The APRA capability review has recommended that APRA focus more intensely on governance, culture and accountability (GCA) in the financial sector and have the power to veto director and executive appointments.
The findings of the APRA capability review, led by Graeme Samuel AC, were published on 17 July 2019 and can be found here.
The review found that APRA has a strong track record in matters of maintaining financial safety and stability but should focus more intensely on GCA in the financial sector. The review also called out APRA’s internal culture and regulatory approach, noting that both need to change.
APRA Chair Wayne Byres has said the review was a “welcome endorsement” of his existing corporate plan and has outlined an action plan to address its 19 recommendations. The government has also pledged to implement its five recommendations.
Since then, APRA has released a draft prudential standard to strengthen remuneration requirements. An overview of the draft remuneration standard can be found here.
Key governance recommendations
The key governance recommendations relevant for directors of financial services entities include that:
- The Government should consider providing APRA with a non-objections power to veto the appointment of directors;
- APRA should enhance its supervisory and policy frameworks, including to embed the recent entity self-assessment process making it a biennial requirement and making self-assessments and APRA’s assessment of each publicly available; and
- APRA should depart from its behind closed doors approach in favour of greater transparency.
Non-objections power to veto director appointments
The review panel comments that the recommendation for APRA to have a non-objections power to veto directors will bring APRA into line with international regulators (such as NZ) and strengthen its capacity to pre-emptively regulate GCA risks.
Following the review, Mr Byres commented in the media that it would create a moral hazard and an administrative burden for APRA that may make it unworkable. However, Treasurer Josh Frydenberg has since said that APRA has agreed to accept all recommendations, including the non-objections power, and that APRA will be provided with additional funding to carry out its expanded role.
Although the panel noted that the power should only be available where the risks associated with an entity warrant it, the AICD is of the view that the proposed power creates a potential moral hazard whereby APRA might be considered responsible for the quality of the board and management of regulated entities.
Further, the AICD is of the view that the current system which includes a self-assessed fit and proper person test for board and executive roles and APRA’s power to disqualify individuals is sufficient. This is critical so as not to confuse the responsibilities and accountabilities of the board with the prudential regulator.
Intensified supervision of culture
The recommendation that APRA should embed the recent entity self-assessment process (which suggested widespread governance weaknesses in 36 regulated entities) biennially raises concerns. Particularly the prescriptive set of questions proposed and publication of each self-assessment, thematic review, and any rectification requirements.
Rather than promoting better standards and transparency, the AICD queries whether entities may approach the exercise through a compliance rather than good governance lens (creating a defensive, legal mindset rather than one of continuous improvement).
The review also recommends that CBA-style prudential reviews should be part of the supervisory tool kit going forward. It suggests that several such inquiries be carried out in the next few years to reinforce the need for rigorous self-assessments by entities.
While the CBA prudential inquiry was a valuable and important report, it involved a huge amount of resources – a point also made by Mr Byres. Rolling this out more regularly might not be possible or appropriate. The AICD is of the view that a more flexible, needs based approach should be taken.
Departure from APRA’s ‘behind closed doors’ approach with regulated entities
To embed APRA’s new enforcement approach, the review recommends that APRA should change its existing procedures that create a low appetite for transparent supervisory challenge and enforcement “by departing from its behind closed doors approach with regulated entities and adopting a stronger approach towards recalcitrant institutions”.
The AICD is of the view that a close trusted relationship between APRA and regulated entities is essential to stability in the financial system. A focus on stability and having discretion to respond to system stresses is critical for an effective prudential regulator. Care must be taken not to put that at risk by complicating APRA’s mandate with that of the conduct regulator, ASIC. Increased transparency may have unintended implications for the relationship between APRA and regulated entities and jeopardise financial stability.
Non-executive directors to govern APRA?
After limited discussion, the review panel concluded that APRA would not be well served by the appointment of additional non-executive directors.
The AICD continues to support APRA having non-executive directors to help provide independent, impartial oversight of the prudential regulator. This is even more important given APRA’s expanding powers and remit. Having an effective accountability framework for the regulators is essential to confidence in the financial system.
APRA will be releasing its revised corporate plan in August 2019, which will include initiatives to address the 19 recommendations of the capability review directed at APRA.
In addition to the draft prudential standard on remuneration, APRA is reviewing the broad governance and risk management processes set out in CPS 220 Risk Management and CPS 510 Governance to ensure they remain fit for purpose and address issues related to governance and culture highlighted in the capability review and the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.