APRA’s activities during 2015/16 encompassed its primary supervisory, regulatory and resolution functions, its role as a national statistical agency for the financial sector, and domestic and international liaison. The key activities in these areas are set out below.
Supervisory and regulatory activities
Authorised deposit-taking institutions
Response to the Financial System Inquiry
In its response to the Financial System Inquiry (FSI), the Government endorsed APRA to pursue a number of the recommendations, particularly as they related to the resilience of ADIs.
In July 2015, APRA published the Information Paper International capital comparison study as an important first step in addressing the FSI recommendation to ‘set capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong’ (FSI recommendation 1). In its final report, the FSI suggested that for banks to be regarded as unquestionably strong they should have capital ratios that position them in the top quartile of internationally-active banks. Although APRA announced that it did not intend to mechanically adopt a top quartile benchmark for measuring ‘unquestionably strong’, it indicated that such a benchmark was a useful sense check of the banks’ relative strength. APRA’s study, which adjusted for differences in measurement methodology across jurisdictions and used a number of different measures of capital strength, found that although the Australian major banks were well-capitalised, their June 2014 capital adequacy ratios would need to increase further if they were to be comfortably positioned in the top quartile of internationally-active banks.
Also in July 2015, APRA announced an increase in the amount of capital required for Australian residential mortgage exposures by ADIs accredited to use the internal ratings-based (IRB) approach to credit risk. This change meant that, for ADIs accredited to use the IRB approach, the average risk weight on Australian residential mortgage exposures increased from approximately 16 per cent to at least 25 per cent from 1 July 2016.
This change reflected the FSI’s recommendation that APRA ‘raise the average internal ratings-based (IRB) mortgage risk weight to narrow the difference between average mortgage risk weights for authorised deposit-taking institutions using IRB risk-weight models and those using standardised risk weights’ (FSI recommendation 2). The major ADIs responded to the increased IRB mortgage risk weight by increasing capital levels, which also had the effect of lifting their capital ratios relative to international peers. Recent data indicates the average of the major banks’ risk-based capital ratios are now broadly in line with the bottom of the benchmark suggested by the FSI.
As noted above, APRA intends to use the relative positioning of major bank capital ratios against international counterparts to inform, but not determine, its approach for setting capital adequacy requirements. The improvement in the major banks’ international capital comparison provides time for APRA to consider the full range of factors that are relevant to satisfy the FSI’s ‘unquestionably strong’ recommendation. Critically this includes assessing the impact of the Basel Committee on Banking Supervision’s (Basel Committee’s) reforms as they are finalised and considering how other measures of resilience, such as liquidity, funding, asset quality, and recovery and resolution planning can assist in achieving the FSI’s objective.
Residential mortgage lending
In December 2014, APRA wrote to all ADIs emphasising the importance of sound mortgage lending standards. APRA’s letter identified specific areas of prudential concern, focused on risk profile, investor lending and serviceability assessments. During 2015/16, APRA continued to undertake supervisory actions aimed at ensuring ADIs maintain sound lending standards. To this end, APRA:
- continued to drive improvements in mortgage underwriting standards and serviceability assessment criteria;
- conducted a Hypothetical Borrower Exercise to gauge the impact of improvements to underwriting standards since December 2014 and published a summary of the results; and
- monitored ADIs’ moderation of investor lending, in instances where this had been growing strongly. Where specific undertakings regarding quantitative targets (notably, the 10 per cent year-on-year growth benchmark APRA outlined in its December 2014 letter) and timing had been given by ADIs, APRA ensured that these commitments were adhered to. APRA also engaged banks on the topic of data quality, especially following material reclassifications of home-loan purpose by some ADIs. System-wide growth in investor loans slowed to 5 per cent by end June 2016, compared with a peak of 11 per cent in mid-2015.
Although many of APRA’s initial objectives in this work have been met, sound mortgage lending standards will continue to be an area of focus in the coming year.
Commercial property lending
In the second half of 2015, APRA commenced an industry-wide review of commercial property lending standards. The work has a number of complementary components: a significant data collection focusing on portfolio-wide metrics for recent loan originations, a review of documented underwriting standards, on-site discussions with relevant ADIs, and a detailed review of a sample of transactions. This investigative phase of the work will be complete by the end of 2016, after which APRA expects to produce more detailed publicly available guidance on prudent lending practices in this area.
Basel III-related policy initiatives
In November 2015, APRA consulted on a revised set of amendments to APRA’s prudential framework for securitisation. These amendments were designed to simplify the existing framework to provide more flexibility in funding arrangements for ADIs as originators. APRA’s proposals also reflected the updated framework for securitisation released by the Basel Committee, which primarily focuses on the regulatory capital requirements for ADIs that invest in or provide facilities to securitisations. These recent (late 2014) Basel Committee developments on the capital requirements for ADIs with exposures to securitisation forms part of the Committee’s broader Basel III agenda to reform regulatory standards for banks in response to the global financial crisis and thus contributes to a more resilient banking sector. APRA intends to finalise these amendments to the prudential framework for securitisation by the end of 2016.
In January 2016, the capital buffers introduced as part of the Basel III reforms came into effect. Locally-incorporated ADIs are now required to hold a buffer of Common Equity Tier 1 Capital over and above minimum requirements, comprised of:
- a capital conservation buffer generally equal to 2.5 per cent of risk-weighted assets;
- a countercyclical capital buffer set at a level of between zero and 2.5 per cent of risk-weighted assets, and with the capacity to be varied over time (currently the buffer is set at zero per cent); and
- an additional capital buffer applicable to an ADI designated as a domestic systemically important bank (D-SIB), currently set at 1.0 per cent of risk-weighted assets.
In December 2015, APRA published the Information Paper The countercyclical buffer in Australia, setting out APRA’s approach to assessing the appropriate settings for this buffer, and released for consultation the Prudential Practice Guide APG 110 Capital Buffers (APG 110), which provides guidance on the operation of the capital conservation and countercyclical buffers. APRA published the final version of APG 110 in August 2016.
In March 2016, APRA commenced consultation on the second Basel III liquidity-related standard: the Net Stable Funding Ratio (NSFR). The NSFR supplements the Liquidity Coverage Ratio (LCR), introduced from the beginning of 2015, by establishing a minimum stable funding requirement for ADIs based on the liquidity characteristics of an ADI’s assets and off-balance sheet activities over a one-year time horizon. The NSFR seeks to ensure that long-term assets are financed by at least a minimum amount of stable funding. APRA proposes to apply the NSFR standard to larger, more complex locally-incorporated ADIs that are required to meet the LCR requirement. In addition, APRA consulted on proposed options for the future application of a liquid assets requirement for foreign ADIs. The options proposed were a continuation of the existing 40 per cent LCR requirement, or a new Foreign ADI Liquid Assets Requirement.
A response to submissions, and the associated draft prudential standards, were released for a second round of consultation in September 2016. It is intended that new requirements will come into effect from 1 January 2018.
The development of robust and credible recovery plans by ADIs has continued to be an important area of focus for APRA over the past year. These plans are critical to ensuring that ADIs can recover from a period of severe adversity whilst still providing their essential payment and intermediation services to the community.
APRA’s 2014 stress test of the ADI industry highlighted the need for further improvements in ADI recovery plans. In particular, the stress test identified that, when considering actions to rebuild capital in the stress scenario, there was only limited use of previously documented recovery plans. The stress test also raised concerns about the extent to which ADIs had considered the combined impact of their mitigating actions in a systemic scenario. To be robust and credible, recovery plans must include a realistic and continuously reviewed menu of actions that can be practically implemented in stressed operating conditions, bearing in mind that other ADIs may well be seeking to undertake similar (or related) actions at the same time.
In light of these results, APRA began a thematic review of ADI recovery planning. Over the past year, this led to APRA issuing new guidance to relevant ADIs, and requesting that larger ADIs submit updated recovery plans based on that guidance. Those updated plans were received in May/June 2016, and APRA is now reviewing and benchmarking them in order to highlight areas of better practice that will further increase the credibility of plans in subsequent iterations.
Pricing risk in commercial lines
As was also noted in last year’s Annual Report, heightened levels of price competition continue to be evident in the commercial lines classes of business. In such an environment, the risk to insurers is that the desire to maintain existing customers and market share, as well as win new business, results in inadequate pricing that exposes them to material losses in the future. This price competition has been particularly evident in insurance for large, corporate property risks in the fire and industrial special risks (ISR) class of business.
In 2015/16, APRA conducted a review of the oversight and control of the pricing decision for commercial property insurance for a sample of insurers and reinsurers. The review found these frameworks have largely been operating as intended during this period of heightened competition. Formal pricing frameworks and oversight by risk and governance committees, policies documenting underwriting and pricing guidelines, delegated responsibilities, compliance reviews, regular monitoring and pricing tools were largely found to be in place.
Nonetheless, the review identified a number of better practices which insurers could consider in their pricing frameworks. This feedback was provided to the insurers that participated in the review, with the review’s key findings communicated to the industry and more broadly in October 2016 through APRA’s Insight publication.
Catastrophe modelling governance and risk management
Although the frequency of major catastrophe events has fallen somewhat in the past couple of years, APRA has had a long-standing focus on improving industry catastrophe modelling governance and risk management policies and practices. This reflects the risk that poor policies and practices can lead to property insurers purchasing inadequate levels of reinsurance, exposing them to significant claims costs in the event of a natural catastrophe.
In December 2013, APRA wrote to insurers setting out the conclusions from a thematic review of catastrophe modelling governance and risk management policies and practices, highlighting issues APRA expected insurers to address. In the past year, a follow-up review was conducted by APRA to gauge improvements in this area since the letter was issued. This review found that, in general, insurers:
- demonstrated a better understanding of the strengths, weaknesses and inherent assumptions of catastrophe risk models used;
- often purchased a higher level of catastrophe reinsurance to better reflect the uncertainty inherent in catastrophe modelling output; and
- enhanced their risk appetite statements to clearly set out the insurer’s appetite for catastrophe risk.
CTP claims experience
Insurers face the persistent risk of inadequate reserving for insurance liabilities, which can expose them to potentially significant losses if their claims outlook deteriorates in later years. This is a natural area of supervisory attention. In 2015/16, an area of focus for APRA has been the trends evident in compulsory third party (CTP) insurance, with increased claims frequency in the NSW CTP scheme in particular heightening the risk of adverse claims development for insurers involved in this line of business. The NSW Government has announced plans to introduce reforms with the objective of making the NSW CTP scheme more sustainable and lowering the cost of CTP insurance premiums, by moving to a defined benefit, no fault structure for lower severity claims. The timing of the proposed reforms has yet to be finalised.
In the meantime, APRA has been closely monitoring developments through the analysis of claims data, along with discussions with insurers. A small team has also been tasked with examining the scope for the claims trends in the NSW CTP scheme to spread to other long tail classes of business. Claims data has been collected from CTP insurers to monitor trends in frequency and severity of claims, and to gauge any early indications of similar adverse trends in other classes. This exercise also provided insights for APRA’s assessment of the management and controls in place at these insurers to monitor and manage the impact of this risk on their CTP reserves. This work will continue into the year ahead.
Planning for APRA’s first industry stress test of general insurers commenced in 2015/16. The stress test involves the four largest general insurers and two largest reinsurers, and is a component of APRA’s expanding stress testing programme across industry sectors. As with earlier tests for ADIs and life insurers, the primary objectives of the stress test are to:
- make a quantitative assessment of the resilience of participating insurers to adverse scenarios;
- support insurers to further develop their stress-testing capabilities; and
- support APRA’s ongoing identification of current and emerging risks.
The stress test scenarios have been finalised and provided to the participating insurers, with a view to them reporting their results to APRA later in 2016. Following analysis of the results by APRA, including a review of consistency and reliability, feedback will be provided to the participating insurers and the industry more broadly.
Role of the Appointed Actuary and actuarial advice
In 2015/16 APRA commenced a review of the role of the Appointed Actuary across the life insurance and general insurance industries (in due course, the implications of the conclusions from this review will be considered for the private health insurance industry). The objectives of the review are to examine the existing responsibilities of the Appointed Actuary to ensure they remain appropriate and principles-based, clarify the strategic role to be performed by Appointed Actuaries, and harmonise requirements between the insurance industries where it would improve regulatory outcomes. After informal discussions with the Actuaries Institute and other industry stakeholders, APRA released a discussion paper in June 2016 with a range of specific proposals for consultation.
Life insurance and friendly societies
Group insurance arrangements
As has been the case for a number of years, APRA continued to closely monitor the group insurance market in 2015/16. The flow-through of significant premium increases since 2013, together with more stability in claims costs, has seen this market once again return to profitability. While this is a more sustainable outcome for insurers, it has produced significant and unexpected premium increases for many superannuation fund members.
The current phase of APRA’s work in the group insurance market focuses on the long-term sustainability of scheme benefit structures: these need to be viable for insurers and also meet the needs of fund members. In particular, a key objective is to reduce the likelihood of another significant period of price discontinuity, as seen in recent years. APRA’s work with insurers has examined issues such as the willingness of insurers and superannuation trustees to design group life benefit structures with sustainability as a clear objective; the clarity of claims philosophy; and the effectiveness of adequately-resourced claims processes and procedures. This work has been complemented by a review of the steps taken by trustees to review insurance arrangements, including claims management processes, to ensure they are in the best interests of fund members and that insurance costs do not inappropriately erode the retirement benefits of members.
While the life insurance industry has made good progress in addressing the underlying structural issues that caused market stress a few years ago, more needs to be done. APRA is continuing to discuss how the market can be strengthened with key insurers and reinsurers active in group risk insurance, and with a representative sample of trustees. Areas that have scope to be strengthened further include the review of complex and old definitions, and enhanced dialogue between trustees and insurers to improve benefit design and alignment of group life policy terms to the terms of cover offered to superannuation fund members. The outcomes APRA is seeking to achieve through this work include:
- emphasising the need for insurers and trustees to address sustainability - requiring both sides of the group risk market to work together for positive outcomes for members, and changing practices if necessary to achieve this;
- developing clearer guidance on what constitutes better practice in sustainable benefit design; and
- enhancing APRA’s ability to monitor the on-going sustainability of the market.
Insurers and trustees continue to consider how to balance product and benefit design to provide adequate and sustainable insurance cover for members while ensuring insurance costs do not inappropriately erode retirement benefits. Discussion on these issues will continue among industry participants and APRA.
In March 2016, public attention was drawn to allegations of inappropriate and unfair treatment of a small number of claimants by The Colonial Mutual Life Assurance Society Limited, trading as CommInsure. This matter has subsequently attracted intense scrutiny with respect to the allegations about both the treatment of claimants and the treatment of a whistleblower who was involved in bringing the matters to public attention.
In response to the allegations, the Commonwealth Government asked ASIC to investigate the treatment of claimants, and also to consider whether the matters were isolated to CommInsure or reflected systemic issues within the industry. While APRA does not have the mandate to pursue customer complaints, it nevertheless takes an interest in matters such as this given they can provide important insights into the strength of an institution’s governance, risk management and risk culture. Working alongside ASIC, APRA established a small central team and commenced three streams of work:
- APRA wrote to the boards of all active insurers, as well as a number of trustee boards (given a number of the claimants were members of group risk schemes via their superannuation funds), to seek information about the effectiveness of their governance and oversight mechanisms for matters such as claims handling (including culture), updating of benefit definitions, rejected claims and customer complaints;
- APRA engaged with the board and senior management of CommInsure to gain assurance over the robustness and completeness of the independent reviews commissioned by Comminsure to investigate the allegations and to ensure a focus on stakeholder and community expectations through this process; and
- APRA met with the whistleblower and is considering whether the whistleblowing provisions in the Life Insurance Act 1995, which are designed to prevent the identification and victimisation of whistleblowers, have been adhered to in this matter.
APRA’s consideration of these matters is continuing.
Product design and complexity
In April 2016, APRA made a submission to the Senate Standing Committee on Economics’ ‘Inquiry into the scrutiny of financial advice – Life Insurance Industry’. This Inquiry had its terms of reference expanded in March following the allegations in relation to CommInsure claimants. Although the terms of reference for the inquiry addressed issues that more directly fall within ASIC’s mandate, APRA’s submission addressed a number of key issues including:
- APRA’s heightened supervisory focus on recent issues in the group risk market, in particular to address mispricing and benefit design;
- reiterating APRA’s warning in a May 2015 letter to insurers that claims improvement programs must be genuine and not an excuse to avoid paying legitimate claims;
- the importance of aligning claims practices with claims philosophy, and that this should be a core element of the arrangements between insurers and superannuation trustees; and
- support for the FSI recommendation to find a mechanism to more easily permit rationalisation of legacy products, which add a considerable amount of complexity for insurers and can lead to unsatisfactory outcomes for consumers.
APRA has also encouraged the life insurance industry to take a fresh look at ways to reduce the risks arising from legacy products and complexity.
Preparatory work for APRA’s first life insurance industry stress test began in 2014/15, including extensive liaison with the eight insurers participating in the test. In July 2015, APRA provided the insurers with the relevant scenario data for the test, which included key parameters such as asset market declines, higher interest rates, an increase in unemployment and increased claims rates for particular classes of business.
The results of the stress test were received from the participants in late 2015. Following data quality and consistency checks, and clarification of some aspects of the responses, APRA undertook its analysis of the stress test results, including the development of overall conclusions. Written feedback was provided to all participants in June 2016; this provided both industry-level observations as well as feedback specific to each participant about their results and practices. The written feedback was supplemented with bilateral meetings with all participants to discuss the outcomes further.
APRA’s key observations from the stress test were that:
- the stress scenario produced, unsurprisingly, a significant adverse impact on insurers’ capital positons, although pre-stress capital surpluses were largely restored after the impact of mitigating actions were taken into account;
- the heterogeneous nature of the industry meant that the stress test resulted in widely varying outcomes for insurers with different mixes of business;
- the feasibility, quantum and impact of mitigating actions needs to be carefully considered, given it was difficult to predict ‘second round’ effects (e.g. the response of competitors); and
- insurers’ governance processes for the stress test scenario were broadly satisfactory and had improved since APRA’s initial discussions with insurers as part of the preparatory work prior to the test.
The learnings from this stress test, together with APRA’s experiences when stress testing other industries and the experience of overseas prudential regulators, will be used to develop further guidance for insurers on ways to strengthen their stress testing capabilities and enhance future stress testing exercises for the life insurance industry.
Private health insurers
In its first year of responsibility for supervising private health insurers (PHIs), APRA’s objective was to gradually transition the industry knowledge and supervision processes of the former Private Health Insurance Administration Council (PHIAC) into the APRA supervision framework. Working closely with previous PHIAC supervisors based in Canberra, there has been an orderly transfer of responsibilities to supervisors located in APRA’s other offices, reflecting APRA’s modus operandi of placing supervisors close to the regulated institutions they are responsible for supervising. This transfer included visits to each of the PHIs to introduce the new supervisory teams and as well as the continuation of regular supervisory engagement. Meetings were also held between the boards of a number of insurers and senior APRA representatives. This handover process was largely completed in May 2016.
On the policy front, APRA hosted a series of discussions in May and June 2016 with PHIs and interested stakeholders to outline APRA’s plans for a methodical review of the PHI prudential framework over the coming three years. The objective of the review is to maintain the quality and effectiveness of the prudential framework, and ensure it remains fit for purpose in the context of APRA’s mandate. Insurers were advised that, in 2016/17, APRA will consult on formalising prudential standards for risk management and business continuity in the PHI industry, and review existing standards relating to outsourcing and the Appointed Actuary. While APRA anticipates the core principles of its existing cross-industry standards will be applicable to the PHI industry, it has committed to carefully consider whether specific requirements for PHIs are necessary. Equally, where APRA’s review identifies practices in the PHI industry which can be applied to other regulated sectors, APRA will look to take on board those lessons.
APRA also announced it was not intending to review the PHI solvency or capital adequacy prudential standards prior to 2019, unless an issue arises with the prudential framework, or some other development occurs, which warrants an earlier review. This timetable will enable a fuller consideration of the effectiveness of the existing solvency and capital adequacy prudential standards for PHIs, which only came into operation in 2014.
In September 2015, APRA commenced a program of thematic reviews of PHIs’ risk management practices. The review sought to:
- improve the resilience of PHIs to periods of stress through more effective management of risk; and
- enable smoother transition for PHIs to potential new regulatory requirements in future years.
The reviews formed part of APRA’s ongoing prudential supervision, and focused on improving the effectiveness of risk management arrangements within individual insurers. The reviews also provided information about the state of risk management within the industry, and will be beneficial in informing possible changes to the prudential framework, including the development of a risk management prudential standard.
The risk management thematic reviews focused on four key areas — board oversight, effective risk management frameworks, risk management processes, and internal controls — providing insight into the risk governance and operational risk management arrangements within each insurer. Thirteen reviews were completed by the end of June 2016. General observations arising from the reviews to date include:
- boards generally demonstrated a strong commitment to risk management;
- risk management frameworks are being strengthened, but require further work to embed processes into business-as-usual activities;
- the ‘three lines of defence’ model of business assurance is gaining traction; and
- there is an increasing appreciation of the importance of the organisation’s risk culture in assessing the effectiveness of risk management.
Feedback from PHIs to date indicates the reviews have been well received, with the recommendations viewed as useful for enhancing the maturity of their risk management frameworks.
In its engagement with superannuation funds in 2015/16, APRA continued to focus on enhancing board governance and risk management, with specific focus on strengthening governance practices of Registerable Superannuation Entity (RSE) licensee boards, their composition and the effectiveness of their operations. APRA also continued to emphasise, in industry forums and through supervisory activities, the importance of governance and culture in promoting the best interests of superannuation fund members.
To support these efforts, APRA released a discussion paper for consultation, Governance arrangements for RSE licensees, along with draft prudential standards and practice guides in August 2015. This consultation package proposed a number of amendments to Prudential Standard SPS 510 Governance and Prudential Practice Guide SPG 510 Governance intended to promote sound governance practices by the boards of all RSE licensees, including provisions to facilitate APRA’s administration of the Government’s proposed amendments to RSE licensee governance requirements reflected in the Superannuation Legislation Amendment (Governance) Bill 2015 (the Bill). Although the Bill lapsed at prorogation due to the 2016 Federal Election, APRA has indicated that it intends to finalise in the coming months those amendments to the prudential standards and guidance that were not subject to the passage of the Bill.
During 2015/16, APRA also commenced a thematic review of board governance. This thematic review, which is expected to be completed in the second half of 2017, will highlight better industry practices, as well as areas for further improvement, in areas such as director appointment and nomination processes, board renewal and tenure, board size and the ongoing assessment of board performance and effectiveness.
Aligned with the heightened focus on governance, APRA continued to examine industry practices with respect to the management of conflicts. As part of this broader initiative, APRA commenced a thematic review specifically into the way in which RSEs were managing related party arrangements. This review, which is expected to be completed in mid to late 2017, follows a broader 2014 thematic review of conflicts management and will review more deeply, for a sample of superannuation funds across all industry segments, practices in relation to the management and oversight of different types of related party arrangements. The review will include an assessment of the extent to which issues APRA has previously highlighted to the industry have been addressed, and identify if, and where, further improvements in practices are still needed.
Strategy and business planning
In light of an increased focus on efficiency and competition by the Government, and the impact of underlying economic and demographic trends, sound strategic and business planning is essential for RSE licensees’ to effectively manage strategic priorities, respond to the challenges of the evolving industry and environment and ensure members’ best interests are met over the long term.
APRA has observed that, particularly relative to other APRA-regulated sectors, there is scope for the superannuation industry to improve its strategic and business planning practices, and the approaches adopted for benchmarking, monitoring and reviewing the frameworks, processes and resources that support these activities. Given the evolving landscape, and the impact of potential reforms on the future shape of the industry, APRA’s supervision activities over 2015/16 have given increased attention to the quality and effectiveness of RSE licensees’ strategic and business planning practices. This will continue to be an area of focus in 2016/17.
As noted above in relation to the life insurance industry, APRA continued to devote substantial resources to insurance in superannuation throughout 2015/16. Following a thematic review on this topic in 2014/15, APRA has been closely monitoring RSE’s management of, and experience with, group life insurance over 2015/16.
The past few years have seen significant increases in premium rates for group life insurance. However, premium increases alone have not addressed the underlying structural reasons that contributed to the adverse claims experience that significantly impacted the life insurance industry. Further work is needed by the superannuation and life insurance industries to ensure sustainable group insurance arrangements that deliver appropriate outcomes for members at reasonable cost, particularly in an environment of continued low investment returns where the cost of insurance has more material impact on ultimate member benefits.
As noted above, APRA commenced a cross-industry thematic review in 2015/16 with a focus on the sustainability of group life insurance within the superannuation industry, and this is expected to be completed in the coming months.
Investment governance remained an important area of focus for APRA over the past year. Reflecting a difficult investment environment, some RSE licensees have lowered their return targets. Others have made changes to their investment strategies that increase investment risk in order to increase the probability of meeting the return targets advertised to members.
Over 2015/16, APRA’s supervision activity has therefore devoted attention towards ensuring that RSE licensees have in place robust investment governance and investment risk management frameworks and processes. This includes having the right focus and skills at board level, robust and independent performance measurement, advanced investment risk measurement practices (including appropriate stress testing), and disciplined investment processes. Many RSE licencees have enhanced their practices in these areas in accordance with evolution in their investment activities, but many still require further enhancement.
The most significant weaknesses identified included, for some RSE licensees, a lack of understanding of underlying investments, an over-reliance on service providers, and weaknesses in, or misalignment between, investment governance and risk management frameworks.
The superannuation industry needs to be diligent in continuing to refine and lift standards of investment governance. The on-going challenges of a low return environment, coupled with the competitive dynamics of the superannuation industry, pose challenges for the sector. APRA’s attention has been, and will continue to be, directed at how the industry is responding and adapting to these challenges, and how investment governance frameworks support RSE licensees in meeting their members’ best interests obligations.
APRA commenced a liquidity stress-testing thematic review in 2014/15 to gain greater insights into the superannuation industry’s liquidity management and stress-testing practices, and to assess these against the requirements and expectations set out in Prudential Standard SPS 530 Investment Governance (SPS 530).
This review was completed in 2015/16 and indicated that the quality of liquidity stress-testing frameworks varies in sophistication and maturity across RSE licensees. Further, the level of sophistication of liquidity management is not always commensurate with the structure and complexity of the investment activities undertaken by the RSE licensee. The results of this review will be addressed as appropriate through the supervision plans for individual entities who participated in the review. The more general lessons from the review will be communicated more broadly to industry in the coming months and will also provide useful input to APRA’s supervision activities for the superannuation industry more generally.
Cross industry activities
In 2015, APRA established a small team to provide dedicated expertise on the topics of governance, culture and remuneration. The initial focus of the team has primarily been on how ADIs and insurers are implementing the risk culture requirements of Prudential Standard CPS 220 Risk Management (CPS 220). Engagement with a broad selection of industry, at both board and senior executive level, as well as a number of consultants and academics has been used to understand how the industry is approaching the task of assessing and monitoring the risk cultures within individual firms. Although CPS220 does not apply to them, discussions have also been held with some trustees within the superannuation industry.
APRA published a stocktake of industry practices in October 2016.
Margining and risk mitigation for non-centrally cleared derivatives
In February 2016, APRA commenced consultation on its proposed implementation of the internationally-agreed framework for margin requirements and risk mitigation for non-centrally cleared derivatives/
These requirements are designed to reduce systemic risk and contagion effects that may be caused by the default of a derivative counterparty, by ensuring collateral is available to offset any losses that default would cause. The margining proposals will apply to APRA-regulated entities that have a material level of transactions in non-centrally cleared derivatives; most APRA-regulated entities will therefore be unaffected. APRA expects to finalise its requirements later in 2016 and will set an implementation date when there is a clearer picture on implementation plans in other major jurisdictions.These requirements will come into effect over a multi-year transition period.
APRA released a framework for the supervision of conglomerate groups (the ‘Level 3 framework’) in August 2014, but deferred setting an implementation date given the FSI was reviewing the financial services regulatory regime more broadly.
In March 2016, APRA announced a revised implementation timetable for the Level 3 framework, and consulted on some clarifications to the wording of nine prudential standards that are applicable to the Heads of Level 3 groups, and two associated prudential practice guides. In July 2016, APRA released the final requirements for the non-capital components of the Level 3 framework, which will become effective on 1 July 2017.
APRA also announced that it would defer the capital component of the Level 3 framework (i.e. the introduction of a measure of capital adequacy calculated at the conglomerate group level). This deferral will allow for the finalisation of other domestic and international policy initiatives that are currently in progress. APRA anticipates consultation on the Level 3 capital requirements would not commence before mid-2017, and any new requirements stemming from that consultation would not become effective any earlier than 2019.
In October 2014, APRA wrote to ADIs, general insurers and life insurance companies seeking comments on the clarity of its requirements for boards. This was done in conjunction with APRA’s release of An Aid for Directors of ADIs and Insurers. APRA responded to submissions via a letter to industry in August 2015 with a commitment to improve the clarity of language used to communicate APRA’s requirements with respect to boards. As a sizeable proportion of the ADI, general insurance and life insurance prudential standards and practice guides that contain relevant board requirements are planned for review over the next three years or so, the clarifications to board requirements will be made as opportunities arise.
Shared computing services
The use of shared computing services (including cloud computing) represents a significant change to the way technology is employed. While shared computing services may bring benefits, such as economies of scale, they also bring associated risks. In July 2015, APRA released the Information Paper Outsourcing involving shared computing services (including cloud), which outlined prudential considerations and key principles in relation to shared computing services to provide assistance to industry and encourage ongoing dialogue on this evolving area of risk.
In 2015/16, APRA also conducted a survey of 37 regulated institutions collecting information on cyber security threats over the previous 12 months and how these threats were managed by the institutions. The results of the survey were released in October 2016 and showed those involved in the survey experienced a range of cyber security incidents over the period, and those threats that had the potential to cause a material impact appeared to have been well managed through a combination of effective monitoring and response activities.
APRA acts as a national statistical agency for the Australian financial sector. In that role, APRA collects and publishes data from prudentially regulated and other financial institutions to support its primary mission, as well as provide support to other public sector agencies such as the Reserve Bank of Australia (RBA) and the Australian Bureau of Statistics (ABS).
Data collections for APRA’s primary activities
APRA made a number of improvements to its reporting requirements and processes during the year. APRA’s primary data collection system, ‘Direct to APRA’ (D2A), is the reporting system that over 600 ADIs, general and life insurers, superannuation entities and other APRA-reporting entities use to submit data to APRA. D2A allows reporting entities to securely and electronically download, complete, validate and submit data to APRA. Institutions that create and import Standard Business Reporting format reports can also save time and effort in data quality assurance and in data entry.
With the aim of reducing the reporting burden while maintaining the collection of high- quality and timely data, APRA introduced a significant number of new data validation rules within D2A for all reporting industries. These new rules helped institutions identify and fix data errors and explain anomalies at the time they submit data to APRA; they also ensure that submitted data are immediately fit for use by APRA supervisors. During the year, APRA also removed or relaxed over 250 validation rules that were no longer effective at identifying errors.
As part of the transition of responsibility for prudential supervision of private health insurers to APRA, leading up to June 2016 arrangements were put in place to enable insurers to report statistical data to APRA via D2A. The switch to D2A reporting will apply for reporting periods ending on or after 30 June 2016, and provides an opportunity for insurers to reduce the burden of business-to-government reporting.
Statistical publications to assist APRA’s activities and support others
APRA introduced a number of improvements to its regular statistical publications during 2015/16.
In September 2015, APRA released a discussion paper on the future of the ADI Points of Presence statistics. In response to feedback received on the paper, APRA announced it would streamline the statistics and data collection from 2017. APRA also released a discussion paper in January 2016 on proposed changes to its ADI liquidity statistics, reflecting recent changes to the ADI reporting framework. The new statistics will be published for the first time in late 2016.
Following consultations with industry, APRA introduced the new Annual MySuper Statistics report in February 2016. APRA also released more industry-level statistics in the Annual Superannuation Bulletin and more fund-level data in the Annual Fund-level Superannuation Statistics. The publication of these statistics provides a central source of superannuation information and supports the broader transparency objectives of the Stronger Super reforms. APRA also made improvements to the recently introduced Quarterly Superannuation Performance statistics in response to feedback from users.
In June 2016, APRA released a discussion paper on its proposal to expand its publication of industry-level general insurance statistics and institution-level statistics. The proposal to include all non-confidential data in the institution-level statistics is in line with the Government’s Public Data Policy to extend the value of public data to the benefit of the Australian public.
As part of the 2016/17 Budget, the Commonwealth Government announced it will provide $9.7 million for capital expenditure and $11.2 million in operating expenditure over four years to develop and support the modernisation of APRA’s data collection and dissemination capabilities.
Data collections for other agencies
As part of its role as a national financial sector statistics agency, APRA collects data from regulated and unregulated institutions to assist the RBA, ABS, Australian Securities and Investments Commission (ASIC), Australian Taxation Office (ATO) and Department of Health to fulfil their respective roles.
During the financial year, APRA introduced three new superannuation reporting forms for the ABS, which uses these data for statistical purposes. These statistical purposes include compiling and publishing the Australian National Accounts and other statistical publications.
APRA collects a range of data from ADIs and registered financial corporations (RFCs) on behalf of the RBA and the ABS. These data are used by the agencies for their policymaking and statistical roles: for example, the economic statistics collection is used by the ABS for inputs to the calculation of gross domestic product, and by the RBA for calculating credit aggregates for the purposes of setting monetary policy.
Many of the reporting forms in the economic statistics data collection have not been comprehensively reviewed for some time, despite a rapidly changing economy and changes in the way the financial sector interacts with the physical economy. This has meant discrepancies have developed between the data collected on reporting forms and the data required by these agencies; some sections of the reporting forms are also now no longer required. In early 2016, the agencies proposed a draft set of new forms, and engaged in informal consultation with industry to ensure the proposals were reasonable and avoided any unnecessary burden. The formal consultation on the new forms is due to commence in November 2016.
Resolution and enforcement activities
Strengthening APRA’s preparedness for financial failures and crises in regulated institutions was one of the strategic objectives set out in APRA’s 2015-2019 Corporate Plan.
During the year APRA aligned a number of existing functions into a single, expanded Resolution and Enforcement unit. This unit covers policy and framework development, internal processes for responding to a failure or crisis event as well as developing industry responsiveness through improved recovery and resolution planning. The unit also includes APRA’s Enforcement function, which supports both ongoing supervisory activities and potential resolution actions as well as the administration of the Financial Claims Schemes, which may be important to managing the orderly exit from the industry of a regulated institution.
Crisis management policy
APRA continued its work in identifying and progressing enhancements to Australia’s failure and crisis management framework. This primarily included working with Treasury on crisis-related legislative reform, in particular the development of the Financial System Legislation Amendment (Resilience and Collateral Protection) Act 2016 which includes a power to temporarily stay close-out rights in resolution, and the progression of a wider legislative reform package that is intended to strengthen APRA’s crisis management powers. The Government has supported improvements in this area, in line with the FSI’s final report (Recommendation 5) which noted there are some gaps and deficiencies in the Australian statutory framework for crisis management and resolution when compared with international standards. Other work has focussed on developing APRA’s policies on recovery and resolution planning, including potential prepositioning measures to improve the resolvability of regulated institutions, in collaboration with members of the Council of Financial Regulators (CFR).
Crisis management operations
A number of activities were undertaken in 2015/16 to operationalise aspects of the crisis management framework. These included enhanced crisis management procedures and processes, including revised governance for problem entity escalation, monitoring and reporting (both within APRA and external with CFR agencies) and the identification of external expertise potentially needed in the event of a failure (for example, expertise may be needed in areas such as valuation, corporate restructure or insolvency and arrangements). In addition, further work was conducted to improve the operationalisation of the Financial Claims Scheme with an assurance program and testing sequential steps with CFR agencies.
APRA also continued to enhance its analysis tools and processes, and internal and external communication protocols to deal effectively with regulated institutions in severe distress.
Forensic analysis and enforcement
APRA’s supervisory approach is aimed at identifying and evaluating potential risks in regulated institutions at an early stage, and seeking to have these risks appropriately mitigated before they could pose a threat to the viability of the regulated institution.
As a prudential regulator, APRA uses its formal enforcement powers less than traditional law enforcement agencies, preferring instead to focus on risk management practice and prevention measures. However, should a regulated institution be unwilling or unable to take the necessary corrective action, APRA will use its enforcement powers to protect the interests of depositors, policyholders and superannuation fund members. Enforcement activity may also be needed to support the resolution of a failing entity.
During 2015/16, APRA’s enforcement resources continued to support frontline supervision in the early identification of emerging risks, so as to minimize the need for more intrusive intervention at a later stage. In addition, APRA released a report on its investigation into the failure of Trio Capital Limited, a result of which APRA removed 13 former Trio directors from the superannuation industry for specified periods of time.
APRA continues to develop and strengthen its network of information sharing with other regulators and law enforcement agencies to ensure that its supervisors have access to, and can assess the impact of, any relevant information on their regulated institutions.
Domestic liaison activities
APRA has strong working relationships with Australia’s key financial regulatory agencies - the RBA and ASIC. APRA also maintains a close and cooperative working relationship with the Australian Treasury. As noted above, the four agencies cooperate on a multilateral basis through their shared membership of the CFR. Beyond the members of the CFR, APRA also has active engagement with a range of other domestic bodies (see table on page 49). These engagements are typically guided by a Memorandum of Understanding (MoU) which, while not legally binding, signifies a commitment to cooperate and share relevant information, and establishes the practical arrangements by which this will occur. Many of these MoUs are available on APRA’s website (see table on page 48). In 2015/16, APRA signed an MoU with the Department of Health.
|Australian Bureau of Statistics|
|Australian Competition and Consumer Commission|
|Australian Crime Commission|
|Australian Federal Police|
|Australian Securities and Investments Commission|
|Australian Taxation Office|
|Australian Transactions Report and Analysis Centre|
|Council of Financial Regulators|
|The Commissioner for Fair Trading, Office of Fair Trading, Department of Commerce|
|Department of Health|
|Motor Accident Insurance Commission of Queensland|
|Motor Accident Authority of NSW|
|Reserve Bank of Australia|
|Workcover Authority of NSW|
List of domestic MoUs
In 2015, ASIC established its Digital Finance Advisory Committee (DFAC), primarily comprised of FinTech industry representatives. APRA joined DFAC as an observer. While the role of DFAC is to help inform ASIC’s work in this area, APRA’s participation provides insights on developments in this rapidly evolving area.
APRA also liaises with professional and industry associations for each industry sector that APRA regulates.
List of domestic agencies and organisations with whom APRA met during 2015/16
|Public Sector||Private Sector|
|Auditing and Assurance Standards Board||Actuaries Institute|
|Australian Accounting Standards Board||Association of Superannuation Funds of Australia|
|Australian Bureau of Statistics||Australian Bankers’ Association|
|Australian Federal Police||Australian Financial Markets Association|
|Australian Securities and Investments Commission||Australian Institute of Superannuation Trustees|
|Australian Taxation Office||Australian Retail Credit Association|
|Australian Transactions Report and Analysis Centre||Australian Securitisation Forum|
|Commonwealth Treasury||Banking and Finance Sector Group|
|Council of Financial Regulators||Corporate Superannuation Association|
|Department of Foreign Affairs and Trade||Customer Owned Banking Association|
|Department of Health||Finance Brokers Association of Australia|
|Financial Reporting Council||Financial Services Council|
|Heads of Commonwealth Law Enforcement Agencies||Industry Super Australia|
|Motor Accident Insurance Commission of Queensland||Insurance Council of Australia|
|Office of Best Practice Regulation||Health Insurance Restricted and Regional membership Association of Australia|
|Productivity Commission||Mortgage and Finance Association of Australia|
|Reserve Bank of Australia||Private Healthcare Australia|
|State Insurance Regulatory Authority||Risk Management Association Australia|
APRA’s primary international activities take two main forms:
- liaison with overseas home and host supervisory agencies on the activities of internationally active firms, including through participation in supervisory colleges; and
- participation in global standard-setting bodies to ensure relevant characteristics of the Australian financial system are taken into account in how international standards evolve.
During 2015/16, APRA signed two new MoUs with international agencies, taking to 29 the number of overseas regulatory agencies with which APRA has established formal bilateral information sharing arrangements. In July 2015, APRA signed an MoU with the Dubai Financial Services Authority, and an MoU was signed with the Central Bank of Timor-Leste in December 2015.
APRA is one of 56 signatories to the International Association of Insurance Supervisors (IAIS) multilateral MoU arrangements that now cover agencies supervising insurers which write over 65 per cent of global premiums. APRA also participates in institution-specific multilateral arrangements to support the sharing of confidential information in supervisory colleges involving internationally active financial institutions, including those headquartered in Australia.
APRA’s engagement with international agencies and standard setting bodies is summarised in the lists below.
International organisations that APRA was a member of during 2015/16:
- Asian Forum of Insurance Regulators
- Basel Committee on Banking Supervision
- Executives’ Meeting of East Asia
- Pacific Central Banks (Working Group on Banking Supervision)
- Financial Stability Board (Standing Committee on Supervisory and Regulatory Cooperation and Working Group on Governance Frameworks)
- International Association of Deposit Insurers
- International Association of Insurance Supervisors
- International Credit Union Regulators Network
- International Forum of Insurance Guarantee Schemes
- International Organisation of Pension Supervisors
- Trans-Tasman Council on Banking Supervision
International organisations APRA liaised with or assisted during 2015/16:
- ASEAN Insurance Training and Research Institute
- Asian Development Bank
- Asia-Pacific Economic Cooperation - Financial Regulators Training Initiative
- Association of Financial Supervisors of Pacific Countries
- Financial Stability Institute
- International Accounting Standards Board
- International Monetary Fund
- Organisation for Economic Cooperation and Development
- South East Asian Central Banks
- South Pacific Central Bank Governors
- World Bank
In addition to these activities, APRA also receives visits from international delegations for a range of core business and other purposes. Over 2015/16, APRA received visits from 51 international delegations from 21 countries, most commonly from China and Indonesia. Interest was focused on APRA’s risk-based supervisory model, Australia’s retirement income arrangements and supervision of superannuation funds, and requirements to establish operations in Australia. APRA also hosted the Integrated Financial Supervisors Conference in Sydney in September 2015.
In support of ‘whole of Government’ engagement with development partner countries, APRA undertakes targeted technical assistance activities, primarily in the Asia-Pacific region. These activities provide valuable interaction with the partner countries involved, including in respect of Australian institutions operating in those jurisdictions. Most of these activities are funded under programs agreed with agencies responsible for administering international aid, particularly the Department of Foreign Affairs and Trade (DFAT) and, to a lesser extent, the International Monetary Fund (IMF). As APRA is otherwise funded by levies on the institutions it supervises, it is considered inappropriate for more than incidental amounts of these funds to be used for technical assistance purposes.
With very limited staff resources available for these activities, APRA favours multilateral initiatives and can only accommodate a small number of the requests it receives. All such activities are subject to postponement or cancellation in the case of core business priorities. Nevertheless, as well as strengthening the prudential frameworks and activities of the partner agencies involved, these activities offer APRA valuable staff development and retention benefits.
Engagement with Indonesia is with the integrated regulator Otoritas Jasa Keuangan (OJK) and Bank Indonesia (BI) under the Government Partnership Fund (GPF II). During 2015/16, this engagement was primarily through APRA hosting four internships, which focused on risk-based prudential supervision including risk-rating procedures, crisis management and conglomerates. APRA also hosted a joint visit by senior OJK and BI staff, and another by the OJK Commission of Non-bank Financial Institutions. Over 2015/16, APRA hosted a total of 17 interns and other visitors from Indonesia.
In the Pacific, APRA supported several training programs under the multilateral Government Partnerships for Development (GPFD) program with local and visiting Pacific prudential regulators. Over the past year, the on-site training programs ranged across banking and other credit intermediaries, general insurance and provident funds.
APRA also plays its part in supporting the training activities of the Financial Stability Institute and various regional groups in the Asia Pacific region such as SEANZA and SEACEN. Over the year, APRA provided speakers to two regional conferences in Taiwan and Hong Kong SAR.