Rejected super legislation is a chance to get it right

New research provides a framework for government’s next move

In a nation where huge superannuation pools are likely to hold the key to retirement for an ageing population, a robust debate has put the spotlight on the Australian Government's push for more independent directors on super fund boards.

In November last year, the Superannuation Legislation Amendment (Trustee Governance) Bill 2015 failed to pass through the Senate, with critics condemning what they considered to be rushed and sloppy drafting of the legislation.

The proposed changes, flagged in the 2010 Super System Review and the 2014 Financial Services Inquiry, called for all large-scale superannuation funds – retail, industry, public sector and corporate alike – to have a minimum of one-third independent directors and an independent chair as part of efforts to improve consumer protections across the industry.

Now Scott Donald, director of the Centre for Law, Markets and Regulation at UNSW, and Suzanne Le Mire, an associate professor at University of Adelaide law school, have outlined a framework in their forthcoming paper, Independence and the Governance of Superannuation Funds, to inform a rethink of the legislation.

As part of their literature review, Donald and Le Mire found there is a "naïve belief" that independent directors, good governance and superior fund performance are interlinked.

"[But] there was actually no empirical evidence to sustain that," Donald says, adding that while independence may be desirable, its impact on investment performance is unclear.

The authors also suggest the "cognitive" independence of directors should be the focus for the industry, rather than relying on "structural" rules to guarantee independence.

As Donald explains: "Directors should have a willingness and capacity to exercise a genuinely independent judgment in the interests of members, and should be held accountable for such, irrespective of their mode of appointment or whether they satisfy some statutory definition of independence."

Moreover, the authors claim there is scope for the government and regulators "to harness a wider variety of regulatory techniques to achieve what we take to be their underlying policy objective of entrenching cognitive independence".

‘The evidence is not entirely clear over whether independence makes a big difference, and in what situations’


Political pressure

There is little doubt that superior governance of the nation's superannuation funds is a desirable goal given that they hold about $2 trillion of the retirement savings of Australians.

But some commentators see the Australian Government's campaign for more independent directors as an ideologically driven bid to reduce the influence of unions within industry super funds. Those funds have operated on an equal representation model, whereby the board is split 50:50 between employer and employee representatives.

 Geoff Warren, research director at the Centre for International Finance and Regulation, which co-funded the research, believes Donald and Le Mire's work will help inform a more robust rationale for the imposition of greater independence on super fund boards without simply accepting unproven claims that such measures will automatically result in the better performance of funds.

Significantly, the research also provides a framework for improved legislation through its consideration of four ways to approach the regulation of independence: capacity, status, power and structural barriers.

"What it does for the policy debate is to deliver a framework to think about this issue and how to approach it," Warren says. "It's really valuable because it actually provides a context for the government's deliberations about where to go next."

'Capacity', the authors note, refers to the typical way of obtaining independence through the selection of a person on a board with the ability to act independently "even when there is exposure to influences that would otherwise threaten independence".

Such an avenue requires careful selection of the individual and assumes that independence is stable across time and circumstance.

'Status' allocates a designated independent standing status to a person or body and "signals, both outwardly to audiences and inwardly to the body or person concerned, that an important feature of their role is independence".

This may be implied through a title such as independent director, or be linked with the nature of a role where it is widely understood, as with judges.

'Power' considers issues such as how independent directors could have the capacity to drive decision-making and set agendas, even when contrary to the interests of others.

For example, if there was a stipulation that independent directors had to make up one-third of the board – rather than being a sole independent director, as is often the case – they would then have potential allies and a possible voting bloc.

Mandating specific structural barriers is seen as a way of identifying and prohibiting "connections thought to threaten or be inconsistent with independence".

According to the authors: "This option provides a measurable way of defining and regulating independence. It is theoretically possible to consider the context within which a person operates and identify the persons or relationships that might threaten their objectivity. For example, a close connection between a judge and a litigant may undermine that judge's ability to exercise impartial judgment."

Warren says the paper contributes to a broader debate about whether independence is actually necessary on boards, especially given that industry super funds in which equal representation is the norm have, in general, performed strongly and generated strong returns for members.

"It hasn't stopped industry funds from performing well," he says.

While conceptual arguments exist that independence is probably beneficial, Warren notes that the jury remains out on the extent to which a greater proportion of independent directors on boards actually improves outcomes in the corporate sector.

"The evidence is not entirely clear over whether independence makes a big difference, and in what situations. It is like looking for a needle in a hay stack, as governance arrangements are only a small part of what determines performance," Warren says.

‘You can get everything apparently right and the company can still go wrong’


No panacea

Donald believes the rejection of the government's Bill late last year creates an opportunity for further reflection on precisely what board member independence may offer the superannuation system. 

"It can be quite potent or quite impotent depending on the circumstances," he says, noting that the collapse in the past of overseas banks and companies such as Enron occurred despite them having a strong representation of independent directors.

"So what that tells you is 'be careful'. Sometimes the symbolic addition of an independent director is just that – it's symbolic. It doesn't actually change the risk and other issues associated with the governance of the organisation. You can get everything apparently right and the company can still go wrong. At other times it can be absolutely crucial," Donald says.

The paper from Donald and Le Mire adds to the research of UNSW Business School professor Peter Swan and colleague Marc-Oliver Fischer, who in 2013 questioned conventional wisdom that independent board directors increase firm value.

Swan and Fischer studied the performance of almost 1000 Australian companies since the ASX introduced voluntary governance guidelines in 2003. Those that followed the board independence recommendations increased CEO and director pay, yet underperformed financially.

In a secondary, complementary paper on which they have started working, Donald and Le Mire will evaluate the practical issues associated with using structural regulation to achieve cognitive independence on superannuation fund boards.

While the federal government has indicated it will press on with the Superannuation Legislation Amendment (Trustee Governance) Bill in some form, Donald says the rapid pace of attempted reforms last year led to a rushed first draft of the legislation that needs some significant changes if it is to garner the support of crucial cross-benchers in the Senate.

"I would hope that they would take on board some of the work that has been done by a variety of people to try to make this more sensible," Donald says.


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