As stated in section 11 (The role of the government), only governments can regulate to enforce codes of private (and public) conduct. In a retirement saving context, we suggested that this covers minimum disclosure and reporting standards (covered in the last section 18) and also requires financial service providers “…to ensure investors and experts know what they need to know”.
Code of conduct
The Financial Markets Authority (FMA) is:
“…the New Zealand government agency responsible for enforcing securities, financial reporting and company law as they apply to financial services and securities markets. We also regulate securities exchanges, financial advisers and brokers, auditors, trustees and issuers - including issuers of KiwiSaver and superannuation schemes.” (web site accessible here)
The FM Apartners “…with public and private organisations to develop and promote education resources and messages to help investors make better investment decisions.” (FMA website here)
It has published A guide to the FMA’s view of conduct (2017)[1] We will confine our comments to issues associated with ‘collective investment vehicles’ such as those that might be used by people who are saving for retirement.
The Guide says that ‘good conduct’ matters and that this extends from the initial investment, through additional contributions and regular reporting and on to the benefit payment. It involves providers demonstrating that conduct “in a clear, concise and compelling way.” (page 8). It summarises ‘conduct’ under five headings that, seemingly deliberately, all ‘happen’ to start with ‘C’: capability, conflict, culture, control and communication. It provides specific guidelines that ask questions that relate to each of those five areas.
All this seems sound in theory and difficult to challenge in principle. However, we will not really know what it means in practice until the FMA tries to put some regulatory runs on the board. The Guidewas published in February 2017, more than two years ago and it’s now eight years since the FMA started. At this stage, we cannot tell whether any of this has improved, or will improve, the financial services industry’s ‘conduct’.
In fact, we go further – with specific regard to superannuation and workplace savings schemes and the other collective investment vehicles used by New Zealanders to save for retirement, has there ever been a case of bad conduct; of a scheme failing or disappearing with the money?[2]We cannot think of any so what precisely will be the measures of ‘success’ with respect to New Zealanders’ interactions with collective investment vehicles?
We agree that the financial services industry can always be ‘better behaved’ (disclosure, fees etc.) but the retirement savings component of the industry has never suffered from the kinds of failure in finance companies that were the main reason for the FMA’s establishment and the introduction of the current regulatory regime. With specific regard to retirement savings, we remain unconvinced that A guide to the FMA’s view of conduct will make any material difference to the experience of New Zealanders who are saving for retirement. We doubt that, had a similar regime been in place in Australia, it would have prevented the practices identified by its Royal Commission review[3]. We look forward to seeing any evidence in that regard.
Governance of collective investment vehicles
For many decades, ‘superannuation schemes’ were run under ordinary trust law, as that was developed under the Law of Equity and regulated by the Trustee Act 1956, that applied to all trusts, not just superannuation schemes. Employer-sponsored occupational schemes typically had the employer as sponsor and trustees as the scheme’s administrator. Sometimes, a company was incorporated for the purpose of acting as trustee but otherwise, they were usually employees of the sponsoring employer.
Initially, the schemes were regulated by the Inland Revenue, given the tax concessions granted to contributions, investment income and benefits. In 1976, the Superannuation Schemes Act become the governing legislation and the Government Actuary assumed regulatory control[4]. Under the successor act (Superannuation Schemes Act 1989, accessible here) and with the disappearance of tax favours, the regulatory oversight changed from ‘approval’ by the Government Actuary to ‘registration’ with the Government Actuary but the trustees’/beneficiaries’ relationship remained. There were still no particular regulatory requirements as to the trustees. Under section 2 of the 1989 Act, trustees were “…the persons who were designated as such in the trust deed…”
The point of this brief history is that the arrangements ‘worked’ from a regulatory viewpoint. No schemes ‘fell over’. Broadly, they did what they said they would do with only a light regulatory oversight.
That relatively informal arrangement changed with the introduction of ‘Investment Statements’ and prospectus-based disclosure under the Securities Act in 1998. That introduced complexity and cost but probably worsened the regulatory environment and contributed nothing to the governance of superannuation. That has now been replaced by the ‘Product Disclosure Statement’ - see section 18 (Disclosure – both initial and ongoing) for more on this. At the same time, new rules about trustees were introduced. They now had to be equivalent to those of every other scheme that solicits investments from the public. A new industry of licensed independent trustees (LITs) has been established as every scheme must have one, equivalent to a supervisor, and the compliance costs have risen accordingly. For defined benefit schemes this has added to the costs of providing the benefits and for defined contribution schemes it has reduced the returns and therefore reduced the benefits ultimately payable.
Section 124 of the Financial Markets Conduct Act 2013 (accessible here) now requires all ‘managed investment schemes’ “…to meet key common governance and reporting standards” and replaces sponsors/promoters and trustees with ‘managers’ and ‘supervisors’ who “…owe duties of care to investors’.[5] Supervisors for most schemes (by assets and members) must now be one of a very small group of ‘corporate trustees’.
We think it’s time our suggested review of retirement income arrangements addressed the questions we raise at the end of this section. The old superannuation governance regime ‘worked’ if the test is whether savers did get what they were promised.
On investment performance comparisons
There is a generally accepted principle that past performance does not and cannot indicate future performance. Words to this effect are stated on most investment return disclosures. Yet despite this, many investment decisions by investors are in fact driven by relative past performance and the industry often continues to publish returns in a way that encourages this behaviour. It is not uncommon for managers to market on the basis of “our return was the highest for the ‘n’ years ending 31 March 2019”. Also, with the launch of the Fund Finder tool on the Sorted website available here, there is now a regulatory encouragement and endorsement for paying close attention to short-term past performance. Given this, we think the standards of conduct should focus on making sure that the use of historical performance numbers is not misleading and that it allows appropriate comparisons between providers of the reasons for the performance and not just the absolute return outcome.
Historical practice let managers choose to disclose returns on whatever basis they decided. Most chose to disclose ‘gross of fees and tax’ (bigger numbers) but those declared returns had little connection with the return that the investor received.
Investment performance in surveys is mostly disclosed on a time-weighted basis, net of fees and before tax, assuming no cash inflows or outgoings. However, many managers continue to publish returns before fees and before tax as well and put the emphasis on these. The important return is the return that the investor gets in the hand, i.e. the return after fees and after tax and allowing for cash flows. This will be a net money-weighted return.
Under KiwiSaver, and now for all CIVs, managers must publish returns in quarterly ‘fund updates’ net of fees and net of tax at the highest tax rate, using a time-weighted basis. These returns must be published on the manager’s website and provided to the FMA. KiwiSaver returns are used on the Sorted website’s Fund finder calculator (accessible here). This is a considerable improvement on historical practices. It is, however, unhelpful and confusing that managers are still allowed to publish returns on other bases. It would be beneficial if managers were only allowed to disclose on a basis that is consistent with a single set of principles.
What is lacking in the new regime however, is independent and competent analyses of the returns. Given that the central data base has details of the investment strategies and net of tax and fees returns, it would make sense for an independent body to publish league tables of the returns grouped in comparable bands. This has not happened from within the industry and so should have been recommended by the Retirement Commissioner’s 2016 Review.
Also, the government or the FMA, should contract a university’s finance or business faculty to analyse the data and publish regular reports. The government is in the ideal position to organise analyses of the data and should do that. Would it not help savers if we could see whether what managers say they do to achieve returns is what they actually do?
On disclosure of fees
The Retirement Commissioner’s 2016 Review (accessible here at page 14) recommended that KiwiSaver schemes should be required to disclose “…the total dollar cost of all fees on [members’] annual statements [being]…the total of all administration and management costs, including any underlying management or performance fees.”
The FMA published a ‘methodology notice’[6]that required KiwiSaver schemes to comply with the new disclosure requirement with annual statements for 2018 and later. In the associated Guidance note(a ‘tracked changes’ version of which is accessible here), the FMA says it prefers that providers use the ‘cents per unit’ (CPU) on the ‘valuation day’ basis, rather than the ‘total annual fund charge’ (TAFC) basis but will allow the TAFC basis in the meantime.
The CPU basis will work for funds that have ‘units’ on which to calculate the fees. For the rest, the TAFC is the only practical basis.
The FMA has suggested:
“The FMA encourages KiwiSaver members to compare the fees they are paying for their chosen funds with those of other providers and they can do this by looking at the fund updates and the product disclosure statements.” (Media release 8 June 2017)
We think this is wishful thinking and won’t happen. We support the move to standardise fee disclosure, even to have those expressed in both dollars and percentages but suggest this will not be a game-changer. Also, this new regime should not be confined to KiwiSaver schemes. All CIVs should be required to disclose fees in dollar terms. Also, the fees disclosed should not be the fees for the last year but the fees for each of the last ten years where the data is available for that investor. Understanding the trend in fees and seeing the total fees over a reasonable period of time is more likely to focus an investor’s mind.
Terms of reference for 2019 Review
The Terms of Reference for the Retirement Commissioner’s 2019 Review asked for information with respect to:
“4. Information about, and relevant to, the public’s perception and understanding of KiwiSaver fees,including:
a. The level and types of fees charged by KiwiSaver providers; and
b. The impact that fees may have on KiwiSaverbalances.”
If the more detailed questions we suggest below are addressed, the government’s assessment request will be covered. However, the 2019 Review should include all CIVs, not just KiwiSaver schemes.
Questions that New Zealand needs to discuss on regulation:
The FMA started on 1 May 2011 to, amongst other things rationalise the regulation of financial markets and to “…promote confident and informed participation in New Zealand’s financial markets”[7]. With specific regard to superannuation schemes and other similar ‘collective investment vehicles’ how is it doing? What is it doing? How specifically might these activities promote that confident and informed participation?
In the seven years to 30 June 2018, the FMA has spent $217 million on all of its activities[8], including the supervision of ‘collective investment vehicles’. Has New Zealand received good value against the FMA’s stated objectives (“well-informed consumers and investors, healthy and robust businesses, competitive markets, good conduct by businesses and global recognition of New Zealand as a strong business environment.”)?
Given the large costs involved to schemes (members and sponsors) of the move to the new regulatory regime under the Financial Markets Conducts Act 2013, how is the new regime working? How specifically has the security of savers’ entitlements been enhanced by comparison with the previous regime? What have ‘supervisors’ added to the governance process and what do ‘managers’ think of the way things work now?
The government has intervened on the publication of fees for just KiwiSaver schemes. Why not extend that to all ‘collective investment vehicles’? How much do KiwiSaver members now understand about the fees they pay?
Why can’t the government require, as a condition of approval, that all ‘collective investment vehicles’ (not just KiwiSaver schemes) submit quarterly investment performance data to a central clearing agency (perhaps a university’s accounting faculty)? This would allow published comparisons to be made on a consistent basis.
[1]The FMA’s Guide is accessible here.
[2]The only case that comes close to such a scheme was the occupational schemes sponsored by Fortex Group Limited but this involved short-paid contributions to the schemes (both those deducted from employees’ pay and the employer’s own contributions)when receivership intervened (decisions analysed in 6 Waikato Law Review 127, accessible here). That was more a matter of employment law (unpaid remuneration) than trust law. There was no difficulty with respect to the assets that were already in the schemes.
[3]Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, February 2019, Final Report, accessible here.
[4]After a two-year period of regulatory confusion created by the introduction of the compulsory ‘New Zealand Superannuation Scheme’ and associated ‘approved alternative schemes’ under the New Zealand Superannuation Act 1974.
[5]‘Trustees’ are still possible for ‘restricted schemes’.
[6]Consultation paper: KiwiSaver annual statements – calculation of total fees in dollars(June 2017) accessible here.
[7]Annual Report (2012), Financial Markets Authority (accessible here) at page 3.
[8]Expenditure details extracted from the FMA’s Annual reports, posted here.