Super in the spotlight

AUSTRALIA'S $1.3 trillion superannuation industry is set for its biggest overhaul in two decades with the imminent release of an issues paper which is likely to recommend greater powers to the financial services regulator and stiffer capital requirements for super funds.

The reform package, Stronger Super, prepared by a consultative committee chaired by former Future Fund boss Paul Costello, includes setting up a new simple default fund, MySuper, back-office reforms known as SuperStream, and beefing up the Australian Prudential Regulation Authority's powers to enable it to monitor and protect the country's growing pool of retirement savings better.

The package is believed to include overhauling the capital requirements of super funds from a flat $5 million at present to a risk-weighted capital requirement. It is also expected to give APRA the power to set standards in superannuation, including creating some statutory cost categories that could be released to the public to allow comparison between super funds.

This is a powerful weapon for APRA's Ross Jones, who is responsible for the oversight of the country's retirement savings as it means APRA will have the power to set standards that are enforceable rather than having to get Parliament to pass any such changes, as in the present system.

If he wants to, Jones will be able to lift the transparency of the industry by calling for a higher level of disclosure of super funds. He could do this by introducing standards that require funds to release information on fees, returns and costs, to allow industry benchmarking.

He could also introduce standards that required super funds to provide greater detail on the performance and structure of their investments so members could see what investments their funds were buying and selling.

Right now there is too little transparency as to which assets the funds invest in, or how risky some of them may be. For instance, when it comes to cash, some funds that invest in cash-plus and cash-enhanced funds are investing in things other than cash. Such funds offer better returns than straight cash by investing in shares and property as well as bank bills and fixed-interest securities, but they are much higher risk and some investors don't realise this.

Not surprisingly, some sections of the industry are worried that increased powers to APRA could result in more intrusive regulation. But that depends on APRA and whether it has the stomach to implement these powers to improve the transparency of an industry that has become increasingly opaque over the years.

With super funds making decisions on the fourth-largest pool of managed money in the world, largely built from compulsory savings, more needs to be done to direct the spotlight on to governance, board composition, conflicts of interest and the standard of education of superannuation board and trustee members.

But APRA will only be able to go so far. As this column has already pointed out, the Costello consultative committee was not allowed to touch on key governance issues such as transparency regarding how much trustees are paid or the composition of super boards, as they were excluded from the terms of reference.

Super funds are not obliged by law to disclose detailed investment outcomes or the salaries of senior executives or the board. Nor are they required to provide members with a full set of audited accounts.

And, in most cases, members don't have control over the people who manage their money. As a rule, members do not elect the managers or trustees. This means they can't replace them.

This has created a perception that the boards of industry funds are retirement homes for both business leaders and union officials.

Nevertheless, changes to capital requirements and new powers to APRA have the potential to turn the super industry upside down.

In the case of capital requirements, super funds currently are required to hold $5 million in capital, irrespective of the size of the fund. This figure was set back in 1993, when the industry was worth just $126 billion and super funds were a fraction of their current size.

The Costello report is expected to follow through on Jeremy Cooper's recommendation to introduce a risk-weighted capital model to the industry.

This will be a bonus for retail funds - such as AMP - which have a life insurance business and are therefore required to hold much higher levels of capital.

AMP had $159 billion in assets under management as at June 30, and its regulatory capital resources are $2.1 billion, which is a far cry from the $5 million required by industry funds.

Changes to regulatory capital will have a great impact on the super industry and will need to be phased in over time. For example, if the reforms require super funds to hold between 0.05 per cent and 1 per cent in risk-weighted capital, then a $40 billion fund will need to lift its capital from $5 million to between $200 million and $400 million.

The purpose of holding sufficient capital is to reduce the risks associated with a fund having a mismatch between assets and liabilities. For instance, if a fund has too big a weighting to illiquid assets and its profile of members is skewed towards retirement, it could present issues when the members come to withdraw their funds.

The decision in 1991 to set up a superannuation guarantee scheme to force people to save for their retirement was far sighted. But two decades on, our super system is out of date and in desperate need of reform. The Costello report will hopefully give APRA the power to make some headway in the reform stakes. But the ball will be in APRA's court if it doesn't take it up, come the next federal election, the Coalition will.