Australia: APRA's enforcement priorities for RSEs in 2016 – know them well and be prepared

APRA's 2015 Annual Report contains good insights into where the regulator intends to focus its scrutiny. Conflicts of interest, insurance in superannuation, investment governance, liquidity management, remuneration disclosure and risk management frameworks are high-priority areas for APRA.

Here is our guide to APRA's concerns and the steps superannuation trustees can take to ensure their policies and procedures pass APRA's inspection.

  1. CONFLICTS OF INTEREST

Prudential Standard SPS 521 Conflicts of Interest requires RSE licensees to:

  • develop, implement and review a conflicts management policy that is approved by the Board;
  • identify all relevant duties and relevant interests; and
  • develop registers of relevant duties and relevant interests.

APRA is concerned that RSE licensees are taking a very narrow interpretation of conflicts management and their duties under the Prudential Standard. Strikingly, APRA believes that implementation of the Prudential Standard's requirements are still in their early stages and that further steps need to be taken by many RSE licensees to improve their conflicts management practices.

Specific concerns discussed by APRA are in the table below. We recommend all RSE licensees review their conflicts management frameworks with particular focus on these sections.

APRA CONCERN

RELEVANT SECTION

Some conflicts management frameworks only focus on directors of the RSE licensees and do not consider potential conflicts beyond those individuals.

Paragraph 19:

"An RSE licensee's conflicts management policy must include processes for undertaking regular and thorough enquiry to identify all conflicts arising from the RSE licensee's relationship, or the relationship of a responsible person or employee, with an existing or prospective service provider or adviser, including those conflicts that have the potential to affect the service provider's performance in respect of the obligations undertaken for the RSE licensee's business operations".

Inadequate weight is given to related party conflicts in some conflict management frameworks.

Paragraph 19 (above) and Paragraph 7:

"For the purposes of this Prudential Standard, a reference to a 'conflict' is a reference to a conflict:

  1. between the duties owed by an RSE licensee, or a responsible person of an RSE licensee, to beneficiaries and the duties owed by them to any other person;
  2. between the interests of beneficiaries and the duties owed by an RSE licensee, or a responsible person of the RSE licensee, to any other person;
  3. between an interest of an RSE licensee, an associate of an RSE licensee or a responsible person or an employee of an RSE licensee, and the RSE licensee's duties to beneficiaries; and
  4. between an interest of an RSE licensee, an associate of an RSE licensee or a responsible person or an employee of an RSE licensee and the interests of beneficiaries."
No independent expert review has been undertaken of the conflicts management framework.

Paragraph 20

"An RSE licensee must ensure that the appropriateness, effectiveness and adequacy of its conflicts management framework are subject to a comprehensive review by operationally independent, appropriately trained and competent persons at least every three years."1

  1. INSURANCE IN SUPERANNUATION

Prudential Standard SPS250 Insurance in Superannuation requires an RSE licensee to:

  • ensure that insurance arrangements adequately address the minimum requirements set out in this Prudential Standard; and
  • formulate and give effect to appropriate selection processes for, and due diligence of, insurers and monitor relationships with insurers on an ongoing basis.

APRA is concerned that RSE licensees are not maintaining sufficiently detailed, accurate and timely insurance data under the Prudential Standard, nor will those RSE licensees be compliant with the requirement to maintain those records for a period of five years by 1 July 2016.

RSE licensees should review how they record and maintain their insurance data with a view to greater scrutiny by APRA. In doing so, RSE licensees should be mindful of the following sections of the Prudential Standard:

  • Paragraph 15: "An RSE licensee must maintain records of sufficient detail for a prospective insurer to properly assess the insured benefits that are made available. These records must include, for at least the previous five years, the claims experience, membership, sum insured and premiums paid in relation to beneficiaries."
  • Paragraph 30: "An RSE licensee must meet the requirement to maintain the records referred to in paragraph 15 within three years of the effective date. An RSE licensee must make an assessment of the data already available to meet the requirements of paragraph 15 and report to APRA before 31 December 2013 as to when the RSE licensee expects to achieve full compliance with paragraph 15."

Separately, APRA is concerned that some insurance management frameworks developed under the Prudential Standard are too compliance focused, and should be better integrated with their business operations. APRA believes RSE licensees should focus more to insurance benefit design to ensure sustainability and its appropriateness for the members of the RSE licensees' funds.

  1. INVESTMENT GOVERNANCE AND LIQUIDITY MANAGEMENT

Prudential Standard SPS 530 Investment Governance requires an RSE licensee to:

  • formulate specific and measurable investment objectives for each investment option, including return and risk objectives;
  • develop and implement an effective due diligence process for the selection of investments;
  • determine appropriate measures to monitor the performance of investments on an ongoing basis;
  • review the investment objectives and investment strategies on a periodic basis; and
  • formulate a liquidity management plan.

APRA's supervisory attention to date has focused on RSE licensees' understanding of the risks associated with increasing allocations to overseas assets, the use of lifecycle investment strategies, and their risk management approach to insourcing investment management functions.

APRA is concerned that some RSE licensees:

  • have significant weaknesses in their investment governance and risk management frameworks, evidenced by a lack of understanding of underlying investments and an over-reliance on service providers;
  • are risking a lessening of the quality and timeliness of services during and after they are brought in-house; and
  • have difficulty defining a "liquidity event" and the liquidity profile of different assets in their liquidity stress test assumptions and modelling.

APRA has noted considerable variation in the liquidity management practices adopted by RSE licensees and, in some cases, inadequate understanding of what is expected to meet the requirements in the prudential standard in this area.

Accordingly, we recommend RSE licensees consider whether their investment governance framework is appropriate to address APRA's concerns.

  1. REMUNERATION DISCLOSURE

Prudential Standard SPS 510 Governance requires:

  • the Board must have a policy on Board renewal and procedures for assessing Board performance;
  • a Board Remuneration Committee must be established and the RSE licensee must have a Remuneration Policy that aligns remuneration and risk management;
  • a Board Audit Committee must be established; and
  • an RSE licensee must have a dedicated internal audit function.

While RSE licensees' compliance in this area is generally good, APRA has identified anomalies and errors in remuneration reporting. APRA considers the disclosure of director and executive remuneration to be an important element of the enhanced transparency obligations of the superannuation industry.

Accordingly, RSE licensees should consider the adequacy of their Remuneration Policy with particular focus on Paragraph 23 of the Prudential Standard which states:

"For the purposes of this Prudential Standard, remuneration arrangements include measures of performance, the mix of forms of remuneration (such as fixed and variable components, and cash and equity-related benefits) and the timing of eligibility to receive payments that a person receives by virtue of the role that they undertake for the RSE licensee. All forms of remuneration are captured by this Prudential Standard, regardless of where, or from whom, the remuneration is sourced."

  1. RISK MANAGEMENT

Prudential Standard SPS 220 Risk Management requires an RSE licensee to:

  • have a written business plan that sets out the high-level strategic direction on the RSE licensee's approach to managing its business operations;
  • maintain a Board-approved risk appetite statement;
  • maintain a Board-approved risk management strategy that describes the key elements of the risk management framework that give effect to the RSE licensee's strategy for managing risk;
  • notify APRA when the RSE licensee becomes aware of a significant breach of, or material deviation from, the risk management framework, or discovers that the risk management framework does not adequately address a material risk; and
  • maintain adequate technical, human and financial resources at a level that is adequate for the RSE licensee's business operations.

APRA has observed that some RSE boards have yet to develop a sound understanding of the differences between risk management and compliance. In a similar vein, APRA's supervision activities also found there is scope for boards to further enhance risk appetite statements to achieve more balance been qualitative and quantitative assessment of risk.

Given APRA expects boards to ensure that risk appetite and risk tolerance form part of a board's strategic considerations, planning and decision-making and are embedded in an RSE's operations, we recommend RSE licensees consider the adequacy of their risk management framework, with a particular focus on the requirement of Paragraph 10 that:

"An RSE licensee must, at a minimum, ensure that its risk management framework covers all material risks, both financial and non-financial, to the RSE licensee's business operations, having regard to the size, business mix and complexity of those operations."
  1. NEXT STEPS

APRA has clearly signalled what it's focus areas will be. The best advice for RSE licensees is bring your policies up to standard and know that they comply with all Prudential Standards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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