APRA and HIH Royal Commission - Essay Example

Law of Financial Institutions and Services: APRA and HIH Royal Commission Student name: Student number: Tutor: Date: Introduction Australian Prudential Regulation Authority (APRA) started operation in July 1, 1998 as the national regulator of financial institutions such as superannuation, insurance companies, and deposit takers (Grant 2005). In 2001, APRA was criticised by the HIH Royal Commission for failure to take an action to prevent the fall of the insurance company. Then again, it was criticised for its inactivity, and in addition to the fact that its regulation of the retirement savings was not as effective as expected (Rowland 2003). This came about after APRA’s supervision of the superannuation industry that faces collapse. HIH was made of different government-licensed insurance companies such as CIC Insurance Limited (CIC) and HIH Casualty and General Insurance. The company dealt with compulsory insurance such as compulsory third party regulation and worker’s compensation, and non-compulsory insurance such as travel insurance (Grant 2005). Among APRA’s fundamental roles after the collapse of HIH was explaining its role in using its capacity to prevent the collapse. HIH accused APRA for failing to use its regulatory powers before the collapse. This is consistent with the Insurance Act 1973, which specifies the requirements needed for operating insurance firms in the country, such as reporting requirements, solvency requirements, and entry requirements. HIH Royal Commission strongly accused APRA of inaction leading to its collapse (Medaglia & Marvin 2003). This essay argues that the alleged failures of APRA were attributable to the regulatory framework that divided responsibility for regulation between prudential regulation (APRA) and consumer or investor protection (ASIC). The Insurance Act 1973 imposes prudential requirements on the general insurers. Among its creations in this regard is the Australian Prudential Regulation Authority (APRA), which is instituted to be the prudential regulator for prudential supervision of the whole financial services sector under the Australian Prudential Regulation Authority Act 1998 9 (Medaglia & Marvin 2003). APRA’s main failures in regards to the collapse of HIH touch on the divided responsibility for regulation between prudential regulation (APRA) and consumer or investor protection. The separation of roles ensured that APRA’s key regulatory roles under the Insurance Act 1973 become restricted, such as the power to investigate, intervene and administer insurance firms, the power to demand financial institutions to observe prudential standards, including appropriate liquidity, capitalisation and governance and to intercede when the policyholders are at risk, and lastly appointment of inspector when a company reaches near liquidation state (Grant 2005). Insurance Act 1973 does not prevent an insurance firm from collapsing. Rather, it permits APRA in certain situations to review the company’s affairs in situations of public interest. However, the divided responsibility for regulation between prudential regulation (APRA) and consumer or investor protection (ASIC) made the role impossible. APRA was specifically guided by the Insurance Act 1973. However, the act division of consumer or investor protection and prudential regulation made it unsuitable to help overcome challenges that HIH Royal Commission faced. Therefore, the circumstance that led to HIH’s liquidation concerned investor regulation and prudential regulation. Therefore, it narrowed APRA’s scope to suitably evaluate the true risk HIH encountered and could not intervene to order investigations following investor protection concerns. Indeed, a submission made by HIH Royal Commission indicated that prevalent weaknesses of the Insurance Act 1973 in creating separate arms to oversee regulation of the insurance sector caused weak and non-interventionist supervisory and regulatory regime. At this rate, it could further be argued that the limitations of Insurance Act 1973 made substantial impacts on APRA’s supervisory framework. By assigning the roles of consumer or investor protection to ASIC and prudential regulation to APRA, the latter had restricted regulatory mandate (Medaglia & Marvin 2003). Indeed, the immediate impact is that APRA assumed that financial firms had both internal compliance systems and solvency or capital support to protect consumer interests. Such an assumption made APRA to assume that since companies had such systems in place, they were placed to protect consumer or investor interests. Still, it narrowed its perspective on its key mandate in prudential regulation. Indeed, in 2002, APRA ensured compliance with the minimal legal solvency provisions but assumed that HIH could not rely on it to detect breaches of the prudential requirements as well as to guide HIH on the proper management practices and undertaking an audit role (McCoacg & Landy 2012). This is since ASIC has often undertaken the role of ensuring that companies engage in proper management practices and undertake proper audit role. Therefore, dividing responsibility for regulation between ASIC and APRA made the latter’s failures to originate from lack of will rather than lack of power. The regulatory strategy employed by ASIC involves monitoring and encouraging consumer protection and market integrity as well as licensing financial services and products. ASIC’s power are set out by Corporations Act 2001 (Cth). ASIC plays the role of providing guidance to help companies to comply, influence the views and conducts of the companies and to enable the companies to avoid engaging in illegal and improper behaviour (Medaglia & Marvin 2003). In this regards, while ASIC stressed enforcement of critical components of effective regulations. In fact, APRA plays a supervisory role. Yet again, unlike APRA, the ASIC is not mandate to give similar kind of attention to the financial capability of regulated institution. While ASIC’s mandate is unambiguous, that of APRA is not. This means that the rule governing the conducts of companies as well as how investment schemes should operate may not generate divisions between companies, as the standards are applicable and relatable to the charges of fraud and misconduct (Palmer & Cerruti 2009). The same can however not be said of APRA. This means that the ambiguity of APRA in prudential regulation explains its failure to relate to particular problems that the insurance industry faced just before the collapse of HIH. An additional failure of APRA is anchored in its role and association with ASIC. As established above, APRA’s regulatory strategy is significantly different from that of ASIC. APRA emphasises on supervision instead of enforcement. Therefore, its role is not to prosecute. Rather, it is to see to it that their financial performance is in the interest of the superannuation fund members, policy-holders, and depositors (Medaglia & Marvin 2003). This also means that ASIC operates based on the regulatory perspective that enforcement should be supported by education, while APRA centres on supervision through the support of enforcement. However, in the case of HIH Royal Commission, the situation needed the joint application of supervision and regulation. However, APRA could only manager supervision. Still, APRA failed to undertake its supervisory role. An overall assumption from this is that APRA had poor regulatory foresight. Indeed, APRA was sued by APRA liquidators in November 2002 for alleging that the collapse of HIH was due to poor regulatory oversight and that APRA showed negligence of duty by permitting HIH to acquire FAI Insurance Limited in 1998 that at that time faced significance financial troubles. Critically, APRA’s failures and inactions to respond in time and appropriately to sign’s of HIH’s impending collapse, as the ‘prudential regulator, led to the collapse of HIH. APRA had therefore failed to provide advanced warning of the financial problems that HIH faced before it requested for involuntary liquidation. As stated by the Australian Prudential Regulation Authority Act 1998, among APRA’s key responsibilities involved ensuring that the insurers have sufficient reserves that are equivalent to their exposures (Medaglia & Marvin 2003). Indeed, according to a report/submission made by HIH Royal Commission, two-thirds of the funds that APRA monitors was not given risk taking. At the same time, most of the 1,200 super funds in Australia had often failed to submit their annual reports in time. In HIH Royal Commission’s submission, all indications pointed to APRA as not being aggressive enough in supervising the insurance industry (Rowland 2003). Other Causes of the collapse On the other hand, it could be argued that the alleged failures of APRA are not necessarily attributable to the regulatory framework that divided responsibility for regulation between prudential regulation (APRA) and consumer or investor protection (ASIC). The underlying argument is that while APRA’s failure did not contribute to the eventual collapse of HIH Royal Commission, the manner in which its exercised its power and discharged its duties under Insurance Act 1973 was inconsistent with what should be been expected from the prudential regulator of Australia’s insurance industry. Critically, the role of APRA as a prudential regulator is not to guarantee that companies it regulates would not fail. Rather, it expresses the role of prudential regulator is to mitigate the risk and the probability that a general insurance company would fail, to provide detection of early warning signs that a company may fail, and to assume a position to understand the circumstances that may lead to failure of a company it regulates (APRA 2003). Therefore, APRA’s failures were basically a result of organizational problems originating from the new system established after creation of APRA in 1998, its inability to act under section 115 of the Insurance Act 1973, its incapacity to act under section 52 of the Act, its failure to identify HIH Royal Commission’s non-compliance with section 29 of the Act (Medaglia & Marvin 2003). Still, it could be argued in support of APRA that since APRA was acting in secrecy in solving internal issues, there could have been fewer triggers to warrant appointment of an inspector. This however does not justify acquisition of APRA against all the claims since it did appoint inspectors to look into IHI’s issues along with its subsidiaries on March 25, while HIH failed to inform APRA that it had prepared to appoint a liquidator on the same day, just hours before it had to report his half-year results. Australia’s Corporations Law demands that March 16 is the deadline. What is apparent from this statement is that APRA’s actions to appoint an inspector were rather late (APRA 2003). HIH’s criticism therefore holds ground since it reserves to appoint government inspectors to investigate insurers facing financial difficulties, it should have appointed an inspector at least one year before the provisional liquidation. From the above discussion, it is concluded that APRA fell below the tolerable standards of a prudential regulator. In fact, the facts released by HIH indicate that at the time preceding HIH’s collapse, Australia faced significant problems with insurance regulations. Conclusion To a greater extent, the failings of APRA are attributable to the regulatory framework that divides responsibility for regulating between consumer/investor protection under the ASIC Act and the responsibility for prudential regulation under the APRA Act. This separation of roles restricted APRA’s key regulatory roles under the Insurance Act 1973 such as the power to investigate, intervene and administer insurance firms, the power to demand financial institutions to observe prudential standards, including appropriate liquidity, capitalisation and governance and to intercede when the policyholders are at risk, and lastly appointment of inspector when a company reaches near liquidation state. This limited APRA’s capacity to mitigate the risks and the probability of HIH’s collapse, to provide detection of early warning signs that a company may fail, and to assume a position to understand the circumstances that may lead to HIH’s failure. References Grant, R 2005, "Australia’s corporate regulators—the ACCC, ASIC and APRA," Parliament of Australia Research Brief June 2005 McCoacg, L & Landy, D 2012, Australia: banking Regulation, viewed 30 Nov 2014, Medaglia, E & Marvin, B 2003, “The American Perspective: Insurer Insolvency and its Impact on the Policyholder," Prepared for and Presented to the Australian Insurance Law Association August 14, 2003 Adelaide, Australia Palmer, J & Cerruti, C 2009, "Is there a need to rethink the supervisory process?" Reforming Financial Regulation and Supervision: Going Back to Basics International Conference Madrid June 25, 2009 Rowland, M 2003, “APRA criticised over supervision of superannuation industry," ABC.Net, viewed 29 Nov 2014, APRA 2003, “HIH Royal Commission CLosing Submission Austalian Prudential Regulation Authority,” Austalian Prudential Regulation Authority, viewed 29 Nov 2014, Read More