Some regulatory roadblocks for new Retirement Income Covenant

Alert to all industry and retail superannuation funds – compliance with the proposed retirement income covenant (RIC) faces two major regulatory roadblocks: personal advice and anti-hawking. There is an urgent need for regulatory relief or reform in relation to this.

There are two major regulatory problems that are thrown up by the recently proposed RIC, to be legislated into section 52 of the SIS Act. As we know, the new RIC will require superannuation trustees to formulate, regularly review and give effect to a retirement income strategy that meets certain prescribed requirements.

In the broader context of financial services law, the two problematic elements are:

  • the requirement to take steps to gather information about member needs, which will inform the formulation of the retirement income strategy; and
  • the incidental aspect of the trustee engaging with members of the fund to discuss not only the potential needs of fund members in retirement, but also to discuss what relevant retirement income solutions the trustee can facilitate through the superannuation fund.

Roadblock #1: Personal advice risk

The first activity of getting information raises the issue of the trustee inadvertently running foul of the personal advice prohibition. As we know, this legislative prohibition has two distinct limbs: the first is whether the relevant person interfacing with the member actually took their relevant personal circumstances into account (i.e. the subjective limb).

But the second limb (i.e. the objective limb) is even more problematic for two reasons:

  • first, because it can effectively deem an interaction to be personal advice where the client could have had a reasonable expectation that the interfacing person had considered the client’s personal circumstances; and
  • second, because in the wake of the High Court decision in Westpac v ASIC, there is almost a presumption of personal advice where an entity such as a trustee has both personal information about the client and has a legal duty to act in the client’s best interests.

So it follows that in the course of using personal interactions to elicit information from superannuation fund members in respect of their retirement income needs, the trustee runs a real risk of activating the personal advice requirements (through both the subjective and objective limbs), including the best financial interests fact-finding obligations.

The Explanatory Memorandum to the proposed RIC addresses this point indirectly by noting that trustees need not elicit client-specific information, but could rely on publicly available information. However, there are numerous examples mentioned in the Explanatory Memorandum where the Explanatory Memorandum refers to very specific pieces of member information, for example:

  • Paragraph 17.72: “trustees may consider information about whether beneficiaries are likely to have assets in other funds, other pensions or non-superannuation assets”;
  • Paragraph 17.36: which states that trustees have discretion as to how they balance objectives “using their understanding of the needs and preferences of beneficiaries when formulating the strategy”; and
  • Paragraph 17.31: other specific member information such as superannuation balances, expected eligibility for age pensions, partner status, home ownership, gender, expected retirement age, expected draw-down years, other demographic considerations.

It is not inconceivable or unrealistic that where a trustee formulates a relevant income strategy based on some or all of these factors, that it could be held to be providing personal advice.

Unlike the DDO regime, the RIC legislation contains no exception from the personal advise prohibition in respect of information gathering.

It is true that a trustee could seek to leverage the DDO exemption in this regard, but this would be quite a clumsy and potentially shaky strategy.

Roadblock #2: Anti-hawking risk

The anti-hawking regime seems to treat a pension interest as a separate financial product to an accumulation interest.

We reach this conclusion based on the following factors:

  • section 761E(7) of the Corporations Act indicates that the regulations may make provision to determine the meaning of ‘issue’ in relation to a class of financial products;
  • regulation 7.1.04E of the Corporations Regulations is made under section 761E(7), and applies if a member of a superannuation fund, who has a superannuation interest in the growth phase, elects to receive a pension in relation to that interest. Under sub-clause (2) of the regulation, a superannuation fund is taken to issue a new financial product when (a) it acknowledges receipt of the member’s election, or (b) it makes the first payment of the pension, whichever occurs first;
  • use of the word ‘new’ in this context suggests that a pension is a separate financial product to the growth phase of a superannuation interest; and
  • inserting this distinction into the language of the anti-hawking prohibition under s 992A(1) of the Corporations Act (that a person must not ‘offer a financial product for issue’), ultimately means that trustees who engage in unsolicited contact regarding pension products with existing members will be in breach of the anti-hawking regime.

This means that prima facie, a trustee or a party acting on behalf of, or by agreement with, the trustee could not interface with superannuation members to discuss the possible take-up of a retirement income solution by the member in a contact interaction which is captured by the anti-hawking regime (such as phone calls or branch conversations) without breaching the prohibition.

ASIC in Regulatory Guide 38 The hawking prohibition addresses this scenario by suggesting that it would be permissible for a trustee to provide information to a member about the pension product, provided that this would not consist of a prohibited offer, issue, sale or invitation. As you may be aware, we have taken the view that this is extremely ambiguous territory in practice – because even the provision of some information about a financial product, such as a pension product, could amount to an implied invitation and therefore, be captured by the anti-hawking prohibition.

The solution

The fact that an interaction by a trustee or a third-party product provider which is envisaged by, and in some respects required by, the proposed RIC could breach the personal advice and anti-hawking prohibitions seems curious, certainly unintended, and contrary to government policy.

It seems to us that a modification of the Corporations Act would be warranted in this scenario.

Such a modification could provide, for example, that the personal advice prohibition and the anti-hawking prohibition would not apply where the relevant interaction/communication with a member is made by the trustee or a party on behalf of the trustee in pursuit of compliance with the RIC. The key proposition would be to enable trustees to communicate with superannuation fund members freely in respect of retirement income options, particularly as members approach retirement phase.

It is of course possible that ASIC could decline to provide modification by pointing to the need for intervention by Treasury.  The reality is that the proposed timeframe for compliance with the RIC by 1 July 2022, not to mention the need for substantial preparation for the new regime, is likely to be problematic in this regard. An alternate to an ASIC modification might be for APRA to provide some suitable relief but this said, it seems more appropriate for relief to emanate from ASIC given that relief is sought in respect of personal advice and anti-hawking.

 

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160
Hartley Spring
Hartley Spring
Senior Associate
+61 2 9322 4656
Preeta Seshachari
Preeta Seshachari
Senior Associate
+61 2 9225 5763

RETIREMENT INCOME COVENANT FINALLY SEES THE LIGHT OF DAY

By Ruth Stringer and Preeta Seshachari

After a long gestation period, the Federal Government’s proposed retirement income covenant (RIC) for superannuation trustees has finally been revealed with the publication of Exposure Draft legislation (available here). The new covenant will require superannuation trustees to develop a retirement income strategy for the benefit of beneficiaries who are retired or are approaching retirement. The reform should bring about an increased focus on how trustees can better support their members to design retirement income solutions that are fit for purpose.

What does the RIC require trustees to do?

The RIC requires trustees to formulate and give effect to a retirement income strategy that addresses how trustees will assist beneficiaries to achieve and balance the following objectives:

  • to maximise expected retirement income over the period of retirement;
  • to manage expected risks to the sustainability and stability of retirement income over the period of retirement; and
  • to have flexible access to expected funds over the period of retirement.

Additionally, trustees will be required to:

  • take reasonable steps to gather information necessary to inform the formulation and review of the strategy;
  • record the strategy in writing;
  • record a number of actions and decisions relating to the strategy; and
  • make a summary of the strategy publicly available on the fund’s website.

Key matters to be determined by trustees

For the purposes of formulating and giving effect to the strategy required under the RIC, trustees have discretion to determine a number of matters such as:

  • the class (and sub-classes) of beneficiaries who are retired or who are approaching retirement. This corresponds to the idea of “cohorts” for whom the strategy may make different provision;
  • the meaning of “period of retirement” (which is likely to vary across different funds, based on the member demographics and potentially also across different categories of beneficiaries);
  • the meaning of “retirement income” which must include income produced by the superannuation fund and the age pension and may also include any other income the trustee determines is appropriate (again, this is likely to vary across different categories of beneficiaries and also, different trustees may have differing appetites to do the work necessary to factor in, and accommodate for, any income that members may derive from other sources);
  • the type and scope of assistance to be provided by the trustee, noting that the assistance must also meet the sole purpose test and be in beneficiaries’ best financial interests; and
  • the approach to balancing the three key objectives referred to above.

The legislation makes reference to investment risk, inflation risk and longevity risks as risks that will need to be addressed in the formulation of the strategy as a minimum. It also contemplates “any other risks to the sustainability and stability of the retirement income”.  Trustees will need to consider what other risks ought to be considered for this purpose.  These could include, for example, risks associated with access to insurance cover and risks associated with declining health and cognitive decline.

The Exposure Draft Explanatory Memorandum notes that the retirement income strategy is expected to express the general actions the trustee will take to assist their members to balance key retirement income objectives (i.e. trustees are not expected to give effect to the strategy by giving personal advice or by considering the circumstances of individual members).

So it seems that trustees will be expected to gather data and make an assessment of the needs of members but not so as to drill down to the individual needs of each member. Rather, this is more akin to the best interests obligation in the sense that trustees will be required to consider attributes of the member group as a whole (or of particular cohorts) and use this information to develop its strategy. This seems to be the basis for the statements in the Exposure Draft Explanatory Memorandum that trustees will be able to fulfil the requirements of the RIC without providing personal advice.

The task of complying with the RIC will have some parallels and overlaps with what is required of trustees in fulfilling their Design and Distribution Obligations (DDO). It raises a question as to whether superannuation trustees should be relieved of their obligations under DDO with respect to retirement income products, given that the RIC creates a bespoke and more targeted statutory regime for the provision of suitable retirement income products to retirees.

Great expectations

The legislation uses the terms “expected retirement income”, “expected risks” and “expected funds”, which seems to be intended to require trustees to make determinations about what is “expected” in each area, and for those expectations to be communicated to members. This is an interesting concept to use in legislation – it begs the question: whose expectations? The trustee’s? The member’s? APRA’s? In context, it seems to refer to expectations that the trustee would formulate and articulate in its strategy however once communicated to members, these expectations will inevitably become adopted as member expectations, for better or worse.

Arguably, trustees could be doing more under the current regime to educate members about what to expect in retirement, however there are regulatory impediments to doing so and some in the industry have been waiting to see the final shape of the RIC before looking at ways of enhancing their retirement income product offerings.  The RIC is an invitation to find new and more compelling ways for trustees to engage with their members on this vitally important topic, within the guard rails of what is allowed under the financial product advice rules.

While momentum seems to be building around the prospect of reforming and simplifying the financial product advice regime, any reform process is not going to happen overnight. We anticipate that retirement income strategies will develop and evolve over time. Ideally, reforms to financial product advice laws will happen in tandem with this evolution and will support trustees to be able to engage more meaningfully with their members as they navigate from the relative simplicity of the accumulation phase into the retirement phase.

Further information

If you have any questions or comments about the RIC, feel free to get in touch with our team members below.

 

Michael Vrisakis
Michael Vrisakis
Partner
+61 2 9322 4411
Ruth Stringer
Ruth Stringer
Consultant
+61 2 9225 5099
Scott Donald
Scott Donald
External Consultant
+61 2 9225 5640
Preeta Seshachari
Preeta Seshachari
Senior Associate
+61 2 9225 5763
Tamanna Islam
Tamanna Islam
Senior Associate
+61 2 9225 5160