Improvements required by APRA-regulated entities to make changes 5 min read
In the discussion paper released yesterday, APRA says that 'well governed entities are more resilient in times of stress, more agile in times of change, and demonstrate more sophisticated risk judgement'. And yet, 32% of APRA-regulated entities have governance risks falling outside APRA's risk appetite.
APRA's proposed response is to impose more prescriptive requirements for the appointment and tenure of directors of banks, insurers and RSE licensees. There are eight specific proposals that are designed to increase the skills and capabilities of directors and reduce the potential for conflicts that might affect decision-making by directors. They are modest proposals premised on the basis that 'better' directors will lead to better governance. Governance is defined by APRA as the 'principles, practices, processes and behaviours that determine how entities are directed and controlled'.
You have until 6 June 2025 to provide your feedback.
In this Insight, the eight proposals are set out below together with our comments.
1. Skills and capabilities
The skills and capabilities of boards and directors will be improved by prudential standards requiring entities to identify and document clearly defined, measurable and quantifiable skills and capabilities. The intention is to raise minimum standards 'irrespective of nominations process or board structure' (APRA is pre-empting the responses from some RSE licensees).
It might be noted that CPS 510 and SPS 510 already require as much and, therefore, this proposal appears to be nothing more than a restatement of the existing law. However, APRA says too many regulated entities have adopted vague and narrow skills and capability requirements and too many rely on director self-assessments. Hence the need for more prescription. This is a theme of the discussion paper.
2. Fitness and propriety
Prudential standards will prescribe higher minimum requirements for a responsible person (including a director) of a regulated entity to meet the fit and proper person standard.
Again, one might think the law already imposes a high standard. However, again APRA says the requirements 'fail to generate meaningful outcomes' because, among other things, a narrow view is taken of what constitutes fitness and propriety and, again, there is an excessive reliance on self-assessment. APRA is also concerned that entities do not have sufficient regard to the capacity of directors to balance multiple roles. And this goes to the next proposal.
3. Conflicts management
Prudential standards will extend the existing requirements for RSE licensees to have conflicts management frameworks to banks and insurers. The purpose is to mitigate the 'common challenges' of directors holding multiple roles within a group, directors having relationships with suppliers and directors' personal financial interests and affiliations.
We make two observations about this proposal:
First, in order to satisfy the existing fit and proper person requirements a director should not have a conflict that would prevent them performing their duties. However, there is an exception where the entity is satisfied that, despite the conflict, it would be 'prudent' to conclude the conflict will not create a material risk that the director will not be able to perform their duties.
Second, an RSE licensee and its directors have statutory duties to act in the best financial interests of beneficiaries and to give the interests of their beneficiaries priority over their own interests and those of anyone else. Banks and insurers and their directors do not have the same obligations. These are differences of substance that may well mean it is appropriate for the management of conflicts for directors to be treated differently in the prudential standards (as they are today) according to whether they are directors of a bank, insurer or RSE licensee.
4. Independence
Prudential standards for banks and insurers will limit the number of directors who are members of more than one board in a group, among other even more modest proposals. The purpose of this proposal is to reduce intra-group conflicts of interests and strengthen the independence of regulated entity boards. Legislation contains independence requirements for directors of RSE licensees.
5. Board performance review
Prudential standards will require external expert independent performance reviews of boards, committees and individual directors every three years. Reports must be provided to APRA.
While this proposal seems sensible, it will be one more review undertaken by the consultants and we think there is a risk that too much weight is given to the expertise and independence of consulting firms.
6. Role clarity
APRA is worried that boards spend too much time on operational matters at the expense of strategic issues and risk oversight. To help, APRA proposes to amend the prudential standards to clearly articulate what should be done by whom.
There is nothing wrong with this proposal, although we do note there is a great deal of law and guidance describing the roles of the board on the one hand and senior management on the other.
7. Board committees
Reflecting the importance of risk management and the three lines of defence, RSE licensees that are significant financial institutions will be required to have separate audit and risk committees.
On the other hand, reflecting the cost of maintaining separate audit and risk committees (and, perhaps, lesser systemic importance), those APRA-regulated entities that are not significant financial institutions will not have to do so.
8. Director tenure and board renewal
One can't help but hear APRA's exasperation with this last proposal—a lifetime default tenure for non-executive directors at a related entity. This will be combined with a power for APRA to extend that tenure where special circumstances warrant an exception.
Conclusion
While APRA's proposals to bolster the capability and independence of directors of regulated entities are modest, they provide a pretty clear picture of what APRA thinks are shortcomings now. What is also clear is that APRA has been talking about many of them over a long period. Perhaps it is fair to say APRA's patience is coming to an end.