Michael Cullen - Financial Assets Forum
19 October 2000
Thursday 19 October 2000
Opening Address to the Governance and Change – Crown Financial Assets Forum
Dr Cullen's opening address to the Governance and Change – Crown Financial Assets Forum
It is a pleasure to be here today and to have the opportunity to take part in this important forum at a time when I have recently released the details of a prefunding superannuation scheme which is projected to reach roughly 50 percent of GDP at its peak.
The Crown is a significant holder of financial assets, holding over $10.4 billion of marketable securities and deposits as at the end of the last financial year. In addition, the Crown has an interest in the financial assets of Crown entities and state-owned enterprises. Together the Crown’s principal financial institutions—ACC, EQC, GSF, NPF, NZDMO, PTO, and RBNZ—hold financial instruments worth in excess of $23 billion.
Good governance arrangements are necessary to ensure that those financial assets are invested efficiently, earning strong long-term returns that adequately compensate the Crown for the investment risk undertaken.
The Crown’s credibility and commitment, as
well the public’s confidence,
that those financial institutions are sustainable and their assets will not be diverted for purposes other than those for which they are intended, depends to a large degree on the governance framework adopted for managing those assets.
The elements of good governance design that should apply to public sector investment funds include the following arrangements, which are consistent with the Crown entity reforms to which Cabinet recently agreed:
the Crown establishes
the board as a statutory entity, sets the high-level
investment objective in the fund’s governing legislation,
delegates authority to the board to invest the fund’s
assets, and assesses the board’s performance;
the statutory investment objective embraces the principle of management on a prudent and commercial basis, consistent with best-practice portfolio management;
the board, composed of members with relevant expertise, is responsible for management of the fund;
the board contracts with private-sector investment managers and custodians, who are responsible for day-to-day funds management and administration;
the Minister or the Governor-General, on the advice of the Minister, makes board appointments;
the Minister has a capacity to communicate the government’s expectations for the fund’s performance; and
the relationship between the board and the Minister is transparent.
Pre-funding NZS and restructuring the management of GSF are two areas where significant work on governance is being carried out.
I would like to take this opportunity to thank those Treasury officials who have worked on the prefunding proposal for their initiative and commitment to the design. I would also like to congratulate everyone – from inside the government and from the savings industry – who has made a constructive contribution to that design.
The motivation behind prefunding NZS is to smooth the fiscal adjustments associated with an ageing demographic structure, whilst preserving, as the government is committed to, a universal publicly funded pension and the link between that pension and the average wage.
By setting aside resources now, when they are affordable, the Crown will build up a stock of financial assets to subsidise the cost of current-year expenditure in the future. Robust governance arrangements are required to ensure that NZSF is available solely for the purpose of the payment of superannuation entitlements, to maintain public confidence in the fund, and not to compromise the stability of retirement income policy.
The motivation behind diversifying GSF is to realise the substantial gains that could be expected from investment by GSF in a broader range of asset classes than those to which it is currently limited. At present, the GSF investment portfolio is managed within a government department, the Ministry of Economic Development.
In the private sector, a diversified investment portfolio would be managed by specialist fund managers. A similar approach is desirable for GSF but would be difficult to achieve within the current departmental arrangement, whose asset management specialty is confined largely to New Zealand government stock and corporate bonds. Consequently, new governance arrangements have been developed for GSF.
The proposed governance structures for NZSF and GSF illustrate the elements of good design.
NZSF and GSF will be managed on behalf of the
Crown by a Crown entity, called the Guardians of NZS and the
GSF New Zealand, respectively. Each fund is a portfolio of
assets, not owned by the board but remaining under the
economic ownership of the Crown.
As a Crown entity, each board is subject to the standard Crown entity governance arrangements, including performance accountability requirements.
Each board is responsible for the investment of the fund, and its members will be appointed on the basis of their relevant knowledge and experience in finance, economics, accounting, or law. They are appointed by the Governor-General, on the advice of the Minister, in the case of the Guardians of NZS, or by the Minister, in the case of GSFNZ. Board members serve up to two terms of three years each. Remuneration is in accordance with standard guidelines from the State Services Commission.
When appointing the Guardians of NZS, the
Government plans to consult with organisations representing
older people, employees, employers,
and the savings industry to identify people to nominate for the board. Consultation regarding appointments to the board of GSFNZ is not required for the protection of members’ interests, as benefits are defined in statute and members have recourse to an appeals process on board decisions.
In addition, the interests of the Crown and other employers are closely aligned. Even so, some informal consultation with major stakeholder groups may occur. For both funds, however, board members are required to be appointed on the basis of their commercial expertise and not as interest group representatives.
The investment objective for each fund
is defined by the legislated parameters surrounding the
approach to investment. The investment strategy—that is,
the actual assets or classes of assets in which the fund
will be invested—
adopted by each board is required to be consistent with the investment objective. The investment objective is expected to be enduring, whereas the investment strategy is expected to change over time.
A question of potential relevance to both funds is the extent to which, and the manner in which they should be subject to some broad ethical norms as investors of public monies.
This issue of so-called ethical investment deserves clearheaded and rational debate.
Each board will have wide autonomy in
managing the fund for which it is responsible. It will have
sufficient power to conduct its related management
including the relationship with its secretariat, funds management firms, and custodians, independently.
Each board will decide the investment
strategy independently of the government but, in all
instances, has a statutory obligation to invest the fund on
a prudent and commercial basis, consistent with
best-practice portfolio management.
Any Ministerial notices or directions must be consistent with that objective, ensuring that commercial criteria and practice dominate each board’s portfolio choices.
The rationale for having a Ministerial power to issue notices or directions is that the performance of each fund directly affects the financial performance of the Crown as a whole, impacting on the operating balance, future cash requirements, and Crown net worth.
The boards will be subject to the standard accountability and reporting requirements for Crown entities. To enable transparent assessment of performance, each board will produce audited financial statements of the fund for which it is responsible, as well as audited financial statements of its own operations.
Each board will contract an output agreement with the Minister to provide the Crown with funds management services and prepare a statement of intent. It will report against them in its annual report, which will be delivered to the Minister, who must table it in the House.
The statement of intent will
address key issues and the investment environment facing the
board, strategies that the board will implement to meet the
issues it is facing, key performance indicators that measure
the performance of the board,
how the board will protect the Crown’s economic ownership. The board must also provide information for overall Crown financial management, such as preparation of the Crown financial statements.
GSF is already subject to normal taxation rules, and NZSF will be as well, which ensures that fund managers face the correct incentives when making investment decisions. If the funds were tax-exempt, they would require complicated governance rules, which could bias them toward investments with lower return or higher risk characteristics. Likewise, if the funds were tax-exempt, the Crown could experience the loss of tax revenue from other sources, as they could trade on their tax-exempt status with taxable entities through joint venture schemes.
The Guardians of NZS will be responsible for managing NZSF. It will not determine the contribution rate to the fund, the policy parameters around NZS entitlements, or other matters for which the government of the day is appropriately responsible. Similarly, the board of GSFNZ will not determine benefits to members, which are defined in statute.
Governance arrangements that embody these principles are also being developed in the context of the Earthquake Commission, whose financial assets, like those of GSF, which I agreed in principle to diversify.