Submissions - KPMG
This report contains 9 pages
KPMG provides extensive assurance and advisory services to the Managed Investments and Superannuation industry in Australia.
Our role as assurance providers provides us with a unique opportunity to observe changes in the business objectives and strategies of those organisations that manage "other people's money".
In essence our view is that significant improvements have occurred in the areas of awareness of fiduciary responsibilities and implementation of appropriate compliance practices. There are some refinements that can be made now and review processes such as this one are necessary to ensure future continuous improvements are made within the industry for the enhanced security of investors and the increased efficiency of operators.
This submission focuses only on three specific areas of the terms of reference of your Review. Those areas are:
1 whether the arrangements have delivered benefits in terms of greater certainty as to the responsibilities, obligations and liability of scheme operators (known as `responsible entities' under the legislation);
2 whether the arrangements have strengthened compliance practices, procedures and awareness amongst responsible entities and others involved in the managed investments industry; and
3 whether refinements could be made (whether requiring legislative amendment or not) to enable the arrangements to operate more efficiently and effectively while not unnecessarily detracting from the protection afforded to members.
The comments made in this submission are based on our experiences with different industry participants from a variety of organisations in regions throughout Australia. Apart from the officers of responsible entities themselves, the participants we refer to include consumers, asset managers, administrators, distributors and the regulatory agencies as well.
Based on our experiences, we believe that the great majority of Boards of responsible entities ("REs") are certain of their responsibilities, obligations etc under the legislation. The format of licensing procedures that require financial and operational capabilities to be demonstrated to the regulator's satisfaction has been a key factor in this area.
Some smaller organisations may baulk at the existence of these licensing requirements. However, those that are committed to establishing a reputable and viable business in the industry have been prepared to obtain the necessary capital to meet those requirements.
Notwithstanding this, there are certain matters relating to REs' responsibilities and obligations that we believe warrant more detailed commentary.
The first focuses on a variable factor within the operation of the industry that has the potential to cause uncertainty in this area and that relates to a responsible entity's decision on whether or not to outsource one or more key business processes.
The decision to outsource is driven by a generally accepted view in the industry that very few organisations can fulfil all functional roles (distribution, asset management, accounting and administration, registry, custody, product development) efficiently and cost competitively due to the need to achieve a certain scale in activity to provide a return on minimum invested capital and fixed costs.
With continued consolidation occurring in each of these key functional areas to achieve economies of scale, REs have identified increases in the risk of:
n there being a shortage of alternative, comparable standard service providers in the region;
n a lack of detailed standard reporting obligations on the quality and effectiveness of operational controls existing at the service providers; and
n the level and nature of interactivity between the service provider and the RE becoming an inhibitor to changing business process arrangements.
The RE might well understand that "the buck stops here" and have thorough monitoring processes in place to receive reports on operational and financial capabilities. However, the dynamics of the industry can change very quickly. It would be desirable for the Board of an RE to have conducted some broader "strategic" risk analysis in this area to ensure that the RE is capable of reacting effectively in the event of sudden and dramatic changes in the circumstances of a key service provider. Further comment is made on this aspect at point 2.1.
The second matter focuses on the nature of the relationship between the Compliance Committee ("Committee") and the RE.
The introduction of suitably experienced, independent persons to serve on Committees of REs appears to us to be delivering substantial benefits in maintaining a proper sense of governance within the operations of the RE. These benefits are discussed in Section 2 of our submission.
However, in our role as auditors of compliance plans, there still seems to be some doubt as to how the relationship between the Committee and the RE should be balanced in terms of there being a healthy "tension" between the RE Board (and its management) and the Committee and a recognition that the resources of the REs own compliance function can and should be expected to be relied on to support the Committee in fulfilling its role under the legislation.
Debate in the last two years has ranged over topics such as
n whether the Committee should engage external professionals to conduct reviews of the work of the RE's own compliance personnel; to
n whether the Committee should be engaged in providing some form of internal review or authorisation of all transactions between the RE and the registered scheme as well as monitoring adherence to the compliance plan of the registered scheme; to
n to what extent the external auditor of the compliance plan should be "directed" by the compliance committee as opposed to the RE who appoints the auditor of the compliance plan.
The existence of the Independent Compliance Committee Members Forum ("ICCMF") has proven to be of great value in facilitating discussion and debate on these topics. It would be of benefit for representatives of ASIC, the assurance profession, the REs and the ICCMF to develop some practical written guidance in this matter.
The third matter involves what might be seen as either a "duplication" or a "diminution" of the obligations of an RE in relation to unitholders in a registered scheme whose units are "stapled" to the issued securities of the RE.
In this instance the unitholders of the scheme derive benefits from the activities of the RE itself as well as the benefits derived from the REs management of the assets held in the scheme.
It might be argued that there exists a higher duty of care or accountability for the governance of the RE so as to put it on the same level as unitholders in a scheme. Conversely, it might be argued that because of the merging of benefits to the unitholders from both the RE's activities and the return on scheme assets managed by the RE there is no real benefit in providing the additional oversight of compliance committees reporting on compliance plans etc which imposes an additional cost that corporate vehicles do not have to bear.
We believe that this type of security holding is gaining more popularity, particularly in the area of property asset management. Therefore practical guidance on this matter from ASIC would be timely and appropriate.
Based on our experiences, KPMG believe this has occurred and that there is a much more positive attitude to continuously improving in the compliance area within the industry.
As mentioned in Section 1, the introduction of suitably experienced, independent persons to serve on Compliance Committees of REs appears to us to be delivering substantial benefits in maintaining a proper sense of governance within the operations of the RE. These benefits arise from a requirement by the Committee members that they have available to them:
n an increase in the resources designated for the compliance functions in REs;
n a transparency in compliance processes as a result of clearly documented risks, mitigating procedures (and controls) and identification of accountable persons to manage those procedures; and
n regular interaction with key operational staff within the RE to satisfy the Committee members as to the competency of those operational staff.
In our observations, Committees that comprise persons from a mix of legal, operational and financial backgrounds provides the most effective working group in this area.
Once again though, certain matters are worth commenting on in more detail.
Compliance Committees are often presented with analyses of operational risk and implemented compliance procedures to mitigate those risks.
However, the process of conducting strategic risk reviews among REs is not as prevalent as we believe it should be within the industry. In conducting a strategic risk review, the Board of the RE formally recognises and documents how it will manage strategic business risks including dealing with issues such as capital requirements to support business operations, resource management in respect of attracting and retaining skilled asset managers and ensuring that there is a proper appreciation of the risks associated with various asset management strategies (eg the risks associated with managing hedge funds are distinctly different from managing a portfolio of assets matched against a specific index; the risks associated with operating an RE using wholly in-house resources are distinctly different from operating an RE using substantially outsourced service providers).
Having conducted a strategic risk review, compliance personnel within the RE and members of Compliance Committees gain a better appreciation of the overall risk environment within which they will be required to operate. This facilitates the formulation of consistent operational risk management practices with the individual business units of the RE.
Whilst awareness level have increased in relation to the need for properly documented compliance procedures, there is still debate in the industry on issues such as
n what constitutes "too much detail" in a compliance plan;
n the cost effective application of "industry standards" in documenting compliance programs and designing compliance procedures to address risks identified in those programs;
ASIC have maintained that they will not be the standard setter in this regard but we believe that the industry will need to move more rapidly towards adopting a standard for risk assessment, program documentation etc.
REs have expressed concern about perceptions (of regulators or unitholders) formed by reason of regular modifications to compliance plans lodged with ASIC. The fact is that the majority of such modifications arise from changes in operational structure, system improvements etc that would be expected to occur with participants in any dynamic industry.
The next matter is that KPMG believes there is a need to appreciate that the occurrence of breaches in operational procedures which are detected and rectified as a result of following procedures in compliance plans should not necessarily be construed as a breach of a compliance plan itself.
The fact is that operational errors occur as a daily part of any business activity. Compliance procedures described in a plan may either be preventative, detective or a combination of the two. It appears to us that procedures which are designed to minimise the risk of an adverse consequence to the unitholders are of paramount importance in determining whether a compliance plan is adequate, but the effectiveness of timely detective procedures in a plan to monitor adherence to the legislation and the constitution of a scheme also have their place.
In this area we would like to submit our views on two matters.
The first relates specifically to the need for the compliance plan audit appointment to be personal to the individual auditor rather than ensure that, in all instances, the auditor engaged to perform the audit of the REs financial statements is a different individual to the auditor of the compliance plan.
At present, the legislation imposes what we believe are burdensome procedures for changing (within the same firm) auditors of compliance plans.
Whilst we appreciate ASIC's concern to ensure that auditor is not changed for "questionable" reasons, we believe there is little probative value in maintaining the current procedures which make it difficult for a firm to reassign workloads as and when required to deal with either client conflicts or provide additional resources if the RE takes on additional schemes as a result of a merger etc.
We believe that a change in the legislation is in order that allows the appointment of the auditor of the compliance plan to be a firm appointment rather than an individual appointment and that the benefits of maintaining the restriction of the auditor of the RE being different to that of the compliance plan be revisited.
The second matter relates to streamlining the nature of compliance reporting as between superannuation and non-superannuation managed vehicles.
KPMG believe that this would further reduce the risk of divergent compliance practices within the same organisation due to their management of a mix of such products. Whilst there are certain specific reasons to have some additional areas of legislative compliance reported on for regulated superannuation entities, we believe it could only benefit the industry if the reports on legislative and constitutional compliance were handled in the same manner, irrespective of their tax status or the existence of different regulatory agency involvement.
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