House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Employment and Workplace Relations and Minister for Financial Services and Superannuation, the Hon Bill Shorten MP)

Chapter 2 Prudential standards

Outline of chapter

2.1 Schedule 2 to this Bill amends the SIS Act to give APRA the power to issue prudential standards in relation to prudential matters in superannuation. This chapter explains the new arrangements for prudential standards.

Context of amendments

2.2 As the prudential regulator for RSE licensees, APRA primarily relies on the supervisory powers given to it under the SIS Act and accompanying SIS regulations.

2.3 Currently, APRA's role includes the enforcement of a range of requirements found in the SIS Act and SIS regulations. However, making changes to these standards in response to changes within the superannuation industry can involve significant time lags. While APRA can issue guidance material on expected standards, these are not legally binding.

2.4 Recognising the need for greater flexibility and adaptability in respect of legally enforceable standards, the Review recommended APRA be given a standards-making power in relation to superannuation.

2.5 Prudential standards, determined and drafted by APRA, are designed to improve the clarity and certainty of prudential regulation by providing additional detail on the prudential matters set out in the enabling legislation. Prudential standards are legislative instruments within the meaning of the Legislative Instruments Act 2003 (LI Act), and are therefore disallowable by Parliament, subject to scrutiny by the Standing Committee on Regulations and Ordinances and to appropriate consultation with industry as part of their development and ongoing revision.

2.6 As Australia's financial system prudential regulator, APRA already has the power to issue prudential standards in relation to authorised deposit-taking institutions, life insurance companies and general insurance companies, but not for superannuation funds. Prudential standards-making powers across the other parts of the financial system have been successful in providing APRA with the flexibility to effectively adapt to industry developments and the ability to provide regulated entities with clearer and more tailored legal requirements.

Summary of new law

2.7 Schedule 2 of this Bill amends the SIS Act to give APRA the power to issue prudential standards in relation to prudential matters in superannuation to be complied with by RSE licensees.

Comparison of key features of new law and current law

Detailed explanation of new law

Prudential standards requirements

2.8 APRA will be given the power to issue prudential standards in relation to superannuation prudential matters. The legislative framework for these powers will be similar to the frameworks for prudential standards for the other prudentially-regulated industries.

2.9 APRA may determine prudential standards relating to prudential matters. The standards must be complied with by RSE licensees of RSEs or their connected entities, a specified class of RSE licensees or their connected entities, one or more specified RSE licensees or one or more specified connected entities. [Schedule 2, item 1, subsection 34C(1)]

2.10 'Connected entities' are subsidiaries, as defined in the Corporations Act, or other entities as prescribed in regulations. Extending the application of prudential standards to connected entities aims to ensure compliance with prudential standards cannot be avoided through arrangements with related entities. [Schedule 2, item 4, subsection 10(1)]

2.11 Prudential standards may impose different requirements to be complied with by different classes of RSE licensees or connected entities, in different situations or in respect of different activities. This allows APRA to have one prudential standard for a given topic covering different requirements. [Schedule 2, item 1, subsection 34C(2)]

2.12 A prudential standard may require each RSE licensee of an RSE, each RSE of a specified class of RSE licensee, a specified RSE licensee or each of two or more specified RSE licensees to ensure its (or their) connected entities satisfy particular requirements. This will enable APRA to ensure RSE licensees are responsible for their connected entities complying with particular requirements in prudential standards. [Schedule 2, item 1, subsection 34C(3)]

2.13 APRA may exercise powers and discretions under the prudential standards, including but not limited to discretions to approve, impose, adjust or exclude specific prudential requirements in relation to particular or specified RSE licensees or connected entities. This will allow APRA to flexibly or quickly respond to situations where such discretion is necessary. For example, this may cover situations involving transitional arrangements relating to the operational risk reserve. [Schedule 2, item 1, subsection 34C(5)]

Content of prudential standards - prudential matters

2.14 Consistent with APRA's powers in the other prudentially-regulated sectors, APRA will be able to determine prudential standards in relation to prudential matters. The definition of prudential matters, which is described further in the paragraphs that follow, includes elements from the definitions applying to banking and general insurance but recognises that different considerations apply to superannuation, which has accumulation funds (where liabilities reflect the investment gains and losses) and defined benefit funds (where there will be defined liabilities). The definition complements APRA's prudential regulation of superannuation, both existing and agreed to as part of the Government's Stronger Super reforms.

2.15 The prudential matters for which APRA can determine prudential standards are matters relating to:

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the conduct by an RSE licensee of an RSE of the affairs of the RSE or a connected entity in such a way as to protect the interests or meet the reasonable expectations of the beneficiaries of the RSE; [Schedule 2, item 1, paragraph 34C(4)(a)]

•

the conduct by a connected entity of an RSE licensee of an RSE of the affairs of a connected entity in such a way as to protect the interests or meet the reasonable expectations of the beneficiaries of the RSE; [Schedule 2, item 1, paragraph 34C(4)(b)]

•

the conduct by an RSE licensee of an RSE of the affairs of the RSE licensee in such a way as to keep itself in a sound financial position or not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(c)]

•

the conduct by an RSE licensee of an RSE of the affairs of the RSE in such a way as not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(d)]

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the conduct by a connected entity of its affairs in such a way as to keep itself in a sound financial position or not to cause or promote instability in the Australian financial system; [Schedule 2, item 1, paragraph 34C(4)(e)]

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the conduct by an RSE licensee of an RSE, or a connected entity, of any of its affairs that are relevant to the RSE with integrity, prudence and professional skill; [Schedule 2, item 1, paragraph 34C(4)(f)]

•

matters relating to appointment of auditors and actuaries; and [Schedule 2, item 1, paragraph 34C(4)(g)]

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the conduct of audits and actuarial investigations. [Schedule 2, item 1, paragraph 34C(4)(h)]

2.16 The inclusion of conduct by an RSE licensee of the affairs of the RSE or a connected entity in such a way as to protect the interests of beneficiaries in this definition recognises that prudential matters in relation to superannuation include issues related to operating in a way that ensures that the interests of beneficiaries are not adversely affected. It also recognises that the nature of these interests may vary depending on the type of fund (accumulation or defined benefit) or product (for example, choice or MySuper).

2.17 Prudential matters also include conduct by an RSE licensee of the affairs of the RSE or a connected entity in such a way as to meet the reasonable expectations of beneficiaries. This makes it clear that prudential standards are not restricted to issues addressing potential adverse or detrimental impacts on the interests of beneficiaries but can also cover issues involving the advancement of beneficiaries' interests. This will allow APRA to make prudential standards that ensure the conduct of RSE licensees meets beneficiaries' reasonable expectations in relation to all aspects of their superannuation interest (for example, expectations related to investments, the generation of retirement benefits and other product features), consistent with existing standards and covenants under the SIS Act.

2.18 For example, in an accumulation fund, a member's entitlement will be dependent on net investment returns, rather than being a specified dollar amount or sum referable to a formula. In this context, it is appropriate for prudential standards to go beyond simply protecting the value of member contributions but also to cover investing contributions to generate additional retirement benefits.

2.19 Prudential matters also include matters relating to appointment of auditors and the conduct of audits. This is primarily to move APRA's existing prudential regulation in relation to auditors and audits from the SIS Act and SIS Regulations into prudential standards, providing greater flexibility and adaptability for these.

2.20 Prudential matters also include matters relating to appointment of actuaries and the conduct of actuarial investigations. This will allow APRA to determine standards in relation to existing circumstances where the actuarial investigations are required (that is, for defined benefit funds).

2.21 The remainder of the definition of prudential matters is consistent with the definitions applying to the other prudentially-regulated sectors. These aspects seek to minimise the risk of an RSE licensee acting in a way that would undermine its own sound financial position, the financial soundness or stability of an RSE for which it is trustee or that of Australia's financial system. While these risks are arguably lower in the context of superannuation than they are in the banking sector for example (given the nature of accumulation funds, and the way superannuation funds interact with the wider system), the superannuation system is an integral part of Australia's financial system and must be effectively regulated to minimise risk.

2.22 While APRA will determine the content and coverage of its prudential standards, prudential standards are expected to cover issues such as: governance, fitness and propriety, conflicts of interest, outsourcing, risk management, investment governance, insurance, business continuity management, audit, operational risk financial requirement and defined benefit funding and solvency.

2.23 Later tranches of legislation will ensure that APRA has the necessary power to determine prudential standards to facilitate the transition process to MySuper.

Revocation or variation of prudential standards and legislative instruments rules

2.24 APRA may, in writing, vary or revoke a standard. This allows APRA to flexibly adapt or retract standards in response to changing circumstances. [Schedule 2, item 1, subsection 34C(6)]

2.25 A standard made in relation to one or more specified RSE licensees (or connected entities) or an instrument varying a standard applying to one or more specified RSE licensees (or connected entities) comes into force from the later of:

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the day on which APRA gives a copy of the standard or variation to the RSE licensee (or connected entity) to which the standard applies; and

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if APRA includes with the copy of the standard or variation given to the RSE licensee (or connected entity) notice that the standard or variation will come into force on a later day-on that later day. [Schedule 2, item 1, subsection 34C(7)]

2.26 The revocation of a standard made in relation to one or more specified RSE licensees (or connected entities) comes into force on the later of:

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the day on which APRA gives notice of the revocation to the RSE licensee (or connected entity) to which the standard relates; and

•

the day specified in that notice as the day on which the revocation comes into force. [Schedule 2, item 1, subsection 34C(8)]

2.27 Subsections 34C(7) and (8) ensure any changes to the standards that apply to specified RSE licensees or connected entities can only come into force on or after the day in which notice of the change is given to the affected entity. [Schedule 2, item 1, subsections 34C(7 ) and ( 8)]

2.28 A standard made in relation to one or more specified RSE licensees (or connected entities), or an instrument varying or revoking a standard or applying to one or more specified RSE licensees (or connected entities) is not a legislative instrument. [Schedule 2, item 1, subsection 34C(9)]

2.29 As entity-specific prudential standards are not legislative instruments, in contrast with prudential standards applying to all or a class of entities, they are not subject to the processes for tabling, disallowance and registration in the LI Act. They are more in the nature of an administrative instrument and for that reason it is appropriate that they be merits reviewable under section 344 of the SIS Act.

2.30 Accordingly, a decision to determine, vary or revoke a prudential standard referred to in new paragraph 34C(1)(e) or (f) (that is, relating to one or more specified entities) is a reviewable decision subject to reconsideration by APRA upon written request and further review by the Administrative Appeals Tribunal under section 344 of the SIS Act. [Schedule 2, item 9, paragraph 10(1)(doc)]

2.31 Section 344 of the SIS Act sets out a procedure for merits review of decisions listed in the definition of 'reviewable decision' in section 10 of the Act. Under that process a person who is affected by and dissatisfied with a reviewable decision of the Regulator may, within 21 days of receiving notice of the decision, request the Regulator to reconsider the decision, giving reasons for the request. The Regulator must then reconsider the decision before the end of 60 days after the day on which the Regulator received the request. If the Regulator confirms or only varies the decision then the person affected by the decision may seek further review in the Administrative Appeals Tribunal.

2.32 Otherwise, any other instrument (prudential standard) made under new section 34C is a legislative instrument for the purposes of the LI Act. APRA must comply with the LI Act requirements in determining a prudential standard, including requirements relating to consultation with those likely to be affected by the proposed prudential standard. [Schedule 2, item 1, subsection 34C(10)]

Relationship between prudential standards and other law

2.33 To avoid any confusion due to potential conflict between prudential standards and other law, a prudential standard may be determined that elaborates, supplements or otherwise deals with any aspect of a prudential matter to which a covenant in sections 52 to 53 or prescribed under section 54A of the SIS Act relates, or a prudential matter to which a provision of the SIS Act or the SIS Regulations relates. However, a prudential standard is of no effect to the extent that it conflicts with the SIS Act or the SIS Regulations. [Schedule 2, item 1, subsections 34D(1 ) and ( 2)]

2.34 To ensure there is no conflict between a prudential standard and operating standards made under Part 3 of the SIS Act, the SIS Regulations will be amended to remove aspects of operating standards that would conflict with prudential standards.

2.35 To ensure there is no conflict between a condition imposed on an RSE licence and prudential standards, new subsection 29EA(2A) has been inserted to give preference to a licence condition over anything in prudential standards. [Schedule 2, item 23, subsection 29EA(2A)]

Notification of prudential standards

2.36 If APRA determines or varies a prudential standard applying to one or more specified RSE licensees or one or more specified connected entities (under new paragraph 34C(1)(e) or (f)), APRA must give a copy of the standard or variation to the affected entity. This ensures APRA gives appropriate notice to affected entities. [Schedule 2, item 1, subsection 34E(1)]

2.37 If APRA revokes a prudential standard applying to one or more specified RSE licensees or one or more specified connected entities (under new paragraph 34C(1)(e) or (f)), APRA must give notice to the affected entity. This also ensures APRA gives appropriate notice to affected entities. [Schedule 2, item 1, subsection 34E(2)]

Compliance with prudential standards

2.38 RSE licensees will have a direct obligation to comply with prudential standards determined by APRA. Including 'prudential standards' in the definition of RSE licensee law ensures licensees are required to comply with prudential standards as a condition of their licence. Consequently, the existing rules for compliance and potential consequences associated with failure to comply with licence conditions will apply to prudential standards, enabling APRA to use its existing suite of enforcement tools to ensure compliance. [Schedule 2, item 10, paragraph 10(1)(aa)]

2.39 RSE licensees will also need to ensure that their connected entities comply with prudential standards (where the prudential standards require this). As noted in paragraph 2.12, APRA can determine prudential standards that require RSE licensees to ensure their connected entities comply with prudential standards. Failure of an RSE licensee to comply with these requirements would similarly be subject to the existing regime relating to licence conditions.

2.40 It is intended that later tranches of legislation will require auditors and actuaries to comply with the prudential standards that apply to them, including requirements relating to fitness and propriety.

2.41 Recognising the importance of effective enforcement powers to the successful operation of APRA's prudential standards-making power and its broader supervision of the superannuation industry, further consideration will be given to APRA's directions powers in relation to superannuation and whether they should be more consistent with APRA's powers in relation to the other prudentially-regulated sectors.

APRA to monitor prudential matters

2.42 APRA will monitor prudential standards through:

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the collection and analysis of information in respect of prudential matters concerning RSE licensees and connected entities;

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encouraging and promoting the carrying out of sound practices by RSE licensees and connected entities in relation to prudential matters; and

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evaluating the effectiveness and carrying out of those practices. [Schedule 2, item 1, section 34F ]

Application and transitional provisions

2.43 APRA will have a prudential standards-making power from the date of Royal Assent. It is expected that APRA will finalise its proposed standards by the end of 2012 and industry will generally have until 1 July 2013 to transition to these arrangements. However, APRA also intends to issue prudential standards to facilitate the transition to MySuper, which may have application from 1 January 2013.

Consequential amendments

2.44 Item 3 inserts a reference to Part 3A into the list of provisions for which APRA has general administration, reflecting that this provision relates to APRA's functions. [Schedule 2, item 3, subparagraph 6(1)(a)(i)]

2.45 As discussed further in paragraph 2.10 above, item 4 inserts a definition for a 'connected entity' to an RSE licensee of an RSE. [Schedule 2, item 4, subsection 10(1)]

2.46 Item 5 inserts a definition for 'prudential matter' as having meaning given by new subsection 34C(4). The definition of prudential matters is discussed further at paragraphs 2.15 to 2.21. [Schedule 2, item 5, subsection 10(1)]

2.47 Item 6 inserts a definition for 'prudential standard' as meaning a standard determined by APRA under new subsection 34C(1). [Schedule 2, item 6, subsection 10(1)]

2.48 Item 9 inserts under the definition of 'reviewable decision' a decision to determine, vary or revoke a prudential standard referred to in new paragraph 34C(1)(e) or (f). [Schedule 2, item 9, paragraph 10(1)(doc)]

2.49 Item 10 inserts 'prudential standards' into the definition of 'RSE licensee law'. RSE licensee law is used in Part 2A of the SIS Act to define the rules that must be complied with as a condition of APRA granting an RSE licence. The purpose of including prudential standards under the definition of RSE licensee law is to ensure that it is a condition of an RSE licence for the licensee to comply with prudential standards. APRA would be able to enforce compliance with prudential standards through its existing mechanisms relating to licence conditions and the existing consequences applying to breaches of licence conditions would extend to prudential standards. [Schedule 2, item 10, paragraph 10(1)(aa)]

2.50 Item 11 inserts a definition of 'subsidiary' as having the same meaning as in the Corporations Act. A definition of subsidiary is introduced to form part of the definition of 'connected entity'. [Schedule 2, item 11, subsection 10(1)]

2.51 Items 12, 13, 24, 34 and 37 to 49, include 'prudential standards' in sections, subsections, or paragraphs that make general references to the SIS Act and SIS Regulations. Including prudential standards in these references reflects that prudential standards are similarly relevant legislative instruments.

2.52 Item 20 repeals paragraph 29D(1)(d) of the SIS Act, which requires RSE licence applicants to meet the requirements of operating standards relating to fitness and propriety, and replaces it with an equivalent requirement for prudential standards to be met. This is a consequence of APRA's intention to define standards for fitness and propriety in a prudential standard and subsequently repeal the operating standard. [Schedule 2, item 20, paragraph 29D(1)(d)]

2.53 It is intended that later tranches of legislation will include additional consequential amendments in relation to the references to fitness and propriety under the SIS Act.

2.54 It is also intended that later tranches of legislation will include further consequential amendments as a result of material covered in prudential standards (for example, in relation to auditors and actuaries).

2.55 To ensure there is no conflict between prudential standards and operating standards, it is intended that regulations repeal any duplicative operating standards at the time prudential standards come into effect.