Accountability: A New Regime for APRA Regulated Entities
Accountability goes to the very heart of organisational culture. Where appropriate consequences are not applied in respect of non-compliance and ethical misconduct, the organisational culture can be expected to further deteriorate and foster poor customer outcomes and risk events with the potential for significant reputational damage. There were many examples of this showcased in the hearings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (FSRC).
The Treasury of the Commonwealth Government of Australia (The Treasury) released a discussion paper on 22 January 2020 on the proposed introduction of the Financial Accountability Regime (FAR). The discussion paper follows the Government’s announcement on 4 February 2019 that the Banking Executive Accountability Regime (BEAR) would be extended to all entities regulated by the Australian Prudential Regulation Authority (APRA) and be jointly administered by APRA and the Australian Securities and Investments Commission (ASIC), in response to FSRC recommendations 3.9, 4.12, 6.6, 6.7 and 6.8.
The key differences between FAR and BEAR include the:
* Broader set of relevant entities to which the FAR applies.
* Introduction of ‘core’ and ‘enhanced’ compliance entity classifications, with no accountability maps and statements being required for the former.
* Joint administration by APRA and ASIC, rather than APRA only.
* Broader range of penalties that can be applied by regulators, rather than disqualification only.
The FAR will operate in conjunction with a number of other developing regulatory frameworks, including APRA’s Cross Industry Prudential Standard 511 Remuneration (CPS 511) and ASIC’s Design and Distribution Obligations (DDO).
The discussion paper does not provide an indication of the timeline for implementation of the FAR, but these details are expected to be announced in conjunction with the pending draft legislation.
The FAR will replace and extend upon the BEAR for banking institutions, which became effective for major banks from 1 July 2018 and smaller Authorised Deposit-taking Institutions (ADIs) from 1 July 2019. The FAR will apply to all APRA regulated insurers (including private health insurers who were excluded from the FSRC) and superannuation trustees, as well as licensed Non-Operating Holding Companies (NOHCs).
As this change has been anticipated since the release of the FSRC Final Report, many insurers and superannuation trustees have already commenced their preparations for complying with a BEAR style regime. APRA regulated entities at the larger end of the market and those under heightened regulatory scrutiny as a result of the FSRC are relatively more advanced in their preparations. A number of entities have not commenced any formal preparations, given the sheer volume of regulatory change and the limited resources available to progress risk and compliance initiatives.
The FAR will not extend to financial services organisations regulated by ASIC only. A further extension of the FAR to all ASIC regulated institutions may be the subject of a subsequent discussion paper, following implementation of the current proposals. However, some large ASIC regulated institutions with a strong risk and compliance culture and commitment to progressing towards better practice have commenced work in relation to their accountability frameworks.
Core and Enhanced Compliance
Enhanced compliance entities include all ADIs and superannuation trustees with over $10 billion in total assets, all life insurers with over $4 billion in total assets, and all general and private health insurers with over $2 billion in total assets. It is proposed that exemption powers will exist to enable particular entities or classes of entities to be reclassified from enhanced to core compliance entities. The small, medium and large classifications associated with the BEAR will fall away upon the transition to FAR.
Following the learnings from the BEAR implementation and the regulatory impact borne by smaller entities, only enhanced compliance entities will be required to complete accountability maps and statements. Core compliance entities will be required to review accountabilities within their business operations and assign specified accountabilities to identified accountable persons, an exercise which a number of ADIs and other entities have found beneficial.
Under the FAR, 40% of the variable remuneration of any accountable person’s total remuneration must be deferred for four years, unless the amount to be deferred is less than $50,000. This simplifies the approach adopted under the BEAR regime, which involved differing calculations of deferral amounts based on total assets of the institution.
APRA’s remuneration requirements apply in addition to the FAR / BEAR regimes, and are currently under further development within the construct of CPS 511, which will replace the relevant provisions in CPS 510 once finalised.
The standard remains subject to rework at present following substantive industry feedback and further consultation processes, particularly in respect of the 50% cap on financial metrics in the calculation of variable remuneration. Further commentary is available within our prior blog post on this topic at: https://www.halladvisory.com/single-post/2019/The-511-on-
Product Design and Distribution
In June 2019, in response to FSRC recommendation 1.17, APRA consulted on a modification of the BEAR to require the assignment of end-to-end product accountability as part of the accountability framework. The requirements for assignment of the product accountability will now be implemented under the FAR for all APRA regulated institutions.
The product accountability requirements under FAR and the joint administration of the regime by ASIC dovetails neatly with ASIC’s new DDO regime that applies from 5 April 2021. The DDO regime requires financial product issuers to develop financial products that meet genuine customer need and structure their distribution arrangements to ensure that financial products are appropriately matched with relevant target customers. ASIC recently released a draft Regulatory Guide on 19 December 2019, as part of Consultation Paper 325 Product Design and Distribution Obligations, which delves into their expectations of licensees in this regard.
Further, The Treasury released draft legislation on 31 January 2020 in respect of the prohibition of hawking of all financial products, including insurance and superannuation products, in response to FSRC recommendations 3.4 and 4.1.
The combination of these changes, in addition to the product intervention powers now held by ASIC, will act to lift the bar for financial product issuers when developing and reviewing their product offerings and distribution arrangements. They will also enable entities and regulators alike to take appropriate remedial action to enforce accountability as issues are identified.
The FAR will be jointly administered by APRA and ASIC, with a broader range of penalties available for application, including civil penalties or fines, in addition to the existing disqualifications powers. This will allow for more proportionate action across a broader range of conduct, and the ability to influence culture before conduct warranting disqualification emerges.
The FAR announcement also coincides closely with the release of draft legislation by The Treasury on 31 January 2020 in respect of the revised roles of superannuation regulators. ASIC will be empowered to take action in respect of a broader range of conduct of superannuation trustees, either within its own right or in conjunction with APRA, while APRA continues its role as the prudential and member outcomes regulator. To facilitate, modifications to the Corporations Act 2001, the Australian Securities and Investments Act 2001 and the Superannuation Industry (Supervision) Act 1997 will be made, and a new class of financial service in Providing a Superannuation Trustee Service will be created.
The combination of these changes will equip the key financial regulators with a broader toolkit of powers to respond to misconduct as and when its identified and bring the responsible entities and individuals to account. It also provides regulated entities with further impetus for enhancing their governance, culture, remuneration and accountability frameworks.
During a speech to the Australian Institute of Company Directors Breakfast on 20 February 2020, APRA Deputy Chair Helen Rowell noted the ability of entities to use external advisors to facilitate, provide structure, and challenge internal dialogue in the development of accountability frameworks, while reiterating the expectation that entities maintain ownership of the process and documented outcomes.
Please get in touch if you’d like to receive further information on our service offerings in this regard and discuss the implications of the regulatory developments canvassed above in more detail.