Australia: APRA Seeks Consultation on Supervising Conglomerate Groups: Taming the Behemoth

Taming the behemoth: APRA seeks consultation on supervising conglomerate groups

On 18 March 2010, the Australian Prudential Regulation Regulation Authority (APRA) released a discussion paper containing proposals for a new 'level 3 supervision framework' (Framework). The Framework builds on APRA's existing capital requirements^[1] to ensure that conglomerate groups hold adequate capital. APRA aims to protect regulated entities within conglomerates from troublesome risks within the group.

The proposed Framework contains proposals on a range of principles based risk management and governance standards that will apply to the parent company of the conglomerate group

In general, APRA will apply the Framework to conglomerate groups containing two or more material entities that are either APRA-regulated entities operating in different industries, or a combination of at least one APRA-regulated entity and at least one material unregulated entity.

Under the Framework a conglomerate group must hold a surplus of eligible capital over required capital, net of any adjustments, to ensure adequate capital is held to cover risks within the group. A sufficient portion of the surplus must be readily transferable among group entities so that capital shortfalls within the group can be adequately addressed.

APRA is considering two methods for measuring eligible capital at conglomerate level. One is a top-down method and the other, in parallel with the determination of required capital, is a building block approach. Both methods are expected to arrive at the same result, although this may not always be the case. APRA will be collecting data on both proposed methods and evaluating them before finalising how eligible capital is to be calculated.

Through the Framework, APRA is proposing to apply a number of existing prudential standards in respect of governance and risk management to the Level 3 Head. The standards will also cover business continuity management, outsourcing, fit and proper tests, audit and related matters, risk concentrations, intra-group transactions and intra-group exposure.

The proposed Framework will involve not only assessing both capital adequacy and compliance with governance and risk management requirements, but also ensuring that the structure of the group does not give rise to excessive unmitigated risks. Supervision will take into account the individual structure and character of each group.

Where there are prudential reasons, the proposal is to allow APRA to impose, on a case-by-case basis, additional requirements on the Level 3 Head or on an APRA-regulated entity within the group. These include additional capital, risk management or reporting requirements.

What this means?

Although APRA is already supervising banking and general insurance entities on a group basis, the changes should better protect policyholders by ensuring there are adequate governance procedures over capital in respect of various different entities that make up a conglomerate group. The practical implication is that it gives APRA regulated entities that are part of a conglomerate added protection against one of their own fellow 'conglomerate members' becoming a risk to their viability.

For general insurers, the proposals may result in additional obligations and some uncertainty surrounds the 'discretionary' powers accorded to APRA.

Written submissions are due in by 18 June 2010 and the proposed Framework is expected to be finalised during 2011 with a view to commencement during 2012.

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