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SUBMISSION ON THE SAFETY OF SUPERANNUATION ISSUES PAPER FOR THE TREASURY SUPERANNUATION WORKING GROUP FEBRUARY 2002 INDEX Letter of Transmission 3 Introduction 4 Superannuation is not a Risk Free Investment 5 Superannuation Safety and Regulation 5 Prudential standards making powers 8 Investments 8 Capital 8 Outsourcing 8 Governance and Operational Risk 8 Annual General Meetings 8 Related party transactions 9 Public disclosure of annual returns 9 Financial Assistance for failed superannuation funds 9 Conclusion 10 2 Ms Sue Vroombout Superannuation Working Group C/- The Treasury Langton Crescent CANBERRA ACT 2600 1 February 2002 Dear Sue Please find enclosed a submission by AMP to the Superannuation Working Group in response to the Issues Paper ‘ Options for Improving the Safety of Superannuation’ released in October 2001. AMP is a leading Australian international financial services company providing around eight million customers world-wide with wealth creation and asset protection products and services. As a major provider of superannuation products and services and as the largest manager of superannuation savings in Australia, AMP is pleased to be able to make this submission to the Working Group. The safety of superannuation is a critical on-going issue and AMP welcomes the Government’s focus on these issues at this time. Yours sincerely Simon Edwards Manager Strategic Policy AMP Government Affairs 3 Introduction Individual savings accumulated through the operation of Australia’s superannuation system should be accorded the highest possible level of protection commensurate with the objective of creating a pool of personal wealth sufficient to provide retirement incomes to individual contributors. As a result of the mandatory employer contribution requirements operating within Australia, it is appropriate that the Parliament and the Government establish a regulatory framework that addresses systemic risk to superannuation savings. It is appropriate to acknowledge that to date the Australian superannuation system has evidenced a low level of lost member funds relative to the size of funds invested. Notwithstanding this encouraging fact, the current size of superannuation savings, the projected growth in superannuation savings and the significance of superannuation to individual welfare, necessitates a vigilant approach to superannuation risk assessment in particular and systemic safety issues in general. Every individual who is required or who chooses to save for their retirement through an independently managed superannuation fund is entitled to expect that the level of systemic management risk attached to their investment is no more than would pertain if their superannuation were held in any other similarly administered superannuation fund. This submission does not address the safety of funds accumulated in self managed superannuation vehicles as it is not part of the Working Group’s terms of reference. To this end, a reference to a ‘managed superannuation fund is a reference to a superannuation fund that is not a self managed fund and therefore to a fund that has at least one contributing non-family member employee. To ensure that there is an equality of systemic management risk across all managed superannuation funds, regulation should be based on the level of risk to the contributor. Regulatory requirements, imposed and supervised by a public regulator, should seek to deliver the highest degree of transparency of action and decision making by those responsible for a managed superannuation fund at the lowest possible cost to the contributor. Such a framework must be capable of measurement, monitoring and enforcement. A ‘one size fits all’ approach to superannuation regulation is not appropriate and will not secure superannuation savings as it ignores the inherent risk profiles of superannuation funds. Furthermore, a system based on a checklist of rules ignores the fundamental nature of risk that specifically exists in any organisation or structure. It is to this inherent risk that regulation should be addressed. 4 Superannuation is not a Risk Free Investment Australia’s compulsory superannuation system and the incentives provided through taxation concessions for voluntary superannuation contributions require and induce individuals to commit savings to superannuation funds. These contributions are not and have never been made without a risk of loss. Neither the Federal Government nor any trustee of a superannuation fund can guarantee the absolute safety of funds. The large amounts of money invested in superannuation and the considerable volume of financial transactions create the potential for misappropriation, dishonesty, fraud and criminal theft. The risks that exist for all superannuation savings can be considered as a spectrum of probability dependant on a multitude of factors among which are: the size of the fund; the professional management structures of the funds’ manager; the financial resources of the trustee/fund manager; the independence of trustees from employer contributors; the quality of accounting systems; the presence and quality of independent auditors; and the quality and skill of trustees. In addition, all superannuation savings that are invested in equity markets face the risk of investment loss. Without such investment risk however the level of superannuation savings will never be sufficient to provide a basic, let alone a reasonable, level of retirement income. Investment risk should therefore be accepted by a regulator as valuable and worthy. Investment risk can be distinguished from other forms of risk to superannuation safety in that the risk factor potentially benefits contributors. Nevertheless, as recent evidence from the collapse of the Enron Corporation in the USA and the effect of that collapse upon the 401K fund of its employees illustrates, the regulator should consider investment risk when creating a risk profile for a superannuation fund. Superannuation Safety and Regulation Aside from investment risk, those factors which impact upon the relative degree of safety of a managed superannuation fund can be said to be inherent or systemic to the structure of the management vehicle used to collect, account for, invest, monitor, calculate and report on superannuation savings. The trustee system is an appropriate framework in an environment of mandatory contributions and no choice or portability. AMP supports the basic trustee framework and does not agree that the administration system contained in the Managed Investments Act (MIA) would provide a better model or framework for superannuation. 5 The lack of a capacity for individuals to calculate systemic risk in their superannuation investment and to move mandatory contributions between superannuation funds warrants the maintenance of the trustee model. Regulation of systemic risk (the risk that exists in the way a system operates) is the key to superannuation safety. As has been long acknowledged, there are various risk profiles across the range of managed superannuation funds. While academic and media attention has focused most deliberately upon those funds that are relatively small (either in numbers of members or funds invested) and which are most closely linked to an employer contributor, such a focus is really no more than a conceptualisation of the nature of risk. As such AMP does not agree that the focus of the Working Party should be on any one particular form of managed superannuation fund. To this end AMP agrees that the safety of superannuation would be increased if all trustees were to be licenced (approved) as part of a broad risk based assessment of all managed superannuation funds. Such licencing should focus on the ability of trustees to deliver an acceptable level of safety for the superannuation savings of any member in their trust. AMP believes that the present SIS Act already contains an appropriate framework from which such licensing could be implemented. APRA has the power under SIS to pre-vet applicants who wish to become approved trustees, to monitor their behaviour and to impose strict sanctions in the event of non compliance. These powers should be exercised by APRA to secure a regulated class of trustees that, in all the circumstances of the superannuation funds they manage, can hold the confidence of the public. Through a universal licensing regime conditions could be set within a licence that would reflect the systemic risk of the managed superannuation fund. Such conditions would address the risks identified in the Working Group’s papers, for example, by requiring a trustee to have a risk based compliance plan and/or a detailed investment plan. APRA instruments would also appear to have sufficient flexibility to allow them to be tailored to reflect different types of superannuation funds and changing market or legislative conditions. A major factor that APRA should consider in determining conditions for licences should be the capacity of members of a fund to transfer their benefit out of that fund. The proportion of members and the proportion of funds that are ‘free’ to be moved at the direction of a member should impact the requirements imposed on trustees. If and until "choice" legislation is introduced any differences in the conditions attaching to trustee instruments and the regulation of superannuation funds generally should in AMP’s view be based on this distinction and not whether a fund is or is not operated for profit, its AUM or the size of its membership. 6 If all trustees of managed superannuation funds were required to obtain an APRA approval instrument and that instrument were to be established on the basis of an overall risk assessment of the fund, then in AMP’s view the public could better anticipate a safer superannuation system. Moreover, by requiring a consistent assessment platform for all trustees, focused on risk alone, APRA would be better positioned to monitor and regulate trustee behaviour. AMP is of the view that a universal APRA licence would not substantially impact on current industry participants. The vast majority of managed superannuation funds already demonstrate the requisite capacities to obtain an approved trustee status. AMP acknowledges that some smaller funds may view the possible cost of developing more substantial safety systems or processes as excessive relative to their funds under management. This should not be a sufficient reason for allowing such funds to operate outside the licensing requirements as it is an admission that the safety of some member funds is less than others. AMP considers the potential of a properly administered licensing regime to be far more efficacious to superannuation safety than any raft of additional general prescriptive regulation. Given the ability of the regulator to date to monitor and act on the significant number of present requirements contained in the SIS Act and its regulations, AMP believes further prescription will inhibit not assist the regulator. Indeed AMP considers the marginal return of additional regulations would be negative for the majority of superannuation members. Ultimately AMP endorses the view that the success of any reform will be dependent upon the regulator having adequate resource levels and skills to properly implement and monitor compliance. However as noted above the cost of safety is borne by members in the form of lower returns. Consequently additional ‘safety’ requirements that add marginally little to reducing risk can actually reduce the retirement benefit of members. This is not desirable nor appropriate. The following comments address several of the issues raised by the Working Group in its Consultation Paper. As a general response AMP supports fully those measures that increase transparency and reduce member risk. AMP does not agree with proposals that will not achieve the ultimate goal of reducing risk in the superannuation system but which merely add to the cost of providing superannuation services. 7 Prudential standards making powers AMP has no objection to giving APRA additional power if the evidence shows it requires it to effectively regulate the industry. As with any standards AMP assumes industry consultation would be incorporated in the approval process to ensure effective implementation on a cost effective basis. Investments AMP judges that in terms of investment, SIS is already adequate in terms of general obligations imposed on trustees and that adding further prescription is not necessarily the solution. AMP recommends that consideration be given to adding a condition to an approved trustee instrument to resolve the current problems encountered by APRA in regulating investments – see also comment below concerning related party transactions. Capital While some operational risk can be lessened by adequate capital resourcing, insurance will in many cases provide greater protection for members. Furthermore the cost of such insurance will reflect a real market based assessment of the risks involved. Accordingly AMP recommends that where appropriate compulsory insurance be considered as an approved trustee condition. Outsourcing AMP supports application of the current draft outsourcing standard to superannuation trustees subject to certain comments on that draft which have already been conveyed to APRA. Governance and Operational Risk AMP has noted the considerable comment already made on this proposal by a number of industry participants and has nothing further to add to the substantive comments made above. Annual General Meetings AMP does not support the proposal to introduce Annual General Meetings for superannuation funds as an appropriate or cost effective means of giving members the opportunity to hold trustees to account more directly. AMP supports the proposal to increase transparency through measures such as the public disclosure of annual returns and more meaningful disclosure of certain member information, for example administration costs. It is important to remember that in making trustees more accountable members of employer sponsored funds have limited options available to them if they are unhappy with their fund. 8 Consideration should be given to ensuring members of these funds in particular receive appropriate education as to what their options are when they have concerns about the management of their fund (which would usually be outside the jurisdiction of the SCT). Related party transactions AMP strongly supports the abolition of related party investments, subject to the retention of existing exemptions. There is no clear need for in house assets, loans to members etc from a members' perspective and AMP believes that all investments should be at arms length. There are other means available to individuals who wish to invest in their employer companies or obtain financial assistance and superannuation funds should not, in AMP’s opinion, be used for this purpose. Public disclosure of annual returns AMP supports this proposal as a means of increasing transparency within the industry. As referred to previously member education is an important adjunct to any increase in transparency. Financial assistance for failed superannuation funds As mentioned above insurance would in AMP’s view be a preferable and more market oriented alternative to a universal levy for failed superannuation funds. An industry assistance fund could in the longer term act as a disincentive for prudent risk management with the cost of failure being borne by prudent trustees and their members. Moreover in the absence of a single risk based regulatory structure that effectively risk rates superannuation funds it is inequitable to require the members of low risk funds to ultimately subsidise the members of higher risk funds. Given it is in the province of Government to create and manage a single risk based regulatory framework, a decision to allow a non-risk based regulatory framework to operate should place the onus on Government to provide a safety net for lost member funds. 9 Conclusion To date the Australian superannuation system has recorded a low level of lost member funds relative to the size of funds invested and under management. The large amount of money accumulating in Australian superannuation funds will require the superannuation industry to be vigilant in protecting funds so that they do not fall prey to fraud, dishonesty, theft or negligence. The ability of superannuation trustees to manage and protect the superannuation savings of all Australians is a systemic issue that requires a systemic response from the regulator and the Government. All regulation of the superannuation industry should be risk based and risk should be defined, measured and monitored by APRA. All forms of risk, including investment risk, should be assessed by the regulator. All trustees of superannuation funds should be licenced by the regulator on the basis of a risk assessment with the licence if necessary setting out whatever requirements the regulator considers necessary to establish an acceptable level of risk. Licences and any conditions therein should be monitored by the regulator and, where necessary, the regulator should use all powers necessary within the SIS Act to enforce the licence and maintain the safety of superannuation savings. 10