Safety in Outsourcing: New Rules for Superannuation Trustees

The Safety in Superannuation reform package that amended the Superannuation (Industry) Supervision Act and Regulations became effective on 1 July 2004. In addition to the introduction of a licensing regime for superannuation trustees and a registration regime for certain superannuation funds, the reform package introduced new operating standards that trustees must comply with. One of these operating standards is the Operating Standard on Outsourcing. The Outsourcing Standard is accompanied by APRA Superannuation Guidance Note 130.1 which seeks to clarify the operation of the standard.

The Outsourcing Standard will apply to all superannuation trustees who become licensed under the new licensing regime. It applies to all material outsourcing agreements (definition discussed below) entered into after a particular trustee has become licensed. During the two-year transition period, non-complying outsourcing agreements can remain in place without a trustee being in breach of the Outsourcing Standard. However, after the transition period ends on 30 June 2006 (or six months earlier if APRA decides to shorten it) all material outsourcing agreements that are entered into before or during the transition period must comply with the Outsourcing Standard or be terminated.

Having regard to the fact that there is a requirement to terminate non-complying material outsourcing agreements and that APRA will be considering a trustee's outsourcing arrangements as part of its license application, it is critical that trustees who intend to apply for a license commence a due diligence of their outsourcing arrangements now. In this article we discuss some of the key features of the Outsourcing Standard and how they relate to an outsourcing due diligence.

Agreements or arrangements

The Outsourcing Standard applies to all 'material outsourcing agreements' and it sets out the content requirements that material outsourcing agreements must comply with. The definition of material outsourcing agreement is broad and it captures agreements or arrangements between a service provider and a trustee where the service provider performs a 'material business activity'. The use of the broad words 'agreement or arrangement' could extend to informal, undocumented arrangements. Accordingly, trustees must take care when they perform an outsourcing due diligence to identify all material outsourcing arrangements regardless of the extent to which they have been formalised.

A material business activity is defined to be a business activity of the trustee a disruption to which, or the poor performance of which, has the potential to affect the interests of members of the relevant superannuation fund or have significant impact, having regard to a number of factors, on the trustee or the relevant superannuation fund. Once all of the activities of the trustee which are outsourced have been identified as part of the due diligence process, it will then be necessary to assess each of those activities to determine whether or not they are material. Examples of factors going to materiality are provided in the Guidance Note and include the degree of difficulty in finding an alternative provider or bringing the activity in-house and the compliance issues that would be faced if a problem arose with the service provider.

However, 'business activity' is not defined and little guidance can be found in case law. There are cases which interpret the meaning of 'carrying on a business' in a tax and company law context. These cases emphasise the importance of repeated, continuous or systematic transactions. By analogy, perhaps, a business activity of a trustee, might be the transactions that a trustee performs, or could perform, continuously, regularly or systematically. Whatever the interpretation of 'business activity', in our view, an important starting point in the process of identifying business activities will be the trust deed since it will set out the scope of the trustee's activities.

Outsourcing by service providers

The Outsourcing Standard also covers agreements or arrangements between a service provider and another service provider where that agreement or arrangement provides for the performance of material business activities that were covered by the material outsourcing agreement. Clearly, trustees need to ensure that appropriate terms are contained in the outsourcing agreement with the service provider who is actually performing the outsourced activities, even if the trustee is not a party to that agreement. The key point here is to map all the relationships between the trustee and its various service providers, including those further down the chain, in the due diligence process.

Terminating outsourcing agreements

Although the Outsourcing Standard provides that non-complying material outsourcing agreements must be terminated before or at the end of the transition period, it does not operate to override contract law. That is, if in terminating a non-complying outsourcing agreement in order to comply with the Outsourcing Standard a trustee breaches the terms of that agreement, the trustee may be liable for any damages suffered by the service provider.

In the event that amending or terminating outsourcing agreements in order to comply with the Outsourcing Standard is not commercially feasible, it may be appropriate to consider obtaining an exemption from the Outsourcing Standard from APRA.

As an aside, we note that the International Organization of Securities Commissions recently published a consultation report entitled "Principles on Outsourcing of Financial Services for Market Intermediaries". The publication of this report demonstrates that the extent of outsourcing in the financial services industry, and the way in which the particular risks associated with outsourcing are managed, is a global issue and not peculiar to Australian superannuation trustees.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.