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New Trustee Obligations and APRA’s Prudential Standards Making Power.

23 December, 2011

 

Tranche 2 of the Government’s Stronger Super legislative package was released on 12 Dec, 2011 in the exposure draft Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012. 
 
The Bill will amend the Superannuation Industry (Supervision) Act 1993 (SIS Act) by:
 
  • replacing and expanding the existing trustee duties and covenants;

 

  • introducing new duties for directors of superannuation trustees;

 

  • modifying the trustee’s right of indemnity; and

 

  • introducing APRA’s prudential standards making power.
 
The changes are significant. They are also difficult to understand and likely to be difficult to comply with. Trustees and directors will be faced with making decisions and exercising their powers without any certainty that they will have complied with their new duties. The following sets out a brief (and incomplete) summary of the key changes.
 
The enhanced trustee obligations for MySuper
 
Trustees offering MySuper will be required to:
 
  • promote the financial interests of the MySuper beneficiaries, in particular net returns;

 

  • determine, annually, whether the MySuper assets (or the MySuper assets and assets with which they are pooled) are sufficient to ensure that the financial interests of the MySuper beneficiaries are not disadvantaged;

 

  • determine, annually, whether the number of MySuper beneficiaries and the number of beneficiaries of the fund (we assume excluding the MySuper beneficiaries already counted) is sufficient to ensure that the financial interests of the MySuper beneficiaries are not disadvantaged.
 
These are onerous obligations – trustees are required to “ensure” that their beneficiaries’ financial interests are not disadvantaged.  In measuring disadvantage, trustees must compare their MySuper beneficiaries’ financial interests to the financial interests of MySuper beneficiaries in other funds. 
 
A director of a trustee must exercise a reasonable degree of care and diligence to ensure that the trustee carries out these obligations.
 
The new trustee covenants
 
The covenants which apply to trustees have been deleted and replaced with new, more extensive and more specific covenants.  Separate covenants apply to trustees of registrable superannuation entities (RSEs) and to self managed superannuation funds (SMSFs).
 
The governing rules of RSEs are taken to include eleven covenants.  In addition to the core existing covenants to act honestly, to exercise care, skill and diligence (although the standard has been changed to that of a “prudent superannuation trustee”) and to perform the trustee’s duties and exercise its powers in the best interests of the beneficiaries, there are new covenants. 
 
Trustees will now also be required:
 
  • to do all things reasonably practicable to avoid a conflict between the interests of beneficiaries and the interests of the trustee or the trustee’s duty to any other person; and

 

  • where there is a conflict, to give priority to the duties and interests of the beneficiaries;

 

  • to act fairly in dealing with all classes of beneficiaries and not give beneficiaries of one class an unfair advantage over another; and to act fairly in dealing with all beneficiaries within a class and not give a beneficiary an unfair advantage over another.
 
Duty of priority: 
 
Oddly, given the Government’s intention to increase standards which apply to superannuation trustees, the duty of priority may well lower it.  It appears to give permission to trustees to act with a conflict of interest or duty where they are not able to do so now.  However, in acting with a conflict of interest or duty, they must give priority to the interests of beneficiaries.  The duty of priority is a favourite with Government, but it is extremely unclear what a trustee is required to do in order to discharge the duty.  There is no body of law to assist. 
 
Duty to act fairly: 
 
The duties to act fairly are also difficult. They do not appear to be limited to (nor even to include) a duty of impartiality, rather they appear to expose trustees to the risk of legal action on the grounds that the trustee has treated them “unfairly”.  This has been the domain of the Superannuation Complaints Tribunal, not courts.
 
Other trustee covenants
 
The Bill also introduces more extensive investment covenants which will apply when a trustee formulates, regularly reviews and gives effect to an investment strategy.  They now include considering whether reliable valuation information is available and the expected tax consequences.
 
Trustees must also exercise due diligence in developing, offering and reviewing investment options and they must ensure that the investment options offered allow adequate diversification.  These obligations will require trustees of wrap style products to consider the investment choice given to members more closely than they may do now.
 
Trustees will also need to formulate, regularly review and give effect to an insurance strategy and a risk managed strategy which address the prescribed matters.
 
Covenants for directors
 
In addition to their existing duty to exercise a reasonable degree of care and skill to ensure that the trustee complies with its covenants, each director will have duties which mirror the trustee’s. 
 
Directors will be required to:
 
  • act honestly;

 

  • exercise care, skill and diligence (of the standard of a prudent superannuation trustee director);

 

  • perform the director’s duties and exercise the director’s powers in the best interests of the beneficiaries;

 

  • do all things reasonably practicable to avoid a conflict;

 

  • where there is a conflict, give priority to the duties to and interests of beneficiaries; and

 

  • not to enter into a contract which would prevent the director or the trustee from performing or exercising their functions and powers.  
 
SMSFs
 
Covenants are also imposed on SMSF trustees and their directors.  They are a sub-set of the covenants described above. 
 
Defence under section 55(5) watered down
 
Currently trustees who follow the investment direction of a beneficiary, are protected from an action from the beneficiary for loss or damage as a result of an investment under section 55(5).  The defence will be significantly reduced by applying only where the trustee has complied with:
 
  • all of the trustee’s covenants (and not just the covenant in relation to formulating and giving effect to an appropriate investment strategy); and

 

  • for a MySuper beneficiary, the enhanced trustee obligations in relation to MySuper.
 
Trustee’s right of indemnity
 
A trustee’s right of indemnity from fund assets will be restricted so that:
 
  • a trustee will not be able to recover from the assets of the fund amounts which are paid from trustee capital maintained to cover operational risk of the fund; and

 

  • a trustee must exhaust the operational risk reserve maintained in a fund and its other financial resources maintained to cover the risk (namely, trustee capital) before being indemnified from the other assets of the fund for the costs of operational risk.
 
There is more to come on trustee capital and operational risk reserves, both in further tranches of legislation and prudential standards.
 
Prudential standards making power
 
The Bill will insert into the SIS Act APRA’s prudential standards making power in relation to superannuation.
 
As expected, the power is broadly drafted, and allows APRA to make standards in respect of “prudential matters”.  A standard may be binding on all RSE licensees and their connected entities, or only a class of licensees, or even only on one or more specified licensees.
 
“Prudential matters” include matters relating to the conduct of an RSE licensee or a “connected entity” of the RSE licensee of its affairs (or the affairs of the RSE):
 
  • in such a way as to protect the interests or meet the reasonable expectations of the beneficiaries of the RSE;

 

  • to keep itself in a sound financial position and not cause or promote instability in the Australian financial system;

 

  • whilst the words are awkward, apparently to conduct itself with integrity, prudence and professional skill.
 
Prudential matters also include matters relating to the appointment of auditors and actuaries, and the conduct of audits and actuarial investigations.
 
A “connected entity” will be defined to mean a subsidiary of the RSE licensee, or any other entity defined by regulations.
 
The prudential standards may elaborate, supplement or otherwise deal with matters that are also dealt with under the SIS Act, but are of no effect to the extent they conflict with the Act or the Regulations.
 
The prudential standards made under this power will be included in the definition of “RSE licensee law”, and so will need to be complied with under RSE licensees’ licence conditions.
 
The draft Explanatory Memorandum to the amendments states that it is proposed that APRA will finalise its proposed standards by the end of 2012, and industry will generally have until 1 July 2013 to transition to the new arrangements.
 
 
For further informtation, please contact:
 
John Edstein, Mallesons Stephen Jaques
john.edstein@mallesons.com
 
Michelle Levy, Mallesons Stephen Jaques
michelle.levy@mallesons.com
 
Simun Soljo, Mallesons Stephen Jaques
simun.soljo@mallesons.com
 
 

 

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