Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

Transcription

1 Can we better protect members best interests and deliver better retirement savings outcomes in Australia? The better the question. The better the answer. The better the world works.

2 Content Foreword 3 Members best interests duties that apply to trustees 5 How do trustees focus on members best interests culture? 10 Members best interests in superannuation in A road map for trustees for the transformation following the Royal Commission report 18 Should we wait and see or act now? 21 What next: steps to be taken by trustees 22 EY contacts 23 2 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

3 Foreword Australia s superannuation industry is considered a global success story for amassing the world s fourth largest retirement asset pool. However, the shortcomings surfaced by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) and other reviews mean the industry is prone to losing the confidence and trust of its members and the public. Understandably, members are demanding value, transparency, and service for their rapidly growing AUD 2.7tn in retirement assets and AUD 30bn in annual fees and charges. Right now, the industry is facing questions around whether trustees are adequately managing conflicts of interest and acting in members best interests. These apparently simple questions are, in reality, difficult to answer. Since inception, the objective of Australia s mandatory superannuation system has remained unclear. Although details regarding members best interests duty have been enshrined in law for many years, the legislation lacks granularity, leaving conduct expectations open to interpretation. Moreover, limited member engagement has left trustees with fewer case laws to help interpret the meaning of members best interests duties, member outcomes or conflicts of interest. These issues are further complicated by the rapid pace of change and growth in terms of the size, complexity and importance of Australia s superannuation system, which has an asset pool already substantially larger than the country s gross domestic product and is forecasted to reach AUD 7tn in assets under management by Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 3

4 How can the industry regain public confidence? To deliver members best interests outcomes for Australians retirement savings, all stakeholders must play their part. Policy makers and regulators need to evolve their overarching and industry-wide frameworks and policies related to members best interests and conflicts of interest. In particular, they must better define community expectations, enshrine them in law and regulation, and establish adequate scrutiny and deterrents. This document offers observations and guidance based on global best practices to support trustees in the crucial task of responding to the regulatory evolution already affecting superannuation funds. It will help trustees act decisively to improve member confidence and ensure regulatory compliance. Specifically, looking through the trustee lens, it discusses the following questions: Why: What does best interests duty mean for my members? How: How do I measure, monitor, compare and evidence my members best interests duty effectively? What next: What must I be doing to show that I am acting in members best interests and continue to evolve even if I already have a strong and compliant framework? This document also poses questions that the trustees should be asking themselves and recommends some must do actions. It s time for expectations on policy, regulation, industry governance, scrutiny, accountability, delivery and maturity to catch up with our rapidly evolving superannuation system. The reward will justify the significant transformation efforts to all stakeholders, which is to be able to deliver better retirement savings outcomes for millions of Australians. Maree Pallisco National Superannuation Leader, Financial Services Partner, EY 4 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

5 Members best interests duties that apply to trustees Trustees must ensure that their superannuation fund s enterprise risk management (ERM) system aligns with the fund s size, complexity and context, and that it covers all parts of the trustee s areas of accountability. This requires integrating risks related to members best interests and conflicts of interest into risk culture and risk governance and extending culture and governance along the entire value chain including in-house and outsourced operations as well as product and service providers. Different superannuation funds have different risk exposures Type of fund Risk issues related to conflicts of interest and members best interests Profit for members funds (e.g., industry public sector) Although members join via awards or employer agreements by default, the conflicts of interest and members best interests duties are still the fund s areas of direct control. The use of related third-party product and service providers creates a diverse exposure to risks. Profit for shareholders funds (e.g., retail) The use of related third-party product and service providers creates a significantly higher exposure to risks. The key source of employers and members must be won by each fund. This process is directly exposed to risks related to financial advice duties and members best interests. Self-managed superannuation funds (SMSFs) As trustees and members are the same, SMSFs practically operate in accordance with the members best interests duties codified in the law, but are subject to regulatory scrutiny by the Australian Taxation Office (ATO), potentially creating the opportunity for regulatory arbitrage. How are current regulations and legislation defining members best interests? The Superannuation Industry (Supervision) Act 1993 The trustee boards of Australian superannuation funds regulated by the Australian Prudential Regulation Authority (APRA) have a paramount fiduciary duty to act in the best interests of members, as covenanted in sections 52 and 52A of the Superannuation Industry (Supervision) Act 1993 (Cth) (SIS Act 1993). Boards need to ensure that this imperative is operationalised and embedded in the funds organisational culture, governance, investment frameworks, and delivery across all aspects of the business to demonstrate the level of trust and confidence expected by the members. Sections 52(2)(c) and 52A(2)(c) of the Act enshrine the general trust law duties in terms of registrable superannuation entity (RSE) licensees and directors of corporate trustees of RSE licensees to act in the best interests of members if a fund s trust deed remains silent on these duties. Justice Mark Moshinsky 1 recently wrote that section 52(2) (c), dealing with the duty of a trustee to act in the best interests of members, and equivalent section 52A(2) (c) dealing with the duty of directors, are arguably the amalgam of two general law duties: Duty of fidelity and loyalty: To act in the best interests of beneficiaries means to ensure that their interests are paramount and that all beneficiaries are treated impartially between different classes of beneficiaries. Duty to pursue to the utmost with appropriate diligence and prudence the interests of the beneficiaries: Trustees must do the best they can for the benefit of their beneficiaries and not merely avoid harming them. 1 Justice Mark Moshinsky, The Continuing Evolution of the Best Interests Duty for Superannuation Trustees from Cowan v Scargill to the Current Regulatory Framework, 9 March 2018, Federal Court of Australia website, assessed 19 September Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 5

6 While interpreting section 52(2)(c) covenant, trustees must take into account the Australian superannuation context. The High Court of Australia, in its decision in Finch v Telstra Super Pty Ltd (2010) HCA 36, stated: For some people, superannuation is their greatest asset apart from their houses; for others it is even more valuable. Different criteria might be thought to apply to the operation of a superannuation fund from those which apply to discretionary decisions made by a trustee holding a power of appointment under a non-superannuation trust. Superannuation is not a matter of mere bounty, or potential enjoyment of another s benefaction. It is something for which, in large measure, employees have exchanged value their work and their contributions. Superannuation is a method of attracting labour. The legitimate expectations which beneficiaries of superannuation funds have that decisions about benefit will be soundly taken are thus high. So is the general importance of them being sound. Trustee board s responsibilities The duty to act in members best interests is founded in the general law duties of trustees, particularly in the general law duty of fidelity and loyalty, which requires trustees to place members interests above all other interests and pursue those interests with utmost prudence and diligence. Trustee boards of APRA-regulated superannuation funds are responsible and accountable for developing and executing robust processes that deliver sound retirement savings outcomes in the best interests of members and their post-retirement financial well-being. Although a trustee can delegate and outsource various aspects of its delivery responsibilities, its board remains wholly accountable for delivering on its trustee responsibilities to manage risk and act in members best interests. To maintain confidence in the stability, integrity and prosperity of the system, the Australian community, the Government and external regulators hold trustee boards of superannuation funds to a high fiduciary standard, with strong expectations for the quality of the culture they lead in executing their duties. 6 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

7 The New South Wales Court of Appeal, in its decision on Manglicmot v Commonwealth Bank Officers Superannuation Corporation Pty Ltd (2011) NSWCA 204, considered trustee board duties of large APRA-regulated superannuation funds under the SIS Act 1993 and how boards are required to be acting in the best interests of members: Trustee boards should be assessed on the quality of their governance framework and decision-making processes (inputs) rather than on the outcomes to members that have arisen with the benefit of hindsight (outputs). The trustee boards process of decision-making and the substance of the decisions are critical to demonstrate whether directors of the boards have conducted the process in the members best interests. The interpretation of duty with respect to each decision will depend on the facts and circumstances of each case. Trustee boards should focus on embedding: Strong organisational beliefs and culture led by the member- centric boards Quality decision-making processes that ensure members best interests are paramount across all areas of the fund s responsibility Effective and commensurate measures to comprehensively identify and manage all conflicts of interest along the entire field of accountability Meaning of acting in the best interests of members Justice Moshinsky asked whether the word best adds something. In the context of this document, we must ask: How is best brought to life in a trustee board s governance framework? Best may mean that the trustee must do its utmost to further the interests of the beneficiaries (i.e., in process), but it is acknowledged that the word best is not about achieving the best outcome. The best interests duty is to exercise the relevant discretion having sole regard to what is in the best interests of members. 2 One commentator has proposed that the best interests duty and the standard of care for superannuation trustees mean that the best possible outcome ought to be targeted while qualified by prudence, as well as reinforcing the additional element of effort, so that any supine attitude on the part of the trustee is to be rejected. 3 In July 2018, Professor Pamela Hanrahan reiterated, This has been described as involving not just the pursuit of the best possible authorised end or outcome (as the trustee rationally conceives the matter) for the trust as a whole but also the observance of proper procedures and processes in decision-making. 4 The covenant also appears capable of being applied to classes of beneficiaries not confined to beneficiaries as a whole. If a trust or power affects only some of the beneficiaries or objects, then it is this group of beneficiaries best interests that must be advanced. As such, we suggest that trustee boards should continually assess and reassess this question: Does the culture of the fund continue to bring to life the best in terms of their members best interests? Directors duties If a superannuation trustee fails to comply with members best interests, trustee directors may also be in breach of their director s duties of care and diligence under section 180 of the Corporations Act 2001 (Cth). This has been the subject of a recent judicial comment by the Federal Court of Australia in Australian Securities and Investments Commission v Cassimatis (No 8) (2016) FCA 1023: The federal court found that Emmanuel Cassimatis and his wife Julie Cassimatis breached their directors duties by permitting, or failing to prevent, Storm Financial Limited from providing inappropriate investment advice. The court held that a reasonable director with the responsibilities of that of the Cassimatis would have been aware of a strong likelihood of contravention of the law and would have taken precautions to prevent it. 2 Pamela Hanrahan, Legal Framework Governing Aspects of the Australian Superannuation System, Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, July Paul Collins, The Best Interests Duty and Standard of Care for Superannuation Trustees, Australian Law Journal, September 2014 in Mark Moshinsky, The Continuing Evolution of the Best Interests Duty for Superannuation Trustees from Cowan V Scargill to the Current Regulatory Framework, 9 March 2018, Federal Court of Australia website, assessed 12 September Pamela Hanrahan, Legal Framework Governing Aspects of the Australian Superannuation System, Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, July Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 7

8 Superannuation trustee boards must, therefore, ensure that their organisations have appropriate measures in place to effectively manage risk and monitor compliance with the trustee s obligations to act in members best interests. Overriding of members best interests obligations To the extent a trustee board s governance framework does not preserve the paramountcy of the fiduciary duty to act in the best interests of members, these duties are enshrined in sections 52 and 52A of the SIS Act Specifically, sections 52(2)(d) and 52A(2)(d) make it clear that the duty to act in the best interests of members is paramount and must override conflicting obligations that trustee directors of superannuation funds may have, such as directors duties in the Corporations Act 2001 (Cth) in terms of their roles to act in the capacity of a corporate director or trustee of a managed investment scheme. RSE licensees must, under the law, comply with APRA s prudential standard to take all reasonable steps to manage conflicts that arise to ensure that their trustee duties to members are not adversely affected and remain paramount. Report 474 by the Australian Securities and Investment Commission (ASIC) clearly articulates a similar view of conflicts of interest, particu- larly in vertically integrated financial institutions. 5 Most funds in the industry have already operationalised this to some degree. Trustees must ensure that their funds can demonstrate that they have: Identified all conflicts of interest, and relevant decisions and context for members best interests along their field of accountability A strong conflict management framework and culture centred on their members best interests APRA s Prudential Standard SPS 521 Conflicts of Interest Trustee boards of APRA-regulated superannuation funds are ultimately responsible for approving, developing and implementing a comprehensive governance framework to manage conflicts of interest and operationalise a risk culture. Given the constant change in Australia s superannuation industry, the framework must be continually reviewed to ensure that it reflects the members profile, and that it is appropriate to the fund s size and business model as well as the complexity of the RSE licensee s business operations. To support trustee boards of RSE licensees in developing a conflicts of management framework, APRA outlines its expectations of RSE duties and responsibilities to members in two guidance documents: Prudential Standard SPS 521 Conflicts of Interest; and Prudential Practice Guide SPG 521 Conflicts of Interest. Trustee governance framework Given that the membership profile of large APRA-regulated superannuation funds varies, the way in which the best interests covenant operates will depend on the facts and circumstances of each case. While case law in relation to other best interests provisions may offer guidance, the particular statutory context may affect the construction of those provisions for example, sections 601FC(1)(c) and 961B(1) of the Corporations Act 2001 (Cth) for responsible entities of managed investment schemes and licensed financial advisers, section 7(2)(a) of Trustee Act 1958 (Vic), and equivalent provisions in other state legislation. One critical question arises: Is the best interests covenant concerned only with the process of decision-making, or is it also concerned with the substance or merits of the decision itself? If the test is concerned with the substance of the decision assessed at the time it is taken, then it must be tested by reference to the facts and matters known and knowable at the time. EY s view is that it is based on both. That is, trustee boards must consider both quantitative and qualitative aspects to demonstrate quality decision-making processes and governance frameworks in assessing this. We consider that the best interests duty is not purely confined to matters of process but extends to the substance of the decision. This is supported by the Chancery Division of the High Court s decision on Cowan v Scargill [1985] Ch 270: The court observed that, In the case of a power of investment the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question; and the prospects of the yield of income and capital appreciation both have to be considered in judging the return from the investment. 5 Culture, conduct and conflicts of interest in vertically integrated businesses in the funds-management industry, Australian Securities and Investment Commission, March Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

9 Two critical questions remain: As the fourth largest retirement system in the world, does best mean looking for the best practices globally? Is there benefit in knowing leading practices in areas, such as governance, product and service provider management, risk management, customer experience, or technology, from around the globe? Community expectations in a globalised world where access to international information is only a screen tap away may seem to make this a reasonable request. APRA expects superannuation funds to adopt sound governance and business management practices commensurate with community expectations. RSE licensees must move beyond a focus on meeting minimum prudential requirements in order to meet these expectations. Reference for quote: (page 8, APRA Discussion Paper, Strengthening Superannuation Member Outcomes, 13 December 2017). Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 9

10 How do trustees focus on members best interests culture? Superannuation is a complex business that covers several stakeholders and many different business components (chart 1). With more than 100 million data and payment transactions taking place between employers and funds or their administrators annually, superannuation is a mass transaction business. Chart 1: A generic superannuation value chain Government policies, ATO, and other regulators Trustee and RSE board 3 4 Trustee and management function of the fund Products The public and the industry 1 Employers + Employees 12 2 Related party or third-party product and service providers as applicable 5 7 Investment management including portfolio companies, asset managers, and custodians 6 11 Finance planners, advisors, and other intermediaries including clearing house and gateways 10 9 Distribution, platforms, engagement, and advice Member and employer service centres 8 Superannuation and retirement administration Benefits management including life risk, rollovers, general benefits, and pensions Source: EY To varying degrees, trustees powers and duties reach across all 12 elements. Many trustees outsource the execution and responsibility for elements, functions or products to related or third parties. But, even for outsourced elements, trustees retain their overall accountabilities, statutory members best interests duties, and other key oversight responsibilities. elements of the superannuation value chain including all related and third-party product and service providers. Trustees, therefore, need a suite of frameworks, processes, policies, and tools to effectively and efficiently evidence and discharge the members best interests duty. To effectively discharge their duties generally, and focus on members best interests specifically, trustees must demonstrate that they are acting in members best interests across all 10 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

11 Members best interests in superannuation in 2025 What can we expect in Australia on the basis of what s happening overseas? Australia is likely to make use of learnings from overseas markets to enhance our existing policies, frameworks and solutions to restore member confidence. EY has been working to deliver better retirement savings across different jurisdictions. On the basis of our experiences overseas, we can anticipate what the Australian members best interests model might look like. As the case studies show, better member outcomes are being achieved when the model: Focuses on culture to ensure long-term change and sustainability Is principles-based, but supported by sufficient, proactive and practical guidance to help trustees operationalise in a meaningful and comparable manner Focuses on evidence, transparency and disclosure of achievements, gaps and areas for improvements to strengthen accountability and enable members to decide and act Case studies South Africa: King IV report The King IV Report on Corporate Governance for South Africa 2016 by the Institute of Directors in Southern Africa outlines 17 principles tailored to pension funds. The report requires an evolution from apply or explain why not to apply and explain why these are applied method that demonstrates trustees understanding and responsibilities to members. Both elements created better outcomes for trustees and members. UK: Treating Customers Fairly regulation More than 10 years ago, the UK s Financial Conduct Authority (FCA) introduced a principles-based regulation to better protect customers requiring providers to evidence that they treated customers fairly while introducing six organisationally critical areas as proxy. The FCA articulated four simple expectations: 1. Customers expect financial services and products that meet their needs from firms they trust. 2. All firms must be able to show consistently that fair treatment of customers is at the heart of their business model. 3.Senior managements must establish the right culture to convert good intentions into fair outcomes for consumers. 4. Management information is very important in analysing trends, helping forecast the future, and solving any problems. Firms should use it to monitor customer treatment, expectations and outcomes. The regulation improved customer outcomes through sustainable cultural change focused on treating customers fairly (chart 2). Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 11

12 Chart 2: Treating Customers Fairly Defined outcomes Six critical areas that influence a firm s culture of customer treatment Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture. 1 Leadership: All managers should make clear in their practices and communication that the fair treatment of customers is fundamental to the firm's operation. Controls and monitoring should be applied to other staff. 1 2 Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly. 2 Strategy: The firm can articulate a clear vision featuring fair treatment of customers. Strategic decisions such as change management and outsourcing reflect the centrality of customers to the firm s future. Risk levels should reflect customer concerns and feedback. Consumers are provided with clear information and are kept appropriately informed before during and after the point of sale. Decision-making: At all levels, decisions should reflect on the fair treatment of customers. Feedback from staff, customers, and other external sources should be used, where appropriate. This management information should feed into properly balancing customers' interests against shareholders Whenever consumers receive advice, the advice is suitable and takes account of their circumstances. Consumers are provided with products that perform as firms have led them to expect, and associated services are of acceptable standards. Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim, or make a complaint. 5 4 Recruitment, training, and competence: Staff selection should reflect the importance of customer treatment to the firm. Management should then train and maintain staff knowledge, behaviour and values to accord with fair customer, treatment. Managers should also reward good staff performance in this regard and act on poor performance. Reward: The firm s reward framework (such as incentives and bonuses) should be transparent, recognize good quality, and support the fair treatment of customers. In other words, firms should not concentrate on sales, volumes, and profit without considering quality and controls to mitigate this risky framework. 6 Controls: The firm should have controls that reflect the fair treatment of customers. These should be integral to the firm s risk framework. 5 Source: FCA As can be seen, the defined customer outcomes can be linked to all levels of the firm s culture focused on treating customers fairly. 12 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

13 UK: The Pensions Regulator s members best interests annual reports approach In 2017, The Pensions Regulator in the UK issued a framework and guidance for pension fund trustees to assess and evidence that they act in their members best interests. Three aspects are important: 1. The assessment is based on qualitative and quantitative aspects using evidence and continuous monitoring to minimise incidents and costly remediation, in turn, impacting member confidence. 2. The trustee chair must annually create a report that documents why the fund thinks they acted in members best interests and where they identified gaps. 3. The annual report must contain an action plan to address areas where the trustees believe they have inadequately acted in members best interests. While it is too early to draw concrete conclusions from the framework s recent implementation, the approach appears prudent, practical, and balanced (chart 3) to fulfil its intended objectives and drive necessary change. Chart 3: A sample balanced scorecard to assess members best interests outcomes Framework purpose Evidence to discharge obligations of the board of directors and the trustee Assessment scope Governance, investments, custody, administration, fees, returns, satisfaction, engagement, and service provider governance including partner performance and regulation Assessment approach Evidence-based and comprehensive Member need and segmentation Detailed assessment of member needs on the basis of relevant segmentation Balanced scoring Qualitative and quantitative assessment, and balanced scorecard that covers financial, customer satisfaction, organisational, and learning aspects across all stakeholders Comparison Against customer and stakeholder expectations, domestic and overseas peers, and comparable substitution products or services Annual assessment Conduct of comprehensive annual assessment along all parts of the operation and partners Ongoing monitoring Continuous performance and outcome monitoring including of service providers Scenarios and projections Projection and running reasonable scenarios for current performance and outcomes of products and services, and regulatory, business and market context changes and their impact Communication, disclosure, and reporting Stakeholder reporting, disclosure and communication of outcomes, and planned remediation actions and initiatives A Responsibility discharge evidence B Conflicts of interest risk management evidence C Customer outcome evidence Source: EY Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 13

14 How should trustees respond? In the next decade, we expect more granular legal and regulatory clarity over what constitutes members best interests. In response, trustees will transform the way they enact, measure and evidence their duties, moving up the continuum (chart 4). Chart 4: Five steps to effectively document acting in members best interest 1 Do you have frameworks, processes, policies, and procedures? 2 Are they tailored to the specifics of your business and operating model? 3 Are they commensurate to the size, complexity, and context of the fund, its business as well as its key stakeholders? 4 Are they effectively complying across all elements of the value chain, and all products and service providers? 5 Are they effectively embedded in the respective elements, activities as well as products and service providers? Source: FCA The Royal Commission indicated that many trustees have some form of frameworks, policies and procedures in place related to members best interests and conflicts of interest (step 1). Some of these frameworks are tailored to the fund s specific business and context (step 2). But, very few trustees have yet to evolve beyond step Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

15 Will policy makers or members catalyse change? In the next few years, will policy makers bring in measures to ensure that all trustees regularly review and evolve their frameworks and solutions as the environment changes? Or, will the customer lens and community expectations drive a higher standard than law and prudential regulation, and be the driving force up the continuum? If this is the case, trustees are likely to converge their members best interests frameworks and strategy around delivery solutions for their member experience and customer-centric culture. Q: Trustees must consider the following questions: How do you ensure that you have a comprehensive overview of all decisions, inputs, and relevant key outcomes across the realm of all your trustee responsibilities for your members best interests duty? How do you enable, maintain, and evolve effective oversight over all inputs, decisions, and considerations along all parts of the value chain including all related and third-party product and service providers? How do we impose the requirements on all our product and service providers including sub-service providers effectively and efficiently, even if they themselves are not regulated? How can trustees operationalise this across the business? Acting in members best interests aligns to a fair allocation of value, and has qualitative and quantitative elements, including culture, incentives, conflicts, and conduct. To engender members trust that the superannuation trustee will deliver on their promise, right across the business, trustees need to demonstrate: Integrity: The trustees should act according to a set of principles or values, and be capable of being counted on to keep commitments and do what they say. Competence: The trustees should be capable of successfully performing their roles and responsibilities. Compassion: The trustees should care about the needs of others, particularly their members and employees, and will work for the good of everyone. To systematically operationalise, assess, and evidence how trustees act in their members best interests, EY addresses 16 components of a trustee s area of accountability or responsibility, each with supporting frameworks, policies and procedures. Each component impacts how trustees (or delegated related or third-party product and service providers) exercise their powers or duties, behave, are incentivised, and make decisions on inputs and outcomes. Most leading organisations already have many of these elements in place. Analysing each of these components as well as their respective outcomes and maturity acts as proxy for whether a trustee has frameworks and solutions in place that are tailored, commensurate, cascaded, and embedded. It also provides a robust and systematic insight into decision-making, inputs and outputs. Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 15

16 Chart 5: Key elements impacting members best interests Trust, governance, and culture What is our framework to monitor and manage trust, culture, and confidence with key external stakeholders? Is it fit for purpose and effective? Purpose, values, beliefs, behaviours, incentives, and business strategy What are our purpose, values, beliefs, behaviours, incentives, and business strategy? Are they aligned with those of your members? Board and risk governance Is our board and risk governance adequate and fit for purpose for the context of the organisation, including size, complexity, and importance for members, and is it effective? Best interest management Is our best interest framework fit for purpose and effectively covering all aspects of our accountability across the business? How do we cascade them through and embed them in all providers? Conflicts of interest management Is our conflicts management framework fit for purpose and effectively covering all aspects of our accountability across the business as well as our product and service providers and their relevant operation? Investment governance Is our investment governance framework fit for purpose and effective? How do we cascade them through and embed in all managers, product and service providers as well as portfolio companies? Operations governance Is our operations oversight framework fit for purpose and effectively covering all aspects of our responsibilities and obligations? How do we cascade them through and embed in all providers? Role clarity, accountability, and empowerment Do we have strategic and operational roles and responsibility clarity and alignment between all parties with accountability, empowerment and adequate documentation? Enterprise risk and compliance management Are our ERM and Compliance frameworks and appetite fit for purpose and effective covering all aspects of our obligations? How do we cascade them through and embed in all providers? Controls and incident management and culture What is our internal control and incident culture, framework and are they fit for purpose and effective to fulfil our obligations? How do we cascade them through and embed in all providers? Reporting and planning Are our reporting and planning frameworks and solutions fit for purpose and effective covering all aspects we are accountable for, to empower informed decision making? Capacity, capability and priority management Are our capabilities and priorities and that of our service providers fit for purpose and effective across all aspects of the business we are accountable for? People, culture and change Are the People and change frameworks of our product and service providers fit for purpose and effectively covering all aspects of the business? Source: EY Product and service provider management How well do we know our desired culture, risk appetite, and member best interests are embedded in the way we manage our related and third parties and outsourcing arrangements? Reporting and planning What is your communication, transparency and disclosure culture" and frameworks and how do they align with stakeholders interest and members best interest? How are they cascaded and embedded? Enablement and informed decisions What is your culture, focus, priority and frameworks to enable stakeholders, particularly members to make informed decisions about your products and services? 16 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

17 Each of these elements (chart 5) are critical. However, they must be systematically aligned with a members best interests lens. First, we start by assessing: board and risk governance (point 3), best interests management (point 4), and conflicts of interest management (point 5). If the overarching board risk governance framework as well as the management frameworks of members best interests and conflicts of interest aren t aligned to the desired culture of the fund, the design effectiveness of all other elements will be unable to achieve and support a member-centric organisation. Q: Trustees must consider the following questions: 1. What is our members best interests culture, and how is our strategy and risk appetite aligned to this? 2. How do you enable, maintain, and evolve effective oversight over all inputs, decisions, and considerations along all parts of the value chain including all related and third-party product and service providers? 3. Do we have a comprehensive overview of all explicit and implicit conflicts of interest including those for related or third-party product and service providers? How: should you shift your culture and not rely on more regulation? The Australian superannuation industry has a widespread and regulator-driven compliance culture, which has had reports of shortcoming in this rapidly growing and changing environment. Decline in the levels of trust and confidence in superannuation and broader financial services in the country is eventually amplifying the industry s challenges. More prescriptive regulation might not be the answer to the issues faced by Australia s superannuation system that has already outgrown the size of the country s banking system. Lessons from the UK s experience of implementing its Treating Customers Fairly regulation suggest that Australian superannuation trustees need to evolve their culture from compliantly servicing and managing members and their money to servicing and managing members and their money in members best interests. Supported by good regulation, legal clarity, professional scrutiny and powerful deterrents for substandard behaviour, we expect that such a cultural shift will create a win-win situation. It will improve members long-term outcomes while supporting trustees with certainty around community expectations and best practices. Q: Trustees must consider the following questions: 1. How do we evolve our culture and primary focus around the management of members best interests and conflicts of interest? 2. How can we effectively and efficiently cascade this culture across all areas of our business including our trustee responsibilities on outsourced functions, and related and third-party product and service providers? 3. How are we overseeing our frameworks and solutions related to members best interests duties and conflicts of interest across all our direct and indirect investment vehicles, managers, and portfolio companies as well as proxy voting and board positions of companies Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 17

18 A road map for trustees for the transformation following the Royal Commission report The road to comprehensive, commensurate and evidenced members best interests across trustees entire business and operations will take time and effort to evolve and transform. Vested interests, status quo favouritism, regulatory and legal uncertainty, and unpredictable transition and preparation periods mean we cannot be certain about the future of members best interests. However, what we know with certainty is that change will happen as the members best interests duty already exists in law. That leaves all trustees with five immediate considerations (chart 6) to get their house in order to minimise the risks of their members best interests and conflicts of interest: Chart 6: A sample road map for a trustee s members best interests transformation Regulatory and legal clarity Horizon 1 Conduct an as-is analysis Horizon 2 Get your house in order Horizon 3 Evolve Horizon 4 Sustain Horizon 5 Excel Stop? Source: EY 18 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

19 Suggested steps for trustees to take towards this transformation 1. Carry out comprehensive evaluation and detailed as-is analysis of all relevant decisions, their input, context and outcomes that may directly or indirectly impact members best interests across the entire value chain including all related and third-party product and service providers. This includes, but is not limited to: the trustee s operations, marketing, employer and member advice, contribution and data exchange, administration, investments, life insurance, benefits management, and rollovers. This also includes the assessment of members best interests culture and conduct as well as existing management frameworks, policies and solutions evidencing an organisational culture that is aligned to members best interests, with a live customer-centric focus. 2. Identify and remediate any incidents that took place over the past decade. Consider the following questions: What are our current risk exposures related to members best interests and conflict of interest, across the entire business? What do we need to remediate? 3. Carry out a comprehensive identification and documentation of existing and emerging conflicts of interest, their risks, impacts and mitigation measures for the entire value chain including all related and third- party product and service providers. This may be part of a comprehensive Prudential Standard SPS 220 Risk Management risk review. 4. Commensurate members best interests and conflict of interest impact scenario to determine the future state short and medium term: Identify the trustee s desired management risk appetite, culture, and conduct related to its members best interests and conflict of interest. Identify the details of future state commensurate management frameworks and solutions related to its members best interests and conflict of interest, on all levels for the trustee including, but not limited to, strategic, operational, organisational, and commercial Determine how swiftly the trustee and all its product and service providers must evolve to determine commensurate future state to minimise trustee risks. Determine the decision criteria for the evolution and the future state, as well as a road map to achieve the future state. 5. Execute a minimum set of it s not complicated initiatives to minimise the trustee s existing risks related to members best interests and conflicts of interest, irrespective of legal or regulatory change. The aim should be to effectively evidence that the trustee has commensurate risk appetite, culture, conduct, frameworks, and solutions; and is acting in members best interests and managing conflicts in the current regulatory and industry context. This will include, at a minimum, enhancing existing frameworks and solutions, and creating evidence for existing members and stakeholders to communicate how the trustee is acting in members best interests. We expect that all trustees will quickly begin addressing these questions to minimise their members best interests risks, and enhance their relevant mitigation and documentation measures, in turn, limiting potential penalties. The speed and magnitude of change will depend on: Urgency to change: threat-value perceived by decisionmakers, potentially including widespread class actions, large personal penalties or further investigations Regulatory clarity: time to define and implement refined and new measures of regulation applicable for APRA-regulated superannuation funds Existing deterrents: for non-compliance on members best interests including members expressing disapproval RSE Licensees will need to reassess current governance practices and undertake a rigorous review of their organisational culture, strategy, risk management and conflicts of interest frameworks to ensure all functions of the business are aligned with members best interests, now and ahead for the future. Undertaking this action in an open and transparent manner will enhance the integrity of our Australian superannuation system and instil the confidence and trust of members placed in RSE Licensees to act in their best interests and responsibly manage their retirement savings and long term financial well-being outcomes. Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 19

20 It is time for RSE licensees to Lorem Ipsum is simply dummy text review their strategic and business of the printing and typesetting practices, decision making and industry. Lorem Ipsum has been oversight of fund expenditure and the industry s standard dummy approach to defining, assessing text ever since the 1500s, when and delivering sound outcomes an unknown printer took a galley for members having regards to of type and scrambled it to make these draft prudential standards a type specimen book. It has and guides. A members best survived not only five centuries, interests governance, strategic and but also the leap into electronic operational framework will assist in typesetting, remaining essentially this process. unchanged. 20 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

21 Should we wait and see or act now? Who will wait for clarity and who will proactively evolve beyond horizon 2, and transform culture, frameworks, and solutions to better protect members, their interests and outcomes? Do trustees have a comprehensive and commensurate understanding of all: Relevant decisions, processes, related context and inputs to members best interests Conflicts of interest risks and mitigation measures across their entire business and value chain including all related and third-party product and service providers Are trustees confident that they are not in breach of their duty of effective risk management, mentioned in section 52 of SIS Act 1993, to adequately cover and implement frameworks, policies and procedures to manage members best interests and conflict of interest risks that are commensurate, cascaded through all product and service providers, and embedded sustainably across all stakeholders? This challenges the wait-and-see approach because trustees are increasingly both risk-exposed to members and to themselves. Q: To decide which the better option is, trustees need to consider the following questions: What will the strategic and operational implications on all stakeholders be if trustees swiftly evolve with a commensurate level of members best interests and comprehensive conflict management? What will be our decision criteria for the evolution and the future state? As trustees, does our risk appetite align with our existing and future risks related to members best interests and conflicts of interest? How agile are we for the continuous change of these risks and our responsibilities to our members? What are our long-term best interests and conflict of interest transformation strategy, road map and detailed action plan to ensure we minimise risk, and act commensurately in members best interests? The proposed new prudential standard SPS 225 Outcomes Assessment and updated SPS 220 Risk Management (along with new Prudential Practice Guides SPG 221 Strategic and Business Planning and SPG 225 Outcomes Assessment) have been introduced by APRA to assist RSE licensees to focus on sound strategic and business planning processes and rigorous decision making processes. RSE licensees will be required to review their existing policies and processes to ensure they can meet the proposed requirements, expected to be in force in early Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 21

22 What next: steps to be taken by trustees The Australian superannuation industry needs swift, clear and systematic measures to restore public and member confidence, requiring transformation, short-term discomfort, and industry wide collaboration. The benefits of such measures are clear: better member outcomes and better financial well-being for millions of Australians today and tomorrow. The Royal Commission has already outlined a suite of aspects and information relevant to superannuation, advice, and life insurance for trustees, or their related or third-party product and service providers. Trustees should consider and act on this information with clarity as a matter of urgency. Risks and duties related to members best interests and conflicts of interest must be at the centre of attention for all trustees we well as their product and service providers. Risk exposure, possible impact, and mitigation solutions vary considerably among trustees. But, all trustees must act now to get their house in order. For this, they need to: 1. Carry out a comprehensive stock-take of an as-is analysis EY contacts 2. Identify and remediate any incidents that took place over the past decade 3. Identify and document existing conflicts of interest for the entire business 4. Conduct an impact scenario on members best interests and conflict of interest Maree Pallisco maree.pallisco@au.ey.com 5. Execute a minimum set of it s not complicated initiatives We do not envisage a one-size-fits-all approach, but rather a wide range of different trustee responses to the speed and extent of change. Members needs are highly diverse. Individual trustees, and their risk appetite as well as different business and operating models will also dictate the speed and nature of transition to a new world of compliance and risk management for members best interests and conflicts of interest. But all trustees must create processes and evidence that demonstrate appropriate management of conflicts of interest and members best interests. Inadequate action by some trustees or their product and service providers will create collateral brand damage for all. Whereas, good management will create better outcomes for all stakeholders. Josef Pilger josef.pilger@au.ey.com Antoinette Elias antoinette.elias@au.ey.com 22 Can we better protect members best interests and deliver better retirement savings outcomes in Australia?

23 Graeme McKenzie graeme.mckenzie@au.ey.com Michelle Segaert michelle.segaert@au.ey.com Jessica Hall jessica.e.hall@au.ey.com Charlie Puddicombe charlie.puddicombe@au.ey.com Can we better protect members best interests and deliver better retirement savings outcomes in Australia? 23