APRA expects super funds to consider ESG under Superannuation Prudential Standard SPS 530 and Guide (SPG 530)
The Australian Prudential Regulation Authority (APRA) now requires Registrable Superannuation Entities (RSEs) to demonstrate an understanding of the environmental, social and governance (ESG) risks and opportunities, stress testing, valuation and the governance of investments. These requirements have come in under Superannuation Prudential Standard SPS 530 Investment Governance (SPS 530, ‘the Standard’).
APRA also recently released Superannuation Practice Guide SPG 530 Investment Governance (SPG 530, ‘the Guide’), providing advice and direction for RSEs on how to comply with the Standard.
In this article, we unpack the details of the Standard and Guide in a need-to-know summary.
After industry consultation following the release of the draft back in November 2022, superannuation stakeholders called for APRA to consider ESG risks, stress testing, valuation and the governance of investments in its strengthened standards. The regulator listened and did take this into account in finalising the Standard and Guide, released last month (July 2023).
To facilitate the request from industry stakeholders, the Guide provides updated guidance to RSE licensees in the ‘formulation, implementation, maintenance and oversight of an investment strategy’. The Guide sets out prudent practice and provides:
- additional guidelines to support requirements relating to liquidity management, stress testing and asset valuations;
- an outline of how APRA expects trustees will consider ESG risk factors as part of their overall investment risk management;
- greater clarity in areas requested by industry in applying the standard; and
- a more streamlined approach to guidance, bringing the Guide in line with APRA’s Modernising the Prudential Architecture strategic initiative.
Margaret Cole, APRA Deputy Chair, stated ‘by making these significant changes, APRA seeks to drive more robust governance of fund investments and ensure trustees put the best financial interests of their members at the centre of investment strategies and decisions’.
She further stated that ‘the reforms have been broadly welcomed by trustees, many of whom have sharpened their focus on the valuation of unlisted assets, liquidity management and stress testing in recent months. We note that in some cases trustees have already aligned their investment governance to the draft guidance released for consultation in November 2022’.
Key changes and how they impact your fund
ESG considerations and climate risk
SPS 530 incorporates ESG considerations and climate risk into prudent investment governance and expects RSE licensees to demonstrate an understanding of the risk and opportunities present in a range of ESG factors.
RSE licensees should promptly develop an ESG framework, or review and amend their existing framework, to ensure that they are able to demonstrate how ESG risk considerations are integrated into their investment analysis, decision making and oversight processes to ensure that the appropriate resources are available to identify and respond to material ESG factors and climate risks using recognised industry criteria.
An RSE licensee should also consider how it uses its influence to generate value. APRA also expects them to be able to demonstrate how stewardship activities contribute to value creation, are appropriate given resources and investment mix, are cost-effective and are properly disclosed.
The strengthened ESG consideration requirements have been well received by the industry, particularly by associations in the corporate social responsibility (CSR) space.
The changes have been warmly welcomed by the Responsible Investment Association Australia (RIAA). Estelle Parker, Executive Manager, stated that SPS 530 signifies that ‘there is now no ambiguity around whether or not trustees need to consider ESG risk factors – and opportunities – when managing the retirement savings of Australians’.
The changes have also been supported by the Principles for Responsible Investment (PRI), which welcomed the update to SPG 530, which ‘among other things, confirms expectations that super funds consider sustainability-related, market-wide risks and can incorporate environmental and social impact objectives in their investment strategies’.
Liquidity management
Liquidity management ensures that RSE licensees can meet their liquidity requirements, including ensuring that beneficiaries can redeem investments as required, irrespective of market conditions.
APRA expects that RSE licensees are able to demonstrate adequate liquidity management practices commensurate with the nature, risk and complexity of investments and business operations. APRA further expects RSE licensees to consider the potential impacts on beneficiaries of secondary risks associated with liquidity risk.
The strengthened liquidity management requirements mean that RSE licensees must specifically tailor and amend their liquidity management practices to ensure that they sufficiently reflect the circumstances and operations of the entity as well as adequately considering secondary risks associated with liquidity, including risks in relation to selling assets at ‘stale’ prices, increasing the proportion of illiquid assets, and the cost of restoring the portfolio to the desired position.
Stress testing
An RSE licensee must have a comprehensive investment stress- testing program that is approved by the Board and is integrated into its investment governance framework.
The strengthened stress-testing protocols require RSE licensees to develop a structured, repeatable stress-testing process that is commensurate to the risk and nature of the entity’s investment strategy. RSE licensees must develop a stress-testing program that addresses a range of systemic and market-wide risks and macroeconomic events, while also now being required to consider liquidity stress and climate risk in line with Prudential Practice Guide CPG 229 Climate Change Financial Risks (CPG 229).
SPG 530 imposes greater focus on stress-testing results, including the imposition of clear and meaningful reporting to the Board and Board committees to facilitate a means by which the Board can challenge the insights from stress testing and any potential actions relating to investment decisions taken to respond to the stress-testing results.
RSE licensees are now required to demonstrate consideration of how its stress-testing program informs its business planning process and investment strategy.
Asset valuation and valuation governance
An RSE licensee must have an adequate valuation governance framework, which consists of the structures, processes, procedures and controls necessary to identify and manage valuation risk of investments.
SPG 530 imposes a rigorous and active approach to valuation governance which ensures reflection of asset valuations, recognises the impact on performance and enables the equitable distribution of investment earnings to beneficiaries.
An RSE licensee’s valuation framework must now ensure effective Board and management ownership and oversight, robust policies and processes, allocation of adequate expertise and resources to the valuation of investments, consistent valuation methodologies, demonstrable support of valuations by appropriate judgements and assumptions, appropriately and regularly calibrated valuation inputs, and operational and structural independence between investment decision-making persons and investment valuation persons.
SPS 530 ultimately heightens the onus placed on RSE licensees with respect to their valuation governance requirements and framework.
Please contact Anne MacNamara if you require assistance in ensuring your RSE adequately complies with the strengthened investment governance standards under SPS 530.
This article was written with the assistance of Aash Velhal, Law Graduate.