Making mergers work Why only one in four superannuation mergers succeed
22 February 2023
22 February 2023
In Australia, the superannuation industry has become a finance behemoth with more than 3 trillion of funds under management (FUM) and substantial ownership of the Australian equity market (ASX). Some funds are expected to have more than a trillion dollars FUM by 2030, rivalling the Big 4 banks.
The Australian Prudential Regulation Authority (APRA) have long been focused on ensuring superfunds are maximising members' retirement balances. Unsurprisingly, they are increasingly concerned about erosion of retirement balances by excessive fees, poor returns and insurance premiums. They have introduced reform to make it easier for members to compare the performance of funds through the annual performance tests on workplace default funds with a MySuper account. There are significant consequences for RSEs who fail the performance test more than once, who are no longer able to accept member contributions. Many of the funds who fail have little option other than to seek an opportunity to merge with a better performing fund.
APRA are questioning the ability of smaller funds to create operational synergies and the sustainability of funds with less than $30 billion under management. Widespread consolidation is expected to continue, with smaller funds seeking an opportunity to merge with a better performing fund and larger funds seeking scale to drive further efficiencies and differentiate investment performance through the ability to invest directly in alternative assets. Industry consolidation could see 20 superfunds by 2030.
There are pros and cons to large funds – scale can create operational synergies and reduce fees but it can also create complexity, risk, cumbersome governance and less operational agility.
There is no doubt that some consolidation is necessary and in the best financial interest of members, however funds need to have a clear strategy to ensure any merger is in fact in the best interest of members and that they successfully execute to ensure they realise the benefits intended.
History has shown that only a very small number of mergers succeed, with only 1 in 4 proceeding beyond an MOU. Coupled to this, those that do proceed are often suboptimal in terms of the outcomes realised for both the superfund and its members.
Consolidation, when done well, is good for everyone. For members, benefits include better fund performance secured through the efficiencies gained from being a ‘bigger player’ with increased buying power. For the superfunds involved, there's an opportunity to improve competitiveness, as well as market and brand position.
While mergers in the super space often sound relatively straightforward - with many seeing them as a ‘lifeline’ out of trouble - execution is often a lot more difficult because being in the ‘same’ industry often means very little when it comes to integrating things like products, very different technology platforms and operating models.
Unsuccessful integration, however, can land superfunds in very hot water with APRA and lead to disappointing outcomes for members.
To avoid this kind of failure, it’s imperative that RSEs consider the 11 most common reasons for mergers failing before they even consider entering into a MOU.
#1 No strategic clarity upfront around why you should merge, who you should merge with and the end game
Many mergers fail because there’s simply no strategic clarity around defining the ‘why’ or business case for a merger - including the strategic objectives and perceived benefits of merging, as well as why it is in the members’ best financial interest.
Strategic clarity has a knock-on effect on other aspects of a merger, including defining ‘who’ it is best to merge with; ‘what’ the future fund might look like i.e. the target state, underestimating the complexity in achieving this and the financial instruments needed to do so (the ‘how’).
In terms of the ‘who’ to merge with, a good ‘fit’ depends on clear criteria around what makes a good fit to your organisation, including factors such as:
Working this out ‘as you go’ is a recipe for failure. Knowing your ‘end game’ will help you ensure every step in the merger process is handled with the strategic objectives in mind to ensure what success looks like is clear to everyone.
Clarity on who makes merger-related decisions is important. This could be the Board, collectively, or the Board might delegate this to the Chair or CEO. This needs to be supported by a documented agreement to avoid confusion and potential conflict in future.
In some cases, preliminary discussions may occur (with or without board sanction) in order to "feel out" interested merger parties. These discussions may create false expectations if not managed properly.
Although the trustee board is responsible for making the call on whether to merge, and with who, the shareholders of the trustee company remain important voices in the overall merger process.
At some point in the project, attention will turn to the treatment of the transferor trustee company. Critical in this piece is the understanding of the rights the shareholders enjoy under the relevant trustee company constitution. These are not trivial.
Proper consultation based on a respect for shareholder rights is a critical path to success.
Unhappy shareholders may vent their disapproval by replacing board members.
The importance of a programme manager experienced in superfund mergers cannot be overstated. The sector is filled with those who put themselves forward as having managed multiple mergers - but aren’t true experts in the RSE space.
Their knowledge of these types of integrations is theoretical at best; but not practical.
Superfund mergers require a precise, tailored merger model based on actual experience.
The experience needs to be based on proper mergers of superannuation entities. There are many streams of work that require close attention throughout the project, which must be managed in tandem – including due diligence, investments, licensing and regulator liaison, treatment of employees, key industrial instruments, brand, premises, life insurance, alignment of reserves, material services contracts, disclosure (to all stakeholders), legacy compliance issues and governance.
At the same time, a proper business case for the merger needs to be prepared and maintained.
Even basic matters such as arranging meetings with proper agendas and minute taking need to be properly handled.
One interesting dimension of successful mergers is the presence of an overall mission statement. This may sound trite, but understanding in simple terms why we are merging is important.
Put another way, a merger justified on grounds of "because we have to" is less likely to succeed compared to a merger "which will create the leading super fund in our industry".
A successor fund transfer is essentially the bulk transfer of members and their benefits from one superannuation fund to another.
Unfortunately, inadequate understanding of the transaction documentation involved and the shared infrastructure required to support a successful successor fund transfer is widespread, posing a massive execution risk and slowing momentum.
Understanding the relationship between the MOU, the SFT deed and the transition plan are critical.
As part of this understanding is the need to know what board meetings will consider what documents with what supporting materials. Put another way, do I understand what risk the board will be adopting at each part of the project?
Comity and a clear understand between parties of the basics of the merger is vital, including:
One common error is to think that an MOU "makes a deal".
The role of the MOU is to record the deal. If you can't explain simply what the deal is, there is more work required.
The importance of thorough due diligence cannot be overstated - failure to identify key risk areas during the due diligence process can lead to significant liability later on. Details such as the incorrect valuation of assets or interrogating whether the merging funds have pay parity are often overlooked.
When a final attestation is signed by the RSEs, they’re giving their assurance that the merger can proceed. This can only be done in confidence when their due diligence has been thorough. Failure to discover anything that should have been obvious at the due diligence phase of a project will often lead to probing from APRA and lengthy liaison with the regulator.
The due diligence process should also be supported by an adequate data room and fit-for-purpose data room protocols. This is critical in terms of identifying potential risks that will inform warranties and support the transition plan sign off.
For a merger to be successful, you need to document the principles and approach that will govern the merger and clearly lay out ‘what happens next’ once transfer has occurred. This includes the new roles, responsibilities and future organisation structure. Understanding whether a transition plan is legally or not legally enforceable can prevent a lot of pain in future.
Counter-intuitively, the transition plan does not need to be a sophisticated document. It should describe:
The plan itself then articulates the key steps to deliver what we want post merger.
Workable, right-sized merger governance structures that work in the ‘real world’ are a critical element to get right. A governance model that is overly complex can break momentum and result in ineffective or unnecessary meetings and slow down decision making and progress; even resulting in reworks and confusion.
In addition, Board delegations should be clear and support timely progress.
Communication to stakeholders, employees and the regulator must be carefully timed and sequenced. An experienced project manager will understand the complexities involved in communicating to each of these groups and how to allay fears and help manage objections and uncertainty from the outset.
Identifying the 9 discrete classes of stakeholder, and developing a proper plan for each group, is essential.
The communications plans of both funds need to be in sync.
Much like renovating a home, mergers are often infinitely more complex, more time-consuming and more costly than ever anticipated. Done right, there are significant benefits, but this relies heavily on entering into them with a thorough understanding of the complexity and level of effort to get it right.
Failing to invest in a sustainable integration leads to expected synergies not materialising. Well thought out integration plans are essential to define how the target state will be achieved. They consider adequate resourcing, creating space to integrate, executive time and effort, understanding the interdependencies of work streams, and an understanding of the multi-faceted nature of many issues. The devil is often in the detail and socialising plans widely can help to avoid pitfalls.
Bringing employees, members and stakeholders on the integration journey requires regular, two-way communication so that issues can be dealt with when they arise. Identifying flow on impacts upstream and downstream through the value chain is essential. Underestimate the complexity at your peril – whilst there are two entities new issues are created and it is essential that enough space is created for leaders to lead, BAU activities to continue and integration activities to occur concurrently.
Ashurst’s team has deep experience and expertise in the successful merger of superfunds. Please be in touch if we can help ensure your merger is the ‘1 in 4’ that does succeed.
Authors: Niki Short, Partner; and Scott Charaneka, Partner.