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Finance and Public Administration Legislation Committee
08/08/2012

BURGESS, Mr Mark, Managing Director, Future Fund Management Agency

FEENEY, Dr Greg, Assistant Secretary, Funds and Actuarial Branch, Department of Finance and Deregulation

GREENSLADE, Mr Alan, First Assistant Secretary, Funds and Superannuation Division, Department of Finance and Deregulation

HAGART, Mr Gordon, Head of ESG Management Risk, Future Fund Management Agency

CHAIR: Welcome. Information on parliamentary privilege and the protection of witnesses and evidence has been provided to you. I remind witnesses that the Senate has resolved that an officer of a department of the Commonwealth or of a state shall not be asked to give opinions on matters of policy and shall be given reasonable opportunity to refer questions asked of the officer to superior officers. There is no minister here today. This resolution prohibits only questions asking for opinions on matters of policy and does not preclude questions asking for explanations of policies or the actual questions about when and how policies were adopted. The committee has your submissions and I now invite you both to give a short opening statement and at the conclusion of your remarks I invite members of the committee to put forward questions.

Mr Greenslade : We do not wish to make an opening statement. Both Dr Feeney and I are here to answer questions.

Mr Burgess : I am joined here by my colleague Mr Gordon Hagart. He is head of ESG risk management and has been with the Future Fund since 2009. He has extensive experience in the area, including having spent three years in the UN working on the UN PRI principles amongst other things. He is also a senior consultant and widely considered to be an expert in the field.

Senator DI NATALE: Thanks very much, Mr Burgess and other witnesses, for presenting today. Just for some clarity around the way the fund currently works and the development of the investment mandate as it stands, can you just outline of the process for the development of that investment mandate and the powers that the minister currently has in defining that mandate?

Mr Greenslade : The investment mandate sets a clear, long-term objective for the Future Fund. It sets a benchmark return and makes a statement about risk and return and a few operational matters. Essentially it is a framework that provides broad guidance and responsibility for making investment decisions, including developing investment policies consistent with the mandate. That is the responsibility of the Future Fund Board of Guardians, and Mr Burgess can expand on how that works.

Mr Burgess : As you would be aware, one of the key principles of the fund is the independence of the board and the board's position of taking an independent approach inside the mandate and inside the act as it stands. That is at the highest level; below that we have very clearly defined investment processes and structures on which we then position the portfolio. Our approach is to run a diversified portfolio with a long-term focus to enhance returns with an adequate or appropriate level of risk. Inside that, of course, are many factors. I could go into them in detail, and I am sure that we will discuss some of them today, but one that I would like to touch on particularly is our approach to environmental, social and governance factors. We do consider those to be very important. We implement them inside our investment process, and they are a very critical part of the overall approach to investing the funds. So it cascades down from a very clearly defined structure and framework which, just as an aside, is recognised globally as being at a very, very high level.

Senator DI NATALE: Does the minister have the capacity to update that mandate at any time?

Mr Greenslade : Yes, there are provisions in there. The mandate can be changed.

Senator DI NATALE: Are there any exclusions currently specified in the investment mandate?

Mr Greenslade : No, there are no specific exclusions.

Senator DI NATALE: And the direction around Telstra?

Mr Greenslade : Sorry; yes, there is a prohibition on purchasing Telstra shares. That flows from the structural issue to do with the set-up of the fund.

Senator DI NATALE: I am aware of why it is there; the point is that there currently is within the act the capacity for the minister to update the mandate at any time. Is that correct?

Mr Greenslade : Yes, that is correct—the two ministers responsible.

Senator DI NATALE: And there currently is the capacity within the act to outline the list of exclusions—and, in fact, there already is one around Telstra. Is that correct?

Mr Greenslade : As I said earlier, there is a specific reason for the inclusion of Telstra. But I go back to the Future Fund Act and the arrangement established. There is a broad intent for the various provisions in the act—the mandate and so on. That clear intent is that the board makes investments at arm's length from government. The act assigns responsibility to the Future Fund Board of Guardians. The board is a separate legal entity and has responsibility for deciding how to invest. An investment mandate essentially provides strategic guidance from the government to the board whilst maintaining the board's independence in investment decisions. That was reinforced a few years ago when the then government introduced an amendment to the act, section 18A, which prevents ministers from giving directions which require the board to invest in particular assets, in particular businesses or in particular activities. Successive governments have stated that they do not wish to influence the Future Fund board's investment decisions.

Senator DI NATALE: Yes, I understand all of that, and I am aware of the issues around trying to set up an independent structure of government and broadly agree with that. However, there is within the act already the capacity for a minister to list exclusions—in fact, we already know that there is one—and, if I happen to be the appropriate minister tomorrow morning by some miracle, I could wake up and add a list of exclusions tomorrow which the fund would be forced to respond to.

Mr Greenslade : I think that the Telstra example is a specific and different one; it is not excluded for investment or other policy reasons. The legislation does not explicitly address exclusions; there is not something explicit in the legislation which says that the government can make exclusions. As I said, the provisions in the legislation are intended to ensure that the Future Fund is not invested in a way that is inconsistent with its objective and that those decisions are at arm's length from government.

Senator DI NATALE: Sure; but my point remains that, under the current act, it is possible for the minister to identify particular industries that it does not want to fund to invest in. That power exists at present under the act. It is just a simple question: does the minister have the power to be to do that at present under the act? It is a very straightforward question.

Mr Greenslade : If you want further information, I think I need to take it on notice. As I said, the whole framework is around these decisions being made—

Senator DI NATALE: No, I am asking a specific question around the act. It is very straightforward question and requires a yes or no answer.

CHAIR: Senator Di Natale, you have asked that question three times now. The witness was trying to respond, and he asked to take it on notice. He has the prerogative to do that.

Senator DI NATALE: Just to clarify: you cannot answer the question as to whether the minister has the capacity to list an exclusion under the act?

Mr Greenslade : As I said, I think there is a whole—

Senator DI NATALE: Let's move on.

CHAIR: Senator Di Natale, you have asked the question three times. Please allow the witness to conclude his remarks and his response to you. Mr Greenslade, you have the call.

Mr Greenslade : I might just leave it there. I was trying to say that there is a whole set of arrangements which are very clear around the intent on investment decision-making. This is a specific question that asks a different question, and I would like to take that on notice.

Senator DI NATALE: I do not mean to labour the point. The reason I have highlighted this issue is simply to demonstrate that, under what is being proposed here, there is no change to the capacity of the minister to be able to list exclusions. Those powers already exist within the current act, and I am particularly interested in the submission about the fact that what already exists within the act—which is the capacity for the minister to highlight exclusions—somehow compromises the independence of the fund. That is what I am really trying to get out.

Mr Greenslade : Could I explain a little bit more what we are trying to say in our submission? First of all, I go back to Telstra and explain that the provision around Telstra was simply because that was a transferred asset into the Future Fund at the time that the fund was created and there had to be provision in some form or another to advise the board, notwithstanding there was this independent framework, on what it did with some assets that were transferred. Otherwise, the mandate would not have made a lot of sense. So that specifically happened as a result of transferred assets.

I do characterise the provisions in the bill somewhat differently to the way you, Senator, have said there is not much change. I think there is—it is potentially quite a wide-ranging framework for influence by the minister in decision-making, so it could create a range of excluded types of investment and set quite a broad set of ethical guidelines, potentially. In that way the bill does amend the purpose of the Future Fund; it is very clear in the legislation. It has a focus on strengthening the Commonwealth's long-term financial position, and it would change that to using the Future Fund to try to achieve other policy objectives. That is in our view, as put in our submission, a significant change. There are significant considerations that flow from that, which we are suggesting the committee may wish to consider. For example, it creates ambiguity around the role of the board and the potential for conflicts in purpose when making investment decisions. We have expressed the view that it would constrain the ability of the board to deliver on its long-term investment strategy, and that has implications for costs, implications for future returns and implications for the government's future position, which is what this fund was set up for.

The other point I would make which I think really distinguishes the bill from current arrangements, is that it goes to the question of who makes investment decisions. To date, the policy of successive governments has been to ensure that investment decisions are independent of government, and that view is reflected in the Future Fund act, as I indicated. It is essentially an arm's-length arrangement, and the view has been that that is in the best interests of taxpayers. The arrangement has worked well to date, and, as Mr Burgess said, some of the Future Fund's approaches are considered international best practice. The present arrangements have provided for a stable, long-term investment mandate from government. The bill would create a second set of ministerial directions with different policy objectives; that is the difference with the Telstra point. Those policy objectives could change over time—they could change with different governments and so on—so it would create a shorter-term as opposed to a longer-term horizon on some of those objectives. That would be hard to manage and undermine the ability to invest for the long term and potentially reduce returns. So I do characterise it as quite different to the current arrangements.

Senator DI NATALE: We will disagree on that, because I think that the power of government to intervene in investment decisions as they currently stand exist within the act. It is a decision of successive governments not to do that. I respect that, but I do not think that the power does not exist within the act.

Let us focus on the issues that we are most concerned about here. Clearly my concern in this is the now over $200 million investment by the fund in the tobacco industry in an environment where the government has commendably pursued a strategy to reduce smoking rates in this country and globally through its plain packaging initiative; yet the fund continues to invest over $200 million in the industry. We as a nation have signed on to the global convention on Tobacco. In fact, we are one of 174 countries to do that. The WHO Framework Convention on Tobacco Control says very explicitly that government institutions and their bodies should not have financial interest in the tobacco industry. It says that very explicitly. We are a signatory to this convention, and the convention says that we as a nation should not be investing in the tobacco industry. The fund has also said explicitly that Australia has ratified—and I will use the words from the submission—'a number of international national conventions and treaties that limit certain activities,' and:

Where the Board becomes aware that the activities of an entity or funding activity may contravene an international treaty ratified by Australia, the Board will consider the exclusion or removal of the investment from the portfolio.

Why haven't you done that yet?

Mr Greenslade : First of all, let me agree with you that Australia is considered one of the world's leaders in terms of public health policies in this space, and those policies include current legislation before the parliament on plain packaging of tobacco products. The last budget had a measure to reduce personal allowances for duty-free tobacco, a 25 per cent increase in the tobacco excise, campaigns to encourage people to quit smoking and subsidised nicotine patches through the Pharmaceutical Benefits Scheme. So, yes, I agree—we have significant health policies in that area.

I would make the point before I deal with your specific question about the convention that of course the bill goes to much more than tobacco, the point I made in my earlier comments. It creates quite a wide framework for ministerial guidance in this space. But with respect to the WHO convention on tobacco control, Australia is a signatory to that convention. There are guidelines within that convention that contain a number of recommendations. Recommendations 4.7 and 7.2 go to financial interests, as you indicated. I should point out that those guidelines acknowledge the sovereign right of the parties to the convention to determine and establish their tobacco control policies. The guidelines are not binding and they do not have treaty status.

Senator DI NATALE: So we have signed on to a convention around tobacco control that makes it very clear that countries which are signatories to this convention should not be investing in the tobacco industry. The fund acknowledges and has acknowledged in the past through its decision to divest itself of stocks in cluster munitions as a result of Australia signing on to the treaty on cluster weapons, yet here in this area of government policy where clearly we have pursued a line of action around a whole range of reforms, including plain packaging, you have made a decision to continue investing in tobacco. I see a large inconsistency. With due respect, the reason this bill is here is because the fund has not acted in this area.

Mr Greenslade : Let me just reiterate. First of all, the guidelines are not binding. They do not have treaty status, so it is essentially a matter for the Future Fund how within the context of its ESG policy it has assessed these matters. Perhaps they can explain how they do that.

Mr Burgess : You quoted from the guidelines. There are 83 guidelines attached to that, from memory, or some large number like that. The actual convention itself we look very closely at and we have sought advice from the department and also external advice. In accordance with our policy, we believe we are adhering to the conventions and treaties in Australia. I would like to get to a discussion about the bill itself as well, if I could. You talked about the reason for the bill being in place. The bill stretches far and wide and it is the fund's view and the board's view, which respects parliament's ability to assess bills obviously and determine what is appropriate, that the bill does stretch a long way and have very broad implications for the fund potentially and its reputation. I would like to go into that in more detail, but certainly on the specific aspect of tobacco we believe that we are adhering to the conventions. We use it as a key criterion, that and the legal status. This applies to all of our investments on a very broad basis. I would add that we do apply our environmental and social governance policies clearly against all of our investments as well, so where we invest in any industry we ensure, for example, that the industry is acting in the right way, is adhering to the best corporate principles and is doing the right thing by its fiduciary duties.

Senator DI NATALE: Let us pursue that. I am more than happy to talk to you about the bill in a moment. Let us pursue that issue. On the question around adhering to ESG principles, I find it incomprehensible that investing in a product whose sole purpose is essentially to kill somebody is somehow consistent with a responsible approach. I think those things are mutually exclusive. However, we heard in earlier evidence from one of the submissions that there is the opportunity to influence the behaviour of some industries that may in fact improve what some people might see as an industry that cannot be improved but in this case let us take the submission that was given earlier that perhaps there should be engaging with the industry around its some would say quite litigious approach. We know that the industry has been bombarding the health department with freedom of information requests and a number of things that have impacted adversely on the nation's health budget. What has the fund done to work with the tobacco industry to ensure it modifies its approach in either of those areas?

Mr Burgess : In relation to our approach and our assessment of corporate behaviour, I think it was mentioned before that in a variety of industries—

Senator DI NATALE: I am asking about tobacco here.

Mr Burgess : I think this is important because it has to have context. In a variety of industries legal action can be being taken by parties against other parties, including governments, at any point in time. The most important aspect, and this is something we assess carefully, is that our investments of any variety approach that in the right and correct way in terms of their own corporate governance. There are very clear frameworks on which we expect our fiduciaries, acting as holders of our investments effectively, to behave in their engagement of governments, engagements with legal practices. If we find that that is not the case, we engage with them and we will take action against them if they are not adopting the correct corporate approach. At the end of the day corporations should run their own businesses. That is their job to do. But the institutional side does have an influence on encouraging good behaviour and assessing what behaviour is taking place. We actively pursue that across all of our portfolios.

Senator DI NATALE: So how would you encourage good behaviour within the tobacco industry?

Mr Burgess : In the example of any industry that wants to take legal action—

Senator DI NATALE: Tobacco.

Mr Burgess : In the example of an industry that wants to take legal action, and as you said they are taking legal action, they must do it in the right way in the right steps in adherence with the regulations and practices of the country in which they are operating. I do not think you are suggesting that they are not and I am not here to defend what they are doing per se, but that is the test we apply across all industries. They must follow the local laws in which they are operating.

Senator DI NATALE: With due respect, you are investing over $200 million of taxpayers' dollars—my money, everybody's money. I think you do need to defend what they are doing because we are all investing in this industry through the actions of the Future Fund.

Mr Burgess : I am not sure I am here to defend. What I will defend is that any industry is able to take legal action against the government where it deems to be appropriate and it must do that in the right way. That is a basic principle of running businesses and doing the correct thing. We would expect that from any investment that we are involved in.

Senator DI NATALE: Do I take that to mean that you define responsible investment and taking an ESG approach as simply somebody obeying the law, being good corporate citizens in terms of being compliant with the law, and that it is acceptable for an industry, for example, to sue the Australian government, to continue marketing its product in developing countries, to continue doing what it has done consistently, which has been to try and prevent public health reforms to try and limit the harms inflicted by that product? All those things are irrelevant in the ESG framework that you deal with?

Mr Burgess : What you are asking is the question of the entire ESG framework. One of the aspects of it is that they act in accordance with the law and regulations of the country. We also look at whether they are acting in a sustainable way. Do they have good corporate governance and control? Are they being held accountable as fiduciaries of the corporations, are they behaving in the correct manner? We do that across all the industries, and that is in line with global best practice in this area. We also visit with them on a regular basis to assess what their processes are and how that is developing. We do that across a range of industries or our managers do it on our behalf in terms of global investing.

Senator DI NATALE: Can a company that kills people act in a sustainable way?

Mr Burgess : That is somewhat of a leading question. We expect them to behave in a correct way in terms of their corporate behaviour, to follow the laws and regulations of the countries in which they operate and to do that with good faith and transparency as part of our ESG framework.

Senator DI NATALE: Let us talk about reputation. You are concerned about the reputational impacts of this bill. What is the reputation of Norway's sovereign wealth fund or, for that matter, the fund in New Zealand?

Mr Burgess : The fund in New Zealand I think has an excellent reputation for its independence from government and its independent structure. The fund in Norway has a reputation for its framework. I do not know them personally. But on the point of reputation, and this gets to the aspect of overall reputation, the Future Fund is considered to be an extremely highly regarded global organisation. It is regarded that way because of its independence, because of the certainty of its mandate and the certainty of the way it is going to invest. That is I think to the credit of the organisations and governments that have supported the Future Fund over time and to the board of guardians over that period of time. That reputation is extremely highly regarded. It then reflects on the way Australia is regarded in, for example, the sovereign wealth forums and other forums we operate in. It also supports our ability to take long-term investment decisions and to partner with others. Others know what the certainty is going to be in dealing with us as a fund. I think that holds us in good stead, and perhaps later I can give some examples of how that manifests itself in the portfolio. But the fund itself has an extremely high reputation and I think it is to the credit of all that built the fund over a period of time and has very clear principles around particularly things like independence and accountability. The independence aspect is really the most commonly held best practice aspect globally, and the fund is held in high regard.

Senator DI NATALE: The question of the reputation of the Future Fund is not the issue here. Are you saying it is impossible to achieve certainty through an approach that might involve exclusions and a responsible investment framework in the way that Norway and New Zealand do, that we cannot get certainty and independence and achieve those other objectives? What I am getting at here is that my understanding of the situation in Norway and New Zealand is that they are well respected, they are well regarded, there is certainty and there is independence.

Mr Burgess : I think with due respect there is a nexus trying to be drawn here between Norway and New Zealand and the bill that is being proposed and discussed. In our opinion there is no nexus because the bill that is being discussed introduces a framework which is truly unique. We have been unable to find a framework globally that is similar to this. I say this respectfully, that this is for the parliament to decide, not for us, but the framework is not in alignment with either of those examples, in our opinion. The framework does introduce the risk of uncertainty, high degrees of uncertainty in terms of the outcome. Uncertainty, as we point out in our submission, on definition, for example. It is interesting that of the three areas are talked about, as you know, we exclude cluster munitions, landmines manufacturing, very clearly defined exclusions based on our principles and process. Components is very difficult to define, for example. The other aspect, which is the introduction of a broadly diversified socially responsible and ethical practices framework, does create high degrees of uncertainty and we think that is a unique aspect of this bill. We do not think the Norway and New Zealand examples are parallels to that.

Senator DI NATALE: Part of the point of this inquiry is to look at the bill specifically and to look at whether we can improve the bill. That is why we are all having this discussion, what amendments might be necessary. What I am getting at is whether you see the notion of having an approach to investment that encompasses what I think the general public would see as a more responsible approach to investment, and that would mean divestment of tobacco, as a bare minimum, potentially along with other industries in the same way that has been achieved in New Zealand and Norway. Could those things can be achieved and the fund continue maintaining its reputation, maintaining a relationship that is an arm's length from government and ensuring that there continues to be certainty? Are those things mutually exclusive, in your view?

Mr Burgess : In relation to tobacco, as you will have seen from our research, only three funds of the 22 largest state funds exclude tobacco globally. They do adopt frameworks similar to our own, which is the legal framework but with the very important overlay of environmental and social governance policies below that. As I mentioned before, it is best practice behaviour of the corporations in which they operate.

In addition, the other aspect of best practice is the independence of the board and its ability to monitor, control and set best practice levels. Across our investments the choice of our managers is absolutely crucial. That again is a best practice framework which, to the credit of the fund, was put in place early on.

Senator DI NATALE: With respect, the question I asked was whether it is possible to continue those things that we all agree are of importance—certainty and independence—but to also take an approach that looks at particular industries and lists them as exclusions. Can those things continue to operate in the same way they have in New Zealand and Norway? If you are saying that they cannot, you are in fact saying that funds in Norway and New Zealand lack both or either of the two things which we think are important—independence and certainty.

Mr Burgess : Perhaps I can answer that by saying it is a somewhat hypothetical question.

Senator DI NATALE: No, it is not. Let us put this bill to one side. Is there any theoretical framework you can see that would allow us to make specific exclusions around an industry like tobacco and still give you what you think you need in order to operate effectively as an entity?

Mr Greenslade : Before Mr Burgess talks about how that might operate, the first point I would make is that the bill does much more than just make some exclusions for tobacco. I would go to the point that there is a framework which creates potentially a range of other exemptions and a set of ethical guidelines that would potentially be difficult to implement. That goes to the point I made before—that it changes the focus of the board. The board has a very clear mandate. It is widely acknowledged to be a very sound approach in Australia and I have attended a number of international forums with wealth funds and we are very highly regarded for our approach. The robustness of our current framework is one of the reasons that Australia was asked to lead the development of the Santiago principles. The bill would change that and give a second set of objectives. So it is a clear change.

The mandate is very clear. It is a long-term mandate. The bill creates a framework where the second set of objectives and policies flowing from that could change over time. Necessarily aspects of the board's role would become will more short-termist. There is that about how it will work, notwithstanding how Mr Burgess might describe what will happen in practice. It is a matter of principle. There is a change in focus and it is having two balls in the air rather than one—which one do you worry about most? The other point I would make is that it would be a significant policy change. We say in our submission that this would need to be weighed up by this committee and by parliament when voting on the bill. Policy change is the role of government here—who makes investment decisions? Essentially, it would change the current arms-length arrangement whereby the board invests independently within a very broad strategic guideline. So I characterise it as quite a change and from that would flow some practical problems.

Senator DI NATALE: I understand that and I will get back to further questions in a moment, but on this point we have heard competing views on the impact of the framework and what that would mean in terms of the bill. I hear your concerns about those things specifically but my question to you now is a different one. If this bill were to be revised so that it contained one simple exclusion—that is, tobacco—would the fund determine that that would compromise the independence of the fund and the question about certainty to an extent to which the fund would still determine that it was an unacceptable proposition?

Mr Burgess : Given how important this bill is to Australia's reputation and the reputation of the fund and its operation, we have obviously begun to outline, and I would like to expand further, aspects of this bill which I think bring that into a very difficult position because of the uncertainty it would create. If the example you have given were the proposal—and I mean this with the utmost—I think the committee should separately review that proposal and ask us to respond to it because the exclusions and the way in which this is managed is extremely important for the management of a large pool of assets, it is extremely important for our reputation globally and it is extremely important for our ability to, say, partner and with others in investing in long-term assets. If there is doubt or uncertainty about the governance structure of the fund, it calls into question some very significant issues about the management and the reputational aspects of the fund. To answer an on-the-run example of what the next proposal may be would be difficult for me because of its importance.

Senator DI NATALE: Thank you for that candour. Let us talk about some of the specifics of the bill, as we have discussed. Is it possible, in the way the bill is drafted, that ultimately the development of these guidelines is done within the framework of the fund's current operations, at arm's length from government, and that in fact the development of these specific principles is not going to be legislated in this form? We have already said that the power exists under the act for the government to outline a list of exclusions, if it determines it wants to do that; it is just the decision of government not to do that as it currently stands. We are not asking government to develop the guidelines. Is it not possible that we can do this within the existing framework of what the board already does?

Mr Greenslade : I may not have fully understood your question, but as I read the legislation it clearly does make that a function of government. It makes it a function of the responsible ministers to make those exclusions and to develop guidelines.

Senator DI NATALE: But why would it have to come from the minister? If the board appointed a chief responsible investment officer who had a mandate to comply with best practice, why would that be political interference? If the structure that was set up was in fact that the board appointed an entity, an officer who had responsibility for complying with the guidelines, why would that be interference from government?

Mr Greenslade : There are two things here. The bill gives ministers a clear role and sets a legislative framework. So anything which comes through those guidelines will have the force of law and the Future Fund board would have to address those very seriously. It would very much put ministers in the position of making those directions. If you are characterising the question as to why the board cannot have a framework which does some of those things, I think it would be wrong to characterise the board as not having a framework which enables it to interact responsibly in investing issues. Mr Burgess spent some time describing those principles and how they go about it. If you are asking whether they can be done within the current construct I think the answer is that these matters are already considered within the current construct.

Senator DI NATALE: My point is that once the framework is established by the minister it continues to operate in the way it does now, at arm's length from government. To be frank, the reason we are having this discussion is that I think the fund has abjectly failed in the implementation of its ESG principles and clearly we have very different expectations about what that should mean. As I have said previously, the investment in an industry like the tobacco industry—

CHAIR: Do you have a question, Senator Di Natale, rather than making a statement?

Senator DI NATALE: I am quite happy to ask further questions later, if we have time.

CHAIR: Mr Greenslade wants to respond to a statement.

Mr Greenslade : To take an opposite view, you characterised establishing a set of directions as being, once established, at arm's length from government. I do not that is the case at all. There is no arrangement at the moment by which the government has any role in directing on the types of investments that may be made. It would break down the arms-length role because government ministers would be involved in determining what can and cannot be invested in. So it would not be at arm's length from government. It would go to who parliament wants to make investment decisions.

Senator RYAN: Is it fair to characterise one of the distinctive elements of the Future Fund, when comparing it to similar bodies, as its degree of independence?

Mr Burgess : That is a very good question. It is not just the degree of independence but also the demand that it acts at best practice level. It is good to be independent but it is very important to be good and to be independent at best practice levels. There is absolutely no doubt that that is extremely well regarded globally and among financial institutions and is in line, we believe, with best practice.

Senator RYAN: Is it also fair to say, Mr Greenslade, that for all the ministers responsible thus far—you mentioned earlier it being a consistent theme—that that independence was a defining feature of the Future Fund since its creation?

Mr Greenslade : Very much so. It is consistent with the legislative framework and that is the way ministers have operated.

Senator RYAN: And their constant statements. Senator Di Natale asked some questions about whether parliament could simply pass a law excluding tobacco. Would it be fair to say that perceptions of that degree of independence, domestically and internationally, would not just be whittled down by ministerial fiat but, if parliament started to pass exclusions willy-nilly and limitations on the role of the Future Fund, that that would also impact on this important perception of independence?

Mr Burgess : Parliament can have the will to do it, but when you look at all of the best practice globally, that is deliberately not envisaged in most of the government structures—in almost all. There is a reason for that: independence, choosing a board of guardians of high standing and quality and then implementing processes and structures around that to have a good investment strategy is clearly regarded as best practice.

Senator RYAN: Clearly it would be within parliament's remit. Parliaments can do a lot of things that we limit ourselves from doing, but if I were to ask you or the department whether or not parliament started every few years to pass an exclusion—one day it might be tobacco and in 10-years time it might be the coal industry—if we put aside the economic effects, if that were a path down which the parliament chose to go and I sought your advice here about the impact of that on the perception of the independence of the fund with, would your response be that it would have an impact?

Mr Burgess : It would have an impact on the independence of the fund and on the operation of the fund. Any uncertainty or lack of clarity around the mandate, or even expected future lack of clarity around the mandate, can certainly affect the fund, particularly as it invests on a long-term basis at best practice level while working with global partners in that investment.

Senator RYAN: One of the points in this bill is the introduction of some terms which you have described as unclear—socially responsible, ethical investment practices. If there is a specific ban on an industry or if there is a reference to a table or to a third-party organisation which might say that an organisation is good or bad and which gives the Future Fund a reference point, how would you go about meeting a criterion that is not necessarily clear and easy to meet in that sense?

Mr Burgess : As you will have seen in our submission, we are concerned about the lack of clarity when it comes to the proposed bill. There are terms and references to terms which are difficult to define, that would require a great deal of judgment, and we think that does compromise and make difficult the investment program—particularly, as I mentioned, the possibility that that may change over time and may be reinterpreted by others. The way we approach this is to look towards best practice in our environmental and social governance program. We do believe that adhering to the right behaviours, adhering to the right corporate governance structures, corporations and investment managers acting on our behalf, acting in the correct way is important, but it does take judgment and that is why it works well inside the independent framework of the Future Fund, as it does for other best practice institutions.

Senator RYAN: One of the other examples is with respect to companies that manufacture nuclear weapons or are involved in their simulation. I think that was one of the terms used. I want to refer to this because this to me illuminates some of the complexity involved in this. The Future Fund currently has holdings in Boeing, has it not?

Mr Burgess : That is correct.

Senator RYAN: As far as I have been able to ascertain, Boeing is a group that some NGOs and others have said would not meet the criteria—because it would be involved in the production of nuclear arms or things that support them. Is this the sort of thing you have already looked into? If not, how would you go about resolving issues where decisions are needed to be made that might be based on national security information or that might be hard to ascertain?

Mr Burgess : We have a clearly defined structure and process for any investment, not just in relation to Boeing, to ensure that it meets our ESG policies and therefore must be in line with Australia's conventions and laws. In relation to Boeing itself, it is held for broadly diversified reasons. It is a highly diversified company, as you are aware. It is a very large aircraft manufacturer, as you would be well aware, as are other aircraft manufacturers, such as EADS. But we do put it through a filter to ensure that it does fit and match against the conventions. I might ask Gordon to go through that three-stage filter.

Mr Hagart : I think it is important to see that this investability test is just one small part of our ESG approach. In terms of how we think of these companies, there is really a three-stage test; firstly, is the investment or funding legal? Clearly, we will not make investments that are not legal. That is something we are very anxious to ascertain. Secondly, we recognise the nature of our organisation and the fact that Australia as a country has state party obligations to certain treaties. If our investment were to not be conforming with those state party obligations, that would also be a problem, and that entity would also not be investible. If those two tests are satisfied—and we believe they are, for all our investments—then we turn to the third element of our policy, which essentially extracts us as the investor from the equation and says, 'What does the company actually do? What are the economic activities of the company and do those economic activities contravene the nature of the international conventions or treaties ratified by Australia?' We apply that test to all companies and we believe that all our companies satisfy those three tests. If they do not, they are not investable.

Senator RYAN: Is it your view that if this bill were passed you would not be able to invest in a company like Boeing?

Mr Burgess : That is also a good question. There are about 100 UNPRI signatories; of the top 40-odd funds I think there are only three or four that exclude on their view of the nuclear armament issue. There is a lot of conjecture and debate about which companies do apply—

Senator RYAN: That is not the sort of thing governments tend to make publicly available either—who is working on sensitive areas.

Mr Burgess : That is an area in which there is debate. In our own case, we clearly hold it for the reasons that I have outlined, as we do a number of stocks in that area.

Senator RYAN: The other issue that struck me about the bill was that it refers to simulation. These are computer-driven simulations of nuclear weapons tests that are done by nuclear powers. They involve pretty substantial supercomputer work. Would it concern you at all if, for example, that provision were enacted and we suddenly found out that Microsoft or IBM were actually suppliers to the Pentagon and they were involved in simulation activity? Senator Di Natale referred to the investment universe earlier, but this bill is so broad that if we started knocking off Boeing, Microsoft, EADS and IBM, we are actually starting to see a pretty significant restriction, are we not, on your ability to invest?

Mr Burgess : One of the aspects we talk about in our submission is clarity, because of that danger and risk. Words such as 'component producers' can be extremely broadly interpreted. Other aspects of the bill could be potentially broadly interpreted. To the extent that there is a discretionary element to the minister's ability to add or subtract from the bill, that can also be further broadly interpreted, it would be difficult to gauge exactly what the outcome of that would be, but we would request that clarity is an absolutely critical part of any mandate, and I think it is one of the key reasons why the fund is held in such high regard today.

Senator RYAN: Norway is often thrown up as an example, and I note the Department of Finance and Deregulation submission points out that Rio Tinto is a prohibited investment from the Norwegian fund. I have just been looking through others, and the company that makes the trams that I came here on this morning—the Melbourne trams—is also a prohibited investment—Alstom. I am not sure, Mr Greenslade, how aware you are of the Norwegian fund's limitations, but it would strike me that if it is getting into companies like Rio Tinto and Alstom it is actually more restrictive than might have been portrayed by a quick reading that tobacco and a few nuclear weapons companies are prohibited.

Mr Greenslade : I think that is right, Senator, and I think that is really one of the potential developments that can happen where legislation and a mandate provide for broad guidelines and a range of extensions as the practical issues of how that is interpreted of ready-raised companies like Boeing.

I think they are significant and there would need to be a way of resolving that. Inevitably, I think you find ministers having to get involved in the question of what something means. What does the instruction, 'Don't invest in something' mean? The Future Fund board would, I expect—as Mr Burgess said—want some clarity. It would start dragging ministers into just how far this would go. The danger is an ever-growing list, as we have seen with Norway. I think those provisions to take some companies off the list—

Senator RYAN: Thales, for example, has been removed from the prohibited list.

Mr Greenslade : Yes, but the quantum goes up over time.

Senator RYAN: It is one of those things: it is easier to be found guilty than to prove one's innocence. What you are saying, Mr Greenslade, is that the Future Fund would ask for certainty around such guidelines. So to keep and continue to attract high-calibre people to the board of guardians and to the staff, the minister would need to give more specific direction. If that were not there, would it be fair to say we would find the Future Fund going back to the minister to seek such clarity as investment decisions were being made?

Mr Greenslade : I think it would be the call of the Future Fund board, but I think that would be inevitable—otherwise the Future Fund board would be in the position of having to make some significant interpretative judgments.

Senator RYAN: You might need lawyers rather than market experts.

Mr Burgess : It is absolutely correct that passage of the bill could lead to a very lengthy discussion or debate about interpretation of the bill, about aspects of the bill and about the minister's interpretations. It goes to the issue—and this relates to your previous question—of exclusions as a starting point. A great deal of improved corporate behaviour and behaviour generally comes from the engagement practices that take place. This is philosophically important and the board itself has looked closely at this. As you would be aware, the board introduced a further improvement and enhancement to its ESG policy in February this year. The board has also announced a governance committee which is specifically focused on overseeing and monitoring its process in this area. Fundamentally, through engagement with corporations and engagement with entities we invest with, you can get better and improved behaviour—you can debate and discuss the issues. The Norwegians may historically have had an exclusions mentality, but they, interestingly, have recently introduced a two-step phase—including more of an engagement phase. I think they are beginning to recognise the importance of that. I would say we are ahead of them on that to some extent. An engagement phase, retaining the possibility of exclusions—there is no question that that is also part of our ESG policy if required—is the philosophical approach to getting good environmental, social and governance outcomes.

Senator RYAN: There are obviously limits to what impact an investor—even one the size of the Future Fund—may have. If, for example, we suddenly found we could not invest in Honeywell, Boeing, Lockheed Martin or even IBM or Microsoft—companies of that scale—because of nuclear weapons related issues, you would expect your degree of influence over them being involved in such activities, given their US focus, to be limited. So what would likely happen is that the Future Fund would be denied the opportunity to invest and obtain the potential rate of return such investment might offer because it would somehow qualify as an endorsement of that activity. I do not imagine Boeing or Lockheed Martin saying to the Pentagon, 'No, we are sorry—the Future Fund has called up from Australia and they do not want us to be involved in that industry anymore.'

Mr Burgess : I think it has broad implications. I do believe that shareholders collectively can improve behaviour—there is no question of that—and we are part of that, as you would appreciate. I think that the uncertainty and lack of clarity in the bill has another effect. You have mentioned a number of listed companies, but I am thinking of an example we are currently looking at here in Australia—two Australian infrastructure opportunities. We will be partnering with others as we often do. These are 10-year investments and investments which I think are to the benefit of Australia and certainly to the fund. If there were some lack of clarity which raised a concern that, on some future occasion, our ability to invest with them may be compromised—that we may have to sell for some reason or management of these investments may be taken out of the board's hands—that could affect our ability to invest. We raised those issues in our submission. We do have, as you appreciate, quite a large portfolio in areas, such as infrastructure, which require long-term certain outcomes and frameworks. So there is that secondary aspect which I think needs to be considered in the bill as well.

Senator RYAN: One of earlier witnesses referred to this being, effectively, an opportunity to introduce a particular standard and then raise the bar later on—as has happened in Europe. One of the examples they referred to was that of indirect support for industries. An example would be company A refusing to deal with company B if company B deals with, or holds an interest in, a company which deals in a prohibited area. That was described as an indirect limitation. Given what you have just outlined about cooperation on long-term infrastructure projects, if we went to a ban on you holding instruments in organisations which held instruments in prohibited activities, that would seriously limit your freedom to invest—particularly as you might invest with a company in 2012 and they might undertake some of this prohibited investment in 2018, only halfway through your investment.

Mr Burgess : When we choose to invest over the long term, to protect against those sorts of issues, we are very careful in choosing the fiduciaries we work with and the governance structure. But there is a point there. When we do long-term investing, we negotiate hard to have controls in our contracts—to have rights of veto or to have people sitting on a board to make sure our investment is well managed and well controlled. We can do that because we have the certainty of being an independent organisation with a clearly defined mandate and structure. If that comes into doubt, it will be harder for us to negotiate to get those controls and to put them in place. I think that is an important issue. Any uncertainty in the mandate does raise other implications which need to be considered very carefully.

Senator RYAN: Finally, I want to turn again to the Norwegian example which is often—in my view erroneously—held up. Norway, I suggest, has a reasonably transparent process for exclusions. There is the Council of Ethics which advises the Ministry of Finance.

But is it fair to say that, despite it being transparent, that does reduce certainty? You have talked about long investment time frames for a fund that is meant to pay out or provide resources to the Commonwealth for a number of decades yet. Even if you do have a transparent process, if you head down the Norwegian path of having exclusions, that cannot do anything but reduce certainty in the mandate because of the fact that certain companies one year will be excluded, whereas two, three or maybe even five years earlier they were not.

Mr Burgess : As we discussed before, we do not believe the Norwegian framework is anywhere near close to this framework. This is a unique framework that we have been unable to find anywhere else. In relation to the Norwegians themselves, interestingly, they only invest in relatively liquid assets at the moment. That may be—and I cannot comment because I am not aware—because as they go into longer dated investments, which I think is an appropriate way to invest, particularly with a long-term mandate, they are going to reach those issues, I would imagine. That is just an estimate on my part.

To re-emphasise, though, because the board can act independently it does consider these important environmental and social issues. I want to emphasise that. But the most important thing is that by being independent and by doing it within a framework of independence you are able to factor that into the management of your assets. You are able to negotiate positions where you can sit on boards and control the quality outcomes of your assets. If there is any uncertainty in the mandate, that becomes quite difficult to do.

Senator RYAN: Uncertainty is by its nature introduced when you introduce a level of political involvement. Call me cynical. You might get a grandstanding politician who tries to do a particular event. I do not expect you to comment on that. Political involvement by its nature introduces some uncertainty, as opposed to the process you are talking about.

Mr Burgess : As we mentioned in our submission, we have been unable to find an example where a minister has that day-to-day ability to make changes, as is currently structured under the bill. I think that is deliberate, for the reason of certainty. I think one of the great benefits of the fund is we are able to take a long-term approach. As we mentioned in our submission, one of the potential dangers of the bill is that it would certainly have to bring forward a more short-term approach. It may in fact, as I say, affect our investment in some key asset classes.

Senator DI NATALE: To get to this question of certainty and the reputation for independence that I think Senator Ryan is so concerned about, I will go back to his previous scenario. He mentioned that, if we were to exclude tobacco today and something else in the following 10 years, we would introduce uncertainty and erode the fund's reputation for independence. We have a range of fund managers who stand to make a lot of money as a result of the fund's investment decisions. Am I to understand that, if that scenario came to pass, somehow they would change their minds simply on the basis of the fact that we have seen two exclusions passed in 10 years? Is that a realistic scenario to you?

Mr Burgess : With the utmost respect, it perhaps underestimates the way in which the fund is constructed. We have a broadly diversified fund, as you know, in line with our mandate that is targeting investment returns with adequate risk, including the risk of controlling environmental, social and governance policies. What I was alluding to before is that we also have a large direct investment program where we partner with world's best practice, such as the Canadians, for example, or others who are looking to buy stakes in investment areas that we have a collective interest in. It is in partnership with peers like us that a lack of certainty, a lack of clarity and the potential involvement of a minister of the Crown can affect the relationships and the standing of the fund over a period of time. That is an issue that needs to be considered carefully.

I think one of the reasons that all of the major funds that we have been able to identify have independence—and I was recently in Canada visiting the five top major funds there, including the Canadian Pension Plan, which has a very clearly defined role and independence from the environment of government—is that they are, like us, investing for the long term, often in direct assets. While we may use a fund manager—and in fact under the act we need to use a fund manager between us and the asset—our relationship with our partners and our reputation globally among our peers is absolutely vital. One of the aspects that I think is to the credit of the fund is that, as our mandate currently stands and as our governance framework currently stands, we are partner of choice amongst the best investors globally. I think that does reflect very well on our current structure.

Senator DI NATALE: I understand that there is clearly a difference here around the impact of this decision on the perceptions of independence and what level of uncertainty it creates. But over the past decade or so we have seen that the sovereign wealth funds of a number of countries—we have mentioned Norway and New Zealand a couple of times, but it is not just Norway and New Zealand; it is also Sweden and France—have all been subject to legislative direction to invest responsibly. Can you provide me with any evidence that suggests that that legislative direction around the investment decisions of those sovereign wealth funds has impacted adversely on the performance of those funds?

Mr Burgess : You have chosen a couple of examples there and I have not looked at all of their legislative frameworks. I would be surprised—but I do not have the information—to think that they have proposed the kind of bill that we are discussing today, because clarity of mandate, clarity of responsibility and independence of the board are a very common best practice structure. I was not involved in the early structuring of the Future Fund, but I am sure that was taken into consideration, because you need that clarity to ensure that the fund acts in the right way, works to best practice, is able to attract peers and takes a long-term view. I cannot comment on, say, a change in a Swedish act. I do know for a fact, though, that independence of the operation of the major funds is embedded in legislation in the best practice environments, and the Canadians are a great example of that.

Senator DI NATALE: We are hearing these theoretical arguments about how independence will be compromised, but we have examples where there has been legislative direction. I want to get back to this question of whether it is possible for there to be legislative direction around responsible investment practices and still guarantee independence, and whether there is the potential to make changes to this bill to guarantee the things that you are concerned about, because it is done in other places. They have achieved this. We are having this discussion as though Australia is the first nation on earth to implement mandated, legislated responsible investment practices. I keep hearing these theoretical objections. I accept that you may have some issues with the way the bill is structured. I want to get back to the point I was trying to make earlier. Do we have the capacity, at least in theory, to achieve some degree of legislated responsible investment practice, as has already occurred in other countries, and would that be acceptable to the fund?

Mr Burgess : I think there is an assumption in your question that we do not have a responsible investment practice, and we do.

Senator DI NATALE: No, I am talking about practice legislated by government.

CHAIR: Senator Di Natale, could I just remind you we are running out of time. You put a question to the witness. Please allow him to conclude his answer.

Mr Burgess : The assumption is that we do not have a responsible investment process, and in fact we do. There are many reasons why we do, including the quality of the guardians and the quality of our structure. We are asked to operate at best practice levels. That is required of us. We believe that taking environmental, social and governance practices into account, setting standards for our fiduciaries and setting standards for the choice of our managers and the assets that we invest in is a vital part of investing—and not only that, it adds to investment performance if you have the right structure of responsibility framework.

The assumption in your question is that we do not do it currently; the reality is that we do do it currently. We have a framework around that. We follow the laws and conventions of Australia, but we also have an engagement program. We have staffing. We expect our fund managers to have engagement. We will take action against fiduciaries and entities that do not act with the best behaviour, in accordance with best practice governance, such as the UN global compact, for example, or other measures of this behaviour. So we are doing that on a day-to-day basis, and I did come with some examples today, but perhaps we will not have time. But we engage on a very regular basis to ensure we do have a responsible investment process. It is inside our environmental, social and governance policy. The board is focused on it. It revised it again in February. We have recently announced a governance committee to ensure that it remains a key focus of the board. This is a very important part of our investment program.

Senator DI NATALE: That is not the assumption in the question, so let me try and be very clear about this. You have given evidence where you contend that providing legislative direction to invest responsibly provides an unacceptable threat to the independence of the fund. I am putting to you that that is precisely what has happened. Legislation has been through parliaments across the world, and I have given you a handful of countries where that has happened. What I am asking you is to demonstrate to me how that has compromised the independence of those sovereign wealth funds and the performance of those sovereign wealth funds. It is all very well and good to have this discussion in the abstract. We have examples where that has happened and I am not hearing any evidence to demonstrate that it has been a problem in those settings.

Mr Burgess : You have mentioned a number of countries and it is very difficult to comment on any one piece of legislation. But in our submission we focused on the bill itself, and the bill itself, as we have outlined, has some implications that we would respectfully request be considered carefully by the committee. There are aspects of this structure which we have not seen anywhere else. It introduces a structure that is different to the fund's current standing, its independence and in fact its world standing as a well-structured governance structure. It is up to the parliament and we respectfully recognise that, but under the current structure there are a variety of factors that give us some concerns and that we think may have implications for the fund and the management of the fund over time.

Mr Greenslade : Could I just jump in and make this point. You have mentioned the legislative arrangements. I think it would be incorrect to characterise the Future Fund arrangements as arrangements where there is absolute silence in terms of the legislative requirements on the fund being responsible and acting appropriately. The Future Fund Management Agency, which Mr Burgess heads, operates under the Financial Management and Accountability Act, so he has the same obligations as the head of any Commonwealth government department. He and his staff are required to make efficient, effective and ethical use of Commonwealth resources. The agency staff operate in accordance with the Australian Public Service values and code of conduct, and one of those values is that the Australian Public Service has the highest ethical standards.

The Future Fund is accountable to parliament through estimates and the tabling of annual reports. The board is required through the mandate to act in a way that is unlikely to cause diminution of the Australian government's reputation. They have to have regard for international best practice. This is a long list. The board has duties under the Future Fund Act to behave in certain ways. The board is fully compliant with the Santiago principles, which it led the development of. It is one of only five sovereign wealth funds that has published details and made itself accountable under those principles. So I think it is wrong to characterise the current arrangements as laissez faire—I am not saying you said that, exactly, Senator—or to say that the government or the parliament has not given the board a framework or indications of how it is expected to operate in terms of broad standards and responsibilities. This legislation goes well beyond that framework to a different approach.

CHAIR: Thank you. I thank the Future Fund and the department for the submissions, and all other witnesses. I thank the secretariat and also Hansard. I remind those witnesses who took questions on notice that we need to have those answers to the secretariat by Monday so that we can finalise our report.

Committee adjourned at 12:59