14 February 2020

Financial Services Royal Commission draft legislation: Major changes for superannuation trustees and not enough time?

This article was written by Sarah Yu, Nathan Hodge, Damien Richard and Mandy Tsang.

Major changes to licensing for APRA-regulated superannuation trustees

The package of proposed legislation includes a draft bill[1] (Bill) and regulations which make important changes to the Australian financial services licence (AFSL) regime for APRA-regulated superannuation trustees.  Unless the transitional provisions are altered, some superannuation trustees may need to be granted an AFSL, or have their AFSL varied, before 1 July 2020.

Key takeaways

  • Holders of a registrable superannuation entity (RSE) licence will require an AFSL before 1 July 2020. Some RSE licensees that already hold an AFSL may need to vary their AFSL authorisations before 1 July 2020.

  • A new kind of financial service will be introduced, providing a “superannuation trustee service”. AFSL obligations will therefore apply to a far broader range of the activities involved in operating a superannuation fund as trustee.

  • The proposed transitional provisions are limited, particularly for non-public offer RSE licensees that do not hold an AFSL authorising dealing in superannuation products.

  • Without the appropriate AFSL authorisations, an RSE licensee will be unable to continue business. Accordingly, RSE licensees should prioritise reviewing their AFSL position in light of these proposals.

The proposed changes in detail

Repeal of AFSL deal exemption

Superannuation trustees currently have the benefit of certain exemptions from the requirement to hold an AFSL.  Non-public offer (or corporate superannuation) trustees generally are not required to hold an AFSL authorisation to deal in superannuation products or in fund assets[2].  While public offer superannuation trustees require an AFSL authorisation to deal in superannuation products, they may rely on an ASIC Instrument[3] which provides an exemption for dealing in fund assets.  Superannuation trustees that provide financial product advice generally require an AFSL covering that service, and this will not be affected by the proposals.

It is proposed that the dealing exemption available to corporate superannuation trustees will be repealed with effect from 1 July 2020.  This means that trustees previously relying on the exemption will need to either be granted an AFSL before 1 July 2020 with appropriate authorisations, or ensure that the deal authorisation in their existing AFSL adequately covers both dealing in superannuation products and fund assets by that time.  There is no transitional relief currently proposed for this change.

The status of the ASIC Instrument relied on by some public offer superannuation trustees covering dealing in fund assets is not referred to in the materials released.  It is possible that the exemption will be revoked, for consistency with the repeal of the dealing exemption for corporate superannuation trustees.  If the ASIC Instrument is revoked, some public offer superannuation trustees may need to vary their AFSL dealing authorisations to adequately cover the range of fund assets.  It is not known if transitional relief would apply.

A new financial service – providing a superannuation trustee service

RSE licensees will need to hold an AFSL authorisation covering the new financial services of providing a “superannuation trustee service” from 1 July 2020.  A person provides a superannuation trustee service if the person operates a registrable superannuation entity as trustee.  Very limited AFSL exemptions will apply.

The purpose of the new financial service is to apply AFSL obligations to a far broader range of activities involved in operating a superannuation fund as trustee.  Examples given in the explanatory materials include handling member insurance claims, fee charging practices, investment selection, product changes, oversight of service providers, and transfer, payment and rollover practices.

One effect of this change will be that these activities will be subject to the general AFSL obligations, including the duty to act honestly, efficiently and fairly (and the potential for significant monetary penalties if these obligations are breached).

The proposed transitional provisions concerning this new authorisation are limited.  RSE licensees who, just before 1 July 2020, hold an AFSL which authorises dealing in superannuation products will be deemed to be authorised to provide a superannuation trustee service from 1 July 2020.  These licensees will therefore not need to lodge an application with ASIC seeking the new authorisation.  Trustees of public offer superannuation funds should generally have the benefit of this transitional relief, however corporate superannuation trustees may not.

RSE licensees that apply for an AFSL authorisation to deal in superannuation products on or before 30 June 2020 will be deemed to hold an authorisation to provide a superannuation trustee service only from the time the AFSL is issued or varied by ASIC on or after 1 July 2020.  While this transitional relief will facilitate those applicants obtaining the new authorisation, it will not permit them to provide a superannuation trustee service before the AFSL is issued or varied. Accordingly, this transitional provision seems to be of limited value.

RSE licensees that provide a superannuation trustee service only to wholesale clients will be exempt from the requirement to hold the new superannuation trustee service authorisation.  Limited categories of wholesale clients will apply for this purpose, such as to the trustee of a pooled superannuation trust (PST) where the PST has net assets of at least $10 million.

Trustees of PSTs

Trustees of PSTs which meet certain conditions are covered by separate AFSL exemptions, which will continue and be expanded to cover the new superannuation trustee service.

Other implications – OTC derivatives reporting

The application of the OTC derivative trade reporting regime in the Corporations Act to a superannuation trustee can be impacted by its AFSL position, that is, whether the trustee holds an AFSL and if so does it cover financial services relating to derivatives.  Trustees should therefore consider the impact of the proposed AFSL changes on the application OTC derivatives trade reporting to their circumstances.  Trustees that become subject to trade reporting may need to enter into a reporting delegation arrangement with a service provider, such as an investment manager or custodian.

Superannuation trustees must have no other duty

The package of proposed legislation includes a draft bill[4] (Bill) which will impose a new condition on a registrable superannuation entity (RSE) licence held by a body corporate.  The condition provides that the licensee “must not have a duty to act in the interests of another person”, other than a duty that arises in the course of:

  • performing the RSE licensee’s duties, or exercising the RSE licensee’s powers, as a trustee of an RSE; or

  • providing personal advice.

The licence condition is proposed to apply from 1 July 2020, with no transitional relief for duties that had arisen before that date.

Key takeaways

  • RSE licensees that carry on business in any capacity other than as trustee of an RSE may need to restructure their businesses before 1 July 2020. An RSE licensee will, for example, no longer be permitted to act as responsible entity of a registered managed investment scheme.

  • RSE licensees should start a review of their business operations and agreements now, as the timeline for any required restructure is very short.

  • The proposed licence condition is broad. It may have unintended consequences, including for RSE licensees whose only business is acting as trustee of an RSE.

  • The draft explanatory materials foreshadow some relief to allow changing responsible entities so that a members’ meeting is not required, and APRA exemptions being granted on a case-by-case basis.

The proposed changes in detail

The explanatory materials to the draft Bill explain that the proposal addresses concerns identified by the Royal Commission with the conflicts management frameworks employed by trustees of RSEs.  The Commission concluded that the frameworks and related policies were often ineffective, as trustees rarely sought to avoid conflicts of interests and duties where appropriate.  In particular, the Commission concluded that RSE licensees should avoid acting in the capacity of responsible entity of a registered managed investment scheme because of the potential conflicts that may arise.

The challenge of restructuring before 1 July 2020 – start a review now

Some RSE licensees will be able to readily identify certain business operations that must either cease before 1 July 2020, or be transferred to another appropriate group company before 1 July 2020.  Such operations could include:

  • acting as responsible entity of a registered managed investment scheme;

  • acting a trustee of a trust which is not an RSE, such as an unregistered unit trust;

  • acting as an investment manager under an investment management agreement;

  • acting as an agent of another entity noting that such arrangements may be put in place when extracting business out of corporate groups;

  • acting as an operator of an investor directed portfolio service; and

  • providing a non-cash payment facility, such as a clearing house.

RSE licensees would be well advised to start a review of their current operations and agreements as soon as possible, as the timeline proposed to complete any restructure is very short indeed.  Third party consents and other time consuming processes may need to be completed as part of any restructure.

But what does the condition mean?

The condition is drafted in surprisingly broad terms, which creates uncertainty and potentially unintended consequences.  As submissions to Treasury on the proposal will highlight these issues, RSE licensees should monitor Treasury’s response to submissions and any further clarification provided or potential changes.

The following points serve to demonstrate some of the legal challenges that the current drafting of the condition poses:

  • The condition prohibits an RSE licensee having “a duty to act in the interests of another person”, subject to limited exceptions. A duty to another person can arise under the law in a very broad range of circumstances, and without the person who owes that duty voluntarily assuming it.  Duties to another person can arise, for example, under the law of equity (eg as a constructive trustee), the law of negligence (to act with reasonable care), employment law (eg a duty of good faith), statute, the law of agency, contract law generally (eg an implied duty of good faith, or an express undertaking to consult or act reasonably) or even under the terms of a court order.  These legal duties could be characterised as a duty to act “in the interests” of another person.  Notably, the proposed condition is not expressed to prohibit a duty to act in the best interests of another person, or to avoid conflicts of interest, which would point to a more limited range of fiduciary duties.

  • The above duties may not be of the kind covered by the exceptions currently proposed in the condition. For example, where a trustee has duties to its employees, would the duty arise “in the course of performing the RSE licensee’s duties, or exercising the RSE licensee’s powers, as a trustee”?  A retail superannuation trustee would not typically regard employee issues as a fund matter, and correspondingly would not typically seek reimbursement from fund assets for employee salaries and related expenses.  A trustee company, as a corporate entity, is necessarily subject to a range of personal duties which are not trust matters.

  • Superannuation trustees are now more commonly entering into more complex commercial arrangements as they seek to innovate and enhance member returns, for example in the area of infrastructure investment. We see superannuation funds engaged in joint ventures and joint bids for assets, and investing in structured alternative assets.  Government policy is to encourage deployment of superannuation funds in economically beneficial areas such as infrastructure and lending.

It is possible that a very broad prohibition as currently proposed will negatively impact on the wiliness of superannuation trustees to engage in these beneficial and innovative transactions.

  • On its face, the proposed RSE licence condition applies only to the RSE licensee and therefore not to any subsidiary that may owe duties to another person. This may result in an RSE licensee having to restructure its operations so that a subsidiary performs a business activity that result in duties being owed to third parties (e.g. infrastructure investments).

  • What comes within an RSE licensee performing its duties and exercising its powers as an RSE licensee will be impacted by the boundaries of the sole purpose test. The Commonwealth Treasurer has stated that in the first quarter of 2020 APRA will be updating its guidance about the sole purpose test.

Superannuation trustee and director indemnity

The package of proposed legislation includes a draft bill[5] (Bill) which narrows the right of a superannuation trustee and a director of a superannuation trustee to be indemnified out of the assets of the superannuation fund.  If the Bill is enacted in its current form, this change will commence on 1 July 2020 in relation to liabilities that arose before or liabilities that arise after 1 July 2020.

Key takeaways

  • From 1 July 2020, a superannuation trustee and a director will not be able to indemnify themselves out of the assets of a superannuation fund for a criminal, civil or administrative penalty incurred by the trustee or the director (as the case may be) in relation to a contravention of a law of the Commonwealth.

  • Superannuation trustees and directors should revisit their decision making and risk management processes to minimise the risk of conduct occurring in relation to which the superannuation trustee or the director will not be covered by insurance (or in the case of a director, their deed of indemnity (DOI) and/or the indemnification provisions (if any) in the trustee company’s constitution).

  • Superannuation trustees and directors should review their insurance policies, in particular the exclusions under their professional indemnity (PI) and directors’ and officers’ (D&O) liability insurance policies.

The proposed changes in detail

The right of indemnity of a superannuation trustee (and a director of a superannuation trustee) under the trust deed of a superannuation fund will, from 1 July 2020, be narrowed to exclude a liability for an amount of a criminal, civil or administrative penalty incurred by the trustee or the director (as the case may be) in relation to a contravention of a law of the Commonwealth.

This proposed change enacts APRA’s position that it put to the Court in APRA v Kelaher [2019] FCA 1521. Although Jagot J accepted APRA’s position “on balance”, Her Honour noted that the issue was not straightforward. These amendments put that position beyond doubt.

There are several difficult issues that are raised by this position:

  • What laws does this exclusion capture? Does the reference to a law of the Commonwealth include a law of a State or a Territory or foreign law? This does not appear to be the case and laws of a Territory are specifically not included under the Acts Interpretation Act 1901 (Cth). This will result in an anomalous situation were a penalty under a Commonwealth law may be treated differently from a penalty under a foreign law or a State or Territory law.

  • What can trustees or directors rely on? If a trustee cannot be indemnified for a penalty, it will need to consider whether its insurance policies will respond. Similarly, if a director or a trustee cannot be indemnified for a penalty, he or she will need to consider whether their DOI and/or the trustee company’s constitution, or their D&O or PI insurance policy, will respond.

The enforceability of an indemnity under a DOI and/or the trustee company’s constitution or cover under an insurance policy for civil or criminal penalties will depend on public policy considerations. The unsatisfactory position for a trustee or a director will be that this can only be determined on a case-by-case basis taking into account the seriousness of the conduct that resulted in the penalty.  For example, indemnification or insurance cover for a criminal penalty is unlikely to be enforceable and usually excluded. In relation to civil penalties, whether indemnification or insurance cover for the penalty is enforceable will depend on the seriousness of the conduct.

  • How are breaches of the section 52 and 52A covenants treated? We note that penalties for civil penalty provisions under the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) have always been excluded from the right of indemnity out of the assets of a superannuation fund. Superannuation trustees and their directors will have to be particularly careful with the statutory covenants in section 52 and 52A covenants becoming civil penalty provisions and the application of those covenants often being nuanced decisions. We recommend that superannuation trustees consider whether they have a robust decision making process to minimise the likelihood of a breach the results in a trustee or director being personally liable for a penalty.

  • What are the key issues for a director? A key risk for a director is that they will not be covered under either their DOI or insurance where:

    • the company is prohibited under statute from indemnifying the director (e.g. under section 199A of the Corporations Act 2001 (Cth) for a liability arising from conduct that was not in good faith) or the company has no assets to indemnify the director; or

    • the conduct comes within an exclusion under the relevant insurance policy or cover under the policy is otherwise unenforceable on public policy grounds.

Superannuation regulator roles

The package of proposed legislation includes a draft bill[6] (Bill), from 1 July 2020, expands ASIC’s role in regulating the superannuation industry. Superannuation trustees will have to engage with both APRA and ASIC when discussing regulatory issues that impact both of their regulatory remits.

Key takeaways

  • From 1 July 2020, engagement with regulators about regulatory issues will become more complex as ASIC and APRA will both regulate Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) provisions that concern consumer protection or member outcomes.

  • From 1 July 2020, an RSE licensee will have to have an AFSL to provide superannuation trustee services (that is discussed in more detail here).

The proposed changes in detail

Superannuation (excluding defined benefits), unlikely the banking and insurance issues, does not promise that a particular result will be achieved but the outcome for a member will depend on the conduct of the superannuation trustee. This key difference was a focal point in the into Misconduct in the Banking, Superannuation and Financial Services Industry and the genesis of the proposed expansion of ASIC’s regulatory remit to include the conduct of a superannuation trustee or a director that may harm a consumer.

From 1 July 2020:

  • ASIC and APRA will both regulate SIS Act provisions that concern consumer protection or member outcomes (including civil penalty provisions such as the trustee and director covenants in section 52 and 52A of the SIS Act); and

  • an RSE licensee will have to have an AFSL to provide superannuation trustee services (that is discussed in more detail here).

Further information

Explore our Royal Commission hub to keep up-to-date, access related content and view additional resources.

We are happy to assist you in considering the proposals and how it impacts to your business.  Please contact your usual KWM contact if you would like to discuss the report further.

 

 

[1] The full title of the draft Bill is the Financial Sector Reform (Hayne Royal Commission Response – Stronger Regulators (2020 Measures)) Bill 2020:  ASIC regulation of superannuation (FSRC Rec 3.8, 6.3, 6.4, 6.5).

[2] Corporations Regulation 7.6.01(1)(a).

[3] ASIC Corporations (Superannuation and Schemes:  Underlying Investments) Instrument 2016/378.

[4] The full title of the draft Bill is the Financial Sector Reform (Hayne Royal Commission Response – Protecting Consumers (2020 Measures)) Bill 2020:  RSE licence condition – no other duty (FSRC Rec 3.1).

[5] The full title of the draft Bill is the Financial Sector Reform (Hayne Royal Commission Response – Stronger Regulators (2020 Measures)) Bill 2020:  ASIC regulation of superannuation (FSRC Rec 3.8, 6.3, 6.4, 6.5).

[6] The full title of the draft Bill is the Financial Sector Reform (Hayne Royal Commission Response – Stronger Regulators (2020 Measures)) Bill 2020:  ASIC regulation of superannuation (FSRC Rec 3.8, 6.3, 6.4, 6.5).

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