APRA has released for consultation proposed requirements for the supervision of conglomerate groups. The consultation package includes proposed revisions to existing prudential standards as well as draft new prudential standards.

What are conglomerate groups?

Conglomerate groups, referred to as Level 3 groups, are groups comprising APRA regulated institutions that perform material activities across more than one APRA regulated industry and/or in one or more non APRA regulated industry. Whether a particular group will be subject to Level 3 supervision will be decided by APRA on a case by case basis based on the following principle:

“…it may be supervised at Level 3 where APRA considers that supervision at Level 1 and/or Level 2 does not adequately capture the risks associated with the group’s activities or provide an adequate view of the overall financial and operational soundness of the group”.

Following the March 2010 discussion paper, submissions from the industry noted the following challenges to the proposed scope of the Level 3 group:

  • it was difficult to determine whether a non APRA regulated institution is material to the group;
  • non APRA regulated institutions which individually are not material could still be material when their activities are considered together; and
  • it proved difficult to determine the capital adequacy of a subset of the accounting consolidated group and that it was counterintuitive to treat the group’s non material institution, such as intermediate holding companies, as external parties for Level 3 purposes.

APRA’s proposed response is to broadly align the scope of the Level 3 group with the accounting consolidation group such that the Level 3 group will be determined as the accounting consolidated group of which the Level 3 head is the parent institution. However, APRA proposes to retain the right to include or exclude specific institutions, for example, if the specific intuition conducts operations which are material to the Level 3 group.

What is the framework for Level 3 supervision?

The proposed Level 3 framework consists of four components: group governance, risk exposures, risk management and capital adequacy. The proposed overarching requirements of the framework are:

  • a Level 3 group must have a robust governance framework that is applied appropriately throughout the group;
  • the intra-group exposures and external aggregate exposures of a Level 3 group must be transparent and prudently managed;
  • a Level 3 group must have an effective group-wide risk management framework in place; and
  • a Level 3 group must have sufficient capital to support the risks of the entire group, including material risks that arise from non APRA regulated activities.

The recently released consultation package focuses on the requirements for group governance and risk exposures. The high level principles on these two areas are:

  • Business practices such as governance, fitness and propriety of key staff, business continuity management and outsourcing should be broadly consistent across institutions of a Level 3 group. APRA’s cross-industry behavioural prudential standards on these aspects of corporate governance reflect good practice. Therefore, APRA will require these standards to be applied across Level 3 groups, including non APRA regulated institutions engaging in business activities that may have a material financial or operational impact on the group.
  • A concentration of risk in one part of, or across, a Level 3 group must not pose a threat to the APRA regulated institutions in the group. In order to adequately manage this risk, Level 3 groups must have systems and processes in place to monitor aggregate exposures across the group as well as intra-group transactions and exposures.

To this end, APRA has released 4 draft new standards and proposed amendments to the following existing standards:

  • Prudential Standard CPS 231 Outsourcing
  • Prudential Standard CPS 232 Business Continuity Management
  • Prudential Standard CPS 510 Governance
  • Prudential Standard CPS 520 Fit and Proper

The “Response to Submissions: Supervision of conglomerate groups” paper (found here together with the draft standards) contains further details on the new draft standards and proposed amendments to the existing standards. The paper also discusses other feedback from the industry and APRA’s response.

Level 2 group framework

As part of the consultation package, APRA proposes changes that will require Level 2 groups to also establish group-wide policies for governance, and fitness and propriety and to align the four standards listed above with the recently released behavioural standards for superannuation. These changes impact on all ADIs, general insurers and life insurers on a Level 1 basis, Level 2 groups and Level 3 groups.

Next steps

Consultation on the proposed changes closes on 1 March 2013. As part of this consultation, APRA has requested that respondents provide an assessment of the compliance impact of the proposed changes.

The proposed capital adequacy component of the Level 3 framework has received the most feedback and APRA is still refining its position on this aspect of the framework. Once this occurs, a separate response paper will address the feedback APRA received along with APRA’s responses on capital adequacy. The second response paper and draft capital adequacy prudential standards will be released for consultation in the first half of 2013.

Under the risk management component of the Level 3 framework, APRA proposes that Prudential Standard CPS 220 Risk Management will apply to Level 3 groups. APRA intends to release a draft CPS 220 as part of the second consultation package. It will apply to ADIs, general insurers and life insurers at Levels 1 and 2 and will supersede Prudential Standard GPS 220 Risk Management and Prudential Standard LPS 220 Risk Management.

The Level 3 framework is intended to become effective from 1 January 2014.