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Prudential Reviews and Enforceable Undertakings

The Australian Prudential Regulation Authority (APRA) supervises the Authorised Deposit-taking Institutions (ADIs) being the banks, building societies and credit unions, as well as life and general insurance and reinsurance companies, friendly societies and superannuation funds (excluding self-managed funds). APRA’s mission is “to establish and enforce prudential standards and practices designed to ensure that, under all reasonable circumstances, financial promises made by institutions we supervise are met within a stable, efficient and competitive financial system.” APRA also plays a role in preserving the integrity of Australia’s retirement incomes policy.

The centrepiece of APRA’s supervisory risk assessment is the Probability and Impact Rating System (PAIRS). PAIRS assist APRA in making judgements about a supervised institution’s risk position. The main objectives of PAIRS assessments are to:

  • determine the probability that the institution may not meet its financial promises; and
  • assess the potential consequences of not meeting those promises.

It is not enough just to identify risk, APRA also responds appropriately to the identified risks. APRA’s supervisory responses are driven by its Supervisory Oversight and Response System (SOARS). Under SOARS supervisory responses can range from a normal cycle of review to a heightened supervisory stance that requires extra supervisory oversight, to mandating improvements or to restructuring a supervised entity, i.e. the four supervision stances are Normal, Oversight, Mandated Improvement, and Restructure.

As part of its supervisory role APRA undertakes prudential reviews. The two main supervisory tools APRA uses are on-site and off-site analysis. These reviews are undertaken by prudential supervisors with in-depth knowledge of institutions in a particular sector, and supported by specialist risk experts. The reviews cover all the main risk areas, e.g. market, operational, credit, liquidity, insurance and reinsurance, contagion risk from related entities, outsourcing, and business continuity. The reviews also comment generally on the organisational capabilities of the institution.

At the conclusion of the review APRA will write to the institution outlining those areas where it may have concerns. APRA will prioritise the issues into Requirements, Recommendations and Requests. A Requirement Issue is something that must be addressed immediately and goes to the heart of the licence whereas a Recommendation is something that APRA expects to be addressed by the next prudential review. If it is has not been addressed it will be re-prioritised as a Recommendation. Similarly, a Request is something that APRA would like to be addressed, but is not urgent, although if left unaddressed will become escalated into a Recommendation. The point being that APRA continues to raise the bar during the process.

In respect of ADIs and Foreign ADIs (FADIs) Chairmont has assisted a particular FADI in addressing credit, treasury management and liquidity issues identified in an APRA Prudential Review. For two other FADIs, Chairmont has taken the lead role in re-writing the institutions credit policies and detailed credit assessment workflow, including the credit risk calculation models.

APRA can require the bodies it supervises to make Enforceable Undertakings to the Federal Court. This does happen although it is not widely known and, for obvious reasons, the institution does not want it published. One review where Chairmont played an important role was where a major fund manager was required to make Enforceable Undertaking in respect to its customer disclosure, unit pricing and corporate actions. When significant undertakings are made it inevitably leads to major culture change across an organisation.

Chairmont has worked on a number of assignments where the institution has either made Enforceable Undertakings to APRA (or ASIC), or needed assistance in addressing the findings of a Prudential Review by APRA.