The Australian Prudential Regulation Authority (APRA) has responded to the issues that have emerged at the Royal Commission into the Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) and the Productivity Commission’s Inquiry into Competition in the Australian Financial System (Productivity Commission) by announcing a review of its enforcement strategy (Enforcement Review).

On 15 November 2018, APRA Deputy Chair John Lonsdale declared that this was a “key priority for APRA over the first three months of 2019”.  The Enforcement Review will examine APRA’s enforcement strategy and infrastructure and how it interacts with APRA’s core supervisory approach.  On 12 November 2018, APRA released the Terms of Reference for the Enforcement Review.

This Insight explores the scope and areas of focus as outlined in the Terms of Reference.

• The Royal Commission and Productivity Commission have been critical of both the Australian Securities and Investments Commission (ASIC) and APRA as regulators in the financial services industry.  Although ASIC has been subject to public criticism before, this is fairly new territory for APRA.
• The scope of the Enforcement Review is broad, suggesting that the review will be wide-ranging. The review will consider and make recommendations on:
  • issues APRA seeks to address through enforcement action;
  • the considerations in deciding whether APRA should take enforcement action; and
  • internal areas of limitation (organisational structure, resources, skills, etc.) within APRA that need to change for APRA to take an appropriate amount of enforcement action.
• The breadth of the Enforcement Review is also reflected in the composition of the External Advisor Panel, which includes a judge, an academic and most notably, an ACCC Commissioner, suggesting that competition issues will also be taken into account.
• The draft recommendations from the Enforcement Review will be made available to APRA members by 28 February 2019 and the final review presented to them by 31 March 2019.

The Royal Commission has revealed that misconduct by financial service entities was not met with sufficient enforcement action by ASIC or APRA.  The misconduct either went unpunished by the industry’s regulators or, when it was punished, the consequences did not meet the seriousness of the conduct.

Although ASIC has been subject to public criticism before, this is fairly new territory for APRA.

In this regard, the Royal Commission has been openly critical of APRA’s role.  The Royal Commission’s Interim Report (Interim Report) not only criticised the lack of action by APRA, it also suggested that APRA’s focus on promoting financial system stability has limited its ability to take proper action when dealing with governance and risk culture issues:

APRA’s chief focus is on governance and risk culture.  Proper governance and risk culture are critical to the prudent conduct of banking business.

The Australian Prudential Regulation Authority Act 1998 (Cth) provides that ‘In performing and exercising its functions and powers, APRA is to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality and, in balancing these objectives, is to promote financial system stability in Australia’.  That is, APRA is obliged to look at issues of governance and risk culture through the lens of financial system stability.   [Emphasis added] [1]

This echoes the criticism of the Productivity Commission in its Inquiry Report (Inquiry Report).  The Productivity Commission found that APRA was hamstrung in its ability to effectively promote objectives such as competition in financial services, given that its mandate is to promote financial system stability. In the Inquiry Report, the Productivity Commission noted:

In the absence of a competition advocate in the financial system, the role of juggling competition and financial stability falls mainly to APRA — but is not a role that it is well placed to fulfil.  In every marginal judgment — and most judgments will by their nature be finely-balanced (crises are an exception) — APRA must surely favour its overarching requirement to promote stability.  An entity such as APRA can never reasonably be challenged by outsiders for being too conservative. But it might be badly damaged if it were ever shown to be too liberal. [2]

On 12 November 2018, APRA released the Terms of Reference for its Enforcement Review.  The review was established in recognition of APRA’s new regulatory responsibilities under the Banking Executive Accounting Regime (BEAR) as well as issues that have emerged as part of the Royal Commission.

APRA Deputy Chair John Lonsdale acknowledged “the need to consider a stronger appetite for formal enforcement action, including giving greater weight to its strategic use as an industry-wide deterrent”.  He added that “[a] lot of APRA’s focus over recent years has been on making sure entities are solvent, have the right liquidity… that’s evolved… now it’s governance, culture and enforcement”.

External Advisory Panel

The Enforcement Review will be internally led by Mr Lonsdale and supported by APRA staff.  An external advisory panel has also been appointed to provide an independent perspective on matters arising from the review.  The panel is comprised of experts in the administration of law and regulatory enforcement:

• former NSW Supreme Court Judge, Dr Robert Austin;
• ACCC Commissioner, Sarah Court; and
• Director for the Centre for Law Markets and Regulation, Professor Dimity Kingsford Smith.

Scope of the review

The Enforcement Review will examine APRA’s approach to prospective use of its enforcement powers to achieve its prudential objective of ensuring that financial promises made by its supervised institutions are met within a stable, efficient and competitive financial system.

The Enforcement Review will:

• examine APRA’s current enforcement strategy and infrastructure, and how it interacts with APRA’s core supervisory approach; and
• assess any legal, practical or structural impediments to APRA taking enforcement action.

The Enforcement Review will make recommendations on:

• the breadth of issues APRA seeks to address through enforcement action;
• the considerations in determining whether APRA should take enforcement action to hold entities and individuals to account, including under the BEAR and other powers;
• the considerations in determining if it is appropriate for APRA to take public enforcement action and the timing of any action, including litigation for general deterrence;
• APRA’s internal governance, organisation, enforcement strategy, resourcing and any other factors relevant to APRA’s enforcement function.

Areas of focus

In examining the issues set out above, the Enforcement Review will focus on:

• the relationship between APRA’s supervisory approach and enforcement action;
• APRA’s process for identifying candidate enforcement actions;
• APRA’s decision making process on whether to take enforcement action;
• APRA’s approach to breach reporting and whistle-blowers;
• the weight given to factors (such as cost, timeliness, remediation, precedent) when deciding whether or not to take enforcement action;
• APRA’s approach to publicly disclosing enforcement priority areas;
• whether internal organisational change would be required to achieve an appropriate level of enforcement;
• whether the resources and skill sets currently within APRA are adequate enough to achieve an appropriate level of enforcement action;
• whether there is greater need for APRA to cooperate more closely with other regulatory agencies on enforcement matters;
• whether the current and proposed legislative framework is adequate to support the recommended approach; and
• any other relevant matters agreed by the APRA members.

Next steps

Draft recommendations will be made available to APRA members by 28 February 2019.  The final review will be presented to APRA members by 31 March 2019.

APRA will make the final recommendations public, along with APRA’s enforcement strategy after being considered by APRA members.

As noted above, Mr Lonsdale announced that the Enforcement Review was one of APRA’s strategic and policy priorities for 2019.  Other strategic and policy priorities for 2019 are:

1. re-examining cases of potential misconduct by regulated entities raised during the Royal Commission where the evidence presented was new to APRA or contradicted what APRA had previously been told;
    
2. administering the BEAR to ensure that it is followed and understood by the major banks, and prepare other Authorised Deposit-Taking Institutions (ADI) for implementation of it;
    
3. making further advancements towards implementing the final elements of the Basel III capital frameworks for ADIs;
    
4. developing a formal prudential framework for recovery and resolution (with consultation starting early next year);
    
5. delivering quality, value-for-money outcomes to superannuation members;
    
6. moving towards further aligning the capital framework for private health insurance with that used in life and general insurance; and
    
7. considering the final report from the Royal Commission and the Government’s subsequent response.

Further information about APRA’s 2019 priorities is available here.