TURKALERT 9 August 2010
Valuation Vigilance - Is your Due Diligence up to Scratch? Summary Last week, APRA wrote to superannuation fund trustees advising them to exercise increased vigilance in relation to the valuation of unlisted investments. APRA has warned that it will be looking for evidence of this increased vigilance in its prudential reviews of trustees. In this TurkAlert we analyse the impact of APRA’s letter on trustees. We also set out some of the issues that trustees should consider in ensuring that their governance and due diligence processes are consistent with APRA’s stance on the valuation of unlisted assets.
Who Does this Impact? Superannuation fund trustees Legal and compliance personnel Internal and external auditors Investment managers
What Action Should be Taken? Superannuation fund trustees should consider the impact of APRA’s letter on their governance and due diligence processes regarding the valuation of unlisted assets, including operational due diligence in relation to their service providers.
In its letter of 4 August 2010 to superannuation fund trustees, APRA has unequivocally stated that it expects trustees, their valuation experts and auditors to exercise increased vigilance to protect member interests in relation to the valuation of unlisted investments. APRA has said that it will be looking for evidence of this increased vigilance in its prudential reviews of superannuation fund trustees. Specifically, APRA has stated that trustees should ensure that there is a strong governance framework for valuations. This framework includes oversight by the Board and relevant committees, clear segregation of duties, soundly developed and documented policies and procedures and robust implementation. The valuation process itself needs to take into account the risks posed by the valuation methodology, the underlying assumptions and the use of modelling. APRA has stated that trustees should understand, and, where necessary, query the underlying bases for valuation, even when valuations are furnished by experts. Trustees also need to consider equity issues between members when determining the suitability of an unlisted investment and its place in the fund.
What does this mean for superannuation fund trustees? GOVERNANCE AND DUE DILIGENCE Trustees should check now that their due diligence processes reflect APRA’s call for increased vigilance. For unlisted investments, this means that, at a minimum, trustees need to review: •
their delegations to the relevant committees (including investment committees) and internal personnel;
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the terms of engagement of external experts including valuation experts and auditors; and
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their due diligence policies and procedures, including relevant checklists
to make sure that proper account is taken of the relevant issues relating to unlisted investments. These include: •
the structure of the investment in question and the extent to which underlying layers of investments can be monitored by the trustee;
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the transparency, independence and robustness of the valuation process;
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the adequacy of the trustee’s resources to evaluate and manage such investments (including allocation of roles to experienced staff with the appropriate level of expertise);
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the adequacy of the trustee’s understanding of the nature and characteristics of the underlying investments; and
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whether the trustee can drill down to the level of constituent assets, when the trustee will do this, and whether appropriate evidence is retained when the trustee does this.
Trustees also need to check whether their processes allow for the consideration of the appropriateness of: •
offshore investments and the valuation bases used for them, given that these may involve reduced transparency; and
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the underlying assets of downstream investments where the downstream manager relies on ‘confidentiality’ as a reason not to reveal the underlying assets.
The trustee needs to ensure that appropriate evidence of the due diligence processes is retained.
VALUATIONS BY INVESTMENT MANAGERS Where the trustee relies on a manager to provide valuations, the trustee needs to make sure that the manager’s valuation principles and processes are appropriate. The trustee needs to assess the manager, both on the initial engagement and on an ongoing basis, on a range of considerations including the manager’s: •
risk management framework;
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resources and infrastructure;
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standards of conduct and investment discipline;
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segregation of duties within its operations;
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relationships and capabilities to source details of underlying assets; and
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level of disclosure.
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Trustees need to check that their due diligence processes and checklists reflect this assessment and that appropriate evidence is retained.
VALUATION AUDITS Where the trustee engages an external auditor to provide valuation reports of downstream investments, the trustee’s due diligence on the valuation process needs to have regard for both the audit engagement letter and the audit report itself. In the audit engagement letter, the trustee should check that proper account is taken of: •
the scope of the valuation audit;
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the auditor’s independence and how any issues are to be addressed (including by notifying the trustee immediately); and
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the measures to prevent forum shopping.
In reviewing the auditor’s valuation audit, the trustee should check: •
the basis of the audit opinion and whether it reflects the scope of the valuation audit;
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within a qualified valuation report, the exceptions noted and their significance to fund members; and
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how any issues relevant to the auditor’s independence have been addressed.
The trustee should also take into account the results of any other reviews conducted outside of the audit process. Paul Cleary has considerable expertise in the provision of specialist financial services and would be pleased to offer strategic superannuation legal advice.
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For more information, please contact: Paul Cleary Partner T: 02 8257 5760 M: 0407 052 170 paul.cleary@turkslegal.com.au
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