CPD: ASIC Report 779 – adviser obligations re superannuation underperformance

Introduction

Superannuation is one of the key pillars of Australian retirement incomes policy, and for many Australians will represent their most significant asset outside their home.  As such, recent years have seen an increasing regulator focus on strengthening consumer protections around individual’s superannuation savings. These protections have an overarching intention of optimising superannuation balances at retirement, a challenge approached by regulators from two sides – reducing the amount of fees eroding balances, and increasing the amount of investment returns growing balances.

These objectives were reflected in two of the most transformative consumer protection reforms seen in superannuation:

• The Protecting Your Superannuation reforms of July 2019, which addressed premiums for default life cover and admin fees for low balance and inactive accounts^[1], and
• The Your Super Your Future reforms of 2021 which introduced new obligations on superannuation trustees to act in their members’ best interests. These obligations included undergoing an annual performance test to prove their right to remain in the system^[2].

To now, the superannuation performance tests – and the accompanying widespread media attention^[3] given to so called ‘dud funds’ – has largely been seen as the sole concern of the funds themselves.

However, in February 2024, ASIC released Report 779 ‘Superannuation choice products: What focus is there on performance?’ which suddenly drew advisers and advice licensees into the fray, calling them out over a lack of monitoring and acting around underperforming funds, and an overreliance on research ratings and APLs when advising clients around specific funds and investment options^[4].

The report was met by consternation in some circles, not only because the obligations it imposes on advisers in relation to superannuation fund performance, but for the calling out of APLs and research ratings, two important resources relied upon when making recommendations.

Background to superannuation fund performance tests

Superannuation performance testing first came into effect in July 2021, and was an outcome of the Productivity Commission Inquiry into the Efficiency and Competitiveness of Australia’s Superannuation System^[5].

The test – which originally only applied to MySuper accounts – is conducted by the Australian Prudential Regulation Authority (APRA) and assesses the performance of a superannuation product by comparing its:

• historical investment performance against a benchmark return, based on the product’s strategic asset allocation, (for example the S&P/ASX 300 Total Return Index for Australian equities, and the Bloomberg Ausbond Composite 0+ Yr Index for Australian fixed interest^[6])
• most recent administration fees against the median fees charged by their peer group.

Products that fail the test are subject to clear legislated consequences – trustees must write to affected members notifying them that their product has failed the test and if a product fails the test two years in a row, it is closed to new members until it passes a future test.

In addition, funds that fail the test can expect to be subjected to heightened supervision from APRA to ensure that trustees are delivering better outcomes for their members.

Since July 2023, the test has also been applied to Trustee Directed Products (TDPs), a subset of the choice accumulation sector.

Positive consumer outcomes from the performance tests

Since the introduction of the tests, 80 MySuper products representing 14 million accounts and $900 billion in assets, and 805 TDPs representing 4 million accounts and $360 billion in assets, have been assessed by APRA^[7].

To date, 14 MySuper products have failed the test, of which 13 have exited the market or have announced plans to do so. This has resulted in over 800,000 member accounts merging with a better performing fund. The remaining MySuper product has since improved its performance.

TDP testing, which began 2 years later, has so far found 12 per cent of TDPs (roughly 100 products) to be underperforming, with trustees forced to advise members in these products that they had failed the test. Interestingly, this 12% failure rate comprised a 25% failure rate for platform TDPs, compared to only 4% for non-platform products^[8]).

TDPs failing the test again in 2024 will be forced to close to new members.

From a consumer protection perspective, the tests are regarded by many observers as a consumer protection success. As Treasury noted in their March 2024 Consultation Paper,

“The test has removed underperforming products in the MySuper sector, improving member outcomes, and enhancing transparency on the performance of their products. Without the test, affected members were unlikely to have known that they were in an underperforming product and would have remained there.” ^[9]

(Whilst there are some experts^[10] who claim that the test actually undermines consumer interests – by encouraging a more conservative investment approach with lower scope for outperformance – this is yet to be proven, and in any case is beyond the scope of this discussion).

The Grattan Institute, in a submission to government^[11], reference a Treasury estimate that the performance test could reap $10.7 billion in benefits over the subsequent decade through under-performing funds improving or exiting. The Grattan Institute also noted that some funds who had failed the performance test had reduced their fees, saving their members around $100m in fees, with the potential future savings even greater.

So where does Report 779 come in?

ASIC released Report 779 in February 2024, its purpose being to examine the role of superannuation trustees, financial advisers and Australian financial services licensees in influencing the investment options that make up member superannuation portfolios as part of a choice superannuation product (including TDPs).

According to APRA, Choice products accounted for 79% of funds under management in retail super funds, and as such, are frequently held as an outcome of financial advic^[12].

What did Report 779 find?

Based on its review (encompassing 10 fund trustees, 21 advice licensees and 88 advice files), the report’s high-level finding was there was:

“Often insufficient focus on performance and a lack of transparency about persistently underperforming investment options”.

The report noted that Trustees, advisers and advice licensees significantly influence the make-up of a choice member’s superannuation investment portfolio, and were concerned that some members may be unaware that the options they are invested in are not performing as anticipated and that there could be better options available to them.

It stated that while members are the ultimate decision makers in relation to their portfolios and bear the risk of underperformance, trustees, advisers and licensees must take steps to:

• support members in earning good net returns from their superannuation investments and meeting their financial objectives, and
• address and reduce member exposure to persistently underperforming options where appropriate.

ASIC observed that ‘For many trustees, advisers and advice licensees this will require improvements to their practices’.

Detailed findings

In conducting their review, ASIC found a number of deficiencies in the way trustees, advisers, and licensees were discharging their legal obligations.

Its review of trustees found – in some cases – insufficient focus on investment performance in deciding to offer, and continue offering, certain investment options. ASIC found that – despite underperformance ranging from 0.2% to 6.7% below the benchmark stated in the applicable PDS – some trustees were failing to take action or even monitor underperforming options. Communication to members about persistent underperformance was also lacking.

ASIC also took trustees to task over the following failures:

• an over reliance on research ratings, and having a low benchmark for such ratings (e.g. neutral rather than investment grade)
• offering products purely to broaden their range, or purely in response to adviser demand
• failing to have triggers forcing the withdrawal and review of the product’s TMD in the event of persistent underperformance.

Trustees were also urged to consider providing additional communications to members who may have ceased an advice relationship, noting that many members were in products designed to be accessed with personal advice, but not all members maintained an ongoing advice relationship.

Advisers not meeting Best Interests Duty in relation to performance

Catching many in the advice profession by surprise, ASIC also shone a spotlight on what it said was failings on the part of advisers and licensees.

Across the 88 advice files reviewed (all involving recommendations relating to underperforming options), only one quarter included a recommendation for a full replacement or redemption for the underperforming option.

For the remaining 66 files, the adviser’s most recent recommendation was to invest in or retain (i.e. hold, increase or partially reduce an existing investment in) the underperforming option.

Further, ASIC found 12% of advice files reviewed contained advice deficiencies relating to the underperforming option that were a major factor in the adviser failing to demonstrate compliance with:

• the best interests duty, and
• the appropriate advice obligation.

ASIC concerns with these files were that they did not:

• demonstrate that the adviser had conducted a reasonable investigation and assessment of the underperforming option
• identify underperformance, and
• explain why it was appropriate for the client to retain the option despite the underperformance.

It should be noted that ASIC does acknowledge there can be sound reasons to keep clients in an underperforming option, including for CGT reasons, or if the switching costs outweigh the underperformance.

In summary, ASIC was less concerned about the actual recommendation to invest in or retain an underperforming option, and more about the lack of investigation and client communication about why that recommendation was being made.

Licensees in the cross hairs too

21 AFSLs were also reviewed for Report 779, with particular focus on the construction of Approved Product Lists. ASIC found almost a third of AFSLs were including superannuation options on their APL solely on the availability of options within certain superannuation choice products or a minimum external product research rating, without records of further research or consideration.

Over reliance on APLs and Research Ratings

Arguably the most significant call out from Report 779 was what ASIC considered to be an over-reliance on third parties – trustees and AFSLs being too reliant on research ratings, and advisers being too reliant on APLs, and research ratings. Special mention was made to the fact that using the benchmark rating of ‘neutral’ to determine whether an option remained available was setting the bar quite low

The message to advisers from ASIC is that ultimately, the adviser is responsible for their recommendation:

“When relevant to the subject matter of the advice, advisers should treat performance as a primary consideration and consider information from a range of sources to develop and support their recommendations.
Advisers should be careful not to over-rely on advice licensee product approvals or external research ratings. The fact that an option is approved by an advice licensee or has a minimum external research rating does not mean that an adviser can ignore the performance of the option when providing personal advice.
Advisers must also ensure that their advice explains the basis upon which the advice was given. Regardless of whether the adviser’s recommendation is to acquire, retain or redeem an underperforming option, they should explain why that recommendation is appropriate despite the underperformance and based on the client’s relevant circumstances.” ASIC Report 779.

Advisers can’t set and forget

It is clear that advisers can’t rely on the appropriateness of their advice at a ‘point in time’ – rather there is an obligation to continually monitor, communicate, and act in relation to superannuation fund performance.

Better practices called out by ASIC

By way of guidance, Report 779 also identified what ASIC regarded as better practices around identifying and making recommendations in relation to underperforming options. These ‘better practice’ examples included advice files which incorporated:

• explanations of why the option was being recommended within a broader diversified portfolio, its performance over various timeframes, and why the outlook was positive
• a copy of the advice licensee’s most recent research about the underperforming option, including details about its objectives, investment approach, asset allocation and performance against a relevant benchmark over various periods
• a copy of the underperforming option’s most recent TMD and a file note recording the adviser’s consideration of the TMD, indicating that the adviser had considered the target market for the option when determining its suitability for the client.

Media coverage and industry reaction

The initial response among the advice profession was one of surprise and alarm. ASIC’s own media release^[13] said they were “considering a range of regulatory responses where there was an indication clients were at risk of detriment as a result of personal advice”, and the accompanying trade media headlines were understandably alarmist^[14].

The overall recommendations about the need to make performance a priority focus in the context of superannuation investment options, and the reminder that advisers shouldn’t blindly rely on research ratings and APL inclusion as a proxy for due diligence likely also came as a shock for many. Indeed, at a time when many advisers have been deliberately unchaining their value proposition from investment performance, Report 779 almost seemed like a backward step^[15].

But is it really?

Or has the assessment of investment performance always been a core part of an adviser’s role, and integral to their Best Interests Duty?

Section 961B (2) – of the Corporations Act, which cover the Best Interests Duty, refers to the need to:

“Conduct a reasonable investigation into the financial products that might achieve those of the objectives and meet those of the needs of the client that would reasonably be considered as relevant to advice on that subject matter”^[16]

And in RG 175, ASIC suggests:

“One way an advice provider can conduct a reasonable investigation into financial products, for the purposes of s961B(2)(e)(i), is by benchmarking the product at appropriate intervals against the market for similar products to establish its competitiveness on key criteria, such as: (a) performance history over an appropriate period; (b) features; (c) fees; and (d) risk.”^[17]

In this context, perhaps the recommendations of Report 779 shouldn’t come as a surprise, and for the majority of professional, client centric financial advisers, they are unlikely to require any major overhauling of processes.

Summary

Superannuation Performance Testing is one of the most significant financial consumer protection initiatives of the last decade, and one which has been found to have delivered meaningfully improved outcomes for superannuation members.

Initially applying to default ‘MySuper’ products only, in 2023 the test was extended to Choice products, thus bringing into scope many products used by financial advisers. In Report 779, ASIC examined whether trustees, advisers, and AFSLs were placing enough focus investment performance. Their Report noted several concerning deficiencies in the way advisers and trustees were monitoring, acting on, and communicating instances of underperformance in superannuation options.

ASIC’s high-level guidance for advisers when dealing with underperformance is not to rely on research ratings and APL inclusions as a proxy for due diligence, and instead conduct their own thorough investigations as to the performance of a given option, the reasons for that performance, and the future performance outlook. The details and outcomes of these investigations need to be accurately recorded and communicated to the client. This applies not just at the point of the initial advice but also throughout the duration of the client/adviser relationship.

 

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References:
[1] https://www.superguide.com.au/how-super-works/protecting-your-super-package
[2] https://www.allens.com.au/insights-news/insights/2021/02/your-future-your-super-reforms-introduced-to-parliament/
[3] https://www.afr.com/policy/tax-and-super/super-funds-advisers-keep-customers-in-the-dark-on-duds-asic-20240221-p5f6nz
[4] https://download.asic.gov.au/media/dmifq31x/rep779-published-21-february-2024.pdf
[5] https://treasury.gov.au/sites/default/files/2024-03/c2024-471223-cp.pdf
[6] https://www.selectingsuper.com.au/learning_centre/the-superannuation-performance-test
[7] https://treasury.gov.au/sites/default/files/2024-03/c2024-471223-cp.pdf
[8] Ibid
[9] Ibid
[10] https://www.afr.com/chanticleer/this-fundie-says-benchmark-hugging-is-hurting-super-funds-20240317-p5fcza
[11] https://grattan.edu.au/wp-content/uploads/2024/05/Grattan-2024-Submission-to-the-Treasury-review-of-the-YFYS-performance-test.pdf
[12] https://download.asic.gov.au/media/dmifq31x/rep779-published-21-february-2024.pdf
[13] https://asic.gov.au/about-asic/news-centre/find-a-media-release/2024-releases/24-026mr-asic-calls-on-industry-to-improve-oversight-of-choice-super-performance-and-address-issues/
[14] https://www.ifa.com.au/news/33898-regulatory-response-looms-as-asic-finds-deficiencies-in-adviser-oversight-of-super-performance
[15] https://www.advisely.com.au/blog/future-fit-advice/what-does-asic-report-779-mean-for-advice/456
[16] https://www5.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s961b.html
[17] https://download.asic.gov.au/media/bbjdpjjc/rg175-published-15-june-2021-20231103.pdf