APRA discussion papers: financial resources for risk events and superannuation transfer planning

Proposed changes and their implications for RSE licensees 12 min read

Proposed changes and their implications for RSE licensees

APRA has released two discussion papers which will be of interest to RSE licensees as the key proposals (if implemented) will change the manner in which financial resources are held and used to manage operational risk events and will require RSE licensees to meet minimum standards for planning, pre-positioning and executing transfers of members.

In this Insight, we provide an overview of the proposals and key implications for RSE licensees.

The proposals are contained in:

• APRA Discussion Paper Financial resources for risk events in superannuation (November 2022) (Discussion Paper: ORFR); and
• APRA Discussion Paper Superannuation transfer planning: Proposed enhancements (November 2022) (Discussion Paper: Superannuation transfer planning).

The proposals are connected with the financial contingency and resolution planning proposals in draft APRA CPS 190 published in December 2021; the operational risk management proposals in draft APRA CPS 230 published in July 2022; and the strategic planning and member outcomes proposals published in August 2022.

Key proposed changes 

Key proposed changes to the existing regulatory regime are summarised below.

Financial resources for risk events  

• Existing requirements of SPS 114 will be replaced with the 'Baseline+ model' which will require RSE licensees to hold financial resources to respond to operational risk events that would consist of a two-tiered model involving: (1) a baseline component to ensure ready access to financial resources to fund recovery or exit activity; and (2) an operational risk component which will be the primary source of funds to address operational risk events.
• RSE licensees will have flexibility to calculate an individual baseline component amount for their business operations using either an RSE licensee-led method or a basic calculation method (eg number of members multiplied by a specified cost per member). The baseline component will be able to be used for actions relating to the business continuity plan, financial contingency plan, resolution plan or to undertake a transfer of members or a transfer of MySuper assets where an RSE licensee's MySuper authorisation is cancelled. Any use of the baseline component will need to be replenished over three years.
• APRA will remove its guidance that RSE licensees need to hold at least 25bps of FUM and RSE licensees will have flexibility to determine the level of the operational risk component that is appropriate for their business operations with a target amount to be set by the trustee and a lower tolerance limit which would define the core risk resources that need to be available to meet operational risks. APRA will relax replenishment requirements so that the replenishment cycle can be spread over multiple years to ensure the loss arising from the operational risk event is spread equitably across the membership base.
• The definition of 'operational risk event' will be broadened to expand the allowable uses to include investigations, remediations and mitigation related activities to address operational risk within the fund, as well as to encourage risk prevention activities.
• Existing notification requirements from SPS 114 will be removed, but RSE licensees will remain subject to existing breach notification requirements, and APRA will seek to collect further operational risk data through amendments to the reporting framework.

The proposals in Discussion Paper: ORFR give RSE licensees greater flexibility with respect to the management of the financial resources held to meet the ORFR requirements. It also opens up the opportunity for mid-size to larger funds to reduce the amount of resources held to meet the ORFR requirement if it is appropriate to do so having regard to the risks and likely costs faced by the trustee. Whilst the greater flexibility is generally beneficial, it may lead to varying approaches and reserving levels across the industry. This may cause trustees some headaches during successor fund transfer (SFT) negotiations and the transition phase where the typical industry practice is to align reserving levels prior to the SFT. Trustees involved in negotiating an SFT may need to take a more nuanced approach to comparison of ORFR reserves.

The closing date for submissions on the proposals in the Discussion Paper: ORFR is 17 March 2023. Information provided in response to the paper will inform revisions to the prudential framework, with consultation on the draft standard and guidance expected to commence mid-2023. APRA intends to finalise the revised SPS 114 in early 2024 with an effective date of 1 January 2025.

Superannuation transfer planning

• Current guidance on business planning in SPG 515 will be elevated to new requirements in SPS 515 so that RSE licensees must consider and plan for future circumstances that may necessitate an SFT, which aims to ensure that where an RSE licensee decides that an SFT (in or out) is necessary, the RSE licensee has plans in place to reduce the risk to members of a protracted, costly, disruptive or unsuccessful transfer.
• New requirements will be imposed relating to the transfer of MySuper product assets, which will ensure that risks and issues that might impede a successful SFT in respect of a MySuper product are identified and addressed within a 90-day period in the event that the RSE licensee's MySuper authorisation is cancelled. Subject to consultation, this proposal is intended to take effect from 1 July 2023.
• APRA will update guidance on SFTs and wind-ups, which will provide enhanced guidance on the execution phase of an SFT, in particular relating to project management, documentation and administration matters.

The proposals in Discussion Paper: Superannuation transfer planning aim to introduce more sophisticated policies and procedures relating to transfers of members. RSE licensees who are currently exploring merger opportunities may wish to have regard to the proposed guidance provided by APRA which relates to planning, pre-positioning and decision making and execution of SFTs (although we expect many funds will be undertaking these processes in any event).

The closing date for submissions on the proposals in the Discussion Paper: Superannuation transfer planning is 10 March 2023. After considering submissions and consulting further on the concurrent review of SPS 515, APRA will release proposed draft changes for further consultation in the first half of 2023.

Proposals: financial resources for risk events

RSE licensees are currently subject to the obligation under section 52(8) of the Superannuation Industry (Supervision) Act (SIS Act) to maintain and manage financial resources to cover operation risk, and the operational risk financial requirement (ORFR) in SPS 114.

APRA intends to replace the existing SPS 114 with materially reshaped requirements in response to industry submissions that raised the following key issues regarding the ORFR:

• Scope of permitted use: RSE licensees use other reserves to address operational risk events as the current narrow definition is perceived as a barrier.
• ORFR amount held: RSE licensees do not conduct analysis to determine an adequate amount of resources required to satisfy the ORFR, instead holding the guidance amount of 25bps of FUM.
• Barriers to efficient use: notification and replenishment requirements are perceived as barriers.
• Sufficient resources: there is no existing requirement to provide confidence that sufficient financial resources are available for recovery or exit.

APRA's view is that the prudential framework could be enhanced to ensure members are equitably protected from the impacts of operational risk events.

Baseline+ model

Through the 'Baseline+ model', APRA proposes to require RSE licensees to hold financial resources to respond to operational risk events that would consist of a two-tiered model:

• a baseline component, to ensure ready access to financial resources to fund recovery or exit activity—this component would also satisfy the requirement in draft CPS 190 to have adequate resources for contingency planning purposes; and
• an operational risk component, to spread the impact of operational risk fairly across different cohorts of members. This is expected to be the primary source of funds to address operational risk events—with a target amount to be set by the trustee and a lower tolerance limit which would define the core risk resources that need to be available to meet operational risks.

In addition to the specific requirements applying to the two components (see further below), RSE licensees will be required to:

• ensure the Board approves the amount held for the components;
• determine how the financial resources to meet each component are to be held and invested; and
• document the RSE licensee's approach in strategy that is approved by the Board and reviewed at least annually or following a material change to its operational risk profile.

RSE licensees would continue to be able to hold the resources either in a reserve in the fund, as trustee capital or a combination of both. Where the financial resources are held in a reserve, APRA expects that the RSE licensee would ensure the assets in the reserve provide unrestricted commitment of financial resources to address operational risks.

The following table from the paper compares the two components:

Baseline component

APRA's view is that an effective transfer of members, and recovery and resolution of the trustee company, should be funded ahead of time with a focus on the equitable treatment of members. The role of the baseline component is, therefore, for RSE licensees to maintain a specific pool of financial resources to enable a transfer of members to take place.

APRA proposes that the baseline component can be used for the purposes of funding the:

• activation of a business continuity plan under draft CPS 230;
• activation of a financial contingency plan under draft CPS 190;
• activation of a resolution plan under draft CPS 900; and
• activation of a plan that involves the transfer or receipt of members under proposed enhancements to SPS 515 (see further below).

APRA will permit RSE licensees flexibility to calculate an individual baseline component amount for their business operations using one of two methods, namely:

• RSE licensee-led method: an amount that the RSE licensee can demonstrate as sufficient to allow it to undertake the actions covered by the baseline component while ensuring business operations are maintained; or
• basic calculation method: an amount based on the number of members, with the potential to be subject to a minimum dollar amount determined by APRA (eg $100 per member).

APRA's expectation is that the majority of RSE licensees will seek to adopt the RSE licensee-led method. If the RSE licensee-led method is widely adopted, we will likely see a variety of approaches adopted by trustees having regard to their business operations and risk profile and, therefore, vastly different reserving levels between funds. Whilst greater flexibility is generally beneficial, it may cause trustees some headaches during SFT negotiations and the transition phase where the typical industry practice is to align reserving levels prior to the SFT. That said, APRA is considering the appropriateness of requiring a minimum amount to ensure that all members are protected. 

If only a partial transfer of members occurs, or the circumstances involve the recovery of the position of the trustee company, the baseline component will need to be replenished to protect the remaining members within three years. If all members are transferred out, then no replenishment will be required.

Operational risk component

APRA expects that the operational risk component will be used as the primary source of financial resources to manage the impact of operational risk, supported by appropriate controls.

APRA proposes to broaden the definition of 'operational risk event' to allow RSE licensees to address potential problems before they adversely affect members. APRA says the new definition is intended to expand the allowable uses to include investigations, remediations and mitigation-related activities to address operational risk within the fund, as well as to encourage risk prevention activities. We have set out a comparison of the proposed definition against the current definition below.

Calculation of the operational risk component amount will remain consistent with the current method to determine ORFR—that is:

• there will be a target amount set by the RSE licensee which is the optimum amount that would address the expected impact of operational risks occurring in the normal course of business, plus a buffer to facilitate longer-term replenishment approaches and responding where the baseline amount is insufficient; and
• there will be a lower tolerance limit which would indicate when the financial resources held are materially below the optimum amount.

In a significant change from the current approach, APRA will remove its guidance that RSE licensees need to hold at least 25bps of FUM. APRA's view is that the amounts held to meet the ORFR have increased over and above the risks arising in the normal course of many RSE licensee business operations. We think this could open up the opportunity for mid-size to larger funds to reduce the amount of resources held to meet the ORFR requirement if it is appropriate to do so having regard to the risks and likely costs faced by the trustee.

Additionally, APRA will relax replenishment requirements so that where the level of financial resources held by the operational risk component falls below the lower tolerance limit, RSE licensees will need to implement a replenishment plan to replenish funds to the target amount within a period that the trustee determines is equitable and minimises the risk of adverse member outcomes. This means the replenishment cycle can be spread over multiple years to ensure the loss arising from the operational risk event is spread equitably across the membership base.

RSE licensees will also be able to continue to implement investment strategies for the operational risk component, provided sufficient liquidity is maintained and the risk profile is appropriate.

Notification requirements

APRA proposes to remove the existing notification requirements from SPS 114. RSE licensees will remain subject to existing breach notification requirements, and APRA will seek to collect further operational risk data through amendments to the reporting framework as part of the Superannuation Data Transformation Phase 2 project.

Matters for consultation

APRA is seeking input on various questions, including:

• what changes would enhance the proposed scope of permitted use for the baseline component and for the operational risk component;
• what legal or practical restrictions may impede RSE licensees from implementing or complying with the proposed Baseline+ model;
• whether RSE licensees have sufficient capability to calculate the proposed baseline component, and what methodology would be used;
• whether APRA should provide a basic calculation option, with the amount held linked to member numbers or whether there are there any other methods that would be more efficient or better targeted; and
• how a maximum timeframe for the replenishment of the operational risk component to its target amount be set.

APRA also requests information on the estimated costs of compliance with the proposed changes.

Proposals: superannuation transfer planning 

APRA expects consolidation within the superannuation industry to continue as RSE licensees seek opportunities to become more efficient and strengthen capabilities to deliver quality outcomes for members. Over the last three years we have seen a number of reforms which have the effect of highlighting issues (both internally and public-facing) relating to sustainability, performance or cost—to name a few, the legislated performance test, APRA's heatmaps and the business performance review.

APRA has observed some instances where RSE licensees have not planned or executed transfers in a prudent and timely manner, leading to poor outcomes for members. Some areas where issues were identified by APRA and referred to in the Discussion Paper: Superannuation transfer planning are: product or systems integration; mechanisms for delivery of services to members; availability of a suitable transfer partner; concentration of service providers (in particular, fund administrators); and legal matters (such as the application of the equivalent rights test and due diligence costs). 

The proposals in the paper seek to ensure that RSE licensees are:

• planning: well prepared to take prompt action, including to transfer members to another superannuation fund to promote the financial interests of beneficiaries.
• pre-position and decision making: able to act promptly to triggers, and undertake an objective and thorough analysis of transfer options to determine the best outcome for members.
• execution: able to execute transfers proactively and efficiently with robust governance, risk and conflicts-management practices that support the timely completion of an SFT.

Planning

APRA intends to elevate current guidance relating to contingency planning from Prudential Practice Guide: Strategic and Business Planning (SPG 515) to new requirements for member transfer planning in SPS 515. In particular, it is proposed that the new requirements in SPS 515 will require RSE licensees to:

• develop and implement processes to monitor performance with the RSE licensee's business plan;
• have in place triggers for remedial action to address business performance review (BPR) issues, including escalation steps to prepare for a complete or partial SFT; and
• consider the circumstances in which an SFT to another RSE licensee would be in the best interests of members.

More broadly, RSE licensees will be required to be prepared to make changes to address BPR issues and achieve improved member outcomes—this may be achieved through changes to product features, investment strategies, member services or fee structures (ie the first order of business upon experiencing BPR issues will not necessarily be an SFT). RSE licensees will also be expected to consider where changes to the business operations may be necessary to improve outcomes for members in response to emerging issues.

Under the proposals, all RSE licensees will be expected to be able to demonstrate that they undertake proper planning to deal with circumstances that may necessitate a transfer of members (either in or out of the fund).

The proposed guidance by APRA would identify that a prudent approach to planning includes:

• undertaking market scanning to identify credible transfer options and partners;
• ensuring that transfer options are regularly reviewed and updated so they remain relevant;
• exploratory discussions with potential transfer partners;
• provision of risk analysis to the Board to identify how and where the need for a transfer may arise; and
• the Board considering high level options for how and when a transfer of members may be implemented and how this integrates with other RSE licensee contingency planning.

Pre-positioning and decision making

APRA has observed that RSE licensees can struggle to take prompt and proportionate action to respond to poor performance outcomes, which can expose members to additional risk and cost. In response to these concerns, APRA intends to replace SPG 227 with enhanced guidance and expectations of prudent practice when preparing for an SFT (referred to as 'pre-positioning'). Pre-positioning will reduce the risk of SFTs failing late in the piece due to matters that should have been identified as barriers early on in the SFT process.

The proposed guidance by APRA would identify that, as the need for a potential transfer becomes more pressing, an RSE licensee would take increasingly detailed preparatory steps, including to:

• develop the business case for a transfer, including how it will deliver better outcomes and address any concerns driving the potential need for a transfer;
• establish effective governance arrangements to support timely and unconflicted decision making in a transfer;
• undertake appropriate due diligence;
• identify barriers, including legislative, operational, cultural and practical barriers;
• determine how to address barriers and identify deal-breakers at an early stage; and
• develop plans for implementing a timely transfer and engaging with APRA during the process.

RSE licensees who are currently exploring merger opportunities may wish to have regard to the proposed guidance provided by APRA (although we expect many funds will be undertaking these processes in any event).

In connection with the pre-positioning proposals, APRA intends to impose new requirements in respect of the transfer of assets where APRA cancels a MySuper authorisation. Under the proposals, APRA will be empowered to (among other things) require an RSE licensee to:

• take specific steps identified in Attachment A of the paper where a trigger relating to the MySuper product is reached—eg where an RSE licensee’s MySuper product first fails the performance test or where APRA has reason to believe that one of the grounds for cancelling a MySuper authority is met under section 29U(2) of the SIS Act.
• prepare a documented process for the transfer of MySuper assets, which includes: governance arrangements; roles and responsibilities of key stakeholders; identification of the target receiving RSE licensee and MySuper product; and communication strategy.

Execution

During recent SFTs, APRA observed a number of execution risks which must be properly managed to ensure SFTs are implemented in an efficient manner. In particular:

• Extended timeframes: certain SFTs have taken excessive time to implement because of poor project management, unclear accountabilities between the RSE licensees, and inefficient governance structures.
• Legal complexity: RSE licensees have had difficulty balancing the need for compliance with complex legal obligations with a pragmatic approach.
• Resource constraints: RSE licensees have struggled to secure additional resources to maintain ongoing business operations whilst undertaking the SFT and associated transition risks.

The proposed amendments to SPG 227 will include enhanced guidance on the execution phase of the SFT, covering expectations relating to an RSE licensee's business plan, prudent project management, impact on business operations, documentation and administration matters.

Specifically, the proposed guidance by APRA would suggest that prudent management of critical components of the execution of a transfer plan would include:

• managing the transfer project, including having clear accountabilities and efficient governance structures to support timely decision making and ensuring that decision making is well documented and demonstrably in the best financial interests of beneficiaries;
• demonstrating how the RSE licensee’s execution of the transfer will realise the intended benefits for members;
• managing operational risks arising during the execution phase, including those arising from significant changes in people, processes and systems;
• communicating with members;
• engaging with APRA, where regulatory approvals and requests for relief in relation to portability and administration outage periods are often necessary; and
• attending to wind ups, de-registrations and reporting requirements in a timely manner.

Matters for consultation

APRA is seeking input on various questions, including:

• what minimum steps trustees should take to be prepared to transfer members;
• what performance indicators trustees use to identify where a transfer of members is required;
• what guidelines would support trustees to ensure appropriate due diligence is undertaken without resulting in undue cost and delays; and
• what the most significant barriers to transfers of members are, and how their impact can be reduced so that transfers are timely, orderly and less costly.

As above, APRA also requests information on the estimated costs of compliance with the proposed changes.

Next steps 

RSE licensees should be aware of the breadth of the proposals and consider undertaking a cost-benefit analysis of the proposed changes in order to provide a meaningful submission to APRA if considered appropriate.

If you wish to discuss a submission, or have questions about the issues raised in this Insight, please get in touch with any of the people below.