By M Scott Donald and Ruth Stringer
Amongst the measures introduced by the government in its Your Future Your Super policy initiative is a test of the historical performance of each MySuper product in the market. Trustees whose MySuper product fail the performance test conducted annually by APRA will be required to send to all members holding that product a letter in prescribed form that informs the member of the product’s underperformance and advises the member that they ought to consider switching to another product. If the MySuper product fails the test in the following year, the trustee cannot accept new members into that product until such time as the product passes the test.
There has been considerable criticism of the policy, substance and modality of the regime implementing the test. This paper does not engage directly with the criticism. Rather, it considers the question whether failing the test would constitute a breach of trust (or one of the statutory covenants deemed by section 52 of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act) on the part of the trustee). The question is important because those are the primary means by which members can seek remediation from the trustee, either individually or as participants in a class action. At first blush it might seem that would be a ‘no-brainer’: failing a key regulatory test would, you might think, signal a deficiency on the part of the trustee’s fulfilment of its obligations, especially when something as core to its role as the investment performance delivered to members is concerned. The true position, it turns out, is considerably more complicated (like many things in superannuation).
The (Under)performance Test
The genesis of the performance test can be found in the Productivity Commission 2018 Inquiry Report into the efficiency and competitiveness of the superannuation system. That Report recommended that all MySuper (and choice) products should have to earn the ‘right to remain’ in the system and that persistent under-performers should be weeded out. The Report outlined an evaluation method and a process by which that method would be applied. It also recommended that the consequence of failing the test in consecutive years ought to be that APRA should direct the trustee to withdraw the investment option or revoke the trustee’s MySuper authorisation. APRA would then oversee the transition of members of the underperforming MySuper product into a ‘superior’ (i.e. not underperforming) product.
The Your Future Your Super initiative implements this recommendation, with some important departures. It inserts into the SIS Act a new regime, Part 6A, that together with specially formulated Regulations, imposes upon APRA a requirement to conduct a test on the performance of all MySuper products annually, and to identify those whose performance over the lookback period did not achieve a certain minimum level of performance relative to a bespoke benchmark. The use of 8 years as the performance window was retained, as was (broadly) the way in which the performance of each product relative to its tailored benchmark was calculated. However, the Productivity Commission’s recommendation that failing products be subjected to a 12-month period of remediation, after which recalcitrant funds would be forcibly withdrawn, their members transferred to a better performing option, was not accepted. Rather, as noted above, the trustees of products that have failed the test are required to notify their members using a letter the contents of which are prescribed in the Superannuation Industry (Supervision) Regulations. The trustee of a product failing in consecutive years is prohibited from admitting new members to that product, but APRA can determine that the block is to be lifted if the performance of the product subsequently satisfies the test.
Underperformance and breach
Much of the messaging around the launch of the performance test implies that members have lost money through underperforming funds and that this is the result of trustees not performing their role with sufficient skill, diligence or independence from conflicting interests. Hence the need for regulatory intervention.
As intuitively appealing as that simple logic would appear, the relationship between historic underperformance and trustee breach is not that simple. Nor is the policy rationale on which the initiative is based. There are a number of reasons for this.
The most basic is that an assessment of whether a trustee has performed its duties properly and exercised its powers appropriately is assessed ex ante. That is to say, the assessment is based on the circumstances and standards at the time the conduct occurred and without regard for the outcomes of the conduct. Although it is considerably more likely that litigation will be initiated where the outcome has in fact been unfavourable, the court will not apply hindsight and regard an unfavourable outcome as evidence of itself of a dereliction of duty by the trustee. There might be any number of reasons for historical poor investment performance, including bad luck, that would not constitute a breach of the trustee’s duties.
A more subtle reason is a corollary of the ex ante perspective: many, if not most, trustees will have formulated and implemented investment strategies over the past 7 years that do not identify as a consideration outperformance of the tailored benchmark now anticipated by section 60C of the SIS Act. They would have formulated and implemented their investment strategies having regard to the matters identified in the covenant in section 52(6) of the SIS Act. They would have done so carefully and diligently, and in pursuit of the best interests of their members, as required by the covenants expressed in sections 52(2)(b) and (c). It is entirely possible that a trustee could have achieved an investment objective, say, to outperform the increase in the CPI by 3% over rolling 5 year periods, and yet fail the section 60C test. That would be particularly likely if there was strong share market performance (such as over the past 5 years), but the investment strategies followed within that market were less successful than the market as a whole (perhaps they were underweighted to the Resources sector, which has outperformed over the past 5 years, or picked stocks that have lagged the rest of the market). Or it may be that the fund has performed well for the past 5 years but despite following a properly formulated strategy, had a sticky patch in the years immediately preceding that. Equally, a product could fail to achieve its objective, and pass the section 60C test. Even if failing to achieve their stated objective constituted a breach of trust (itself a questionable proposition), to impugn the decisions that led to the achievement of the objective on the basis of a test imposed later would be entirely unfair.
It is important to recognise also that a product can fail the section 60C test without ‘losing money’ for the member. The test compares the notional performance of the investment strategy applied to the product to a benchmark calculated in a way tailored to reflect that strategy. In rising markets both the product and the benchmark may register strongly positive returns, but the product will fail the test if its calculated performance lags the tailored benchmark by more than 0.5% per annum. So a product earning 10% per annum over the measurement window when its tailored benchmark earned 12% per annum over the same period, would fail the 60C test because its measured underperformance would be in the order of 2% per annum. In this respect the 60C test is consistent with the general law position since a trustee could conceivably breach its duties even if the trust fund did not decline in value.
In cases where a loss is suffered but the trustee has not breached its fiduciary or statutory duties, the trustee will have no claim against the trustee even if the product concerned has failed the section 60C test. As Lindley LJ noted in Re Chapman, investment losses do not necessarily constitute a breach of trust because the trustee is not ‘an insurer’. Similarly, there is nothing to suggest that failing the performance test would disqualify a trustee from relying on the statutory defence in section 55(5) so long as the trustee can establish compliance with the SIS Act covenants.
Finally, and contrary to the impression created by rhetoric in the Press and on the floor of the Parliament, the objective of the policy is not primarily punitive. Except to the extent described below, the new regime does not impose sanctions on a trustee for underperformance. The policy is rather motivated by a desire to improve the efficiency of the system as a whole. As the Productivity Commission noted in its report:
‘Muted competitive pressure from the demand side — members and their advisers — means that competition is not playing the corrective role that it does in other, less complex markets. 
In a system in which the disciplining effects of market competition on individual products and trustees are muted for reasons inherent in the design of the system, such as compulsion, complexity and industrial relations, other mechanisms are required to ensure that the vast stores of financial wealth in the system are employed efficiently. The performance test is one of those mechanisms. The consequences of a product failing the test are therefore not punitive, or even remedial, they have the rather modest aims of reducing the likelihood of additional members having their contributions managed by a trustee whose long term investment performance suggests is less skilled than others, and suggesting to members whose benefits are already being managed by such a trustee to consider an alternative fund. That system-wide objective is a crucial concern for Treasury, who crafted the policy, and APRA, who are responsible for implementing it.
An Inherent Tension
The conclusion that a failed section 60C test does not constitute, nor necessarily signal, a breach of duty by the trustee of a superannuation product is not the end of the matter. For the reasons outlined below, the existence of the test may place the trustee in a position where it is in breach, not because of failing the test, but because of the decisions it took because of the existence of the test.
To see why, it is first necessary to recognise that a failed test is likely to have adverse consequences for both the trustee and its members.
It is obvious that the trustee will face adverse consequences. Clearly it will suffer reputational harm. It may also suffer a decline in revenues if the failed test results in a reduction in future contributions into the product, or even member outflows. Both are outcomes the trustee would prefer to avoid.
Members of the fund may also suffer adverse consequences from a failed test, beyond the poor performance they have already incurred. Fund outflows would be expected to adversely affect those left behind as economies of scale are wound back, causing average costs to rise. Illiquid private market assets may also have to be realised prematurely to meet the outflows, incurring performance ‘haircuts’ on the way out and potentially distorting the investment portfolio away from its stated investment objective. A prudent trustee would not want to expose members’ interests to the risk of these adverse events.
From this it is arguable that a prudent trustee might, as a result of the covenant in section 52(2)(b), owe a duty to take positive steps to avoid failing the test, given the likely adverse consequences for members of failing that are brought about by the regime. Failure to consider the consequences that may flow from a failed test would also undermine the strategic planning required of the trustee by APRA Prudential Standard SPS 515 Strategic Planning and Member Outcomes. A trustee might also argue that consideration of the s60C regime is a ‘relevant matter’ for the purposes of the investment strategy covenant articulated by s52(6)(viii) of the SIS Act.
The problem is that the trustee’s personal interests and those of the members do not necessarily always coincide. No trustee will want to fail the section 60C test. And, as we have seen, the members also have an interest (albeit possibly less weighty) in the product not failing the test. However, key parts of the regulatory regime, including the covenants in section 52(2)(c) and 52(6) and APRA’s Superannuation Prudential Standard SPS 530 Investment Governance (Nov 2012), are dedicated to ensuring that the trustee crafts and implements investment strategies appropriate for the circumstances particularly of its fund and the investment options made available therein. Trustees are also required to prioritise member interests over their own interests. Although not failing the test may be desirable for members (especially in light of the adverse consequences that could flow from failing), having a strategy tailored to their precise needs and circumstances would seem to be more important, and those 2 objectives will not always align perfectly. How much weight, then, ought the trustee put on the desirability of not failing the test? Too much weight and it risks being accused of prioritising its own interests over members and not crafting a strategy tailored to its members’ needs; not enough weight and it risks being accused of not exercising sufficient care in avoiding the foreseeable adverse consequences of failing the tests for members. Put simply, would constraining the investment strategy to limit the risk of failing the section 60C test itself constitute a breach of the covenants articulated in sections 52(2)(c) (best interests) and/or (d) (prioritising members’ interests where there is a conflict), when not doing so might constitute a breach of the covenant articulated in sections 52(2)(b) (care, skill and diligence)? Moreover is above-benchmark performance of the type embedded in the section 60C test an objective that might be implied from fund communications, including its PDS and website? Might it be designated a ‘legitimate expectation’? It is quite the tightrope.
The new regime in Part 6A of the SIS Act places trustees in a difficult position. Its focus on investment performance is simplistic and not well aligned with the governance requirements already in place, particularly the emphasis on trustees setting and pursuing objectives that reflect the particular needs of their specific membership base. As a result of the new regime, trustees should clearly minimise administration costs that don’t carry the potential for enhanced investment returns even if those costs have utility for members. But how salient in the risk equation for the trustee is avoiding a fail grade in the test? Failing the test would not of itself seem to be grounds for alleging a breach of trust, but failure to consider the adverse implications of underperformance brought about by the regime itself might very well be!
If you have any questions or comments about the Your Future Your Super regime, feel free to get in touch with our team members below.
 Productivity Commission, Superannuation: Assessing Efficiency and Competitiveness, (Inquiry Report No. 91, 21 December 2018).
 Ibid, Recommendation 4.
 Ibid, 37.
 Schedule 2A, SIS Regulations.
 Section 60F(2), SIS Act.
 Section 60F(3) and (8), SIS Act in conjunction with regulation 9AB.20, SIS Regs.
 Australian Prudential Regulation Authority v Kelaher  FCA 1521, .
 See for instance Nestle v National Westminster Bank  1 WLR 1260, albeit that the plaintiff in that case was unable on the facts to demonstrate that there was a performance shortfall requiring remediation.
  2 Ch 763 at 777-8.
 Above n 1, 22.