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Superannuation Legislation Amendment (Trustee Governance) Bill 2015



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ISSN 1328-8091

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BILLS DIGEST NO. 40, 2015-16 9 NOVEMBER 2015

Superannuation Legislation Amendment (Trustee Governance) Bill 2015 Kai Swoboda Economics Section

Contents

The Bills Digest at a glance ................................................... 3

Purpose of the Bill ............................................................... 4

Structure of the Bill ............................................................. 4

Background ......................................................................... 4

Nature of governance .............................................................. 4

Governance of superannuation funds ................................... 4

Independent directors ............................................................. 5

Trustee governance arrangements ......................................... 6

Policy development ................................................................. 6

Cooper Review ...................................................................... 6

Government response to the Cooper Review ....................... 7

Coalition policy ...................................................................... 7

Financial system review ........................................................ 8

Relevant consultation .............................................................. 9

2015 draft legislation ............................................................ 9

2015 draft prudential standards ........................................... 9

Superannuation industry overview ......................................... 9

Committee consideration .................................................. 10

Senate Economics Legislation Committee............................. 10

Senate Scrutiny of Bills Committee ....................................... 11

Policy position of non-government parties/independents ... 11

Position of major interest groups ....................................... 11

Support for the Bill ................................................................ 11

Opposition to the Bill ............................................................. 12

Financial impact ................................................................ 15

Date introduced: 16 September 2015

House: House of Representatives

Portfolio: Treasury

Commencement: Sections 1-3, Schedule 1 and item 17 in Schedule 2 commence on Royal Assent. The remaining items in Schedule 2 commence on 1 July 2016.

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

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Statement of Compatibility with Human Rights .................. 15

Key issues ......................................................................... 15

Do we need to mandate a minimum share of independent directors and an independent chair for superannuation funds?.......................................................... 15

Arguments for the measures............................................... 15

Arguments against the measures ........................................ 15

Trustee arrangements for pension funds overseas ............... 16

Does an ‘independent’ board improve performance? .......... 16

Costs and benefits associated with implementing the proposed arrangements ...................................................... 18

Key provisions—Schedule 1 ............................................... 18

Existing arrangements ........................................................... 18

Provisions of the Bill .............................................................. 19

Repeal of equal representation model ............................... 19

RSE licensee must have independent directors or trustees and an independent chair ..................................... 19

Meaning of ‘independent’ ................................................... 20

Determinations of independence ....................................... 21

Transitional provisions ........................................................ 22

Key provisions—Schedule 2................................................... 22

What parts of the broad policy are NOT in the Bill? ............. 23

Mandatory public reporting on whether an RSE trustee has a majority of independent directors or not .................. 23

APRA prudential standards and guidance ........................... 24

Concluding comments ....................................................... 25

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The Bills Digest at a glance

Purpose of the Bill

• The purpose of the Bill is to implement a board governance structure for certain superannuation funds that requires at least one-third of trustee directors to be independent and that the chair also be independent.

Background

• The inclusion of independent directors on the board of listed companies emerged in corporate governance policy in the early 1990s in Australia, with corporate principles developed by the Australian Stock Exchange including that boards comprise a majority of independent directors and that the chair should be an independent director.

• The 2009-10 Cooper review of superannuation endorsed mandating that one-third of directors be ‘non associated’ directors and the recent Murray Report of the financial system supported mandating for a majority of ‘independent’ directors and an ‘independent’ chair on superannuation fund boards.

Key elements

• The Bill repeals the existing provisions of the Superannuation Industry (Supervision) Act 1993 that establish the equal representation model and replaces them with requirements that:

- the chair of the registrable superannuation entity (RSE) licensee’s board of directors must be independent from the RSE licensee (for RSE licensees that are a body corporate) - at least one-third of the RSE licensee’s directors or trustees must be independent from the RSE licensee - the RSE licensee must comply with any requirements of the prudential standards in relation to the

appointment or removal of directors who are independent from the RSE. • The meaning of independent from an RSE licensee includes conditions under which a person is excluded. These encompass limits on shareholding interests (subject to certain exclusions) and minimum periods for the person’s business relationships that were material with the RSE licensee or trustee and employment with

certain related entities.

• The regulator—the Australian Prudential Regulation Authority (APRA)—will be empowered to develop prudential standards and also make determinations about whether or not a person is considered independent from an RSE licensee.

Stakeholder concerns

• The policy reasons for the measures proposed by the Bill are contested—although there is general agreement about the importance of good governance at a board level to entity performance.

• There are differing views about whether requirements for independent trustee members and an independent chair should be mandated or expressed in general principles which individual boards can choose to implement.

Key arguments

• The main arguments for the measures proposed by the Bill broadly relate to the general acceptance of the principle that independent board members and chairs bring improved decision making processes, a greater diversity of skills and experience which will contribute to both strengthening the superannuation system overall as well as member interests.

• The main arguments against the measures proposed by the Bill include that the existing equal representation model has performed well; the model is an important feature of the superannuation system and is prevalent in many overseas pension funds; and that there is a lack of evidence to support the changes as the imposition of a principles-based framework creates a lack of flexibility for boards and creates additional costs without any equivalent benefits.

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Purpose of the Bill The purpose of the Superannuation Legislation Amendment (Trustee Governance) Bill 2015 is to amend the Superannuation Industry (Supervision) Act 19931 (SIS Act) and the Governance of Australian Government Superannuation Schemes Act 20112 to require that certain superannuation funds have at least one-third of directors or trustees that are independent from the licensee of the fund and that an independent director or trustee be chair of the trustee board.

The Bill provides for a three year phase-in period for the requirements from the day of Royal Assent—except for those provisions relating to the Commonwealth Superannuation Corporation (CSC) which is the trustee of various Commonwealth superannuation schemes, which will apply to new board appointments from 1 July 2016.

Structure of the Bill There are two Schedules to the Bill:

• Schedule 1 implements the changes to the SIS Act

• Schedule 2 broadly implements similar arrangements in relation to appointments to the CSC.

Background Nature of governance The term ‘governance’ when used in relation to an organisation or business:

encompasses the system by which an organisation is controlled and operates, and the mechanisms by which it, and its people, are held to account. Ethics, risk management, compliance and administration are all elements of governance. 3

The terms ‘governance’ and ‘corporate governance’ are used interchangeably in relation to organisations although the term ‘corporate governance’ can have specific relevance to companies (as opposed to other forms of business and non-business organisations). The concept of governance at an organisation level has its roots in the development of corporations with the separation of ownership (shareholders) from control (management) and how to manage the principal-agent ‘problem’ that potentially arises due to the different interests of management and other stakeholders.4

Importantly, the concept of governance covers structural elements such as those that regulate how the management function is arranged (such as board functions and membership) and the duties and obligations of relevant people that are part of the organisation. It also covers elements that may not be able to be directly regulated, such as ensuring that the relevant people have appropriate skills and experience and a positive organisational culture.5

Governance of superannuation funds Superannuation funds in Australia are established under a ‘trust model’, whereby the trustee (which for superannuation funds is usually a company) has an obligation to act in the best interests of its members. The use of this trust model for superannuation funds is embedded in the SIS Act, with all APRA-regulated superannuation funds operating as trusts, usually with a company as the trustee.6 The individual directors of the trustee company (sometimes referred to as the ‘trustee board’ with the individuals referred to a ‘trustee directors’) are required under the SIS Act to operate the fund in the best interests of members—given that the sole purpose of the superannuation system is to provide retirement benefits to members.7 Added on to the trust model are the

1. Superannuation Industry (Supervision) Act 1993 (SIS Act), accessed 3 November 2015. 2. Governance of Australian Government Superannuation Schemes Act 2011, accessed 3 November 2015. 3. Governance Institute of Australia (GIA), ‘Governance foundations’, GIA website, accessed 24 September 2015. 4. J du Plessis, A Hargovan and M Bagaric, Principles of contemporary corporate governance, 2nd edn, Cambridge University Press, Cambridge,

2011, pp. 5-10. 5. Ibid.

6. J Cooper, Review into the governance, efficiency, structure and operation of Australia’s superannuation system (Cooper Review), Part 2: recommendation packages, The Review, Canberra, June 2010, p. 44, accessed 24 September 2015. 7. Ibid., p. 45.

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licensing arrangements in the SIS Act, which include adherence to relevant prudential standards covering a range of corporate governance issues such as conflicts of interest and risk management.8

Independent directors Interest in the concept of an independent (also referred to as a ‘non-executive’) board director emerged in the corporate governance literature in the 1980s and 1990s as greater recognition was given to the role played by board directors that were separate to management (who are referred to as ‘executive directors’ or ‘inside directors’) in bringing additional expertise to the decision making process as well as providing a check on self-interest and abuse within corporate management.9

The application of a broader policy to mandate requirements for the inclusion of independent directors on the board of listed companies was included in a key UK governance review in 1992 (known as the Cadbury Review after its chair Sir Adrian Cadbury).10 The Cadbury Review, commissioned at a time of increasing lack of investor confidence in the honesty and accountability of listed companies and by sudden financial collapses of some companies, supported minimum numbers of independent directors, with the concept of independence based on independence of judgement and independence of association:

Non-executive directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. We recommend that the calibre and number of non-executive directors on a board should be such that their views will carry significant weight in the board’s decisions. To meet our recommendations on the composition of sub-committees of the board, all boards will require a minimum of three non-executive directors, one of whom may be the chairman of the company provided he or she is not also its executive head. Additionally, two of the three should be independent in the terms set out in the next paragraph.

An essential quality which non-executive directors should bring to the board’s deliberations is that of independence of judgement. We recommend that the majority of non-executives on a board should be independent of the company. This means that apart from their directors’ fees and shareholdings, they should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. It is for the board to decide in particular cases whether this definition is met. Information about the relevant interests of directors should be disclosed in the Directors’ Report.

11

In Australia, an emphasis on corporate governance policy arose in the early 1990s from a series of reports sponsored by the Business Council of Australia known as the ‘Bosch reports’.12 Conducted at a similar time to the Cadbury Review, the first Bosch report (published in 1991) included amongst the suggested principles for better corporate practices and conduct, that independent directors were important. However, rather than recommending any particular number of non-executive directors the first Bosch report merely noted that it would be a useful safeguard to appoint at least two directors who have no personal or professional association with the company.13 The second Bosch report, which took account of the Cadbury Review recommendations, was delivered in 2003. By that time, the suggestion that directors be independent was more prominent, with the preference that the majority of directors should be independent.14

The Australian Stock Exchange’s Corporate Governance Council published its Principles of Good Corporate Governance and Best Practice Recommendations in 2003.15 ASX-listed companies were to adopt the best practice recommendations and, if not to disclose ‘why not’.16 One of the best practice principles espoused by the

8. Australian Prudential Regulation Authority (APRA), ‘Superannuation prudential standards’, APRA website, accessed 24 September 2015. Adherence to the prudential standards is a requirement of Part 3A of the SIS Act. 9. J du Plessis et al, op. cit., p. 110. 10. Committee on the Financial Aspects of Corporate Governance (UK), Report on the financial aspects of corporate governance (Cadbury Report),

London, 1992, paragraphs 2.1 and 2.2, accessed 7 October 2015. 11. Ibid., paragraphs 4.11 and 4.12. 12. J du Plessis et al, Principles, op. cit., p. 136. 13. Ibid., p. 138. 14. Ibid., p. 140. 15. Australian Stock Exchange (ASX) Corporate Governance Council, Principles of good corporate governance and best practice recommendations,

ASX, March 2003, accessed 3 November 2015. 16. Ibid., p. 5.

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ASX Corporate Governance Council was that ‘a majority of the board should be independent directors’.17 A further best practice recommendation was that ‘the chair should be an independent director’.18 The most recent version of the ASX Principles of Good Governance and Best Practice Recommendations, released in 2014 (third edition), has retained this approach.19 The ASX principles, while not directly applying to superannuation funds, provide a useful framework against which to assess the specific requirements for the independence of superannuation fund trustee directors.

Trustee governance arrangements Under existing arrangements, the trustee of an APRA-regulated superannuation fund is known as an RSE licensee as it operates under a Registrable Superannuation Entity licence issued by APRA under Part 2A of the SIS Act.20 Part 9 of the SIS Act requires that the board of a corporate trustee for a standard employer-sponsored fund of five or more members must consist of equal numbers of employer representatives and member representatives—these are referred to as the equal representation rules. The boards of such RSE licensees may appoint an independent director if that is permitted under an RSE's governing rules and is requested by the employer or member representatives on the board.21

Superannuation fund trustees are subject to a broad range of governance requirements including a range of operating standards established in the SIS Act such as operating standards that form part of licensing conditions, specified covenants that are to be part of the governing rules of superannuation funds and prudential standards issued by the Australian Prudential Regulation Authority (APRA).22

Policy development The proposals included in the Bill have their origins in the recommendations of a review of the superannuation system conducted in 2009-2010.23 While the recommendations relating to trustee board composition were largely rejected by the Gillard Government,24 the Coalition’s 2013 election policy was broadly similar to the provisions of the Bill.25

Cooper Review The ‘Super System Review’, (known as the ‘Cooper Review’ after its chair Jeremy Cooper), led to a number of important changes under the Gillard Government including the introduction of a low-cost default superannuation product (‘MySuper’), efforts to improve the ‘back office’ efficiency of the superannuation system (‘Superstream’) and some changes to the regulation of self-managed superannuation funds (SMSFs).26

In terms of superannuation fund governance, the final report of the Cooper Review observed that trustee governance structures had not kept up with developments in the industry and that there had been difficulties for trustees and their trustee‐directors in understanding what is expected of them.27 The recommendations to improve governance arrangements included creating a distinct new office of ‘trustee‐director’ with all statutory

17. Ibid., recommendation 2.1, p. 19. 18. Ibid., recommendation 2.2, p. 21. 19. ASX Corporate Governance Council, Principles of good corporate governance and best practice recommendations, 3rd edn, ASX, Sydney, 2014, pp. 17-18, accessed 7 October 2015.

20. Under section 10 of the SIS Act the term RSE licensee means a constitutional corporation, body corporate, or group of individual trustees, that holds an RSE licence granted under section 29D. 21. APRA, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, pp. 4-5, accessed 2 November 2015. 22. Part 3 of the SIS Act provides that operating standards for regulated superannuation funds may be prescribed in regulations that may cover

issues such as the number of trustees and the composition of boards and committees and the disclosure of information about funds to the Regulator. Covenants to be included in the governing rules of registrable superannuation entities are specified in section 52 of the SIS Act and include a covenant for each trustee to act honestly in all matters concerning the entity and to perform the trustee’s duties and exercise the trustee’s powers in the best interest of the beneficiaries. Prudential standards are established under Part 3A of the SIS Act. Standards established to date cover issues such as conflicts of interest and outsourcing. See Australian Prudential Regulation Authority (APRA), ‘Superannuation prudential standards’, op. cit. 23. J Cooper, Cooper review, op. cit. 24. Treasury, Stronger super, Treasury, December 2010, accessed 7 October 2015. 25. Liberal Party of Australia and the Nationals, The Coalition’s policy for superannuation, Coalition policy document, Election 2013, p. 5, accessed

3 November 2015. 26. A summary of some of the outcomes of the Cooper Review is included in K Swoboda, Major superannuation and retirement income changes in Australia: a chronology, Research paper series 2013-14, Parliamentary Library, Canberra, 2014, accessed 3 November 2015. 27. J Cooper, Cooper review, Part 2, op. cit., p. 43.

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duties (including those which would otherwise be imposed by the Corporations Act 200128) to be fully set out in the SIS Act29 and for an industry council to develop (with APRA coordination and in consultation with stakeholders) a ‘Code of Trustee Governance’ for trustees of superannuation funds and their trustee‐directors to assist with identifying best practice in the industry.30 It is important to note that in formulating its recommendations, the Cooper Review considered that the corporate governance arrangements that applied to ASX-listed companies were a ‘reasonable starting point’ for the arrangements that should apply to superannuation fund trustees ‘given the profound impact the latter have on the retirement incomes of members’.31

In relation to the structure of the trustee board (the matters which are the subject of this Bill), the Cooper Review recommended that ‘non-associated’ trustee members be mandated as part of trustee boards:

• if a trustee board does not have equal representation, the trustee must have a majority of ‘non‐associated’ trustee‐directors32 and

• for those boards that have equal representation because their company constitutions or other binding arrangements so require, the SIS Act should be amended so that no less than one‐third of the total number of member representative trustee‐directors must be ‘non‐associated’ and no less than one‐third of employer representative trustee‐directors must be non‐associated.33

The term ‘non-associated’ nominated by the Cooper Review was derived from the concept of independent directors on company boards. However, no clear definition of the term was provided, with the Cooper Review providing an outline of what the term would cover:

For this purpose, the term ‘non‐associated’ would have a different meaning from the term ‘independent’ in the SIS Act. For example, the Panel believes that a member of the fund could be a ‘non‐associated’ trustee‐director. Non‐ associated trustee‐directors would still need to be free of connections to, or associations with, employer sponsors, the appointor (other than by reason of the appointment itself), entities related to the trustee, employer groups, unions, service providers and should not be current or former executives of the fund or a related entity. Of course, if a non‐associated trustee‐director is paid for their duties as a trustee‐director, the fee should be paid only from fund assets and not by any third party.

34

Government response to the Cooper Review The Gillard Government response to the Cooper Review recommendations (labelled as ‘Stronger Super’) was released on 16 December 2010.35 In relation to the recommendations about the appointment of non-associated members to trustee boards, the Government did not support the proposals, considering that the composition of a trustee board was a matter for the board to determine.36

Coalition policy At the time of the release of the Cooper Review’s trustee governance recommendations and the subsequent Gillard Government response, the Coalition expressed its view that the Cooper Review recommendations about requiring independent directors to be appointed to boards should be implemented. The then Shadow Minister for Financial Services and Superannuation, Senator Mathias Cormann, noted in 2010 that:

The Minister shied away from outlining necessary reforms to improve corporate governance of superannuation funds and to ensure competition in the default fund market.

28. Corporations Act 2001, accessed 3 November 2015. 29. J Cooper, Cooper Review, Part 2, op. cit., recommendation 2.1, p. 48. 30. Ibid., recommendation 2.18, p. 61. 31. Ibid., p. 44. 32. Ibid., recommendation 2.6, p. 55. 33. Ibid., recommendation 2.7, p. 56. 34. Ibid., p. 55. The term ‘independent’ is used in section 10 of the SIS Act to cover an independent director for a corporate trustee and

independent trustee. 35. Treasury, Stronger super, op. cit. 36. Ibid., pp. 26-27.

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Where are the reforms for example to ensure mandatory disclosure of conflicts of interest, to require independent directors on superannuation fund boards, disclosure of director remuneration and directors of super funds to sit on a single fund and not hold multi-directorships. 37

In August 2012, during the debate on a Bill that included provisions relating to trustee governance arrangements, Senator Cormann outlined how the Coalition viewed the recommendations of the Cooper Review and would amend the existing arrangements, should it be in government, to include ‘the appropriate provision of independent directors on superannuation fund boards’.38

In government, should we be successful at the next election, we will implement the sensible corporate governance reform recommendations made by the Cooper review that would see mandatory disclosure of conflicts of interest, the appropriate provision of independent directors on superannuation fund boards and which would force directors who want to sit on multiple boards and where there is clearly an apparent risk of conflict of interest to be required to demonstrate to APRA that they do not have in fact any foreseeable conflicts of interest. There is also the issue of conflicts of interest in relation to related party transactions that do need further tidying up when it comes to corporate governance standards.

39

In the lead in to the 2013 election, the Coalition’s policy, although not specifically setting out what changes it would make, if elected to government, questioned the equal representation model and stated that ‘the Coalition will work with all relevant stakeholders to ensure Australia’s superannuation system has appropriately high standards of corporate governance’.40

Since its election in 2013, the Coalition government has moved cautiously in pursuing changes to superannuation fund governance arrangements. A November 2013 consultation paper entitled, Better regulation and governance, enhanced transparency and improved competition in superannuation, sought feedback on some of the specific areas that are being proposed for change by the Bill, including:

What is the most appropriate definition of independence for directors in the context of superannuation boards?

What is an appropriate proportion of independent directors for superannuation boards?

Both the ASX Principles for listed companies and APRA’s requirements for banking and insurance entities either suggest or require an independent chair. Should superannuation trustee boards have independent chairs? 41

Financial system review The time taken to implement the changes proposed by the Bill since the 2013 election can be partly explained by the undertaking of the Financial System Inquiry (known as the ‘Murray Report’ after the chair of the review, former CEO of the Commonwealth Bank David Murray AO).

In its final report to the Government, delivered in December 2014, the Murray Report arguably went further than the Cooper Review in that it recommended a majority of directors be independent and also that the chair be independent.42 In making this recommendation, the Murray Report observed:

[i]ncluding independent directors on boards is consistent with international best practice on corporate governance. Independent directors improve decision making by bringing an objective perspective to issues the board considers. They also hold other directors accountable for their conduct, particularly in relation to conflicts of interest. 43

37. M Cormann, Shorten super statement short on detail and substance, media release, 26 October 2010, accessed 7 October 2015. 38. M Cormann, ‘Second reading speech: Superannuation Legislation Amendment (Trustee Obligations and Prudential Standards) Bill 2012’, Senate, Debates, 14 August 2012, p. 5037, accessed 7 October 2015. 39. Ibid.

40. Liberal Party of Australia and The Nationals Coalition, The Coalition’s policy for superannuation, op. cit. 41. Treasury, Better regulation and governance, enhanced transparency and improved competition in superannuation, Discussion paper, Treasury, Canberra, 28 November 2013, pp. 12-13, accessed 7 October 2015. 42. D Murray, Financial System Inquiry: final report (Murray Report), Treasury, Canberra, November 2014, p. 133, accessed 7 October 2015. 43. Ibid.

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Relevant consultation

2015 draft legislation On 26 June 2015, then Assistant Treasurer, Josh Frydenberg, proposed that all APRA-regulated superannuation funds, including corporate, industry, public sector, and retail funds, have a minimum of one third independent directors on their trustee board and an independent chair.44 His announcement coincided with the release of draft legislation covering matters included in the Bill.45 Thirty-two submissions were received during the consultation period.46 Subsequently Treasury noted that there had been a number of ‘refinements’ included in the Bill such as:

• clarifying that the independent chair is not in addition to the one-third share of independent directors

• more detail and a revised definition of independent including amendments to the term ‘substantial shareholding’, and

• inserting a regulation making power that will specify circumstances that would result in a person being either independent or not independent.47

However, the broad policy proposals remain unchanged in the Bill.

2015 draft prudential standards APRA has recently undertaken consultation with the superannuation industry for material that will support the changes proposed by the Bill (prudential standards and guidance on governance matters).48

On 26 June 2015, APRA wrote to all RSE licensees seeking feedback on initial proposals to amend its superannuation prudential framework to support the changes outlined in the draft legislation.49

On 31 August 2015, APRA published two draft prudential standards (‘SPS 510 Governance’ and ‘SPS 512 Governance Transition’) and two draft prudential practice guides (‘SPG 510 Governance’ and ‘SPG 512 Governance Transition’) for consultation.50 At the time, APRA noted that, subject to the passage of the legislation, it expected to release the final prudential standards and prudential practice guides in December 2015 with the prudential standards expected to take effect on the date that they are registered on the Federal Register of Legislative Instruments.51

Superannuation industry overview As at 30 June 2015, there was over $2 trillion invested by superannuation funds on behalf of members.52 While about one-third of this is held in self-managed superannuation funds (SMSFs), the large superannuation funds— divided broadly into not-for-profit funds (industry funds, corporate funds and public sector funds) and for-profit funds (retail funds) account for a significant share of assets (figure 1). Retail funds and industry funds are the more important part of the sectors in terms of member accounts and assets—this largely reflects the closure of defined benefit corporate and public sector schemes and the transition to defined contribution schemes.53

The value of superannuation savings is likely to continue to increase over the medium to long term, with various estimates putting the value of assets managed by superannuation funds in the order of $6-9 trillion in the mid-

44. J Frydenberg (Assistant Treasurer), Improving superannuation governance, media release, 26 June 2015, accessed 13 October 2015. 45. Treasury, ‘Reforms to superannuation governance’, Treasury website, accessed 12 October 2015. 46. Treasury, ‘Submissions to Treasury—Reforms to superannuation governance’, Treasury website, accessed 3 November 2015. 47. Treasury, Superannuation Legislation Amendment (Trustee Governance) Bill 2015 and associated regulation: Governance arrangements for

registrable superannuation entities, summary of consultation process, Treasury, Canberra, 2015, pp. 3-4, accessed 12 October 2015. 48. Adherence to prudential standards is a requirement of the superannuation licencing arrangements so these are mandatory. Prudential standards that are currently in place include operational risk and insurance in superannuation (APRA, ‘Superannuation Prudential Standards’,

op. cit.). Prudential practice guides aim to assist funds by generally outlining prudent practices in relation to certain elements of their business. Examples of areas in which prudential practice guides have been produced include conflicts of interest and investment governance (Ibid.). 49. APRA, Governance arrangements for RSE licensees, Discussion paper, APRA, Sydney, 31 August 2015, p. 3, accessed 13 October 2015. 50. APRA, ‘Governance arrangements for RSE licensees—August 2015’, APRA website, accessed 13 October 2015. 51. Ibid.

52. APRA, Statistics: quarterly superannuation performance June 2015, APRA, Sydney, 20 August 2015, p. 8, accessed 15 October 2015. 53. APRA, Statistics: annual superannuation bulletin June 2013, June 2013, revised 5 February 2014, pp. 22 and 28, accessed 19 October 2015.

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2030s.54 While the structure of the industry will continue to evolve, the expectations of some analysts are for the SMSF sector to continue to account for around one-third of superannuation assets and for there to be continuing consolidation among retail and industry funds due to economies of scale and regulatory costs and a slow decline in the prominence of corporate and public sector funds.55

Figure 1 Superannuation industry member accounts and assets, by fund type (excluding SMSFs), 2004 to 2013

Source: APRA, Statistics: quarterly superannuation performance June 2015, op. cit.

Committee consideration Senate Economics Legislation Committee On 17 September 2015, the Senate Selection of Bills Committee referred the Bill to the Senate Economics Legislation Committee for inquiry and report by 9 November 2015.56 The stated reasons for the referral by the

54. R Maddock, Superannuation asset allocations and growth projections, paper prepared for the Financial Services Council, 17 February 2014, p. 6, accessed 19 October 2015. 55. Deloitte, Dynamics of the Australian superannuation system, the next 20 years: 2013-2033, Deloitte, September 2013, p. 17, accessed 19 October 2015; KPMG, Supertrends: The trends shaping Australia’s superannuation industry, KPMG, 2015, p. 19, accessed 19 October 2015. 56. The terms of reference, submissions to the Senate Economics Committee and the final report (when published) are on the inquiry homepage,

accessed 23 September 2015.

0

3,000

6,000

9,000

12,000

15,000

18,000

Jun 2004 Jun 2007 Jun 2010 Jun 2013

Member accounts ('000)

Corporate

Industry

Public Sector

Retail

0

90

180

270

360

450

Jun 2004 Jun 2007 Jun 2010 Jun 2013

Total assets ($billion)

Corporate

Industry

Public sector

Retail

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Selection Committee were to consider whether there is currently a problem with superannuation governance and what impact the Bill would have on superannuation funds and their members and ‘to ensure detailed scrutiny of the legislation and seek stakeholder input on the impact of the bill’.57

At the time of writing this Bills Digest the Senate Economics Legislation Committee had not reported on the Bill.

Senate Scrutiny of Bills Committee The Senate Scrutiny of Bills Committee included some comments on the Bill in its Alert Digest tabled in the Senate on 14 October 2015.58 The Scrutiny of Bills Committee drew attention to the creation of an offence to contravene a direction to comply by APRA (proposed subclauses 92(4) of the SIS Act) and to make the offence one of strict liability. The Committee noted that the Explanatory Memorandum contained ‘a detailed explanation, which comprehensively outlines the justification for the approach, including addressing relevant principles outlined in the Guide to Framing Commonwealth Offences, Infringement Notices and Enforcement Powers’ and that ‘[i]n light of the detailed information provided the committee leaves question of whether the proposed approach is appropriate to the Senate as a whole’.59

Policy position of non-government parties/independents The Australian Labor Party (ALP) does not support the Bill. In debate in the House of Representatives, some of the reasons given for this position include:

• the equal representation model for industry funds has performed well relative to other parts of the industry

• a ‘one-size fits all’ governance model is not appropriate for superannuation funds which should be able to appoint independent directors if they think it is in the best interest of the fund rather than this being imposed by a prescriptive approach and

• the changes will impose significant costs on fund members.60

The Australian Greens do not support the Bill. In debate in the House of Representatives, Mr Adam Bandt noted several reasons for opposing the proposed changes including the absence of ‘glaring’ governance problems in superannuation funds.61

Of the independent and other minor party members in the House of Representatives, the Bill was supported by Ms Cathy McGowan and opposed by Mr Bob Katter and Mr Andrew Wilkie.62 Mr Clive Palmer did not vote on the Bill.63

At the time of writing the views of independent and minor party Senators have not been publicly expressed.

Position of major interest groups Major interest groups, including those in the superannuation industry, peak union and business groups and others have different views on the merits of the proposals included in the Bill (table 1).

Support for the Bill Key interest groups that have indicated their support for the Bill include the Financial Services Council (FSC),64 the Association of Superannuation Funds of Australia (ASFA),65 the Australian Chamber of Commerce and

57. Senate Selection of Bills Committee, Report, 12, 17 September 2015, p. 3, appendices 7 and 8, accessed 23 September 2015. 58. Senate Scrutiny of Bills Committee, Alert digest, 11, 14 October 2015, p. 36, accessed 2 November 2015. 59. Ibid.

60. C Bowen, ‘Second reading speech: Superannuation Legislation Amendment (Trustee Governance) Bill 2015’, House of Representatives, Debates, (proof), 20 October 2015, p. 102, accessed 26 October 2015; J Chalmers, ‘Second reading speech: Superannuation Legislation Amendment (Trustee Governance) Bill 2015’, House of Representatives, Debates, (proof), 20 October 2015, p. 110, accessed 26 October 2015.

61. A Bandt, ‘Second reading speech: Superannuation Legislation Amendment (Trustee Governance) Bill 2015’, House of Representatives, Debates, (proof), 20 October 2015, p. 49, accessed 26 October 2015. 62. Australia, House of Representatives, ‘Superannuation Legislation Amendment (Trustee Governance) Bill 2015’, Votes and proceedings, 152, 20 October 2015, p. 1670, accessed 26 October 2015. 63. Ibid.

64. FSC, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 30 September 2015, accessed 3 November 2015. 65. ASFA, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, accessed 3 November 2015.

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Industry (ACCI),66 the Australian Institute of Company Directors (AICD)67 and the consumer group Choice.68 The broad view of these groups is that the measures included in the Bill will strengthen the superannuation system and protect consumers.

Opposition to the Bill Key interest groups that oppose the measures included in the Bill include the Australian Institute of Superannuation Trustees (AIST),69 Industry Super Australia (ISA),70 the Corporate Superannuation Association71 and the Australian Council of Trade Unions (ACTU).72 In general, these groups question the need for the proposed arrangements given the performance of the equal representation model.

The Australian Industry Group (AIG) and National Seniors Australia support the provisions in the Bill that mandate one-third independent directors but do not support the requirement that the chair be an independent director.73 The broad rationale for not supporting the requirement that the chair be independent is that the board is best placed to decide who has the skills and capacity to fulfil the role of chair.

While the Governance Institute of Australia had previously supported some of the measures proposed by the Bill, it does not support the Bill in its current form and recommends a non-prescriptive approach to governance be taken.74

A number of industry groups made specific recommendations on aspects of the Bill in their submissions to the Senate Economics Committee inquiry into the Bill and in submissions to previous consultation processes on governance issues. Some of these are discussed in the key issues and provisions section below.

66. ACCI, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, accessed 3 November 2015. 67. AICD, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, accessed 3 November 2015. 68. Choice, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015,

14 October 2015, accessed 3 November 2015. 69. AIST, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, accessed 3 November 2015. 70. ISA, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015,

14 October 2015, accessed 3 November 2015. 71. Corporate Superannuation Association, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 5 October 2015, accessed 3 November 2015. 72. ACTU, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015,

14 October 2015, accessed 5 November 2015. 73. Australian Industry Group, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, p. 2; National Seniors Australia, Submission to Senate Economics Committee, Inquiry into the

Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 15 October 2015, p. 2, accessed 26 October 2015. 74. GIA, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, 14 October 2015, accessed 6 November 2015.

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Table 1 Summary of the positions of major interest groups on the Bill

Organisation Position Primary rationale

Superannuation industry

Australian Institute of Superannuation Trustees Oppose ‘The proposed changes however, abolish the legislative basis for equal representation on superannuation fund boards and disrupt the

governance structures of the sector that has consistently outperformed, providing the highest returns for members’. 75

Industry Super Australia Oppose The measures are ‘ill-conceived’, ‘unnecessary’, ‘not supported by evidence’, ‘costly’, ‘poorly focussed’, ‘ineffective’ and the outcomes are ‘unexpected’. 76

Association of Superannuation Funds of Australia

Support ‘This support should not be seen as a criticism of current governance structures, but instead recognises changing community expectations, increased complexity and risk in running superannuation businesses, and significantly higher regulatory standards and liability’.

77

Financial Services Council Support ‘[the reforms] create a minimum standard of governance to better protect consumers that are members of all types of APRA-regulated superannuation funds’. 78

Corporate Superannuation Association Oppose ‘The proposed compulsion for trustee boards to include a minimum one-third of independent members creates high cost for corporate funds and

their members but without equivalent benefits.’ 79

Related peak bodies

Australian Council of Trade Unions Oppose ‘The current model is a proven success and a key part of the nation’s retirement income system. Supporting the structures which have made

this system successful is endorsement of the success of the current model and its key features - low cost and high outcome’. 80

Australian Chamber of Commerce and Industry Support ‘[C]onflicts of interest can be quite subtle and a sufficiency of independent directors makes conflicts of interest more likely to be

perceived, recognised and called out. Independent directors can reshape a culture so that the board or trustees are more questioning which makes much less likely a closed culture of group think or accommodating acceptance’.

81

Council of Small Business Australia Support ‘All types of superannuation funds have been effected by governance failures from time to time and the reforms will provide an important,

additional layer of protection against future failures’. 82

Australian Industry Group Support, but does not support independent chair

‘[T]he requirement to have one-third independent directors, if introduced and administered in an appropriate way, could build on and accelerate the gradual trend towards a greater proportion of independent directors on superannuation boards’.

75. AIST, Submission, op. cit., p. 3. 76. ISA, Submission, op. cit., p. 4. 77. ASFA, Submission, op. cit. 78. FSC, Submission, op. cit. 79. Corporate Superannuation Association, Submission, op. cit., p. 1. 80. ACTU, Submission, op. cit., p. 20. 81. ACCI, Submission, op. cit., p. 16. 82. Council of Small Business Australia, Submission, op. cit., p. 1.

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Organisation Position Primary rationale

‘Our view is that the Board should be free to determine the best person from those available to chair the Board’. 83

Consumer organisations

Choice Support ‘Requiring a minimum one third independent directors on boards and an

independent chair is a sensible change that will strengthen the superannuation system for the benefit of consumers’. 84

National Seniors Australia Support, but does not support independent chair

‘[I]ncreasing independence in the board composition is important in improving accountability of fund management to members. The nature of these funds is that accountability is limited and the addition of independent directors will enhance accountability and protection of member interests’.

‘[T]he proposed change is one of the prescriptive measures that is simply unhelpful. The chair needs to be the best person for the job as decided by the board - ‘independent’ or otherwise. It needs to be the best person for that role’.

85

Other

Australian Institute of Company Directors (AICD) Support ‘Greater independence on the boards of superannuation trustee companies should be encouraged, consistent with internationally

recognised principles of good governance … a requirement that at least one-third of the board be independent … is supported’. 86

McKell Institute Oppose ‘[T]he representative model most closely satisfies the objectives of

meeting the best interests of members and maximising Australian’s retirement incomes. All the facts support this overall finding’. 87

Governance Institute of Australia Oppose ‘Given the problems we identify in the revised definition of independence in the Superannuation Legislation Amendment (Trustee

Governance) Bill 2015 … now is the time to step back and have a discussion about the governance outcomes for superannuation funds that should be sought, rather than a political discussion as has dominated all consultation on this issue to date’.

88

83. Australian Industry Group, Submission, op. cit., p. 3. 84. Choice, Submission, op. cit., p. 1. 85. National Seniors Australia, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 1, accessed 26 October 2015.

86. AICD, Submission, op. cit., p. 1. 87. McKell Institute, Submission to Senate Economics Committee, Inquiry into the Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 1, accessed 3 November 2015. 88. GIA, Submission, op. cit., p. 1.

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Financial impact The Explanatory Memorandum notes that the Bill has a nil financial impact.89

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible as it does not raise any human rights issues.90

Key issues Do we need to mandate a minimum share of independent directors and an independent chair for superannuation funds? The threshold question to address in debate about the provisions of the Bill is whether certain superannuation funds should have specific governance requirements in relation to the composition of the trustee board to require one-third independent trustee directors and an independent chair. Arguments for and against the proposal canvas a number of issues including the appropriateness of mandating a specific model, the financial costs in adopting new governance arrangements for the funds involved and the potential benefits to the sector and fund members of such changes.

Arguments for the measures One of the main arguments for the measures proposed by the Bill relates to the general acceptance of the principle that independent board members and chairs bring improved decision making processes, a greater diversity of skills and experience which will contribute to both strengthening the superannuation system overall as well as member interests.91 To support this view, the Government points to the conclusions drawn by the Cooper Review and the Murray Report and that the approach is consistent with international best practice on corporate governance.92 These broad arguments are supported by a number of major interest groups including the FSC, ACCI, the Council of Small Business Associations of Australia and consumer group Choice.93 The FSC notes:

The minimum standard of governance provided for in the Bill will protect consumers from circumstances where the judgement of non-independent directors may be influenced by the interests of a subset of the membership, a shareholder or a sponsoring organisation.

Arguments that the reforms are not necessary because funds with no independent directors have a track record of good investment performance misrepresent the purpose of the reforms. The focus of the reforms is governance and the behaviour of boards, not investment performance. All superannuation funds, be they retail, industry, public or corporate funds, have the capacity to improve their governance process.

94

Arguments against the measures The main arguments against the measures proposed by the Bill include:

• that the equal representation model has performed well

• the equal representation model is an important feature of the superannuation system and is prevalent in many overseas pension funds

• there is a lack of evidence to support the changes and

89. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 4, accessed 6 November 2015. 90. The Statement of Compatibility with Human Rights can be found at pages 28-29 and 62-63 of the Explanatory Memorandum to the Bill. 91. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 8. 92. Ibid., pp. 8-9. 93. FSC, Submission, op. cit., p. 2; ACCI, Submission, op. cit., p. 3; Council of Small Business Australia, Submission, op. cit., p. 1; Choice,

Submission, op. cit., p. 1. 94. FSC, Submission, op. cit. p. 2.

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• the imposition of a principles-based framework, creating a lack of flexibility for boards and creating additional costs without any equivalent benefits.95

The AIST sums up many of these arguments, noting that:

The lack of evidence to support governance changes highlights a significant flaw in this proposed reform process. Regulated superannuation funds are a major contributor to the Australian economy, with the not-for-profit superannuation sector representing more than $650 billion in funds under management. While good governance practices should be encouraged and pursued at all times, AIST submits that mandatory changes to board composition will mean significant changes to the culture of these large financial institutions and disruption to fund activities, without any evidence of the need for such reform, or an articulated benefit to the members. These changes will also come at a substantial cost (both through implementation and ongoing higher director fees) - to be borne by the members.

96

Trustee arrangements for pension funds overseas Governance arrangements for pension funds overseas provide some reference for the changes proposed by the Bill. It is important to distinguish between arrangements applying to corporations generally and those applying to pension funds in particular.

As noted earlier, support for a corporate board to comprise a majority of independent directors and an independent chair gained momentum in governance reviews in the 1990s and 2000s and these requirements are now established in key governance documents such as the ASX’s Principles of Good Corporate Governance and Best Practice Recommendations. A recent summary of board independence requirements by the Organisation for Economic Co-operation and Development (OECD) concluded that almost all jurisdictions had introduced a requirement or recommendation with regard to a minimum number or ratio of independent directors—three jurisdictions (India, Hungary and the United States) had introduced a binding requirement for a majority independent board, while the others had taken a ‘comply or explain’ approach.97

The Explanatory Memorandum notes arrangements in Canada and the United Kingdom for corporations where it is recommended that a majority or at least one-half of boards should be comprised of ‘unrelated’ or ‘independent’ directors.98 Importantly, individual companies in Canada and the United Kingdom are not required to implement such a structure but are only required to report about adherence to such a principle.99

A 2015 report by Mercer on the governance of superannuation (pension) funds examined the prevalence of independent directors on pension funds across a number of countries.100 This research found that in nearly all OECD countries, boards for occupational pension arrangements are comprised of an equal number of employer and employee representatives but that this approach needed to be considered in the context of the different legal framework operating in many OECD countries.101 Possibly the most relevant to Australia, given the use of the trust model are arrangements in the United Kingdom for defined contribution schemes that require a majority of independent trustees or a majority of non-affiliated trustees depending on the type of scheme.102

Does an ‘independent’ board improve performance? There is a broad economics-based literature on the relationship between good governance practices and firm performance, with studies examining the relationships between structural governance practices such as board size, independent directors, independent chairs, use of sub-committees and other matters and performance as measured by profitability and share price.

95. ISA, Submission, op. cit., p. 42; AIST, Submission, op. cit., p. 7; McKell Institute, AIST, Submission, op. cit., p. 1. 96. AIST, Submission, op. cit., p. 7. 97. OECD, G20/OECD principles of corporate governance, 5 September 2015, pp. 70-79, accessed 12 October 2015. 98. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 41. 99. Toronto Stock Exchange (TSX), Corporate governance: A guide to good disclosure, TSX, Toronto, Canada, p. 6, accessed 27 October 2015;

Financial Reporting Council (UK), The UK Corporate Governance Code, September 2014, p. 11, accessed 27 October 2015. 100. Mercer, Governance of superannuation funds: A report on independence requirements for trustee boards, May 2015, accessed 27 October 2015. 101. Ibid., p. 16. 102. Ibid., p. 19.

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In general, these studies have found mixed results on the impact of independent directors on firm performance.103 A 2010 review of empirical literature on the effects of independent directors on firm performance found that there was no strong evidence about the presence of a majority of independent directors:

[T]he notion that firm performance improves with the presence of a majority or supermajority independent directors on the board of firms is yet to have conclusive evidence. In fact, a good number of the studies point to the fact that the presence of more executive directors on the board positively affects firm performance than can ever be contemplated under a board with majority or supermajority independent directors. In the same vein some studies clearly point out that in some instances, the presence of independent directors makes positive firm performance impossible.

104

More relevant to the provisions of this Bill are studies that have examined the impact of independent directors on the performance of superannuation (or ‘pension’) funds.105 These include:

• A 2008 study of US public sponsored pension plans over the period 2001-2005 on the impact of outside or independent trustees on investment performance. The study found no relationship between board composition and characteristics and investment performance as measured by the excess return of the fund but that ‘board composition plays an important role in plan funding status and asset allocation decisions’.106

• A 2012 study of defined contribution funds in Poland over the period 1999-2010 found a positive correlation between the number of outsiders on the board and the pension unit return. The study also found that other characteristics such as the age or the education of the board members or the Chairman may be important.107

• A 2013 study of the influence of various governance arrangements including the proportion of independent directors on superannuation funds trustee boards in Australia for 2009 and 2012. The study found that there was a beneficial impact of independent directors on industry fund boards but that this relationship was negative for retail funds and concluded that ‘the beneficial impact of independent directors on [i]ndustry [fund] boards gives great weight to the Cooper recommendation for appointment of one-third independent directors’.108

• A 2015 study of the relationship of between various governance arrangements and fees for non-for-profit superannuation funds between 2009-10 and 2011-12. The study concluded that the relationship for board independence had mixed results and the results from the analysis were insignificant.109

While industry groups aligned with the industry superannuation funds cite evidence that industry funds have outperformed retail funds as a justification for not proceeding with the proposed changes, there is no empirical evidence that the changes would further improve the performance of affected funds.110

As part of its 2012 examination of default fund arrangements, the Productivity Commission noted that the equal representation model has generally operated well to date, but that some arguments for an equal representation

103. See for example, S Ferris and S Yan, ‘Do independent directors and chairmen matter? The role of boards of directors in mutual fund governance’, Journal of Corporate Finance, 13, 2007, pp. 392-420; G Vintila and S Gherghina, ‘An empirical investigation of the relationship between corporate governance mechanisms, CEO characteristics and listed companies’ performance’, International Business Research, 5(10), 2012, pp. 175-191, ProQuest database, both accessed 15 October 2015.

104. R Chibuike Iwu-Egwuonwu, ‘Some empirical literature evidence on the effects of independent directors on firm performance’, Journal of Economics and International Finance, 2(9), September 2010, p. 196, accessed 15 October 2015. 105. The term ‘pension fund’ is used in some countries to describe retirement savings funds that are broadly equivalent to superannuation funds in Australia. 106. J Harper, Board of trustee composition and investment performance of US public pension plans, Rotman International Centre for Pension

Management, February 2008, p. 1, accessed 15 October 2015. 107. O Kowalewski, ‘Corporate governance and pension fund performance’, Contemporary Economics, 2012, 6(1), p. 41, accessed 15 October 2015. 108. E Torunn Nisbet, Influence of board structure on the performance and governance framework of Australia’s superannuation funds, Flinders

Business School, December 2013, p. 33, accessed 15 October 2015. 109. M Tan and M Cam, ‘Does governance structure influence pension fund fees and costs? An examination of Australian not-for-profit superannuation funds’, Australian Journal of Management, 2015, 40(1), p. 131, accessed 15 October 2015. 110. AIST, Submission to Treasury, Reforms to superannuation governance—Exposure draft, p. 9, 23 July 2015, accessed 15 October 2015;

ISA, Submission to Treasury, Reforms to superannuation governance—Exposure draft, p. 9, 23 July 2015, accessed 15 October 2015.

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structure become less compelling as funds actively broaden their membership beyond their traditional base.111 At that time, the Productivity Commission did not support mandating a particular governance structure:

The Commission considers that issues relating to board structure are important. However, overall, there is a lack of compelling evidence to suggest that any one model of board structure should be viewed as clearly preferable in all cases. Therefore, the Commission does not consider it appropriate at this time for a particular structure to be mandated. Further, the Commission would not want to see restrictions placed on board structures without such restrictions having a sufficient evidentiary basis, particularly given the potential impact they could have on competition for default listing.

112

Costs and benefits associated with implementing the proposed arrangements Implementing the measures proposed by the Bill is estimated to cost the affected superannuation funds $12.3 million per year in ongoing costs and $8.5 million in start-up costs.113 These costs included some trustee directors changing from being appointed by unions or business groups to being appointed as an independent member by the board as well as 30 per cent of affected boards increasing in size to meet the new requirements.114

Implementation costs estimated by Industry Super Australia (ISA)—the peak industry body for industry superannuation funds—prepared on the basis of the proposed measures in the draft Bill were for a five-year cost of between $89 million and $168 million.115 In relation to this Bill ISA noted that:

[T]he Government’s assessment of direct costs is unrealistic and understates these costs. The estimate is flawed because it (i) ignores the inevitable upward pressure on director fees that will occur with the appointment of a large number of directors (ii) does not consider the costs that retail funds will bear in implementing the charges; and (iii) makes no provision for knock-on costs arising from the need to restructure the boards of subsidiaries of funds.

116

The Corporate Super Association provided estimates for implementation costs for different sized corporate superannuation funds:

• a medium sized corporate superannuation fund ($670 million in assets and 3,600 members) had estimated base additional costs of $150,000, an increase of 10 per cent on administration fees and

• a larger fund with close to $5 billion in assets had estimated increased costs of $160,000 per annum.117

Unlike the costs, the benefits of the measures proposed by the Bill do not have a specific monetary value. As noted previously, the key benefits advocated by the Government and organisations that support the Bill relate to the general acceptance of the principle that independent board members and chairs bring improved decision making processes, a greater diversity of skills and experience which will contribute to both strengthening the superannuation system overall as well as member interests.118

A separate argument for the measures proposed by the Bill advocated by the FSC relates to an expected pressure for mergers between subscale and inefficient funds which will lower fees for superannuation consumers.119

Key provisions—Schedule 1 Existing arrangements Part 9 of the SIS Act includes specific governance arrangements relating to the composition of the trustee of a superannuation fund. As stated above, the equal representation rules provide for equal representation of

111. Productivity Commission (PC), Default superannuation funds in modern awards, Inquiry report, 60, PC, Canberra, October 2012, pp. 100-101, accessed 29 October 2015. 112. Ibid., p. 102. 113. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 44. 114. Ibid., p. 49. 115. ISA, Submission, op. cit., p. 42. 116. Ibid., p. 13. 117. Corporate Superannuation Association, Submission, op. cit., p. 2. 118. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 8. 119. Ibid., pp. 3-4.

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employer and member representatives and allows for the appointment of an additional independent trustee or additional independent director.120

The terms independent director and independent trustee are defined in the SIS Act so that the director or trustee is not a member of the fund, is not an associate nor an employee of an employer or employee sponsor of the fund and is not in any capacity a representative of a trade union or other organisation representing the interests of the fund.121 Non-adherence to the equal representation rules may result in a fund being directed not to accept any contributions made to the fund by an employer sponsor.122

Appointing more than one independent director to funds with equal representation boards requires the fund to apply for an exemption to the SIS Act.123 The equal representation rules also provide some additional requirements under the Superannuation Industry (Supervision) Regulations for a decision by the trustee board to be valid only where at least two-thirds of the total number of directors voted for it.124

Provisions of the Bill Item 1 of Schedule 1 to the Bill repeals and replaces Part 9 of the SIS Act. The new Part 9 contains the substantive elements of the changes that will require at least one-third of trustees to be independent, for the chair to be independent. To that end it includes a list of circumstances in which a person will be independent for the purposes of the new Part 9.

Repeal of equal representation model The new Part 9 does not include any reference to the equal representation model. However, the Explanatory Memorandum notes that the representation of employer and employee groups is still provided for. ’The composition of superannuation trustee boards, beyond the one-third independent directors prescribed, will remain at the discretion of the board’, with trustees able to enshrine equal representation (or voting rules) in their constitution.125

The removal of the equal representation model is opposed by several interest groups including AIST and ISA.126 AIST notes that:

We oppose the removal of equal representation from the legislation and consequently the guaranteed voice of the members through their representation on the board, or alternatively on a policy committee. Similarly, the removal of equal representation eliminates the guaranteed voice to employers.

… both a member and an employer voice in a mandatory savings system are vital and that it should be preserved in all sectors of the APRA-regulated superannuation industry. The representative model ensures a deep knowledge of the membership, representation of their respective interests in a mandatory system, and proper consideration of all relevant issues in the pursuit of the best possible outcomes for members.

127

The retention of the model for the remaining two-thirds of the board was supported by ASFA, who noted some potential unintended consequences such as a superannuation fund board comprising one-third independent directors and two-thirds employer representatives (meaning members would have no direct representation on the trustee board) or two-thirds member representatives (meaning employer groups would have no direct representation).128

RSE licensee must have independent directors or trustees and an independent chair Proposed section 86 provides that the chair of the RSE licensee’s board of directors must be independent from the RSE licensee (for RSE licensees that are a body corporate), that at least one-third of the RSE licensee’s

120. Superannuation Industry (Supervision) Act 1993 (SIS Act), section 89. 121. SIS Act, section 10. 122. SIS Act, section 87. 123. APRA, Submission, op. cit., p. 4. 124. Superannuation Industry (Supervision) Regulations 1994, regulation 4.08, accessed 29 October 2015. 125. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 42. 126. ISA, Submission, op. cit., p. 5, AIST, Submission, op. cit., p. 4. 127. AIST, Submission, op. cit., p. 14. 128. ASFA, Submission, op. cit., p. 13.

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directors or trustees must be independent from the RSE licensee (the chair is included in meeting the one-third requirement) and that the RSE licensee must comply with any requirements of the prudential standards relation to the appointment or removal of directors who are independent from the RSE.

As previously noted, the requirement in proposed section 86 that the chair be required to be independent was not supported by AIG and National Seniors Australia who otherwise supported the one-third independent requirements. This position was based on the view that the board is best placed to decide who has the skills and capacity to fulfil the role of chair.129 AIG noted that:

The general governance argument in support of having an independent chair is based on a very different notion of independence than the one put forward in this Bill - namely independence from the senior management.

While we agree that Chairs should not be part of the management team, we do not believe the case has been made that the best Chair for a fund would be “independent” as defined in this Bill.

Our view is that the Board should be free to determine the best person from those available to chair the Board. 130

Meaning of ‘independent’ Proposed section 87 lists the circumstances in which a person will be independent from an RSE licensee for the purposes of satisfying the independent director requirements in proposed section 86 as follows:

• first, a person is considered to be independent from an RSE licensee unless certain conditions—relating to a nominated shareholding interest in the RSE licensee ownership arrangements and certain business and employment relationships with the RSE licensee—are present:

- a specified nominated thresholds limit of under five per cent shareholding interest (subject to certain exclusions) for an RSE licensee that is a body corporate in the share capital of the RSE licensee and in the share capital of the body corporate that is related to the RSE licensee

- a specified three-year minimum period for the person’s business relationships that were material with the RSE licensee or trustee and - a specified three-year minimum period for the person’s employment as a director or executive officer of the RSE licensee, a body corporate that is related to the RSE licensee, with any of the individual trustees if

the RSE is a group of individual trustees, an employer-sponsor of the fund who is a large employer and an organisation (representing the interests of one or more employer-sponsors or representing the interests of members of the fund who has the right to appoint directors or trustees of the RSE licensee) (proposed subsections 87(1)-87(3)) • second, there is a regulation-making power under which a person falls within the meaning of independent if

certain circumstances apply (proposed subsection 87(3)) and

• third, APRA may determine, under a process outlined in proposed sections 88 and 89, whether a person is independent from an RSE licensee or not (proposed subsection 87(4)).

The use of specific thresholds of three years and a shareholding interest of five per cent to determine independence from ownership, business and employment arrangements are broadly similar to the ASX Principles of Good Corporate Governance and Best Practice Recommendations and the Financial Services Council’s FSC Standard No. 20: Superannuation Governance Policy.131

A key term used to establish these thresholds relates to circumstances that are ‘material’ to a business relationship that the person or RSE licensee may have had—a circumstance that the Explanatory Memorandum notes will depend on the circumstances in each case.132

129. AIG, Submission, op. cit., p. 2; National Seniors Australia, Submission, op. cit., p. 2. 130. AIG, Submission, op. cit., p. 4. 131. ASX Corporate Governance Council, Principles of good corporate governance and best practice recommendations (3rd edn), op. cit., p. 16; FSC, FSC Standard No. 20: Superannuation Governance Policy, FSC, Sydney, March 2013, p. 10, accessed 29 October 2015. These two

documents refer to the definition of ‘substantial shareholding’ in section 9 of the Corporations Act 2001 which includes voting interests of 5 per cent or more of the total number of votes attached to voting shares in the body, or interests in the scheme (accessed 29 October 2015). 132. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 17.

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The rationale for the regulation-making power is ‘to determine circumstances in which a person is considered independent regardless of the circumstances in new section 87(1)’.133 The rationale for the power for APRA to make determinations is to ‘allow APRA to respond to situations where a person’s circumstances and his or her capacity to exercise independent judgement is clear but for reasons such as timing, restructures and acquisitions’.134

A number of views have been expressed by major interest groups on the overall drafting of the independence requirements and some of the specific elements:

• AIG considers that:

- the provisions of new paragraph 87(1)(c)(ii), which prescribe that a person would not be independent if they were a director or executive officer of a body corporate that is related to the RSE licensee create the potential for a practice to emerge where non-independent directors were more likely than independent directors to be appointed to subsidiary or joint venture boards—where it may make very good sense for a Board member of a fund to also serve on the board of a subsidiary or joint venture and

- the provisions of new paragraph 87(1)(f)(i), which prescribes that a person would not be independent if they were, or had in the previous 3 years been, an executive officer or director of an employer-sponsor who employs more than 500 members of the fund, would ‘impose ongoing compliance costs or, more likely, give rise to a reticence to appoint to the boards of large funds current or recent directors or officers of domestic organisations with large numbers of employees’.135 • ASFA considers that the definition of independent should be amended to enable a director to sit on the

board of multiple related RSEs under the same financial conglomerate group as an independent director, rather than RSE licensees having to rely on the real uncertainty of an APRA determination.136

• ISA provide a range of circumstances under current arrangements that may need to be changed under the independence requirements relating to relationships and governance arrangements in the not-for-profit environment.137

• The Governance Institute of Australia considers that ‘any strictly prescriptive definition will inevitability lead to difficulties’ and that ‘now is the time to step back and have a discussion about the governance outcomes for superannuation funds that should be sought’.138 While the Governance Institute of Australia had previously supported proposals for one-third independent directors and an independent chair on superannuation fund trustee boards it now considered that ‘it would be best if the Bill did not proceed’.139

Determinations of independence Proposed sections 88-90 create a process whereby APRA may determine an application by an RSE licensee that a person is independent from the RSE licensee. APRA may also determine, on its own volition, that a person is not independent from an RSE licensee. In making a positive determination that a person is independent, or a negative determination that a person is not independent, APRA is required to take into account the terms of proposed section 87 about circumstances that prevent a person from being independent as well as the circumstances prescribed by regulations. The Explanatory Memorandum notes that ‘one situation where the power to determine a person to be independent is where a person’s circumstances mean that they do not meet the independence requirements, but they are considered to be capable of exercising independent judgement’.140

133. Ibid., p. 18. 134. Ibid. 135. AIG, Submission, op. cit., p. 4. 136. ASFA, Submission, op. cit., p. 4. 137. ISA, Submission, op. cit., pp. 23-27. 138. GIA, Submission, op. cit., p. 1. 139. Ibid.; GIA, Submission to Treasury, Reforms to superannuation governance—Exposure draft, 23 July 2015, p. 1, accessed 2 November 2015. 140. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 19.

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APRA has indicated that it expects to use the power in proposed section 90 (determination that a person is not independent) infrequently on the basis that ‘the legislative definition should provide sufficient information to undertake a robust assessment of a director’s independence in most circumstances’.141

Importantly, proposed section 92 empowers APRA to direct an RSE licensee of a registrable superannuation entity to comply with the terms of new Part 9 of the SIS Act if the licensee has contravened Part 9 on one or more occasions and APRA is satisfied that the seriousness or frequency, or both, of the contraventions warrants giving the direction. Proposed subsection 92(4) creates an offence of strict liability if an RSE licensee, without reasonable excuse, contravenes the APRA direction.142

Transitional provisions Part 3 of Schedule 1 to the Bill provides for a transitional period for existing funds of three years from the date of Royal Assent for the new Part 9 to take effect by providing that requirements do not apply if the RSE licensee complies with any requirements of the transitional prudential standards.143

This effectively provides for a period of three years for trustee boards to change their composition. Some interest groups, such as ISA, saw this period as being too short with AIST arguing for a five year period.144 AFSA supported a three year period but considered that it should not commence until the relevant requirements (including the prudential standards) are finalised, and suggested a transitional three year period commencing on 1 July 2016 or three years after Royal Assent, whichever is later.145

Key provisions—Schedule 2 The provisions of Schedule 2 to the Bill apply similar arrangements to the Commonwealth Superannuation Corporation (CSC). The CSC is the trustee for a number of Commonwealth public sector superannuation and military superannuation funds including the:

• Commonwealth Superannuation Scheme (CSS)

• Military Superannuation and Benefits Scheme (MilitarySuper)

• Public Sector Superannuation Scheme (PSS)

• Public Sector Superannuation accumulation plan (PSSap)

• Defence Force Retirement and Death Benefits Scheme (DFRDB Scheme)

• Papua New Guinea Scheme (PNG Scheme).146

Under the Governance of Australian Government Superannuation Schemes Act the CSC is comprised of a Chair and ten other directors. The Bill reduces the number of other directors from ten to eight.147

Currently, three of the other directors are nominated by the Australian Council of Trade Unions and two are nominated by the Chief of the Defence Force.148 The Minister chooses the five other directors, but must consult with the Defence Minister before making the appointment.149

The Chair of the CSC is appointed by the Minister after agreement is given by the Board.150

Under the Bill, the number of directors nominated by the Australian Council of Trade Unions is reduced from three to two.151 The number of other directors who are chosen by the Minister is reduced from five to four.152

141. APRA, Submission, op. cit., pp. 8-9. 142. The penalty for the offence is 60 penalty units, which is equivalent to $10,800. 143. The content of APRA’s draft prudential standards relating to the Bill is discussed further below. 144. ISA, Submission, op. cit., pp. 28; AIST, Submission, op. cit., p. 20. 145. ASFA, Submission, op. cit., p. 15. 146. Commonwealth Superannuation Corporation (CSC), ‘Who we are’, CSC website, accessed 2 November 2015. 147. Item 7 of Part 2 of Schedule 2 to the Bill amends subsection 11(2) of the Governance of Australian Government Superannuation Schemes Act. 148. Governance of Australian Government Superannuation Schemes Act 2011, section 11, accessed 12 October 2015. 149. Governance of Australian Government Superannuation Schemes Act, subsection 12(4). 150. Governance of Australian Government Superannuation Schemes Act, subsection 12(5). 151. Item 9 of Part 2 of Schedule 2 to the Bill amends paragraph 11(2)(a) of the Governance of Australian Government Superannuation Schemes

Act.

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Items 11 and 15 translates this smaller overall number of directors in reducing the quorum at a meeting of the Board or decisions taken without a meeting from nine to six.

The amendments in Schedule 2 to the Bill to the Governance of Australian Superannuation Schemes Act provide for similar independence requirements as will be applied to superannuation funds by the amendments in Schedule 1 to the Bill—that is, one-third of the total of nine directors must be independent.

Items 1 and 2 operate so that a person is independent from CSC if the person satisfies the provisions of section 87 of the SIS Act as amended by the Bill. Those directors who are not nominated by the Australian Council of Trade Unions or the Chief of the Defence Force must be independent from CSC.

Item 3 (proposed subsection 12(7) of the Governance of Australia Government Superannuation Schemes Act provides that a person’s appointment as a director to be independent from CSC is not invalid if, after the appointment, the person ceases to be independent from CSC. However, item 4 inserts proposed subsection 17(5A) to expand the available reasons for the Minister to terminate the appointment of a director to include that they have ceased to be independent from CSC.

Item 16 provides that the application of amendments relating to appointments and termination of existing appointments does not apply to those that occur prior to Royal Assent. Item 17 provides that appointments to the board (with the exception of those appointed by the Chief of the Defence Force) in the period between Royal Assent and 1 July 2016 will cease on the earlier of, the term of appointment, or the end of 30 June 2016.

What parts of the broad policy are NOT in the Bill? While the Bill contains the main elements of the policy relating to independent trustee directors and the chair being independent, there are some matters canvassed as part of the overall policy that are not included in the Bill.

Mandatory public reporting on whether an RSE trustee has a majority of independent directors or not The Explanatory Memorandum notes that all RSEs will be required to publicly report (on an ‘if not, why not’ basis) in the annual report of each of their RSEs whether they have a majority of independent directors or not.153 The intent of this requirement is to provide RSE trustees with ‘with the opportunity to provide a clear indication of the rationale underlying their composition. In particular, it allows the board to explain how it believes that its chosen composition will best serve the interests of fund members’.154 This policy is not in the Bill. As noted in the Explanatory Memorandum this will take effect for financial years beginning from 1 July 2019 and be implemented through changes to the reporting requirements in the Corporations Regulations 2001.155

Such a requirement for ‘if not, why not’ reporting on board composition is based on the ASX Principles of Good Corporate Governance and Best Practice Recommendations, which provides that listed entities that do not adopt the recommended principles are required to explain why it has not adopted a recommendation.156 The ASX notes that:

Requiring this explanation ensures that the market receives an appropriate level of information about the entity’s governance arrangements so that:

• security holders and other stakeholders in the investment community can have a meaningful dialogue with the board and management on governance matters;

• security holders can factor that information into their decision on how to vote on particular resolutions; and

• investors can factor that information into their decision on whether or not to invest in the entity’s securities.

152. Item 10 of Part 2 of Schedule 2 to the Bill amends the note to subsection 11(2) of the Governance of Australian Government Superannuation Schemes Act. 153. Explanatory Memorandum, Superannuation Legislation Amendment (Trustee Governance) Bill 2015, p. 11. 154. Ibid. 155. Ibid. 156. ASX Corporate Governance Council, Principles of good corporate governance and best practice recommendations, 3rd edn, op. cit., p. 3.

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The “if not, why not” approach is fundamental to the operation of the Principles and Recommendations. 157

The requirement for such reporting was opposed by a number of superannuation industry organisations including ISA, ASFA and AIST, for a number of reasons including additional red tape, confusion about compliance with ‘best practice’ and have the potential to lead to appointments for compliance purposes rather than on merit.158 Industry Super Australia noted:

The proposed requirement would make bad law. It would require funds to report against a standard that is not required of them, and may create a perception that a trustee who has complied with proposed section 86(1) is nonetheless avoiding its legal obligations. 159

APRA prudential standards and guidance As previously noted, on 31 August 2015, APRA published two draft prudential standards (‘SPS 510 Governance’ and ‘512 Governance Transition’) and two draft prudential practice guides (‘SPG 510 Governance’ and ‘SPG 512 Governance Transition’) for consultation.

The prudential standards and guidance provide additional detail about how the requirements for independent trustee directors and an independent chair are implemented in practice. Some important elements of the governance prudential standards that are separate to those outlined in the Bill—but arguably consistent with its application—cover prescriptive requirements for the composition of a board:

• a majority of directors present and eligible to vote at all Board meetings must be non-executive directors

• the board must have in place a procedure for assessing, at least annually, the performance and independence of individual directors

• ‘Remuneration Committee’ membership160—the chair must be an independent director and at least one-third of the members of committee must be independent, and

• ‘Audit Committee’ membership161—the chair must be an independent director, at least one-third of the members must be independent and the chair of the board may be a member of the committee, but may not chair.162

A number of interest groups including ASFA, AIST and ISA do not support the mandating of independent directors and an independent chair largely on the basis that it should be up to the board to determine the appointments but also because it may lead to an overall board size that is not appropriate or may not lead to the ‘best’ members to be appointed to such committees.163 ASFA noted that:

By mandating a minimum number of independent directors on the [audit and remuneration committees], trustee boards could be forced to remove non-independent committee members with audit and remuneration experience from these two committees and replace them with directors who, while independent, have little or no experience in these areas.

164

The prudential standards and guidance reflect the draft Bill as released in August 2015. APRA has indicated that further changes will be made to the standards. For example, APRA notes that following changes to the meaning of independent in the Bill (which means that a person will not be considered to be independent if they have, or have had, a business relationship with the RSE licensee that is, or was at the time, material to either the person or the RSE licensee) the standards will be changed to include a requirement for RSE licensees to establish, as part

157. Ibid. 158. ISA, Submission, op. cit., p. 29; ASFA, Submission, op. cit., pp. 9-10; AIST, Submission, op. cit., p. 5. 159. ISA, Submission, op. cit., p. 29. 160. The Remuneration Committee—a board sub-committee that is a common feature of company boards—is responsible for the oversight of the

remuneration policy that applies to senior staff in the entity, including board members. 161. The Audit Committee—a board sub-committee that is a common feature of company boards—is responsible advising the board on financial reporting and risk management framework and for the adequacy and independence of both the internal and external audit functions. 162. APRA, Prudential Standard SPS 510: Governance, draft, August 2015, paras. 20, 23, 42-43 and 52-54, accessed 19 October 2015. 163. ASFA, Submission, op. cit., p. 14; AIST, Submission, op. cit., p. 5; ISA, Submission, op. cit., p. 29. 164. ASFA, Submission, op. cit., p. 14.

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of their governance framework, a policy which addresses how the materiality of such relationships will be determined when assessing the independence of current or potential directors.165

Concluding comments The policy reasons for the measures proposed by the Bill are contested. While there is general agreement about the importance of good governance at a board level to entity performance, there are differing views about whether requirements for independent trustee members and an independent chair should be mandated or expressed in general principles which individual boards can choose to implement.

There are also different views as to whether the success of the equal representation model, under which superannuation funds can choose to appoint independent members or even chairs to their boards, will be affected by the changes proposed by the Bill. At one end of the spectrum, the measures proposed by the Bill can be viewed as a pragmatic response to a general move towards appointing more independent members to such boards—one which some funds are already implementing. However, others argue that the success of the equal representation model is an important part of the superannuation system and that there is little evidence that the changes proposed by the Bill are required or desirable.

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165. APRA, ‘Prudential Standards and Guidance — Frequently Asked Questions’, FAQ 1, APRA website, accessed 10 October 2015.