Superannuation governance in 2017: What does good look like?

Helen Rowell, Deputy Chairman - AIST Governance Ideas Exchange, Melbourne

Good morning everybody. It is a pleasure to be here and participate in today’s event.

Governance has long been, and will continue to be, a key focus for APRA in its supervision of APRA-regulated entities and industries – superannuation is no different. Superannuation trustees are responsible for the oversight of increasingly complex financial services businesses in an environment of significant change, the pace of which shows no signs of slowing. Robust governance practices that support sound decision-making are therefore essential for ensuring the business operations of trustees remain sustainable into the future and will continue to meet the best interests of their members.

I last spoke at this forum two years ago and it seems that many of the governance issues that I touched on then remain just as topical today. So as we look back over the last two years, what has changed in relation to superannuation governance practices and where is further progress still needed? Today I want to highlight APRA’s perspectives on “what good looks like”, which will hopefully assist you in improving your own governance practices where needed.

The governance landscape in 2017

An external observer, passing a cursory glance over the industry, may consider that little has changed in the last two years as the size and composition of superannuation boards is little changed. For example, in the case of not-for-profit boards:

• average board size was 7 in 2016 (unchanged from 2014)

• average board tenure is 5.5 years in 2016 (slightly reduced from 5.8 years in 2014)

• the percentage of directors with more than 12 years’ tenure is 14.4 per cent in 2016 (compared with 15.1 per cent in 2014)

• the percentage of independent directors has increased marginally, from 9 per cent in 2014 to 11 per cent in 2016; and

• the percentage of women on boards has also increased a little from 26 per cent in 2014 to 30 per cent in 2016 (although there are still a handful of all-male boards).

However, this is not the full story. There does seem to be some momentum for change:

• there is increased recognition by the industry of the importance of sound governance practices and improved decision-making

• individual funds are improving the diversity and skill mix on their boards;

• steps are being taken by AIST members to implement the AIST’s Governance Code, which was released earlier this year; and

• there is a sharper focus, as a result of various regulatory reform proposals and APRA’s supervision activities, on the need for trustees to deliver quality, value-for-money member outcomes and to assess the extent to which that is being achieved.

APRA’s recent thematic review of board governance practices also indicates that there has been some positive steps taken by the industry to enhance superannuation governance practices, and I will talk about some of these in a moment. But first, let me comment briefly on the AIST’s Governance Code.

AIST Governance Code

I would like to commend the AIST for the release of the Code. APRA welcomes industry initiatives such as this, which seek to promote improvement in practices without the need for regulatory action.

The eight principles that underpin the AIST Governance Code are broadly consistent with the requirements of APRA’s prudential standard on superannuation governance. Many of the requirements contained within the Code also align with the better practice examples observed in APRA’s thematic review.

Establishing the Code is certainly a good start, but it will take some time for the Code’s principles to be universally adopted by all AIST members. I would encourage those boards that are yet to adopt the Code to work towards this without delay. It will also be important that AIST members go beyond just complying with the letter of the Code, and seek to really live it through meeting its spirit and intent. It needs to be seen as more than just a compliance exercise, if it is to be effective in its objective of promoting improved governance practices across the superannuation industry.

APRA’s thematic review of board governance

Let me turn now to some high level observations from APRA’s thematic review of board governance, with a particular focus on some of the better practices that we identified. The review commenced in 2016, but has largely been undertaken over the course of 2017. We expect to release the general findings from the review (probably via a letter to industry) in the coming months.

The review covered 29 trustees, across all segments of the industry and a range of fund sizes – and, as expected, we observed some variation in the standard of governance practices across the industry. The particular focus of the review was on practices in relation to board appointment and renewal, including determination of optimal board composition, and board renewal policies and practices. It also looked at board performance assessment practices.

Member representation and board governance arrangements

Many aspects of board governance arrangements have remained largely unchanged since they were first put in place following the implementation of the Superannuation Guarantee in the 1980s. And yet, over the intervening period the industry has undergone significant change and trustee business operations have evolved to become much more complex. That has implications for the concept of member representation, for example:

• the nature of employment and hence the link to employer representation for public-offer funds is changing, as increasingly members are self-employed or employed by (often multiple) small employers rather than one or a few larger employers

• the proportion of fund members that are members of unions is likely to have declined, consistent with the decline in union membership generally; and

• an increasing proportion of members are moving into the post-retirement (or draw-down) phase, raising the need to consider representation of this segment of a fund’s membership.

Reflecting this, we are seeing some boards thinking more about how their governance arrangements need to change to better represent their members. They are diving deeper into their demographic data, engaging with members to understand their needs and using this information to assess the extent to which the board genuinely represents its members. These boards, in collaboration with the nominating bodies, are considering a range of diversity factors (such as gender, age and location) when seeking director candidates.

Composition

Given that trustees are running increasingly complex business operations and providing a wide range of services to their members, it is essential that the board is appropriately skilled to meet this challenge. Better practice governance was evidenced by trustees considering the optimal board composition in a dynamic manner, as part of their strategic planning process. These boards seek to ensure that the requisite skills, capability, and experience needed to execute their strategy are achieved for the board as a whole, rather than merely ensuring that each individual director passes muster in terms of minimum fit and proper requirements (although that is obviously an important prerequisite). This approach is viewed as necessary to ensure there is adequate diversity of perspectives and views on the board, to support better quality decision-making through appropriate review and challenge.

Unfortunately, however, very few boards that were part of the thematic review were able to articulate, or had formally documented, what the optimal composition of the board should be now and how this might change into the future in accordance with the strategic direction of their operations.

Renewal

To achieve and maintain optimal composition, a renewal policy must be in place that enables appropriate candidates to be appointed and also promotes the identification and training of potential future candidates as part of sound succession planning.

Typically, under board constitutions and charters, only nominating organisations have the right to veto the appointment or reappointment of directors. APRA is also aware of several boards that have experienced challenges in appointing quality candidates with the necessary capabilities (particularly superannuation and financial expertise), in part due to the limitations imposed by the constitution. To address this, and support better governance practice, a number of boards have been working to develop strong collaborative relationships with their nominating bodies to ensure that they understand both the board’s strategic direction and the type of candidates that are required.

Some boards are also recognising the importance of carefully considered succession planning as part of their broader strategic planning. This ensures that boards don’t just look to fill a vacancy as it arises but think about the skills and experience that will need to be replaced as each director’s term is likely to end, as part of ongoing renewal planning. Most notably, recent appointments to some boards have added cyber and digital skills to the mix, to enhance board capability to provide appropriate review and challenge in this ever changing space.

Assessing board performance

The final area from the thematic review that I would like to mention today is assessing the performance of the board, which appears to be one of the weaker areas of governance practices based on the results of the review.

APRA did observe an increasing number of boards that are thinking about assessment of the performance of the board as a whole in terms of its skills, experience and the way it functions, rather than only assessing individual directors. It is also encouraging to see some boards thinking carefully about the best way to achieve an objective and independent assessment. This is often through the use of external experts and, whilst there is a cost to this, the benefits provided in identifying improvements needed to ensure a properly functioning, appropriately skilled board should not be underestimated. There is an inherent conflict in relying heavily on self-assessment as a mechanism to assess board and individual director performance that is addressed through independent assessment mechanisms.

Where a performance assessment identifies ‘gaps’ in performance, it is imperative that action is taken. Those boards that are willing to address ‘underperformance’ through training requirements or other actions, and that take steps to respond to identified weaknesses in the operation of the board as a whole, are more likely to enhance their decision-making and deliver better outcomes for members over time.

A word on independence

Before I wrap up, I imagine you are expecting me to make some comment on the Government’s proposed legislative amendments to require a minimum of one-third independent directors and an independent chair on superannuation boards. APRA’s position on the value of having independent directors on boards remains unchanged. As I indicated in this forum back in 2015, independent directors broaden the skills and capabilities that can be brought to the board table, and improve decision-making by bringing an objective perspective to issues the board considers. They are also well-placed to hold other directors accountable, particularly in relation to conflicts of interest. This is as relevant for directors of industry and other not-for profit funds that may face potential conflicts with the interests of their stakeholders (such as nominating organisations), as it is for directors of retail funds.

I would also add that boards of all stripes that have appointed independent directors support the view that it positively contributes to governance and decision-making, and ultimately leads to better outcomes for members.

Of course just having independent directors on a board is not sufficient on its own to ensure sound governance; all of the other aspects of a robust governance framework and approach (some of which I have touched on today) also need to be in place and working well. Nevertheless, as I suggested in 2015, I would encourage all of you to see the Government’s proposed governance reforms as an ideal catalyst to reflect on your governance arrangements, review the changes that are needed and take steps to refresh your approach.

So what does “better practice governance” look like?

To sum up the key elements of better practice governance that APRA would like to see adopted across the superannuation industry, they would include:

• a clearly articulated view of the optimal board composition (in terms of size, skill mix, and relevant diversity considerations) that is needed in the context of the trustee’s current and expected future membership profile and scope of business operations – and of course ideally including some independent directors

• a director selection process that provides a clear role for the board (and not just nominating bodies) in the appointment of candidates, with a view to ensuring that candidates bring the skills and capabilities needed to oversight execution of the trustee’s strategy and its ongoing business operations and are a “good fit”

• sound renewal and succession planning processes, that include an approach to tenure limits and reappointment that strikes an appropriate balance between ensuring continuity and bringing diversity and fresh perspectives, where the criteria for any exceptions to tenure policy are clear and limited, and the policy is actually followed in practice; and

• a robust and objective board assessment process, that considers the performance of the board as a whole as well as individual directors and leads to concrete recommendations and actions that are implemented.

APRA is observing changes in governance practices, and acknowledgement by some trustee boards that the arrangements that were appropriate when the trustee was established may not be appropriate for the future. We would encourage all trustees to be clear about their future strategy, what their business operations will look like and the governance arrangements that will be needed to support these.

The AIST Code is a good foundation, but good governance is not just about complying with a prudential standard, or following a Code. It is about continually striving to improve practices and ensure the trustee itself, as well as its business operations, remain fit for the future. The findings of the thematic review, some of which I have touched on today, are intended to assist you with this, and raise the bar for governance practices across the superannuation industry.

I am sure the industry will rise to the challenge, and in the years ahead we will be able to look back and reflect on the good progress that has been made!