Australian regulator will force funds to improve standards

Australia’s prudential regulator has flagged a range of changes that will bring regulatory oversight for the country’s $1.3 trillion industry up to a level similar to that in the insurance and banking industries.

Australian superannuation industry bodies have come out in support of the sweeping regulatory overhaul that will require funds to hold capital in reserve and also to provide more transparency around investment decisions.

The Australian Prudential Regulation Authority (APRA) previously only had the power to provide guidance to funds. But under new supervisory powers given to the regulator by the Federal Government, APRA will be able to set prudential standards from 2013.

In a recently released discussion paper on its proposed standards, APRA says all funds will be required to increase their reporting procedures around investment decisions, conflicts of interest and hiring external managers.

When it comes to investment decisions, trustees must outline their risk and return objectives and monitor these on an ongoing basis. Trustees must also indicate a benchmark or benchmarks against which they will measure their performance.

APRA will also require trustees to consider performance fees, taxation implications and overall costs and take into account the availability of timely and independent valuation information when setting and implementing investment strategies.

Funds will also have to clearly articulate risk appetite both at an operational level and for individual risks. This will form part of a formal risk-management framework that funds must provide, report on and monitor.

The risk framework will also involve both identifying the risks members will face and the likely “maximum impact” of any particular risk being realised.

Trustees will be required to show how the risk management framework, and monitoring and management procedures are appropriate for the size, scope and complexity of the fund.

The standards also seek to beef up the governance requirements for funds.

While the recent Cooper review recommended funds ensure a third of their directors were independent, APRA has flagged it will encourage funds to appoint at least one independent director.

As part of its proposed governance improvements, APRA will also require funds to put in place a board renewal policy that will indicate the maximum terms for directors.

Funds will also be required to establish and maintain a board remuneration committee, which would make remuneration for senior executives and directors publicly available.

Directors will also have to report extensively on their interests, and boards will have to develop and maintain a conflict of interest management framework, which would involve comprehensive internal monitoring, reporting and controls.

The chief executive of the Australian Institute of Superannuation Trustees (AIST), Fiona Reynolds (pictured), says the proposed changes that seek to improve governance standards at funds are in line with the governance framework the institute already advocates.

“We knew APRA’s supervisory powers were being enhanced, and the main concern of the industry was to make sure that the approach of APRA was flexible,” Reynolds says.

“So it’s good to see that APRA has steered clear of taking a one-size-fits-all approach and will look at how different funds operate and the different circumstances with which they might manage such things as operational reserves. We think this is the right approach but there is still plenty of finer detail that the industry and APRA will need to nut out together to ensure compliance costs are kept to a minimum and the industry is absolutely clear about the new requirements.”

While APRA fell short of enforcing minimum capital reserves for funds, its discussion paper notes that in other industries there is a requirement to set aside 0.25 per cent of funds under management.

This money could be primarily used to compensate members if they experienced administrative errors.

Trustees of defined benefit schemes must also ensure that the financial position of the fund and any sub-funds allows all liabilities to be met as they fall due.

APRA has released the discussion paper and the industry has until December 23 to provide feedback.

Financial Services Council chief executive officer John Brogden says the new standards will become a critical part of the superannuation regulatory framework and the industry will engage in extensive consultation with APRA on the development of regulation.

He says some funds will need to lift their game to meet the requirements of a suite of proposed changes that has the potential to substantially increase a fund’s compliance costs.

“While a large number of super funds will already be meeting these governance requirements, it will appropriately raise the bar for many others,” Brogden says.

APRA will also require trustees to up the ante on disclosure when it comes to external service providers.

This will involve more formalised due diligence requirements and a written outsourcing policy.

The Association of Superannuation Funds of Australia (ASFA) also lent its support to improved regulatory standards, saying that it had long called for APRA to have standard-making power for the industry.

ASFA chief executive Pauline Vamos says current disclosure requirements could actually make it difficult for trustees to provide transparent disclosure and that it was timely to revisit regulation in this area.

As part of its response to the discussion paper, ASFA will hold a round of national seminars during October to canvass the views of members on the changes.