APRA’s governance shake-up sparks debate over reputational risk rules

APRA’s proposed governance reforms are stirring debate in the industry, particularly due to the ambiguity surrounding the suggestion that “perceived conflicts of interest” and “changes in personal circumstances” could create reputational risks. 

Last week, the prudential regulator unveiled proposals aimed at improving governance standards for super funds, banks, and insurers - the first major update in over a decade.

The reforms address key issues including skills and capabilities, fitness and propriety, conflict management, and director tenure, with a strong emphasis on reputational risk in leadership appointments.

Namely, APRA’s proposals emphasise super funds must integrate reputational risk into their assessment of directors and executives, ensuring candidates align with high ethical standards to protect the integrity and trust of the sector.

Speaking to InvestorDaily, Luke Barrett, a partner at Gilbert + Tobin, said super funds already “factor brand and reputational risks into their general decision-making”, particularly when appointing independent directors and senior executives.

He noted that these individuals are seen as “assets that strengthen the organisation”.

Instead, Barrett believes the reforms will have a bigger impact on the appointment of the representative directors who are selected to represent members and employers.

These representatives are usually put forward through elections or nominations, and Barrett suggested that “funds often have little scope to take issue with the candidates put forward, other than to say they are not ‘fit and proper’ for the role”.

“It seems APRA is using that lever to shoehorn reputational risk considerations into the grounds on which a fund can reject the candidates put forward to them,” Barrett explained.

“APRA is suggesting that reputational risks should form part of the assessment of whether candidates for board and executive positions are ‘fit and proper’ for the role.  This might be a way of dealing with the reality under corporate law that the shareholders in a trustee often have a largely unfettered right to appoint directors”.

According to Barrett, depending on how this is implemented, it could lead to more rigorous pre-vetting procedures.

“If this gets up, we may see the evolution of pre-vetting procedures that clear candidates in advance of being put forward for election or appointment to avoid the inconvenience of a failed process,” he said.

However, Barrett urged funds to seek more clarity from APRA on a key aspect of its consultation paper - the suggestion that “perceived conflicts of interest” and “changes in personal circumstances” can create reputational risks that affect their role.

Namely, the prudential regulator is proposing stricter baseline expectations for fitness and propriety by incorporating “perceived conflicts of interest” into its definition of fit and proper. It also proposes the introduction of “changes in personal circumstances” that could pose reputational risks as triggers for reassessing appointments. 

On this latter point, Barrett said: “Funds should be seeking clarity on what sorts of personal circumstances APRA is talking about”. 

“It can’t just be bankruptcy or regulatory disqualification: those occurrences would be rare and are already dealt with under the existing ‘fit and proper’ rules,” he said. 

“Commencing a role with one of the fund’s service providers or stakeholders probably isn’t the sort of change in personal circumstance they are meaning either, because that would be caught by existing rules on managing conflicts of interest and disclosing other positions held”. 

Regarding “perceived conflicts of interest”, Barrett stressed that “care is needed to avoid decision making being impeded by vague notions of non-existent conflicts that might nevertheless be perceived”.  

“Bear in mind that some conflicts of interest are inherent in the equal representation model. Member representative directors are often members of the fund they govern. Employer-representative directors are often members while also being on the board having been selected by the employers. This is an example of a conflict of interest that is permissible, even though some might perceive there to be a conflict of interest,” Barrett said. 

The reforms have also sparked concern over the potential for overreach that could stifle board diversity.

As such, Barrett stressed the need to balance reputational risk management with fairness, ensuring directors aren’t unfairly excluded over unsubstantiated allegations or guilt-by-association.

“That balance can be struck by taking a forensic and considered approach to vetting procedures,” he suggested. 

“For example, rather than simply focussing on whether a board candidate is employed by, or has been put forward by, an organisation involved in a separate controversy, it would be prudent to enquire about the person’s involvement in that controversy and whether they have enough time to dedicate to their board role having regard to their outside commitments and priorities.” 

While APRA insists that its proposals will not interfere with the “equal representation model,” Barrett pointed out that the enhanced focus on skills and experience may have an impact on the pool of candidates.

“Depending on the fund, that impact may or may not be felt equally by both cohorts,” he said.

Overall, Barrett believes “most of the criteria that APRA is putting forward is entirely appropriate”.

“It makes sense for funds to focus more tangibly on the skills and experience that are needed, the amount of time directors have to commit to their role and prior misconduct,” he told concluded.