On 17 May 2018, the Australian Prudential Regulation Authority (APRA) released the findings of a thematic review it conducted of the board governance of 29 superannuation funds representing a “broad cross-section of fund type, fund size, ownership structures, and board composition.”
Less than two weeks later, on 29 May 2018, the Productivity Commission released a draft report commenting on the efficiency and competitiveness of Australia’s superannuation sector.
Though recent improvements to governance practices were acknowledged in both reports, a clear theme was that governance standards within the sector need to improve.
Submissions to the Productivity Commission responding to their draft report are due on 13 July 2018. The AICD intends to participate in this process and encourages members to communicate their views to the policy team directly. The AICD will focus on governance themes from the report, rather than broader questions around the overall structure of the superannuation sector.
The expected timing of the final report of the Productivity Commission to the Australian Government is to be advised.
However, in the interim, what can directors, from both within and outside the superannuation sector, take from these two reports?
1. Assessment of board performance
Regular board assessment is an essential part of good governance practice. It is critical that boards put measures in place to evaluate their performance on a regular basis, and quickly act on any recommendations which flow from any evaluation findings.
APRA’s review found that assessment of board performance was a weaker area of governance practice among the Registrable Superannuation Entities (RSEs) surveyed. In particular, APRA observed:
- A lack of a proper framework to address board underperformance across the review population;
- Board performance was being assessed as a whole, but not individual director performance;
- Board self-assessment was often the sole method of assessing board performance; and
- Board assessment methodology focussed on a subjective assessment of the skills and capabilities of individual directors, rather than the quality and level of contribution of the director to the board.
APRA recommends that RSEs have a robust and objective board assessment process which includes regular external review of board performance.
The Productivity Commission agreed with this conclusion in its draft report, observing that there was insufficient evidence in the sector of regular board evaluation (particularly external evaluation). It has recommended that RSE boards have and disclose processes to assess, at least annually, the board’s performance relative to its objectives and the performance of individual directors, and seek external third party evaluation of board performance at least every three years.
2. Board composition
According to the APRA report, the majority of surveyed RSEs did not actively consider what skills, capabilities and collective experience the board would need to implement its strategic plan. In addition, RSE board committees also were found to lack a clear criteria in terms of composition, training, and “fit and proper” policies.
To address the issues it identified, APRA’s report recommends that RSEs consider, determine, document and regularly review the optimal composition of board and board committees in the context of the RSE’s business operations and strategic plan.
Similarly, the Productivity Commission cited research indicating “inadequate board control” over board appointment processes, and even the appointment of ill-suited nominees to the board. Potentially reflecting these shortcomings, the Productivity Commission found that only 55 per cent of responding CEOs surveyed strongly agreed that their board had the right mix of capabilities.
In short, both reports recognise that a strong focus on board composition, and particularly the skill-set of individual directors, support better governance on boards. For this reason, the AICD recommends that all boards create, and regularly update, a skills matrix to enhance the process of board appointments. A skills matrix which identifies skill and experience gaps on the board can be useful for a board, irrespective of the size of the company, or the sector in which it operates.
3. The use of Independent experts
In its report, APRA also observed that some RSE boards were engaging a considerable number of independent experts and consultants, which it observed might suggest a skills deficiency on those boards. APRA also commented that some boards were experiencing difficulties appointing quality candidates due to limitations imposed by constitutions subject to the equal representation rule, which requires required employer-sponsored RSE boards to have an equal number of employer and member representative directors.
Given this, the Productivity Commission’s draft recommendation that the “equal representation” rule be removed is a welcome one, and is a position which the AICD took during public consultations in 2017. Its removal would enable RSE boards to recruit from a wider pool of talent, which would help to resolve the issues identified by APRA in relation to skills deficiency, and a potential over-reliance on independent experts. While the use of independent experts can be critical for a board, APRA’s observations regarding the use of independent experts is a salient one for directors. Directors should consider whether the continued use of a particular set of experts, or experts on a particular topic, is something that would be better addressed through strategic board appointments. As observed above, a skills matrix can also assist directors in identifying any significant gaps in expertise.
4. Related party transactions
A strong risk management framework is imperative to ensure that RSE boards make decisions in the best interests of members. However, this issue remains a concern for the superannuation sector.
The Productivity Commission observed that “related party transactions remain a concern”, and some arrangements between funds and related party providers “are not sufficiently cognisant of members’ best interests”.
APRA is currently conducting a review of related-party transactions in the sector, which will add further to the debate. In any event, the two reports serve as a timely reminder that a key component of good governance is risk management of conflicts and perceived conflicts, and the accountability and transparency of decision-making processes.
To state the obvious, the perception of “insider favours” can be particularly damaging for the brand and reputation of any company or institution. We suggest that the release of these reports should prompt directors to evaluate their organisation’s risk management framework, and consider whether similar concerns could be shared in relation to their business.
5. A word on independent directors
The Productivity Commission concluded that best practice from a corporate governance perspective would include the presence of a “critical mass” of independent directors on RSE boards. This conclusion is the latest in a number of government inquiries recommending changes to the law in respect of this issue.
In terms of the definition of independence, the Commission appears to favour the definition found in the Government’s proposed superannuation governance reforms, which are yet to pass through the Federal Parliament.
The AICD has long maintained that the inclusion of a minimum level of independent directors on RSE boards would represent a positive improvement to governance arrangements in the sector, subject to the definition of “independence” being appropriately framed.
Independent directors, that is, directors who are not aligned or perceived to be aligned with either management or other interests, bring a unique perspective and valuable experience to board deliberations.
The inclusion of independent directors would align the superannuation sector with internationally recognised best practice governance standards. It would also bring additional oversight and governance of related-party transactions, which were identified as a continuing problem by the Productivity Commission.
The equal representation rule no longer reflects the practical reality of the superannuation sector, particularly in relation to large public offer funds.
Public offer funds can be joined by any member of the public, irrespective of whether they are employed by a particular employer, or a member of a particular union or other employee representative. The AICD is concerned that, amongst other things, the equal representation model leaves some groups “unrepresented”.
The challenges faced by some RSE boards in obtaining appropriately qualified nominees, as identified by APRA, further suggests the need to expand the “talent pool” of directors capable of being appointed.
However, as the Productivity Commission observes, “it is of equal importance (and arguably matters more) to ensure that funds have thorough processes in place to recruit highly skilled and experienced boards as it is to focus on the number of independent directors.” This is undoubtedly correct.
The presence of a substantial number of independent directors is a necessary, but not sufficient, component of building an effective and high performing board. Other factors, such as tenure, skills assessment, the board’s process for evaluation and renewal are all relevant factors.
While many of the issues identified by APRA and the Productivity Commission relate solely to the superannuation industry, the recommendations and observations relating to board composition and performance assessments are applicable to boards from all sectors.
The observations provide an opportunity for all directors to critically examine their recruitment processes and performance evaluation systems to ensure they have the right mix of people at the table.
The AICD provides board advice and consultation services. The AICD’s advisory service focuses specifically on providing independent governance advice to clients. For more information, book a consultation with our team to speak with us about how we can help your organisation.