditions will apply to prudential standards, enabling APRA to use its existing suite of enforcement tools to ensure compliance. [Schedule 2, item 10, paragraph 10(1)(aa)]

2.39 RSE licensees will also need to ensure that their connected entities comply with prudential standards (where the prudential standards require this). As noted in paragraph 2.12, APRA can determine prudential standards that require RSE licensees to ensure their connected entities comply with prudential standards. Failure of an RSE licensee to comply with these requirements would similarly be subject to the existing regime relating to licence conditions.

2.40 It is intended that later tranches of legislation will require auditors and actuaries to comply with the prudential standards that apply to them, including requirements relating to fitness and propriety.

2.41 Recognising the importance of effective enforcement powers to the successful operation of APRA's prudential standards-making power and its broader supervision of the superannuation industry, further consideration will be given to APRA's directions powers in relation to superannuation and whether they should be more consistent with APRA's powers in relation to the other prudentially-regulated sectors.

APRA to monitor prudential matters

2.42 APRA will monitor prudential standards through:

•

the collection and analysis of information in respect of prudential matters concerning RSE licensees and connected entities;

•

encouraging and promoting the carrying out of sound practices by RSE licensees and connected entities in relation to prudential matters; and

•

evaluating the effectiveness and carrying out of those practices. [Schedule 2, item 1, section 34F ]

Application and transitional provisions

2.43 APRA will have a prudential standards-making power from the date of Royal Assent. It is expected that APRA will finalise its proposed standards by the end of 2012 and industry will generally have until 1 July 2013 to transition to these arrangements. However, APRA also intends to issue prudential standards to facilitate the transition to MySuper, which may have application from 1 January 2013.

Consequential amendments

2.44 Item 3 inserts a reference to Part 3A into the list of provisions for which APRA has general administration, reflecting that this provision relates to APRA's functions. [Schedule 2, item 3, subparagraph 6(1)(a)(i)]

2.45 As discussed further in paragraph 2.10 above, item 4 inserts a definition for a 'connected entity' to an RSE licensee of an RSE. [Schedule 2, item 4, subsection 10(1)]

2.46 Item 5 inserts a definition for 'prudential matter' as having meaning given by new subsection 34C(4). The definition of prudential matters is discussed further at paragraphs 2.15 to 2.21. [Schedule 2, item 5, subsection 10(1)]

2.47 Item 6 inserts a definition for 'prudential standard' as meaning a standard determined by APRA under new subsection 34C(1). [Schedule 2, item 6, subsection 10(1)]

2.48 Item 9 inserts under the definition of 'reviewable decision' a decision to determine, vary or revoke a prudential standard referred to in new paragraph 34C(1)(e) or (f). [Schedule 2, item 9, paragraph 10(1)(doc)]

2.49 Item 10 inserts 'prudential standards' into the definition of 'RSE licensee law'. RSE licensee law is used in Part 2A of the SIS Act to define the rules that must be complied with as a condition of APRA granting an RSE licence. The purpose of including prudential standards under the definition of RSE licensee law is to ensure that it is a condition of an RSE licence for the licensee to comply with prudential standards. APRA would be able to enforce compliance with prudential standards through its existing mechanisms relating to licence conditions and the existing consequences applying to breaches of licence conditions would extend to prudential standards. [Schedule 2, item 10, paragraph 10(1)(aa)]

2.50 Item 11 inserts a definition of 'subsidiary' as having the same meaning as in the Corporations Act. A definition of subsidiary is introduced to form part of the definition of 'connected entity'. [Schedule 2, item 11, subsection 10(1)]

2.51 Items 12, 13, 24, 34 and 37 to 49, include 'prudential standards' in sections, subsections, or paragraphs that make general references to the SIS Act and SIS Regulations. Including prudential standards in these references reflects that prudential standards are similarly relevant legislative instruments.

2.52 Item 20 repeals paragraph 29D(1)(d) of the SIS Act, which requires RSE licence applicants to meet the requirements of operating standards relating to fitness and propriety, and replaces it with an equivalent requirement for prudential standards to be met. This is a consequence of APRA's intention to define standards for fitness and propriety in a prudential standard and subsequently repeal the operating standard. [Schedule 2, item 20, paragraph 29D(1)(d)]

2.53 It is intended that later tranches of legislation will include additional consequential amendments in relation to the references to fitness and propriety under the SIS Act.

2.54 It is also intended that later tranches of legislation will include further consequential amendments as a result of material covered in prudential standards (for example, in relation to auditors and actuaries).

2.55 To ensure there is no conflict between prudential standards and operating standards, it is intended that regulations repeal any duplicative operating standards at the time prudential standards come into effect.

Chapter 3 Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

This Bill is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview of the Bill

This Bill contains the second tranche of legislation for the Government's Stronger Super (MySuper and governance) reforms, including expanding the covenants for registrable superannuation entity (RSE) licensees, applying new trustee duties to trustees of an RSE that offers a MySuper product and applying personal duties to the directors of corporate trustees in their own right. It also provides details of the power for APRA to issue prudential standards in relation to superannuation.

This Bill adds to the current Superannuation Industry (Supervision) Act 1993 obligations for trustees. The penalties that apply for breaches of trustee duties remain unchanged.

As prudential standards are legislative instruments, each prudential standard determined by APRA will need to be assessed for compatibility with human rights and freedoms and a Statement of Compatibility completed. Any prudential standards made by APRA that apply to individual entities will be merits reviewable.

Human rights implications

This Bill does not engage any of the applicable rights or freedoms.

Conclusion

This Bill is compatible with human rights as it does not raise any human rights issues.

Bill Shorten. Minister for Employment and Workplace Relations, and Minister for Financial Services and Superannuation

Index

Schedule 1: Trustee obligations

Schedule 2: Prudential standards