Modest governance reforms proposed for superannuation funds
The release by the Federal Government of draft legislation mandating one-third independent directors and an independent chair on the boards of all APRA-regulated superannuation funds (corporate, industry, public sector, and retail funds, but not self-managed funds) has been welcomed by some in the superannuation industry and rejected by others.
Existing research confirms that a majority of independent directors is the best governance outcome — a majority allows the directors to influence the operation of the board; it focuses the board on the skills it requires; and it aligns super funds with the governance arrangements in their investee companies. So it is hard to see how the pragmatic first step on mandating one-third independent directors is anything but a good way forward, allowing for an orderly transition over the next few years.
The proposals will improve board renewal processes, because they will assist the boards to identify the skills, knowledge, experience and capabilities needed to meet not only the current but also the future challenges of the industry. When assessing the skills and competencies needed to align with the strategic objectives of the superannuation fund, the board can also assess the current and desired diversity that it seeks. Improved diversity of thinking has been shown to correlate with high performance.
Those with an informed governance perspective continue to advocate for a majority of independent directors (with appropriate re-election/accountability requirements), because independent directors need to be able to influence how the board is operating. Furthermore, research shows majority independence is the most prevalent standard internationally and that retirement schemes in developed countries are moving towards appointing more independent directors.
But there is no doubt that one-third is a pragmatic, initial step in ensuring board effectiveness. One-third independent directors will assist in improving board renewal, as it will introduce new skills onto boards and assist the board to develop board skills matrices. The creation of a board skills matrix is an opportunity for considered reflection and productive discussion on how the board of directors is constituted currently and also how it believes it should best be constituted in the future to align with the strategic objectives of the entity.
And a majority of independent directors on the boards of superannuation funds aligns with board composition on their investee companies, which is a better governance outcome.
The issue that will see differing views put forward is the definition of independence. In the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations, the indicators of independence set out in Box 2.1 are examples of interests, positions, associations and relationships that may raise doubts about independence and require consideration, but they do not prescribe a loss of independence. If the board considers a Recommendation is inappropriate to its particular circumstances, it has the flexibility not to adopt it —- a flexibility tempered by the requirement to explain why.
The Australian Prudential Regulatory Authority (APRA) has previously taken the criteria for independence in the Corporate Governance Principles and Recommendations and applied them as prescriptive criteria in the prudential standards applicable to financial institutions. While the draft legislation allows APRA to make determinations as to whether a person is independent or not, and also allows APRA to make a determination that a person is independent if it is reasonably satisfied that the person is likely to be able to exercise independent judgment in their role as a director, it will be interesting to see if the definition of independence operates as prescriptive criteria in the APRA prudential standards.
The draft legislation also introduces a requirement to report (on an 'if not, why not' basis) in the annual report on whether a superannuation fund has a majority of independent directors commencing 1 July 2019. The key principle underpinning the ASX Corporate Governance Council’s guidelines is the 'if not, why not' model comprising suggestions for sound practice designed to optimise corporate performance and accountability in the interests of shareholders and the broader economy — this model provides for other approaches, subject to explanation. It will also be interesting to see how this disclosure requirement with its flexibility subject to explanation will operate, given the strong move to introduce a majority of independent directors.