Victorian Auditor-General’s report 
23 May 2012 
Management of Trust Funds in the Justice Portfolio
Audit summary
Background
The Victorian Property Fund (VPF) and the Public Purpose Fund (PPF) are among the largest trust funds managed within the Justice portfolio. At 30 June 2011, VPF held $328 million and PPF held $598 million.  
VPF is managed by Consumer Affairs Victoria (CAV), a division of the Department of Justice. Surplus funds that are not required for regulation or compensation may be used for a number of purposes allowed under the Estate Agents Act 1980, such as low-income housing and promoting property ownership. Unspent funds are invested.
PPF is managed by the Legal Services Board (LSB), a public authority established under the Legal Profession Act 2004. PPF provides money to cover the costs of regulating legal practitioners and to fund legal aid, the development of the legal profession and law reform, and grants for projects in legal education and research. 
The Centralised Treasury and Investment Policy was introduced in June 2009. The policy requires public sector agencies' borrowings and investments to be made through either the Treasury Corporation of Victoria or the Victorian Funds Management Corporation. Standing Direction 4.5.6, issued by the Minister for Finance under the Financial Management Act 1994, gives the policy legal force, but only for those public bodies that do not have specific investing powers under their own legislation.
The policy does not apply to:
·	agencies that have been granted an ‘exemption’ by the Treasurer
·	certain categories of funds, such as money held in trust for private beneficiaries, which the policy describes as ‘exceptions’
·	agencies with specific investing powers under their own legislation, unless the Minister for Finance or Treasurer agrees to include them. This amendment to the policy was made by the Minister for Finance in February 2011.
The audit examined whether VPF and PPF are fulfilling the purposes for which they were established and whether the management of the funds is sound. The audit assessed the oversight and management of investments, the regulation of the use of trust accounts, the management of grants from the two funds, and the application of the Centralised Treasury and Investment Policy. 
Conclusions
VPF and PPF are both well administered and effectively support the purposes for which they were established. Implementing the recommendations in this report will build on the solid management foundations already in place. 
However, the actions of both CAV and LSB demonstrate shortcomings in the Centralised Treasury and Investment Policy. Instead of a seamless policy and legislative framework that provides agencies with clear rules, responsibilities and guidance, the framework for centralising the investments of CAV, LSB and other public agencies is fragmented, inconsistent and ambiguous. 
The Centralised Treasury and Investment Policy: 
·	does not have legal force in the case of agencies with specific investing powers 
·	can, however, be applied to an agency with specific investing powers if there is a ministerial decision to do so
·	provides for two categories of exclusion—‘exceptions’ and ‘exemptions’—that are confusing and open to misinterpretation
·	allows agencies to enter into investing arrangements with the Victorian Funds Management Corporation but still control investment decisions, thereby failing to maximise the use of the corporation's investment expertise to reduce investment risk and costs across the public sector.
The Department of Treasury and Finance (DTF) has not achieved comprehensive compliance with the policy. It has therefore not achieved the policy's objectives, which include efficient and low-risk investment across the public sector.
CAV and LSB have both experienced difficulties with the application of the policy. CAV is meeting the policy's requirements but has not finalised an investment agreement with the Victorian Funds Management Corporation despite nearly three years of negotiations. LSB advised that it is ‘unwilling to voluntarily place investments with the Victorian Funds Management Corporation’ and considers that investing with the corporation would constitute a breach of its trustee duties. LSB was non-compliant with the policy until it was amended in February 2011. The amendment effectively removed the obligation for LSB to invest with the Treasury Corporation of Victoria or the Victorian Funds Management Corporation. 
Agencies such as CAV and LSB carry high prudential obligations as a consequence of the significant sums of money under their management. While some of this is private money held on trust, there are significant financial implications for the state if this money is poorly managed. A clear policy framework that can be applied to all agencies is required to guide the management of these investments. A comprehensive review is necessary to reset the policies, legislation and standing directions and strengthen public sector investment management.
Findings
Centralised Treasury and Investment Policy
DTF needs to review the guidance and assurance it offers agencies to achieve more effective compliance with the policy. Developing options for reforming the legislative framework would strengthen the treasury and investment management arrangements.
In February 2011, the policy was changed so that agencies with specific investing powers that were not already borrowing and investing through the Treasury Corporation of Victoria and the Victorian Funds Management Corporation were not subject to the policy. Ministerial approval is required for agencies with specific investing powers to be brought under the policy. DTF did not effectively communicate to agencies the change to the policy. 
DTF initiated arrangements for specialist third-party prudential supervision of the Victorian Funds Management Corporation in October 2011—two years after the policy was launched. However, DTF's prudential supervision of the Victorian Funds Management Corporation does not provide the same level of assurance to all agencies required to invest with the corporation. Those agencies required to invest with the Victorian Funds Management Corporation under the Borrowing and Investments Powers Act 1987 will receive detailed confirmation on their fund management. However, agencies complying with the policy will have to make their own arrangements to obtain the same level of assurance.   
The October 2011 performance audit report on TAFE Governance noted that improvements in the design of Standing Direction 4.5.6 were needed and recommended that DTF review the intended application of the standing direction. However, insufficient action has been taken to resolve these issues and the situation remains unsatisfactory. This is evident from the difficulties experienced by LSB and CAV in relation to the policy and standing direction.
Prior to the February 2011 amendment, PPF was not invested with the Treasury Corporation of Victoria or the Victorian Funds Management Corporation. LSB was therefore not meeting its obligations under the policy. The February 2011 amendment effectively removed the obligation for LSB to invest with the Treasury Corporation of Victoria or the Victorian Funds Management Corporation. 
However, in an apparent breakdown of communication between LSB and DTF, LSB applied for an exemption from the policy in June 2011. The Attorney-General’s office informed LSB that the policy did not apply to LSB and that no further action was required. LSB did not appropriately seek to understand on what basis the policy did not apply.
CAV's proposed agreement with the Victorian Funds Management Corporation for investment of VPF will meet the policy's requirements. However, CAV proposes to retain the power to make key investment decisions, increasing the risk that decisions are made without sufficient investment expertise. The corporation would be limited to performing a transactional role. 
CAV has adopted this position because it has not obtained sufficient assurance that the Victorian Funds Management Corporation's investment management is sound and wishes to have close oversight of all investment decisions. However, this approach will not maximise the policy's intended benefits of reducing investment costs and reducing investment risk by using the expertise of the Victorian Funds Management Corporation. Allowing public bodies to retain control of key investment decisions is at odds with the policy's intention and further adds to the lack of clarity for those agencies covered by the policy. 
Victorian Property Fund
VPF has met its investment targets in eight of the past 10 years. CAV has sound processes for assessing grant funding submissions. The main issue for CAV, besides finalisation of its investment agreement with the Victorian Funds Management Corporation, is the lack of an agreed strategic framework with DTF to guide the management of VPF and to inform its long-term investment. 
VPF holds $196 million in excess of what is required to meet its purposes. Over the past decade, the funds held in VPF have more than doubled. Between 2001–02 and 2006–07, the fund's income exceeded its expenditure by an average of $37 million. At 30 June 2011 CAV estimated that there was a surplus amounting to 60 per cent of the fund’s total value. This surplus will continue to grow under current granting levels and there has been insufficient analysis as to the most effective deployment of this growing surplus.
Expenditure from VPF is not wholly within CAV's control, as it is reflected in the state's Budget. CAV and DTF do not have a clear plan for managing VPF's large, increasing surplus. This will hamper efficient investment planning.  
Given the size of VPF, CAV should strengthen its oversight and risk management arrangements. Effective oversight will become particularly important when CAV transfers the day-to-day management of the fund to the Victorian Funds Management Corporation, as CAV proposes to retain responsibility for important investment decisions. Despite nearly three years of negotiations, CAV and the Victorian Funds Management Corporation have failed to reach agreement on the management of VPF.
Public Purpose Fund
Since it was established in 2005, LSB has set conservative objectives for PPF investment. Under its current investment plan, which was adopted in 2009, LSB has achieved its primary objective of avoiding loss of value. LSB has achieved PPF's targets for investment returns in all years except 2007–08 and 2008–09 due to the global financial crisis. 
LSB is thorough and diligent in its oversight and management of PPF investment. LSB has the expertise required to effectively interpret and challenge the information provided by fund managers and LSB's investment adviser. The fund is appropriately structured and invested to fulfil its purposes without containing excessive funds. 
LSB's investment plans, investment management and financial processes also demonstrate effective attention to risk. However, with increased uncertainty in the financial system since the global financial crisis, LSB needs to extend its management of investment risk by more actively planning for unfavourable contingencies. 
LSB's processes for identifying areas of need, assessing funding submissions and administering grants are well managed. However, funding from PPF varies each year as it is dependent on investment and interest income. This affects recipients of annual funding, particularly Victoria Legal Aid, which receives the largest component of funding from PPF. LSB made changes to the fund's investment plan in 2009 to improve the stability in investment income. 
Recommendations
Number	Recommendation	Page	
1.	Consumer Affairs Victoria should strengthen its oversight arrangements by:
·	improving the frequency and rigour of its Trust Fund Governance Committee's supervision of, and capacity to make investment decisions on, the Victorian Property Fund 
·	reviewing its external adviser arrangements
·	planning for contingencies where investment risks cannot be fully mitigated
·	setting targets and actively monitoring the timeliness of its consumer claims resolution
·	developing and annually reviewing a strategic framework for the Victorian Property Fund that provides the basis for efficient investment, together with the Department of Treasury and Finance.  	14	
2.	The Legal Services Board should: 
·	more actively monitor the fees it pays to fund managers to confirm that rates remain consistent with rates available in the wider market for fund management services
·	strengthen its readiness to respond to serious financial risks by undertaking contingency planning 
·	actively monitor performance against targets for timely response to consumer claims for compensation.	24	
3.	The Department of Treasury and Finance should prioritise developing advice to the government on reforming the policy and legislative framework to strengthen treasury and investment arrangements.	31	
4.	The Department of Treasury and Finance should, in the interim:
·	issue updated guidance on compliance with the Centralised Treasury and Investment Policy to better clarify the responsibilities of agencies 
·	issue improved guidance on the factors considered in deciding exclusions from the policy 
·	seek a sufficient level of assurance from agencies that are excluded from the policy on their oversight and controls
·	provide information on the findings of prudential reviews of the Victorian Funds Management Corporation and the credit quality of Treasury Corporation of Victoria investments to all agencies covered by the policy.	31	
Submissions and comments received
In addition to progressive engagement during the course of the audit, in accordance with section 16(3) of the Audit Act 1994 a copy of this report was provided to the Department of Justice, the Legal Services Board and the Department of Treasury and Finance with a request for submissions or comments.
Agency views have been considered in reaching our audit conclusions and are represented to the extent relevant and warranted in preparing this report. Their full section 16(3) submissions and comments however, are included in Appendix B.