Royal Commission: Are Solutions Harder Than Grasping At A Column Of Smoke?
While the Royal Commission spotlight has focused heavily on the major banks, the non-bank owned mass of the superannuation industry must also adjust to the climate of change with a resolve for improvement.
As Commissioner Kenneth Hayne adjourned the final hearing at the Commonwealth Law Courts in Melbourne, the focus had already shifted to finding solutions to the failures. He’d previously suggested that the hunt for solutions might be harder than grasping a column of smoke.
Hayne and the counsel and office assisting will be spending a large part of their Christmas ‘break’ finalising the report which will be delivered to government in January. The report will contain recommendations which – while not binding policy on government - will be politically impossible to ignore regardless of the composition of the next government.
Changes to the law
The Hayne recommendations will initiate yet another wave of legislative and regulatory reforms impacting the superannuation industry. We have a fairly good idea of what shape these are likely to take.
In the opening statement to the round seven hearings, counsel assisting identified ten areas where responses to the interim report had seen substantial agreement from respondents – with four being directly applicable to the superannuation industry.
Superannuation trustees should expect proposed reforms to include four main themes:
simplification of the law;
simplification of disclosure;
civil penalties for breaches of the best interests’ duty; and
ending grandfathered commissions.
Simplification of the law
Regulation tends to oscillate between principles-based regulation and detailed, prescriptive rules-based regulation.
Principles-based regulation relies on the use of fewer words and greater interpretation and discretion in application by regulators and courts. Rules-based regulation typically takes the form of detailed, prescriptive rules-based regulation which tries to cover all exceptions and scenarios.
A shift towards simplification of financial services and superannuation law may see a pivot by the Australian Securities and Investments Commission (ASIC) to greater use of principles-based standards, more akin to the prudential standards issued by the Australian Prudential Regulation Authority (APRA) and the associated soft law guidance.
The demands for absolute clarity and certainty on the one hand seem to be giving way to simpler (and less certain) principles-based regulation where regulators have greater discretion to determine whether practices and conduct are inconsistent with the principles.
The financial services chapter of the Corporations Act seems the likely target of simplification, and product disclosure appears due for a rethink.
Simplification of disclosure requirements
Product disclosure is based on the premise that individuals are at liberty to freely decide what they want, what’s best for them, and are capable of doing that. Of course, some people are... but most people are not.
While wonderful at a theoretical level, relying on financial product disclosure becomes problematic when actual people are involved. Existing regulation by way of product disclosure assumes that individuals are:
adequately financially literate to understand what they are reading;
motivated, engaged and have the time to read product disclosure documents;
have all the information necessary to make an informed decision about what is best for them; and
continue to remain attentive to changes in product terms which are disclosed.
Learnings from behavioural economics have demonstrated the challenges that regulation based on disclosure face. Attempts at promoting financial literacy and personal responsibility are well meaning but will inevitably fall short for many Australians. Effective reforms to simplify financial product disclosure would involve less lawyers and more behavioural design experts.
Simplification of the prescribed formats of disclosure may assist in promoting better understanding of disclosed material. However, the challenge remains that most people simply don’t have the attention or patience to wade through product disclosure – let alone compare it to alternatives in the context of their personal circumstances.
Recommendations directed at simplifying the disclosure laws would benefit from consideration of the increasing reliance individuals are likely to have on the data economy which will enable the fast comparison of financial products, and application to a financial profile of the individual to best meet their needs.
The future of financial product disclosure probably looks more like SkyScanner or Booking.com and less like the lovechild of a retirement village brochure and the Corporations Act.
The Royal Commission may even be bold enough to consider whether now is the time to recommend the extension of the Consumer Data Right to financial products, to require standardised financial product disclosure in machine-readable API format.
Civil penalties for breaching the best interests duty
In her opening statement to the round seven hearings, counsel assisting the Commission, Rowena Orr QC, suggested strong support for “legislative changes to impose civil penalties for a breach of the requirements in the SIS Act that the trustee of a superannuation fund or directors of the trustee perform their duties and exercise their powers in the best interests of beneficiaries”.
The suggestion that there are no penalties for a breach of the best interests duty by a superannuation trustee might appear to be an outrageous loophole for trustees to avoid responsibility. On closer inspection, there is more to it than this. It’s not really a loophole, but by design that the trustee duties do not have civil penalties directly attached to a breach.
The purpose of including the covenants in the SIS Act was to protect them as the irreducible core which was not to be eroded by the drafting of trust deeds which specifically excluded such duties: the SIS Act covenants and best interests duty are protected as the irreducible core of the trust.
The SIS Act is a little peculiar in that it imports the ‘covenants’ into the trust deed, rather than imposing the covenants directly in the RSE Licensee (trustee). The practical implication of this is that any alleged breach of the duty is a matter for a court to deal with by determining whether the duty was breached, and if so the application of remedies to achieve the outcome the court rules as being correct.
There are also regulatory mechanisms to enforce compliance with the best interests duty. APRA has powers to direct trustees to comply with RSE License conditions which includes a standard condition requiring proper performance of trustee duties (including both statutory and general law best interests duties). There are penalties attached with not a following APRA directions
The reality is that civil actions against superannuation trustees are few and far between. The individual complaint resolution schemes (Superannuation Complaints Tribunal, Financial Ombudsman Service, and now Australian Financial Complaints Authority) have been effective in dealing with most individual grievances, and there has been little appetite for litigation for breaches of the covenants by trustees.
The imposition of civil penalties for a breach of the best interests duty would fundamentally shift the responsibility for making such a determination from a court to the regulator (presumably APRA).
This would be likely to create demands for detailed guidance on what is exactly meant by best interests in various contexts (and safe harbour). It would also raise the prospect of judicial review of the administrative decision by a regulator to apply a quasi-judicial test.
Changing the law to impose civil penalties might not be as simple as first expected. It raises the question of whether the statutory best interests obligation would be integrated or sit alongside the fiduciary obligation?
A best interests obligation might need to sit alongside the existing obligation if the intention was to retain the protection of the general law core of the trustee fiduciary duties (and remedies), while providing an incentive for trustees to ensure that they perform duties and exercise powers in the best interests of beneficiaries.
More interesting still (and possibly more important) is the question of whether a new best interests obligation would extend to Trustee Directors or senior managers personally, much as the Banking Executive Accountability Regime places responsibility on individuals rather than the corporate entity.
Creating incentives for conduct and practices which promote the best interests of beneficiaries is a sensible policy objective. Caution may be required in ensuring that the form of any change operates as intended and doesn’t create too much complexity and uncertainty.
Ending grandfathered commissions
The closest we might come to consensus is in relation to ending grandfathered commissions from superannuation accounts. There was only a single objection to this recommendation in the interim report.
This should happen, and there’s little further to add as grandfathered commissions paid from superannuation accounts serve no useful purpose to members.
Getting our house in order
If effective solutions to the failures illuminated by the Royal Commission are to be found, they cannot be limited to changes to the law or the way regulators supervise the industry.
Meaningful change must come from within the people responsible for the management of the superannuation industry.
For all the flash smart phone apps and talk of artificial intelligence and distributed ledgers, it may seem extraordinary to ordinary Australians that so many of the problems have a genesis in operational process and system failures.
Yes, there are often complex legacy systems, dependencies on supplied data and outsourced arrangements. But the fact that some superannuation trustees are getting fees and deductions wrong - failing in their fundamental duty to accurately administer the fund - is something which can and should be priority number one.
It’s time we took this aspect of operational risk more seriously as an industry – and invested in more robust controls and better monitoring and reporting. If we can improve this, we also go a long way to resolving problems of prolonged and expensive remediation, complaint handling and delayed breach reporting. If we can improve this, we can make the superannuation system even better for the people it exists to benefit.
Jonathan Steffanoni - Principal Consultant, Legal and Risk
QMV provides trusted advisory, consulting and technology to Australia’s leading superannuation, insurance, banking and wealth management organisations.
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