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23 September 2005
In May 2005 the Australian Prudential Regulation Authority (APRA) released a draft Prudential Standard and an associated discussion paper on the governance of APRA-regulated institutions. The draft standard sets out the minimum governance requirements that all authorized deposit-taking institutions (ADIs) such as banks, building societies and credit unions must adhere to as part of their overall governance arrangements.
APRA expects the draft standard to be finalized by early 2006, taking effect from the end of an ADI's then current financial year. This update summarizes the draft standard in relation to ADIs operating in Australia and comments on industry feedback to the governance proposals.
The draft standard is predicated on eight key principles that ADIs must consider when developing and implementing governance arrangements. These principles are:
The draft standard sets out the minimum requirements that ADIs must meet to ensure adequate adherence to these principles, emphasizing that the ultimate responsibility for sound and prudent management rests with the board.
A board must have a formal charter setting out its roles and responsibilities and any delegation of authority to management must be clearly documented. Directors must avoid conflicts of interest between their role as a director and their other activities, and remove themselves from any discussions with respect to matters where there is such a conflict. The board must also establish procedures for assessing its own performance as well as those of the individual directors and senior managers.
Boards must have a minimum of five directors, a majority of whom must be independent non-executive directors. A director's independence is assessed according to the Australian Stock Exchange's Corporate Governance Principles, which preclude members of management, substantial shareholders or material consultants, suppliers or customers of the company being classified as independent directors. A non-executive director is one who has not been employed or retained by the ADI (or any related bodies) at any time during the previous three years.
The chairperson of the board must be an independent non-executive director and cannot have been the chief executive officer of the ADI at any time during the previous three years. A majority of directors present and eligible to vote at all board meetings must be non-executives.
The board must also have a formal policy on board renewal, thereby ensuring the board remains open to new ideas while retaining adequate expertise. ADIs must provide APRA with details of the attendance record of all directors at board and relevant committee meetings.
The board must establish audit and risk management committees with clearly defined charters that set out the committees' roles, objectives, responsibilities, authorities and tenures. Where an ADI is part of a corporate group, the ADI may apply to APRA to use group board committees for its audit and risk committees.
The audit committee must have at least three members, all of whom are non-executive directors, and the majority of the members must be independent. The risk committee should be responsible for the formulation and monitoring of the ADI's risk management strategy. If the risk committee has no decision-making capacity with respect to particular transactions, it may be combined with the audit committee.
Unless exempted by APRA, an ADI must have an independent internal audit function to evaluate the adequacy and effectiveness of the financial and risk management framework of the ADI. In relation to external audits, the draft standard incorporates a number of requirements relating to the independence of external auditors that are consistent with the Corporations Act 2001.
ADIs must ensure that their internal policies and contractual arrangements do not explicitly or implicitly restrict or discourage any prospective, current or former officer, employee or contractor (including all professional service providers) from disclosing any information to APRA that may be relevant to the management and prudential supervision of the ADI.
The industry response to the draft standard has been guarded, with some believing that it is too prescriptive and inflexible. Ralph Evans, chief executive officer of the Australian Institute of Company Directors, commented:
"while the Australian Institute of Company Directors commends the action taken by APRA in response to the industry consultation process, it believes that changes to the proposed requirements do not go far enough."(1)
The institute is also concerned that the 'comply or else' mentality undermines the foundations of good governance and that companies should be able to choose the governance structure that best fits their circumstances.
However, other observers believe the minimum requirement standards merely reflect the direction of international financial services regulation. Gary Anderson, managing director of international risk consultants Protiviti, believes that to ensure compliance there must be a benchmark to measure against; hence the need for minimum standards.(2) This view is consistent with the position expressed in APRA's discussion paper, which states that APRA's primary duty as the prudential regulator is to look after the interests of depositors. Therefore, APRA contends that minimum governance requirements are necessary to ensure that ADIs' decision-making frameworks are sound and to protect beneficiaries' interests.
The chief executive of Chartered Secretaries Australia, Tim Sheehy, warns that the
draft standard would have a "very harsh impact"(3) on smaller ADIs such as community
banks, friendly societies and trustees of superannuation funds. Chartered Secretaries
Australia believes the draft standard's requirement that ADIs have a dedicated
internal audit function would result in small ADIs' payroll costs soaring, and
that the requirement for boards to have a majority of non-executive directors
and an independent non-executive chairperson could force small ADIs to appoint
inexperienced directors due to the expense of appropriately qualified candidates.
In reality, the compliance burden for larger ADIs under the draft governance standard should be minimal, but there could be issues for smaller institutions. Of greater concern to larger institutions may be the three-year stand-down period required under the draft standard before an ADI's former chief executive officer can become chairperson of the board. While this measure is designed to ensure that the chairperson is independent of management, given the extent and rapidity of change in markets many of the benefits a former chief executive officer can bring to a board may be lost during a three-year stand-down period. It remains to be seen what changes, if any, APRA will make to the final Governance Prudential Standard to be introduced in January 2006.
For further information on this topic please contact Paul Rubenstein or Lior Harel at Arnold Bloch Leibler by telephone (+61 2 9226 7100) or by fax (+61 2 9226 7120) or by email (firstname.lastname@example.org or email@example.com).
(2) Stuart Fagg, "APRA Goes Prescriptive on Corporate Governance", crikey.com.au, August 25 2005.
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