ASIC's (limited) guidance on superannuation fees and costs disclosure

In brief

Today (1 July) sees the implementation of changes to the fee and cost disclosure rules for superannuation and managed investment products. While a new information sheet from ASIC provides guidance on certain aspects of the new rules, superannuation trustees have been left to grapple largely unaided with some of the more difficult issues surrounding the proper characterisation and disclosure of certain fees and costs. Partner Geoff Sanders, Regulatory Counsel Larissa Macpherson and Senior Associate Frances Dunn look at key aspects of the new guidance and examine some of the outstanding compliance challenges.

Fees and indirect costs

The scope of the 'indirect cost' and 'indirect cost ratio' concepts under the new fee and cost disclosure rules have proven particularly challenging for many super trustees to integrate into the existing fee and cost framework of their products.

The indirect cost of a particular product or investment option is defined as any amount that the trustee 'knows, or reasonably ought to know, will directly or indirectly reduce the return on the investment of a member', and which is not charged to members as a fee.
While some uncertainty remains, ASIC has made an attempt in Information Sheet 197 to clarify the distinction between a fee and an indirect cost.

In particular, ASIC acknowledges that the indirect cost would encompass the following (provided that these are not charged to members as a fee):

costs that are deducted from the return before it is received in the common fund which includes the member’s investment (eg, brokerage on a share sale or a property management fee based on the gross rent collected); and costs that are deducted from the common fund which includes the member’s investment itself (eg, a trustee’s operating costs or a management fee paid to an external fund manager).

In contrast, ASIC provides the following examples of fees:

We expect that fees charged to members will include:
• fees that are deducted directly from the member’s account (e.g. an administration fee in the form of a flat weekly fee); and
• fees, such as an investment fee, that are charged by the trustee through a reduction in a unit price (e.g. a percentage-based fee).

While this is useful guidance, we expect that the following two issues, in particular, will continue to challenge trustees.

A fee or a cost?

Before Information Sheet 197 was issued, there had been a great deal of confusion in the industry as to whether certain trustee costs should be rightly characterised as an investment fee, an administration fee or an indirect cost.

The confusion arises as a result of the broad definitions of 'investment fee' and 'administration fee' in the Superannuation Industry (Supervision) Act 1993 (Cth) (the SIS Act), both of which specifically state that the fee may include costs incurred by the trustee that 'relate to' the investment or administration (respectively) of the relevant fund.

Given those broad definitions and the fact that fees charged to members are expressly excluded from the 'indirect cost' definition, many trustees have struggled with the proper characterisation of amounts such as fees paid to external administrators or to external investment managers under mandate arrangements. In particular, on a broad reading of the definitions of investment and administration fees, those amounts should rightly be treated as fees and disclosed as such, but such an approach is incongruous with what most in the industry instinctively think of as a fee.

In our view, ASIC's limited guidance on this issue does assist trustees in making the relevant distinction, but further clarification would be useful.

In particular, ASIC appears to be supporting the view that 'only a fee is a fee' – that is, that investment fees and administration fees are restricted to those amounts that are directly charged to members after the net investment return applicable to the relevant product or investment option has been calculated and the unit price or earning rate has been determined (whether those amounts are deducted directly from the member’s account, such as via a flat weekly fee, or through a unit price reduction, such as a percentage-based fee).

In contrast, costs that are deducted or provided for before the unit price or earning rate of the relevant product or investment option is determined would appear to fall within the scope of ASIC's interpretation of indirect costs. Information Sheet 197 contemplates that such costs might be deducted before investment returns are received by the super fund, or could be deducted or provided for within the super fund before net investment returns are calculated and allocated to member accounts via unit prices or crediting rates. Helpfully, ASIC's view appears consistent with the view traditionally held within the industry, though it does remain difficult to reconcile with the existing broad statutory definitions of 'investment fee' and 'administration fee'.

Further, the examples provided by ASIC are fairly straightforward and it would have been more useful for it to set out a range of more detailed scenarios involving direct and indirect costs incurred by the super fund (including, most importantly, common costs such as administration and investment mandate costs) to demonstrate how ASIC would allocate these amounts between the fee and indirect cost concepts in each case.

Further, while the ASIC view is welcomed as a sensible practical interpretation of the relevant terms, the limitations and uncertainty resulting from the fee definition in section 29V of the SIS Act still leaves super fund trustees in a difficult position. This could be addressed by Parliament revisiting the definitions in the existing legislation, with a view to making clearer the distinction between a fee and a cost.
In the meantime, it would be helpful if the more detailed guidance promised by ASIC in proposed revised Regulatory Guide 97 Disclosing fees and costs in PDSs and periodic statements were to shed more light on this issue.

How far must super trustees 'look through' to indirect costs?

As noted above, the indirect cost of a particular product or investment option must include amounts that the trustee 'knows, or reasonably ought to know, will directly or indirectly reduce the return on the investment of a member'.

This broad definition appears to call for at least some degree of reporting of investment-related costs on a 'look-through' basis. Indeed, a strict interpretation would require trustees to look endlessly through cascading investment structures through which the fund's assets are held, and seek to identify all deductions made at any level within those structures, on the basis that these are costs of which the trustee should reasonably be aware.

So, for example, where a fund has invested in a managed fund product that itself holds interests in further managed funds (ie the fund is invested in a 'fund of funds' product), the legislation potentially requires the trustee to confirm and disclose as indirect costs all of the management fees, performance fees and all other costs being deducted at each investment level, on the basis that all of those amounts will ultimately reduce the return received by the super fund.

Clearly, this would impose an extremely onerous obligation and would not be feasible in practice for many funds, from an information-gathering or a cost perspective, given the varied investment structures often employed.

However, to date, ASIC has not clarified the extent of the 'look-through' required by the 'indirect cost' concept and has instead simply used Information Sheet 197 to confirm that it will seek to conduct further industry consultation on the issue, with a view to preparing comprehensive guidance in an updated Regulatory Guide 97.

In these circumstances, and in light of the statutory obligation (albeit deferred) under s29QC of the SIS Act for a super trustee to calculate its disclosures to members consistently with its reporting to APRA, a trustee might form the view that the only costs that it reasonably ought to know are those that it is also required to report to APRA under 'look-through' obligations as are prescribed in APRA's Reporting Standard SRS 702.0 (Investment Performance), which requires trustees to report through to the first non-connected entity only.

Performance fee disclosure

ASIC has acknowledged the lack of uniformity in the industry regarding disclosures of performance fees. In Information Sheet 197, ASIC expressed its disapproval of what it sees as the common practice of super funds disclosing future performance fees by reporting historical data taken from the previous year. In ASIC's view, this practice may be misleading because it suggests that those past performance fees (and, by extension, the performance of the relevant product) may be achieved in the future.

ASIC instead expects trustees to go through the process of formulating future estimates based on 'reasonable assumptions' and having regard to existing regulatory guidance on disclosing prospective financial information, to allow 'meaningful comparison between superannuation funds'.

However, by expressing concerns about the suitability of using historical data, ASIC has brought into doubt the adequacy of a prevalent industry approach to dealing with this tricky disclosure obligation without offering specific detailed guidance on its preferred approach. In practice, the obligation to give 'reasonable estimates' of future performance fees means that trustees cannot simply quote historical data. Instead, trustees must actively turn their minds to the assumptions, both express and implied, on which the proposed figures are based (eg unchanged market conditions) and consider how reasonable they are. A degree of subjective assessment will therefore be required.

Ideally, ASIC's position on the disclosure of future performance fees in the super context would be further clarified in detailed guidance, so as to promote ASIC's stated goal of allowing for 'meaningful comparison' between superannuation funds. In the meantime, trustees should prepare these disclosures having regard to existing relevant guidance: in particular, Regulatory Guide 97 and Regulatory Guide 170 Prospective financial information.

Disclosure relief (?) for managed investment products

While Information Sheet 197 itself is primarily aimed at super trustees, ASIC also used the media release accompanying its release to clarify the application of clearly mistaken earlier regulatory changes that had introduced revised fee disclosure wording for managed investment products.

In particular, ASIC has stated that although the prescribed consumer warning for both super and managed investment products includes the statement 'Your employer may be able to negotiate to pay lower administration fees', this sentence can be omitted in relation to managed investment products.

While this guidance from ASIC is welcome, given that the statement is patently irrelevant outside the superannuation context, responsible entities of managed investment schemes may be understandably confused and concerned that ASIC has granted this 'relief' in a passing comment in a media release (see ASIC 14-132MR) rather than in a formal relief instrument or regulatory guide.

Extension of 'facilitative approach' to compliance

ASIC also used Information Sheet 197 to announce the extension of its 'facilitative approach' to compliance with various Stronger Super reforms, including the changes to fees and costs disclosures, until 1 July 2015.

ASIC states that, until that date, it will be adopting a measured approach where there are inadvertent breaches of the rules or where systems changes are underway, provided that industry participants are making 'reasonable efforts' to comply.

Super trustees can take from this a measure of comfort that the new disclosure rules will not be enforced unnecessarily strictly during this transitional phase, so long as funds are clearly trying to comply with the spirit of the rules. It is unclear, though, whether and to what extent ASIC might be lenient in any particular circumstance, so industry participants should not be casual about the new disclosure rules.

In any event, trustees should be aware that this extension of the facilitative approach does not effectively amount to a one-year deferral of the start date for the new rules, as has been reported elsewhere.

Other disclosure issues addressed by ASIC

Information Sheet 197 also offers guidance on the following aspects of the new disclosure rules as they apply to superannuation funds:

• Apportionment: ASIC has confirmed that, where applicable, trustees must apportion amounts across each of the prescribed categories of fees or costs to arrive at and disclose an amount (if any) for each category for each MySuper and Choice product on offer.
• Fee and cost disclosure must be net of tax: Information Sheet 197 explains that disclosures of fees and costs must take account of any applicable GST (less income tax credits) and stamp duty. Fees must also be disclosed gross of income tax and, in particular, without reduction for any relevant income tax deduction the trustee may be entitled to claim.
• Intra-fund advice fees: ASIC has specified the circumstances in which fees for intra-fund advice must be disclosed as an administration fee, rather than an advice fee.