Governance Bites #82: KiwiSaver and managed fund supervision, with David Callanan.

In this episode, Mark Banicevich talks to David Callanan about supervising KiwiSaver schemes and managed funds, which is like a separate layer of governance to the board of directors. David outlines supervision and custody, and how the supervisor interacts with the fund manager's board of directors. They discuss the key issues facing managed funds, and the macro-economic and societal issues facing fund managers. David also shares his advice for new directors. 
David Callanan General Manager of Corporate Trustee Services at Public Trust. He is a Fellow of the Governance Institute of Australia, and has been Chief Risk Officer at Public Trust, Tower Insurance, and RACQ Insurance in Australia (often including Company Secretary). He spent 4 years at PwC in Australia and London, and worked for the Citibank-State Street joint venture CitiStreet Australia for 6 years prior to that. 
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Transcript

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Hi, my name is David Callanan. I’m the general manager of corporate trustee services at Public Trust, here to talk to Mark again about funds management, the role of a supervisor, the role of a custodian, and overall, how we deliver great outcomes for New Zealand investors. Hi, welcome to Governance Bites. My name is Mark Banicevich, and as you just heard, today, it’s a pleasure to spend more time with David Callanan. David, thank you very much for your time. Thank you, and I’m really pleased you got the memo about the matching shirts. I know, I know. That was a really important thing for us to get right today. Public Trust colours, so you nailed it. I actually did think about that when I put it on. I thought, "Oh, I'm wearing Public Trust colours." We are here to talk about KiwiSaver and fund management supervision, because that’s one of the services that Public Trust offers, of course, is supervision to KiwiSaver schemes and managed funds. Can you tell us just briefly about supervision? I know you covered this a little bit last time we chatted. Yeah. But let’s just have an intro. Yeah, look, the role of a supervisor can also be labelled as the role of a trustee. So, and a trust is a legal entity that exists to look after the interests of underlying beneficiaries. And so, when it comes to the role of a supervisor, as it’s described in the New Zealand context, if you’re running a managed fund, a managed investment scheme, or a KiwiSaver fund, you are obligated to have a licensed supervisor. So Public Trust is one of three licensed supervisors for managed investment schemes in New Zealand, and effectively, we’re there to sit alongside the fund manager or the KiwiSaver provider and make sure that they’re delivering on the promise to, for those underlying investors. So to some extent, you’re almost acting like an independent governance entity, overseeing, and then you’re talking to the entity’s own board. Yeah. Yeah, that’s right. So we sit alongside in some ways the regulator who, along with the legislation itself, kind of sets the expectations and the parameters, the rules of engagement for the, in the market. So we sit, I guess, on a macro, from a macro lens, we sit quite closely with the regulator, and in fact, they call us a ‘frontline regulator’. Now, technically, I don’t think we are a regulator. We do sit on the other side where we’re very close to our clients, who are these fund managers or KiwiSaver providers, for instance, and by sitting alongside those entities, those boards, we’re able to get right into the details of how they’re delivering on their, as I said, on their promise. And when I say ‘promise’, it’s about the product that they’re delivering, running an effective and efficient business, because, you know, the burden of fees in these products is actually really important, as well. So ensuring that they’re efficient is also relevant. But we get, yeah, we get quite close to the managers, quite close to the boards, and we’re seen as a source of assurance. Independence, as you said, Mark, is really important to our role, and that’s the licensing regime that we operate under ensures that we fulfil that role independently. A bit off topic, and not really a conversation for today, but, you know, you mentioned the concept of a trust, which is really a legal construct, right. It has its roots in the law of equity in England. Kind of wonder what the structures are like in non-Westminster countries. Because, you know, with a trust, you have that the trustees are the legal owners of the assets of the trust, but they hold them for the benefit of the beneficiaries, of other people. So yes, it’s a really strange legal construct, really. Yeah, but I think it works quite well because, and something we were going to talk about, and I mentioned this in my setup piece, is the role of a custodian. And the role of - That was my next question. - the supervisor. Yeah, so the role of a supervisor and a custodian, in fact, in New Zealand, they’re woven together. So if, under a trust deed, and under the Financial Markets Conduct Act [2013], where you’re appointed as a supervisor, you are by default responsible for holding the assets, as well. And that is there to give that security, I guess, for the underlying beneficiaries or investors that it’s going to be held for safekeeping. And custody just means safekeeping, really. Yes. It’s a fancy word for a very simple concept. And so, as a supervisor, we are by default also the custodian. Now, in practice, and we will fulfil that role for our supervised entities. In practice, we, you know, little Public Trust in New Zealand, we don’t actually have the capability to act as a custodian for all types of assets. So we will, in fact, outsource some of those responsibilities, depending on what we’ve come to an arrangement with the relevant fund manager or KiwiSaver provider. And so, for instance, when that comes to our global assets, so if you’re investing in the US stock market, that would, if it was just the US stock market, we could probably set ourselves up to do that. But there’s no fund manager that keeps it that simple. So there’s always, you know, there’s Europe, and then there’s emerging markets, and then there’s different types of assets. You know, people love Japanese bonds or, you know, there’s always something that someone wants to do that’s different. So to manage all of that, we will outsource to a global custodian, one of those, you know, big global investment banks. BNP Paribas, Citibank, those sorts of companies. Yeah, so we work with, yeah, we work with those extensively. And again, that’s just to give confidence to the underlying investor that those assets have been kept safe. And, you know, the reason this regime exists in this way is because of failures of the past. Where there have been issues where fund managers or, you know, they weren’t even fund managers, effectively, they were just running their own bank account and investing it as they wish and, you know, able to just run off with the money or, you know, ultimately end up in, like, a pyramid scheme-type Ponzi structure where they keep investing and chasing their losses. So the structure that exists now works really well, because you have this safe, independent pair of hands that will nurture your asset, if you’re the investor or a KiwiSaver member, and we fulfil that duty fully independently, licensed, overseen separately by the Financial Markets Authority, take that role really seriously. I think it’s very effective. I can’t speak to non-Westminster jurisdictions, but certainly, I think what we have here is quite effective. I think it’s very effective. And, you know, I think one of the things a lot of New Zealanders don’t understand is that if a KiwiSaver fund manager were, for some reason, to get into financial trouble and collapse, you don’t lose your money because your money is held by a custodian, - That's right. - and it gets transferred to a new fund manager, essentially, to take over management. What would happen in practice is the supervisor would step in - Right. - to the shoes of the fund manager and ensure whatever decisions needed to be made, that there was a seamless transition. So yes, I mean, in practice, likely there would be some sort of a wrap-up and a transition into a new fund, particularly given the preservation rules that exist over KiwiSaver. So it’s a long-term investment. It’s there for either saving for your first home initially, but then more importantly, for your retirement. And so it’s in no one’s interest for that to be vulnerable to short-term challenges with a business that maybe has good intent but isn’t able to deliver on, as I said, that promise, which is a long-term outcome. Yes, so the risk for you, if you’re investing in KiwiSaver, is in the volatility of the assets themselves, but not in the fund manager in terms of that financial risk. Why is strong governance of KiwiSaver schemes important to investors? I think we’ve probably covered that a little bit, but let's. Well, yeah, we have previously, but to be honest, it all starts with governance. So, you know, governance is where decisions are made. And if, and I’m in the process at the moment, working with the just newly established Auckland Future Fund, and on that board, and we’re at the early stages of creating something from scratch, right. And so every decision we make now is going to have a very long-term legacy. So I mean, it’s a very obvious, in a microcosm to me right now, some of those setup decisions, how we deliver on those expectations for that, you know, long-term fund, will play out. But even on the day-to-day now with, you know, long-established, well-established businesses, you’re making, you know, your management team, but more importantly, your board are making some big decisions across the entire business. And so, as a supervisor, when we’re talking to the board, we bucket our conversations a little bit, because there’s so much to get your head around. So governance is the first, we call the ‘manager performance function’. So governance is the first cab off the rank if we’re having a conversation with the board. So, you know, that includes things like how they work closely with the management team and the chief executive, in terms of how they remunerate, how they engage, you know, the cadence of meetings, the agendas. But it then also goes down into the kind of traditional governance concepts, like policies and delegations and committee structures. And so that’s, governance is the first from a manager performance function, which is our language, is the first thing that we will focus on. There are a number of other areas we’ll look at. For instance, you know, for a fund manager, investment decision-making, - Of course. - that’s a specific pillar that we look closely at. We also look at the custodian and the operations of the fund administrator, also really important. So, as a supervisor, it does actually all start with governance, because that’s where the key decisions need to be made. Right. How does the supervisor, or the corporate trustee interact with the fund manager’s board of directors? What? Yeah, so all things going well, we don’t need to interact very often, because you’ll have, I guess, as an independent assurance source, you have the comfort knowing that we will come to you if something comes up. So if there’s a material risk or material issue, a breach, for instance, that’s when we might actually proactively engage with the board and say, “Look, we want to come to a session."We want to talk to you about what we’ve seen, any concerns we might have,"or at least to get a shared understanding of a commitment of what needs to happen to go forward.” So there is that element of there’s an escalation point if something’s not going well. But we do interact regularly in terms of just keeping connected, making sure that we understand where the business is going, and again, as I said, we want to understand how governance works within our supervised entities, because that’s the engine room for everything else that happens around it. Yeah. So it is at the heart of how we supervise. Right. Okay, thank you. Now, a fund manager will not just have, for example, a KiwiSaver scheme. They might have, they’ll probably have an unlocked scheme, as well. Yeah. They may do some wholesale investment, too. They may have some specialist funds or trusts for investment. So there’d be multiple investment vehicles that happen within a fund manager. What is the role of the fund manager’s board related to the investment, the investments themselves? Yeah, so there’s lots of different structures, business models for, depending on, for all sorts of different reasons. Our clients cover the full gamut. So you go from a bank, right, who have got, you know, extreme levels of governance and structure, but also resource to support, - Yes. - you know, complex business model design. And, you know, that comes with a burden of cost, but they have got the scale, I guess, to set that up. So probably we see the larger you are, then the more prone you are to making things more complex. Yeah. Whereas, you know, maybe some of our smaller clients, smaller fund managers, they’ve got a very direct and very explicit mandate that’s within, you know, they’re strongly founded in one product or one pillar. But then as they grow and are successful, they start to add more, add more complexity. And again, that’s where governance has to come to the fore, because every one of those small, micro decisions is adding complexity. And so ever more so, it becomes important to invest in your compliance function, your risk function, you know, have you got your eyes up, not just down, in terms of short-term, long-term. And yeah, I think that’s probably what we see, is the more complex it gets, the bigger you get, or sort of the bigger you get, the more complex it gets. You know, they kind of go hand in hand, and that introduces new risks. Right. So some of our clients take a very, you know, in terms of investment decision-making, there are some that have got a strong bent towards passive, which tends to be lower cost. Yes. And so those boards, their focus is with management, is really on picking the lowest cost, consistent passive investment manager. Whereas there are other clients of ours who, you know, they’ve got a bespoke product offering, which is quite active, and their clients want that, they want an active, they’re looking for a little bit more risk, and a return for that risk. So there’s no one-size-fits-all here. There are different, and then there’s blended hybrid versions, you know, across those extremes. We’ve got a client that’s recently, in fact, we’ve got two clients now who have got crypto funds. So cryptocurrency, an interesting asset type in itself, because, you know, let’s not get into that. I was called, on another podcast, I was called "TradFi", a "traditional finance person", and that’s probably a bit more alternative. But there’s an interest, there’s a desire for that kind of asset. Yes. So if you’re on the board of a fund manager and you see there’s a desire from consumers to get into that asset type, why not go there, as long as it’s done with the full disclosure and compliance, and it’s administratively set up really well. And there’s again, there’s a debate to be had about whether you should have crypto within your KiwiSaver, because that is a very long-term investment vehicle. But certainly, in terms of if someone’s going to put their own money aside into whatever kind of asset they want, then they should go for it, so long as there is these good structures that sit behind it. And we, as a supervisor, I guess, want to work alongside our clients and the boards to make sure they’ve got all of that well set up, that you know, your administration, your operations is operating effectively, you’ve got the right asset managers, if you’re outsourcing it, or investment managers, and that you’ve got good processes around disclosure, reporting, all of those things for your clients. So there’s lots of different ways to run, and invest, for a board. They need to understand their approach, hopefully reduce complexity, if you can. But there is always going to be a degree of complexity in a business, because you’re trying to compete in the market where you need to be slightly different from one another. So you need to understand your business, and then we, as a supervisor, hopefully bring that kind of holistic, over-the-top understanding to support those boards in making those decisions. Right. So, as you described, the board’s role, as you’d expect, the higher-level governance, the structure of the entity, the strategy of the entity, which may be decisions around what sort of funds to offer, for example, - Yep. - based on demand in the market. And then you’ll have an investment committee that will be overseeing the investment decisions themselves, and then your investment analysts in a - Supporting them. Yeah. Particularly in an active fund. In a passive fund, it’s more, as you say, about identifying the right manager and keeping the cost down. Yeah. Keeping the structure down. What are the key issues facing managed funds currently, and what do you do as supervisors in those areas? There’s a lot going on for the market at the moment. So in our previous discussions, I’ve talked about the role of the regulator, and they’re raising the bar, which is a good thing. So there’s quite a few things which managers are expecting to be investing in: frameworks, processes. You know, in particular, at the moment, we’ve got to focus on liquidity risk management, which is really important. That's right. So if you’re just investing in, you know, S&P 500 [Standard and Poor's 500, US index], there’s quite a high degree of liquidity in the market. But if you’re investing in property or other private assets, - Private equity. - yeah, so liquidity is, you know, really topical challenge for you to manage. So, you know, rightly, the regulator has set out some parameters that they need to meet in that space. And there’s and there’s lots of other areas like that where the regulator and supervisor, we’ve got a shared interest in the, you know, performance of these funds, and compliance of these funds. So other areas, climate-related disclosures and environmental, social, governance, [ESG] there’s a real focus on that, and conduct generally, which we spoke about in my previous podcast session. Value for money was a big focus recently. So whether you’re active or passive, doesn’t really matter, you need to be able to tell a story that your product delivers a good, valuable service for the fees. Yes. And where there are performance fees associated as well, that bar is even higher. Have you earned those fees is kind of the question that gets asked. So those are all challenging questions for fund managers to navigate. And then the biggest challenge right now is actually one of scale. So in New Zealand, we’re actually relatively small. I mean, no surprise. Very small. Yeah. But the funds management and our retirement savings sector is also very small on global standards, you know, particularly compared to Australia. The superannuation regime has been operating for longer, higher contribution rates, considerable success in terms of growth, and they’re able to invest as a result, in those businesses. Now, they have their own challenges, but I would rather have the challenge of being too big and having a huge amount of influence, you know, politically and in terms of the economy, over there. Here, that influence is much smaller currently. And in fact, New Zealand’s dependence on the New Zealand Superannuation Fund in the long term is becoming more and more apparent. So great decision to set up that fund, but we’re going to be leaning on that more and more, and less KiwiSaver, as a vehicle, or other types of private savings vehicles, can really get to scale. And so I think that’s a big challenge for fund managers. Currently, we’re squabbling over our share of market, but actually, we need to join together a little bit. Grow the market. And get the size of the pie, rather than fighting over our slice. The pie needs to get bigger. Absolutely. And so I think that’s probably the biggest challenge, alongside navigating some, you know, regulatory, you know, managing those internal-facing challenges. I think the bigger challenge is one for New Zealand to lean into. Yeah, and that’s not just, I know from the view of the manager, it’s also from the view of the investor, as well, right. Because, you know, research tends to show that investors should be putting in 12% to 15% of their salary from the day they start working till the day they retire. Australia has moved up to what, 12% or something now? Nearly there. Yeah, next year. Next year. And New Zealand’s on 3 plus 3. So we’re not investing enough to save for our own retirements. So, as you say, there’s still this need to lean on New Zealand Super, and hopefully, the push will happen where those contribution rates will increase so that Kiwis can retire on a much more comfortable footing than they will at the moment. One of the challenges there is that, of course, the people that are making the noise around this are fund managers, and it’s very easy for people to point the finger and say, “You’re just doing it in your own interests.” Self-interest, yeah. It’s really not the case. We have to be doing this for society in general, which does bring me on to my next question. What are the macroeconomic and societal issues that you’re gripping with as a supervisor, that fund managers are gripping with? Yeah, I mean, that is, the retirement adequacy gap is the macro issue for our sector, and in fact, I think for the economy. If we’re going to look ahead 5, 10, 15, 20 years, what’s the legacy that we as market participants right now are going to leave? And I think, again, you can always look to the Australian example, but it is a really good example. Absolutely. Where you had a Labor Party over there, and it’s not about the politics, it’s about the decision that was made, kind of selfless decision, to invest some political capital in a retirement scheme, in the superannuation. Early 70s, wasn’t it? [No. 1992.] More recent than that, I think? Yeah, I mean, 80s and into the 90s, I remember Bob Hawke and Paul Keating. I'll have to look it up. So, and they started small, like KiwiSaver did. And I think it was the plan with KiwiSaver here, too, was for it to keep growing. Yes. But it sort of got cut off at a certain point. But that took political capital, right. And so I think there either needs to be an investment of political capital in New Zealand to really tackle it, or there needs to be a groundswell. And I think that’s where the fund managers, and also individual investors, need to be taking personal accountability for their own retirement adequacy. So I think that is for me, right now, that is the thing that I think about the most. There are other challenges as well, you know, that when you have, let’s just talk about KiwiSaver, if you have $100 billion, do where do you invest that money to get big bang for buck in terms of the economy? And, you know, there are some investors, some fund managers, KiwiSaver providers right now that are finding some unique ways to invest that money to get multiple benefits. So very basic ESG investing would see you exclude certain types of assets - Yes. - to get a good ethical or environmental-type outcome. But impact investing is now coming, is growing very, very, it’s progressing anyway, it’s probably not as fast as it could. But what that means is that people are able to see their retirement savings doing good. So whether that’s supporting CHIPs [Community Housing Improvement Program], you community housing, infrastructure development projects, whether that’s investing in homes for the homeless or lower-cost, you know, houses for, you know, build-to-rent type programs. They all have risks, but they also are mechanisms to use capital for potentially good in New Zealand. So I think there are lots of ways that this$100 billion in KiwiSaver, but even more broadly, we can and probably should be investing to get those multiple benefits. And that might include, and this is something that that certainly from a policy perspective is under discussion, more investment in New Zealand private assets, because we’re because we are so small. Why do we send all of our money offshore? Why not invest in some local businesses and create that self-fulfilling local economy while we continue to grow at scale? You may as well utilise that capital locally. While balancing that with diversification. Yeah, absolutely. Having a small allocation to New Zealand, but even a small allocation on $100 billion is a reasonable sum of money. Yeah, right now, it’s microscopic. So there is some, definitely some room for that opportunity to be exploited, whether we’re talking impact investing or private assets. Yeah, infrastructure, and so forth. And well, to be honest, that’s the big conversation, which is yeah, infrastructure. So public-private partnerships, - Yes. - very successfully, industry funds in Australia have had a massive, delivered a massive change program in terms of infrastructure. I saw over the weekend that the most successful public infrastructure project is in Sydney. It’s one of the Transurban or Urban Link tunnels. And so it’s just printing money right now. Yes. And that’s owned by industry funds. Wow. And so, but that’s an infrastructure, like, that delivers great economic benefits for Sydney. Absolutely. As well. So I think that that infrastructure opportunity, the more we can lean into that in New Zealand, then, you know, the more we can make the economy thrive. Absolutely. What does good look like when it comes to funds management, and how does governance fit into what good looks like? That’s a very broad question. What does good look like? I think it starts with governance. So a strong board that understands its business will, and gets good information, will make better decisions and drive good outcomes for the customers, the consumers. So governance is at the heart. Good also means good conduct, which we’ve mentioned previously, investing in compliance, investing in systems and tools, because I think we run the risk, particularly in little old New Zealand, where the number eight wire, kind of, you can only get so far with that, right. And there’s a point that, particularly if you’re talking about a long-term investment vehicle, you need to set things up for the long term. So it takes that upfront investment and commitment. So to me, "good" really looks like thinking about those longer-term outcomes. And I think I also reflect on Public Trust’s legacy. So we’ve been here for 150 years, and what good looked like 150 years ago is different to what it looks like now. But what was happening back then was a focus on vulnerable customers. It was a focus on setting things up for the longer term. So when Public Trust was founded, the world was a very different place, but some of those basic principles, I think, still apply now. So if you’re setting up a business in a way that you’re going to be fit for purpose and ready to deliver for consumers, particularly our most vulnerable consumers, over the long term, then I think you’re more likely to be successful, than if you’re focusing purely on short-term financial, you know, just driving towards a low-cost, high-revenue model, which, you know, delivering dividends, - Yes. - I think you get perverse outcomes. And good conduct, good governance, will ensure that you can deliver good shorter-term outcomes while delivering on a longer-term outcome. Right, well, that’s a great answer to quite a complex question. Thank you. A final question for you. What advice would you give to a new director? Okay, good question. So I’m actually, I’ve just become a new director, as I mentioned before, on this Auckland Future Fund. It’s slightly different because we’re all new directors. But I have been thinking about this. I think you need to understand the business model. I think I may have already said this, as well, but if you’re coming in, particularly to an established organisation, and you’re going to be asked to contribute to, or make, big decisions for the outcomes, not just for your business, but for those underlying customers, consumers, investors, KiwiSaver members, in the case of KiwiSaver funds, you need to understand the business model and the levers that you can pull to adjust the outcomes. So one of the ways that you can do that, obviously, spend some time with the management team, with the chief executive, ask good questions, don’t think, don’t come in knowing the answers, ask good questions, be open-minded as to, you know, what the, what good looks like in that context. Then the other thing that I would say is you can also lean on the advice of other stakeholders. So have a chat with the supervisor, have a chat with the auditor, and do that without management, because then you’ll get the kind of real story. So those are good shortcuts. So you could spend hours reading policy documents and annual reports, and you know, all that sort of stuff, but it’s the conversations that you have with the people that are involved with these businesses. You could even speak to key service providers. What’s that experience look like for you? What are your challenges that in navigating your relationship with this entity? So I think a new director has a unique opportunity to come in without the biases of the past and to be informed about what this organisation is doing, both in terms of the detail of the deliverables for those investors and the short-term performance, but also how they’re setting themselves up for success, who they partner with, what they’re saying when the board’s not in the room, you know, what’s the culture of the place. Talk to some staff. Yes. I know Craig Stobo's just recently become the chair of the Financial Markets Authority, and he’s spent a huge amount of time with the staff to get to know them. And, you know, so he could just spend time with Samantha Barrass, the CEO, and of course, he’s done that. Yes. And she’s a great operator. He’s got a lot from, of course, engagement with that executive team. But also, he said, “No, I want to hear from the staff,"and I want to hear from market participants.” And he’s also going offshore to talk to, you know, what are the equivalent competitors do - well, not competitors - what’s happening in other jurisdictions? So I mean, that's a shout-out to Craig, he’s spending a lot of time there. And that’s a new chair, as opposed to just a new director. Yes. But as we've spoken about previously, you know, as the chair, you’re the captain of the team, so that role is hugely important. So having those conversations builds up, I guess, that deeper understanding of how the organisation operates in reality. So that you have that foundation to then look forward as to what decisions need to be made for the longer term. That’s really valuable. Thank you very much, David. I really appreciate your time today. Hopefully, we’ll get a chance to catch up again soon. Yeah, sounds good. We’ll see you next episode. Thanks, Mark. Thank you for watching this episode of Governance Bites. We have more episodes on YouTube and your favourite podcast channel, where I interview directors and experts on various topics relating to boards of directors and governance. We’d love to see you back, and please like, subscribe, and share the videos and podcasts.