APRA S FIT AND PROPER REQUIREMENTS

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1 APRA S FIT AND PROPER REQUIREMENTS Consultation Paper Australian Prudential Regulation Authority

2 PREAMBLE APRA was created out of the Government s financial sector reforms that were implemented as a result of the Financial System Inquiry in APRA is responsible for the safety and soundness of regulated financial institutions, including authorised deposit-taking institutions (ADIs), general insurers, life companies and superannuation entities. As part of its mandate, APRA has developed and implemented a prudential framework across these industries. There are, however, areas of the prudential framework where practice and experience have highlighted a need for improvement. One such area concerns the fitness and propriety of individuals who hold positions of responsibility ( responsible persons ) within regulated financial institutions. This is an important prudential issue as institutional failures are generally the consequence of the actions of individuals taken together with other external factors. APRA proposes to amend the prudential supervisory regimes for ADIs, general insurers, and life companies to ensure there is appropriate consideration and evaluation of the fitness and propriety of individuals who are, or seek to be, responsible persons in relation to these institutions. The fit and proper regime for superannuation entities is being dealt with separately. Written submissions on the proposals in this consultation paper, and the prudential standards, should be forwarded by 28 May 2004 to: Mr Bob Mackintosh Senior Manager Policy, Research and Consulting Australian Prudential Regulation Authority GPO Box 9836 SYDNEY NSW 2001 Or APRA i

3 TABLE OF CONTENTS GLOSSARY... 1 INTRODUCTION...2 Scope and objectives of the proposals...2 Structure of this paper...4 CHAPTER 1 RATIONALE FOR THE PROPOSED REFORMS...5 Rationale for fit and proper requirements in APRA-regulated institutions...5 Context for the proposed reforms...6 CHAPTER 2 LEGISLATIVE FRAMEWORK...7 Banking Act...7 Insurance Act...7 Life Insurance Act...9 CHAPTER 3 OVERVIEW OF PROPOSED REQUIREMENTS ADIs...10 General insurance...11 Life insurance...11 Proposed fit and proper criteria for APRA-regulated institutions...11 Conclusion...13 APPENDIX 1 CORPORATIONS ACT 2001 REQUIREMENTS Corporations Act 2001 (Corporations Act)...14 Corporate Law Economic Reform Program No 9 (CLERP 9)...15 APPENDIX 2 FIT AND PROPER MODELS OF INTERNATIONAL REGULATORS AND BODIES Financial Services Authority (FSA) (UK)...16 Office of the Superintendent of Financial Institutions (OSFI) (Canada)...17 The Joint Forum on Financial Conglomerates (Joint Forum)...18 European Commission (EC)...18 APRA ii

4 GLOSSARY ADI APRA ASIC Authorised Deposit-taking Institution under the Banking Act Australian Prudential Regulation Authority Australian Securities and Investments Commission Banking Act Banking Act 1959 Basel Committee Board CLERP 9 CLERP Bill Basel Committee on Banking Supervision Board of Directors Corporate Law Economic Reform Program No.9 CLERP (Audit Reform and Corporate Disclosure) Bill 2003 Corporations Act Corporations Act 2001 EC EU FRFI FSA IAIS European Commission European Union Federally regulated financial institutions Financial Services Authority (UK) International Association of Insurance Supervisors Insurance Act Insurance Act 1973 Insurer or general insurer IOSCO Joint Forum General insurer authorised under the Insurance Act International Organisation of Securities Commissions The Joint Forum on Financial Conglomerates Life Insurance Act Life Insurance Act 1995 Life insurance company or life company NOHC OSFI Life insurance company authorised under the Life Insurance Act Non-operating holding company (authorised under either the Banking Act or Insurance Act) Office of the Superintendent of Financial Institutions (Canada) APRA 1

5 INTRODUCTION APRA s prudential regimes for ADIs, and for the general insurance and life insurance industries (including friendly societies) have ensured strong and modern supervision of Australia s regulated financial institutions. A key feature of APRA s prudential supervision powers is the ability to issue prudential standards under the Banking Act 1959 (Banking Act), the Insurance Act 1973 (Insurance Act) and the Life Insurance Act 1995 (Life Insurance Act). The introduction of prudential standards on fit and proper is seen as a key component of this framework, and one that will serve to strengthen the safety and soundness of regulated financial institutions. This will provide greater protection for beneficiaries of these institutions. 1 The purpose of this paper is to seek comment on the proposed framework for assessing the fitness and propriety of responsible persons 2 who work in the regulated financial sector. This paper provides the rationale for APRA s proposed standard for a harmonised fit and proper framework applicable to APRA-regulated institutions. 3 It outlines existing fit and proper requirements and examines the proposed requirements. [This paper should be read together with the draft prudential standards available at Scope and objectives of the proposals APRA s supervisory approach has traditionally focused upon the regulated institution, although it has paid considerable attention to the individuals responsible for the institution. Recent Australian and international experience has shown the importance of closer supervisory scrutiny of the conduct of individuals in positions of responsibility. In the case of APRA-regulated institutions, this additional scrutiny is necessary for APRA to ensure their ongoing safety and stability. APRA believes the best way to achieve this is through the application of a harmonised framework for assessing responsible persons of APRA-regulated institutions. APRA 1 While APRA also has responsibility for the prudential supervision of most of the superannuation industry, fit and proper matters for superannuation entities are not considered in the context of this consultation paper but are being dealt with separately as part of the reforms arising from the Superannuation Safety Amendment Bill It is intended that a similar test to that proposed here will be incorporated into the Superannuation Industry (Supervision) Regulations 1994 as part of those reforms, with effect from 1 July As defined in the draft prudential standards. 3 References to APRA-regulated institutions throughout this paper exclude superannuation entities. APRA 2

6 therefore proposes to introduce harmonised prudential standards on fit and proper for application to APRA-regulated institutions. These will also apply to authorised nonoperating holding companies (NOHCs) of ADIs and general insurers. The aim of the proposed requirements is to ensure that responsible persons of these institutions have the technical competence and integrity necessary to perform these roles. In APRA s view, the most efficient way to achieve harmonisation is to require all APRAregulated institutions to develop a fit and proper policy that incorporates an explicit test of fitness and propriety for the assessment of a responsible person both prior to appointment, and on an ongoing basis. A clear framework with respect to fit and proper matters is intended to provide guidance and clarity to industry as to APRA s expectations on the minimum standards to be met by people who serve in responsible person roles. This framework will be embodied in the criteria established for determining the fitness and propriety of responsible persons. The proposals set out in this paper are intended to create a framework that: reduces the risk of loss to beneficiaries due to mismanagement or misconduct in APRA-regulated institutions; explains APRA s expectations of minimum standards that responsible persons who manage APRA-regulated institutions must meet; ensures that only persons who are fit and proper are able to act as responsible persons in respect of APRA-regulated institutions; allows APRA to remove and/or disqualify individuals who are not fit and proper from responsible person roles in APRA-regulated institutions; assists in strengthening the governance framework of APRA-regulated institutions and harmonises requirements; reflects fit and proper requirements that are consistent and compatible with best practice, both domestically and internationally; and promotes confidence in APRA-regulated institutions amongst users of financial services, and the public generally. APRA 3

7 Structure of this paper This paper is divided into three chapters. Chapter 1 sets out APRA s rationale for introducing, and in some cases strengthening, fit and proper requirements. Chapter 2 outlines the existing fit and proper requirements under APRA-administered legislation. Chapter 3 provides an overview of the proposed fit and proper requirements. An overview of relevant domestic and international fit and proper requirements is set out in the appendices. APRA 4

8 CHAPTER 1 RATIONALE FOR THE PROPOSED REFORMS This chapter discusses the need for a consistent framework of fit and proper requirements for APRA-regulated institutions. Rationale for fit and proper requirements in APRA-regulated institutions Prudentially regulated institutions may fail as a consequence of unpredictable adverse economic or industry conditions. Very often, however, institutions fail because those responsible for their management and operations are individually, or collectively, unable to balance their growth or profit aspirations for the institution with the need to adequately and appropriately manage risks. Failures can also occur because of mismanagement and incompetence. One of the reasons for prudential regulation is to ensure that beneficiaries of APRAregulated institutions receive greater protection than investors in other corporations and investment vehicles. The safety and soundness of APRA-regulated institutions is crucial for the confidence with which Australians deal with these institutions, and for the overall stability of the Australian financial system. The proposed fit and proper framework is intended to reduce the risk of regulated institutional failure due to incompetent, reckless or improper risk management by responsible persons. This framework will ensure that APRA-regulated institutions have in place policies and procedures that include comprehensive fit and proper assessments of responsible persons. These internal assessments would be supported by APRA s powers to remove and / or disqualify persons who are not fit and proper, or to require that the institution concerned remove the person in question. The person may also face disqualification from holding such a position in any APRA-regulated institution. APRA s ability to influence behaviour that poses unnecessary risks to a regulated institution, by requiring regulated institutions to remove, and in future not employ, responsible persons who are not fit and proper also reduces the likelihood that the institution will fail to comply with prudential supervisory requirements. APRA will be in a position to intervene where responsible persons are unable or unwilling to reduce their institution s risk of failure, and ensure that such people cannot hold responsible person positions in other APRA-regulated institutions. APRA 5

9 Context for the proposed reforms A number of themes run through APRA s proposals concerning the fitness and propriety of responsible persons in regulated institutions. Firstly, APRA aims to protect beneficiaries via administrative sanction, the key sanction being APRA s ability to prevent a person from working as a responsible person in the regulated financial sector. The standards of evidence and procedures necessary to apply this sanction are more flexible than for civil or criminal actions. Administrative sanctions are balanced by both sound internal decision-making processes, and external review mechanisms via the Administrative Appeals Tribunal and the courts. Extensive due process is therefore provided for individuals who are the subject of fit and proper assessments. Secondly, a harmonised fit and proper model for ADIs, general insurers and life companies assists APRA in its role as an integrated prudential regulator. APRA also proposes to introduce similar requirements for NOHCs of ADIs and general insurers. The application of a harmonised framework will assist APRA in its supervision of both individual institutions and conglomerates, and promote equity for responsible persons in all APRA-regulated industries. Finally, there has been an increased focus, both domestically and internationally, on standards of conduct and the necessary degree of skill and competence for persons responsible for managing and advising financial institutions. APRA seeks to ensure that its requirements continue to reflect best practice regulatory developments. 4 4 Appendices 1 and 2 outline other domestic and international requirements with respect to fit and proper. APRA 6

10 CHAPTER 2 LEGISLATIVE FRAMEWORK This chapter provides an overview of the existing legislative framework that APRAregulated institutions are required to comply with in respect of fitness and propriety. Banking Act The Banking Act has recently been amended to enhance APRA s powers in respect of directors and senior managers of ADIs and NOHCs as well as auditors of ADIs. 5 Disqualified persons 6 commit an offence if they act as a director or senior manager for an ADI or authorised NOHC. 7 APRA can remove a director or senior manager of an ADI or authorised NOHC if satisfied that the person is a disqualified person, or does not meet one or more of the criteria for fitness and propriety as set out in the Prudential Standards. 8 APRA may also disqualify a person if the person is not a fit and proper person to be, or to act as, a director or senior manager of an ADI or authorised NOHC. 9 Whereas removal of a person means that person cannot act in the position from which they have been removed, disqualification has the effect of prohibiting the person concerned from acting as a director or senior manager for any ADI or NOHC. Additionally, APRA can direct an ADI to remove a person from their position as an auditor of the ADI. 10 APRA must be satisfied that the person has failed to perform adequately and properly the functions and duties of their position, or that the person does not meet the fit and proper criteria set out in prudential standards. Insurance Act The Insurance Act was substantially amended by the General Insurance Reform Act Tests of fitness and propriety were introduced for directors, senior managers, auditors 5 These changes came into effect on 27 November 2003 when the Financial Sector Legislation Amendment Act (No.1) 2003 received Royal Assent. 6 As defined in section 20 of the Banking Act. 7 Refer section 19 of the Banking Act. APRA can determine that a person is not a disqualified person if satisfied that the person is highly unlikely to be a prudential risk to any ADI or NOHC (refer section 22 of the Banking Act). 8 Refer section 23 of the Banking Act. 9 Refer section 21 of the Banking Act. A regulation covering such matters is currently in the process of being drafted for tabling in parliament. 10 Refer section 17 of the Banking Act. APRA 7

11 and actuaries of general insurers. As stated in APRA s 2001 Policy Discussion Paper, 11 the objective of such tests is to ensure that general insurers are subject to high quality control and management an objective consistent with international codes and standards such as the International Association of Insurance Supervisors Core Principles and the recommendations of the Joint Forum. 12 The Insurance Act provides for the removal (by the general insurer under direction from APRA) and disqualification (both automatically and by APRA) of persons from being directors or senior managers of general insurers or NOHCs. 13 These provisions are consistent with those outlined above in the Banking Act and are subject to review processes. Additionally, auditors and actuaries of general insurers can be removed from their positions through approval and revocation of approval powers. 14 To support this legislative framework, APRA has determined a prudential standard, Prudential Standard GPS 220 Risk Management for General Insurers (GPS 220), detailing fit and proper requirements which align with the disqualification criteria specified in the Insurance Act. GPS 220 specifically requires general insurers to have in place a policy on fit and proper requirements that, at a minimum, addresses the criteria in GPS 220. Insurers are responsible for applying this policy to persons occupying key positions, defined as directors, senior managers, the Approved Auditor and the Approved Actuary. 15 More specifically, insurers must ensure that persons occupying key positions have the degree of probity and competence commensurate with their responsibilities. The criteria for fitness and propriety set out in GPS 220 include, amongst other things: that a person has not been convicted of one of a range of specified offences related to dishonesty and dealings with financial sector institutions; that a person has never been bankrupt, and has no relevant conflicts of interest; and that a person is not of bad repute within the business and financial community. 11 Prudential Supervision of General Insurance, Policy Discussion Paper, March The Insurance Core Principles outline the essential principles that need to be in place for a supervisory system to be effective, provide explanatory notes that set out the rationale underlying each principle, and outline criteria to facilitate comprehensive and consistent assessments. These Core Principles act as a basic benchmark for insurance supervisors in all jurisdictions, particularly for identifying areas in existing regimes that require improvement. The Joint Forum consists of international regulatory bodies for banks, insurers, and securities markets. 13 The removal power is contained in section 27 of the Insurance Act, and sections 24 and 25A contain disqualification powers. 14 Refer sections 40 and 42 of the Insurance Act. 15 For insurers operating in Australia as branches (foreign insurers), key positions do not include directors but include the agent in Australia appointed under section 118 of the Insurance Act. APRA 8

12 In addition, auditors and actuaries are required to be approved by APRA 16 and must meet eligibility criteria (in addition to the fit and proper criteria). Where an Approved Auditor or Approved Actuary fails to perform adequately and properly the functions and duties of their position, or does not meet the eligibility criteria or fit and proper criteria, APRA may revoke the approval of the auditor or actuary. In that case the auditor or actuary will no longer be able to act in that capacity for the insurer. Life Insurance Act The Life Insurance Act contains no explicit provisions covering fit and proper matters. APRA has no explicit power under the Act to remove directors or senior managers who in APRA s opinion are not fit and proper. APRA does, however, have the power to make prudential standards under the Life Insurance Act. Accordingly, APRA may make a prudential standard that requires a life company to put in place a fit and proper policy for responsible persons. Where a life company contravenes a prudential standard, APRA may issue directions to the life company. Among other things, these may include directions to remove directors, executive officers, employees or auditors, or to terminate the appointment of the appointed actuary. An actuary is eligible for appointment on meeting the requirements under section 93 of the Life Insurance Act. APRA may declare a person as not eligible for appointment as a life company s actuary if the person has failed to perform adequately and properly the functions and duties of an actuary appointed under the Act. For auditors, APRA must approve all external auditors under the Life Insurance Act, and can revoke this approval An insurer must appoint an auditor and actuary in accordance with section 39 of the Insurance Act and have that appointment approved by APRA in accordance with section 40 of the Insurance Act. 17 Refer sections 85 and 86 of the Life Insurance Act APRA 9

13 CHAPTER 3 OVERVIEW OF PROPOSED REQUIREMENTS This chapter provides an overview of the proposed fit and proper requirements that APRA is seeking to introduce for APRA-regulated institutions. APRA s preference is for harmonised fit and proper requirements for APRA-regulated institutions, which would be set out in prudential standards. APRA-regulated institutions would be required to develop a fit and proper policy that, at a minimum, includes the criteria for assessing the fitness and propriety of responsible persons, and other associated matters. For ADIs and general insurers, and their NOHCs, APRA also has legislative powers to remove or disqualify certain responsible persons under certain circumstances. ADIs There is no existing prudential standard with respect to fit and proper requirements for ADIs and their NOHCs. The proposed prudential standard will require ADIs and authorised NOHCs to develop a fit and proper policy including assessment of the fitness and propriety of individuals who are defined as responsible persons. Responsible persons in a locally incorporated ADI or a NOHC (and their subsidiaries) include directors, senior managers and auditors. In the case of foreign ADIs, responsible persons are defined as the senior managers and the auditor of the Australian operations of the foreign ADI, and the senior officer outside Australia with responsibility for overseeing the Australian operation. These policies must, at a minimum, address the fit and proper criteria set out in the standard. The key criteria in determining whether a person is fit and proper to serve as a responsible person are whether the person has the necessary technical competence for the position through reference to attributes such as knowledge, skills, and experience, and whether the individual is of good fame and character, through reference to attributes such as diligence, honesty, integrity, and reputation of the person. The proposed prudential standard sets out these fit and proper requirements and will clarify the types of matters that APRA may consider in deciding whether to direct an ADI or authorised NOHC to remove a person. APRA 10

14 General insurance The fit and proper framework for general insurers is currently the most comprehensive of all of APRA s regulated industries. As discussed above, GPS 220 sets out the requirements with respect to risk management for general insurers, including fit and proper requirements. APRA considers that these fit and proper criteria could be further enhanced. Responsible persons within locally incorporated insurers include directors, senior managers, the Approved Auditor and Approved Actuary. For foreign general insurers, responsible persons would not include directors, but would include the senior managers of the Australian operations, the foreign general insurer s agent in Australia (appointed under the Insurance Act), the Approved Auditor, the Approved Actuary and the senior officer outside Australia responsible for overseeing the Australian operation. In the case of a general insurance NOHC, responsible persons are defined as the directors, senior managers and auditor of the NOHC. Under the proposal, APRA would introduce a dedicated standard on fit and proper requirements for general insurers, building on the existing fit and proper requirements in GPS 220. In addition, APRA proposes to make a new prudential standard for authorised NOHCs of general insurers. Application of these standards to the general insurance industry on a consolidated basis will be addressed in a separate discussion paper on supervision of general insurance conglomerates to be released later this year. Life insurance APRA is proposing to introduce a new prudential standard for life insurance companies covering fit and proper requirements. There is currently no such standard for life companies. The proposed standard would include the fit and proper requirements outlined above for ADIs and general insurers, and be applicable to responsible persons, who are defined to include directors, senior managers, the Approved Auditor and the Appointed Actuary of a life company. Proposed fit and proper criteria for APRA-regulated institutions The proposed fit and proper criteria incorporate matters to be addressed in determining whether an individual is fit and proper to act as a responsible person of an APRA- APRA 11

15 regulated institution. The criteria would include, inter alia, an assessment of whether a person has: appropriate knowledge, skills, experience, competence, judgement, character, honesty and integrity for the responsible person position in question; been subject to criticism, discipline, disqualification or removal by a professional or regulatory body or Court; been subject to adverse findings in relevant criminal or civil proceedings; been refused a licence for a commercial or professional activity; failed to manage personal debts satisfactorily; been a responsible officer in an entity at the time it failed; been obstructive, misleading or untruthful in dealing with regulatory bodies, or a Court; demonstrated a lack of willingness to comply with regulatory or professional requirements; breached a fiduciary obligation; been involved in business practices that appear negligent, deceitful, or otherwise improper; failed to deal with conflicts of interest appropriately; or been, or is, considered of bad repute. The criteria are to be considered in the context of the responsible person position for which the person is being considered, or already acts, and based on evidence that the institution can reasonably obtain with regard to the person concerned. These criteria would be set out in the prudential standards on fit and proper and include matters that a regulated institution will, at a minimum, be required to address in its fit and proper policy. There is some flexibility, however, in the application of these criteria. Specifically, a person who is determined to be not fit and proper for a particular role is not automatically excluded from every other responsible person role. Where, however, a person is found to be not fit and proper due to a lack of diligence, honesty, integrity or APRA 12

16 because of poor judgement or reputation, that individual will normally not be suitable for any position of responsibility. Additionally, it may not necessarily follow that a person is not fit and proper where they do not meet one or more criterion although this may be the case depending on the severity of the matter. Such a failure would be considered as part of an overall assessment of the fitness and propriety of the person for the particular position, any relevant circumstances and any rectification actions that may be in progress at the time. For further detail refer to the draft fit and proper prudential standards. 18 Conclusion APRA proposes to set a clear benchmark for the fitness and propriety of responsible persons in APRA-regulated institutions via the introduction of fit and proper prudential standards. The proposed prudential standards will apply to all APRA-regulated institutions, 19 and will outline the minimum requirements that APRA expects responsible persons of such institutions to meet. These standards will complement APRA s prudential mandate, and increase the protection afforded to the beneficiaries of APRAregulated institutions on whose behalf APRA acts. APRA has considered international developments and requirements when developing these proposals. 20 The new standards are intended to commence on 1 January 2005, subject to the outcome of the consultation process. 18 These are available at 19 With the exception of superannuation entities as highlighted previously. 20 Appendix 2 outlines fit and proper models of international regulators. APRA 13

17 APPENDIX 1 CORPORATIONS ACT 2001 REQUIREMENTS The material provided in this and the following appendix is purely for information purposes. APRA s fit and proper requirements are an APRA requirement designed for the purpose of determining whether a person is suitable to act as a responsible person of an APRA-regulated institution. Other regulators may have their own requirements with respect to fitness and propriety that persons may be required to meet in relation to particular matters. The APRA fit and proper test will have no bearing in relation to tests of other regulators. The use of the term responsible person has no overlap or context in respect of other regulators or other regimes; for example, the concept of responsible officer as defined in the Corporations Act need bear no relationship to responsible person as defined by APRA. Corporations Act 2001 (Corporations Act) Whilst the Corporations Act does not contain specific requirements concerning the fitness and propriety of individuals, it does impose minimum standards on the behaviour of officers and employees of corporations. Specifically, Part 2D.6 details the circumstances under which a person will be automatically disqualified from managing corporations. These include where the person has a conviction on indictment of an offence in relation to decisions that affect the business of a corporation or its financial standing; an offence involving a contravention of the Corporations Act punishable by imprisonment for 12 months or more; an offence involving dishonesty punishable by more than 3 months imprisonment; conviction for an offence against the law of a foreign country punishable by more than 12 months imprisonment; and being an undischarged bankrupt. Additionally, there are provisions where a court or the Australian Securities and Investments Commission (ASIC) have the power to disqualify a person. The Financial Services Reform Act 2001 amends the Corporations Act and establishes a single harmonised regime for the regulation of financial service providers in the Australian marketplace. The Corporations Act now requires providers of financial services and products to be licensed by ASIC, to meet minimum requirements in terms of competency, good fame and character and to meet certain disclosure requirements in relation to products and services provided to retail investors. This regulation therefore targets a market distinct to that covered by APRA as the prudential regulator. APRA 14

18 Corporate Law Economic Reform Program No 9 (CLERP 9) In December 2003, the CLERP (Audit Reform and Disclosure) Bill 2003 (CLERP Bill) was tabled in Parliament. 21 The draft CLERP Bill continues the government s economic law reform program. It specifically deals with corporate disclosure and reporting laws. The disclosure requirements set out under this draft Bill are designed to preserve market integrity and provide greater protection to investors, and, as such, focus on the provision of audit services, auditor independence, and continuous disclosure to the market. APRA s fit and proper proposals impose additional requirements specifically related to prudential regulation. These extra requirements would ensure that persons who act in relation to APRA-regulated institutions do so in a prudent manner, thus affording beneficiaries appropriate protection. 21 The draft Bill gives legislative form to the policy proposals contained in the September 2002 CLERP 9 policy proposal paper: Corporate disclosure: Strengthening the financial reporting framework. The Bill can be viewed at APRA 15

19 APPENDIX 2 FIT AND PROPER MODELS OF INTERNATIONAL REGULATORS AND BODIES Financial Services Authority (FSA) (UK) The FSA has a formal fit and proper test (FIT) applicable to regulated entities. 22 FIT details the criteria to be applied when assessing the fitness and propriety of persons for approval as an approved person 23 for the purpose of performing a controlled function. 24 When developing this test, the FSA was driven by its statutory objectives to maintain confidence in the financial system, to promote public understanding of the financial system, to secure an appropriate degree of consumer protection, and to reduce financial crime. The FSA states in its consultation paper 25 on this matter that, these objectives will be met through application of the fit and proper person test by enabling the FSA to set the criteria which are intended to ensure that only fit and proper persons are engaged in controlled functions in the financial services industry, and by the issuance of Statements of Principle and a Code of Practice with respect to standards of behaviour expected of individuals who work in the financial services industry. The FSA FIT test is applied as part of the comprehensive approval process for appointment to the performance of controlled functions. Controlled functions include a wide range of functions from directors, CEOs, auditors, and actuaries through to significant management functions and advisory functions. In the assessment of the fitness and propriety of a person to perform a controlled function, the FSA gives consideration to the person s honesty, integrity, reputation, their competence and capability, and their financial soundness. The FIT Handbook contains further detail as to the matters related to these individual characteristics that must be considered in any determination of fitness and propriety. 22 The Fit and Proper Test for Approved Persons, FSA Handbook, Financial Services Authority, United Kingdom, October An approved person is a person approved by the FSA under s59 of the Financial Services and Markets Act 2000 for the performance of a controlled function. 24 A controlled function is one included in the FSA s Table of Controlled functions (Supervision Manual Chapter 10 Approved Persons July 2003). 25 Consultation Paper 26 - The Regulation of Approved Persons, July APRA 16

20 Office of the Superintendent of Financial Institutions (OSFI) (Canada) Whilst OSFI has not developed a formal fit and proper test in legislation it administers, it does have legislative power to impose certain requirements on Federally Regulated Financial Institutions (FRFIs; these institutions are banks, insurance companies, trust or loan companies, or cooperative credit associations) and their key officers. 26 Under this regime, OSFI will consider the individual applicants of a FRFI for the purposes of issuing a licence. When an applicant seeks to be incorporated as a FRFI, certain information must be provided to OSFI in support of their application. Standard information requirements include the provision of the curriculum vitae of senior executive officers, directors, the principal officer, chief agent, and significant individual shareholders (these people are all classified as key individuals); background security checks for these key individuals; and details of any refusal by any regulatory agency to allow the individuals to establish or acquire an entity, agency, subsidiary, or branch or to carry on financial activities. OSFI may also seek any other information pertaining to matters that may be relevant in the assessment of the application, including, but not limited to, private investigator reports, credit checks, and other references. The effectiveness of a FRFI s Board and management is then reviewed on an on-going basis as part of the supervisory process. This review does not, however, place specific attention on issues of fitness and propriety unless a specific problem in this area has been identified. Prior to approving incorporation of a FRFI, the acquisition of a significant interest in an FRFI, or the establishment of a foreign bank branch in Canada, the relevant Minister shall take into account all matters that the Minister considers relevant to any such application. These matters include the business record and experience of the applicant; the character and integrity of the applicant, or if it is a body corporate, that it is operated in a manner consistent with standards of good character and integrity; and whether the FRFI will be operated responsibly by persons with the competence and experience suitable for involvement in the operation of a financial institution. Once a FRFI is granted permission to operate, OSFI requires notification of replacement of senior executive officers, directors, and principal officers. The Superintendent also has the power to remove, disqualify, or suspend a director, senior officer, principal 26 Key officers are senior executive officers, directors, the principal officer, and the chief agent. APRA 17

21 officer, or chief agent on the basis of competence, business record, experience, conduct or character. The Canadian Bank Act 27 does not directly specify fit and proper requirements, but does contain duties of directors and officers, including a duty of care. Certain persons are additionally automatically disqualified from being a director of a bank. The Joint Forum on Financial Conglomerates (Joint Forum) The Joint Forum comprises the international regulatory bodies for banks (Basel Committee on Banking Supervision (Basel Committee)), insurers (International Association of Insurance Supervisors (IAIS)), and securities markets (International Organisation of Securities Commissions (IOSCO)). This group has developed fit and proper principles applicable to financial conglomerates that are intended to assist local supervisors when assessing whether entities are being managed in a sound and prudent manner. These principles are also designed to identify situations where key shareholders of the entity can exert a material influence on the management and operations of the entity. This approach is intended to ensure that persons in a position to influence the management or operations of an entity are of good fame and character and appropriately experienced and qualified. This should ensure that their actions are not likely to undermine the sound and prudent management of the institution. The Joint Forum determines fitness by an assessment based on formal qualifications, previous experience, and track record. An individual s propriety is measured according to a range of factors, including whether they have a criminal record, their financial position, any civil actions, whether they have been expelled from professional bodies, and whether they have been subject to sanctions from other regulators. The Basel Committee and the IAIS have further extended these principles to address the issue of fit and proper persons for single entities, specifically banks and insurance companies. European Commission (EC) The EC is responsible for policy initiatives and preparation of European Union (EU) legislation. In 2000, the EC issued a consultation paper concerning an EU approach to 27 These requirements are replicated in a similar form in other OSFI-administered legislation, including the Insurance Companies Act, Trust and Loan Companies Act, and the Cooperative Credit Association Act. APRA 18

22 the prudential supervision of financial conglomerates. 28 An assessment of the fitness and propriety of managers and directors, and the question of the suitability of major shareholders, are included as key elements to ensure the sound and prudent management of the regulated entity. This paper also proposes applying fit and proper tests to those financial conglomerates where there are entities in the group that are outside the direct control of a financial regulator. It also endorses the need for the legally appointed managers and directors to be required to meet the fit and proper test (as per the Joint Forum paper 29 ) on an ongoing basis. 28 Towards an EU Directive on the Prudential Supervision of Financial Conglomerates, European Commission, December The EU Commission attends the Joint Forum in an observer capacity. APRA 19

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