Banking Executive Accountability Regime (BEAR) consultation paper released

On 13 July 2017, the Federal Government released a consultation paper (CP) in relation to the proposed Banking Executive Accountability Regime (BEAR) announced in the May 2017 Federal Budget. We covered the Federal Budget announcement in our May 2017 Financial Services Update.

The CP confirms that BEAR will raise substantially the risk to which banks and their executives and others in senior management are exposed, through the introduction of civil penalties with high monetary thresholds and disqualification powers against individuals. All banks will be affected, including foreign banks, and BEAR's impact will extend beyond banking activities to other activities of the bank's corporate group, whether in Australia or elsewhere.

The CP does not propose a specific timetable for implementation. While there appears to be a desire within Government to implement BEAR quickly, the CP notes that authorised deposit-taking institutions (ADIs) will need time to undertake changes to systems, structures, policies and contracts for effective implementation. Responses to the CP are due by 3 August 2017.

We outline the key elements of the CP, which is relatively brief and high level, below.

Scope of BEAR - all ADIs and their subsidiaries

It is proposed that BEAR will apply to all ADIs and all entities within a group of which the ADI is the parent (but only those other entities that sit below the ADI, not above it). Both Australian and offshore subsidiaries of ADIs will be captured by the regime. This raises some interesting questions on jurisdictional scope which are not addressed in the CP, such as:

• Is it intended that BEAR apply to offshore activities of foreign banks which operate branches in Australia, including activities of these global banks and their offshore subsidiaries with no connection to Australia?
• To what extent will there be provisions that reconcile or recognise differences in regimes operating in other jurisdictions that apply to ADIs and their offshore entities, such as the UK Senior Managers Regime (UK SMR) or the Hong Kong Manager in Charge (HK MIC) regime?

The CP justifies applying BEAR to non-banking operations of ADI group entities (such as insurance and wealth management), but not extending the regime to competitors that are not part of an ADI group, on the basis that ADIs have a "unique position" and "enjoy a privileged position of trust in the financial system".

Scope of BEAR – accountable persons

The legislation will introduce the concept of an "accountable person" to capture the most senior individuals within an ADI and its subsidiaries and businesses. The CP says this definition is intended to build on, rather than replace, existing concepts within the regulatory framework, such as "responsible persons", "senior managers" and "directors".

The CP proposes a definition of "accountable person" including both a prescribed element and a principles-based element. As to the prescribed element, drawing inspiration from the UK SMR, the CP proposes that the following would be prescribed accountable persons:

• Chair
• Chairs of Risk Committee, Audit Committee and Remuneration Committee
• CEO, CFO, CRO, COO, CIO
• Head of Internal Audit
• Head of Foreign Bank Branch and Senior Officer Outside Australia.

As to the principles-based element, other individuals who have significant influence over conduct and behaviour and whose actions could pose risks to the business and its customers, such as the head of a key business area, would be accountable persons.

We anticipate that there will be a range of views as to how, in particular, these two tests will be applied in practice, including in relation to the operations of an ADI's subsidiaries, and in relation to foreign banks – for example, would the global CEO of a global foreign bank which operates as a branch in Australia be considered an "accountable person" for BEAR?

Expectations (conduct rules)

The CP contemplates the development of a set of conduct "expectations", with a focus on systemic and prudential matters.  Unsurprisingly, it draws heavily on the UK SMR in listing out a proposed set of expectations which would apply to ADIs and accountable persons. We set these out below in the appendix.

The scope of these expectations is critical – it is the failure to meet them which will enliven APRA's powers to seek civil penalties against the ADI and to disqualify, and direct the reduction of the remuneration of, individuals. As can be seen in the appendix, these expectations are cast in broad terms, which highlights the significance of the risk to which the ADI and its accountable persons will be exposed.

Systems and processes, including management information (MI) flows, will need to be considered carefully, to ensure that the ADI and its accountable persons can be satisfied that the expectations are being met at all times. The UK experience is that this led to root and branch reviews of MI flows and processes.

Remuneration

Chapter 6 of the CP considers the Budget announcement that a minimum of 40% of an ADI executive's variable remuneration (and 60% of remuneration for some executives, including the CEO) will be deferred for four years, with APRA to have stronger powers to require ADIs to change their remuneration policies if APRA considers that outcomes are inappropriate.

The CP flags the possibility that ADIs may respond by increasing fixed remuneration and queries whether that is problematic, or something that should be prevented. Creating a remuneration system that appropriately balances all of the factors that contribute to a culture aligned to sound risk management is complex, and perhaps the better question for comment is whether a focus on this single aspect of remuneration can be effective.

The CP also seeks submissions on the definition of what constitutes variable remuneration, to ensure it is clear and responsive to future developments.  Presumably short-term as well as long-term incentives, including equity-based schemes, all fall within the ambit of "variable remuneration". There will be a number of secondary questions as to how it is to be valued in calculating the 40%, and precisely how the four year deferral should operate. For example, what happens if employment ends before the four year deferral expires? Can tranches of the deferred amount vest over the period, or must there be a full deferral?

One area where APRA may seek to exercise its stronger powers is the inclusion of malus provisions permitting clawback of remuneration if unacceptable behaviour comes to light after payment is made. Although such provisions are not unusual, they are used relatively rarely, which may be an area for APRA involvement.

Registration and accountability mapping

As foreshadowed in the Budget announcement, ADIs will be required to register all accountable persons with APRA. ADIs will be required to notify APRA in advance of a proposed appointment and an assessment of the suitability of the person for the role, so as to enable APRA to consult its register and advise the ADI if it has issues with the proposed appointment.

ADIs will also be required to provide APRA with accountability statements covering in detail the role and responsibilities of each accountable person. A consolidated accountability map must be prepared to ensure all roles and responsibilities are allocated across the ADI group.  Accountability statements (and updated accountability maps) must be provided to APRA each time an individual is proposed for registration, and on an ongoing basis if there is a change to the responsibilities of an accountable person. Clearly, ADIs will need to ensure systems are in place to ensure all role and responsibility changes are reflected in up to date accountability maps.

The CP raises for consideration certain "prescribed responsibilities" to be covered as a minimum, based on the UK SMR approach.

Based on our experience advising banks and other financial institutions in the UK on accountability mapping, this will not be a straightforward exercise. The accountable persons will clearly have a significant interest in how the responsibilities are allocated, given the personal liability and risk to which they are exposed and the views of executives and other accountable persons may not always align.

Removal and disqualification of accountable persons

The CP acknowledges that APRA already has existing powers to direct an ADI to remove directors and senior managers, and powers to apply to Court for orders disqualifying individuals. The CP proposes that new powers be introduced to "enhance" APRA's powers to include a direct power to remove an accountable person where APRA is satisfied that the individual is not a fit and proper person for the role, or does not meet the new expectations (discussed above).

The CP does not go into any detail on the proposed new powers, but it can be reasonably expected that the powers would not be dissimilar to those which ASIC presently has under the Corporations Act to make banning orders in respect of individuals. The CP mentions that there should be due process, and a right of appeal, which would be consistent with the ASIC banning order regime (which includes a right to a hearing before a delegate, and a right of appeal to the Administrative Appeals Tribunal).

Overlapping civil penalty proceedings

There is a real prospect that the same conduct or misconduct by an ADI or a subsidiary could amount to both a breach of an ADI's responsibilities under the BEAR and contravention of a range of other civil penalty or other provisions to which the ADI or subsidiary is subject. For example, significant systemic failures in the wealth management business of an ADI could give rise to civil penalty provisions under the Future of Financial Advice regime as well as the new BEAR expectations. It will be interesting to see whether, in this type of situation, APRA or ASIC would take the lead in civil penalty proceedings, or whether each could commence proceedings within their respective jurisdictions.  One would hope that an ADI would not be subject to separate proceedings by the two regulators. 

We would expect the BEAR legislation to include provisions analogous to those in the Corporations Act that, in effect, prevent a person from being held to be both criminally and civilly liable. However, precisely how the civil penalties in the BEAR will interact with any regime of criminal responsibility – including, for example, under the Corporations Act – remains to be seen.

Insurance

In the context of civil penalties (against ADIs) and disqualification powers (against accountable persons), the CP raises for consideration a question in relation to whether the ADIs and accountable persons should be precluded under BEAR from taking out insurance against civil penalties and the exercise of disqualification powers respectively. It is common for insurance not to extend to criminal conduct (and indeed, public policy renders void any insurance or other indemnity in respect of serious criminal conduct) and there are specific statutory limits on the availability of insurance against civil liability for regulatory obligations, including some breaches of directors duties under the Corporations Act. However, this would significantly increase the risk to which ADIs and their executives are exposed as a result of the new regime.

If the BEAR legislation does not ultimately prohibit insurance, ADIs should take steps to ensure that their insurance policies unambiguously extend to civil penalties (and ideally to all penalties, civil or criminal, to the extent insurable at law) under the new regime. In particular, it would be important in doing so to review any exceptions exclusions and sub-limits contained within insurance policies. Nonetheless, even if an insurance policy is sufficiently comprehensive, ADIs should be aware that this territory is uncertain in respect of any potential overlap between civil and criminal responsibility: insurance clauses covering certain criminal penalties may offend against public policy and to this extent will be void.

What you can do now and how can Ashurst help?

As a starting point, there is an opportunity to make submissions in response to the CP. Submissions are due by 3 August 2017.  

In light of what appears to be bipartisan support in Canberra for BEAR, there is a real prospect BEAR could be implemented reasonably quickly, and broadly in line with the proposals outlined in the CP. As APRA itself notes, implementation of the systems, processes and contractual arrangements will take time and ADIs and their executives should prepare as soon as possible for the introduction of BEAR. Steps which could usefully be taken include:

1. Preparing accountability statements and maps, and identifying accountable persons
2. Considering the MI flows and systems required to demonstrate compliance with expectations, in line with allocated responsibilities
3. Briefing executives and other accountable persons on the implications of BEAR and the bank's proposed approach to the allocation of responsibilities
4. Reviewing employment contracts (including in relation to remuneration arrangements) and responsibilities
5. Reviewing insurance arrangements (for the ADI and accountable persons)

We would be happy to assist all of our ADI clients in their preparation for BEAR and on its implementation. Our leading local team in Australia can draw on the extensive experience of our teams in the UK and Hong Kong in having advised on the implementation of the UK SMR and HK MIC regime.

Appendix 1 - proposed BEAR expectations