House of Representatives

Explanatory Memorandum

(Circulated by authority of the Assistant Treasurer, Senator the Hon Rod Kemp)

Regulation Impact Statement

Background

The Australian Prudential Regulation Authority (APRA) administers the Superannuation Industry (Supervision) Act 1993 (the 'SIS Act'). The SIS Act regulates all superannuation entities, including industry funds, public offer funds, employer related funds and excluded superannuation funds.

At present, an excluded superannuation fund is a superannuation fund with fewer than five members. The number of excluded superannuation funds has grown rapidly from a low of around 60,000 in 1991 to a current estimate of 180,000, representing some $42 billion in assets under management. Excluded superannuation funds comprise 97% of the total number of funds but account for only 12% of total industry assets and 1.8% of fund members.

A. PROBLEM IDENTIFICATION

At present the definition of an excluded superannuation fund is simply a superannuation fund with fewer than five members. Excluded superannuation funds are subject to less onerous prudential requirements under the SIS Act. They are exempt from, among other things:

•

the requirements to establish internal complaints resolution systems and the operation of the Superannuation (Resolution of Complaints) Act 1993 ;

•

the requirement to have a registered company auditor;

•

many of the detailed requirements to regularly report to members.

Excluded funds are exempted from these requirements on the basis that members of these funds are capable of looking after their own interests. Members of such funds are normally related (e.g.husband and wife, or business partners) and usually act as trustees and therefore can readily influence the investment strategy and administration of the fund.

The definition of excluded fund does not currently require a particular relationship or common interest between members, nor does it ensure that all fund members have equal influence or power within the fund. As a result the situation arises where excluded superannuation funds include members who are not in a position to protect their own interests.

There are, for example, excluded funds where a 'mum and dad' or 'family' fund has been extended to include a non-related employee of the fund's employer-sponsor. The employee is then an arm's length member, as he or she generally lacks a clear commonality of interest with other members. Further, as the employee is not normally a trustee or related to a trustee he or she lacks equality of influence and thus the ability to be involved in trustee decision making.

APRA's annual return data indicates that approximately 16% of excluded superannuation funds contain arm's length members (i.e. members who are not relatives or associates of trustees of the fund), who are not in a position to look after their own interests. Despite this, these members do not have the protection of the additional prudential requirements (as outlined above) which are designed to protect members in such a situation.

To overcome these problems, the Bill proposes to amend the definition of an excluded superannuation fund (to be renamed a self managed superannuation fund). Requirements are included for both a commonality of interest between members (i.e. all members to be related or business partners) and a mechanism for all members of such funds to be involved in trustee decision making (i.e. all members to be trustees).

The proposed change will ensure that excluded funds that currently contain arm's length members in need of prudential protection and do not choose to transfer those members out of the fund will not be classified as self managed superannuation funds. They will remain regulated by APRA and the added prudential requirements will apply to protect the interests of the arm's length members in such funds. Alternatively, such funds can transfer an arm's length member(s) to a prudentially regulated fund to satisfy the definition of a self managed superannuation fund.

B. POLICY OBJECTIVE

The policy objective of the amendment to the definition of excluded superannuation fund under the Superannuation Industry (Superannuation) Act 1993 is to ensure that all members of excluded superannuation funds are able to protect their interests.

C. IDENTIFICATION OF ALTERNATIVES

The following options were identified as being capable, at least partly, of achieving the objectives outlined above:

Option 1

Proceed with the proposed change to the definition of an excluded fund (to be renamed a self managed superannuation fund); or

Option 2

Do not change the definition of 'excluded superannuation fund' but instead apply to all excluded funds the additional prudential requirements from which they are currently exempt.

D. IMPACT ANALYSIS

1. Impact group identification

The following groups are likely to be significantly affected by the proposal amendment to the definition of an excluded superannuation fund.

Industry

Excluded funds containing members who are not trustees will be required to either:

a)

transfer the arm's length members to another fund;

b)

have these members become trustees (where this is possible in accordance with the changed definition);

c)

cease to be an excluded fund and appoint an approved trustee within the meaning of the SIS Act; or

d)

have the existing trustee become an approved trustee within the meaning of the SIS Act.

Approved trustee companies may see an increase in the number of small funds under their trusteeship.

Members

Arm's length members of an excluded fund may have their benefit transferred to a prudentially regulated superannuation fund and receive regular detailed reports, access to complaints resolution schemes and possibly more investment options.

Trustees

Small trustee companies with no family or business relationship to the members will no longer be able to be trustees.

Employers/small business

Employers, including small business employers, will be required to pay superannuation contributions for arm's length employees into a different fund than the employer's existing excluded fund.

Government

The proposed change in definition of excluded superannuation fund will not have any major impact on APRA.

Option 1: Proceed with the proposed change to the definition of an excluded fund (to be renamed a self managed superannuation fund)

COSTS

The change in the definition will not impose a cost on all excluded superannuation funds, rather only on the trustees of excluded superannuation funds that currently contain arm's length members. The extent of these costs will depend on whether the trustees decide to transfer the arm's length members to a prudentially regulated superannuation fund, or whether the trustees wish to keep arm's length members in the fund and appoint an approved trustee.

Due to the diversity of excluded funds it is not possible to quantify the likely costs of the proposed amendment as such costs will not be uniform. There may however, be some 'one-off' costs for both trustees of excluded funds and for some employers.

For trustees transferring members to other superannuation funds these costs will include some accounting costs to establish the amount of the member's benefit. These costs are likely to be minimal as funds are required to keep current records of member balances. There will also be expenses resulting from transferring an arms length member's benefit to a new fund.

Where an arms length member becomes a trustee or a director of the trustee company there may be some additional legal costs in preparing appropriate documentation or amending the fund's trust deed.

The employer may have some additional administrative and financial costs in determining new superannuation arrangements for employees (e.g. finding an appropriate master trust or industry fund).

It is not anticipated that there will be any additional 'on-going' costs to either trustees or employers as a result to the proposed change to the definition where a fund transfers an arm's length member, or where such a member becomes a trustee.

If the trustees of an existing excluded superannuation fund wish to keep their arm's length members they will be required to either:

a)

resign as trustee for the superannuation fund and appoint an approved trustee (a trustee approved by the Commissioner to act as trustee to public offer funds); or

b)

become an approved trustee within the meaning of the SIS Act.

Where a trustee of the excluded superannuation fund resigns and installs an approved trustee there may be administration and financial costs associated with the winding up of the excluded superannuation fund (if required), joining fees (if any) of the approved trustee and costs associated with the transfer of assets (including stamp duty, where appropriate) between the funds. The approved trustee will also charge an ongoing administration fee to manage the fund though this will to some extent offset the prior cost of managing the excluded fund.

It is also possible that the approved trustee will not allow, or have the necessary systems in place, to manage the same investments that were previously conducted by the trustee of the excluded superannuation fund, requiring a change in the fund's investment mix.

Few, if any, existing excluded fund trustees are likely to apply to become approved trustee themselves. The requirements involved in becoming an approved trustee are quite extensive and the costs likely to be prohibitive (for example, normally the trustee company must have $5 million in net assets).

It is expected that this proposal will result in negligible additional cost to Government.

BENEFITS

The proposed changes give arm's length members far greater access to information about their superannuation benefits whichever option an excluded fund takes in order to satisfy the new definition. These members will receive regular information about the operations and investments of their superannuation fund. This will give them a clearer picture of how their superannuation benefits are being managed to provide a retirement income. They will also have access to regular and detailed member information. This will ensure that the member is better informed about the growth of their benefits.

In addition, where such members are transferred out of an excluded fund to a public offer fund they will be able to choose between various options in order to maximise their long term retirement income, because many public offer funds provide a range of investment options. Such a facility is rarely available to members of excluded superannuation funds.

Option 2: Apply the additional prudential requirements to all funds

COSTS

This would impose change on the full 180,000 excluded funds rather than only 16% of these funds, which currently contain arm's length members. It would, for example, require all these funds to establish complaints resolution mechanisms even though the only decisions they could complain about would be decisions made by themselves (as trustees). This would lead to unnecessary bureaucratic red tape that would achieve little benefit at a significant cost.

BENEFITS

As the additional prudential requirements would apply to all funds, arm's length members currently in excluded funds would have their interests better protected than is currently the case, though no better protected than would be the case under Option 1.

E. RECOMMENDATION

Option 1 is the preferred option as it ensures that the interests of arm's length members are properly protected, without impacting unnecessarily on the vast majority of excluded funds, as would be the case with Option 2.

F. OTHER ISSUES

Invitations were extended to a range of industry bodies with an interest in excluded superannuation funds to make submissions to APRA when it was the Insurance and Superannuation Commission (ISC) during the ISC' review of excluded superannuation funds. Industry bodies consulted included the Australian Society of CPAs; Association of Superannuation Funds of Australia (ASFA); Life, Investment and Superannuation Association of Australia (LISA); and the Trustee Corporations Association of Australia. A range of issues were considered by these organisation. Only two written submissions, from ASFA and LISA, considered changes to the definition of excluded funds in any detail.

ASFA recommended that the current definition of excluded fund be changed so that there be no arm's length members. The submission recommended that the fewer than five members, aspect of the definition be considered and that any change to the definition allow for transitional arrangements. Generous transitional arrangements have been included in the Bill. LISA submitted that excluded funds be defined as those with fewer than five members, none of which are non-associates and that for the purpose of associate that section 26AAB of the Tax Act be used.

As part of the review of excluded superannuation fund operations, the views of individual trustees and their advisers about regulatory changes were sought and considered as part of the project. While individual views varied widely, anecdotal evidence suggested a overall belief by trustees that excluded funds were generally family or business oriented funds and should not contain arm's length members.

A draft of the Bill was released for public comment. In addition to this, consultation on the draft Bill was undertaken with a large number of industry bodies, including the ASFA, the Australian Society of Certified Practicing Accountants, the Australian Taxpayers Association, and the Small Superannuation Funds Association.

IMPACT ON COMPETITION

It is expected that the adoption of Option 1 will have a minimal impact on competition.

There will be no negative flow-on effects to the rest of the community.