Submission APRA Conflicts of Interest. Presented by Australian Institute of Superannuation Trustees

Transcription

1 Submission APRA Conflicts of Interest Presented by Australian Institute of Superannuation Trustees

2 Page 2 Introduction In, APRA published a Discussion Paper entitled Management of conflicts of interest RSE licensees, incorporating a draft Prudential Practice Guide. APRA has called for submissions by 30. AIST welcomes the opportunity to make a submission to APRA on this issue. APRA has previously called for submissions on this issue, and AIST responded to that request. A copy of our earlier submission has been included in this submission, for information purposes only. AIST The Australian Institution of Superannuation Trustees (AIST) is a national not-forprofit organisation whose members are superannuation fund trustee directors and officers of industry, public sector, and corporate superannuation funds who operate with a representative Trustee Board of Directors. AIST advocates on behalf of its members, it undertakes research, develops policy and provides professional training, consulting services and supports trustee directors and staff to help meet the challenges of managing superannuation funds and advancing the interests of their fund members. The not for profit sector manages $450 billion of retirement savings of behalf of Australian workers. Contacts Fiona Reynolds, CEO (03) Andrew Barr, Policy & Research Manager (03)

3 Page 3 Section One - Introduction A. Background With around $1 trillion now invested in superannuation, and almost all working Australians having some interest in a fund, the quality of decision making in the management and oversight of the superannuation industry is of critical policy importance. Three pieces of recent research inform this discussion. They are (i) APRA s publication Investment performance, asset allocation, and expenses of large superannuation funds issued on 8 May, 2008 in which significant behavioural differences between not-for-profit fund Trustee Boards and their traditional sector equivalents were clearly documented. One interpretation of the data was that traditional sector Trustees were markedly less diligent than the not-for-profit Trustee Directors they spent substantially less time on their Board role within the fund, there were fewer of them, and they were less likely to engage the services of independent external experts to assist them to meet their fiduciary responsibilities. A more feasible interpretation is that traditional sector Trustees see their role as incidental to their role with their employer, the fund promoter. They see the two roles as one, with no real or practical separation; effectively, they do not perceive that they have a real responsibility to the fund members in the manner common to Trustee Directors in the not-for-profit sector. Indeed, they see the time they spend working on the business of the fund for and on behalf of their employer as indistinguishable from that they spend as a Trustee working for and on behalf of members. The conflict of interest is obvious and massive. Sadly, when the element of self interest is added it becomes unlikely that people placed in this situation will act against the interest of their employer when that interest is counter to the interests of members. It must be conceded that Trustees appointed to the Boards of company and public sector roles by the employer can be subject to the same pressures. The survey data suggests that they are better able to separate their roles. (ii) Dr Shey Newitt s soon to be published research commissioned by AIST on the efficiency of the operation of Trustee Boards in the not-for-profit sector (a copy of the draft report is enclosed as Attachment One). This paper adds to the findings of the APRA research in that it shows these Boards scoring high in matters relating to conflicts of interest. They also score

4 Page 4 high relative to public company boards in earlier research conducted by Newitt. While the paper reveals other areas deserving of attention, Newitt s research suggests that the passion of the not-for-profit Boards (where there is equal representation of members and employers among Trustees) to provide the optimal outcome for their members - aided by the absence of the need to meet the needs of a second master which often has different objectives - is a key driver of effort and outcomes. (iii) The University of Sydney team lead by Mike Rafferty. Rafferty s paper titled Governance and Performance in the Australian Occupational Superannuation Industry commissioned by AIST and presented at CMSF 2009 (a copy of the paper is enclosed as Attachment Two). This paper analysed the relative performance of the not-for-profit and traditional sectors when measured as the growth in member accounts i.e. the effect of fees and charges and investment returns on given levels of contribution over the recent market/economic cycle, covering the period of high returns (March 2004 to November 2007) and the period of the downturn (November 2007 to January 2008) using widely accepted analytical tools and procedures. The results were significant they showed the not-for-profit funds enjoyed an out-performance of up to 2.4%pa over the period. That 2.4%pa translates into a 40% (approx) higher retirement benefit over a 40 year working life. The research indicates that this outperformance can be expected to prevail over that 40 year period. While there is still much debate about the attribution of performance differential to specific governance attributes, other research has found that differences in fees and charges between the retail and not-for-profit fund sectors is the main contributor to performance differentials. The outsourced model of service provision adopted by many of the not-forprofit funds, combined with their single-minded focus on optimizing member benefits, is the likely source of this outcome. Traditional sector trustees are often required to use the services provided by their employer, irrespective of the cost and quality of service delivered. Excessive fees and charges are just one example of how conflicts of interest, if not appropriately managed, can manifest themselves in poorer outcomes for fund members. Conflicts can also lead to sub-optimal decision making in the selection of fund managers and other outsource providers; loss of competitive advantage or commercial intellectual property rights; inappropriate or biased advice, to name a few.

5 Page 5 For these reasons, AIST welcomes APRA s Guidance on the Management of Conflicts of Interest within superannuation funds. We believe that conflicts of interest represent a real threat to the integrity of the industry and members savings, if not managed properly. B. Corporations Act 2001 Most superannuation fund trustees are now incorporated under the Corporations Act. Sections of the Act already require Directors to make disclosures, and for Boards to disallow participation in decision making by conflicted directors in certain circumstances. AIST believes the Corporations Act requirements are the best starting point for trustees to use in building an appropriate code or policy for the management of conflicts of interest. However, we recognise that the particular circumstances of superannuation funds require specific additional guidance on best practice. We encourage APRA to include more specific reference to these Corporations Act requirements, and to ensure the content of their guidance is fully consistent with those requirements. C. Conflicted directors contributions to Board AIST acknowledges that a superannuation fund risk management strategy is incomplete if it lacks a thoroughly documented conflicts of interest policy. Such a policy must enable the Trustee Board to identify conflicts of interest / potential conflicts of interest in a timely fashion and ensure it can address any conflicts that do arise expeditiously and equitably. One policy option is to strive to eliminate the possibility of conflict arising. The extreme manifestation of such a policy would be to have a blanket requirement that only persons with no real or potential conflicts of interest can be appointed to or remain on the Board. The risk inherent in such a policy is that a Board so constituted may lack the experience and expertise vital to the optimal operation of the fund. Less extreme is a policy whereby Trustee Directors with a real or perceived conflict are totally excluded from involvement in matters for which they are conflicted. Trustee Directors so placed would not only be excluded from Board consideration of the issue but would also not receive material relating to it provided to other Directors. Again, this approach eliminates the risk of a conflicted Trustee Director being involved in a decision, but it also has the (possible) effect of removing from the decision making process the person(s) most able to contribute to the Board s decision. Moreover, it results in Directors not being across all matters important to the sound operation of the fund.

6 Page 6 This throws into relief what AIST believes to be a fundamental question: should the conflicts of interest policy be aimed at eliminating the potential for a conflict to occur or should it be aimed at producing the optimal outcomes for the fund and its beneficiaries? AIST leans to the latter position, provided always that conflicts are identified and managed in an open and transparent fashion. While conflicts of interest have the potential to negatively impact decision making, and hence outcomes for fund members, it is important to recognise that in seeking people with the right skills and experience, Boards often cannot avoid individuals with existing commercial relationships which give rise to conflicts. Boards need to consider each conflict on its own, and make a decision about its management within the context of the conflicted director s contribution to the Board generally, and in relation to the issue where the conflict has arisen. Boards need a range of measures at their disposal to appropriately manage conflicts, including excluding conflicted directors from decision making only, to excluding them from all consideration of the conflictrelated issue. In brief, the policy we favour is one where conflicts are identified in a timely fashion and that the non-conflicted Trustee Directors assess the degree/size of the conflict and determine whether to what degree it might disqualify the conflicted Trustee Director(s) from any participation in the decision making process. For instance, while the conflict might be sufficient to prevent the conflicted parties from voting on the matter it may not be deemed sufficient to prevent their participation in the discussion process. Similarly, the conflict may be deemed to be sufficiently immaterial to allow full participation in the process. AIST sees the obvious advantages of this policy approach as it enables the involvement of Trustee Directors with relevant knowledge that would otherwise be precluded and it does enable Boards to treat differing degrees of conflict in different ways.

7 Page 7 Section Two - Response to Specific Items Item 6 - Associates and non-pecuniary interests Paragraph 6 of the draft Guide defines a conflict of interest for the purposes of the Guide. The draft paragraph 6 does not specifically mention interests which might be held through associates of a Director, nor does it specifically state that interests may be pecuniary or non-pecuniary. We believe that paragraph 6 should include some reference to associates (relatives and related persons) of directors. ASIC s RG 181 does refer to associates, and we understand that the commonly accepted meaning of material personal interest as used in Section 191 of the Corporations Act includes indirect interests. However, a reference to the fact that interests extend beyond those held directly should not limit the legal application of the general rule. Similarly, non-pecuniary interests should be specifically mentioned. Item 7 - No additional comment Item 8 AIST agrees the APRA expectation that a fund Risk Management Strategy will address the conflict of interest matters as outlined. AIST believes that the conflict of interest policy should be freely available but doubts the value of publishing it as part of general member information. Item 9 AIST strongly supports the proposition that all Trustee Directors new and existing should disclose all actual and potential conflicts of interest, and supports the widely practiced policy of Directors being required to up-date the register of disclosed conflicts at least prior to each Board and Committee meeting. This effectively means that Trustee Boards should mandate the option under section 192 of the Corporations Act under which Directors give standing notice of potential conflicts of interest. While AIST supports the recommendation for the establishment of a register of interests under paragraph 9, and a regime of standing declarations, based on the s192 requirements we believe that the Guide needs to clearly state that a standing declaration of potential conflict does not release a Director

8 Page 8 from the duty to bring an actual conflict to the Board s attention as and when it arises. While a register of standing declarations cannot be relied on to alert the Board to an imminent actual conflict, its role in assisting the Board in that regard can be enhanced where the Conflicts of Interest policy stipulates that Directors provide details of the nature and extent of the interest appropriate to assisting the Board in identifying actual conflicts as they arise. AIST believes the Guide needs to make this point more strongly, without explicitly mandating what nature and extent entails. Item 10 No additional comment Item 11 There is no mention of the possibility of a Board deciding that a new appointee s disclosed conflicts are sufficient to render him/her unable to effectively carry out their fiduciary responsibilities. Even in the circumstance where Directors are nominated by sponsoring bodies (e.g. unions and employer associations) this is an option which AIST believes Trustee Boards should be encouraged to adopt where appropriate. In this context we refer to APRA s Superannuation Guidance Note SGN which addresses the question of Directors so compromised. AIST believes that nominee Directors should also have the option of divesting themselves of the cause of such serious conflict, noting always our concern re conflicts arising through the holdings of those associated with a Trustee Director. Items Embedded / Related Party Arrangements The content of these items applies more typically to the traditional than to the not-for-profit sector, although where not-for-profit funds own or part-own service providers similar conflicts can arise. The traditional model is for the fund promoter to provide services such as administration, insurance and custody as part of a package investment formally was also exclusively provided. In the 1970 s the consulting actuaries and the investment banking houses unbundled the service packages and thereby secured a significant market share. The unbundled, outsourced concept has further developed in the industry fund sector. The arrangements described have been in place for almost 100 years, and in fact until the 1970 s were almost exclusively the way superannuation was

9 Page 9 provided. It is beyond question that they will create conflicts of interest as Trustees endeavour to serve two masters, and almost invariably favour the one that pays their salary over the one that protects the interests of members of the fund. As noted in Item 15, the issue is somewhat ameliorated in circumstances where the embedded arrangement is clearly and unambiguously made known to the member / prospective member. Unfortunately, that transparency is less rather than more likely to occur. Where it is disclosed in fund documentation it is frequently found towards the back of the PDS where only the most determined client will find it. Even then, what is more important is what the salesperson says, and that is unlikely to be anything which will alert the member/prospective member to the potentially detrimental impact of the provision. Moreover, any Trustee Director who pursued the course of action set out in Item 17 would need to have a short-tem view of his/her employment with the fund promoter. It is not a career enhancing strategy. Consideration of this issue is further complicated by the research referred to in the Background section of this submission which establishes beyond doubt that the not-for-profit funds provide superior benefits to members than traditionally-structured funds. Moreover, in a market where the bulk of contributions received are mandated (SGC) by the Government, the Government has an increased responsibility to ensure that contributors/taxpayers achieve optimal outcomes. While AIST represents and supports the not-for-profit sector, and believes that the not-for-profit model is far superior to the traditional one, it questions whether application of conflict of interest principles is the appropriate way to bring about change. It reeks of a back-door approach if the Government wants to address this issue surely they should do so in an open and direct way. A policy change of such magnitude should surely not be introduced in this way. Indeed, it ought to be possible in a free market for different service delivery models to co-exist and to compete with each other, provided always that they compete openly, transparently and on a level playing field. To that end we would support a regime in respect of these matters where All related party transactions need to be disclosed including the potentially detrimental impacts they may produce. Related party transactions need to be benchmarked as to cost and service quality, and where they do not meet industry standards those deficiencies made known to members / potential members.

10 Page 10 AIST has far greater concerns in respect of the conflicts of interest, and consequential market distortion, created by the distribution function within the traditional sector. Remuneration by commission where advisors are employees of a product provider, paid differential commissions for competing products, recipients of soft dollar rewards and volume bonuses for pushing clients into a particular product is certain to create issues, particularly where contributions are mandated. AIST favours a regime where Persons contracted to sell one only product, or who are required by employment contract to primarily sell one only product, should be designated a sales representative of the promoting organisation and prohibited from using a euphemism which creates the impression of independence. Distributors or superannuation products are required to act in the best interests of their clients and financial incentives to push clients to particular products (volume bonuses, soft dollar rewards) are outlawed. The base role of commissions is reviewed does the succession of disasters created by the commission structure culminating in the Storm affair indicate that this is a remuneration model past its use-by date?

11 Page 11 Section Three - Other Issues AIST believes that two other related matters should be canvassed in a comprehensive discussion of conflicts of interest. They are (i) Gifts & Hospitality The Guide does not specifically mention gifts and hospitality potential and current by service providers offer, although these can exert untoward influence on Director s decision making. We believe the Guide should make some mention of gifts and hospitality offers, and how trustees should manage the risk to decision making which arise, as a result of fund staff and Trustee Directors accepting benefits from service providers / expiring service providers. A gift register for both staff and Trustee Directors represents best practice. (ii) Directors on multiple fund Boards AIST believes that another conflict which needs to be identified and managed is the conflict of duty. Such a conflict could arise, for instance, where a person is a Trustee Director of more than one fund, particularly where those funds may in fact or potentially compete for members. Some argue that the transition of most larger funds to public offer status automatically creates a significant conflict of interest for any Trustee Director of more than one such a fund. AIST does not share that view but acknowledges that where funds compete for the same membership appropriate arrangements to manage the potential/perceived/actual conflict need to be implemented. The key issue appears to be around the obligation of Trustee Directors to make information they have acquired available to all funds with which they have a connection? Should information acquired at one fund be made available to another fund, even if it creates no disadvantage to the first fund? Should information acquired independently from all funds be made available to them all and should that information transfer be simultaneous? The purist approach may be to create a situation where people may serve on one-only superannuation fund Board this prevents any conflict of duty occurring but it also curtails the cross fertilization of ideas between funds.

12 Page 12 A more sensible approach may be to ensure that people do not serve on Boards which compete directly for members for instance, two funds in the same sector. Another sensible provision could be established around the nature of the information acquired. If it was proprietary in any way e.g. a result of a research project by one fund or purchased from a service provider then it should not be shared. If, however, it was acquired through attendance at a seminar or conference, or by reading a publication, then it can reasonably be shared. As with conflict of interest policy, it must be acknowledged that the policy can only provide the means by which conflict is identified and managed the policy in and of itself cannot ensure that conflicted Trustee Directors behave appropriately. The link between competition between funds, and the interests of the funds beneficiaries is a complex one. However, AIST accepts that conflicts can arise as a result of Directors on multiple Boards, and we believe that the Guide should provide guidance on appropriate management measures. Conflicts of this type are among the most visible, and the focus needs to be on appropriate management techniques.