Australian Prudential Regulation Authority (APRA) released its final revisions to Prudential Standard SPS 530 (Investment Governance) (SPS) on 19 July. SPS 530 was accompanied by a letter to Registrable Superannuation Entity (RSE) licensees that addressed matters raised in submissions during the consultation period and outlined APRA’s planned enhancements to supporting guidance.
Those releases were followed be a string of articles in the Australian Financial Review about the valuation of unlisted assets by superannuation trustees. Those articles highlight that RSEs have daily unit prices, but unlisted assets are not valued daily.
This article looks at the requirements of the new SPS 530 and suggests changes that could be made (either by RSE licensees themselves or with the assistance of law reform) to promote better outcomes for members as a whole and to improve the efficiency of the superannuation sector.
What are the key changes to SPS 530?
The following are the key changes to SPS 530.
- Stress testing – an RSE licensee’s comprehensive investment stress testing program will be required to be approved by the Board, integrated into the RSE licensee’s investment governance framework, completed at least annually and comply with other prescribed minimum requirements. Review and documentation requirements will also be introduced.
- Valuations – an RSE licensee will be required to establish a valuation governance framework, with a Board approved valuation policy that satisfies prescribed minimum requirements.
- Liquidity management – in addition to existing requirements, an RSE licensee’s liquidity management plan will be required to outline the roles and responsibilities of persons involved in the management and oversight of liquidity risk and outline the key metrics to be reported to, and periodically reviewed by, the Board, relevant Board committees and senior management. An RSE licensee will also be required to implement liquidity stress testing as part of its comprehensive stress testing program.
How is the final SPS 530 different to the draft?
Broadly, APRA made the following minor amendments to the draft of SPS 530 that was released for consultation in September 2021:
- Consistent use of terminology to ‘develop, implement and maintain’ frameworks, policies and processes, where relevant.
- Clarification that stress-testing programs and valuation governance are to be regarded as components of the overall investment governance framework.
- Clarification that regular reporting to the Board for each investment option and MySuper product does not necessarily have to include detailed reporting on individual investments. Instead, the Board must approve appropriate measures to monitor performance, including the benchmarking methodology, and ensure that investments that are failing to meet benchmarks are reported to it.
- Clarification that the valuation governance framework requirements do not require the establishment of a stand-alone Board valuation sub-committee.
Valuation governance framework
The revised SPS 530 contains a new requirement for an RSE licensee to have an adequate valuation governance framework which consists of the structures, processes, procedures and controls necessary to identify and manage the valuation risk of investments.
The valuation governance framework will need to include a Board approved valuation policy which, at a minimum, outlines:
- the roles and responsibilities of persons for the oversight and management of valuation processes and procedures, including the Board, relevant Board committees and senior management;
- the key metrics and information that must be reported to the Board, relevant Board committees and senior management, and the frequency of that reporting;
- the valuation methodology employed for each asset class (and sub-asset class and instrument/holding vehicle type where relevant), including the sources of valuation inputs;
- the circumstances under which independent external valuations are to be obtained;
- the frequency of valuation of investments having regard to the prevailing market, economic environment, member equity considerations and matters concerning the ongoing appropriateness of the asset valuation;
- the circumstances in which interim valuations are to be made, to ensure the approach taken is consistent and transparent;
- the triggers that would require an interim valuation of investments outside of the frequency determined under (5) above and which reflect the circumstances identified in (6) above;
- a review process to ensure that the valuation policy remains effective;
- the validation of valuation outputs including any back-testing procedures; and
- the circumstances as to when to accept, reject or reassess valuations of investments to ensure that an RSE licensee’s valuations remain appropriate, including an escalation procedure for the resolution of any disputed valuations.
An RSE licensee will also be required to ensure that the key metrics and information referred to in (2) above are periodically reviewed by the Board, relevant Board committees and senior management, to ensure that they remain appropriate to enable sufficient oversight of valuation risk.
Valuations and unit pricing
The joint ASIC and APRA guide Unit pricing: Guide to good practice (RG 94), which was issued in 2008, recognises that appropriate valuation of assets and any related liabilities is essential to the calculation of unit prices. Further, RG 94 states, as a guide to good practice, that:
- in principle, unit prices should only be struck with the same frequency that asset values are determined; and
- unit prices should be struck as frequently as you make it is possible to buy or sell units in a fund.
Why do RSEs have daily unit pricing and could improvements be made?
RSEs have daily unit pricing for the sensible reason that transactions happen daily. On any given business day, contributions are received, investment switches occur, rollovers and transfers are processed and benefits are paid. However, two questions are worth considering:
- Could transactions be restricted to windows that are aligned to asset valuations?
- Could the volume of transactions be reduced resulting in savings that would ultimately be passed on to members?
Nearly all RSEs currently offer their members daily investment switching, although there are no laws or regulations that mandate this. We suggest that RSE licensees consider what duties or powers they have regarding investment switching and, where discretion exists, whether it would be in the best financial interests of members to reduce the frequency at which investment switching is permitted. In addition to the best financial interests covenant, an RSE licensee covenants:
- to act fairly in dealing with classes of beneficiaries within the fund; and
- to act fairly in dealing with beneficiaries within a class.
Superannuation is a long-term investment and RSE licensees caution members against trying to time financial markets. Against that backdrop, is the ability for a member to switch investments daily a valuable member feature or a potential risk to members? How often would a prudent member switch investment options?
It seems to us that the great majority of super members, if they ever choose an investment option, do so around the time that they join the fund and leave that choice in place for a number of years. Annual rebalancing of investments might be advisable. However, we cannot see a need for a member to switch investment options more than once a year, unless the member is seeking to time the market or to game the valuation of fund assets.
Whenever markets drop substantially, RSE licensees are concerned that members will crystalise their losses by switching to investment options with less exposure to growth assets and miss out on a subsequent market rebound. RSE licensees should continue to discourage members from trying to time the market. It is highly unlikely that any RSE licensee would suggest that it provides members with the ability to make daily investment switches so that members can time financial markets.
We query whether members are actually switching between investment options with a view to benefiting from lags in asset valuations. However, to the extent that a member benefits from doing so, it is at the expense of other members. If an RSE licensee restricted members to making one investment switch per 12 month period, that would eliminate the possibility of a member switching and shortly after switching back to try to benefit from delays in valuing some assets.
RG 94 suggests that periodic valuations should, where possible, occur at different times to avoid concentrating the effect of any changes in valuation. If that is not practicable and valuations for unlisted assets tend to be received at certain times each year, we suggest that an RSE licensee explore the possibility of having blackout periods where no members are permitted to switch or, conversely, windows in which switching is permitted. The sooner a switch occurs after assets have been revalued, the fairer the outcome for both the transacting member and the other members.
Unlike investment switches, the timing of other transactions is entirely outside the control of RSE licensees. For example, under regulation 6.34A of the Superannuation Industry (Supervision) Regulations 1994 (Cth), if a trustee of a transferring fund is required to rollover or transfer an amount to a receiving fund, this must generally take place as soon as practicable, but in any case not later than 3 business days, after receiving the rollover or transfer request.
We acknowledge that removing daily investment switching might result in a small number of members changing funds to try to time the market or to game the valuation of fund assets. The law does not currently impose a limit on how often a member can change funds.
In our view, the law should be amended to prevent a member from changing funds where the member has changed funds in the previous 12 months, with appropriate exceptions to allow a member to consolidate their super from multiple funds or where the member has been given a significant event notice, e.g. where fees are increasing. The restriction that we propose would only apply to prevent a member changing funds twice in a 12 month period. Consequently, it would impact very few members and would have a negligible effect on competition. However, it would make it much harder for a member to move between funds with a view to timing the market or gaming valuations and it would eliminate the possibility of a member frequently changing funds for those purposes.
The timing of contributions is another area where amendments might make the system more efficient and enable RSE licensees to better align transactions with valuations. Currently, superannuation guarantee contributions are due 28 days after the end of a quarter, but can be made earlier or more frequently. Would there be advantages in being more prescriptive about when employer contributions are required so that RSE licensees can more effectively plan for them?
When does the revised SPS 530 apply and will existing exclusions carry over?
The revised SPS 530 will commence on 1 January 2023 and will apply to all RSE licensees.
APRA may adjust or exclude a specific requirement in SPS 530 in relation to a particular RSE licensee. Importantly, an RSE licensee must contact APRA if it seeks to rely, for the purposes of complying with the revised SPS 530, on a previous exercise of discretion by APRA under a previous version of the prudential standard.
Prudential practice guides coming
APRA indicated that it would release draft SPG 530 and draft SPG 531 for consultation in the fourth quarter of 2022 ahead of the commencement of the revised SPS 530.
APRA has stated that draft SPG 531 will outline APRA’s expectations regarding robust valuation governance frameworks and will address:
- valuation governance, including the use of independent experts, segregation of investment decision makers and valuers, the development of a valuation methodology and the use of stand-alone board sub-committees and Board reporting;
- valuation methodology, including sources of valuations and their hierarchies, valuation approaches and methodologies, and the use of assumptions and estimates in valuations, independent assurances and triggers for interim valuations;
- frequency and monitoring, including how an appropriate frequency for valuing assets would be determined, with an expectation that this would generally be at least quarterly, and how the sequencing of valuations would be managed across different asset types; and
- types of valuation risk, including a comprehensive list of the types of valuation risk APRA expects prudent RSE licensees would consider.
How can we help?
If you have any questions about the amendments to SPS 530, unit pricing or changing how frequently members are permitted to switch investments, please contact Phil Turner.