In brief
The Federal Government has released the exposure draft of the Treasury Laws Amendment (Banking Executive Accountability and Related Measures) Bill, together with a draft Explanatory Memorandum. This follows on from the release of the Banking Executive Accountability Regime (BEAR) consultation paper in July which raised eyebrows with its short three-week consultation period. The exposure draft only provides five working days for interested parties to lodge a submission. This is a clear indication of the Government's desire to implement BEAR swiftly. Partner Michelle Levy and Senior Associates Sarah Burgemeister and Brenton Pollard report.
Who is affected by BEAR?
The BEAR will impose obligations on Authorised Deposit-Taking Institutions (ADIs), subsidiaries of ADIs (albeit indirectly), and Accountable Persons.
ADIs
The ADIs impacted by BEAR will be Australian banks and Australian branches of foreign banks. Offshore operations of a foreign ADI will not be subject to BEAR.
Obligations will also apply to the subsidiaries of ADIs and overseas branches of Australian-based ADIs. By including bank subsidiaries in the BEAR, the Government will impose additional obligations on regulated entities that do not apply to competitors not owned by an ADI. A focus of many of the BEAR consultation paper submissions was the unfair playing field created by this uneven application of regulation. The draft Explanatory Memorandum justifies the extension to subsidiaries on the following basis:
Poor behaviour in a subsidiary can have a negative effect on the ADI's brand and public standing and has the potential to undermine confidence in the ADI itself. Where the activities of a subsidiary are significant, then an accountable person should have responsibility for that subsidiary.
However, the draft legislation does not give effect to the intended materiality threshold for activities of subsidiaries. It appears to apply to all subsidiaries of ADIs, regardless of the significance of their activities to the ADI as a whole, with the ability for the Minister to exempt certain entities. No guidance has been provided as to the circumstances in which discretion will be exercised to exempt certain persons or entities from the regime.
In implementing the regime, ADIs will also need to give consideration to the extra-territorial effects of the legislation and its potential application to foreign branches and subsidiaries of Australian banks.
Accountable Persons
Accountable Persons are:
- the ADI's directors (including non-executive directors);
- each person who holds a position with the ADI or a subsidiary and who because of that position has 'actual or effective responsibility' for the 'management and control' of the ADI or subsidiary or a 'significant or substantial part or aspect' of the ADI's or subsidiary's operations; and
- each person with a prescribed responsibility, including the chief executive officer, the chief financial officer, the head of HR and the head of the ADI's anti-money laundering functions among others.
A number of consultation paper submissions asserted that non-executive directors should be excluded given the existing obligations that applied to directors and the nature of a non-executive director's oversight role. The Government has, nonetheless, elected for all non-executive directors to be Accountable Persons. The Explanatory Memorandum acknowledges that BEAR obligations will only apply to the performance by non-executive directors of their oversight role. In due course, further guidance as to the Australian Prudential Regulation Authority's (APRA's) expectations of how, in practice, non-executive directors are to demonstrate compliance with the new accountability obligations would be welcomed.
The ADI must notify APRA of the appointment of an Accountable Person and the termination of their appointment. The ADI must declare that it considers the person suitable to be an Accountable Person. APRA will keep a record of all Accountable Persons.
Key obligations on ADIs and Accountable Persons
ADIs
ADIs will have accountability obligations, key personnel obligations, deferred remuneration obligations and notification obligations.
Accountability obligations
An ADI's accountability obligations are to conduct its business with:
- honesty, integrity and with due skill, care and diligence;
- deal with APRA in an open, cooperative and constructive way;
- take reasonable steps in conducting its business to prevent matters from arising that would adversely affect the ADI's prudential standing or reputation;
- take reasonable steps to ensure that each of its Accountable Persons complies with their accountability obligations; and
- take reasonable steps to ensure that each of its subsidiaries complies with the same obligations.
The above obligations are not defined in the draft legislation because, in the Government's view, the ordinary meaning of these terms is well understood and has been considered and established by case law.
In order to take reasonable steps, an ADI must (at least) ensure that there is:
- appropriate governance, control and risk management;
- appropriate delegations of responsibility; and
- appropriate procedures for identifying and remediating problems that arise or may arise.
Some of the accountability obligations appear to be broader than those proposed in the consultation paper. In particular, the requirement to take reasonable steps to prevent matters arising that would adversely affect the ADI's reputation is likely to heighten concerns of ADI Boards of the processes in place to safeguard against reputational risks. In any event, these kinds of provisions in legislation are notoriously difficult because compliance is tested with the benefit of hindsight (as the case law on directors' duties shows).
Key personnel obligations
An ADI's key personnel obligations are to ensure that:
- the responsibilities of the ADI's Accountable Persons covers each significant or important aspect of the ADI's operations; and
- that none of each of its Accountable Persons are prohibited from being an Accountable Person.
A person is prohibited from being an Accountable Person if they are not registered with APRA by the ADI as an Accountable Person or if they have been disqualified. APRA may direct an ADI to reallocate the responsibilities of an Accountable Person to another person if APRA considers the current allocation is likely to create a prudential risk.
Deferred remuneration obligations
The draft legislation represents the Government's latest approach to influence remuneration received by senior banking executives. ADIs will now be required to defer not insignificant portions of an Accountable Person's variable remuneration for a period of four years. Those Accountable Persons who earn more than $500,000 will be facing a deferral of almost half their pay with the CEO being the most affected. CEOs will be required to defer the lesser of 60 per cent of variable remuneration or 40 per cent of total remuneration for a minimum of four years. Such deferrals are intended to encourage executives to focus on the long term implications of material decisions with remuneration at risk should they be found to be in breach of their accountable obligations.
Notification obligations
An ADI must provide an accountability statement for each Accountable Person and an accountability map. APRA must also be notified of certain events such as a person ceasing to be an Accountable Person. In addition, the ADI must take reasonable steps to ensure that each of its subsidiaries complies with these obligations.
An accountability statement must specify the responsibilities of an Accountable Person and the area of the ADI or subsidiary that the Accountable Person has effective management and control. This is accompanied by the accountability map which must list the names of all Accountable Persons and provide their responsibilities and reporting lines. Both the accountability statement and map must be updated with APRA within fourteen days of any change. The requirements for accountability maps are less onerous than anticipated by the consultation paper and do not require a detailed explanation of the governance arrangements in place at the ADI or ADI subsidiary.
Accountable Persons
An Accountable Person will have the following obligations:
- conduct responsibilities with honesty, integrity and with due skill, care and diligence;
- deal with APRA in an open, cooperative and constructive way; and
- take reasonable steps in conducting those responsibilities to prevent matters from arising that would adversely affect the prudential standing or reputation of the ADI.
As noted above, the BEAR is intended not only to improve the conduct of banks and their executives, but to keep them out of the media. While that is something many would applaud, it will be a difficult obligation for Accountable Persons to safeguard against.
Issues arising from the draft legislation
Position of ADI subsidiaries
It is unclear which managers of ADI subsidiaries will be deemed as Accountable Persons. The draft legislation requires that a person have actual or effective responsibility for the management or control of a significant part of a subsidiary's operations. This provides a much broader scope than a person having actual or effective responsibility for the group's operations.
The burden for subsidiaries arising from the accountability requirements could therefore be immense. This would include the requirement for subsidiaries to submit accountability statements and maps to APRA and to update within 14 days if there is any change.
Examination powers
The draft legislation contains certain provisions that were not contemplated during the consultation period. For example, APRA has been given the power to examine an individual under oath or affirmation that it reasonably believes or suspects will be able to provide information relevant to an investigation. The draft legislation makes it an offence to fail to attend an interview with APRA (punishable with a fine of $6300) although an interviewee is not forced to answer questions.
This aligns with ASIC's power (although ASIC has the power to force answers from interviewees) to compel an individual on oath or affirmation to provide information relevant to a matter under investigation and further reinforces the Federal Government's general approach to attempt to augment the powers of financial services regulators.
Penalties
As foreshadowed by the consultation paper, penalties for ADIs and Accountable Persons are severe. Large ADIs will face penalties of up to $210 million and will be barred from obtaining insurance for such penalties. Accountable Persons can find themselves disqualified by APRA for a breach of the BEAR obligations. Likely in response to criticism in the consultation paper responses, an opportunity to make submissions to APRA will be provided to an Accountable Person prior to being disqualified.
Timing
The Federal Government intends that BEAR will apply from 1 July 2018 regime, which is ambitious for such a complex regime and likely fails to appreciate the significant work required by banks to ensure compliance with the new regime.
An exception is the remuneration requirements whereby an ADI will still be required to update remuneration policies by 1 July 2018 but will have until 1 January 2020 to update the employment contract of an Accountable Person to be BEAR compliant.
ASIC's power to ban senior officials in the financial sector
It is worth noting that the Government is currently consulting on enhancing ASIC's ability to ban individuals in the financial services sector as part of its objective to improve individual accountability and corporate culture. These powers would operate independently of BEAR despite the clear intersection with APRA's proposed powers.
Conclusion
The draft Explanatory Memorandum says that obligations detailed in the draft legislation will complement existing obligations. In fact, they will overlap and repeat many existing duties for banks and their executives and directors. This is inconsistent with Government's Cutting Red Tape principles and will create ongoing complexity and uncertainty.
A hallmark of the introduction of the Senior Managers Regime in the United Kingdom was the unprecedented levels of engagement between regulators and financial institutions. It is surprising that the Government has taken a different approach to the implemenation of BEAR which, despite the banks expressing their willingness to work with the Government, imposes a regulatory regime with significant consequences in a short timeframe and with limited consultation.