It’s a great pleasure for me to have this opportunity of addressing the National Council Dinner of the Trustee Corporations Association - an organisation with which APRA has a growing, though not yet intimate, relationship.
In issuing the invitation to me last year, Paul suggested I talk about developments regarding the regulatory framework for superannuation and APRA’s likely role in supervising trustee corporations. I will say what I can about each of these topics and touch on a few other issues as well.
As prudential supervisor across the entire Australian financial system, APRA’s basic objective is that the commercial good practice evident in well-run institutions should spread across the wider industry. In our view well-managed financial institutions tend to have the following broad characteristics:
- owners, managers, directors and advisers who are fit and proper in terms of their business and technical competence, personal honesty and capacity to handle peak workloads and occasional conflicts of interest;
- strong governance in terms of awareness of obligations to stakeholders, robust and forward-looking business planning, judicious use of external expertise, and independent auditing arrangements;
- capital that is adequate to provide an incentive to succeed and a buffer against adversity;
- a basis for growth; and an indication of long-term commitment;
- relevant, accurate and timely financial reporting to members/customers, the regulator and the market;
- robust risk management systems, including controls over prudent investing that pay due regard to diversification and liquidity, and keeps appropriately clear of speculative, geared, lumpy and non-arm’s-length transactions;
- finally, a willingness to cooperate promptly and fully with the regulator in identifying and rectifying weaknesses that are endangering, or are likely to endanger, member interests.
With the objective of promoting, and where necessary enforcing, these goals we have several important policy initiatives on our plate at present. I will mention just a few.
First, we are in the midst of implementing a radically new prudential supervision regime for general insurance companies. This regime becomes effective on 1 July this year and is the culmination of 3 years intensive work that began soon after APRA was established. It will introduce prudential standards that are both more comprehensive and more discriminating in addressing the risks in general insurance than under the regime we inherited. They will be much more demanding of companies’ internal risk controls and governance and will place more responsibility for compliance on directors, auditors and actuaries.
This new regime will give Australia a world-leading supervisory system for general insurers. Modesty almost dissuades me from quoting a senior executive of Moody’s who said recently that APRA’s new regime will put Australia way ahead of insurance reforms in the UK and continental Europe.
Second, we are working with banking regulators around the world on a major overhaul of the Basel Capital Accord - the set of rules that determines how much capital banks must have for regulatory purposes. The new rules will be more complicated - but they will explicitly encourage banks to improve, and have recognised for regulatory capital purposes, their internal risk control systems. For the first time, they will also incorporate a capital charge for operational risks.
We are also finalising a prudential supervision framework for conglomerate groups that include banks and other deposit-takers. We will subsequently extend the key principles to conglomerates engaged predominantly in insurance.
No doubt the reform area of greatest interest to this audience would be superannuation.
3. ON OUR PLATE: STRENGTHENING SUPERVISION OF SUPERANNUATION
Shape of the industry
We have prudential supervision responsibilities for over 11,000 funds - of these, 375 are public offer, about 2,500 are employer-sponsored and around 7,800 are Small APRA Funds (SAFs) administered by an Approved Trustee. In all, these funds have $330 billion of the $500 billion in super savings - the rest is mostly in life office statutory funds (supervised separately by APRA) and public sector funds of various sorts.
Of the financial sectors we supervise this is by far the most populous and most diverse. Leaving aside the SAFs, there are almost 800 funds with assets less than $1 million, while there are 78 funds with assets over $1 billion at the other end of the spectrum.
The industry’s structure is not, of course, static. Over the past decade, management of superannuation has been progressively shifting from the workplace environment to the retail financial services sector.
This trend - which I would not describe as dramatic, but is certainly persistent - has been driven by:
- the emergence of a thriving financial planning industry and the high powered marketing skills of its agents and advisers;
- increasing mobility and casualisation of the workforce due to companies and staff negotiating more flexible arrangements;
- greater use of payroll systems that can efficiently transfer contributions to multiple schemes by electronic means;
- employer difficulties with the complexities and costs of superannuation administration; and
- the natural spread of voluntary choice-of-fund across non-unionised workplaces.
Looking forward, mandatory choice-of-fund and portability - if they eventuate - would further reinforce this trend. As will account consolidation by members seeking to avoid the accumulation of administration charges involved in running multiple accounts - an average of three per worker at present.
With these factors at work for the foreseeable future, retailisation will remain a key trend in superannuation.
Reforming the supervision framework
APRA put reform of the prudential supervision framework for superannuation on the agenda last year in our submission to the Productivity Commission’s inquiry in to superannuation legislation.
The reasons for doing this can be summarised simply:
- the community clearly expects a level of safety in superannuation investments similar to what’s expected with other prudentially regulated sectors - the very reason that the Wallis Committee recommended that superannuation come under APRA;
- some commonplace and valuable tools are presently not available to the regulator in the case of super - licensing as a condition of entry being the most glaring example (except, of course, for public offer funds).
It’s true that the actual incidence of serious problems in super has, historically, been very small - as industry rightly points out and the media and others often conveniently ignore. But our aim is to be ahead of the game - we want to reduce as far as possible the likelihood that serious problems will occur in future; and when they do occur (as they inevitably will) we want to be able to manage the situation down in an orderly manner.
We also believed the structure of superannuation legislation was exceptionally complex and unwieldy - mixing as it does prudential, retirement incomes and other policy objectives. We would prefer a structure similar to the one used for banks and insurers ie legislation that sets broad prudential objectives and supervisory powers, supplemented by standards and guidelines.
To progress the consideration of these and other matters the Government published an issues paper last October and commissioned a working group to consult with industry and prepare recommendations by the end of this month. That consultation has occurred and the working group - chaired by Don Mercer, an APRA Board member - will deliver it views on schedule. The Association made a useful and thoughtful submission.
Without anticipating the working group’s final recommendations I will touch on the importance of one aspect already mentioned – licensing.
One of the key draft recommendations of the Working Group issued earlier this month was for universal licensing of trustees - either of the corporate entity or a ‘notional trustee entity’.
We regard this as an essential feature of any supervisory regime. To put it bluntly, it’s much easier to keep the chooks alive if the foxes never get into the fowl-yard.
Prudentially, a universal licensing regime would have many benefits. APRA would be able to conduct prior assessment of trustees and funds, impose specific licence conditions and revoke licences where warranted. It would also give us the opportunity to lift base management standards across the industry and to have a better understanding of the trustee and fund population.
The Working Group’s draft recommendations also favoured licensing by ASIC under the Financial Services Reform Act for funds that are dealing or advising.
There would clearly be a need for APRA and ASIC to work together to minimise duplication and compliance burdens for industry. In particular, a single entry point for licensing was recommended. And there would need to be transitional arrangements to ease the load on both industry and regulators in newly licensing some 2,500 trustee entities.
Supervision in the field
In the meantime, our supervisory activity with the superannuation industry has progressively intensified over the past couple of years.
Our process is a combination of off-site review and on-site inspection, with the intensity of focus determined by a risk rating of all entities.
Our Specialised Institutions Division (which is responsible for supervising mono-line financial institutions) conducted 565 visits to funds and 47 to Approved Trustees in the year to June 2001. Since then, intensity has been stepped up another notch, with 494 visits to funds and 28 to Approved Trustees in the second half of 2001. Smaller funds were a particular focus in this period.
Our Diversified Institutions Division (covering conglomerate groups and foreign-owned institutions) held consultations with 28 conglomerates including their superannuation entities during 2000/01. It also conducted five specific consultations and two focused on-site visits to Approved Trustees.
We made a concerted effort to assess the risks of every fund in 2001, and determined that about 8 per cent of them warrant closer supervision or enforcement action to remedy deficiencies.
In the latest issue of our quarterly journal "Insight" we summarised some of the problems and weaknesses we find and have to address in the field. In broad categories they cover:
- inadequate definition and execution of prudent investment strategies - investment strategies are deficient in substance, not being adhered to and/or not reviewed once established;
- sloppy governance practices of trustee boards, including lack of involvement in key decisions, inadequate separation of trustee role from other activities, absence of equal representation where required;
- inadequate administration agreements;
- poor financial control.
Following through on such issues can be very resource-intensive and we are presently increasing our staff to meet the demands of superannuation work, as well as the greater supervision required for general insurers and complex conglomerate groups.
We are budgeting for a 10 per cent increase in total operating expenditure next year, a modest increase in view of the community’s demands of us. After this our spending, inflation adjusted, will still be well below the aggregate pre-APRA cost of prudential supervision.
Finally, I turn to proposals that would have APRA involved with supervision of trustee companies beyond our present role in connection with superannuation. The issue of nationally uniform arrangements for trustee company supervision has a long history, dating from well before APRA was even a glint in Stan Wallis’ eye. I understand that proposals continue to be developed and refined. I am afraid I can shed little light on the details because APRA has not been directly involved.
One thing is clear: the APRA Act allows APRA to be contracted to provide prudential regulation or advisory services on a commercial fee-for-service basis, subject to approval by the Minister and no residual exposure - beyond the terms of the contract - to the Commonwealth.
As I understand it, there are still a number of issues that need to be resolved before APRA could contemplate any such role with State-regulated trustee companies:
- first, the range of activities and types of risks to be covered by regulation and supervision need to be clearly delineated - at present, we only have a good understanding of those companies that are also APRA Approved Trustees;
- second, the Commonwealth and States need to agree on the extent of a future APRA role, if any - there seem to be different views on whether this should include, for example: total or partial supervision; all estate activity or only funds management; and
- third, States will need to legislate for a uniform framework that sets clear mandates, defines limits and boundaries, codifies principles and addresses responsibility for relevant regulatory activities.
My understanding is that, at present, there’s no clear view on what the States will decide amongst themselves, nor on what the Commonwealth’s position would be.
And so, it continues to be a case of watch this space.
While a little frustrating, one of the merits of this uncertain situation is that APRA representatives will probably continue to be invited along to these excellent dinners.
I will close on that note - you can see that APRA has a good deal on its plate at present and for the foreseeable future. But if trustee companies look like heading there as well, we will be happy to take up whatever challenges they present - for a fair price.
Thank you for your attention.