The BEAR Necessities: Understanding the Proposed Banking Executive Accountability Regime
In response to the Coleman Report on Australia’s four large banks (see here for a summary), the 2017 Federal Budget included a proposed Banking Executive Accountability Regime (BEAR) to be administered by the Australian Prudential Regulation Authority (APRA).
Treasury released a consultation paper on the BEAR on 13 July 2017 (the Paper) and has been conducting stakeholder consultations. In setting out its proposals in the Paper, Treasury has drawn inspiration from the “Senior Managers Regime” introduced in March 2016 in the United Kingdom, and the “Manager-in-Charge” measures adopted by the Securities and Futures Commission in Hong Kong in April 2017.Submissions on the Paper are now closed. An exposure draft of legislation is expected soon. The BEAR is a high priority for the Turnbull Government, which wants to see the BEAR implemented quickly.
In this article we explain the proposed BEAR, highlight some unresolved issues, and suggest some actions that authorised deposit-taking institutions (ADIs) can take now to help prepare for the BEAR.
Purpose of the BEAR
The purpose of the BEAR is to improve accountability through better corporate governance, provide deterrence against questionable conduct, and to establish accountability and clear consequences for senior executives in ADIs if community expectations of conduct are not met.
How does the BEAR interact with existing regulation?
The BEAR is in addition to existing regulatory regimes. The BEAR does not, for example, alter existing obligations under the Corporations Act and the credit laws. Nor does the BEAR alter APRA’s existing framework of standards. ASIC continues to be the primary regulator of conduct in the financial services industry, and it is yet to be determined how ASIC’s enforcement powers and the provisions of the BEAR will operate when there is overlap.
What entities are captured by the BEAR?
The Paper says that the BEAR will apply to authorised ADIs and their subsidiaries, including subsidiaries of the ADI whose activities are not regulated by APRA. The BEAR will not apply to entities within a corporate group that are not ADIs or subsidiaries of an ADI. For example: There has been some commentary as to whether corporate groups may restructure to minimise their exposure to the BEAR. However, presently there is no anti-avoidance provision being considered.
The Paper does not address responsibility for subsidiaries which are part-owned. One suggested approach is to apply the existing “control test” in the Corporations Act to determine whether a subsidiary would be caught by the BEAR.
Smaller ADIs – scalability?
Treasury has indicated that the Government is unlikely to agree to exempting any ADIs from the BEAR. However, there may be some appetite within Government for a modified BEAR, scalable to the size of the ADI, applying to smaller ADIs, if a compelling case can be made that the imposition of the full requirements of the BEAR may risk reducing the effectiveness of smaller institutions or undermine efforts to promote greater competition. The imposition of the BEAR, resulting in increased compliance costs, needs to be reconciled with the Government’s policy objective of encouraging competition in the banking sector. In our view, additional regulation is a barrier to entry and may chill enhanced competition. A less onerous application of the BEAR to smaller ADIs could be an element in assisting to level the competitive playing field.
Executives and directors covered by the BEAR - Accountable Persons
The Paper proposes that the persons to be covered by the BEAR (Accountable Persons) would be defined to include the most senior directors and executives of an ADI, who will be held to a heightened standard of responsibility and accountability. It will also include directors and senior executives of subsidiaries within a group with an ADI parent.
The proposed definition of an Accountable Person will include a combination of prescription and principle. The prescribed element would include prescribed oversight functions such as Chair of the Risk Committee, and prescribed executive functions such as Chief Executive. The Paper proposes 12 prescribed Accountable Persons functions, namely:
Oversight Functions
Chair: Responsible for chairing and overseeing the performance of the Board.
Chair of the Risk Committee: Responsible for chairing and overseeing the performance of any committee responsible for the oversight of the risk management systems, policies and procedures.
Chair of the Audit Committee: Responsible for chairing and overseeing the performance of any committee responsible for the oversight of the internal audit system.
Chair of the Remuneration Committee: Responsible for chairing and overseeing the performance of any committee responsible for the oversight of the design and the implementation of remuneration policies.
Senior Officer Outside Australia: Under the authority of the Board of a foreign ADI, outside Australia and responsible for overseeing the Australian branch operation of a foreign ADI. This function already exists under APRA’s prudential standard CPS 510.
Executive Functions
Chief Executive: Under the immediate authority of the Board, responsible for carrying out the management of the conduct of the whole business (or relevant activities).
Chief Finance: Responsible for the management of financial resources and reporting directly to the Board in relation to financial affairs.
Chief Risk: Responsible for overall management of risk controls, including the setting and managing of risk exposures, and reporting directly to the Board in relation to its risk management arrangements.
Chief Operations: Responsible for the management of operations and for reporting directly to the Board on the operations function.
Chief Information: Responsible for the management of information technology and for reporting directly to the Board on the information technology function.
Head of Internal Audit: Responsible for the management of the internal audit function and for reporting directly to the Board on the internal audit function.
Head of a Foreign Bank Branch: Ordinarily resident in Australia and responsible for the conduct of the Australian branch operation of a foreign ADI. This function already exists under APRA’s prudential standard CPS 510.
In addition to the prescribed functions, the principles-based element of the definition would capture other individuals who have a significant influence over conduct and behaviour and whose actions could pose risks to the business and its customers. This might apply to people such as the head of a key business area which provides a significant proportion of the ADI’s business or activities based on proportion of gross assets, revenues or profit. It will be up to each ADI to determine which roles within the ADI or its subsidiaries might fit the definition of a principles-based Accountable Person.
It is important that explanatory information and guidance be provided concerning which positions would be captured and which positions would sit outside the BEAR. An ongoing dialogue with APRA concerning application of the BEAR will be helpful to ADIs. Roles and responsibilities may also change over time as, for example, business lines grow and become more profitable, and ADIs will need to monitor changes to their structures which may trigger amendments to their BEAR profile.
What is accountability mapping?
ADIs will be required to provide APRA with accountability statements of senior executive roles and responsibilities across all business areas. It is the intention that the consolidation of all the accountability statements would form a comprehensive “accountability map” to allocate responsibilities across an entire ADI group or sub-group. The Paper suggests that one approach would be to prescribe a minimum set of responsibilities across an ADI group or subgroup that must be allocated to Accountable Persons. In our view, there will need to be clear explanatory material, guidance and dialogue with APRA as to what level within ADIs the BEAR is expected to cover.
What are the expectations of ADIs and Accountable Persons?
The BEAR will include provisions to make clear the expected conduct of ADIs and their Accountable Persons.
The proposed expectations for ADIs would include:
conducting its business with integrity;
conducting its business with due skill, care and diligence;
dealing with APRA in an open and cooperative way; and
taking reasonable steps to:
act in a prudent manner, including by meeting all of the requirements of APRA’s prudential standards, and maintaining a culture which supports adherence to the letter and spirit of these standards;
organise and control its affairs responsibly and effectively; and
ensure that the expectations and accountabilities of the BEAR are applied and met throughout the group or subgroup of which the ADI is parent.
The expectations of Accountable Persons would be to:
act with integrity, due skill, care and diligence and be open and cooperative with APRA; and
take reasonable steps to ensure that:
the activities or business of the ADI for which they are responsible are controlled effectively and comply with relevant regulatory requirements and standards;
any delegations of responsibilities are to an appropriate person and discharged effectively; and
the expectations and accountabilities of the BEAR are applied and met in the area for which they are responsible.
It is likely that these expectations will be set out in the BEAR legislation. However, there are several unresolved issues with expectations of ADIs and Accountable Persons which include:
Vagueness of definitions and the introductions of new terms: There is uncertainty determining what is required when the expectations are defined by ambiguous terms. Terms such as “integrity” and “adherence to the spirit and letter of standards” are unknown and untested in financial services law. We suggest that aligning the expectations with existing terms applying to conduct obligations (such as “efficient, honest and fair”) would create more certainty for ADIs.
Meaning of “open and cooperative”: Questions arise as to what is expected by the obligation for ADIs and Accountable Persons to be “open and cooperative” with APRA. In the context of cooperation with investigative bodies, the issue of whether full cooperation means waiving legal professional privilege has been a vexed question for some time. Guidance is needed in respect of what is meant by the obligation to be “open and cooperative” with APRA, especially in the context of where APRA in the main is responsible for prudential standards and is not the primary enforcement agency for financial services laws.
Scope of expectations for Accountable Persons: The expectation of Accountable Persons to act with integrity is not currently limited with reference to their obligations with respect to the operations of the business. This should be remedied to limit the expectations to the Accountable Person’s obligations in respect of the conduct of the business which he or she is responsible for.
What constitutes “reasonable steps”? Both ADIs and Accountable Persons are expected to take “reasonable steps”, among other things, to comply with relevant laws. In our view, substantive guidance is needed to enable ADIs to ascertain what are “reasonable steps” in a variety of circumstances. This could be done by way of case studies that deal with scenarios, such as what are considered reasonable steps when taking remedial steps after a problem is uncovered.
Deferral of remuneration
The remuneration component of the BEAR will require the deferral of an ADI executive’s variable remuneration for a period of not less than four years. The remuneration provisions will only apply to Accountable Persons who perform executive functions (not persons who perform oversight roles). It is proposed that variable remuneration will include that part of total remuneration that is discretionary and conditional on performance and the delivery of results. A 60% deferral rate for variable remuneration will apply to all Chief Executive Officers of ADIs and 40% for all other executive Accountable Persons.
APRA is to be given enhanced powers to direct ADIs to review and adjust remuneration policies, which would include the power to reduce variable remuneration of an executive Accountable Person if that person does not meet the new expectations of the BEAR and is consequently removed and or disqualified.
The Paper does not deal with what happens in the situation where the responsibilities for the operations of an ADI are only part of an executive’s responsibilities. In these circumstances, it would seem that some sort of pro-rata apportionment would be appropriate.
Registration of Accountable Persons with APRA
The Paper proposes that Accountable Persons will have to be registered with APRA and ADIs will be required to notify APRA in advance of the appointment of any Accountable Person. Upon notification to APRA, APRA would consult its register of Accountable Persons and advise the ADI if the candidate has previously been removed or disqualified by APRA or if APRA was aware of any other issues that could affect the suitability of the candidate. APRA will not take on the responsibility for assessing the suitability of Accountable Persons, but the procedure is intended to give visibility to APRA of Accountable Persons and enable APRA to advise if it has any concerns regarding a candidate.
Increased powers for APRA
Currently, APRA may issue a direction to an ADI to remove a director or senior manager if APRA is satisfied that the person is disqualified from acting in his or her position, or does not meet the fit and proper criteria set out in the prudential standards. APRA may also apply to the Federal Court to disqualify a person from being a senior manager, director or auditor of an ADI where the Court is satisfied the person is not a fit and proper person for that role.
The Paper discusses new powers to be given to APRA to remove and disqualify persons from APRA regulated institutions (not just ADIs subject to the BEAR). It proposes one approach which would enable APRA to disqualify a person from being a senior manager, director or auditor without having to apply to the Federal Court, if it is satisfied that the person is not fit and proper for the role, subject to a right of appeal by the affected person. The form of this power has not yet been finalised, but it suggests the onus would be on ADIs and the individuals involved to demonstrate that the person is suitable as a fit and proper person to continue in the role.
The Paper proposes APRA should have the power to remove and disqualify all Accountable Persons, and it is also proposed that APRA would be able to require an ADI to inform APRA when individuals have been the subject of internal disciplinary proceedings.
Civil penalties for failure to meet the BEAR expectations
In the 2017 Budget, the Government announced new civil penalties for ADIs that failed to meet the new expectations of the BEAR, with a maximum penalty of $200 million for larger ADIs and $50 million for smaller ADIs. The Paper proposes that APRA would be able to seek a civil penalty, among other things, where an ADI failed to meet the new expectations under the BEAR, failed to hold Accountable Persons to account under the BEAR, and where an ADI does not appropriately monitor the suitability of Accountable Persons. The Paper suggests that in order to enhance the deterrent effect, it may be necessary to prevent ADIs from taking out insurance against these civil penalties.
Summary of issues to be resolved in the BEAR
In summary, we see the key unresolved issues with the BEAR as follows:
Aligning the BEAR with existing concepts and obligations (so that new definitions imposing obligations don’t cause confusion).
Liability within group structures for subsidiaries, particularly for subsidiaries which are only part-owned, and whether the control test in the Corporations Act should apply.
Position mapping of accountabilities and whether “Accountable Persons” should be designated positions or whether the flexible definition involving a person’s influence within the ADI should also operate.
Clarifying expectations and whether the use of broad terms such as “integrity” should be replaced by better known terms such as “efficient, honest and fair”.
Limiting the scope of the expectations to actions related to the conduct of the business that the Accountable Person is responsible for.
What constitutes “reasonable steps” in the expectations section, and whether there should be extensive guidance as to what “reasonable steps” means, including that reasonable steps includes taking remedial steps when problems are uncovered.
The definition of “variable” remuneration.
The process and onus of proof for exercise of “fit and proper” disqualification powers and for failure to meet BEAR expectations.
The position of smaller ADI’s and whether a measure of proportionality and scalability should apply to smaller ADIs.
Transitional arrangements for the BEAR.
Timing of the BEAR
Treasury said that the Government is keen to have the legislation in place and operating as soon as possible. It is likely that there will be an exposure draft of the proposed legislation made available for comment, but the consultation period will be limited. There will probably be a period of time before commencement of the BEAR and a transitional window to allow for implementation.
What can ADIs be doing now?
Although there are many details to be resolved, it is expected that the fundamental structure of the BEAR will not be significantly altered. ADI’s can commence preparation for the enactment of the BEAR by taking some preparatory steps, such as:
Keep up-to-date on developments, especially when the exposure draft of legislation is circulated.
Commence putting your analysis, development and implementation team together. This is likely to include human resources, compliance, company secretarial, legal and risk functions. Will all the work be done in-house or will external help be needed?
Outline a draft implementation plan and consider how your organisation will identify relevant subsidiaries and businesses, Accountable Persons and accountability mapping. Who will do these activities, and what assistance will be needed?
Plan for awareness raising, training and development on the BEAR, cultural change, accountability and expectations. What form will this take?
Think past the initial phase to how to embed the requirements within the organisation, and allocating responsibility for reviewing and updating for ongoing compliance.
We can help you prepare for the BEAR.
Kathleen Harris & Patrick Dwyer
Legal Directors