The main point of contention from this inquiry is over the ‘faith-based’ super product carve-out, which is detailed in Schedule 5 of the Treasury Laws Amendment (2022 Measures No. 3) Bill 2022. Schedule 5 has been deemed necessary to ‘end super fund religious discrimination’. This was a policy commitment of the Labor Party going into the 2022 Federal Election.
By allowing for ‘faith-based’ products to be subjected to a supplementary performance test, as determined solely by the Australian Prudential Regulation Authority (APRA), this legislation opens the door to other super carve-outs that do not put the financial interests of consumers first.
The Your Future, Your Super (YFYS) performance test was introduced by the previous Coalition Government in 2021 as part of wider reforms to provide greater consumer protection for super members.
This legislative proposal as it currently stands sets a bad precedent for superannuation by entrenching a diversion from the best financial interests test, and undermines the integrity of MySuper.
Furthermore, the bill lacks critical detail on what ‘faith-based’ means and the intent of how it is to be administered, and delegates too much discretionary authority in administering the scheme to APRA in the process.
Ultimately, it seems the bill is a bizarre attempt to water down the super performance testing regime and MySuper by inventing a problem and painting it as a significant community concern.
Whilst Coalition Senators support most of the legislative package before this committee inquiry, we oppose Schedule 5 of the Treasury Laws Amendment (2022 Measures No. 3) Bill 2022 for the following reasons.
Bad precedent
The key problem is that this proposed ‘faith-based’ carve-out delivers a shocking precedent. If enacted, the precedent will be established that investment performance is no longer the sole benchmark and purpose of super.
It will open the floodgates to every tangential idea being a justification for super funds to perform poorly. Hypothetically, we could see a future requirement for 10 per cent of super to be invested in infrastructure, another 10 per cent in agriculture and even bans on foreign investment.
Industry Super Australia (ISA) have pointed out the flaws in this proposal given the purpose of super:
ISA considers that performance tests should be applied consistently to all superannuation products covered by the legislation … it is not clear why it is necessary to introduce a differential test which undermines the intention of the performance test regime by permitting a class of superannuation products to underperform compared with the rest of the market.
If this legislation proceeds as is, then there will be a legislative precedent for future carve-outs which would undermine the YFYS reforms, which were carefully devised to ensure that superannuation funds invest members savings according to the best financial interests duty, and that default funds are subjected to routine performance tests. MySuper products, as default products, must be held to a higher standard, and to allow a default product to be exempt from these standards is to undermine this principle and set a precedent for future underminings.
The bill is a shell
In the bill the key definitions are delegated to APRA. APRA's judgements with-respect-to what is a ‘faith-based’ product could conceivably be subject to review, which would create great uncertainty.
In his submission, UNSW Associate Professor Dr Scott Donald noted the lack of any definition of ‘faith-based’:
It is impossible to escape the need to define ‘faith-based’ because that is the discriminant on which the regime relies. On its face, despite the fact that the regime outlined in Schedule 5 is only available to ‘faith-based’ products, it does not appear to require a definition of what constitutes a ‘faith’. This is convenient because defining a test that would have universal agreement would be extremely difficult and politically fraught. Unfortunately, I submit that the approach currently taken in the Bill does not sidestep the need to provide a definition of the term ‘faith-based’.
Dr Donald describes the regime as ‘a technical sleight-of-hand’, and that the Explanatory Memorandum describes the application regime as ‘essentially mechanical…merely requiring APRA to make an assessment of whether the requisite information has been provided’.
Yet it is unclear how this ‘automatic’ mechanism would work, given the bill does not contain a definition of ‘faith-based’. Dr Donald notes that ‘whilst that would be obvious for many mainstream religions, someone could make an application based on something that none of us has ever heard of as a faith, and there's no obvious way in which APRA could deal with that’.
When asked about a hypothetical application for a ‘faith-based’ carve-out on the basis of a ‘Jedi Knight’ religion, Dr Donald’s response demonstrates the absurdity of this bill:
The way it's written at the moment, yes, I believe they could do that and they could come up with some index they'd created that had to do with the power of the force and that would have to be accepted by APRA.
If a definition of ‘faith-based’ is not provided in legislation, and is left to APRA, then the regulator would seemingly have to determine whether a product is legitimately ‘faith-based’. Given such a difficult definitional task, the regulator may have to simply approve the application ‘automatically’. The Department of the Treasury (Treasury) said that ‘we don't see it as a huge integrity risk’, given the difficulty it would take to set up a false ‘faith-based’ investment index and product.
However, this bill does set the precedent for further undermining of MySuper through allowing divergent investment strategies to perform at a lower standard.
There is also the issue of this bill being discriminatory towards minority faiths, as ‘only major religions are likely to have the financial resources to commission such indices’. Noting previous decisions of the High Court, definitional matters in law on what is considered a ‘religion’ or ‘faith’ are necessarily fraught in a practical sense, and minority faiths are not always as easily protected.
A key issue with the bill is that it is an empty shell. To be viable legislation in accordance with its intent, a ‘faith’ definition should be in the bill. Chartered Accountants Australia and New Zealand (CA ANZ) and CPA Australia asked that the bill and the regulations be changed to ensure ‘a definition of “faith-based product” which is not circular’.
The Responsible Investment Association Australasia (RIAA) expressed concern over the lack detail in the bill:
…from our perspective, the bill as it currently stands is missing some details, such as the definition of 'faith based product' and the specific considerations APRA should have when administering the alternative test regime. This does mean there's a risk of inconsistent treatment of products, inappropriate alternative indices and potentially, at worst, a risk of weakening the consumer protection value of the standard benchmark—and we do believe really fundamentally in that consumer protection value here.
As noted before, the power to approve a ‘faith-based’ super product as a MySuper product would be delegated to APRA. This is a hugely risky approach, given the method taken in this legislation lacks clarity as to how a product is ‘faith-based’ and APRA is given wide discretion to make this determination.
In his submission, Dr Scott Donald explained the proposed process:
The Explanatory Memorandum (‘EM’) describes the regime as essentially mechanical (the EM uses the term ‘automatic’), merely requiring APRA to make an assessment of whether the requisite information has been provided. As such it would appropriately not be a ‘reviewable decision’ under section 344 of the SIS Act. This status would deny a review of the merits of APRA’s decision to an RSE licensee whose application was rejected.
The crucial point however, as Dr Donald points out, is that the ‘bill actually says APRA “may”, it doesn't say it “must”’. It seems to confirm that APRA has the discretion to approve or reject an application for this carve-out under the bill as it stands.
Dr Donald therefore makes the instructive deduction that as APRA must technically make a determination, far from it simply being automatically approved, it does not preclude the decision from being reviewed:
To defend a decision rejecting an otherwise compliant application in court, APRA would, amongst other things, have to be able to demonstrate the existence of a process by which the determination that the approach was not ‘faith-based’ was made, as well as conformity with that process. That is to say, the fact that the RSE licensee whose application was rejected would still be entitled to a review of the decision process, as a matter of administrative law, means that APRA will need a decision process.
The government should make clear how this legislation is intended to work. Is it that APRA is required to determine whether the approach of an applicant is indeed ‘faith-based’ (surely an impossible task without a definition in legislation), or is it that any application should be automatically approved by APRA without recourse to any deliberative assessment on what is
‘faith-based’?
Worryingly, Treasury has confirmed there is nothing in the legislation that requires funds to notify their members if they have failed the primary test:
The legislation is silent on that. There's no expectation that the fund would have to write to members if they, for example, were to fail the current performance test but then pass the supplementary test. There's no obligation for written communication.
Treasury was unable to determine whether a decision had been taken on this, or whether APRA would choose to make the disclosure or if it was simply an ‘implementation issue’.
Undermines MySuper
As the annual performance test currently applies to MySuper products, which are default products that are chosen by an employer, then that test must be stringently upheld without recourse to divergent interests. Default products must be held to a higher standard, and to allow a default product to be exempt from these standards is to undermine this principle and set a precedent for future underminings.
If a product consecutively fails the annual performance test, then they cannot take on new members as a MySuper product.
In his testimony, Dr Donald noted the key differences between MySuper products and choice products:
… there is a big difference between the MySuper products and the choice arena. This is something that has been embedded in the system now for over a decade, that MySuper products are there. You can choose to have your money invested there obviously, but they're essentially there for defaulting members who don't want to take those sorts of decisions. … I believe there is a different sensibility required in the other parts of the sector, both the choice sector and the self-managed super fund sector, in that when you're in those areas you are expected, and are expecting, to exercise a greater degree of choice. Your ability to exercise that choice is reinforced by rights to information from the disclosure regimes and so on.
Furthermore, as put forward by Dr Donald in his submission, ‘the bar for regulatory intervention for the purpose of consumer protection ought to be higher for MySuper products than for products where the individual has exercised an informed choice’.
He rightfully deduces that ‘faith-based’ products are best accommodated in the choice architecture of the superannuation system.
Given the substance of a ‘faith-based’ product’s investment strategy is based on religious beliefs, which largely consists of consciously excluding certain investment options out of principle, then the choice architecture can resolve this tension.
Of course, this does not mean a ‘faith-based’ product cannot pass the annual performance test, but it is unclear why a supplementary test is needed given an individual can make a fully informed decision to choose a fund according to their faith via the choice architecture. Given there has yet to be any performance testing in the choice arena, the case for change has not been met yet.
It is telling that most witnesses supportive of the ‘faith-based’ carve-out did so as part of a broader argument against the MySuper performance test. This lends credence to the notion that this proposed carve-out is being deployed largely as a trojan horse to water-down the performance testing regime and the integrity of the MySuper architecture.
What problem are we trying to solve?
Fourteen funds have failed the MySuper performance test once and four funds have failed twice. The only fund which may be relevant, Catholic Super having failed twice, has already engaged in merger discussion, so there is no clear market problem.
Thirteen funds failed in the first round of the performance testing in 2021, of which 11 were members of the Association of Superannuation Funds of Australia (ASFA). This included Christian Super, who subsequently announced a merger with Australian Ethical Super, and passed the 2022 test.
It is unclear what problem with the performance test this legislation intends to address.
The only religious organisation to make a submission to this inquiry, the Uniting Church in Australia, did so on the basis that Australians wish to invest in funds which align with their ethical values. Whilst it is a basic principle that people should be allowed to invest their money how they choose, this does not substantiate the case for decreasing the performance standards for default MySuper products.
Two funds made submissions to the Treasury consultation on a ‘faith-based’ carve out in legislation, Crescent Wealth and Haven Wealth Partners. Neither of these are MySuper products which are subjected to the annual performance test.
Crescent Wealth noted ‘the lack of availability of reasonable priced Shariah compliant products’, and Haven Wealth noted that fees in relation to these products are still significantly higher than their investment peers.
It is unclear how providing a supplementary performance test for ‘faith-based’ products in the MySuper architecture would solve these issues. These are largely general issues which could apply to nearly all funds subjected to the performance testing regime.
During the inquiry, there was a conflation between ‘faith-based’ or ‘ethical’ products and ESG products. ASFA recommended that the scope of the carve out should be expanded to cover ‘all values based investing, including ethical, ESG and sustainability’, on the basis that ‘many products that employ these values based or principles based investing [are] often born of very legitimate risk management concerns associated with climate change’.
ESG is a mainstream part of investment strategies on the basis of the reality of climate change and environmental risk. It is investment based on economic risk, more than it is ‘ethically–based’.
RIAA clarified this distinction, noting the difference between ‘values-based investing explicitly as opposed to ESG investing, which is more about risk management as opposed to excluding multiple companies from portfolio’:
Senator Bragg: I just want to check one thing because you made some clarifications in your response. The super funds association said in their submission—this is their words, not mine—'The scope should be broadened to all values based investing, including ethical, ESG and sustainability.' I understand your characterisation of values as some sort of a faith based concept, not an ESG based concept, which are quite separate…
Mr O’Connor: Values based to us would be defined as implementing a whole range of values based and ethically driven exclusions in a portfolio. Traditionally, those would be what we would call the ethical investment funds that would exclude possibly gambling, tobacco, weapons, a full range of fossil fuels, animal cruelty, which have the effect of limiting a portfolio of investable stocks. It has quite a different dynamic in terms of its returns profile. I would distinguish what the response is that is required for sustainable and ESG funds as quite a different one.
As has been conceded by Treasury, performance testing of the choice sector has yet to occur. And yet, they argue that this legislative change is primarily relevant to the choice sector.
When asked about what market issue this legislation is seeking to solve, Treasury noted that it would ‘provide certainty to those products in the choice sector at the moment which would be looking at a performance test’.
If they are worried that certain funds in the choice sector could suffer as a result of being subjected to an existing performance test next year, Treasury should explain what the market problem is that would warrant a legislative change.
When asked about which funds could be at risk, Treasury said:.
We don't know. You'd have to wait for the applications, but, yes, the expectation would be quite limited—less than a handful of funds.
The law should not be changed until the problem it seeks to solve has been analysed carefully.
Cherry-picked issue
The bill has been introduced without waiting for the broader Treasury review into the Coalition’s super reforms to conclude.
The specific nature of this carve-out is highly cherry-picked. If this were to be legislated, it would represent a minute adjustment to the performance testing regime which would not address other possible issues which could arise from the YFYS review by Treasury.
If there are legitimate issues with the performance testing, then these issues must be addressed holistically through this review.
AFSA proposed that the bill be changed to allow for a singular ‘adjusted’ benchmark for ‘value-based’ products which does not include the performance of those assets. When asked whether they would support the bill without this change, ASFA did not answer definitively.
AFSA has responded to the bill with a view to larger criticisms of the YFYS performance testing, saying ‘at the very outset, we have had long standing concerns regarding the totality of this test, its reduction of fund performance to the singularity and the subsequent binary nature of the pass-fail. We set that out at the start of our submission’.
In their submission, CA ANZ and CPA Australia recommended that given the broader issues this legislation touches on, they should be raised in the broader YFYS reform review and asked that ‘this proposed change is paused pending the review’.
When asked, Dr Donald also agreed that this should’ve been part of the review in a holistic way:
Yes, I hope so. I hope that that Treasury review has the transparency that you would see in a process such as this so that you would be aware of how the different interests and submissions might come together. But, yes, I think these are issues that have multiple different dimensions. I think it would be useful for it to be seen in a more holistic way.
During Budget Estimates, the Treasury confirmed that commentary on the ‘faith-based’ exemption would not necessarily be excluded from the broader YFYS review. They said that they don’t see themselves as restricted “from going into that space if during the consultation we hear something that is worth the government hearings”.
It is clear that this change should have been consulted as part of the broader review, and experts in this area agree.
Conclusion
The proposed change detailed in Schedule 5 totally undermines MySuper.
It would be opening the floodgates to every wild idea which is not about members’ best financial interests. It would be a shocking precedent.
It does not include the key definition, that being ‘faith-based’, which would allow for it to be viably administered by APRA. It has numerous technical issues around how APRA’s discretion would work.
The proposed change undermines MySuper by seeking to provide for a supplementary performance test for funds which would be better served by the choice sector, which have yet to face the tests.
It is also unclear what problem the bill is intending to fix. The funds that submitted to the Treasury consultation on the bill are not MySuper products, and have not faced the annual performance test. The only MySuper
‘faith-based’ product that has failed the test twice has already started engaging in merger discussions.
Given all this, it is unclear why this legislative change was not considered holistically as part of the YFYS reform review first, prior to being introduced to Parliament.
Even if this was an election commitment of the government, the ramifications of this legislative change means it cannot be passed.
Recommendation
Recommendation
Coalition Senators recommend that:
Treasury Laws Amendment (2022 Measures No. 3) Bill 2022 should only be passed subject to being amended to remove Schedule 5. The MySuper performance testing regime should remain solely focused on the best financial returns for members, without exception;
The performance test should only be extended to trustee-directed choice options; and
A supplementary annual performance test for ‘faith-based’ products should only be considered pending the outcome of the Your Future, Your Super Review being conducted by the Department of the Treasury.
Senator Andrew Bragg
Deputy Chair
Liberal Senator for New South Wales
Senator Dean Smith
Member
Liberal Senator for Western Australia