Everything, Everywhere, All at Once? Unlisted asset valuations and considerations for superannuation funds

New governance and oversight expectations

APRA’s draft guidance on investment governance and valuation practices for RSE licensees draft Prudential Practice Guide SPG 530 Investment Governance (SPG 530) is expected to be finalised in Q2 2023.

Importantly, there are a series of key actions that boards and management need to take, especially with APRA’s thematic review uncovering a considerable number of existing inadequacies and highlighting the centrality of board responsibility in addressing these issues.

Draft SPG 530 sets out the principles and examples of better practice to assist RSE licensees in meeting their requirements under the updated, and more demanding, prudential standards. However, Draft SPG 530 does not provide a prescriptive approach to guide asset owners when valuing an individual asset.  Rather APRA has taken a principles-based approach, recognising the broad spectrum of unlisted investments and variety of valuation approaches.

Therefore, boards and management have some heavy lifting to do over the coming period.  And it is the directors who are ultimately on the hook to ensure their organisation’s valuation process is robust; combined with the pending finalisation of the Financial Accountability Regime, action needs to be taken now.

Addressing heightened concerns through setting new expectations

As Australian superannuation funds grow ever larger and more sophisticated, the trend towards investing in unlisted assets continues unabated.  The valuation and performance of unlisted investments is having greater consequences on overall member outcomes. The need for accurate and timely valuations of unlisted investments was highlighted during COVID lockdowns with listed markets falling sharply, but the valuations of unlisted investments adjusting far more slowly. This was largely due to the time it takes time to arrange new valuations, but also a consequence of the valuation models employed by the independent valuers which tend to dampen the impact of highly volatile market swings.

APRA has voiced its concerns about how valuation processes were conducted during COVID.   The innocuous sounding “Findings from APRA’s superannuation thematic reviews” report from October 2021 rings the alarm bell, noting:

• Some superannuation funds are exposed to material valuation risks;
• Valuation frameworks need to be improved and, in particular, revaluation frameworks were typically assessed as inadequate;
• Board engagement and oversight must be increased; and
• A concerning over-reliance on external parties.

What investments and structures are under the microscope?

Australian superannuation funds have been at the forefront of investing in private real estate and infrastructure.  These investments can have desirable investment characteristics including portfolio diversification, stable cashflows, inflation-linked cashflows and long-term horizons. In recent years, superannuation funds have also made meaningful allocations to private credit, private equity and venture capital.

Larger superannuation funds often have material direct ownership stakes and board seats in unlisted property and infrastructure investments.  This enables the superannuation funds to have greater transparency and control over these investments, which can be particularly beneficial in times of market stress.

However, investments in the latter group of private credit, private equity and venture capital are often held indirectly via pooled investment vehicles where an external fund manager is responsible for valuing the assets.

APRA makes it clear that the Board is responsible for ensuring a robust valuation process for all investments, irrespective of the method of access. 

Pointedly, APRA notes the need for initial and ongoing due diligence on the ability of the Board to rely on valuations conducted by external managers and if it

“cannot satisfy itself about the quality of valuation information on the valuation of each unlisted investment selected, expects that an RSE licensee would consider whether the investment is appropriate for selection or, where already invested, should continue to be held.”

This expectation raises a host of governance and management issues for superannuation funds as it is unlikely that the typical investment team is prepared to sell an investment because the internal audit team is uncomfortable with an external manager’s valuation process.

Next steps for superannuation trustees, RSE licensees and executives

SPG 530 places RSE licensees on notice that APRA expects far greater planning, documentation and diligence when conducting valuations of unlisted investments.

Review and upgrade your current valuation frameworks and policies

• Responsibility for the valuation framework lies with the Board and accordingly the valuation policy should be considered and approved by the Board
• The policy should clearly delineate roles, responsibilities and delegations
• Document the valuation methodology for each asset class

Develop mechanisms to allow proper Board oversight

• Develop regular valuation reporting formats for the Board
• Increase the frequency of these reports during times of market volatility
• Consider establishing a suitably qualified Valuation Committee whose membership does not overlap or conflict with the Investment Committee

Increase the expertise and resources for the valuation of investments

• Operational due diligence, both initial and ongoing, are central to an RSE licensee satisfying itself about the quality of valuation information
• Polices and procedures need to be developed for internal teams and the appointment of external due diligence firms
• Internal audit teams need understand the full valuation process and have the expertise to question valuations.  A “tick the box” approach is not satisfactory
• Demonstrable structural independence between investment teams and the valuation teams

Increased due diligence of external managers

• Deeper understanding of their processes, including documentation of the due diligence undertaken prior to appointment
• Processes to manage the conflicts of interest where the external party is both the manager of the investment and responsible for valuing the investment

Increase the frequency of valuations and establish triggers for more frequent valuations

• APRA now expects that valuations are undertaken quarterly.  In effect this will be a doubling of the workload and resources compared to the currently bi-annual cycle used by many superannuation funds
• The Valuation Policy should include triggers that signal when more frequent valuations are required 
• Interestingly APRA notes both market volatility and changes in government policy as possible triggers to be considered.  This is likely a reflection of the unexpected redemptions and liquidity risks that arose following the Government’s COVID early release of super initiative in 2020

Increased interaction with fund administrators, unit pricing teams and independent valuers

• Develop policies and procedures for appointing a panel of pre-approved external valuers.  SPG 530 will increase the industry-wide demand for external valuers, so consider a wider panel than previously utilised and incorporate the likelihood for increased use of their services in times of market volatility
• Establish clear expectations and procedures so that each part of the valuation and reporting chain can act confidently and promptly if revaluations are required.
  • For example, what is the procedure if the Valuation Committee overrides a valuation that the fund administrator receives from an external manager?

What are the opportunities?

While the above “to do” list may appear daunting, there are organisation-wide benefits from the increased focus on valuations.

Sophisticated superannuation funds already recognise the shortcomings of infrequent valuations and utilise market risk models that can assign a level of volatility or use a listed proxy to “de-smooth” the returns of an unlisted investment. 

RSE licensees must now go a step further and also recognise the member equity issues that can arise from stale pricing.

Investment teams and operational due diligence teams have the opportunity to gain a deeper understanding of their investments and the external managers they deal with.  Evidence of an external managers robust valuation processes should provide increased confidence in the manager’s entire operations – including their selection of investments. 

In addition, increased resources and capabilities for the internal audit team will reduce the current over-dependence on the valuation approaches used by external managers and consultants.  

Finally increased interaction with independent valuers can provide greater insights into the economic drivers of value for an investment.

Many superannuation funds promote concepts such as the total portfolio approach and “one team, one portfolio”.  Management now has the opportunity to leverage SPG 530 to break down silos and foster greater integration of the value chain across operational due diligence, investment teams and valuation teams.

Steve McKenna is an investment management expert, with over 25 years experience in senior public and private sector roles. He has extensive experience in implementing change in complex business environments and a deep technical grounding, combined with sound strategic planning and client outcomes focus.

Rhizome works with superannuation funds in the design, implementation and independent review of risk management frameworks and their components. This includes SPS 220 risk management reviews, design and implementation of accountability frameworks and risk culture assessments and framework design. Our advice is based on practical experience in how to transform how people manage risk, not just how they document policies and processes. Our experience, capability and approach result in tailored and efficient delivery which is further enhanced by deep regulatory knowledge. Our unique insights, blending deep regulatory and industry experience are highly valued by our clients.

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