Analysis of the Cooper Review Final Report

On 29 May 2009 the Labour government announced its review into the superannuation system in Australia, affectionately known as the ‘Cooper Review’ after its chair, Jeremy Cooper. The task of the review was to comprehensively examine the current superannuation system in Australia and address the following issues:

Governance

Examining the legal and regulatory framework of the superannuation system, including issues of trustee knowledge, skills and training; and thoroughly assess the risks involved in the use of debt and leverage and the development of investment options that can lead to a weakening of the diversification principle in the superannuation system.

Efficiency

Ensuring the most efficient operation of the superannuation system for all members, whether active or passive members and whether making compulsory or voluntary contributions, including removing unnecessary complexities from the system and ensuring, in light of its compulsory nature, that it operates in the most cost-effective manner and in the best interests of members.

Structure

Promoting effective competition in the superannuation system that leads to downward pressure on system costs, examining current add-on features of the superannuation system; examining other structural legacy features of the system.

Operation

Maximising returns to members, including through minimising costs, covering both ‘passive defaulting’ members (who should receive maximum returns and value for money through soundly regulated default products) and ‘active selecting’ members (who should not be negatively affected by conflicts of interest that may inhibit advice being in the best interests of members).

The review was conducted in three phases:

  • Governance.
  • Operation and Efficiency.
  • Structure.

The final phase, structure, addressed issues with self-managed superannuation F=funds (SMSFs). Each phase commenced with an issues paper released for public submissions, a preliminary report from the panel, and then the recommendations from the review panel were presented to Treasury on 30 June 2010. Treasury released the review report to the public on 5 July 2010, with the government’s response to the review (Stronger Super) released in December 2010.

Notable recommendations from the review and the government’s response are as follows.

Chapter 1: MySuper and Choice

This chapter outlined in detail the new MySuper concept, where effectively a MySuper product is the default fund under superannuation choice. The MySuper product would be a ‘no-frills’ product where:

  • There would be a single diversified investment strategy for members.
  • Advice to members or employers would be unable to be bundled within the MySuper product.
  • No entry fees could be charged by the fund, exit fees could only be charged on a cost recovery basis
  • The cost of advice to employers would not be able to be borne in any way, either directly or indirectly by member.
  • The cost of advice to members would only be able to be deducted from a member’s account under written agreement from the member.

It is recommended that the industry has at least two years to transition to the new MySuper and Choice model, with both the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) charged with overseeing the transition. The Gillard Government has promised to allow Australians to use this product from 1 July 2013, with the intention being that after an appropriate transition time, MySuper products will be the only products available that will be eligible to receive contributions on behalf of employees who do not choose a fund.

Chapter 3: Investment Governance

In this chapter, areas of note include:

  • The expected costs of the strategy should be included as an operating standard for APRA trustees to consider.
  • The taxation consequences of a strategy should be included as an operating standard for APRA fund trustees.
  • A ‘performance fee standard’ should be developed by APRA in consultation with industry.
  • The trustees of a MySuper product should not pay any performance-based fees unless they accord with the ‘performance fee standard’.

The government agreed, at least in principle, with the above recommendations, with further consultation with industry to provide guidelines.

Recommendation 6.1 – Capital Requirements

This recommendation outlined the capital requirements for the trustees of large APRA funds, as the review panel considers that the current capital requirements for Registrable Superannuation Entities (RSEs) to be too low, as well as there being no link between the risks faced by the fund and the amount of capital required. When the fund suffers loss, it is the fund that bears the cost (unless other third parties are involved), which is ultimately passed on to the members.

The types of operational risks include:

  • Conflicts of interest or duty (or both) among the trustee directors.
  • Poor selection and monitoring of external service providers.
  • Inadequate insurance.
  • Failure to meet compliance obligations.
  • Damage to member records.
  • Computer failure.
  • Failure of software to perform to expectations.
  • Fraud, negligence and misconduct.
  • Miscalculation of member benefits (such as unit pricing errors).
  • Loss of key staff.

Factors that have led to increased operational risks include:

  • The provision of more complex superannuation product offerings.
  • Greater flows of funds due to the introduction of choice of fund and the growth in member investment choice.
  • More widespread adoption of daily unit pricing.
  • A general increase in the number of external service providers that many trustees must monitor.

In response to these risks and the current inadequacy, the panel is recommending that large APRA funds maintain an ‘operational risk reserve’. This reserve would be separate from member balances and the capital requirements imposed under the trustee’s licence. Additionally, the amount of the reserve would not be able to be supported by trustee capital and would therefore need to be maintained separately by the trustee. The amount of the reserve will be subject to a minimum, with a maximum amount based on assets in the fund. ARPA would have the power to require a fund to increase their reserve on a risk-assessed basis. The minimum requirement and risk-weighted requirement would be developed in consultation with industry. It is also expected that this requirement would be in addition to any other capital requirements required under an Australian Financial Services License (AFSL).

In it’s response, the government provided their view that the current capital requirement for superannuation fund trustees should be replaced with a risk-based approach applying to all APRA-regulated funds, requiring that financial resources are held against operational risk. The government has indicated that it will consult closely with industry on the form of such improved capital requirements, as well as the calculation methodology for such requirements.

Chapter 7: Retirement

This chapter outlines some additional requirements for MySuper products with respect to the retirement of members:

  • A MySuper product must offer at least one type of income stream product, either through the fund or with another provider.
  • Trustees of MySuper should be pro-active in providing intra-fund advice to members as they approach retirement age and throughout retirement.
  • MySuper trustees should devise a separate investment strategy for post-retirement members to take into consideration Section 52(2)(f) as well as inflation and longevity risk.

In their response, the government noted the above recommendations, with further consultation required with respect to imposing such mandatory requirements on MySuper products.

Chapter 8: Self-managed Solutions

This chapter outlines the areas that the panel recommends should be implemented with respect to SMSFs. Following on from the release of the issues paper in December 2009 and preliminary report in April 2010, none of the recommendations were surprising, and most were supported by the government (except where noted below):

  • The maximum number of fund members is to remain at four.
  • The panel does not believe that a minimum asset size be imposed for SMSFs.
  • The Australian Taxation Office (ATO) should have the power to impose administrative penalties on SMSF trustees to reflect nature/seriousness of breaches (rather than just having the option to make the fund non-complying). Any penalty is to be paid by trustees personally, not the fund.
  • The ATO should have the power to issue a direction to trustees to remedy a breach. If the direction itself is breached, it would be a liability offence.
  • The ATO should have the power to enforce mandatory education for trustees, with the cost borne by the trustee.

The ATO should have the power to issue binding rulings with respect to SMSFs. The government did not support this recommendation, as they consider that it may result in a SMSF being able to maintain an investment contrary to retirement income policy.

The Superannuation Complaints Tribunal (SCT) will remain unavailable to SMSFs.

An SMSF specialist knowledge requirement should be introduced into RG 146.

An AFSL will be required to provide any advice on SMSFs, including whether to establish an SMSF. The panel recommended that the accountant’s exemption should not be replaced once removed in 2012.

Approved auditor standards will be imposed to ensure independence, with the ATO to monitor auditors, and ASIC overseeing the registration of approved auditors, ensuring relevant education standards are met and devising independence standards.

The ability for superannuation funds to borrow should be reviewed in two years’ time to ensure it has not become a significant focus of superannuation funds.

Credit providers should be required to provide information to APRA to enable the Reserve Bank of Australia (RBA) to publish statistics regarding the level of credit being provided to superannuation funds. The government did not support this recommendation as it would not accurately capture the level of finance provided to SMSFs, and would be of little relevance.

The In-House Assets (IHA) limit should be reduced from 5% to nil. The government did not support this recommendation;

Collectables and personal assets to be prohibited (excluding APRA-regulated funds). The government did not support this recommendation, preferring instead to restrict (not prohibit) the investments by SMSFs in collectables and personal use assets. This legislation has received Royal Assent (new section 62A of the SIS Act), with regulations in SISR 13.18AA also released.

Related party transactions should be tightened (excluding APRA-regulated funds):

  • Where a market exists for an asset, transactions between the fund and a related party must be conducted on that market.
  • Where a market does not exist for an asset, transactions between the fund and a related party must be supported by a valuation from a qualified independent valuer.
  • All assets will be required to be valued at net market value, with valuation guidelines to be published to ensure consistency.

Trustees will be required to provide key information to members each year, including:

  • Whether a Binding Death Benefit Nomination (BDBN) is in place.
  • The level of insurance cover in the fund for the member.
  • Whether the member has a pension in place and the reversionary nature of that pension.
  • The investment return achieved by the member’s superannuation interest.

The government did not support this recommendation on the basis that all members are trustees, an accordingly such information is readily accessible. If such requirements were mandatory, it would place an unnecessary administrative burden on trustees.
The administration burdens for SMSF trustees which are deemed unnecessary are to be removed so that paperwork communication between the trustee and the members is not required, given the trustee is communicating with themselves. The record-keeping of the fund would only require final minutes/resolutions of the final transaction.

A superannuation fund system should be developed to capture vital SMSF information to enable large APRA funds to verify the SMSF details and rollover funds efficiently.

Such information would include:

  • Member details.
  • SMSF trustee details.
  • SMSF bank account details.

Proof of identity checks should be required when a person joins an SMSF. This would reduce the potential for people to access their benefits early, and all details would be verified by the ATO so that the member information matches bank accounts as part of the fund registration process. SMSF registration is to capture who provided the advice.

The rollover of funds to an SMSF is to become a designated service under the Anti-Money Laundering and Counter Terrorism Financing Act 2006 (AML/CTF Act).

Early access of superannuation would be subject to criminal and civil sanctions.

Tax on funds received under an early access scheme should be taxed at the fund non-complying rate, plus penalties.

Anything permitted under SIS or Tax Acts is to automatically be permitted under a superannuation fund’s trust deed, which should reduce the need to update trust deeds regularly. Investment strategies should consider Life and Total and Permanent Disability (TPD) cover for members.

As is evident, there are many recommendations with respect to SMSFs, most of which the government supports. Accordingly, much consultation is still required to ensure the efficient implementation of the recommendations, and to ensure they achieve the desired outcomes.

In general, the panel (and the government) is comfortable with the operation of the SMSF industry, as SMSF members have an interest in their superannuation benefits. Due to the fact that the members of an SMSF are the trustees and they will always be acting in their own best interests, it is contentious as to whether imposing certain restrictions would achieve much. The tightening of some of the investment rules and auditing standards should ensure that funds are being operated appropriately for members’ retirement.

SMSF Issues: No Comment

The following issues were raised in the consultation process and the panel has determined they require no comment or recommendations:

  • Restricting choice and/or control upon a trustee attaining a certain age.
  • Compliance coverage should be determined by the ATO to reflect the level of risk.
  • Increased use of technology would be beneficial throughout the industry, however government involvement would stifle development.
  • Not to mandate that investment strategies be in writing.
  • Improving the process for rollovers from large APRA funds to SMSFs, as the improvement of SMSF data should assist in this process.

Conclusion

As outlined above, the Gillard government has supported many of the recommendations by the Cooper Review panel, with the implementation of some already underway. Consultation is still required with the industry on various areas, with the actual implementation of many of the recommendations dependent upon the passage of legislation through parliament.

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