2008 Operating Framework
1.
Introduction
1.1 Each year,
shareholding Ministers lay out their expectations for the CRIs for the
coming year in the form of the Operating Framework. This is the 2008
Operating Framework. Shareholding Ministers will assess the performance and
actions of the CRIs against the expectations in this Operating Framework.
2.
The policy environment
2.1
The government’s overarching objective is to transform the New
Zealand economy and society towards a more knowledge-based and innovative
future. The Economic Transformation Agenda and its predecessor, the Growth
and Innovation Framework, provide the strategic direction in progressing the
goal of moving New Zealand’s economy into the top half of the OECD. Other
documents support that strategic direction, including the recently consulted
New Zealand Research Agenda. Science and technology continue to exert
increasing influence, to assume greater importance to the economy and
society at large, and to receive growing attention. These trends will
continue.
2.2
Over the past eight years, many new initiatives relevant to science
and technology have sought to advance the Economic Transformation Agenda,
and some initiatives from even earlier times have been embraced and
advanced. It is a long list, across the research, science and technology,
tertiary education and economic portfolios, as well as immigration,
agriculture and forestry, fishing, telecommunications, finance, commerce and
inland revenue portfolios. In addition, there have been substantial changes
within the private sector. The totality of these changes has been
significant; equally, no-one suggests that they are yet sufficient.
2.3
The importance of sustainable development to New Zealand, and our
understanding of how to progress the concept, has also markedly advanced.
Sustainability is now firmly embedded in our direction of travel, and will
remain so. Primary production has continued to assert its role as the
engine room of our economy and we have also seen a rapid emergence of the
role of Māori capital and of Māori involvement in general in our innovation
system.
2.4
This broad policy environment is unlikely to change over the next
twelve months. That said, some existing or nascent initiatives will be
advanced, in some cases a lot.
2.5
The three key innovation portfolios have recently been grouped with
one Minister, for the first time.
3. Why the government owns CRIs
3.1 CRIs represent an internationally unusual
construct, which is necessarily multi-faceted in its aims. The government
owns and invests in CRIs because of the strategically critical role they
play in translating research into benefits for New Zealand – benefits such
as more innovative and competitive firms, enhanced environmental
sustainability, and better informed public policy.
3.2 CRIs have a critical and increasing role
in the development of the New Zealand innovation system. They contain
strategically important research skills, often uniquely, in efficient and
effective institutional forms. They maintain and enhance capability in
existing and new areas of economic, environmental and social importance.
3.3
Ministers have the following expectations of CRIs:
·
to act as strategic partners with
government and to pay close regard to government policy
·
to pay close attention to existing and
emerging national needs in their own strategic planning
·
to maintain strong links with the sectors
to which they are aligned
·
to lead and inform debate and to offer
policy refinement, in areas where they have expertise.
3.4 As CRIs continue to grow and mature they
will continue to become more different from one another in their funding
sources, their modus operandi and strategic outlook. Ministers welcome this
increasing diversity.
3.5
Whilst the government has placed substantial emphasis on the
importance of commercialising technology, and will continue to do so, it is
the public good aspects of CRI capability in particular that make public
ownership both sensible and vital.
3.6
CRIs have obligations to their staff, around 60% of whom choose to be
members of the PSA. The government and the PSA have had, for eight years,
an agreement known as Partnership for Quality. It is a mature, functional
relationship. Shareholding ministers expect the aims of the agreement to be
evidenced in the principles of engagement, good faith and respect. This is
best assured by the development of a formal agreement between a CRI and the
PSA that sets out the means and nature of engagement including a work
programme.
4. Government investment
4.1
When the CRIs were established in the early 1990s a policy imperative
was to increase flexibility, and funding was therefore very substantially
contestable. Additionally, the CRIs were invited to increase their private
sector business and have done so with considerable success. However, this
flexibility may have been at the expense of stability or the maintenance and
enhancement of capability. As time passed it became apparent that we needed
to alter the balance of investment mechanisms, or accept sub-optimal
capability.
4.2
This has been the origin of a range of changes, including the
introduction of capability funding (including backbone funding), the move to
longer-term outcome-based investment and the role of negotiation for some of
the nation’s science, particularly where there is an emphasis on public
good.
4.3
Governors and managers of CRIs have adapted quickly to these
investment changes. However, it is not clear to shareholding Ministers that
CRIs have necessarily completed their adaptation, given that many investment
and disinvestment decisions are now internalised within the company.
4.4
Shareholders urge CRIs to satisfy themselves that they have very good
processes in place to manage this increase in responsibility. This may
involve, for example, focus of a CRI’s activities on fewer fronts.
5. Intellectual property (IP) and commercialisation
5.1 Ministers continue to hold the strong view
that directors should pay as much attention to the company's IP as they do
to human and physical capital.
5.2
Several obligations on directors thus arise.
·
The IP policy of the company should be kept
under active review. For the avoidance of doubt, Ministers are comfortable
with policy that allows an individual or group of employees to materially
benefit from their intellectual contribution.
·
The IP portfolio of the company should be
continually identified and managed.
·
The commercialisation of IP is a company
function, and can take one of many pathways, but CRIs should not ordinarily
be long-term majority owners of commercial ventures.
·
Whilst commercialising IP may entail
assisting an existing private sector entity, or even incubating a new
entity, CRIs should not provide their IP at a devalued rate that makes it a
hidden subsidy for private entities.
5.3
Obligations on the government also arise.
·
Commercialisation may stress a company's
balance sheet. The Equity Investment Fund has been created and is
responding to well developed proposals to address that stress.
·
The government has an obligation to
continue to identify and eliminate impediments to the efficient
commercialisation of IP from CRIs, as seen, for example, in recent changes
to the Pre-Seed Accelerator Fund to allow an increased proportion of
commercialisation funding to come from government.
5.4
In commercialising CRI technologies, wherever possible the chosen
pathway should be in the company’s interest and New Zealand’s interest
simultaneously, particularly where international transactions are involved.
CRIs should be guided by the following criteria. They should:
·
partner effectively with industry as
early as possible
·
maximise wider benefits to New
Zealand
·
aim to ensure ongoing earnings to
New Zealand
·
aim to anchor within New Zealand any
technology transferred
·
consider wholly owned subsidiaries
where industry partners are not immediately available, with a view to
seeking such partnerships downstream as the business consolidates.
6. Collaboration
Onshore
6.1 Interconnectivity lies at the heart of a
successful innovation system. Conversely, introversion and a company-only
focus are costly to New Zealand.
6.2 Ministers acknowledge the many
collaborative successes of CRIs over recent years: with other CRIs, with
universities, with research associations and with industry sectors and
individual private entities. The New Zealand innovation system is starting
to thicken. CRIs have often been the change agents in such collaborations.
Linkages between CRIs, firms, and tertiary education institutes are
extremely important and the CRIs are encouraged to work to increase the rate
at which knowledge is applied for New Zealand benefit.
6.3
One opportunity for collaboration which the CRIs are using well is
the role of CRIs as supervisors of post-graduates. As PhD student numbers
climb quickly, CRIs are encouraged to continue to fulfil this role.
6.4
A second, substantial opportunity for collaboration, or for business
per se, is the forthcoming taxation changes to R&D. Shareholders expect
CRIs to be well familiar with these changes but it is worth underscoring the
amount that the Inland Revenue Department expects to forgo for this 15% tax
concession. It is $630m over four years, on a rising profile.
Offshore
6.5 Science and technology continue to
internationalise. Whilst strong international collaboration at the
investigator level is the norm, institutional collaboration and governmental
collaboration are sometimes less advanced. CRIs should, therefore, continue
to seek opportunities for international collaboration.
6.6 Australian, North American and European
collaboration is now becoming more material at the institutional and
national level, and there are growing links with Korea, China and Japan.
Similarly, international investor interest is increasing, as is the use of
international advisers by institutions, though the latter may yet be
underutilised.
7. Performance
Non-financial performance expectations
7.1 While financial viability is an underlying
requirement for the CRIs, their contribution to New Zealand’s economy,
society and environment is the fundamental reason for continued public
ownership. Achieving, measuring, and reporting on aspects of non-financial
performance such as (but not limited to) science excellence, good employer
practices, and technology transfer activities is expected.
Financial performance expectations
7.2
CRIs were established to operate commercially, in a commercial
model. CRIs should, therefore, ordinarily achieve a rate of return at least
equivalent to their cost of equity. Few do so, consistently. Directors
should note this, because the reason for such a target is to maintain the
integrity of the company. CRIs are an integral part of New Zealand’s
institutional fabric.
7.3
That said, CRIs may, and do, seek extraordinary strategic investments
that lower their rate of return for temporary periods.
7.4
In summary, Ministers ordinarily expect a rate of return at least
equivalent to the cost of equity, but are open to receiving business plans
that achieve less than that, extraordinarily. Either way, Ministers expect
complete financial transparency.
7.5
With regard to debt levels, Ministers expect CRIs to carry out an
externally endorsed review to identify a tailored capital structure target
dependent on each company’s risk/return profile, and to update that target
as the company’s profile changes materially. Failing such a review,
Ministers expect CRIs to structure their balance sheets to achieve a net
gearing ratio of 30% (subject to one month's cash operating expenses), as
long as a minimum interest cover of 3.0 is maintained.
7.6
If a CRI seeks to internally reinvest in science, it is welcome to do
so as long as shareholding Ministers are advised in advance and agree (this
can be achieved through the annual strategic planning round), and so long as
that investment itself does not jeopardise the company’s long-term
viability. Indeed, reinvestment is expected to result, in the long term, in
genuine returns to the CRI and to the wider economy. Some high-risk
reinvestment is, nonetheless, particularly welcomed, as long as boards have
excellent processes in place to manage risk, including exit strategies where
projects have little chance of success.
7.7
When companies have no clearly identified sound investments they
should forecast the payment of a dividend to shareholders to maintain their
expected capital structure. Dividends will be retained within the
innovation system, including to augment the Equity Investment Fund for CRIs.
7.8
That said, the Crown does not own CRIs in order to generate dividend
flows. If the board has sound investment opportunities they should be
progressed.
Hon Pete
Hodgson
Minister of Research, Science and Technology
March
2008
