On 29 May 2018, the Australian Prudential Regulation Authority (APRA) wrote to licensees of registrable superannuation entities outlining its expectations for outsourcing arrangements with related parties. The letter follows APRA’s recent thematic review of a sample of Registrable Superannuation Entities (RSE) licensees’ management and governance of related party arrangements. It also provides some insight into APRA’s findings and expectations regarding outsourcing arrangements more generally. The letter can be viewed here.
The key takeaway is, unsurprisingly, that APRA expects RSE licensees to ensure that both their procurement processes and contractual arrangements are on an arms’ length basis, in the best interests of members, and clearly documented.
We’ve summarised APRA’s key findings and recommendations, and our key takeaway points, as follows:
APRA looked at how licensees structured, managed and enforced contracts with related parties. It found that some agreements lacked important provisions, including as to clear termination triggers, rights on termination and fixed terms for review. APRA viewed this as an indication that timeframes for market testing, benchmarking and performance assessment may be lacking. It noted that, for example, poor performance under investment mandates with related parties tended to be managed through negotiation rather than through the application of performance-based termination or penalty provisions.
APRA recommended: that RSE licensees ensure that related party arrangements are formalised, contain clear and objective performance measurements, and appropriate termination and penalty provisions, and a fixed term for review. Reporting against the relevant measures and triggers should be timely, rigorous and subject to appropriate review and oversight by the RSE licensee.
Takeaway: RSE licensees should review related party engagements to ensure they include appropriate performance measures and reporting, together with formal review and remediation mechanisms (and ultimately, performance-based triggers for termination). This should include reviewing existing arrangements, as well as the processes for considering future arrangements. In some cases it may be appropriate for external advisors or consultants to conduct objective benchmarking and review of the contractual arrangements.
APRA found that there was clear room for improvement in having credible processes in place for benchmarking and market testing of related party arrangements. APRA views this – i.e. testing the arrangements against others available in the market - as essential in order to demonstrate that the arrangements are in the best interests of members.
APRA recommended: that RSE licensees undertake rigorous market-based benchmarking of pricing and services prior to engaging a related party service provider, including utilising independent advice and assessment where appropriate.
Takeaway: RSE licensees should review and document procurement processes which cover related party arrangements as well as third party engagements. These processes should, where appropriate, require benchmarking against alternatives, and clear documentation of the comparisons undertaken. The level of market testing should be determined by reference to the materiality of the service and on an objective cost/benefit basis, and not based on whether the engagement involves a related or non-related party.
Materiality, documentation of decision-making and conflict management
APRA found that there was a range of approaches taken by RSE licensees, in relation to related party arrangements, regarding:
- determining the “materiality” of the arrangement for the purposes of Prudential Standard SPS 231, with respect to which APRA noted its expectation that licensees adopt a conservative approach where there is a level of uncertainty as to whether a business activity is material
- the ability to demonstrate, by way of documentation, that the arrangements are conducted on arm’s length bases and in the best interests of members, with respect to which APRA noted that it was not always clear that alternatives had been thoroughly considered and documented
- whether conflict management frameworks properly dealt with potential conflicts involving responsible offers who had relationships with the service provider, with respect to which APRA noted that better practice is to have policies to ensure that, where a director has a conflict, they are excluded from governance of related party arrangements.
APRA recommended: that decision-making by RSE licensees on the use of related party providers is documented, including assessing materiality and demonstrating that the arrangement is in the best interests of members, and that licensees review their conflicts management frameworks to ensure that they are current and appropriately reflect existing related party arrangements.
Takeaway: Procurement processes should include clear guidelines around assessing materiality, benchmarking against competitors, compliance with a rigorous conflicts management framework, and best interests analysis. Final signoff on procurement arrangements should be subject to appropriate documentation evidencing these matters.
APRA found that there is considerable inconsistency in, and varying quality of, data reported under Reporting Standard SRS 331.0 as to related party arrangements. In particular, APRA suggests that there was inaccurate classification of services provided by “associates”, as opposed to non-associates. APRA acknowledged there is some uncertainty about how the definition of ‘associate’ should apply to certain arrangements, and stated that it is considering amendments to SRS 331.0 and further guidance as to the definition of “associate” in the prudential and reporting frameworks.
APRA recommended: that RSE licensees review their processes for ensuring that arrangements with related party service providers are accurately reported as “associates” on the relevant reporting forms and consistent with the reporting form guidance.
Takeaway: RSE licensees should consider reviewing their reporting processes to ensure that there are no inaccuracies in how related party service providers are described – i.e., as “associates” or not. Advice may be helpful in making the distinction and APRA may issue further guidance.