A damning report on the inefficiencies created by many small Australian superannuation funds has put the industry into a period of reflection this year. The Productivity Commission, a state body, published the report in March but, as the government is discovering, rationalising sub-scale players is not an easy task.

In all likelihood, the Australian Prudential Regulation Authority (Apra) will have to offer several regulatory sticks and carrots to make headway, argued experts.  

Theoretically, funds could rationalise through an annual scale test applied by Apra, the regulator responsible for overseeing the superannuation industry. Unfortunately, it lacks any mechanisms to force funds to take action. 
 
Only a handful of successful unions have occurred in recent years. The most notable was the marriage of the Australian Retirement Fund and Superannuation Trust of Australia to form AustralianSuper in 2006, and then the folding of Health Super into First State Super in 2011.

Others have failed, including the attempted A$10 billion marriage of Vision Super and Equipsuper. The pair was in talks for three years, but Equipsuper pulled out weeks before the deal was to be signed in 2012, citing reluctance by Vision Super to adopt its preferred investment model. 

A year earlier, Maritime Super and Auscoal Super ended talks on an A$8 billion merger, saying they couldn’t find an equitable split on value.

Equipsuper is still on the prowl. It approached Energy Super last year, but that deal fell through when two unions reportedly demanded board positions in the new scheme. It is now said to be seeking an alliance with miner Rio Tinto’s super fund, which would create a A$14 billion retirement scheme with 75,000 members.

The key impediment to mergers lies in large part with the trustees of the super funds, who make the ultimate decision over mergers. They’ve been reluctant to consolidate so far. 

“It doesn’t surprise me when mergers don’t proceed. It can be hard to find synergies, to fit teams together, or to reach agreement on contracts,” said Zak May, head of policy at Industry Super Australia

Michael Rice, a partner at actuarial consulting firm Rice Warner, contended that the reticence was partly down to job security, with a successful merger likely to reduce the number of directors on the combined board. “Some trustees have been on boards since their funds were established in the 1980s, so the role can be seen as a lifetime sinecure,” he said. 

Added to that, the boards of super funds can reject merger advances out of hand.  “A board can simply tell a bidding party to go away, and there’s nothing the bidder can do to appeal to target members by suggesting their current fund could be doing better,” Rice noted. “We believe funds who receive a serious bid and then reject it should be required to explain their reasons to Apra.”

Eva Scheerlink, who represents the interests of directors and fund staff as head of the Australian Institute of Superannuation Trustees, agreed there was a problem with inertia. “Trustees can be very protective of their members and their roles,” she told AsianInvestor. “They need to be reminded of their fiduciary duty to act in the best interests of members.”

Verging on obese

To facilitate consolidation of super funds, Apra will likely need to take a multi-pronged approach. First it should identify funds that would enjoy economies of scale through a merger. In addition, there are factors to consider other than size alone, such as performance and growth measures. 

Other hurdles to mergers must also be considered; perhaps the biggest is the expense. Rice Warner estimated it costs about A$1 million in time and resources for a small fund to integrate with another. 

“Big funds like Australian Super and UniSuper are unlikely to consider mergers with funds under A$10 billion. It’s too expensive to go through the integration process,” said Rice. It may prove an insurmountable problem, unless the regulator steps in to force mergers. 

Another stumbling block is the need for funds to pass equivalence tests ahead of any merger. At present, trustees have to prove their members will receive benefits equal to the status quo once their funds merge with another organisation. 

“It can be a tough hurdle to meet, and trustees need more clarity on how the equivalence test is employed,” said Scheerlink. “Can it be applied on an aggregate basis, for example, rather than in relation to each benefit?”

Then there is Australia’s tax law, which treats asset transfers as a taxable event. Industry observers say this acts as a disincentive.

The Productivity Commission would be wise to address these requirements when making its final recommendations to the federal government in August. 

Even if the government doesn’t address them all, at the very least introducing a single, transferable account should help consolidate funds at bigger, cheaper and more efficient players—and act as a shot across the bows for fund executives and trustees.