19 October 2000
Speech Notes
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
Good afternoon.
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 functions,
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.
ENDS