APRA focuses on increasing importance of investment management due diligence


  • Superannuation fund trustees must use best due diligence practices in assessing the operational capacities of investment managers they intend to appoint.
  • Trustees should ensure their agreements with managers contain adequate provisions requiring the manager to provide the information the trustee needs to satisfy its duty of diligence and reporting.
  • Investment managers (especially offshore managers) need to be ready for enhanced due diligence of their operational structure which they may not be accustomed to in dealing with non-Australian superannuation fund trustees.

With the total value of assets invested by Australian superannuation funds closing in on A$2 trillion, APRA wants to ensure that fund trustees exercise adequate due diligence over their investment managers’ appointment and performance.

Over the last financial year, the value of total superannuation industry assets in Australia increased by 13% to $1.8 trillion (AUD) or the equivalent of 116% of Australia’s GDP. Increasingly, superannuation funds look for strong investment performance in both domestic and offshore markets as the size of their funds under management continue to grow. 

This development has not been lost on the Australian prudential regulator of superannuation funds, APRA. It reflected in its Insight Issue One 2015:

“Strong investment governance is critical to the delivery of optimal financial outcomes for members. The continued economic uncertainty and persistent low interest rate environment make it increasingly difficult for RSE licensees to achieve their risk/return objectives. The need to meet member expectations is leading many funds to increase the number of investment options they offer and the investment activities undertaken in-house. The allocation to overseas assets and the use of lifecycle investment strategies have also been increasing. These investment-related developments necessitate stronger investment governance practices.”

Investment governance and investment risk

As we head into 2016, APRA continues to focus on the standards of investment governance exhibited by superannuation funds following the introduction of its APRA Prudential Standard SPS 530 - Investment Governance on 1 July 2013. Ancillary and relevant are also SPS 230 (Outsourcing) and SPS 220 (Risk Management).

Over the past 2 years, APRA has issued a range of prudential standards to be binding on the superannuation funds it regulates. The prudential standards set out principles of good governance and practice that APRA will expect to see evident in the management and operation of superannuation funds. Investment governance is one such prudential standard.

Investment performance is typically regarded as the area most deserving of focus by the trustees when appointing an investment manager. With the emphasis on returns and access to alternative assets (whether infrastructure, hedge funds or other alternatives), trustees do not always pay the same or enough attention to ‘operational due diligence’ of the investment manager.

In December 2014, APRA outlined its expectations about the way superannuation funds conduct their due diligence of investment managers with a special focus and warning on the relevance and importance of operational due diligence. 

APRA cites research to the effect that more than 50% of hedge fund failures are due to “breakdown in the operational environment”  rather than solely, or even primarily, attributable to investment decision making by the hedge fund managers.

The key points raised by APRA were: 

  • The current due diligence focus of superannuation funds on investment philosophy and process, portfolio composition and performance was relevant and consistent with a trustee’s prudential obligations. However, APRA considers that trustees need to do more on operational due diligence of investment managers so as to confirm whether an investment manager has the operational capabilities required to properly perform its investment functions.
  • When things go wrong – such as: inadequate trade allocation processes, incorrect trading due to mistakes or to rogue trading, valuation errors and inability to process transactions, inability to provide reports and failure to comply with relevant laws and regulations – the problems are typically evidence of a failure of people, processes and systems.
  • These operational risks are not always front of mind for superannuation funds when performing investment due diligence. However, performing operational due diligence will provide useful insights into the risk culture and approach to risk management of the investment manager being contemplated by a superannuation fund.
  •  The trustee must check and obtain information from investment managers on the extent to which related parties may be engaged and the investment managers’ conflict management procedures (including informing the RSE of any conflicts). 
  • APRA will continue to focus on compliance with prudential standards and management of operational and investment risk. However, where warranted, APRA will also assess superannuation funds’ processes around operational due diligence of investment managers.

Attention is drawn to the specific requirements of SPS 530 that there be an effective separation between those making investment decisions and those measuring the impact of those decisions (effectively independence of investment and valuation personnel). 

It should be remembered that the RSE has reporting and disclosure obligations to APRA and so must ensure it obtains, from the investment manager, the information it needs to satisfy those requirements. This requirement (which is regarded as a universal and fundamental risk management strategy by financial institutions) filters down from the RSE to the operational structure of the investment manager.

Special considerations for overseas investment risks

The increasing proportion of investments offshore has also caused APRA to comment on the additional risks faced by superannuation funds as they navigate these markets. 
Additional risks include political, currency and liquidity risks and taxation consequences. APRA has signalled its expectations for strong investment governance and robust risk management to identify and manage such risks.
Be prepared
If you are providing, or intend to provide, investments and/or investment management services to Australian superannuation funds, you can expect to see that these clients will require that a due diligence process be undertaken before appointment of an investment manager or significant investment in an offshore fund. 
You can anticipate that these additional prudential requirements will impact on the extent of the undertakings, obligations and warranties that may be requested of you by Australian superannuation trustees.