Clearer resolution: APRA consults on guidance for strengthening crisis preparedness

On 6 September 2022, APRA released for consultation draft prudential practice guides on financial contingency and resolution planning.

The two new guides, CPG 190 Financial Contingency Planning (“CPG 190”) and CPG 900 Resolution Planning (“CPG 900”), set out principles and examples of best practice to assist APRA-regulated entities to meet the requirements under the proposed new prudential standards CPS 190 Financial Contingency Planning (“CPS 190”) and CPS 900 Resolution Planning (“CPS 900”), which APRA published in December 2021 as part of its consultation on planning for crisis preparedness.

This alert explains key aspects of APRA’s guidance and discusses the important issues for regulated entities to consider as they strengthen their preparedness for crisis.

A refresher on CPS 190 and CPS 900

Our earlier alert on CPS 190 and CPS 900 provides an overview of these draft standards.  As a short refresher:

• all APRA-regulated entities (including ADIs, general and life insurers, private health insurers and responsible entities of APRA-regulated superannuation entities (“RSEs”)) are affected;
• CPS 190 focuses on minimising the risk of entity failure. It will require all APRA-regulated entities to develop credible plans for managing stress that may threaten their viability, including plans for rebuilding financial resilience or effecting an orderly exit while remaining solvent and viable; and
• CPS 900 is focused on minimising the impact of entity failure. CPS 900 would require large or complex APRA-regulated entities to be organised so as to minimise risks to beneficiaries, e.g. depositors or policyholders, and to financial system stability, if the entity were to fail.

CPS 190 is proposed to come into effect from 1 January 2024 for banks and insurers, and from 1 January 2025 for the superannuation industry.  CPS 900 is proposed to come into effect from 1 January 2024.

Both standards are principles-based and non-prescriptive. The guidance is similar.  However, as noted in our earlier alert, APRA-regulated entities should expect, and prepare for, rigorous and detailed work in developing and maintaining the plans required by CPS 190 and CPS 900. This work will require a multi-disciplinary approach and strong governance arrangements to support plan development and implementation. The new guidance illustrates some areas of focus for this work.

Overview of the new guidance

CPG 190

CPG 190 includes a number of statements of how APRA considers a “prudent” entity would approach the task of implementing an effective financial contingency plan. Examples of “prudent” practice include:

• integrating the trigger framework in the financial contingency plan with other monitoring and early warning indicators in the risk management framework and, where applicable, updating the entity’s plan to align with any implications of its resolution plan;
• ensuring the plan is formulated so that the entity’s Board can quickly navigate and easily understand it (e.g. using simulation exercises to test effectiveness of plans);
• developing a framework of “cascading” triggers to support “a graduated dialling up” of the entity’s response to stress;
• clearly setting out accountabilities for activating and implementing the plan;
• providing for a “menu” of credible contingency actions in the plan, to facilitate flexibility in responding to stress;
• focusing on preparatory measures to reduce the risk that execution of contingency actions do not go to plan (e.g. developing “playbooks” for executing actions under various scenarios);
• identifying key stakeholders for contingency actions (e.g. communications, finance and risk teams) and tailoring communication strategies appropriately;
• identifying an approach to engaging with regulators and, where appropriate, meeting disclosure requirements;
• assessing the time needed to execute an action forming part of the plan and the time needed to realise its full benefits;
• assessing the consequences arising from executing an action forming part of the plan; and
• assessing the operational or liquidity requirements for implementing wind-down or run-off strategies contained in the plan.

CPG 190 also makes clear that APRA expects an entity’s Board to review and ensure management updates the plan on an ongoing basis, in the face of changes in market conditions and developments in the business.

The guidance also makes clear that:

• APRA does not expect a contingency plan’s trigger framework to be mechanical or automatic. It should include a variety of indicators of stress, based on both actual and forecast outcomes, which allow the entity to react before triggers are breached;
• for Significant Financial Institutions ("SFIs"), the scenario analysis required to be taken under the prudential standards should, at a minimum, include an idiosyncratic and system stress scenario. However, good practice would require an entity to consider, for example, how an entity’s competitive environment, market sentiment and temporal elements impact contingency actions; and
• to comply with the new standard, it will not be enough merely to have a plan that is sound in theory only - work is required to ensure the plan is credible in practice and supported by a level of detail on practical matters. This means that, even for entities with existing plans, work is likely required to update the plans to comply with the requirements of the standard and guidance.

CPG 900

CPG 900 establishes a framework through which regulated entities can engage with APRA to develop and implement a resolution plan, the execution of which ultimately lies with APRA.

APRA indicates that the planning process will typically occur over several years. After initially gathering information and undertaking preliminary assessments, APRA expects to engage more substantially with the entity on refining resolution options and, if it thinks appropriate, requiring the entity to undertake pre-positioning actions.  The resolution planning process would typically involve “frequent engagement between APRA staff and the regulated entity”, on an “open, cooperative and constructive” basis. APRA may require a regulated entity to undertake an assessment of the feasibility of resolution options, including potential barriers to implementation. This will be an important step of any resolution process.  

Usefully, APRA has provided guidance as to its understanding of “critical functions”. Assessment of critical functions is complex and involves a range of quantitative and qualitative judgments. However, CPG 900 directs attention to a function’s role in the financial system, industry or community impact, and substitutability.  For example, the failure of an insurer that provides insurance to a particular industry “could have significant impacts for the real economy”, and therefore point towards the characterisation of the provision of that insurance as a “critical function”.

Given the importance of an assessment of critical functions to APRA’s view of resolution options, APRA expects entities to engage with an assessment of critical functions early in the process of resolution planning.

APRA set out its views as to the appropriateness of resolution options for different kinds of entities in CPS 900.  The application of some key potential options is shown in Table 1 below:

CPG 900 also includes a number of statements of how APRA considers a “prudent” entity would approach compliance with CPS 900. Examples of “prudent” practice include:

• making sure that there is appropriate oversight of the plan;
• considering the need for engagement with key stakeholders, including regulators, and the key risk indicators that would need to be monitored, in connection with the plan;
• considering its reliance on third-party service providers and financial market infrastructure, where appropriate;
• to the extent that the plan involves an entity continuing to operate following resolution, establishing a plan for returning to sustainable and resilient long-term financial position;
• ensuring that the resolvability assessment and pre-positioning plan have been subject to rigorous review and challenge;
• assessing all relevant steps needed to implement resolution options, including identification of timeframes that may be dependent on external parties;
• where the resolvability assessment identifies clauses in contracts with third party service providers that would inhibit access to relevant services in resolution, clearly demonstrating how pre-positioning measures would mitigate this risk; and
• identifying the capabilities required to execute resolution options.

Key issues for regulated entities to consider

Status of the prudential standards and broader resolution planning reforms

APRA is planning to finalise CPS 190 later in 2022 and CPS 900 in the first half of 2023. 

APRA has indicated that it does not expect to make material changes to CPS 190. It notes that respondents have largely been supportive of the standard, and that guidance was sought on discrete requirements.  

For the draft CPS 900, APRA has indicated that stakeholder feedback on CPS 900 was more substantive, and that APRA expects that some small revisions to CPS 900 may be appropriate, based on current industry feedback, including to clarify the Board’s role in resolution planning and APRA’s expectations relating to disclosure on resolution planning.

Regulated entities and other interested parties should consider whether, in light of APRA’s comments that revisions may be appropriate, they may wish to provide additional feedback to APRA on specific aspects of CPS 900 through this consultation.

The lifecycle of contingency planning and resolution planning

A regulated entity’s contingency plan establishes a plan of action for times of severe stress. This plan requires a trigger framework, governance arrangements for monitoring the plan, recovery and exit actions and a communication strategy. SFIs must also undertake scenario analysis and an assessment of recovery capacity. As the chart below illustrates, this is an entity-led process designed to navigate the period of stress and avoid APRA-directed action.

SFIs should be aware of the need to test their plans through idiosyncratic and systemic stress scenarios and the need to demonstrate to APRA the credibility of certain recovery actions. APRA suggests this could include prior engagement with potential transfer partners where appropriate. How this is to be done, in particular having regard to competition law or commercial considerations, is not explained. It would of course be important for regulated entities to ensure these matters were appropriately and satisfactorily addressed.  

The guidance also says that any entity subject to CPS 900 should ensure that its recovery plan is updated to align with any implications of its resolution plan.  This should not be taken as indicating that development of the recovery plan can be postponed pending the development of a resolution plan.

Practical considerations and implications of CPS 900

APRA confirmed its intention to implement CPS 900 on an entity-by-entity basis to ensure that resolution plans are appropriate for the particular circumstances of the individual entity. Whilst this will assist in developing resolution plans in a proportionate manner, it will mean the precise outcomes for individual entities will not be known in advance. In addition, this approach may present complexities for individual entities if they are required to implement pre-positioning measures which impact third parties (e.g. amending service and supply contracts) on a bilateral basis without a clear, public statement of the regulator’s specific requirements.

As entities progress through resolution planning they must also be conscious that the prudential standards and CPG 900 impose ongoing requirements. Strategic and operational decisions may have consequences for the effectiveness of an entity’s resolution plan. APRA expects entities to notify and engage with APRA if they intend to take action (for example, entering new contracts, restructuring business lines or entering new markets) that would create a material barrier to executing the resolution plan.

Implications for overseas-regulated entities

Overseas-regulated entities with a presence in Australia or Australian entities with material overseas subsidiaries will be required to undertake specific planning in relation to jurisdictional issues. APRA has indicated a preference for contingency actions to be taken by Australian entities rather than overseas parent entities or subsidiaries. As these entities engage with APRA on resolution planning, they should expect APRA to facilitate discussion with overseas regulators to consider how cross-border resolution issues may be resolved.

New approach to prudential standards

In a first for APRA, it has released both “integrated” and “non-integrated” versions of the two new draft prudential practice guides.  The “integrated” versions “map” APRA’s guidance to the relevant paragraphs of the underlying standards (with the text of the standards reproduced in blue boxes alongside the guidance).  They are intended to better support regulated entities in understanding how specific requirements of the standards relate to the relevant guidance.  

Integrated prudential practice guides may become a feature of an entirely new prudential architecture, which APRA has heralded in a separate announcement on 12 September available here.[1]   We’ll discuss that in a separate Alert.

Timing of implementation / next steps in the consultation

While APRA is planning for CPS 900 to be effective from 1 January 2024, APRA has indicated that the requirements of CPS 900 will not need to be met by a particular regulated entity until APRA advises the entity that it is commencing resolution planning.[2]  We anticipate that regulated entities would find it helpful for this to be clearly specified in the section of CPS 900 headed “Application and commencement”.[3]

Even though the guidance gives some comfort about the commencement of resolution planning requirements, APRA has indicated that it plans to engage with entities well before the commencement of formal resolution planning. In light of this, and given the significant amount of work resolution planning will entail, the importance of robust governance arrangements and the need for input from subject matter experts across a regulated entity’s business, regulated entities may wish to begin initial planning preparation in advance of formal approach by APRA. It is certainly not too soon to start planning for financial contingency and resolution, and it is wise to do so before it is too late.