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Economics Legislation Committee
28/10/2015

MORRIS, Ms Carolyn, Senior Manager, Policy Development, Australian Prudential Regulation Authority

ROWELL, Mrs Helen, Member, Australian Prudential Regulation Authority

CHAIR: I welcome to this hearing the representatives of the Australian Prudential Regulation Authority. The committee has received a submission from you, which is submission No. 10. Do you wish to make any adjustments to that submission?

Mrs Rowell : No, we do not.

CHAIR: I now invite you to make a short opening statement if you wish to do so.

Mrs Rowell : Good afternoon, and thank you for providing the opportunity for APRA to appear before the committee today. The bill currently under consideration by the committee is an important one for the superannuation industry, given its focus on enhancing governance standards across the industry. The topic of sound governance has long been a focus for APRA across all of the industries that we regulate. APRA's view on the importance of sound governance and the role independent directors are able to play in supporting sound governance outcomes has been articulated on many occasions, including in our submission to the committee on this bill.

Recent superannuation reforms, including APRA's prudential standards, have contributed to some strengthening of governance practices of RSE licensees over recent times. APRA's view, however, is that there is significant room for further improvement in governance practices across the industry and that the changes proposed in the bill are important in supporting further progress in this area. The proposed requirements in the bill are aligned with APRA's longstanding view on governance arrangements. We would expect their implementation to both assist in reducing the likelihood of poor governance practices in future, as well as to address some of the current weaknesses in governance practices that APRA observes as part of its supervision activities.

The superannuation industry has evolved considerably since the current part 9 board composition requirements were introduced into the legislation in 1993. Approximately 80 per cent of superannuation assets in the APRA regulated sector are now held in public offer RSEs with broad and open membership, and the industry's significance from both the financial system and retirement income policy perspective continues to increase.

There are currently 138 RSE licensees responsible for managing 238 funds. Of these, only 47 non-public offer RSE licensees are required to comply with the requirements of part 9 of the Superanuation Industry (Supervision) Act to have an equal representation board. The 91 current public offer RSE licensees are permitted by the Superanuation Industry (Supervision) Act to choose between having a representative board or an alternative trustee arrangement for which there are no board composition requirements. A number of public offer RSE licensees have chosen to retain the equal representation model for their board when granted a public offer license.

We expect that governance practices and board composition will be strengthened across all segments of the superannuation industry should the bill be passed. The proposed changes do not impose a one size fits all approach. Rather, they provide an opportunity for RSE licensees to reflect on and review the board's current governance arrangements and to determine the governance framework and approach that is most appropriate for their business operations into the future.

APRA's view is that adding independent directors and maintaining a strong connection with the fund's membership are not mutually exclusive. Having a close relationship with members can be achieved under many different governance models. The reforms continue the current flexibility for RSE licensees to determine the appropriate size and composition of their board, and those that wish to retain an equal representation model for the appointment of the non-independent directors are able to do so should they determine that that continues to be appropriate to their circumstances.

The reforms also provide the superannuation industry with an opportunity to deal with some of the more obvious conflicts within their structures and arrangements—for example, common directorships across boards in financial conglomerate groups or material service providers. APRA has witnessed circumstances where current board composition requirements, whether imposed by legislation or by trustee constitutions, have prevented some boards from implementing effective board nomination, appointment and removal processes to support board renewal, particularly when there is recognition that independent directors have an important role to play in boards having the right mix of skills and experience. APRA considers that the proposed requirements in the bill, together with APRA's prudential standards, will go a long way towards addressing this. The requirement to appoint independent directors is also expected to better support trustees to meet the requirement in APRA's prudential standards to have the full range of skills needed for the effective and prudent operation of the RSE licensee's business.

We are aware that a significant concern raised in submissions on the bill relates to the proposed powers in sections 88 and 90 for APRA to determine that a person is or is not independent. In APRA's view, it is important that we are able to address the material concerns in relation to board composition and fit and proper matters in relation to independent directors earlier than is currently the case. Proposed sections 88 and 90 of the bill are therefore necessary in our view to ensure that there is certainty where an individual might have a non-typical relationship with an RSE licensee, such that it is unclear whether the individual is independent or not. It also reflects the practical reality that it is not possible to clearly address in the legislation all situations that may arise in practice and it is essential that APRA be able to respond promptly to provide the necessary certainty to industry.

APRA expects to use the proposed power in section 90 to determine a person is not independent infrequently as the legislative definition of 'independence' should provide sufficient information for RSE licensees to undertake a robust assessment of a director's independence in most circumstances. Similarly, APRA expects that the combination of the certainty in the legislative definition and additional guidance issued by APRA over time will mean that RSE licensees will be confident to appoint persons as independent directors without having to seek formal confirmation from APRA by way of a determination under proposed section 88 that a person is independent. As with similar application processes in the SIS Act and other legislation administered by APRA, we will consider each application made on a case-by-case basis and all such decisions are subject to merits review. APRA did raise some other points in our submission for consideration by the committee and we are happy to answer any questions that you may have.

CHAIR: Thank you very much.

Senator KETTER: Thank you very much, Mrs Rowell, for your submission and your opening statement. I firstly go to intervention in the debate. We had an exchange at estimates recently about your speech. At the heart of it, you are basically saying that an increased number of independent directors is going to lead to improved governance. That is really what you are saying, isn't it?

Mrs Rowell : That is correct.

Senator KETTER: Can you tell us about the evidence that supports the contention?

Mrs Rowell : Our evidence is based on our experience in supervising both the banking and insurance industries and the superannuation industry. We have seen significant enhancements to governance practices on boards and entities where there have been independent directors, and particularly in the superannuation industry where we have seen boards move from not having independent directors to having independent directors.

CHAIR: Where is the measurement of the benefit of that? What studies can you point to, to suggest that that is actually the case rather than your anecdotal information?

Mrs Rowell : Governance is in some ways difficult to measure the outcomes of. Whilst there are some studies that point to enhanced performance that can be attributed to independent directors, there is also qualitative research that supports that view. From APRA's perspective, what is important is the quality and rigour of decision making. There is the review that is applied to making decisions, whether it is about arrangements with service providers, fees that are paid by members or, indeed, investment decisions. Again, our view is that the breadth of skills and the quality of challenge that occurs when there are independent directors on boards is much greater and, therefore, that does lead to decisions which ultimately have benefit for members but it is very difficult to point to any quantitative measure of those benefits.

Senator KETTER: You say that independence leads to skills and experience. This bill does not say anything about skills and experience. It talks more about the relationship between individuals and the RSE.

Mrs Rowell : The superannuation legislative framework has multiple layers to it. There is the legislation and the regulations and then there are APRA prudential standards, and they need to be looked at as a package.

Senator KETTER: Your standards are quite rigorous, I would have thought.

Mrs Rowell : Indeed, they are. But they are limited in their ability to, if you like, direct boards to ensure that they have the proper skills and capabilities. So, in our view, the legislative changes will better support our prudential standards by facilitating trustees, RSE licensees, to look more broadly in bringing skills and capabilities when they are looking to meet the requirements of our prudential standard under the fit-and-proper standard. So I think there is a narrowness of perspective that is taken by many funds in their current processes for appointing directors to boards, and the requirement to look for independent directors will make available a broader pool of skills and capabilities that can be brought onto boards to meet our fit-and-proper requirements.

Senator KETTER: When you say 'narrowness', are you referring to the industry funds?

Mrs Rowell : I am referring across the board to all segments of the industry.

Senator KETTER: Would you be surprised if I were to say to you that, in the large bank super funds, three and four of the directors and more than half of the nominally independent directors are finance industry insiders—people who have had experience working in the finance industry in a profit situation?

Mrs Rowell : In the for-profit sector?

Senator KETTER: Yes, in the large bank super funds.

Mrs Rowell : No. Our experience would be that a number of the directors in the for-profit sector would come from the finance sector.

Senator KETTER: Some people would say that is a narrowness as well.

Mrs Rowell : And I am not disputing or disagreeing with that view.

Senator KETTER: That is in an environment where independent directors are supposedly in the majority or there is a greater number of them. It is not leading to more diversity.

Mrs Rowell : It is not mandated in the for-profit sector at the moment across the board that there be a majority of independent directors. I think there is some scope for the for-profit sector to broaden their search, if you like, for independent directors as well.

Senator KETTER: I am interested in your perspective on the scale of the issue here. In the for-profit sector, we have, I would argue, an inherent conflict of interest in the sense that we have got the need to act in the best interests of the members of the fund but also the imperative to maximise shareholder returns. Do you see that as an important governance issue?

Mrs Rowell : Dealing with those conflicts is an important governance issue. Again, I think this bill supports addressing that more directly, because it will apply a tighter definition of independent director than is currently the case under the Financial Services Council standard, which will mean that there will need to be some changes to some of those boards that will allow some of those conflicts perhaps to be more directly addressed than is the case at present.

Senator KETTER: But you would agree with me that the impact of this bill will be more greatly felt in the not-for-profit sector than in the for-profit sector?

Mrs Rowell : I am not sure that I would agree with that. I think there will be changes in boards across the industry as a result of this bill.

Senator KETTER: I think the regulatory impact statement is fairly clear on that point. I stand to be corrected. Have you had a look at the regulatory impact statement?

Mrs Rowell : Not in detail, no.

Senator KETTER: The work of APRA between 2008 and 2012 seems to be pretty clear in that there is evidence there that suggests the behaviour of trustees does have an impact on asset allocation and the returns of the industry funds. Would you agree with that?

Mrs Rowell : Trustees have ultimate responsibility for setting the investment strategy of the fund as a whole and in determining the options that are made available to members that they can choose to invest in. The outcome of that at a fund level will lead to variations in performance. I think the underlying role of governance and board composition in particular outcomes is less clear and, as I have commented in some forums, I think that in making performance comparisons and understanding the drivers of those performances it is important to look beyond just fund-level average returns—particularly averages across whole industry segments—to draw conclusions and understand the drivers.

Senator KETTER: So you do not suggest that we look at fund-level returns? Isn't that really what the ultimate benefit is to the member—the whole fund return?

Mrs Rowell : It is not, actually. It depends on the fund and it depends on the segment of the fund and the structure of the fund and, hence, what return they are being credited. Within any fund there are different pools of members who will get different outcomes according to whether they are in the default fund or in a choice option. So you need to look at the underlying default option or choice option that they are in to understand their outcomes. So looking at—

Senator KETTER: But those are decisions of the trustees, aren't they?

Mrs Rowell : In part they are decisions of the trustees; in part they are the decisions of individual members. If you compare default fund asset allocation then that is typically a decision of the trustee. But if you are looking at member choice outcomes then that is as much a decision of the member and the choices that they make in how they invest their money. And so aggregating performance at a fund level and, certainly, aggregating performance at an industry segment level, does not give you a good understanding of what the outcomes for individual members will be.

Senator KETTER: Right. Now, you have looked at some of the recent results from the MySuper products in your speech of a week or so ago.

Mrs Rowell : Yes.

Senator KETTER: You said that we are not comparing apples with apples when it comes to investment performance at the fund level. You said that across industry segments the median and range of returns for MySuper products are broadly the same, as are the median and range for total fees and costs. You are looking there at—

CHAIR: I am not sure that this relates to the bill too much, Senator Ketter. I am giving you a fair bit of latitude here, but—

Senator KETTER: We are talking about the performance of funds, and the line of questioning I have is the relationship between the governance structures of the board in terms of the outcomes.

CHAIR: Okay, well, I will listen.

Senator KETTER: I think this is the point that Mrs Rowell has made. Now, you have looked at the MySuper outcomes. Am I correct in understanding that we really only have 12 months' worth of data there to look at?

Mrs Rowell : There is about 18 months' worth of comparable data. For illustration purposes, in the speech I used 12 months' worth of data because we have published annual returns. I was merely using that to illustrate a point around the importance of comparing like-for-like. I have used similar figures in a previous speech and noted that they are only short term, and therefore that it will be some time before they provide any useful basis for comparison because it is important to look at outcomes over the medium to long term.

The key point that I was trying to make in providing that information was the point which I was articulating earlier, which is: needing to make sure you understand what you are comparing in drawing conclusions—particularly as it relates to outcomes for individual members.

Senator KETTER: I am really surprised that you would use 12 months' worth of data to make terribly many conclusions of any worth in any case, because it is such a short period of time—as you have just indicated. When we are talking about people's retirement incomes we are looking for long term.

Mrs Rowell : Which is exactly why I said that it was important to look at how those figures evolved over the long term to see what the outcomes were. I think the key point to be conveyed is that averages are not necessarily a good indication of individual member outcomes because the outcome for an individual member will depend on the specific fund they are in and whether their fund is performing at the median level or the bottom of the range or the top of the range. There is quite a wide variation in outcomes whichever industry segment you are looking at, so, in making judgements about performance over the medium-to-long term, it is important to look at all of the information that is available and not just focus on averages at segment level.

Senator KETTER: If you look at averages it probably comes up with a different outcome, but you have looked at median figures, which is somewhat unusual in these sorts of circumstances, wouldn't you agree?

Mrs Rowell : I am not drawing any conclusions based on the information. I am making an illustration about the importance of comparing on a like-for-like basis and looking at the full range of outcomes. It is the range as much as the median or the average that is relevant in looking at outcomes for individual members.

Senator KETTER: Has APRA provided advice to the government in relation to the bill?

Mrs Rowell : APRA has been involved in discussion with Treasury as part of the development of the bill. I am not sure that constitutes formal advice. The normal policy development process is for the government and Treasury to engage with the relevant regulators around the development of particular policy positions.

Senator KETTER: Have you been engaged in providing advice to anybody else in the Australian parliament?

Mrs Rowell : I have been involved in meetings to answer questions about the specific provisions in the bill, and in particular APRA's powers and how they interrelate, and what the implications in terms of implementation would be in response to the bill.

Senator KETTER: Can you tell us who you have been speaking with?

Mrs Rowell : I participated in meetings with some of the crossbench senators.

Senator KETTER: I take it that, to be consistent, you have been advocating the merits of this bill with the crossbench senators?

Mrs Rowell : I have been providing APRA's perspective on the policy implementation issues of relevance to the bill.

Senator KETTER: That is okay, but you are here before us today advocating the merits of the bill.

Mrs Rowell : I am providing APRA's position on the bill and its implementation and issues. As I have said on many occasions, APRA's view is that independent directors add value and, therefore, we think the direction of the bill is something that we support.

Senator KETTER: Do you think it is appropriate for a regulatory organisation to be involved in briefing members of parliament directly on an issue which is highly contentious?

Mrs Rowell : I think it is appropriate, given the connection between the legislation and APRA's prudential standards and the implementation issues that will flow from that, for APRA to be available to answer questions and provide a perspective on those implementation issues and how the policy may have effect in practice.

CHAIR: Senator Ketter, that was asking for an opinion, so just—

Senator KETTER: Okay. Let us return to the level of independence that APRA sees as being relevant or preferable on boards. The bill prescribes one-third; APRA's position seems to be that you would prefer a majority—is that the case?

Mrs Rowell : That is not correct.

Senator KETTER: Can you tell me where I am wrong, then?

Mrs Rowell : APRA will implement the provisions of the bill. We think that having some independent directors on superannuation boards will add value. The prescribed particular number or proportion is a matter of government policy.

Senator KETTER: Is it not the case that in your communications with industry funds that you are talking to them about lifting the number of independent directors over a period of time, and asking them why they have not got a majority of independent directors on an if not, why not basis?

Mrs Rowell : That is not correct, the bill provides for—

Senator KETTER: I am not talking about the bill, I am talking about APRA's position on the issue of independent directors.

Mrs Rowell : APRA is not currently talking to industry about any particular number of directors on their boards. We have made comments on the bill and we have been asked in different forums what our view on the minimum versus the 'if not, why not' provisions would be. Our observation was that if, as is proposed under the government policy, the Corporations Act is amended to have an 'if not, why not' majority disclosure around that then that would be something that we would expect the funds to take seriously, i.e. to consider the appropriate number of directors for their board and articulate on an if not, why not basis what their position was on the board composition. That should not be construed as suggesting that APRA has an expectation of boards going beyond the minimum one-third.

Senator KETTER: Okay. Where is the evidence that having the one-third level is the optimum level? Why one-third? What is your view about that? Is it a magic number?

Mrs Rowell : The minimum level is a government policy position. APRA's view on the level of independent directors on boards is that there needs to be sufficient numbers that they can actually have an impact from a governance perspective. If you had below one-third, I think, then it would be difficult for the independent directors to actually achieve as strong an impact on governance as might be the case with one-third. Clearly if you go further than that then potentially the independent directors can have more influence. I think there is a recognition in the policy position, but this is probably something better for Treasury to articulate, that the minimum one-third allows those funds that chose to do so to maintain equal representation on the balance of the board, so that the one-third, one-third, one-third structure that we see across the industry, and it seems to be quite effective, is accommodated in the bill.

Senator KETTER: In terms of the remaining two-thirds, I am interested in your view about the fact that we are left with a sort of vacuum or we see the equal representation model being withdrawn on a legislative basis—do you have concerns about that?

Mrs Rowell : We do not actually see it as being a vacuum. As I noted in our submission and also in my opening comments, at the moment public offer funds can chose whether they maintain an equal representation model or go for a different model. There are many public offer funds that already maintain an equal representation model at their choice. Therefore, the approach going forward under the bill will be no different, those funds that wish to enshrine in their constitution an equal representation approach for the balance of the two-thirds of their board can continue to do so.

Senator KETTER: Do you see merit in mandating a certain level of member representation on superannuation boards?

Mrs Rowell : We do not see that it is necessary.

Senator KETTER: It is not necessary, but in the absence of a minimum, is there not then a potential for that to be eroded over time?

Mrs Rowell : There is a potential, I am not sure that we would see—

Senator KETTER: I am surprised that when we are talking about people's retirement incomes, something which is held for the benefit of the members, that you do not see that is a relevant safeguard in the system.

Mrs Rowell : Given that funds and RSE licensees will have the capacity to choose their board composition and those that wish to maintain the equal representation for the balance of the two-thirds can do so, our expectation is that there will be ongoing a significant number of funds that will maintain equal representation even though it is not mandated in the bill.

Senator KETTER: Will you be asking them if not, why not whether they have member representation?

Mrs Rowell : Our expectation is that each RSE licensee will go through an appropriately rigorous process of determining what the composition is that is appropriate for them, what the proportionate number of independent directors that is appropriate for them will be and to have a clear basis for forming that view and for implementing it in practice. If they do that rigorously and effectively then we will accept that.

Senator KETTER: Thank you. Are you familiar with recent research from a United States researcher by the name of Joel Harper that finds certain relations between the number of independent directors and that it has implications in terms of asset allocation.

Mrs Rowell : I am not familiar with that research, no.

Senator BUSHBY: Thank you, Mrs Rowell and Ms Morris for assisting us today. A lot of the questions I was going to ask have actually been covered by Senator Ketter. Just going over a couple of things: the advantages of independent directors—you were asked about that. One of the things that was put to us by one of the witnesses—probably, by a number of witnesses—is that there is a risk that, by introducing independent directors, you will change the culture of these organisations; and, further, that there is a risk that the independent directors could gang up with either of the employer or the employee directors and then deliver outcomes. What do you say to that?

Mrs Rowell : As I indicated in the speech that I gave last week, we do not necessarily see the appointment of independent directors as leading to any change of culture in any fund. Given that the RSE licensee as a whole has the responsibility for deciding on their appointment and nomination processes, the composition of their board and the skill sets that they seek, and the individual directors that they chose to appoint, working with the nominating bodies, then it is within the control, if you like, of each RSE licensee to get the people on the board that fit with their culture. So we do not necessarily see that as changing anything going forward. Sorry, I have forgotten the second part of your question.

Senator BUSHBY: It was about ganging up, which sort of answers that as well.

Mrs Rowell : That is correct, and in our prudential standards we are proposing to have a requirement around each board having a charter, and that charter should cover voting processes and procedures. Again, we would expect the RSE licensees to give consideration to what the appropriate voting arrangements were to ensure that all of the directors on the board could have the appropriate level of influence in decisions.

Senator BUSHBY: And the answer that you gave will probably also apply to the erosion question—the erosion of members' representation over time.

Mrs Rowell : Indeed.

Senator BUSHBY: As I understand it, the bill has a three-year transition period during which the existing board would be responsible for deciding what changes would need to be made to the constitution; what model they would adopt; and how they would deal with these types of issues to ensure that in the longer term they minimise the risk of erosion or directors being appointed who might gang up with one side or the other of the employer and employee relationship. It is correct, isn't it, that any of those decisions will be made by the boards as they currently stand.

Mrs Rowell : That is correct.

Senator BUSHBY: One of the more contentious aspects of the bill according to the evidence that we have seen and heard is the decision to remove the legislative requirement regarding equal representation—and you touched on this a bit in your opening statement. What are the advantages, as APRA sees it, of actually removing the legislative requirement?

Mrs Rowell : I think the key one is that it enables each RSE licensee to determine the composition that is appropriate for them rather than constraining all funds in a particular segment—and, in particular, in this case, the non-public offer segment to follow a model that perhaps they may consider is not appropriate for their fund but at the moment is currently prescribed in legislation that they have to follow.

Senator BUSHBY: But if a particular fund was of the view that an equal representation model was appropriate, the removal of this legislative requirement does not stop them from being able to have an equal representation—that is correct, isn't it?

Mrs Rowell : That is correct; they could amend their constitution, if it does not already provide for it, to provide for it.

Senator BUSHBY: And I suspect that most funds that currently have that type of model would probably continue that model—not all and not necessarily—

Mrs Rowell : Our expectation is that a high proportion of those that currently have it will maintain it for the balance of the two-thirds.

Senator BUSHBY: Another contentious aspect is the way that 'independent director' is defined under the bill. Are you able to explain to us why that particular definition has been adopted in the bill—or is that something that is better for Treasury?

Mrs Rowell : That is probably a question that is better for Treasury.

Senator BUSHBY: Most of the opposition to these aspects of the bill has come from people associated with the equal representation, not-for-profit side of the industry. The bill, though—and you touched on this earlier—will have the same effect right across the industry. That is the case, is it not?

Mrs Rowell : That is correct. It will apply consistently across all segments of the industry, and it will require changes in governance and board composition across the industry.

Senator BUSHBY: I think you indicated earlier that that is likely to have an impact on the retail, or the for-profit, side of the industry in terms of their directors?

Mrs Rowell : It will, because the definition of independent director in the bill is stronger. The key reference point for the retail sector at the moment is the Financial Services Council code, which its members follow. It has a looser definition of independent, and, in particular, does not necessarily preclude some of the intergroup relationships that are now covered under the bill. So that will have an impact on FSC members. There are also a number of retail funds that are not FSC members and therefore do not comply with that code, and so will be forced to have—

Senator BUSHBY: It will probably have an even bigger impact on them than on those that are currently complying with the FSC.

Mrs Rowell : That is correct.

Senator BUSHBY: In that sense, there is the potential to deliver the benefits, in terms of governance, of independent directors right across the board and not just in the industry sector. It is also going to have an impact on the retail side of it and, hopefully, the benefits you have outlined will also be apparent on that side as well, or will be improved.

Mrs Rowell : That is our expectation—that we will see some change in governance and improvements in the retail sector as well.

Senator KETTER: In relation to your meetings with the crossbench senators, were those meetings occurring at the request of those crossbench senators, at your own instigation or at somebody else's instigation?

Mrs Rowell : APRA was asked by the minister's office if we would make ourselves available to answer questions from anyone who wanted to ask questions or get clarification on aspects of the bill.

Senator KETTER: Which minister was that?

Mrs Rowell : It was the office of the Minister for Small Business and Assistant Treasurer.

Senator KETTER: Can you tell us which crossbench senators you advised?

Mrs Rowell : I presume that is acceptable. We had meetings with Senator Muir and with Senator Wang, and we met with the advisers for Senator Day, Senator Lambie and Senator Lazarus.

Senator BUSHBY: I personally, as a senator, have had briefings from government agencies on bills in the past. Is it unusual for APRA to be asked to provide briefings to members of parliament on bills that impact on the operations of APRA and the interaction with the public?

Mrs Rowell : I am not sure I would say it was unusual. It does happen from time to time. It is not necessarily a common occurrence.

Senator BUSHBY: Possibly it does not happen a lot because of the nature of the work you do. But it is not an unusual—

Mrs Rowell : It is not unusual.

CHAIR: Thank you very much for your attendance and your testimony.