APRA ‘warns’ funds on capital adequacy after unit pricing errors hit $750m

The Australian Prudential Regulation Authority (APRA) has fired a shot across the bows of not-for-profit super funds over capital adequacy in the light of the climbing compensation bills for unit pricing errors, which has reached a total of $750 million.

APRA deputy chair, Ross Jones, gave an implied warning over capital adequacy for not-for-profits at the annual executive forum of the Fund Executives Association Ltd (FEAL) in Melbourne on March 1. He said that, to date, all the unit pricing errors which had been discovered had involved retail funds, with the capital backing of institutions. The majority of these had been funds with “a lot of discretionary investment choice”. The total, over the past few years, had reached $750 million, however the number and size of “new errors” had declined considerably in the past 12 months. “So far, they have been able to fix the problems at no cost to the investors,” he said. “;Perhaps people need to look at how this could be dealt with by the not-for-profits.”; After his speech to the forum, Jones was questioned in a closed session operating under Chatham House Rules. The issue of capital adequacy is a sensitive one for not-for-profit super funds because it has also been raised before the Joint Parliamentary Inquiry into Superannuation. If funds were required to have a capital base to deal with these sorts of problems, there would be a dilemma for not-for-profit funds in sourcing that capital. Furthermore, in the interests of improving equity between members, most funds have moved away from having crediting rates and reserves and towards unit pricing in one form or another. Reserves have subsequently been reduced or eliminated. If a not-for-profit had to pay for unit pricing errors – usually compensated for by a funds manager or custodian – the question is whether only existing members should pay, or whether past and future members should also be liable. If insurance is taken out against errors, this will still be a cost to members. Jones also raised concerns about retail funds, apart from the unit pricing problems, with respect to their investment strategies. Because of the wide range of discretionary choices offered by retail funds, their trustees “tend to take a step back a bit”. Jones said: “We have concerns about the strategies if trustees abrogate their responsibilities to financial planners… It all comes down to governance. APRA places the highest priority on people … They need to be fit and proper.” He reiterated concerns about the use of alternative investments, especially as there was increasing pressure on trustees to outperform other funds due to Choice of Fund. “Trustees seeking higher returns might invest more in alternatives. This is where the rub is: perhaps they don’t have a full understanding of the risks. [Alternatives] need the appropriate skills, procedures and systems to manage.” He said there was an example of a fund which invested in a foreign jurisdiction only to discover later that the particular investment contravened the SIS Act. There was a lot of interest in hedge funds, he said. It was an issue for APRA and trustees to ensure there were answers to questions over disclosure requirements, legal jurisdictions, the integrity of brokers and other service providers to hedge funds, lock-up periods and liquidity, performance fees and valuations. “As it happens our statistics show that the level of investment has not been particularly high but it is increasing.” More than 80 fund chief executives and direct reports attended the forum, held at the University of Melbourne’s Melbourne Business School. FEAL has reached an agreement with the School to offer for the first time two courses designed for super fund executives: a graduate certificate and a graduate diploma in organisational leadership. The certificate, which starts this year, contains four subjects, one of which is on applied finance and held in Chicago. The forum was sponsored by IXIS Asset Management, whose chief executive, Karyn West, was instrumental in bringing to Australia the keynote speaker, James Cameron, a UK barrister who is vice chair of Climate Change Capital. Cameron said that in 40-50 years the world would pass the point of irreversibility on climate change. “We don’t really have much time … This will mean that a country like Australia will not be viable… There is now a very solid consensus (on climate change) – probably more so than on any other scientific research endeavour.” Greg Marshall, chief executive and portfolio manager of Logic Fund Management, a hedge fund manager which followed energy depletion and climate change themes, outlined winners and losers from the trends. He said the world had no choice but to go nuclear. Wind and alternative energy supplies would not satisfy demand with sufficient cost efficiency.