Corporate governance for ADIs and insurers - are you already complying?

From 1 October 2006, life insurers, general insurers, and authorised deposit-taking institutions (ADIs) must comply with APRA's new prudential standards on corporate governance. While there has been some concern in the press about the new obligations, in essence they capture what most institutions already do.

In this Alert we'll sketch out the main features of the new prudential standards (all standards can be downloaded here). It's important to remember, however, that these new rules must be read with other finalised prudential standards (which we've already looked at here).

What has been removed from the draft version?

• The Principles section
• the requirement that at least one independent director on the board must have financial expertise
• the provisions dealing with situations where the board of the insurer is not to act in the interests of another member of the corporate group; the oversight by the board of subsidiary entities; and situations where group policies are utilised by the insurer
• general requirements in relation to the board setting up committees and how these should be managed
• the requirement that a copy of the declarations obtained from the auditor indicating that they are in fact independent be provided to APRA has been removed
• the risk management section and provisions dealing with information on directors to be provided to APRA (these are covered by separate prudential standards).

Who sits on a board?

Boards must contain a minimum of five directors, and a majority must at all times be independent directors (see below for an explanation). This includes directors present and eligible to vote at Board meetings. A majority of directors must also be ordinarily resident in Australia.

The skills mix

The new prudential standard requires that collectively the board and senior management "have the full range of skills needed for the effective and prudent operation of the regulated institution, and that each director has skills that allow them to make an effective contribution to Board deliberations and processes." That includes directors' knowledge and understanding of legal and prudential obligations. The list of specific skills in the draft version has however been removed.

Independent directors

An independent director is defined as

• a non-executive director (ie. someone who is not a member of management)
• who is free from any business or other association that could materially interfere with the exercise of their independent judgment

Furthermore, "in assessing whether a director is independent, the Board must apply the definition of independence set out in the ASX Corporate Governance Council's Principles of Good Corporate Governance and Best Practice Recommendations."

"Business or other" associations include, but are not limited to, those arising out of a substantial shareholding, involvement in past management or as a supplier, customer or adviser. As a result, many current boards may not have the right number of independent directors.

Reviewing performance

The Board's performance as a whole and also that of individual directors must be assessed annually. This requires setting Board objectives (such as establishing the overall strategy for the regulated institution, assessing operating and financial conditions against forecasts, or making key decisions in a timely manner) against which performance can be assessed. For individual directors, APRA suggests objectives such as demonstrated expertise, or attendance and participation at Board meetings.