Key Due Diligence Considerations For A Merger

Over the last decade we have seen the superannuation industry shrink considerably – from about 1,100 funds in 2004 to about 185 as of December 2019 (and by one-third from 279 to 185 in the last six years). The push for consolidation seems ever more pressing today with funds facing coronavirus related pressures – the early release scheme and liquidity issues – and pressures from the Government and Regulators calling for a more consolidated industry and reminding trustees that their "role is a privilege and not a right" and the "best path forward" for many may be to merge or exit

Due Diligence

As Commissioner Hayne noted in his report, “those examining a possible merger must consider how the merger will be effected and how the merged fund will be managed and governed.”

The merging of two superannuation funds is one of the most important decisions and transactions that trustees will encounter. There are many important factors which must be considered (we’ve prepared a useful checklist here); spanning across strategy, operations, finance, governance and legal with the determining consideration always being "what is in the best interest of members.”

Trustees considering a merger must undergo a rigorous and well-structured due diligence process, with special attention to the following factors:

Strategic Alignment

Before entertaining a merger, Trustees should consider their strategic objectives and set specific goals to be achieved by the merger. For example, what are the future state operating model objectives, is the strategic objective for merging to increase scale and decrease fees for members, and will merger with the target entity achieve the outcomes sought for members, and if so, over what time frame?

Legal

Is member consent necessary? The legal framework generally provides two legal alternatives for effectuating the transfer of member benefits: by way of obtaining member consent or via a successor fund transfer (SFT). If the latter, a thorough review of each Trust Deed is necessary to ensure the trustees have the appropriate power to effectuate the transfer. Where a Trust Deed does not provide the trustee with the power to transfer benefits via an SFT and rather requires that members be given a choice may be fatal to a merger unless the Trust Deed is amended.

Regulatory Compliance

No due diligence process is complete without enquiry into regulatory compliance. Trustees should review any reported compliance breaches or regulator queries related to compliance with legal and regulatory obligations.

Governance

A key element (and potential stumbling block) of any merger is the composition of a new or reformed board. A review of constitutions and other governing documents can assist with the early identification and resolution of issues, including allowing time for any amendments to constitutions, policies, procedures and risk management frameworks, where appropriate. We cannot forget conflicts of interest – Trustees should identify any potential, perceived or actual conflicts of interest and document how any identified conflicts will be managed.

Material Contracts

A review of key provisions of third-party contracts, especially those identified as relating to material business activities, is vital. Trustees should consider whether the contract will have to be terminated and if so, ensure compliance the termination requirements, including notice periods, is factored into any transition planning. If contracts will be continued, consider the obligations undertaken by the fund and whether on merger such obligations can be met.

Key due diligence considerations when approaching a Merger

Data Quality & Security

With an ever-increasing focus on the depth and quality of fund data, it is imperative that any issues relating to data, including those requiring remediation be identified and understood. Poor data quality of a merging fund can cause issues during and after the transfer for the successor fund. Additionally, identify information security and privacy risks and consider whether there are any recent incidents or breaches that must be addressed.

Membership Profile

Consider whether the two memberships are compatible with each other from a strategic perspective. Can all members be served using existing services and avenues of engagement or will the fund need to invest in more streamlined and fit for purpose services? If COVID has taught us anything, a homogeneous member base carries both benefits and risks, and some diversification may be a good thing. Also, consider competitive advantage – will the merger boost market presence in a segment of the market you are targeting. For example, as we have seen some funds targeting the older membership group with an eye on the retirement phase of superannuation.

Products

The Productivity Commission Inquiry Report – Superannuation: Assessing Efficiency and Competitiveness and the Royal Commission pointed out problems that arise from trustees aiming to replicate options upon transfer to ensure equivalency, thus resulting in too many product offerings. With the Design and Distribution Obligations and Member Outcomes coming into play, it is important for trustees to consider whether replication of product offerings is necessary to meet legal requirements or if it is in members’ best interest that they are transferred to a different product.

Scale and Efficiency

A merger could present opportunity for better scale and improved efficiency of all back-office functions. Administration and outsourcing arrangements for material business activities are key in addressing regulatory pressures related to fees and costs. Trustees must consider how they can leverage any such arrangements to best serve members interests. Will increased scale result in a drop in administration fees? If so, how much and when? Does the merger present opportunity for optimising digital services? If the two funds do not use the same outsourced providers, consider contractual obligations.

Investments

A variety of issues may arise in the investments space during a merger. Trustees should consider the asset management methodology (is it done in-house, fully outsourced or a hybrid of both), investment strategy, the due diligence requirements of each fund, asset liquidity, differing methods of return allocation and compliance requirements (whether mandated by Australian or foreign law).

Financial Matters

Trustees must consider how reserves will be treated upon merger/acquisition; especially where one funds holds more reserves than another. Trustees should consider reviewing all policies related to reserves to identify any issues early on. APRA has noted that it expects trustees address how reserves are equitably attributed across different cohorts of members and warns that reserves should not be used as a mechanism for transferring value between cohorts of members. In addition to reserves, other considerations include tax issues, unallocated monies, insurance premium adjustment mechanisms and overall financial health of each fund.

While a merger is a large undertaking, the early and thorough consideration of the above factors with all key decisions documented can streamline the transition process to deliver the anticipated value of the merger sooner rather than later.

Regards

Gabriela

Gabriela Pirana – Senior Associate

QMV provides trusted advisory, consulting and technology to Australia’s leading superannuation, insurance, banking and wealth management organisations. For further information please telephone our office p +61 3 9620 0707 or submit an online form.

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