New expectations for trustees of superannuation funds part of overhaul of investment governance standard.
The Australian Prudential Regulation Authority (APRA) has issued new draft guidance on investment governance for superannuation fund trustees, with updated expectations across key areas including ESG risks, liquidity risks, stress testing and valuations.
The guidance is designed to assist trustees in meeting requirements under APRA’s recently updated prudential standard on investment governance (SPS 530), which comes into effect on 1 January 2023.
On ESG risk factors, APRA expects trustees to be able to demonstrate an understanding of the risk and opportunities present in a range of ESG factors, including climate risk, and the extent to which they may have a material impact on their risk-return profiles.
Trustees will have to demonstrate how ESG risk considerations are integrated into investment analysis, decision making and oversight, and ensure appropriate resources are available to identify and respond to material ESG factors.
Where trustees determine that ESG risks are financially material, they should be able to demonstrate how this is reflected in the investment strategy, document how the risks will be managed, articulate the portfolio impacts, and how these are to be reflected in terms of return and risk objectives.
In investment due diligence, APRA expects trustees to undertake analysis to assess ESG investment opportunities, seek evidence on potential expected returns, and demonstrate how these opportunities align with the investment strategy and objectives.
Where super fund investments are linked to additional non-financial objectives, such as environmental or social impact related objectives, APRA expects trustees to be able to demonstrate how they monitor the objectives, using “recognised industry criteria”.
Early warnings on liquidity risks
The guidance also calls on trustees to ensure their liquidity risk tolerances are informed by factors such as benefit design, member demographics, the range of investment options offered, and the level of transactional activity.
Trustees should develop and monitor “early warning indicators” to identify emerging liquidity risks, appropriate liquidity buffers within each option, and liquidity limits or triggers for deteriorating cash flow positions.
The guidance also directs trustees to consider the potential impacts from secondary risks associated with liquidity risk – such as the impact of selling assets at ‘stale’ prices, the impact on portfolio quality when illiquid assets increase as a proportion of total assets, and the cost of restoring portfolio quality.
On stress testing, the guidance says trustees should be able to demonstrate how their programmes correspond with the risks and nature of their investment strategy, and that the scope is regularly reviewed and refined.
Stress testing programmes should take into account scenarios involving systemic market-wide risks, macroeconomic events, and targeted events; and they should document how the scenarios are likely to transmit to the investment portfolios.
On valuation governance, the guidance says trustees should ensure their approach appropriately reflects asset valuations, recognising the impact on performance and enabling the equitable distribution of investment earnings to beneficiaries.
Valuations should be supported by appropriate judgments and assumptions, their inputs should be appropriately and regularly calibrated, and there should be operational and structural independence those responsible for investment decision-making and those responsible for undertaking valuations.
When relying on external managers for asset valuations, trustees should be able to demonstrate why they can rely on such valuations, how the methodology and sources of information used are consistent with the terms of the arrangement, and how potential conflicts of interest are being managed.
The guidance says trustees should undertake valuations on at least a quarterly basis, and more frequently during times of heightened market volatility. Trustees should be able to justify decisions to undertake valuations less frequently.
The draft guidance is open for comment until 17 March 2023 and is due to be finalised in Q2 2023.
“Many funds have grown in size and complexity and the intensity and quality of governance must keep pace,” said APRA deputy chair Margaret Cole. “In strengthening investment governance, APRA expects to see trustees having investment strategies that are in the best financial interests of their members, including robust oversight of valuations of assets and improved liquidity management.”