Two of the biggest public-sector superannuation funds, VicSuper and First State Super, look set to join forces after commencing due diligence on a merger proposal.

Combining of the two, which are default funds for public servants in Victoria and NSW, would see the creation of a $120 billion not-for-profit behemoth, second only to the nation’s largest fund, AustralianSuper.

Due diligence and other necessary merger preparations would not see the two funds come together until July 2020.

It is a move that would put pressure on under-performing funds to find a partner or wind themselves up.

The regulator, the Australian Prudential Regulation Authority, is being forced to do something about chronic underperformance among some super funds after pressure from the Productivity Commission and the Hayne royal commission into banking.

First State, a $98 billion fund, will be the senior partners in the deal following an agreement that will give it the chairman and CEO roles as well as a boardroom majority, The Australian has reported.

First State CEO Deanne Stewart was optimistic about the merger plan.

“The merger business case has confirmed there is strong alignment between our funds and we’re confident we could generate significant benefits for our combined membership,” she said.

VicSuper is a $22 billion fund. Well-regarded CEO Michael Dundon will remain with the combined vehicle, at least to bed down the merger.

First State has been on the takeover trail in recent years, buying more than $21 billion worth of assets under management in a range of deals.

In a statement VicSuper said: “We’re in the early stages of discussions, however, we both believe a merger that builds on our shared heritage, values and strengths could provide significant benefits for our members.

“We have a lot in common. We’re both profit-to-member funds, put our members first and believe in the importance of financial advice to help our members make the most of their retirement savings, while also sharing members from similar industries.”