This article was originally published in Financial Standard, January 2018

The long-awaited Productivity Commission report on its three-year inquiry into competition and efficiency in superannuation has made a curious finding and recommendation that "because super funds are legally obliged to act in members' best interests, the fees they charge should not exceed cost recovery levels."

The recommendation is elaborated further to assert that "the Government should enforce this across all MySuper and choice products, and prohibit funds from cross-subsidising between members - which would see an end to excessive fees while also ruling out scope for some members to bear the cost of other members' decisions."

It appears that the Productivity Commission is advocating the enforcement (or maybe the creation) of a general imposition of a not-for-profit (a.k.a. profit-for-member) model which is prevalent amongst industry and corporate funds.

The not-for-profit model generally entails that the governing rules provide for the trustee to be paid an amount calculated by reference to the costs incurred by the trustee in running itself and the fund.

The extension of such a rule to all APRA-regulated superannuation funds would represent a fundamental change to the business model of many retail, platform, and pooled superannuation trust structures and the associated business models.

The recommendation is particularly curious, because it appears to suggest that there are existing laws requiring that fees are charged on a cost recovery basis which are not being adequately complied with or enforced.

Upon closer inspection however, the law only requires that some fees are charged on a cost recovery basis. There is no general requirement that fees must only be charged on a cost recovery basis.

Trustees may generally charge fees to members directly or indirectly, provided that this is permitted by the governing rules of the fund. This means that the level of fees charged to members by superannuation fund trustees is determined by the market, except where the governing rules of the fund or legislation specifically provides that the fee must be limited to cost recovery.

The Superannuation Industry (Supervision) Act 1993 imposes such cost-recovery obligations in relation to insurance and activity-based fees in MySuper products. Section 29VC of the SIS Act requires that such fees "must be no more than it would be if it were charged on a cost recovery basis."

There are also limited obligations which do apply to all superannuation funds, with section 99C of the SIS Act providing that if the trustee charges "a buy-sell spread, a switching fee or an exit fee, the fee must be no more than it would be if it were charged on a cost recovery basis."

The general law also governs the fiduciary relationship between the trustee of a superannuation fund and members, requiring that the trustee must not profit from its fiduciary position without the beneficiary's consent.

This is commonly known as the "no-profit rule." The no-profit rule is however typically negated due to the governing rules of the superannuation fund permitting fees to be charged on a basis other than cost recovery.

The Productivity Commission has been prudent in seeking to address administration fees as a key culprit for eroding member benefits, particularly where determined as a percentage of balances. There is however, no existing legislative requirement that administration fees are charged on a cost recovery basis.

If we are to put the current law to the side, the Productivity Commission's recommendation does raise an important question - that of whether the law should be changed to require that all fees (and administration fees in particular) should be charged on a cost recovery basis.

While such a move may well have merit, in many ways it might only be shifting the problem elsewhere. All superannuation trustees outsource at least some of their activities, meaning that significant costs are incurred to service providers such as custodians, promoters, administrators, insurers, and investment managers.

A move to require fees to be charged on a cost recovery basis would require that a much greater emphasis would be placed on ensuring that the costs incurred by superannuation trustees are not excessively eroding account balances.

This is particularly stark in situations where trustees outsource activities to related parties which are permitted to make a profit, or where there is inadequate competition in the review and appointment of such service providers.

There are existing laws which require that outsourcing of such services is at arms-length and in the best interests of members, and that trustees do not enter into contracts that would prevent or hinder the trustee in properly performing or exercising its functions and powers as trustee. These might become more closely monitored and enforced, if there were a change to require fees to be charged on a cost recovery basis.

Ensuring that the superannuation system remains efficient, and that member benefits are not inappropriately eroded by excessive fees is an important issue requiring attention. If any such change is to be effective, attention will need to be placed on ensuring that the supply chains servicing the superannuation system are also efficient.

Jonathan Steffanoni
Principal Consultant - Legal and Risk

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