E. Service Contracts
Objective
To protect and promote the financial integrity and efficiency of the State-based financial institutions system and to ensure that depositors are adequately protected from the risks that building societies incur in the process of financial intermediation. Towards this end, to ensure that societies are not exposed to undue risk or unfair practices with respect to service contracts.
General Background
Under Section 245 of the FI Code, a society must obtain prior written approval from its SSA before entering into a management contract. Management contracts are defined as arrangements whereby a third party performs the whole or a substantial part of the functions of the society. The key feature of a management contract is the abrogation of total or substantial management control to a person or entity external to the society. Examples include situations where the day-to-day operation of the society is managed through entities controlled by directors or independent third parties.
Service contracts are other arrangements entered by a society to obtain services or products without the abrogation of management control. Each society is likely to enter a variety of such contractual arrangements for valid economic and efficiency reasons, especially where the society neither has, nor seeks, the expertise. While service contracts will cover a range of relationships with external parties, supervisors are concerned with those contracts that create additional risks, create conflicts of interest or require disclosure to members and shareholders.
A conflict of interest may arise where a society enters arrangements with a director or officer (or their associates) for the provision of services. AFIC recognises that some regionally-based societies may face difficulty appointing suitably qualified directors who are not otherwise associated with the provision of services to the society in the normal conduct of business. AFIC does not intend to outlaw such arrangements but seeks to ensure arm's length dealings.
Financial and operating leases entered into in the ordinary course of business on an arm's length basis are not service contracts for the purposes of this section. However, such leases are subject to normal reporting requirements as part of the financial statements.
Prudential Standards
Service Contracts
3.4.5 Review of Service Contracts
3.4.5.a Each society must demonstrate systems for selection, regular review and renewal of service arrangements that ensure arm's length dealings.
3.4.5.b A society must not enter service contracts that:-
· diminish control of the society by the Board;
· diminish the SSA's ability to review and supervise the society; or
· are contrary to the Financial Institutions Legislation.
3.4.5.c Before entering into a service contract a society must consider the risks arising from the proposed arrangement. This includes a documented assessment of the impact of the contract on its operational and control environment as well as the commercial risks that may arise from entering into the contract.
3.4.5.d Where a society enters into a contract (not being a management contract) that permits an external party to make decisions in its name, or on its behalf, then the society must ensure there are adequate systems and controls in place to review the decisions made and ensure they are in accordance with its board approved policies and procedures.
3.4.5.e Where an SSA has concerns with the ability of a society to comply with this standard, it may require it to consult with it, in advance, before entering into some or all future service contracts. In this consultation process the society will need to demonstrate that the proposed contract will not expose it to excessive risk.
3.4.5.f A society must advise its SSA of any service contract under which payments in a current or future year are likely to exceed 5% of non-interest expense. It must consult with its SSA in advance before entering into a service contract where the payments in a current or future year are likely to exceed 10% of non-interest expense. In this consultation process the society will need to demonstrate that the proposed contract will not expose it to excessive risk.
3.4.5.g A society must retain a register of service contracts. At a minimum this should include details of the parties involved, date of commencement, termination date, review date, fee structure, a brief description of the purpose of the contract and a reference to the location of the detailed documentation. The documentation must be made available for review upon request from an SSA.
