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Finance and Public Administration Legislation Committee
Future Fund Management Agency

Future Fund Management Agency

CHAIR: I welcome officers from the Future Fund, in particular the Hon. Peter Costello, the chairman of the Future Fund Board of Guardians; Mr David Neal, the managing director of the Future Fund Management Agency; and Dr Raphael Arndt, the chief investment officer. I also welcome officers from the Department of Finance covering program 1.3, Australian government investment funds. Mr Costello, it is nice to see you back in Parliament House—but you have never appeared before a brutal Senate estimates committee before. I hope you will not be too intimidated.

Mr Costello : I shall bear whatever is thrown at me with as much bravery as I can muster.

CHAIR: Mr Costello, do you wish to make an opening statement?

Mr Costello : It is a pleasure to be here. I was asked to be here by Senator Waters. I thought it would be right for me to come. It has not been traditional for chairs of the Future Fund to come. I think there is one precedent. Normally it is the managing director. I stand ready to answer all of your questions, but, since it is his show, I think it is appropriate for Mr Neal to read out his opening statement.

CHAIR: Mr Neal, we would welcome your opening statement.

Mr Neal : I would like to take a few moments to update the committee on a number of aspects of the Future Fund's operations. I took up my position as managing director at the start of August, and I am privileged to have the opportunity to contribute to the organisation in my new role. The organisation and the portfolios for which we are responsible are performing very well. In October we released our portfolio update to the end of September 2014 and confirmed that the Future Fund returned 14.3 per cent for the 2013-14 financial year—adding $12.7 billion to the value of the portfolio. With further growth in the first quarter of this financial year, the value of the Future Fund stood at $104.5 billion at the end of September, and it has since grown to over $105 billion.

Since May 2006 the fund has produced a return of 7.3 per cent per annum and is now meeting the benchmark return set in the investment mandate. Initial contributions received by the fund were valued at $60.5 billion, and so the fund has added $44 billion as a result of its investment activity. While we are pleased with the fund's performance, we continue to recognise that the return objective is a challenging one and that to achieve it requires material investment risk to be taken. We also recognise the importance of protecting the Commonwealth's capital and we work hard to achieve those required returns without exposing the fund to undue potential for capital loss. We do this by constructing a global, diversified portfolio consistent with our mandate and with global best practice.

Earlier this month there was interest in the Future Fund's taxation arrangements. I think it is important to put a number of points on the record. Under its legislation, the Future Fund is not liable to pay income tax in Australia. It cannot minimise its Australian tax liability, as it has no Australian tax liability. As a sovereign wealth fund, the Future Fund is typically entitled to sovereign immunity when it invests overseas. In the vast bulk of its investments offshore, the Future Fund's sovereign immunity is recognised just as Australia recognises the reciprocal rights to sovereign immunity when other sovereigns invest into Australia. The Future Fund invests through external investment managers and alongside other global institutional investors. This makes the use of subsidiaries and various jurisdictions necessary. The arrangements the fund uses are conservative and transparent to all relevant tax authorities.

There has also been some interest in the matter of investing in companies with exposure to fossil fuels. Again I make a couple of points: we are mandated to seek to maximise return with acceptable risk and we have constructed a diversified global portfolio accordingly. Our policy is that the fund is able to invest in anything that is legal and does not contravene conventions and treaties that Australia has signed. The exception is tobacco, which the board considers to have its own unique characteristics that justify an exclusion. Companies that produce fossil fuels are legal and the board does not exclude them. I reiterate to the committee that the fund is performing well and is well positioned for the future.

CHAIR: Thank you, Mr Neal. The Future Fund has been tasked with managing a number of additional funds through the 2014-15 budget. Is that correct?

Mr Neal : Yes, that is correct.

CHAIR: What funds are they?

Mr Neal : We need the acts to be passed, but the Asset Recycling Fund and the Medical Research Future Fund. In addition there is the DisabilityCare Australia Fund, which is about to be imminently funded.

CHAIR: I do not want to go to matters of policy that have not been announced, but will the investment mandate effectively, for all those same funds, be along the same lines as what the Future Fund currently is?

Mr Neal : We do not have a mandate as yet for the Medical Research Future Fund, because clearly there is no act, and the same for the Asset Recycling Fund. But as we have discussed—I think in this forum before—the expectation would be for the Asset Recycling Fund to be quite a low-risk mandate, because the money comes in and goes out. It is a vehicle for funding activity over relatively short periods, so you would not take a lot of investment risk with a fund like that. For the Medical Research Future Fund we have discussed that, because of its cash flow nature, it would make sense for the risk profile to be somewhere between that low risk of the Nation-building Funds and the other more long-term risky portfolio that we would construct with the Future Fund—so more of a moderate risk profile, but we do not as yet have a mandate.

CHAIR: You might recall at the last estimates I asked whether the Future Fund ever invested in non-income producing assets—bullion and investments of that nature. The answer was no. Is the answer the same today?

Mr Neal : That is correct.

CHAIR: Mr Costello, I think you were the Treasurer that put the original $60 billion into the Future Fund, and now you are assuming the chairmanship of the Future Fund Board of Guardians. Is the original vision of the Future Fund under the Howard-Costello government being fulfilled?

Mr Costello : I do not think it is well understood in Australia, I think it is much better understood outside Australia, that the Future Fund is in fact a sovereign wealth fund. It is a member of the international sovereign wealth funds association; it is the ninth biggest sovereign wealth fund in the world. It is owned by the government of Australia, which holds it ultimately for the people of Australia. It is not a superannuation fund. The Future Fund was set up to invest government surpluses, and it invested surpluses from the budgets in 2005, 2006, 2007. It took the remainder of the Telstra shares when Telstra was being privatised. Cash and shares that were put into the Future Fund totalled $60.5 billion, and that has now been grown to $105 billion. It is the biggest financial asset that the government has, and that the people of Australia have.

That part of the vision is being fulfilled and I think it is an institution that all Australians respect; both sides of politics respect it and have respected it throughout both periods of government that we have had since it was established. Personally, I would like to see our sovereign wealth fund grow bigger, but if the sovereign wealth fund is only able to invest budget surpluses we will not have any money flowing into it until the next budget surplus. I know the minister has that under control. I look forward to further inflows. It is different from a superannuation fund—a superannuation fund getting inflows all the time of nine per cent, 9.5 per cent, 12 per cent from new members. The Future Fund has not had an inflow of money since those budget surpluses were last produced in 2006 and 2007. That is now seven years without an inflow—but I must say it has done pretty well. It has basically made $45 billion off that $60 billion, and it is now the ninth largest sovereign wealth fund in the world.

Senator XENOPHON: Could the role, the function and the effectiveness of the Future Fund be changed in the sense that are there sovereign wealth funds in other countries with a structure somewhat different from ours? Is it not just a function of the available funds but also a function of the structure and role of other sovereign wealth funds that we could be looking at?

Mr Costello : You can have a sovereign wealth fund for many different purposes. There are some sovereign wealth funds that have been set up to invest the proceeds of a depleting asset. I put into that category Norway, with its oil rights, and Kuwait, although the asset does not look too depleted at the moment, but that is why it was set up—the idea being that one day we will run out of oil and we want to have something to show for it, so we set up a sovereign wealth fund. There are then sovereign wealth funds that have been set up to ease the commodity cycle. Chile, for example, is very dependent on copper and it has the Copper Stabilization Fund. The idea is to put aside some money when copper is high for the times when copper is low. Mexico did that with an oil fund. We call those stabilisation funds.

There are some that are national development funds. But the Future Fund is an intergenerational savings vehicle. It was essentially a mechanism whereby in 2006 the Commonwealth locked up money and put it into a box and said, 'That box cannot be opened until after 2020.' As a consequence, sitting on the Commonwealth's balance sheet we now have $105 billion. The legislation says after 2020 the circumstances in which the locked box can be opened. That could be set by legislation—two houses of parliament could change it. But it was really an attempt to say, 'Here we are. We have the ageing of the population. We have our budget under control. We are in surplus. Let's put aside something for future generations.' We did it. I think it will be very valuable in 2020. I hope it is a lot more than it is now. In 2020 those taxpayers who are funding the ageing of the population will be able to draw down on some of the income to help them with their bills, and that is the idea of it.

CHAIR: I have a couple more questions, which may apply to you, Mr Neal. Recently I have met with members of the Australian hedge fund management industry association, who, of course, are very positive about the investment managers that are Australian grown, and their performances and the opportunities they present to domestic investment. They made the point to me yesterday that it is very hard to get investment into some of their vehicles, and mandates from superannuation funds, and, in particular, they did mention the sovereign wealth fund, which is the Future Fund. What is your fund's relationship with domestic investment managers who do not fit the long-only equity, index-tracking funds, like hedge funds?

Mr Neal : Remembering that our mandate is to maximise return, our mandate is to apply global best practice, we put a lot of effort into looking for the best investment managers in the world. There would be organisations in Australia that meet that hurdle. One of the other problems we have, though, as a very large fund, with $105 billion, is that we have to give sizeable mandates to managers, otherwise it does not move our needle—it is not worth our while. Australia is a relatively small market in those terms. When you get to organisations such as hedge funds, which are investing in highly concentrated ways, there would be very few in Australia that could take the sort of mandate that would make it worth our while handing out. That is just a practical issue that we have. I obviously cannot comment on other funds and their use, or not, of the local industry.

CHAIR: I understand that, but we do have some excellent alternative asset managers in this country who have chosen to be domiciled here and invest on a global basis, just like a number of US funds. The concern is that our domestic industry is being forced offshore, because they are not finding the support from some of the institutional investment companies.

Mr Neal : I can assure you that we review domestic managers right alongside every other manager on the globe. We make as much use of domestic managers as the quality of those managers and their scale and ability to absorb our money warrants. We have private equity managers in Australia that we invest with. We obviously have a number of equity managers we invest with. We have a number of managers investing in debt and credit markets in Australia. We have a number of property managers. We have infrastructure managers. So we have significant exposure to this market. You referred specifically to hedge fund managers. That is an area where we at this point have not found a manager with sufficient quality and, importantly, capacity for us to be able to invest.

CHAIR: I think you said some encouraging words for the alternative investment industry. I suspect you will have a number of submissions crossing your door in the weeks to come.

Senator WATERS: Thank you for coming here today, and particularly Mr Costello for making a special trip for us, which is much appreciated. I have some questions for you, Mr Costello. I have your recent opinion piece in The Daily Telegraph that criticises the Australian National University for selling its shares in particular companies on social and environmental grounds.

Senator Cormann: It was a very good piece.

Senator WATERS: On reading that, people might be forgiven for thinking that you have picked a side in this debate—obviously the fossil fuel industry side. In particular I refer to your comment in the final paragraph of your op-ed that the demise of that industry would be a huge cost to the nation. Do you take that into consideration when you are exercising your duties as chair of the Future Fund management board?

Mr Costello : The policy of the Future Fund during the period I have been chair is exactly the same policy it was when David Gonski was the chair, and exactly the same policy when David Murray was the chair. It is this: the Future Fund invests in every stock with the exception of something that would be illegal under an international convention—say, cluster munitions. There is only one stock that it does not invest in that is legal in this country, and that is tobacco. We debated that very long and we have been asked about that here and I will not go over why tobacco is excluded. When you have a big portfolio, some people will not like fossil fuels. Some people will not like gaming.

Senator XENOPHON: Gambling.

Mr Costello : Is there a difference?

Senator XENOPHON: Yes, there is.

Mr Costello : Well, he does not like gambling and there are some people who do not like gaming! Some people don't like investing in Fairfax shares and some people do not like investing in News Corporation shares.

The Commonwealth government could sit down and try to pick stocks according to what it liked and did not like. But we have a rule, which has been the rule under every chairman and it has been the rule that is under every government, which is that, with the exception of tobacco, we will invest in a legal product, provided it is a good investment. In relation to fossil fuels, the big fossil fuel companies in this country would be companies like BHP, Rio, Woodside, Origin and AGL. Do we invest in them? Yes, we do. I think it would be extraordinary if the government of Australia, in its sovereign wealth fund, said it was going to pull out of coal or gas or oil. These are very important industries to Australia. I think it would be extraordinary. Nobody has suggested that. I am not even sure that the Greens have suggested that.

Senator WATERS: We have, for the record.

Mr Costello : Okay. Let me make this point. ANU has not. The point of what I wrote here is that when ANU pulled out of seven stocks people thought they were pulling out of fossil fuels. If you look at those seven stocks, I think four are gold miners, one is a mineral sands company, and two are in fossil fuels. When ANU clarified its position, it confirmed—I read this in the press, and I am only going from that—that ANU still holds BHP—that is, ANU is still invested in fossil fuels. It did not pull out of fossil fuels. So, whatever reason it took to pull out of those seven stocks, it was not to get out of fossil fuels. ANU has not done it. I was speaking to David Gonski, my predecessor as chairman of the Future Fund, who is the chancellor of the UNSW. The UNSW released a statement the other day. They are not pulling out of fossil fuels.

If we were to pull out of fossil fuel, one, we would break the rule we have established, and that is the main reason, but, two, it would be a very strange thing for a country like Australia, which exports coal and gas, for its government to say, 'We think these things are so filthy and so wrong that we will not even touch them on the stock market.' I would think just about every superannuation fund—I think Local Government pulled out and I think UniSuper had an exclusion—would also be invested in those fossil fuels.

Senator WATERS: There are a number of super funds that are not, but the time is limited, so I will leave that point.

Senator Cormann: We are quite happy to go on. Don't feel constrained by time. I think this is a very important occasion this morning.

Senator WATERS: Thank you, Minister.

Senator Cormann: We are very keen to assist the committee.

Senator WATERS: Thank you, I will take that opportunity.

CHAIR: The standing orders are very straightforward that we cannot move on until all questions have been exhausted by all senators, so, Senator Waters, you have as much time as you need.

Senator WATERS: Thanks very much, everybody. This is a rare occasion for us and I will enjoy it greatly.

Senator Cormann: I thought I would clarify that for you.

Senator WATERS: Mr Costello, given your strong views in support of fossil fuels, are you concerned that Australian taxpayers, whose money you are looking after, would be concerned that you are letting your support for the fossil fuel industry cloud your judgement?

Mr Costello : I do not think the Australian taxpayers would think that for a moment.

Senator WATERS: That is not a concern to you?

Mr Costello : You asked me: am I concerned that the Australian taxpayers might think that? The answer is: I do not think they would think that for a moment. The Australian taxpayers, incidentally, are taking very large taxes out of fossil fuel companies. They are taking them at 30 per cent company tax rates. Some of those fossil fuel companies, incidentally, would be amongst the biggest company tax payers in Australia, and then they back up and have taxes taken out of them through state royalties.

Senator WATERS: Not the mining tax or the carbon price, though, of course.

Mr Costello : State royalties. Everything that is mined onshore is subject to a state royalty and, if it is offshore—and I used to administer the tax system; I know a little bit about it—the Commonwealth likes to take a royalty. Then there are some legacy positions such as the North West Shelf where we share revenues. There are PRRT, excise and company tax. If the Australian taxpayer were not able to take taxes out of those, you better think up a big, new tax to replace them.

Senator WATERS: If that is the premise of your argument, why was the decision taken to divest from tobacco?

Mr Costello : That is a very good question. We knew that, once you divested from something, you would open the door. Once you said, 'Tobacco's out'—and we discussed this at our board—people are going to say to you, 'You've established the principle. What about gambling? What about fossil fuels? What about Fairfax shares? Are these things harmful to people?'

CHAIR: Yes, Fairfax is!

Mr Costello : What about News Corporation? We knew this would be the thin edge of the wedge. We sat down and had a long discussion, and here is the rationale for pulling out of tobacco. People will tell you that there is no amount of tobacco that is not harmful—not even one puff, they will tell you. You may not agree with me about this, but I think that you cannot say the same of coal or gas or oil. Every night that I drive home, I use oil. I turn on my lights at home and that uses electricity produced from coal, and then I heat my—

Senator WATERS: You should pop some solar panels on your roof.

Mr Costello : Give me a new subsidy and I probably will.

Senator WATERS: You should have a chat with Minister Cormann about that.

Senator Cormann: We do not have any money for subsidies. Your previous government—

Senator WATERS: I see, because the big end of town is keeping it all.

Senator Cormann: The Labor-Green government left a debt and deficit disaster behind.

Senator WATERS: You should not have abolished those carbon taxes and mining taxes.

CHAIR: Order! Mr Costello, I make the presumption that you get home at night time, when solar panels do not work.

Mr Costello : You are absolutely right.

Senator WATERS: And there are no such things as batteries. There are no advances in battery technology at all.

Mr Costello : I work day and night for the Future Fund, so I do not get home much.

CHAIR: Resume your questions, Senator Waters.

Senator WATERS: I think Mr Costello was speaking.

Mr Costello : But that is the reality. Most Australian homes today are powered by electricity from coal. As far as I know, most Australian cars are still powered by oil. We can sit around and say we should not own stocks in these companies, but we are very, very happy to use the products they produce.

Senator WATERS: Many Australians still smoke too, for that matter, so I do not quite follow the logic of your argument.

Senator Cormann: So you think driving cars and smoking are the same? Do you think we should stop driving cars?

Senator WATERS: Good on you, Minister Cormann. I am asking Mr Costello here.

Senator Cormann: But that is the question. You do think that people should—

Senator WATERS: You do not get to ask the questions here. This is estimates. I will ask Mr Costello my questions.

Senator Cormann: Sure, but I am providing a rhetorical question as my answer.

Senator WATERS: Thank you for your charming intervention. Mr Costello, I am interested in your level of familiarity with climate science.

Mr Costello : I was a member of the House of Representatives for 20 years. I was a minister for nearly 12 years. I sat through many cabinet discussions on the issue. I would know as much as an ordinary member of parliament would know.

CHAIR: Mr Costello, I would say that it is entirely within your brief to take that question if you would like to and further questions along those lines, but there is no requirement. It is completely outside of your appearance here today.

Senator WATERS: Thank you, Chair. Again, I do not understand your line of reasoning.

Senator Cormann: It is not relevant to Mr Costello's responsibilities as Chairman of the Future Fund. We are in an abundance of helpfulness. We have been very broad in our invitation on how we can assist you here today.

Senator WATERS: Thank you for being so helpful.

Senator Cormann: Within the confines of that, I entirely endorse Senator Bernardi's ruling.

Senator WATERS: Moving back to your op-ed, Mr Costello, you talk about ethics in relation to investment. I am interested in what role you think climate science should play in determining what is ethical investment and what is not.

Mr Costello : The Future Fund has a statutory obligation to maximise returns on behalf of the Australian people. The Future Fund was not set up to try and use economic power for political ends. Once you start using economic power for political ends in a government owned institution, I think you run into even bigger ethical issues. You might have one ethical view; he might have another view; I might have another view. The government, in its legislation, is very clear about what it wants the Future Fund to do. It wants the Future Fund to get a return over the long term of CPI plus 4½ to 5½ per cent. That is a real return of 4½ to 5½ per cent. For the first six or seven years, it was below that mandate, and that is because financial markets were awful in 2008-09. It was below the water. You know, the great news is that it just hit that mandate in September 2014. I pay tribute to our staff and everybody else who has worked on that. That is what it does, and it invests in anything that is legal, with the exception of tobacco.

We could say to these blokes, 'Sit around and try and pursue an ethical stock here or a non-ethical one there.' Do you know what you would turn this bloke into? You would turn him into a politician or an ethicist. They could sit around all day and all night doing that, or they could sit around trying to invest for future generations of Australians—and that is what they do because that is what the law says: we invest for future generations of Australians.

Senator WATERS: What role does climate science play in the investment decisions of the Future Fund?

Mr Costello : There is an ESG policy. An ESG policy is such that all of these things can be considered in relation to stocks that are held and in relation to voting at annual general meetings. It is principally exercised by the managers whom the Future Fund retains, but we do not instruct those managers—I think this is where you are getting to—to exclude fossil fuel companies. We have not instructed them under me. We did not instruct them under David Murray. We did not instruct them under David Gonski. We did not instruct them under Nick Minchin. We did not instruct them under Lindsay Tanner. We did not instruct them under Penny Wong. And I cannot imagine this minister instructing us to do it.

Senator Cormann: I am not. I am happy to put that on the record.

Senator WATERS: Are you tacitly instructing them to invest in fossil fuels with an op-ed such as the one you have published?

Mr Costello : No, I am not. I am pleased that you read it and I do appreciate that.

Senator WATERS: It was riveting.

Mr Costello : It was riveting?

Senator Cormann: It was a very good opinion piece, I have to say. I agree.

Mr Costello : I am going to tell the Telegraph to put in a blurb: 'It was riveting—Senator Waters'. The ANU decision was not one to divest fossil fuels. That is my point. I think you would agree with that.

Senator WATERS: It was a partial fossil fuel divestment.

Mr Costello : Hang on. There are two fossil fuel companies out of seven stocks. ANU stayed in the big fossil fuel stocks—BHP, for example. It was not a fossil fuel decision. That is the point I am trying to make here. Most of them were gold miners. We do not know what the reason was. My own view is that it was probably to do with tailings. I am just speculating there. When I saw companies like Newcrest and so on, I thought, 'It could be tailings'—because there has been a big argument at the Lihir gold mine about that. We do not really know what the reason was, but I can assure you of this: it was not a fossil fuel divestment.

Senator WATERS: I believe the ANU contend differently, but I will take that up with them rather than argue with your assumption about their motivations.

Mr Costello : I do not think they do contend differently. I read an article in the paper headlined 'ANU VC: World needs fossil fuels'. That is from the Australian Financial Review of 23 October.

CHAIR: Would you be prepared to table that, Mr Costello, for the benefit of the committee?

Mr Costello : Yes, sure. It is public. It says:

ANU vice-chancellor Ian Young said the world would depend on fossil fuels for “decades to come” as he defended the university’s decision to cull seven resource stocks from its $1.1 billion investment fund.

It goes on to report Mr Young as saying—

Senator WATERS: I have read that article, Mr Costello. By all means table it for the benefit of the committee.

Mr Costello : Hang on. You said they contended that it was divestment of fossil fuel. The AFR article said:

ANU continued to hold major Australian resource companies which produce fossil fuel but had been very highly assessed. These include BHP and Rio.

ANU holds BHP and Rio. They are the big fossil fuel companies.

Senator WATERS: They are taking a step in the right direction. No-one is contending that—

Mr Costello : I think you are changing your ground now. You said that they said they had divested fossil fuels.

Senator WATERS: I said I would take it up with them rather than speculating, through the Financial Review, about what their motivations are.

Mr Costello : I do not think you need to take it up with them, because the Australian Financial Review reported what they said.

Senator WATERS: Thank you. I will take that up with them.

Mr Costello : The AFR took it up with them and they said they had not divested fossil fuels.

Senator WATERS: I will take it up directly with them rather relying on a newspaper report.

Senator LUDWIG: I have a question on a broader issue. It goes to the process. You indicated earlier that you excluded tobacco and you said you understood that that would open up the arguments we are now having. What process did you go through—please just go on if you have already answered this—as an entity to come to the conclusion that you could exclude tobacco?

Mr Costello : Essentially the governance committee of the Future Fund had a discussion about it. It made a recommendation to the Board of Guardians which made that decision. I do not like tobacco. I have no brief for tobacco. But the only reason for not doing it is that we knew that immediately we did it, we would open up all of these arguments. The question became: is there anything that is distinctive about tobacco? The answer the board came to was that no amount of tobacco can be nonharmful, whereas the board does not believe that every amount of oil, coal or gas is harmful.

Senator WATERS: Thank you for clarifying that. Are you across the research that shows that there is an extremely high probability of more than two degrees of global warming if we do not keep two-thirds of known fossil fuel reserves in the ground?

Mr Costello : I have read a lot of research. I am here in my capacity as the chair of the Future Fund, and you are asking me what the Future Fund's investment policy is, and the Future Fund's investment policy is: subject to tobacco, it does not ban any investment which is legally produced and distributed and sold and used in Australia.

CHAIR: Once again, I remind you, Mr Costello: you do not have to answer questions that are outside of your investment—your role.

Senator WATERS: It goes to the contention about what is a safe use and what is not, so it is clearly relevant to your investment decisions.

Senator Cormann: You might want to rephrase your question.

Senator WATERS: I am first seeking to understand if Mr Costello is at least familiar with the research, because, if not, then I might direct my questions to Mr Neal just on this particular point. So, Mr Costello—

Senator Cormann: The thing is: it is a question that is not actually relevant to Mr Costello's responsibilities as chair of the Future Fund; that is the point.

Senator WATERS: It is relevant because—

Senator Cormann: Well, that is your opinion—

Senator WATERS: if your investment policy is that you will not invest in something that is not safe, and you are not across the climate change science that says that coal is not safe, then—

Senator Cormann: You are making a political point.

Senator WATERS: you are not doing your job properly.

CHAIR: Senator Waters, you can ask your question—

Senator WATERS: Thank you; I am attempting to.

CHAIR: but I say to the minister, to Mr Costello and Mr Neal that they are under no requirement to answer any questions that do not extend to the roles and responsibilities that they have today.

Senator WATERS: Sure, and I do not disagree with that, but, again, it is relevant to the investment policy that you yourself just cited.

CHAIR: Ask your question, Senator Waters.

Senator WATERS: Are either of you two gents familiar with the Nature paper from 2009—

Senator Cormann: 'Gents'?

Senator WATERS: and many publications based on that since that say that, to avoid more than two degrees of global warming, two-thirds of fossil fuel reserves need to stay in the ground?

CHAIR: It is not relevant to your portfolio but you may choose to answer.

Mr Costello : I am just going to make the point: whether I have or whether I haven't, that is not how the Future Fund makes its decisions. If you, Senator, are saying that there is no safe use of fossil fuels—so it is as poisonous as tobacco; if that is what you are saying—I would look at that, but there obviously is safe use. You know how I got here today? I flew on a plane. You asked me to come, and I flew on a plane. Was I engaging in an absolutely harmful activity? I do not think so. I really do not think so. But if you are saying that there is no safe use, then you had better get off your plane and out of your Comcar and stop turning on your gas—you'd better do it!

Senator Cormann: Switch off the lights, maybe—that is what is required in order to go down that path.

Senator WATERS: Because only fossil fuels can produce electricity—is that what you are contending? Is that seriously what you are contending, Minister Cormann?

Senator Cormann: I would suggest that about 70 per cent—

Senator WATERS: Do you want to stand by that remark, or would you like to correct the record?

CHAIR: The opportunity for climate change discussions is in another committee, Senator Waters.

Senator WATERS: Then I will assume, unfortunately, that you have not read that research. Can I ask if either of you will commit to reading that research?

CHAIR: It is not relevant to the discussion at hand. Your question is not relevant.

Senator WATERS: I would ask that you each take the time to read that research, given that it is highly relevant to the investment decisions that you are taking.

CHAIR: Do you have any relevant questions?

Senator WATERS: Yes, I have quite a few, and thank you for your earlier suggestion that I ask all of them.

CHAIR: As many as you like.

Senator WATERS: Mr Neal, you were quoted in The Sydney Morning Herald last month as saying that, while you acknowledge that demand for fossil fuels will fall in the long term, there is potential for short-term gain before that happens. Is that an accurate representation and reflection of the agency's position—the fund's position?

Mr Neal : The first thing to remember is that the Future Fund, by its act, is required to invest through investment managers. So the day-to-day decisions on the valuations of stocks and the return opportunities are taken by them. We expect those managers to have regard to all the risks and indeed all opportunities when making a decision to invest in particular stocks. Those would include risks associated with climate change or any other risk, and so, as the prices of stocks change, our managers will form their views on the prospective returns, and that is exactly what we pay them to do.

CHAIR: Senator Waters, before you continue, Senator Dastyari has some questions.

Senator WATERS: I had a follow up question—

CHAIR: That is fine; I am going to come back to you.

Senator WATERS: on that very point.

Senator DASTYARI: Thank you, Mr Costello, and thank you, Mr Neal. I have one follow-up question from where we have been. I just want to get this completely right. This is my understanding. The decision by the Future Fund to divest itself of tobacco stock was entirely a decision of the Future Fund independent of government. It was a decision the Future Fund came to itself, as is appropriate. That is my understanding; is that correct?

Mr Costello : Yes, that is true.

Senator DASTYARI: And that is as it should be.

Mr Costello : It is as it should be. Senator, I was appointed to the Future Fund by the Labor government—by Kevin Rudd. I was on the board during the period that Lindsay Tanner was the minister and I was on the board during the period that Senator Wong was the minister. And I can say to you that neither of them sought to intervene and direct the Future Fund in any way. They respected its independence.

This decision was taken by the board. Senator Wong was probably informed before it was announced but she did not pressure for a decision. She did not seek to instruct a decision. I do not think the government, under the current legislation, could instruct a position, by the way. The government could amend the legislation. It could change the mandate, but I doubt very much, as a matter of law, that the government could direct the Future Fund as to what to put money into and what not—

Senator DASTYARI: And that was never your intention when you designed and created it.

Mr Costello : That was the intention when it was designed. This is owned by the government. We did not want the government to be in a position where it could use financial power to reward or punish companies. So a number of protections were built in. Firstly, there was an independent board that could not be instructed. Secondly, there was the rule, basically, that there would be no exclusions. This was thought about very carefully at the time. I must say that in my experience—I have been on this board under three ministers—they have all respected that very much.

The model of the Future Fund, as an independent financial institution, in my view is very much like the Reserve Bank. The government owns a bank. It engages in banking activities. It pays some dividends to the government but the government has given it independence. That government owns a sovereign wealth fund. It earns dividends for the government. The government does not intervene.

Senator DASTYARI: Mr Neal, there is something that you touched on in your earlier statement, which I want to get on the record because it is a matter of fact. The Future Fund does not pay any taxes in Australia on its investments because it does not need to. Correct?

Mr Neal : Correct.

Senator DASTYARI: Can you explain this. There has been a fair bit of reporting and media about this, which I am sure you would be well aware of—

CHAIR: Senator Dastyari, could you please speak into the microphone.

Senator DASTYARI: Sorry. I am sure the Future Fund will be well aware of a fair bit of media and commentary around this issue to do with tax havens and documents that have been leaked by a journalist group through Luxembourg. Can you just explain your understanding of why the Future Fund does manage investments in the Cayman Islands and in Luxembourg, which is what the essence of the report was about?

Mr Neal : Absolutely. These vehicles in these jurisdictions are an absolutely commonplace and normal structure that the international finance system uses to aggregate capital from around the world. Clearly, given that we do not pay tax in Australia and that we do not pay tax in many of the jurisdictions we invest in around the world—

Senator DASTYARI: Do you pay tax in any of them?

Mr Neal : Yes. There is not sovereign immunity in every jurisdiction. There are certain taxes that we are liable for. Our tax rate ends up being pretty low. It is not completely universal but it is a principle that governments do not tax each other around the world. I cannot say that it is completely universal. These vehicles are used to pull capital from different investors from around the world who all have their own context, their own different perspectives. Some of them are taxpayers. Some of them will be Australian superannuation funds. Some of them would be Canadian superannuation funds or European funds, so the system uses these vehicles to aggregate capital efficiently.

There are two really important points. The first is that, whenever we use any of these vehicles, we use them extremely conservatively. We make sure we are well inside all of the prevailing laws and that they are completely transparent to all the tax authorities so we can completely reject any notion of tax evasion and the use of these vehicles for those purposes. These are totally transparent vehicles. These vehicles ensure that tax is paid as appropriate to that investor in the country in which these investments are made and in their own domicile.

Senator DASTYARI: You are saying that by using these international Luxembourg structures—I am using the term structure; I do not know if that is the right or wrong word—that in no way, shape or form effects either domestically or internationally our tax bill.

Mr Neal : That is right.

Senator DASTYARI: You said before we pay some tax in some other countries sometimes. Does that get shaped by going through this process?

Mr Neal : We use these vehicles to protect our legitimate tax bases and to protect other risks. There are other legal and commercial risks that we can manage using these vehicles. But, from a tax perspective, they are used to protect and preserve our tax basis as a sovereign investor.

Senator DASTYARI: Mr Costello, I think you come at this from so many perspectives. To say something nice, which will mean I will get blasted on Twitter shortly about this, but—

Senator Cormann: You only figure that people are watching what you are saying on Twitter.

Senator DASTYARI: No, they are watching you, Minister Cormann.

Senator Cormann: I don't think they would have much interest in it.

Senator DASTYARI: For 10 years as Treasurer, you did quite a lot—

Senator Cormann: It was 11½ years, actually.

Senator DASTYARI: Sorry—domestically and internationally to address some of those concerns about people's ability to minimise their tax and tax avoidance schemes and. Obviously, every couple of years, it is an ongoing debate and you have to be ever vigilant. Do you think there is a problem at the moment in terms of international tax avoidance?

Mr Costello : Do you mean generally or in relation to the Future Fund?

Senator DASTYARI: Both.

Mr Costello : Let me say in relation to the Future Fund: the Future Fund does not pay tax to the government, because it is the government. There is no point in the government taxing itself.

Senator DASTYARI: No-one is advocating that should happen.

Senator Cormann: It is good to know that.

Mr Costello : The government does not get any more money by taxing itself. That is the first point—in fact it loses money because you have transactional tax. You have costs and all the rest of it. I will give you an analogy: the government has a bank, the Reserve Bank of Australia. It pays dividends. It does not tax those dividends. The government has a sovereign wealth fund. It earns dividends. The government does not tax those dividends, and there would be no point in doing it.

So the Future Fund never minimises Australian tax, because it does not pay any—that is the point. People say, 'Oh, it didn't pay tax. I might have to pay more.' No, no, no. If it did pay tax, your liability would be exactly the same as it is, because it is the government. The government cannot tax itself and make more money. It can tax itself but it does not make more money.

Then you get into: what happens when the Australian government's own sovereign wealth fund goes overseas? Mostly, it is immune overseas. Why is it immune? Other countries give us immunity, because they want us to give them immunity. Why does Julian Assange sit in the Ecuadorian embassy in London? The British police could go in there at any moment they wanted but they recognise the sovereign immunity of the Ecuadorians in London, because they want the Ecuadorians to recognise the sovereign immunity of the British Embassy in Ecuador. That is how it all works. Mostly, the Future Fund is immune, so it is not even avoiding other countries' tax.

I have gone back and looked at this transaction. It was entered into in 2010. I was not the chairman, and Labor was in government. I was not involved in the transaction then but I have gone back and had a look at it, and I think what the Future Fund did then was reasonable commercial practice—to avoid getting caught outside its statute it has to invest alongside managers, its manager was in Luxembourg, Luxembourg is a member of the EU, it sought a ruling, it got a ruling. Companies all the time get private binding rulings from the Australian Taxation Office. It is standard practice. You are bringing a transaction into Australia, you go to the ATO, you say give us a private binding ruling, it gives it, it tells you what your tax would be. This is what they did in Luxembourg—we are coming in, we are investing alongside a manager in Luxembourg, we are seeking a private binding ruling, the Luxembourg tax authority gave it. I am satisfied that that was proper commercial practice.

I will now go to your general question. In a globalised world where the seller can be one jurisdiction and the buyer can be in another jurisdiction and the transition took place over the internet, where has the economic transaction occurred? Did it occur where the seller sold from, did it occur where the buyer bought from, did it occur in cyberspace, which is regulated by nobody? This is what modern taxation authorities are struggling with. If BHP sells iron ore into China, is a profit on the transaction Chinese, for Chinese taxation, or is it for Australian taxation? We would like to say Australian. That might mean, in retrospect, if a Chinese company is selling to us and we are buying from here and putting it in an Australian bank, the Chinese are going to say that they demand that that transaction takes place in China, and it can be taxed to the degree that the Chinese taxation system works. Then these countries enter into double taxation agreements as to how they are going to allocate the profits and everything else.

I went through many negotiations on double taxation agreements. In the world of electronic transfer and the internet and mobile capital and mobile income, your best tax bases are always going to be ones that are local. That is why people say land taxes, consumption taxes—do we know where consumption takes place?—PAYG, because we know where the income of a PAYG person is derived, are going to be your best taxes and the rest you are just going to have to negotiate as best you can on your double taxation agreements. I think you are doing an inquiry, Senator?

Senator DASTYARI: Yes.

Mr Costello : Let me kill you on Twitter—it is a big issue.

Senator DASTYARI: Will you come to our inquiry?

Mr Costello : I'd have to get penalty rates to come to your inquiry! The game is changing all the time, and countries are struggling with this. You will not agree with me on this, but it is one reason we had to introduce a GST—because consumption is very local. You can get that. But when you are dealing with companies like Apple or Google, everybody all around the world, it is very hard. I want to say to the Australian people that the Future Fund is not trying to avoid any tax in Australia, because it is not liable to pay any. You cannot negotiate down what you do not have to pay.

Senator DASTYARI: Is part of what you are saying, Mr Costello—I just want to be clear about this—that when we look at how we deal with this issue of international taxation avoidance it is about looking at the way in which we structure our own domestic taxation system so that we can actually capture it in a different way?

Mr Costello : That might be a response, that we have to structure our taxation, but the other thing is that whatever we are demanding of another country, they are going to demand back on us. You do not want to go looking for a little fish over here and then enter into a tax treaty which enables them to catch a whale back in Australia. You most certainly do not want to do that. I have seen that happen.

The other thing you are going to have to bear in mind is this: there is another concept which you get into here which is called interest withholding taxes, which is just a tax, basically, on a transaction. Some countries say, 'I'm not going to worry about your income. I'm not going to worry about your capital gains. I just have an interest in withholding tax. That way, if you bring a transaction in, we'll get it.' That can work and sometimes a future fund will come under those taxes. But in Australia we went to lengths at one point to get rid of interest withholding taxes because it was thought that this would help us set up what are called offshore banking units. An offshore banking unit is where the money can be loaned by Chilean pension funds to European developers, but you, the Australian bank, could raise the money there and lend it there and you would bring this business into Australia and it would be an offshore banking unit.

Under the government that I was part of and under the previous government we went to great lengths to try and promote Australia as a financial centre, including getting these offshore banking units. His name escapes me, but the Assistant Treasurer at the time in your previous government was very hot to trot on that. This was getting rid of the interest withholding taxes. These transactions would come into Australia, most of the Australian banks had them and they had people working on them. You may not get tax out of the transaction, but you will get income tax out of people who are working on them who would never have jobs otherwise.

We are not the only country in the world that thinks about this. There are European countries that say, 'We'd like the offshore banking unit in our country. Come to our country. We won't have an interest withholding tax.' If you are the future fund and you can base yourself in this country or this country and that country does not have an interest withholding tax and this one does, you can perfectly legally go to that country. That is why they do it. They want you to come in.

CHAIR: Mr Costello and Senator Dastyari, I suspect, Senator Dastyari, you are trying to get evidence for your own committee. This is my committee. You can request Mr Costello yourself another time—

Senator DASTYARI: Mr Costello has already committed to coming to our inquiry.

Mr Costello : I do not think I said that; read the fine print!

CHAIR: I do not know anything about that. Senator, did you have a further question?

Senator DASTYARI: I will move on.

CHAIR: Senator Lundy has a few questions.

Senator LUNDY: Thank you. I asked questions previously regarding the maturity of the Future Fund and at what point the assets within the Future Fund become available to government for the purposes of offsetting their liability. Given the Future Fund is due to mature in 2020, what is the process by which the asset becomes available on budget to the government to offset their budget reported liabilities?

Mr Costello : The legislation currently provides that there can be no drawdown out of the Future Fund until 2020. Then in 2020 it can draw down to fund an unfunded liability. It does not have to.

Senator LUNDY: It does not have to?

Mr Costello : It does not have to, but it has the power to under the current legislation.

Senator LUNDY: To what degree of flexibility does the legislation allow for that drawdown to occur?

Mr Costello : I am sorry, I did not hear that?

Senator LUNDY: To what degree of flexibility is the government afforded in drawing down the Future Fund for the purposes of the unfunded liability and how is that reflected in budget documents?

Mr Costello : The discretion is in the act. I could take you to the section. Basically, that is what it says. It can if it wishes—it does not have to do—after 2020. How is the Future Fund reflected in the budget?

Senator LUNDY: If it were to be drawn down?

Mr Costello : Future Fund earnings actually appear in the budget bottom line at the moment, but they are separated.

Senator Cormann: They do appear.

Senator LUNDY: I appreciate that. My question was more in the context of post-2020. I am trying to get an idea of the scenario if a government chose to draw down on the funds for the purpose. How would that drawing down be reflected on the budget as opposed to—

Senator Cormann: It would be reflected as an expenditure. Subject to no change to the budget treatment, the income that is generated by the Future Fund will continue to appear, as it does now. If that is what the government decided to do, to expend any of that income that is generated, then that would appear as an expenditure in the same way—

Senator LUNDY: Under the Future Fund?

Senator Cormann: No. It would appear as an expenditure in the budget, as an expenditure of government, the same as the income of the Future Fund appears as income of the government in the budget papers.

Senator LUNDY: But we know that the income of the Future Fund is not reflected in any way in offsetting the government's current liabilities. It is treated separately in the budget papers. So my question is: when it is actually being used to offset future liabilities, how does it start to offset the budget bottom line as that asset is accessed?

Senator Cormann: You are going to hypotheticals to the extent that you are making an assumption of what a future government may or may not decide—

Senator LUNDY: I am presuming they will draw down on it at some point.

Senator Cormann: Sure. But the answer stands, though. The income from the Future Fund will continue to appear as income of the Future Fund to the extent that money is expended and will appear as expenditure. I will ask Dr Helgeby to see whether there is any specific—

Ms Halton : There is a technical answer to this question, Senator.

Senator LUNDY: Thank you.

Dr Helgeby : The Future Fund treatment on the cash flow statement is what I think you are discussing. The government's financial statement 9 in BP 1 shows on page 9-9 that we produce a number of bottom lines—a GFS cash surplus or deficit, which includes net Future Fund earnings. Then net Future Fund earnings are taken out to generate a concept called the underlying cash balance, which is the cash balance figure that the government uses in discussing its fiscal position.

Senator LUNDY: Indeed.

Dr Helgeby : Then it is added back, along with net cash flows from investments in financial assets for policy purposes, to create a concept called the headline cash balance. It is in there. It is given that slightly different treatment for the purpose of the underlying cash balance.

Senator LUNDY: Yes, for the purposes of recording the cost of the unfunded liability against the government's underlying cash balance?

Dr Helgeby : The government's balance sheet fully reflects both the Future Fund assets and the liabilities.

Senator LUNDY: I understand what you are saying, but I have taken previous evidence which confirmed the way in which the unfunded liabilities are noted in the budget. When those figures are referred to specifically, there is no reference to the offset in the future of the Future Fund as they potentially come online.

Senator Cormann: Because the government has not made the decision—

Senator LUNDY: I understand that, Senator Cormann. I am seeking clarification. I do not have line of questioning that is trying to trip you over.

Senator Cormann: Sure, but, for the circumstances that you are envisaging to occur, there has to be a decision by government to give effect to that.

Senator LUNDY: That is right, and what I am exploring in the scenario that Mr Helgeby has just described is: how would that be presented in the budget paper were a government to draw down, presumably, on the maturing of the Future Fund?

Senator Cormann: 'Were a government'—I am sorry, but that does go into the realm of hypothetical questioning.

Senator LUNDY: No. I would think it would be a technical explanation of the provisions of the act in that scenario. It is reasonable to anticipate that the Future Fund will be drawn down for the purposes for which it was established, wouldn't you?

Ms Halton : There is an explanation for this which is a technical explanation which goes back to—

Senator LUNDY: I am happy for you to take that on notice.

Ms Halton : table 3, which we just referred to.

Senator Cormann: To the extent that we can add to this on notice, we will provide additional information.

Senator LUNDY: I would appreciate that. I will continue to explore it. For the purposes of the Future Fund and the officials at the table, it is more of an explanation about the process by which funds are released on maturity. We have established today that will be a decision of the executive and I am still exploring the detail of how that is reflected in the budget papers as the budget papers are currently represented. In particular, I am interested if you could provide me with an explanation of how any transfer from the Future Fund to budget for the purposes of funding part of that unfunded liability would be formally represented in the budget papers as they are currently structured.

Dr Helgeby : The year 2020, which is the year in which drawdowns from the fund could occur—

Senator LUNDY: That is correct.

Dr Helgeby : does not yet appear in the budget papers.

Senator LUNDY: I understand that.

Dr Helgeby : So that treatment which appears in the forward estimates is the treatment I have described, which is a GFS cash surplus or deficit line that is produced.

Senator LUNDY: I understand all of that. We have been through that.

Dr Helgeby : An adjustment is then made to that.

Senator LUNDY: If you could take my question on notice, which is to show what it intentionally would look like for the purposes of the structure of the current budget papers—

Senator Cormann: What it would actually look like.

Senator LUNDY: Yes. You do not have to put numbers in there, Senator Cormann. It is just a matter of representational—

CHAIR: The minister has already said they will provide whatever additional information they can within the agreements and the confines of—

Senator Cormann: We will consider it but I am going to be reluctant to entertain hypothetical scenarios at this point.

Senator LUNDY: I am not asking for a figure.

Senator Cormann: Sure. We have taken it on notice and, to the extent we can assist, we will.

Senator LUNDY: Thank you.

Senator WATERS: Mr Neal and Mr Costello, since we know that there is no safe level of climate change above two degrees and to stay below two degrees, two-thirds of fossil fuel reserves need to stay in the ground, will the Future Fund consider cutting its investment in fossil fuels by two-thirds, commensurate with the science?

Senator Cormann: Are you serious?

CHAIR: Senator Waters, this is not an investment inquiry into the Future Fund. I do not think it is appropriate to make statements in regard to climate change allegations and expect the officers to respond.

Senator WATERS: With respect, this is a Nature paper; they are not just allegations, Chair.

CHAIR: Nature is notthe definitive benchmark that the investments are determined by.

Senator WATERS: It is the premier scientific publication.

CHAIR: I would ask you to rephrase your question or I would say to the officers that they do not have to respond to it.

Senator WATERS: Will the Future Fund consider cutting its investment in fossil fuels by two-thirds commensurate with the science?

Mr Costello : You have heard our answer.

Senator WATERS: With respect, I am sorry; I did not hear the response.

CHAIR: You may respond to the science of investment.

Mr Costello : Our answer is that we do not exclude formal fossil fuels from our mandate and we are tasked with getting a return of CPI plus 4½ to 5½ per cent and we will take decisions which are consistent with that.

Senator WATERS: Thank you. So science is irrelevant. It is good to have that clarified.

Senator McKENZIE: I do not think that is what the witness said at all.

Senator WATERS: I believe that is precisely what the witness said.

Senator McKENZIE: No, that is not.

Senator WATERS: Perhaps the witness would like to correct that.

Senator McKENZIE: You should not be paraphrasing, Senator.

CHAIR: It is wrong to respond with gratuitous comments, Senator Waters.

Senator WATERS: If Mr Costello would like to dissuade me from that summary, I am very happy to be dissuaded of that.

CHAIR: You have tried to frame your question along the lines of environmental—

Senator WATERS: I would love to hear that science is relevant.

Senator McKENZIE: Point of order, Chair.

CHAIR: Order!

Senator WATERS: Mr Costello, I do not want to verbal you.

CHAIR: Order! Senator Waters, I will take the call away from you. I was explaining the ruling. You do not talk over the chair. You do not talk over the witnesses. If you are going to be discourteous you will be repaid in kind.

Senator WATERS: I am not seeking to be discourteous, nor am I seeking to verbal Mr Costello. If you would like to correct me in that regard, I was seeking to establish the role of science in investment decisions. My summation of your evidence was that it was not a relevant consideration. If that is not an accurate betrayal of your evidence, please do correct the record.

Mr Costello : Senator, you are trying to make a political point.

Senator WATERS: No, I am genuinely seeking to understand.

Mr Costello : Frankly, nothing I say will stop you from making your political point. So you make your political point but I think the people have heard what I have said, and I have been through this on many occasions—that is, we do not exclude fossil fuels from the portfolio. We invest our portfolio in accordance with our mandate. This is a high the scientific operation—highly. You ought to see some of the logarithms that are involved in this kind of stuff. Senator Waters, if you look at the professionalism of what goes on in the Future Fund you will be very impressed by it. Leave aside the politics. These are people who are being judged by results and their professionalism. This has been a great thing for Australia. It will be good for future generations. It enjoys the support of both sides of the parliament and I hope it enjoys the support of the Greens as well.

Senator WATERS: Of course it does; it has never been contended. But thank you for your rhetoric.

Mr Costello : Okay, that is the first time I have heard you say that. That was very useful!

Senator Cormann: On the record!

Mr Costello : On the record!

Senator WATERS: I am pleased to inform you that we have been campaigning for the establishment of a sovereign wealth fund for longer than you have been the chair.

Mr Costello : You have been in favour of the Future Fund since when?

Senator WATERS: We have been campaigning for a sovereign wealth fund for longer than you have been the chair. I am pleased that you are now aware of our support for your organisation.

Mr Costello : Okay, good on you. I set one up in 2006—

Senator WATERS: Congratulations.

Mr Costello : so you have been supporting us ever since!

Senator WATERS: Congratulations. We do not support your investment in fossil fuels. I am sure that is not news to you.

Senator Cormann: Which is essential to our economic prosperity and to our capacity to—

Senator WATERS: We know your views, Minister Cormann.

Senator Cormann: And they are very sound views, if I may say so myself.

Senator CANAVAN: I want to ask a follow-up question to Senator Waters' line of questioning that we should divest from fossil fuels. Mr Costello, if we were to follow that strategy would the Future Fund be in breach of the mandate it has been given by the parliament to maximise returns and, specifically, to make a return of CPI plus four per cent?

Mr Costello : If the Future Fund board decided it was going to take an asset which was produced by the taxpayers of Australia—that is, budget surpluses—and play politics with it I think that would be a breach of the spirit of the law, if not the letter of the law. This is not a political plaything. The surpluses that were invested in the Future Fund did not just materialise; it took a lot of hard work and a lot of taxpayers paying for them, and we are seeking to maximise the value for those taxpayers. While the government stands by this legislation—and every government since the Future Fund was established has stood by this legislation—we will act in accordance with the legislation. If you want us to change, change the legislation.

Senator WATERS: Mr Costello, you said earlier that you want returns of 4½ to 5½ per cent over the long term. But, Mr Neal, you were quoted earlier this week saying that you acknowledge demand for fossil fuels will fall in the long term. There seems to be a bit of a discrepancy there. If you are acknowledging that fossil fuel demand will drop over the long term, yet you want returns over the long term, are you not considering reducing your exposure to fossil fuel investment?

Mr Neal : I am not sure I acknowledged the certainty of demand falling. I think what I was talking about is that there are risks that demand for all sorts of products can change and the valuation of investments that produce or are involved in any product will change as that outlook itself changes. Our managers' job on our behalf is to find investments that have good prospective returns. They will assess the risks to the outlook, for whatever it is that those companies produce, and form a view on the value and respective returns accordingly. That is a job that we expect our investment managers to do.

Senator WATERS: Given that the climate science, rather than politics, has established that we need to stay below two degrees of warming in order to have a liveable level planet and that requires that two-thirds of fossil fuel needs to stay in the ground, does the fund accept that companies you invest in with fossil fuel reserves on their balance sheets might therefore be overvalued by approximately two-thirds?

Mr Neal : I think that would be a fairly significant leap of logic. There are many things that come into the evaluation of a company—the price of what it produces, the amount of what it produces that it can sell, when it sells it—does it sell it now, does it sell it later—changing regulation, changing tax systems. It is a more complex equation than that but, as I have said, we expect our managers to have regard to all risks that effect the investments that they make, and they put a balanced judgement on that and form a view about which investments they will make and which they will not make.

Senator WATERS: Has the fund assessed the risk to its balance sheet of a rapid decarbonisation of the global economy?

Mr Neal : There are many different outcomes. The one thing that we know for sure is that we do not know what the future looks like, so the way that the fund structures its portfolio has to be as robust as possible to a very wide range of different outcomes. That is why we have a very diversified portfolio across many thousands of stocks and into other sectors—into credit, into property, into infrastructure. We have a broadly diversified portfolio so that we are not overexposed to any one particular risk.

Senator WATERS: So you do conduct assessments of risks of carbon exposure?

Mr Neal : We invest through investment managers, so the individual stockholdings are picked by investment managers on our behalf. Our process ensures that those managers have regard to all the risks affecting those stocks, including the risks of changing regulation for carbon related investments or changing demand for carbon related investments. Their role is to understand those risks and price them accordingly.

Senator WATERS: Do you report on the exposure of the portfolio to the risk of a carbon bubble or stranded assets at all?

Mr Neal : We have been asked that question a couple of times through this committee. It is an extremely difficult question to answer. We have attempted to provide an answer to that using the standard industry classifications in the past and we have provided that answer here. We have noted that that is a really uncertain way of doing it. Our view is that the only way you can really understand that is by understanding the companies that are investing and what their exposures are in great detail, and that is obviously something that we ask our investment managers to do on our behalf.

Senator WATERS: So is that a yes?

Mr Neal : It is complicated and, yes, through our investment managers we do do that.

Senator WATERS: Do you participate at all in what is called the Carbon Disclosure Project?

Mr Neal : No, we do not.

Senator WATERS: Is that a board decision or an investment manager decision?

Mr Neal : That was a decision taken by the management team.

Senator WATERS: Which is the board, or the investment managers?

Mr Neal : We did not refer that to the board—by the internal team, the agency.

Senator WATERS: Why was that decision taken?

Mr Neal : We felt that the survey would not be particularly useful for us, given our structure and the way we manage the portfolio.

Senator WATERS: Why would it not be useful?

Mr Neal : Because, as I said, we believe the best way to manage these risks is by asking our investment managers, who have a very detailed understanding of these companies and their exposures—all their exposures, not just their carbon exposures. We believe they are in the best position to manage our exposure to these kinds of risks.

Senator WATERS: So they are doing that detailed investigation?

Mr Neal : They are understanding, as best as they possibly can, all of the material risk exposures to all of the companies in which they invest.

Senator WATERS: What sort of methodology do they use to assess carbon exposure risk?

Mr Neal : We have 90 investment managers in our portfolios, and they would all have very different methodologies for how they think about that. I cannot answer that question.

Senator WATERS: You just let them do their own thing—there are 90 different ways of doing it?

Mr Neal : We choose our managers because they are high quality managers making good investment decisions and balancing as best as they can all of the different risks that impact on the investments in our portfolio.

Senator WATERS: How specifically do they deal with the carbon exposure risk?

Mr Neal : I cannot answer that question because there are 90 different processes, so they would all have different ways of thinking about those types of risks.

Senator WATERS: Could you take on notice to provide an answer to that question because I am concerned that you, as the managing director, are not across how your investment managers factor in a really significant economic, not to mention environmental, issue? I really would like to understand how it is that carbon risk exposure is being factored into the investment decisions of the fund. I think that is a very important point. So I would really look forward to some more detailed—

CHAIR: Mr Neal has answered that question, but if he can provide some further detail I am sure he will do so.

Senator WATERS: Thank you, Chair, because all he said was that his investment managers each had their own methodology—not that you did not know, Mr Neal, but that they each had their own methodology.

Mr Neal : That is what I said. I said that there are 90 different methodologies because there are 90 different investment managers.

Senator WATERS: Of the 90, in regard to the ones who do, in fact, consider carbon exposure, how does that inform their decisions and what methodology do they use to determine that, particularly if you are not participating in that carbon disclosure project? Could you take that on notice?

Mr Neal : We will have to take that on notice.

Senator WATERS: In that same article of The Sydney Morning Herald in mid-October you are quoted as saying that you were not sure how much risk is already priced into fossil fuel shares. Do you have a means of finding that out?

Mr Neal : These are sometimes career-limiting statements, but I can assure you I am not sure of anything in relation to the future risks. The investing world is not like that. Our job is, for the types of risks, to make our own assessment of what we think the balance of risks may be. It is for our managers to try and understand what the balance of risks may be and to continue to try and balance those against the opportunities that particular investments offer. So I am certainly not sure of any risks that are faced. We do our best job to understand and estimate them and offset them against the opportunities.

Senator WATERS: Okay, but I was met with a perplexed manner—and an attempt at humiliation, perhaps—earlier when I asked if anyone was familiar with climate science, in particular the Nature paper. I just want to get to the fundamental—

Senator Cormann: I am sorry, Senator Waters, I completely object to that characterisation. That is just completely inaccurate.

Senator WATERS: I did not feel humiliated, but I do think you were trying to.

Senator Cormann: I am not responsible for how you feel, but I reject the assertion that you have made there.

CHAIR: I have to concur. You should withdraw the allegation.

Senator WATERS: I certainly do not purport to speak for you, Minister. I will withdraw any inference as to your motives. They are completely foreign to me, so I will leave those to you to have. My apologies for harping on about this, but I do genuinely want to understand how you are factoring in the risks of climate change, both environmentally and economically, to your investment decisions because this is serious on both of those fronts. I apologise, but I still do not have an understanding of how it is that the fund is doing that.

Mr Neal : I feel as though I have answered that question. Our investment managers are tasked every day with understanding the balance of risks and opportunities across all of the investments that they make, and they do that both for climate related risks and every other risk. That is their role, and that is what we require them to do. Investing is a very complicated business. There are many moving parts that can influence the returns and risks of any investment. Climate is one of them, and we require our managers to build that into their assessments.

Senator WATERS: If you could take on notice for me, when you are making those investigations about the methodology that they employ, whether any of those managers have read that 2009 Nature paper about the amount of fossil fuels that need to stay in the ground in order to have a safe climate and, therefore, a functioning economy. I would quite interested, and I suggest it is excellent reading for anyone who is interested in these issues.

Senator SMITH: Mr Neal, at previous estimates we have talked about emerging market strategies. Can you give us—

Senator Cormann: Could I just intervene, for the purposes of assisting the committee? While the Future Fund will, of course, be available for as long as is required, we are proposing that Mr Costello will be released when we get to the lunch break. If there are any questions to Mr Costello, as opposed to Mr Neal, it might be appropriate to prioritise them so that Mr Costello is able to be released when we get to the lunch break.

CHAIR: You are quite right, Senator Cormann. The initiation to Mr Costello was mindful of his departure arrangements. Senator Smith, perhaps you can bear that in mind.

Senator SMITH: Absolutely. Mr Neal, at Senate estimates we have talked about emerging market strategies. Can you give us an update in terms of where the Future Fund's thinking is in regards to emerging markets and what activities you may have undertaken?

Mr Neal : Sure. We continue to believe that emerging markets offer very strong diversification potential. Our mandate, as we have discussed, is to generate the best returns we can but to do that without taking excessive risk, by taking acceptable risk. One way we do that is to build a globally diversified portfolio so that it has very different exposures across the globe. Emerging markets clearly are a very important part of that strategy—large, rapidly developing, rapidly growing economies with lots of opportunity for investment activity and for generating good investment returns.

We take that part of our strategy very seriously. It is a significant component of our equity portfolio. We have increasingly stepped up our research into emerging markets for a number of other parts of our portfolio. We recently made our first real estate investment into Brazil, for example, alongside one of our managers. This is an increasing level of activity for us. One important thing to say is that we do not take this investment activity lightly. These are less developed countries and that often means that the risks are greater.

Senator SMITH: That was the point I was going to. Does it necessarily follow that the risk profile is greater because they are emerging markets?

Mr Neal : As a generalisation, that would be true. They do not have such well developed capital markets, such well developed rule of law, such well developed regulations and so on. Certainly the risks are greater. They also have generally more volatile economies so the risk to the cash flows can be greater. We need to be very careful when we step into these countries. But, given their diversification potential and the potential for interesting returns, we look at it very closely.

Senator SMITH: In one of the tables that you used for your media briefing around the 14-15 October results, there was a particular graph which was looking at global equities. I think 24.4 per cent of that was in developed markets and 9.7 per cent was in emerging markets. What I could not see was what that range of change had been or how fast that trend had been to the 9.7, where I have the interest. Do you have that in front of you so you can see what I am talking about?

Mr Neal : I can give you some numbers. If you go back, for example, to June 2012, we had five per cent in emerging market equities. That became 7.1 by the time of 30 June 2013 and then 9.7 by June 2014. It is still in the region of 9.7 today.

Senator SMITH: Do you expect a similar rate of growth or a faster rate of growth?

Mr Neal : No, I would not expect there to be a material increase at this point. Our strategy does not call for a material increase in the emerging market equity exposure at this point, so I would not expect to see that dramatically rise from here. As I said, what we hope to see, but it is assuming we can find good investments, is a little more emerging market exposure within some of our other sectors—real estate, infrastructure and so on; if we can find good investments.

Senator SMITH: In that media briefing you made the following comment:

Globally, policy makers are seeking to balance the challenge of moving towards more normal policy settings while maintaining efforts to encourage economic growth.

Then you said:

This continues to present both risks and opportunities for investors.

Could you just elaborate on what those risks and opportunities are?

Mr Neal : What we have is very strong policy action offsetting certain deflationary pressures, if you like, from very high debt levels in certain countries. If there is a misstep in that policy of some sort, then you may see a few different outcomes. If the misstep was that they kept the policy too loose for too long, then we may see inflationary pressures come through and that can have very negative impacts on certain assets. Long-term government bonds would be an example as the yields would rise. You may see them try to normalise that policy too soon and perhaps the economies are not ready for that, and so you would see those deflationary pressures start to come on. You might see a recession; you might see equity markets struggle.

Senator SMITH: To use your word 'misstep', has the risk of a misstep increased or decreased over the last 12 months do you think?

Mr Neal : It is almost a conceptual question. I do not think we would see that those risks have significantly changed at all. They have been there now for a number of years. By and large the central banks around the world have done a pretty good job of finding that balance, so I do not think that we would see that that is materially changed.

Senator SMITH: In the annual report, on page 15, it said:

The increase in our developed foreign currency exposure is perhaps the most noteworthy change that we have made over the past year. That has gone from 15% as at the end of last year to 30%.

Could you just explain what that actually means and what the consequence of that is?

Mr Neal : So why do we call that a noteworthy change?

Senator SMITH: Yes.

Mr Neal : Because currencies are volatile; currencies can move rapidly and far, particularly if economic shocks occur. Obviously, the Australian dollar is a currency that is particularly volatile and has, in the past, had that feature of being exposed to an economic downturn. For us, a 15 per cent change—so that is 15 per cent of the total portfolio—in something that is, in itself, a volatile investment is a significant change to the risk profile of our portfolio. Why did we do that? In large part that is a risk management exercise for us. Foreign currency exposure: if we hold US dollars, that US dollar exposure is a diversifying exposure for us because when the world has a hiccup, when there is an economic decline of some sort—some sort of global economic shock—then you tend to find the US dollar strengthening and the Australian dollar weakening in that environment. So for us to hold that investment, it is a defensive exposure.

Senator SMITH: Are you expecting the worst?

Mr Neal : As I conveyed before, we think our role as a prudent long-term investor is almost to expect everything and to manage the portfolio as such that there is no outcome that puts a big hole in the Commonwealth's capital. We look to adjust our portfolio, to have regard to a range of different outcomes and to make sure it is robust to that. No, that does not portend a view that we have that the world is about to fall into a big hole; it is prudent risk management.

Senator SMITH: So where it says 'the increase in our developed foreign currency', that is not just the American dollar but across currencies?

Mr Neal : Correct; it is a basket of foreign currencies.

Senator SMITH: And of course the largest currency in that basket of currencies would be the American dollar?

Mr Neal : Indeed.

CHAIR: Senator Xenophon, I know you have questions, but I am asking if anyone has specific questions for the chair of—

Senator McKENZIE: I do. Mr Costello, fabulous to have you with us.

Mr Costello : Thank you.

Senator McKENZIE: In 2006, when you brought the legislation to set up the future fund into the parliament, did the Greens move any amendments around investment strategy?

Mr Costello : Well of course certainly not in the House of Representatives, because there were no Greens in the House of Reps in those days.

Senator Cormann: The good old days!

Mr Costello : In the Senate, no, I do not think the Greens moved any amendments. I do not recall them even speaking on the bill.

Senator McKENZIE: So Bob Brown said nothing about rapid decarbonisation issues?

Mr Costello : No.

Senator Cormann: He actually supports coal.

Senator McKENZIE: Christine Milne?

Senator WATERS: Look at the Hansard, Senator McKenzie.

Senator Cormann: Dr Brown actually supports coal. He prefers coal to dams. He does not like hydro; he likes coal.

Senator WATERS: The poor man cannot even defend himself, because he is not here—

Senator Cormann: Maybe one day, like Senator Waters, he will like nuclear energy.

Senator WATERS: so keep it clean, folks.

Senator McKENZIE: My question was—

Senator Cormann: Indeed, the Greens, I believe, in Victoria are exchanging preferences with Mr Palmer, who has got some coal interests—

Senator XENOPHON: I raise a point of order. There are relevance issues.

Senator Cormann: The line of questioning has been pursued.

Senator McKENZIE: Not for me as a Victorian senator; I am sorry.

Senator Cormann: I think it is highly relevant.

CHAIR: It is an aside from the principal question. I think that we should go back to the question.

Senator McKENZIE: Thank you very much, Chair.

Mr Costello : My understanding is that the Greens did not speak in the debate in the Senate. This can be checked in the Hansard. I do not recall them supporting the concept of the Future Fund in the negotiations at the time, nor did anyone, to my knowledge, move any amendments directing the Future Fund about what it should or should not invest in.

Senator McKENZIE: Just to be clear, Mr Costello: Bob Brown and Christine Milne, senators at the time, did not raise the issues of climate change, ethical investing, rapid decarbonisation et cetera at the point of setting up the Future Fund?

Mr Costello : They certainly never raised it with me. I moved the—

Senator WATERS: They certainly would not have got much of a hearing even if they had, based on today's experience.

CHAIR: Senator Waters!

Senator McKENZIE: Senator Waters, I have sat here for a very long period of time listening to your inane set of questions.

CHAIR: Senator McKenzie—

Senator McKENZIE: I have one question—

CHAIR: It is very easy for me to take this committee to lunch.

Senator McKENZIE: that you have not had respect—

CHAIR: Senator McKenzie, quiet!

Senator WATERS: No, I do not respect those questions; that is true. I apologise. I will refrain from—

CHAIR: Senator Waters, we have been listening to you in silence.

Senator Cormann: I do have something to add.

CHAIR: Just a moment, Minister. Courtesy is contagious in these committees.

Senator WATERS: I apologise. I will withdraw.

CHAIR: Senator Waters, if you are not going to allow other senators to have their questions, they will not allow you to have yours.

Senator WATERS: I do apologise.

CHAIR: Thank you.

Senator WATERS: I am sure that Senator McKenzie's political questions are fascinating to us all!

CHAIR: Minister, did you have something to add?

Senator Cormann: It is highly relevant to the question that was asked. I guess, in a sense, it is also relevant to the line of questioning that was pursued by Senator Waters before. It is the assessment of the government that the Greens even today—not just back in 2006 but even today—are strong supporters of fossil fuel, because the Leader of the Greens and the Greens political party in the Senate right now are fighting for the maintenance of regular reductions in the real value of the excise on fuel. Indeed, beyond that, the Leader of the Greens in the Senate has made statements to the effect that she is intent on facilitating a windfall to what the Greens have variously described as 'big oil' companies, because the Greens are suggesting that they do not intend to validate the budget measure that the government recently gave effect to by way of tariff proposals tabled in the House of Representatives. Given that the Greens are clearly strongly supportive of fossil fuel generation and use and want to ensure that taxes on fossil fuel use are minimised, I really do not understand the line of questioning that has been pursued by Senator Waters here this morning.

CHAIR: Senator McKenzie.

Senator WATERS: Maybe you should read some science, and then you might understand it.

CHAIR: Senator Waters, once again, I will not give you the call if you continue to disrupt proceedings.

Senator WATERS: I will not stand for that kind of ridiculous verballing. I do not seek the call; I just seek to clarify—

CHAIR: Be quiet then.

Senator Cormann: The record speaks for itself.

Senator McKENZIE: Given that the available possibilities to effect change in 2006 were not taken up by the Greens, Mr Costello, in your recollection was there any public debate from the Greens outside of parliament?

Senator WATERS: You are better than this, Bridget; you really are. At least, I thought you were.

CHAIR: Senator Waters, I will kick you out of the committee.

Senator Cormann: You are so touchy about this; I am a bit surprised.

Senator WATERS: I am a bit embarrassed on everyone's behalf.

CHAIR: You should be embarrassed. Senator McKenzie, ask your question.

Mr Costello : I was responsible for the legislation in the House of Representatives. My recollection is that the Future Fund enjoyed support from the Labor opposition. It went through the Senate. I can say to you that no Green ever discussed the legislation with me. No Green ever sought any amendments to the legislation and—the Hansard record will show this, but my belief is—they did not move any amendments. I think Senator Murray, from the then Australian Democrats, moved some amendments. I do not even think the Greens party spoke in the debate. I was very encouraged today to hear Senator Waters say the Greens support the Future Fund as a sovereign wealth fund. I welcome that. It is legitimately the first time I have heard that said by the Greens.

Senator McKENZIE: Bravo. Well done on getting the investment strategy to the point where it is actually delivering at the moment. Particularly in the difficult climate, could you outlined some of the challenges—perhaps Mr Neal—going forward over the next 12 months in the global economic environment?

Mr Neal : There are always many, I suppose. We touched on one a little earlier. The challenge that some of the large central banks have around the world to continue to navigate through the reduction in debt and deleveraging type activity and trying to get economies going is a very live challenge. The economic recovery in many countries has not been as robust as we would have liked. Europe continues to struggle. It has basically been in a depression. It has been in recession for many years. Europe itself is slowing down and looks vulnerable to perhaps a recession. China has its own risks. It has to rebalance its economy. It seems to be doing a good job of managing that, but clearly there are risks, particularly to us as Australians, obviously. Then you have geopolitical risks and so on. Wherever you look, there are risks. There are always things to keep investors awake at night. Our response to that is to try and understand those risks as best we can and do the best we can to balance our portfolio to those risks. At the end of the day, it is our job to take risk, though. We are not going to generate significant real returns without taking risk, and we have to do that as prudently and as judiciously as we can.

Senator XENOPHON: I go to the issue of remuneration. Is it correct that all Future Fund staff are employed under the Public Service Act?

Mr Neal : That is correct.

Senator XENOPHON: In the annual report, reference is made that base salary increases are based on the financial services sector. Is that the benchmark?

Mr Neal : The remuneration strategy, the policy pursued, is to benchmark everybody within the agency against like work within the Australian financial services industry.

Senator XENOPHON: Who does that benchmarking and when is it done?

Mr Neal : The agency receives advice—this year from Aon Hewitt. They use the well-established benchmarking surveys—the FIRG, the Financial Institutions Remuneration—

Senator XENOPHON: Whatever FIRG stands for—okay.

Mr Neal : They use that survey to benchmark all of our staff.

Senator XENOPHON: Does the Future Fund have to get approval from the Public Service Commissioner or Minister Abetz with respect to remuneration?

Mr Neal : It does not. The act allows for all costs of running the fund, including the agency costs, to be withdrawn from the fund itself.

Senator XENOPHON: Are salary increases uniform for all staff or do they go by function or level?

Mr Neal : I think the best way to describe that is to say that they go by merit. Across all of the staff, there was a general inflationary type increase, and then people who had moved between roles, moved up in roles to more responsible positions would have got an incremental increase over that.

Senator XENOPHON: Sure, but assuming they were in the same position, the same role, what was the increase for June this year, overall?

Mr Neal : Assuming they are in the same role and there was no material change to that role, the increase we gave was three per cent on average. There were some slight changes to that, but it was three per cent.

Senator XENOPHON: Right. So it was not, say, 10 per cent, for instance?

Mr Neal : No. Three per cent was the general increase.

Senator XENOPHON: But in terms of the performance pays—because I see that it is based on individual performance in terms of your own benchmarks and, overall, the way the fund is operating—is that three per cent included in the figure?

Mr Neal : No. That three per cent that I have just quoted to you is the increase in the value of the package, which assumes a constant payment from the performance related pay. The performance related pay fluctuates, given the performance of the fund.

Senator XENOPHON: So that three per cent includes—apart from the fixed salary, which includes superannuation—variable pay based on personal performance and variable pay based on fund performance?

Mr Neal : Correct. It is the increase in the normal expectation for those, yes.

Senator XENOPHON: Insofar as the increase is three per cent, that is somewhat above—the minister might be able to help me on this—the Public Service capping, I think, of an increase at 1½ per cent. Is that right, Minister?

Senator Cormann: The minister responsible for public sector salary arrangements is Senator Abetz, so any questions in relation to public sector salary arrangements would have to be addressed to the relevant estimates where Senator Abetz is available to provide answers.

Senator XENOPHON: Okay. But the short answer, the truncated answer, is that it is about a three per cent rise, which is a bit above the rest of the Public Service.

Mr Neal : I know about the three per cent. I cannot comment, I am afraid, on the Public Service part.

Senator XENOPHON: Thank you.

Senator LUDWIG: I have just a few questions. Mr Neal, you can take some of these on notice, but we will see how we go. My first question goes to the level of funding in all the funds managed by the Future Fund Management Agency—that is, the current ones. Could you just run through what they currently stand at or take it on notice?

Mr Neal : The current balances of each of the funds that we have?

Senator LUDWIG: Yes.

Mr Neal : I can give you that, as at 30 September. The Future Fund, as at 30 September, is $104.5 billion. It is slightly above that now—but $104.5 billion at 30 September. The Building Australia Fund is $3.7 billion, the Education Investment Fund is $3.8 billion and the Health and Hospitals Fund is $2.1 billion.

Senator LUDWIG: Have there been any changes to the work done regarding the change in the investment strategy for any of those funds?

Mr Neal : I think you may be referring to the—

Senator LUDWIG: In this mandate. That is probably a better way of putting it.

Mr Neal : There have been no changes to the investment mandate, no.

Senator LUDWIG: And the rate of return for those funds?

Mr Neal : For those three nation-building funds, for the year to 30 September, the Building Australia Fund and the Education Investment Fund returned 3.1 per cent, and the Health and Hospitals Fund returned three per cent.

Senator LUDWIG: Are there any estimates around the Asset Recycling Fund—I know you do not have it at this point—or the medical research fund or the disability fund about what their investment mandate would be or what their rate of return would be? Have you done any estimates around what they might be?

Mr Neal : DisabilityCare—we have the mandate for that. That act was passed, and we have received a mandate for that, which is a mandate consistent with the nation-building funds—that is, to exceed a return of the bank bill swap rate plus 0.3 per cent per annum. So it is a low-risk, cash based mandate. As I said before, we do not have a mandate in place yet for the Asset Recycling Fund or the Medical Research Future Fund, of course, because they have not been legislated.

Mr Costello : The mandate that you are given really depends on the government's demand for cash. If the government wants you to be cashed up so it can draw down at any time, it will want you to hold in three-month bills or something like that, so you will get a much lower rate. With the Future Fund, because there is no draw-down until 2020, the government can give a much greater mandate, and the returns will be better. So you start off by saying, 'When will the government want to draw?' That determines how liquid your portfolio has to be, and that will determine what sort of rates you can be given.

Senator LUDWIG: That opens up an interesting discussion. So as we move towards 2020, do you then have to consider what the government's investment mandate for each of those funds might be, depending on the draw down.

Mr Costello : What we will have to consider is what the government is likely to draw down after 2020. We have to make sure we are in a position, as we get up to that, to meet the draw down. Technically speaking, you would for other reasons, but you would not be holding liquidity at the moment for a draw down, but you might have to have liquidity for a draw down in 2020. Exactly right. And we are looking at that very carefully.

Senator LUDWIG: Has the government been consulting with you about the Asset Recycling Fund? Have they started to engage with you about what the mandate might look like, and how it might operate?

Mr Neal : We have had discussions about what that might look like, yes.

Senator LUDWIG: What are those discussions?

Mr Neal : I wonder if I should refer that to the department.

Senator LUDWIG: You seem to be going well!

Mr Neal : Given it is their mandate, it is for the government to provide us with the mandate—

Senator LUDWIG: But you have had the discussions, so surely you know what you have discussed.

Senator Cormann: It is appropriate for these sorts of questions about the government's mandate to be handled by the department rather than by the Future Fund, because it is very much a matter of the policy of the government. So if you have a question in that space I invite you to direct them to Dr Helgeby.

Senator LUDWIG: I think Mr Neal was directing me to Dr Helgeby or Mr Youngberry. I am happy for anybody from that side of the table to answer the question.

Mr Youngberry : The discussions we have had with the Future Fund to date on the other funds have only been general discussions, given that the legislation for the ARF is still in the parliament and for the MRFF has not yet been introduced into parliament. So they are really just general discussions about when we get to the point where there is legislation. We need to develop a mandate and go through the consultation process to develop that.

Senator LUDWIG: Given that the Building Australia Fund and the Education Investment Fund have been earmarked but not yet dissolved—my words—has any revisional work been done about what their estimated returns might be or how it will play out?

Mr Youngberry : The balance of the uncommitted funds will change, because the funds will have additional earnings if there are delays in either of those funds commencing. But there is no further revision to the investment mandates or anything of that nature.

Senator LUDWIG: What about a revision to the investment earnings for those two funds. Has any work been done on that?

Mr Youngberry : They just accrue earnings. So it will be reflected in the uncommitted balances that are then transferred into those new funds.

Senator LUDWIG: I take it Minister there is no change of heart. You are going to continue to seek to abolish those two funds?

Senator Cormann: We remain committed to the establishment of the Asset Recycling Fund in the way that was announced in the budget. That includes rolling those two funds into the new Asset Recycling Fund, which is yet to be established by the parliament.

Senator LUDWIG: So you are not going to establish the Asset Recycling Fund through borrowed funds? You are going to continue to wait for those two funds to be abolished?

Senator Cormann: It is not just that. What we have said very clearly in the budget is that we are setting up the Asset Recycling Fund, one, by rolling the uncommitted capital that is in those two pre-existing funds into the Asset Recycling Fund, not dissimilar, I guess, to what the previous Labor government did on coming into government when they abolished various funds that had been put in place by the then previous government, of which Mr Costello was a part, where we had, I believe, the Higher Education Endowment Fund, for example, and various other funds.

Mr Costello : $10 billion.

Senator Cormann: Yes, $10 billion, as Mr Costello reminds me, which the then Labor government rolled into a different fund. The purpose of the Asset Recycling Fund, principally, is to hold the proceeds from the sale of any assets. You would be aware that right now the government is executing the sale of Medibank Private, an asset we still hold for a short while, and the proceeds of the sale of Medibank Private are destined to go into the Asset Recycling Fund. But for efficiency and a whole range of other purposes the government made a judgment that it was appropriate to also consolidate the uncommitted capital that remained in those two funds into that overall fund. It will be utilised as part of our broader asset recycling initiative, which of course is a central part of our strategy to build a stronger more prosperous economy where everyone across Australia has a better opportunity to get ahead.

CHAIR: Senator Ludwig, it is 12:30. Other senators have advised me that they are prepared to put their questions on notice.

Senator LUDWIG: I am happy to put my questions on notice.

CHAIR: It means I can release the Future Fund. Thank you, Mr Costello and Mr Neal, for your attendance today and for your cooperation with the senators. The committee will suspend and then resume at 1:30 with the Department of Finance and we will go through outcome 1.

Pr oceedings suspended from 12:30 to 13 : 30