Federal Budget: Banking Executive Accountability Regime

The proposals will apply to all authorised deposit taking institutions (ADIs). The proposals include the registration of senior executives and directors with APRA, the mapping of senior executives' roles and responsibilities, stronger powers to remove and disqualify senior executives and directors and a new civil penalty regime for misconduct by ADIs.

Key elements of the banking executive accountability regime (BEAR)

The Federal Government has foreshadowed reforms to increase the accountability of senior management in the banking industry.  In the 9 May 2017 Budget, it announced proposed reforms to implement a new Banking Executive Accountability Regime (BEAR).

The key elements of the BEAR as set out in the Budget are:

1. APRA registration and accountability maps: All senior executives and directors will have to register with APRA.  ADIs will have to prepare accountability maps identifying the roles and responsibilities of their senior executives.
2. APRA disqualification powers:  APRA will be given stronger powers to remove and disqualify senior executives and directors of all APRA regulated institutions, not just ADIs.  APRA decisions will be reviewable by the Administrative Appeals Tribunal.
3. New misconduct rules:  A new regime will establish expectations on how ADIs and their executives and directors conduct their business, covering matters such as conducting business with integrity, due skill, care and diligence and acting in a prudent manner.
4. Civil penalty regime:  A new civil penalty regime will be introduced, with maximum penalties of $200m for larger ADIs, and $50m for smaller ADIs.
5. Deferred senior executive remuneration: At least 40% of the variable remuneration of senior executives' will have to be deferred for at least 4 years (with that percentage being at least 60% for some executives, such as CEOs).
6. APRA funding:  APRA will receive funding of $4.2m over 4 years to implement the proposals (suggesting a lead time to implementation), as well as $1m per annum to resource its enforcement activities.

Comment

The Government's proposals have only been communicated in outline at this stage.  Expect to see the details of the BEAR fleshed out in time and a consultation on the proposed changes later this year.  We anticipate that, once detailed, the proposed changes will be implemented through amendments to legislation, as well as through APRA's prudential standards and other APRA guidance.

Here are our initial thoughts on the package outlined yesterday:

1. Increased regulatory risk

Clearly these are significant developments for ADIs and their senior executives.  Although APRA has always had enforcement powers available to it, it has not traditionally been an active enforcement agency.  That may well change!

However, the proposal to enhance APRA's enforcement powers and resources is significant.  Coupled with a new civil penalty regime for ADIs, with very substantial financial penalties, this represents a significant change in the level of regulatory risk facing ADIs and their senior executives.

In other respects, the changes proposed reinforce existing regulations and practices.  For example, senior executives of ADIs are already subject to APRA scrutiny through fit and proper assessments and their roles and responsibilities are generally well documented.  APRA also has powers to apply to court to disqualify a senior executive which fails to meet fit and proper requirements.

2. Accountability mapping – a challenge

The roles and responsibilities of senior executives of ADIs are commonly well documented and known to APRA.  However, the proposed reforms, particularly APRA's new enforcement powers, will cause all ADIs and executives to revisit these arrangements.  We have seen this in the United Kingdom with the Senior Managers Regime.

Although the proposals focus on the mapping of responsibilities of senior executives, at a practical level the allocation exercise will extend well beyond them.  It is to be expected that senior executives will want their reports (including indirect reports) to have clearly documented roles and responsibilities of their own and to be able to certify or attest to compliance with their obligations, so that the senior executives can be assured that they are discharging their roles.  This process will give rise to a cascade of responsibility mapping within ADIs.

ADIs will need to develop effective frameworks for providing information to senior executives (and their reports and so on).  They will also need to review internal compliance and governance policies/frameworks to ensure that all staff subject to the reforms are fully aware of their new functions and responsibilities. In addition, staff will need to be aware of the procedures to follow in the event of a breach.

Our extensive experience in the UK in advising banks and executive teams on the Senior Managers Regime there is that allocating responsibility for particular functions and responsibilities is a significant challenge; particularly when, historically, collective accountability and governance has been a feature of the corporate landscape – different individuals will have different tolerances and ideas as to what their roles and responsibilities are. 

3. The proposed misconduct regime

The proposal refers to "expectations" being established on how ADIs and their executives and directors conduct their business, covering matters such as conducting business with integrity, due skill, care and diligence and acting in a prudent manner.  These would then be backed by a civil penalty regime, with very significant penalties attached – up to $200m.

The form in which these "expectations" will be set is not clear.  It is possible that APRA would set these out in a prudential standard, and in legislation be given the power to enforce the standard through civil penalty proceedings.  Alternatively, it may be proposed that APRA have power to introduce "rules" along the lines of the ASIC Market Integrity Rules (which govern exchange market participants).  It is also possible that an infringement notice regime could be introduced as an alternative to APRA initiating court proceedings.

It would also be reasonable to expect that executives involved in a contravention of the new expectations would be subject to APRA's proposed enhanced enforcement powers, such as disqualification.

Other considerations

In addition to considering the direct aspects of the proposed BEAR, banks will also need to consider other implications the BEAR may have on their business operations and processes.  We note some of these briefly below:

1. Breach reporting: Given the significant increase in penalties, and the likely scope of the new misconduct rules, banks will need to review their breach investigation and reporting processes to ensure they take into account the BEAR, including the role of senior executives in this process who may be impacted by the reports.  These reforms will interact with the work currently being undertaken by the ASIC Enforcement Review Taskforce, which is expected to release its report in September 2017 examining the breach reporting regime and the adequacy of ASIC's regulatory tools and powers.  See our earlier update on this.
2. Private claims risk: The introduction of the proposed misconduct rules creates an additional risk that adverse findings in civil penalty proceedings could lead to private claims and class action risk.  This is particularly concerning as we anticipate that the "expectations" proposed under BEAR will be cast very broadly.
3.  PI and D&O arrangements:  The increased risk of personal liability for executives, and the new civil penalty levels, will also be of concern to insurers. Insurers are likely to reassess the risks involved in existing insurance policies, which carries with it the prospect of future increases in insurance premiums. As banks' compliance and governance frameworks will influence the potential for breaches and any resulting liability, insurers are also likely to take an active interest in such frameworks.  Banks should review their existing directors and officers and professional indemnity insurance policies to ensure adequate coverage under any new regime.
4. Employment: Our UK experience suggests that the accountability mapping process will involve significant consultation with executives, and existing employment contracts and position descriptions will need to be updated to ensure the agreed accountabilities are consistently and clearly documented.  Similarly, remuneration packages and incentive plans will need to be reviewed to reflect the proposed requirements that 40% of variable remuneration (60% for the most senior executives) be deferred for a minimum of four years. ADIs will also need to consider what information they already capture, and what else may be needed, to assess the fitness and propriety of their executives to conduct business consistently with good prudential outcomes.  Properly documenting appraisal data, training records and feedback from managers and peers will assist to discharge the new obligations in this area.

How we can help

The implications of the BEAR are significant.  If implemented as proposed, BEAR will introduce and give rise to significant legal and regulatory risks for the banks.  While the details of the proposal are yet to be announced, banks should begin to consider and structure their response and approach to the reforms so that they are properly prepared when the time comes.

We have a leading team that brings together the key skills required to address and manage these risks from a legal perspective – the experts in our regulatory, disputes, insurance and employment teams.

We also have extensive experience advising numerous clients and management teams in the UK and Europe on the recent introduction of the Senior Managers Regime.  Our advice to banks and their executives on the implementation of that regime has dealt with responsibility mapping and attestations as required by that regime.  

We will provide further updates when further details are announced, drawing on our UK, European and local industry experience.