Section 1 - Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999) - Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999) | Zoe
Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999)
1Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999)
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Turn the raw legal text into a practical explanation grounded in Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999).
Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999)
as amended
made under regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999 and section 230A of the Life Insurance Act 1995
This compilation was prepared on 7 September 2009
taking into account amendments up to Life Insurance (prudential standard) determination No. 2 of 2006 Prudential Standard LPS 510 Governance, Prudential Standard 6.3C Audit
Prepared by the Office of Legislative Drafting and Publishing,
Attorney-General’s Department, Canberra
Table of Contents
Prudential Standard 6.1 (relating to risk management).....................4
Prudential Standard 6.1 (relating to risk management)
Note: see subparagraph (1)(a) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that friendly societies incur in their operations. Towards this end, to ensure that a friendly society is aware of the risks to which it is exposed, and to ensure that these risks are adequately measured, monitored and managed.
General Background
A friendly society that provides investment services and manages funds on behalf of its benefit fund members is inevitably exposed to risks typical of financial intermediation, funds management and trading activities. Careful management of these risks is fundamental to the successful operation of any financial institution. As noted earlier, the primary responsibility for risk management rests firmly with the management of the society.
Prudential supervision comprises quantitative requirements such as capital, liquidity and reporting; together with more qualitative requirements relating to risk management systems. In assessing the appropriate level of capital, an SSA will require detailed information about the risk management procedures and practices of the friendly society.
While there is to be no set formula relating the need for additional capital to particular deficiencies in risk management, an SSA will look for adequate procedures for identifying and measuring risk, adequate procedures for monitoring risk, and appropriate techniques for managing risk.
Inadequate management practices in this area will meet with additional requirements in terms of capital or, in certain cases, with additional requirements with respect to the holding of liquid assets. They may also result in the friendly society being placed under direction, or being directed to limit, suspend or cease some trading or other activities.
Role of the Board of Directors and Senior Management
It is the responsibility of a society’s board of directors and senior management to understand fully the risks associated with a society’s activities, to question management on the scope and prudent management of those risks, and to ensure open and timely discussion and action regarding potential problems and actual losses.
The board of directors is to approve written policies and is to ensure that control systems in place are consistent with the friendly society’s business, and risk management strategies that meet the society’s commitments to benefit fund members who invest in life insurance or other financial products. These policies and systems are to be consistent with the requirements of the Prudential Standards and the society’s obligations under the Friendly Societies Code. The board is to regularly re-evaluate the friendly society's exposure and tolerance to risk. Senior management, and those in responsible areas of funds management and dealing and investment, are to clearly understand the risk measurement and management systems of the friendly society. Senior management is also responsible for ensuring that the activities of the friendly society are conducted within the framework of approved policies and systems. While policies and systems will differ depending on the activities of the friendly society and its risk profile, they should generally include:
clear identification of the positions with delegated responsibility for managing specific risks;
adequate systems for measuring risk;
structured limits on risk taking appropriate to personnel experience, requirements of the Prudential Standards, management and investment objectives, and the agreed tolerance for risk of the friendly society or benefit fund as appropriate;
effective internal controls, including separation of operations and internal audit; and
comprehensive management information systems that ensure both timely monitoring and reporting of exposures, and proper and effective management of benefit fund structures.
Where a friendly society with one or more benefit funds runs non-benefit fund activities through its management fund, the society’s risk management policies and systems are to address the risks these activities could provide to the benefit fund activities, and how these risks are to be identified, measured, monitored and managed.
An SSA will place particular importance on policies and systems in its review of a friendly society and its benefit fund operations.
Assumption of Significant New Risks
The introduction of the Friendly Societies Code provides societies with a number of new opportunities. For example under the new regime, a society can offer new products, widen investment parameters, actively trade across state borders or rationalise activities through mergers or transfers of engagements.
A friendly society, prior to assuming any significant new risk, is to first satisfy its SSA that:
the risks associated with the change in operations or activities have been identified and assessed;
the expertise, policies and systems are in place to measure, monitor and control the risks;
adequate capital is in place to meet new and projected capital obligations; and
the impact on the financial condition of the society and on its members has been considered.
The SSA will, in addition, ensure that it:
has no reason to believe that the society does not currently meet all Prudential Standards; or
has approved a formal extension of time for compliance by the society; or
expects the society to comply with all Prudential Standards within a reasonable period of time as specified by the SSA.
A society is to make available to its SSA whatever information is required by the SSA in order to satisfy it that the above conditions are met.
The assumption of a significant new risk may include:
establishing operations (including commencing to trade or carry on business) interstate or in a different geographical market; or
extending business activities to provide services or products which are substantially different to those currently being provided; or
a significant widening of the authorised investments of a society or of a benefit fund; or
merging or accepting a transfer of engagements.
If a society is uncertain as to whether its proposed activities constitute a ’significant new risk’, it should contact its SSA to discuss the proposal.
Risks may also arise when two or more societies wish to consolidate their businesses by way of a merger or transfer of engagements. The Friendly Societies Code provides for mergers and transfers of engagement either through a special resolution of the society or by a board resolution as agreed by the SSA. Merger/transfer proposals will be assessed by the SSA on the premise that significant new risks are being assumed.
In the case where the approval is by special resolution, sections 364(3) and 377(3) of the Friendly Societies Code require the SSA to approve the content of the information statements to be sent to members of each society involved. Before an information statement will be approved, the SSA must be satisfied that the risks associated with the merger/transfer have been addressed. Similarly, an SSA will not agree to a board resolution to merge/transfer unless satisfied that risks have been addressed.
Specific Risks
The activities of a friendly society, particularly funds management and operation of benefit funds, give rise to a number of risks typical of any financial institution. At the core of the management of these risks are the policies and systems approved by the friendly society’s board. These policies and systems are to be consistent with the Prudential Standards.
(i) Liquidity Risk
Liquidity risk is the risk that a society is unable to promptly meet its obligations as they fall due. This risk applies to both benefit funds and the management fund.
Benefit fund assets may only be invested under its rules, and in accordance with disclosures and representations made to members at the time they invested funds with the society. Nevertheless, there is still potential for liquidity problems which can be reduced by matching the duration of assets with the expected maturity of liabilities, and by ensuring that the current allocation of assets provides a pool of liquid assets sufficient to meet unexpected pay out demands. Access to standby lines of credit from sources external to the friendly society may be an important part of managing liquidity risk.
For many benefit funds where members can withdraw funds on little notice without any surrender penalty, the asset allocation policy, and size of the fund is such that unexpected demands for withdrawals will not present significant liquidity risks to the fund. However, for benefit funds that have either significant holdings of illiquid assets, or are not substantial funds in terms of size, liquidity management may be more important. Prudential Standard 6.1.1.c requires a society to ensure that the level of liquid or readily marketable assets in any benefit fund is not less than 15% of the value of the assets of that benefit fund. The SSA may require this minimum liquidity level to be increased and may, in unusual circumstances and only when it is consistent with disclosures to members, allow the minimum level to be decreased. The level of liquidity will be set by the SSA with regard to the nature of the benefits and services offered by the friendly society, disclosures to members about these benefits and services, and the quality of the society’s expertise and management systems.
In addition to having sufficient liquidity within each benefit fund, each society is to ensure that there is adequate liquidity within the management fund. This requirement is dealt with separately as part of the Management Fund Capital Requirement (Prudential Standard 6.2.11).
Techniques of liquidity management will vary widely and there is no intention to limit the scope for innovation in this area. However, a friendly society is to satisfy its SSA that proposed techniques are supported by experienced personnel and appropriate controls and suitable technology; particularly in any use of derivatives or foreign currency which are only to be utilised in compliance with Prudential Standard 6.1.6.
A friendly society will be expected to demonstrate that adequate systems and procedures are in place to monitor and manage liquidity risk exposures. Such procedures are to:
encompass board approved policies that establish the level of liquidity risk that will be assumed;
set limits and identify clear lines of responsibility for the management of liquidity risk, including any use of derivatives;
define a measurement and control system that monitors and limits liquidity risk, and reports any breaches of those limits to senior management and the board; and
require the regular assessment of the fair value of investments and liquidity risk.
(ii) Market Risk
Market risk is the risk that the value of the assets of a friendly society will decline as a result of changes in interest rates, property or share prices.
To ensure that a society maintains appropriate capital in support of the liabilities of each benefit fund, and the society as a whole, each society is to ensure that, at all times, each benefit fund meets the Benefit Fund Solvency Requirement detailed in Prudential Standard 6.2 A.
Interest rate risk arises because financial institutions hold assets and liabilities with different term structures, market liquidity and cash flows. To the extent that investments and liabilities are matched either because both are variable rate instruments or, in the case of fixed rates, because duration is matched, interest rate risk may be minimised. However, a friendly society may want to actively manage market risk. In accordance with sections 67 and 68 of the Friendly Societies Code in conjunction with Prudential Standard 6.1.6, market risk management may include the use of financial derivative instruments and foreign currency.
It is possible that a friendly society will tailor over-the-counter (OTC) derivatives to meet particular portfolio risks. However, the use of these products may present additional liquidity and credit risks.
Basis risk arises where the basis upon which rates change for the security being hedged differs from the derivative and will be especially evident where derivatives are used to hedge portfolio risk. All transactions involving derivatives are to be in compliance with the Risk Management Statement required to be developed by the society in accordance with Prudential Standard 6.1.6.
Another source of market risk is caused by fluctuations in foreign currency exchange rates. Section 68 of the Friendly Societies Code, in conjunction with Prudential Standard 6.1.6, allows friendly societies to invest assets in foreign currency, and to carry out any of their activities in foreign currency.
A friendly society will be expected to demonstrate that adequate systems and procedures are in place to monitor and manage market risk exposures. Such procedures are to:
encompass board approved policies that establish the level of market risk that will be assumed;
set limits and identify clear lines of responsibility for the management of market risk, including any use of derivatives;
define a measurement and control system that monitors and limits market risk, and reports any breaches of those limits to senior management and the board; and
require the regular assessment of the fair value of investments and market risk.
The financial reporting requirements of Prudential Standard 6.3 include the requirement that benefit funds be accounted for at fair value. However, this requirement only applies to traded securities in the management fund. It is expected that in the general case, many of the assets of the management fund will not be readily marketable - these assets include the society’s operating assets. While it is recognised that determining and reporting a fair value for such assets is not necessarily appropriate, this should not be taken to imply that the risk of movements in the fair value of operational assets of the management fund is a risk that the society need not measure, monitor and manage.
(iii) Credit Risk
The other major source of investment risk is the risk of counterparty default, or credit risk. Within the investment policy of a benefit fund, or the operations of the management fund, there may be considerable flexibility. Investments such as traded debt instruments are exposed to adverse changes in the credit standing of the issuer, or failure of a trading counterparty to deliver, which can adversely affect the yield on such an investment if it is not effectively monitored by a society. Similar risks of adverse variation also arise in property or equity investments, and general credit risk associated with any lending activity.
While capital requirements will provide some protection to members, like other aspects of risk management, a friendly society is to detail its investment policies and credit risk management practices. In particular, management is to demonstrate an understanding of the inter- relationships arising from the various credit risks the friendly society is carrying, and their relationship to market and liquidity risk. A friendly society is to be able to demonstrate that adequate systems and procedures are in place to monitor credit risk as it arises for individual benefit funds, and for the friendly society as a whole. Such systems and procedures are to:
encompass board approved policies that establish the level of credit risk that will be assumed and provide for appropriate diversification of the portfolio;
set limits and identify clear lines of responsibility for the management of credit risk;
define a measurement and control system that monitors and limits credit risk, and reports any breaches of those limits to senior management and the board;
require the regular marking of investments to fair value; and
provide for the use of derivatives only with appropriate counterparties in accordance with the Friendly Societies Code and Prudential Standard 6.1.6.
A friendly society is to also demonstrate that satisfactory policies and systems are in place for controlling risks arising from any off-balance sheet financing. A society’s SSA may, on a case- by-case basis, impose a limit on these commitments, or require the friendly society to hold additional capital, or both.
(iv) Transaction and Technology Risk
Transaction risk is the risk that a financial loss is incurred as a result of a transaction not being executed completely and accurately, and may arise from poor internal management or even possibly legal risk. Proper systems and policies, and experienced personnel will minimise this risk. A friendly society is to be able to demonstrate that it has in place satisfactory systems for accurate and timely data capture, and that personnel and systems can cope with transactions whilst ensuring the proper administration and management of benefit fund operations and the society as a whole. In particular, these policies and systems are to maintain and allow for the separation of assets between benefit funds as provided for by section 99(1) of the Friendly Societies Code. Further, where a friendly society conducts treasury operations, effective separation of front and back office operations is to be established.
Technology risk is the risk of technological failure either through inadequate technological support to manage risks, for example, inappropriate software, or, at the more basic level, failure of a computer system. A friendly society is to have systems that safeguard the integrity and security of its data, including disaster recovery plans.
A particular risk to a society’s data exists due to the potential for damage to or misuse of date- related data, caused by the use of computer programs or code that fail to calculate correctly or record dates after a particular date. This is commonly referred to as the "Year 2000 problem” because many computer and other electronic systems cannot deal with dates after 31 December 1999. However, the problem is not confined to the year 2000 and could arise through a range of other critical dates that might be embedded in computer systems. For convenience, AFIC is referring to this matter as the "Year 2000 problem".
To ensure the security and integrity of a society’s data, the Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to using or storing the society’s data, must be corrected. Directors must:
ensure that appropriate tests are carried out to ascertain that any critical computerised systems using or storing the society’s data are not affected by the Year 2000 problem; and
obtain sufficient assurance that the society’s systems and dates will not be significantly affected by inaccurate data or failure of services by its suppliers.
It may not be possible for every internal and external system to be corrected in the short time available before the year 2000, or any other critical date, arrives. Therefore, in anticipation of possible failures, each society must have a comprehensive written statement dealing with the risks and events that may arise due to either the society or an external service provider suffering disruptions that may, in turn, disrupt the society’s normal business operations. These policies and procedures should form part of a society’s Disaster Recovery Plan in respect of managing both transaction and technology risk and operations risk.
(v) Operations Risk
A friendly society is exposed to a range of operations risk in carrying out its day-to-day business. Whether or not these risks are insured or even insurable, a friendly society is to demonstrate an understanding of the risks involved, and its capacity to measure, monitor and control them.
A particular risk to a society’s operations exists due to the Year 2000 problem. Societies are faced with the potential for impairment of normal business operations through the failure of systems dependent on computer microchips, such as communications, security, and fire protection systems.
To ensure the society’s operations risk is minimised, the Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to the society’s normal business operations must be corrected. Directors must ensure that appropriate tests are carried out to ascertain that any critical computerised systems and devices required for the society’s day-to- day operations are not affected by the Year 2000 problem.
A society must keep its insurance contracts under review to ascertain whether it is covered for interruptions to business and possible litigation, due to non-performance or disruption to business, as a result of the Year 2000 problem.
The costs and resource requirements to address the Year 2000 problem may be beyond the scope of some societies. Where directors are of the opinion that the society will be unable to address the Year 2000 problem adequately, with regard to its critical systems, the society should immediately notify its SSA. The SSA, together with the society, will then consider the appropriate action to be taken to ensure that the interests of the society’s members are not adversely affected by the society’s inability to manage Year 2000 problems adequately.
The practices of management are a particular source of potential loss to a friendly society. While there can be no doubt that management has full discretion to carry on the business as it sees fit, a friendly society is to satisfy its SSA that, at all times, there is sufficient management expertise and resources to perform functions satisfactorily. Although the supervisory structure under the FI Scheme does not provide for the licensing of directors or management, a society’s SSA may seek evidence that management of the friendly society can demonstrate, amongst other attributes:
an intimate knowledge of the business of the society;
appropriate systems to ensure adequate financial and internal control over the services offered;
a commitment by the society to offering only products and services which the society has the expertise and experience to offer; and
the on-going commercial viability of operations.
More specifically, where a friendly society conducts funds management activities, its SSA may seek to be satisfied that the friendly society, at all times:
retains the service of personnel with experience in treasury dealing and operations, property investment and management, and equity investment as appropriate;
maintains adequate financial and internal control over investment functions, including the separation of front and back office of treasury operations; and
operates within dealing limits and procedures for exposure management.
The key to the control of management risk lies in a comprehensive management process, including adequate internal controls and disclosures. The board of directors and senior management of each friendly society is to be fully and frequently informed of decisions and practices undertaken throughout the institution.
Similarly, supervision of management risk requires full and frequent disclosure to SSAs. Accordingly, a friendly society is required to notify its SSA immediately of any significant breakdowns in internal controls. Such reporting will complement reviews on systems conducted by external auditors discussed under Prudential Standard 6.3.
Many of the risks to which the society is exposed as part of its day-to-day operations are insurable. An important source of insurable operations risk arises from potential damage to the physical assets of the friendly society through accident or fire. Further, while compulsory worker's compensation may largely cover potential loss through accidents involving staff, there is a similar risk to members of the public that is not automatically insured. Other operations risk exposures arise from the potential for legal action against the friendly society or its directors. Legal actions include allegations such as: discrimination, giving negligent advice, invasion of privacy, breach of consumer legislation, and fraud.
A friendly society is to carry effective insurance with a reputable insurance company to protect its personnel, operations and physical assets. A friendly society is to carry the following insurance policies with cover at an appropriate level:
(i) fidelity guarantee;
(ii) asset protection, including fire and malicious damage;
(iii) directors' and officers' liability;
(iv) public liability;
(v) professional indemnity; and
(vi) business interruption.
A society’s SSA will seek details of insurance policies and information concerning the society's approach to insurance.
Another type of operations risk is documentation risk. As part of the day-to-day operations, societies will be required to produce documentation to be provided to members or external parties. Such documentation may be required by the Friendly Societies Code (for example, in relation to disclosure documents) or by other external legislation (for example, in relation to superannuation, consumer credit and prescribed interests). A friendly society is to have policies and procedures and adequate control systems in place for the preparation, review and appropriate sign-off of such documentation. Sign-off of any documentation should involve the appropriate professional (lawyer, actuary, accountant etc).
(vi) Derivatives and Foreign Currency Risk
Section 67 of the Friendly Societies Code prohibits the use of derivative instruments except as permitted by the Prudential Standards. In essence, a derivative means a financial asset or liability whose value depends on (or is derived from) other assets, liabilities or indexes (the “underlying”). Derivative transactions are financial contracts and include a wide range of instruments such as forwards, futures, options, swaps, exotics and other composites. While most derivatives fit comfortably within this definition, it is possible that future instruments may be developed that should be dealt with as derivatives under this Standard. AFIC may issue Standards in relation to instruments which must be treated as prohibited financial arrangements for the purposes of section 67 of the Friendly Societies Code.
Similarly, under section 68, a friendly society is only permitted to invest any of its assets in foreign currency or carry out any of its activities in foreign currency in accordance with the Prudential Standards. The nature of some friendly society business is such that there may be a need to undertake activities in foreign currency. In addition the use of derivatives may be an important component of management of various risk exposures.
AFIC recognises that it would be inappropriate to restrict the use of derivatives or foreign currency unduly in such cases. However, because of the potential for such activities to cause significant losses, the board and senior management of societies is to take responsibility for determining the extent of derivatives and foreign currency use in the context of the overall investment strategy for each fund, and for putting in place control mechanisms to monitor and ensure compliance with approved policies and systems.
The requirements for life insurance companies in relation to the use of derivatives are set out in the Insurance and Superannuation Commission (ISC) circular C.I.1, “Derivatives”. Given that the businesses of a friendly society for which derivatives could be expected to be used are in many cases similar to those of life offices, AFIC considers that the prudential supervision of friendly societies in relation to derivatives is to be similar to the supervision of life offices. For this reason, Prudential Standard 6.1.6 is based on the ISC’s circular C.I.1. The Prudential Standard augments C.I.1 by encompassing physical positions in foreign currency denominated assets and liabilities.
A society may use derivatives or foreign currency in a number of ways including:
investing directly in derivatives or foreign currency activities (ie using its own staff and systems);
employing an external investment manager to invest directly on the society’s behalf; or
investing in a collective investment scheme which uses derivatives or foreign currency.
The requirements of Prudential Standard 6.1.6 apply, in varying degrees, to a society using derivatives or foreign currency in any of these ways. The ISC’s Superannuation Circular No. II.D.7 “Derivatives” details for each of the three cases the practical differences involved in implementing the principles of a Risk Management Statement (RMS). The Prudential Standard clarifies the requirements for a society using derivatives or foreign currency via an external party in line with the principles set out in ISC Circular II.D.7.
Where a society’s only use of derivatives is in its role as trustee of a superannuation fund, the society need only meet the ISC’s requirements set out in Circular II.D.7 rather than the requirements set out in this Standard.
Derivatives and foreign currency use will be permitted both in benefit funds and the management fund of a society. A society must not use commodity derivatives, that is, instruments where the value is derived from agricultural, metal or other similarly based assets. As with all aspects of investment policies, it is critical that a society’s policy in relation to derivatives and foreign currency be consistent with the rules of the fund and with representations made to members.
The essential requirement for the management of the risks involved in the area is that a comprehensive risk management system is in place with the primary responsibility for risk management resting firmly with the board and senior management of the society. A society using derivatives or foreign currency exposures for any benefit fund, or the management fund, is to have a board approved RMS detailing the risk management practices for their use, and the nature and extent of controls in place to minimise risk. The RMS is to deal specifically with each fund which may use derivatives or hold foreign currency exposures. Although benefit funds may be divided into classes for the purposes of this requirement, it must be possible to identify exactly how the RMS applies to any selected benefit fund. It is not sufficient that a single RMS be developed for the society as a whole.
A properly implemented RMS is an indispensable prerequisite for the effective monitoring and control of derivatives and foreign currency risk. It is therefore to be an integral part of the documented investment strategy, and accompanying policies and systems of the friendly society. As AFIC does not wish to impose prescriptive Prudential Standards for an RMS, a society’s directors are free to determine the appropriate content in accordance with the extent of derivative and foreign currency usage, and in the context of the society’s overall internal control framework. However, Prudential Standard 6.1.6.c sets out some elements which AFIC believes the RMS should incorporate.
Variations in derivative products are enormous. In the development of the RMS for their society, directors should carefully consider the appropriateness of certain types of derivatives. For example, it is likely that the RMS would preclude transactions which create large potential exposures such as in derivatives:
with a leveraged position in the underlying security;
where exposure cannot be reliably measured;
where closing out is difficult considering the illiquidity of the market; or
where the underlying asset is inadmissible in the context of Prudential Standard 6.2.
Consideration is also to be given to the position of exotic securities (and other assets) such as structured notes which may contain embedded derivatives. A society should ensure the purchase of such assets is carefully considered and is consistent with the RMS.
The RMS is to identify the risk tolerances set by the board. Exposure limits are to include quantitative limits on the exposure to any one counterparty, any one type of derivative or foreign currency, as well as on the aggregate exposure to all derivative positions and foreign currencies. If these limits are breached, the board should consider the position immediately and take action appropriate to the circumstances (eg. altering the exposure, or reassessing the suitability of the RMS limits). All breaches of exposure limits and risk management policies and procedures are to be reported to the SSA when they occur.
All types of risks are to be allowed for in the calculation of exposure limits. The limits should take into account the uncertainty of potential exposure inherent in derivatives. AFIC is aware of the present absence of an Accounting Standard dealing with the measurement and valuation of exposures resulting from derivatives market activity. It is therefore important that societies specify, document and disclose the techniques/methodologies used in the valuation process, and use them consistently until an Accounting Standard specific for the purpose is developed and becomes operative.
Derivatives and foreign currency exposure is to be considered in the context of a society’s and fund’s overall investment strategy. In particular, derivative exposure combined with physical exposure should not result in a total exposure which is inconsistent with the society’s investment strategy as adopted and endorsed by the board.
Directors are required to monitor the effectiveness of the RMS and be satisfied with the level of compliance with it. To assist this process, there are to be adequate internal and external audit procedures in place.
Prior to the commencement of the use of derivatives or the undertaking of activities in foreign currency, a society’s SSA is to be satisfied that the society has in place adequate risk management and control systems. A society will be required to demonstrate, through the RMS and associated policies and procedures, that it has a comprehensive understanding of the risks to which it will be exposed, and the controls that are necessary to manage these risks. If the SSA is not satisfied with the society’s ability to prudently manage the risks involved, the SSA is empowered to issue a stop order preventing the society from using derivatives or entering into foreign currency denominated activities.
The SSA is also to assess the adequacy of the RMS when it is changed. Written certification by the society’s external auditor and its appointed actuary on the adequacy of the RMS is required prior to derivatives or foreign currency use by the society; whenever the RMS is altered; and on an annual basis once derivatives or foreign currency denominated activities are in use.
A society which was authorised to use derivatives or engage in foreign currency denominated activities prior to 1 October 1997 has until 1 January 1998 to comply with this Prudential Standard. During this transitional period, the society is to continue to comply with previous requirements of the registrar in their state.
A society will be required to provide its SSA with details of the impact of open positions on derivative and foreign currency on a monthly basis (or more frequently as determined by the SSA).
Risk management
6.1.1 Liquidity Risk
6.1.1.a A friendly society is to have comprehensive written policies and procedures, and adequate control systems in place to measure, monitor and manage liquidity risk. The society’s board of directors is responsible for approving significant policies, and for endorsing changes thereto. In addition the board is, at least annually, to review the effectiveness of the implementation of approved policies and to endorse those policies. Senior management is responsible for the documentation and regular review of policies and procedures, and the implementation and maintenance of an adequate internal control structure. Adequacy of the liquidity risk management system, and its compliance with the society’s written policies and procedures is to be reviewed and reported on annually to the society's SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.1.b A friendly society is to demonstrate a clear understanding of its liabilities, particularly maturity profiles, and is expected to maintain a level of liquid assets appropriate to operations, plus a buffer for unforeseen demands such as higher than expected surrenders.
6.1.1.c Each benefit fund is to maintain at all times 15% of benefit fund assets in liquid assets or readily marketable securities. Where a benefit fund holds a high level of relatively illiquid assets, or assets that may only be liquidated at considerable cost, the society’s SSA may impose higher specific liquidity requirements for that benefit fund. On the other hand, in cases where it is clear that lower levels of liquidity/marketability within the fund are entirely consistent with disclosures to members and the overall risks to the society, the SSA may reduce the 15% requirement for a particular benefit fund on application by the society.
6.1.1.d In addition to having sufficient liquidity within each benefit fund, a society is to ensure that there is adequate liquidity within the society’s management fund. A minimum management fund liquidity requirement is dealt with separately as part of the Management Fund Capital Requirement (MFCR) in Prudential Standard 6.2 B.
6.1.1.e A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s liquidity risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.2 Market Risk
6.1.2.a A friendly society is to have comprehensive written policies and procedures, and adequate control systems in place to measure, monitor and manage market risk. The society’s board of directors is responsible for approving significant policies, and for endorsing changes thereto. In addition the board is, at least annually, to review the effectiveness of the implementation of approved policies and to endorse those policies. Senior management is responsible for the documentation and regular review of policies and procedures, and the implementation and maintenance of an adequate internal control structure. Adequacy of the market risk management system, and its compliance with the society’s written policies and procedures is to be reviewed and reported on annually to the society's SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.2.b For benefit funds, a critical component of any system for the management of market risk will be the means by which compliance with the Benefit Fund Solvency Requirement (BFSR) in Prudential Standard 6.2 A is measured, monitored and managed. A society’s systems and policies are to be such that the position of the fund relative to the BFSR is frequently assessed. Board approved policies covering required management action in the event of the BFSR being threatened are also to be critical components of a society’s system for the management of market risk.
6.1.2.c Where a friendly society uses derivatives to manage interest rate or other risk, or undertakes foreign currency denominated activities, it is potentially exposed to additional risks. The friendly society is to demonstrate that the use of derivatives or foreign currency is in accordance with the Friendly Societies Code and Prudential Standard 6.1.6.
6.1.2.d A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s market risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.3 Credit Risk
6.1.3.a A friendly society is to have comprehensive written policies and procedures, and adequate control systems in place to measure, monitor and manage credit risk. The society’s board of directors is responsible for approving significant policies, and for endorsing changes thereto. In addition the board is, at least annually, to review the effectiveness of the implementation of approved policies and to endorse those policies. Senior management is responsible for the documentation and regular review of policies and procedures, and the implementation and maintenance of an adequate internal control structure. Adequacy of the credit risk management system, and its compliance with the society's written policies and procedures is to be reviewed and reported on annually to the society's SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.3.b A friendly society is to provide its SSA with a written statement of its investment policies. Such policies are to include specific policies regarding the quality of investments, exposure limits and diversification of the portfolio for each benefit fund. A society’s policies are to identify procedures for ensuring that the society’s contractual obligations under benefit fund rules are met, and that the investment strategy is consistent with disclosures and representations made to members.
6.1.3.c A critical component of the policies and systems in respect of credit risk is the monitoring of the investment strategy of each fund relative to the society’s capital requirements, for both the benefit fund and the management fund. In particular, if large exposures or exposures to in-house assets are to be entered into, they are only to be entered into after adequate consideration of the effects of such exposures on the Inadmissible Assets Requirement under Prudential Standard 6.2.
6.1.3.d A friendly society is to demonstrate that it has a satisfactory system for monitoring and controlling off-balance sheet exposures in the form of guarantees, indemnities, options, overdraft or similar facilities provided to third parties or to other entities in the group, whether direct or contingent. For many societies, such a system may well be a board policy that no such off-balance sheet exposures are to be entered into. In any case, off-balance sheet exposures are to be consistent with the requirements of the Friendly Societies Code and these Prudential Standards.
6.1.3.e A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s credit risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.4 Transaction and Technology Risk
6.1.4.a A friendly society is to have comprehensive written policies and procedures, and adequate control systems in place to measure, monitor and manage transaction and technology risk. The society’s board of directors is responsible for approving significant policies, and for endorsing changes thereto. In addition the board is, at least annually, to review the effectiveness of the implementation of approved policies and to endorse those policies. Senior management is responsible for the documentation and regular review of policies and procedures, and the implementation and maintenance of an adequate internal control structure. Adequacy of the transaction and technology risk management system, and its compliance with the society’s written policies and procedures is to be reviewed and reported on annually to the society’s SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.4.b A friendly society is to be able to demonstrate risk management and processing systems that monitor transactions, and exposures from transactions. In addition to experienced personnel, a friendly society is to have the necessary technological support to effect risk management techniques associated with portfolio management of equities, property or treasury management, including any use of derivatives or foreign currency in accordance with Prudential Standard 6.1.6. Before expanding into new areas of financial investments or products, a friendly society is to ensure that proper systems and controls are in place and are supported by appropriate technology.
6.1.4.c A friendly society is to provide for the physical security of its financial transactions and information. Policies and systems are also to identify procedures for off-site backup and other disaster recovery considerations. These systems are to be tested on a regular basis (at least annually).
6.1.4.d A friendly society is to have policies and systems in place to protect the society from fraud or other criminal activity involving technology. Such systems are to be checked by the internal audit function (where relevant) and be reviewed by the society’s external auditors.
6.1.4.e A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s transaction and technology risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.4.f The Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to using or storing the society’s data, must be corrected. Directors must:
ensure that full testing is carried out to ascertain that any critical systems for using or storing the society’s data are not affected by the Year 2000 problem; and
obtain sufficient assurance that the society’s systems and dates will not be significantly affected by inaccurate data or failure of services by its suppliers.
6.1.4.g Each society must have a comprehensive written statement dealing with the risks and events that may arise due to either the society or an external service provider suffering disruptions that may, in turn, disrupt the society’s normal business operations. These policies and procedures should form part of a society’s Disaster Recovery Plan in respect of managing both transaction and technology risk and operations risk.
6.1.5 Operations Risk
6.1.5.a A friendly society is to have comprehensive written policies and procedures, and adequate control systems in place to measure, monitor and manage operations risk. The society’s board of directors is responsible for approving significant policies, and for endorsing changes thereto. In addition the board is, at least annually, to review the effectiveness of the implementation of approved policies and to endorse those policies. Senior management is responsible for the documentation and regular review of policies and procedures, and the implementation and maintenance of an adequate internal control structure. Adequacy of the operations risk management system, and its compliance with the society’s written policies and procedures is to be reviewed and reported on annually to the society’s SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.5.b A friendly society is to satisfy its SSA that, at all times, it retains management expertise and resources appropriate to its activities. An SSA will require evidence that the management of the friendly society can demonstrate, amongst other attributes:
an intimate knowledge of the businesses of the society;
appropriate systems to ensure adequate financial and internal control over the services offered;
a commitment by the society to offering only products and services which the society has the expertise and experience to offer; and
the on-going commercial viability of operations.
6.1.5.c A friendly society is to immediately notify its SSA of any significant breakdown in internal controls that could cause a material departure or omission from the legal, prudential or policy obligations of the society. Such notification is to include the nature of the breakdown, impact on the society’s operations, action taken to rectify the problem, and action to prevent similar breakdown in the future.
6.1.5.d A friendly society is to conduct an annual review of its policy in respect of insurance, including details of individual insurance policies. Guidance for minimum expectations of insurance cover, deductibles and the like may be published by AFIC from time to time. A society is not to rely on published minima but is to evaluate its own risks and obtain appropriate cover. A society’s SSA will review each society’s policy in respect of insurance.
6.1.5.e A friendly society is to carry the following insurance policies with cover at an appropriate level:
(i) fidelity guarantee;
(ii) asset protection, including fire and malicious damage;
(iii) directors’ and officers’ liability;
(iv) public liability;
(v) professional indemnity; and
(vi) business interruption.
6.1.5.f A friendly society is to have policies and systems in respect of documentation risk. Documentation to be provided to members and external parties may be required by the Friendly Societies Code (for example, in relation to disclosure documents) or by other external legislation (for example, in relation to superannuation, consumer credit and prescribed interests). A friendly society is to have policies and procedures and adequate control systems in place for the preparation, review and appropriate sign-off of such documentation. Sign-off of any documentation should involve the appropriate professional (lawyer, actuary, accountant etc).
6.1.5.g A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s operations risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.5.h Directors of a society should ensure that a full review and assessment of the risks associated with the Year 2000 problem is undertaken. Those systems affected that are critical to the society’s normal business operations must be corrected. Directors must ensure that full testing is carried out to ascertain that any critical computerised systems and devices required for the society’s day-to-day operations are not affected by the Year 2000 problem.
6.1.5.i A society must keep its insurance contracts under review to ascertain whether it is covered for interruptions to business and possible litigation, due to non- performance or disruption to business, as a result of the Year 2000 problem.
6.1.5.j Where directors are of the opinion that the society will be unable to address the Year 2000 problem adequately, with regard to its critical systems, the society should immediately notify its SSA.
6.1.6 Derivatives and Foreign Currency Risk
6.1.6.a Section 67 of the Friendly Societies Code sets out the definition of derivative arrangements. In essence, a derivative means a financial asset or liability whose value depends on (or is derived from) other assets, liabilities or indexes (the “underlying”). Derivative transactions are financial contracts and include a wide range of instruments such as forwards, futures, options, swaps, exotics and other composites. A society must not use commodity derivatives, that is, instruments where the value is derived from agricultural, metal or other similarly based assets. Section 68 of the Friendly Societies Code provides that, except as permitted by the Standards, a society is not to invest any of its asset in foreign currency or carry out any of its activities in foreign currency.
6.1.6.b A society using derivatives or holding foreign currency exposures for any benefit fund or the management fund, is to maintain at all times satisfactory risk management practices as evidenced by a board approved Risk Management Statement (RMS). A society is to provide its SSA, on request, with a copy of the RMS. The RMS is to deal specifically with the management fund and each benefit fund which may use derivatives or hold foreign currency exposures. Although benefit funds may be divided into classes for the purposes of this requirement, it must be possible to identify exactly how the RMS applies to any selected benefit fund and the management fund. Adequacy of the derivatives and foreign currency risk management system, and its compliance with the society’s written policies and procedures is to be reviewed and reported on annually to the society's SSA by its external auditor. The operation and implementation of internal control systems may be subject to review during inspections by the SSA.
6.1.6.c The society’s RMS is to include, but is not limited to, the following elements:
be in writing and readily accessible by all people involved in derivative and foreign currency activities;
be reprinted and re-circulated when amended;
identify the objectives of the board of directors in using derivatives or foreign currency;
identify the types of derivative or foreign currency instruments which can be used or any restrictions on the use of certain instruments;
identify the risk tolerances set by the board of directors (in the context of the society’s and benefit fund’s overall investment strategy);
require regular assessment of the impact of derivative and foreign currency use on the BFSR or MFCR;
clearly delineate the lines of authority and responsibility, including trading limits;
ensure all people involved in derivative or foreign currency activities are fully aware of the policies and procedures contained in the RMS;
require that the board of directors approve all significant policies and procedures relating to the management of risks;
require that the board of directors is regularly informed of significant individual exposures and the aggregate exposure (both derivatives in isolation and combined with physical exposure);
make the board’s audit committee responsible for ensuring that:
- authority limits are not exceeded;
- systems and policies are adequate (eg measuring risk, monitoring limits, separation of duties);
- all risk management policies and procedures are reviewed thoroughly at least annually;
- reporting is regular and comprehensive; and
- senior management is notified of breaches in internal control.
ensure that expertise and resource levels, both personnel and systems, are sufficient;
require worst case simulations and sensitivity analysis to be regularly undertaken to provide an indication of how a portfolio will react under certain circumstances, and to monitor the effectiveness of hedging techniques;
provide for compliance with reporting requirements to the SSA;
require all relevant types of risks including credit, market, liquidity, basis, operations, and legal risk, to be analysed and adequately provided for; in particular, counterparty risk (including overseas stock and futures exchanges) is to be analysed and provided for;
require incentives for excessive risk taking to be eliminated; and
contain guidelines to ensure that personnel responsible for control and monitoring procedures are adequately segregated from and independent of personnel conducting derivative or foreign currency activities and have sufficient expertise to perform their tasks.
6.1.6.d Directors are to certify as part of the director’s report required by section 336 of the Friendly Societies Code and, if applicable, the director’s report required under Prudential Standard 6.3.4.d, that they:
have a board approved RMS in place;
understand its contents;
have monitored its effectiveness;
have received regular reports on its operations; and
are satisfied with the level of compliance with the RMS.
6.1.6.e A society is to implement satisfactory internal audit procedures and external audit arrangements to ensure compliance with, and appropriate monitoring of the effectiveness of the RMS. The operation of the RMS in practice is subject to review during on-site inspections by the SSA. Any breach of exposure limits or risk management policies or procedures in relation to the RMS is to be reported to the SSA, as well as the society’s board, when they occur.
6.1.6.f A society which uses financial derivatives or engages in foreign currency denominated activities is to provide its SSA with monthly statements of open positions in derivatives and foreign currency, and the effect of any of these open positions on the BFSR for each benefit fund involved and the MFCR for the management fund. That is, the statement is to show the estimated BFSR/MFCR with the derivatives and foreign currency positions, and how much that would differ if all open positions were closed out for cash. An SSA may require a society to report more frequently than monthly or to provide details on transactions in addition to open positions.
6.1.6.g Before a society starts to use derivatives or engage in foreign currency denominated activities, the society’s external auditor is to provide a written report on the adequacy of the RMS. Once in use, the society’s external auditor is to report as part of the audit report accompanying the annual financial statements on whether the RMS is in place and, in accordance with Prudential Standard 6.3.8.g, whether it has been complied with. Furthermore, when the RMS is changed, the society is to obtain its auditor’s written opinion on the change, and whether or not the change alters any previous conclusions regarding the adequacy of the RMS.
6.1.6.h Before a society starts to use derivatives or engage in foreign currency denominated activities, the society’s appointed actuary is required to report on the adequacy of the RMS and the potential impact of exposure to derivatives or foreign currency. Once in use, the appointed actuary’s financial condition investigation is to include consideration of the RMS, compliance with it and the impact of the exposure to derivatives and foreign currency as part of the overall assessment of assets and liabilities. When the RMS is changed, the society is to obtain its appointed actuary’s written opinion on the change, and whether or not the change alters any previous conclusions regarding the adequacy of the RMS. These requirements apply to derivatives or foreign currency use in both the management fund and benefit funds.
6.1.6.i Before a society starts to use derivatives or engage in foreign currency denominated activities, its SSA is to be satisfied that the RMS and associated risk management systems are adequate. The society is to provide its SSA with the written report from the society’s external auditor and appointed actuary that the society’s RMS is adequate. If a society fails to satisfy its SSA that its practices are adequate to measure, monitor and manage the risks involved, the SSA may issue a stop order preventing the society from entering into any derivative or foreign currency transaction. When the RMS is changed, the society is to provide the SSA with the opinions of the external auditor and appointed actuary and seek the opinion of the SSA on the change, and whether or not the change alters any previous conclusions regarding the adequacy of the RMS and associated risk management systems.
6.1.6.j Where a society is using an external investment manager to invest directly on its behalf (as opposed to a collective investment), the society is to prepare an RMS in conjunction with its external manager. Due to the required content of the RMS, the society should place the onus on the external manager to prepare most elements of the RMS. The society must ensure that its investment strategies and objectives in using derivatives or foreign currency denominated activities, and its reporting requirements, are adequately reflected in the contract with the external manager. Compliance with this contract must be monitored by the society. The society is to implement satisfactory internal and external audit arrangements to ensure compliance with, and appropriate monitoring of the effectiveness of the RMS. Generally, the same requirements apply to the preparation of an RMS as if the society were engaged directly in derivatives use or foreign currency denominated activities, including the role of the auditor and actuary and the reporting requirements.
6.1.6.k Where a society may be exposed to derivatives or foreign currency risk as a result of investing in a third party offered collective investment, it will not be required to prepare an RMS. However, as part of its risk management procedures, the society should satisfy itself that the use of derivatives or foreign currency denominated activities is consistent with the society’s investment strategy and tolerance for risk. To this end, the society may:
obtain a copy of the RMS (if available), or equivalent, in relation to the collective investment and be satisfied with its adequacy;
review and be satisfied with the risk management practices of the external manager, and with the ability of the external manager to comply with the RMS, or equivalent; and
seek regular and comprehensive reporting by the external manager.
6.1.6.l While a society may choose to involve the external auditor and actuary in the review the RMS or the investment management policies and practices in relation to derivatives or foreign currency risk arising from a collective investment, it is not a requirement of this Standard. Similarly, the society is not required to comply with reporting requirements as set out in this Standard.
6.1.6.m A society’s SSA may vary any or all of the reporting and consultation Prudential Standards in particular cases as dictated by the nature of the risks involved. Failure by a friendly society to satisfy its SSA that the society’s derivatives or foreign currency risk management practices are adequate to manage the risks involved may lead to it being required to maintain higher capital or liquidity, or having other limitations placed on its investment activity.
6.1.7 Assumption of Significant New Risk
6.1.7.a A society prior to assuming any significant new risk is to first satisfy its SSA that the risks associated with the change in activities have been assessed; that expertise, policies and systems are in place to measure, monitor and control the risk; that adequate capital is in place; and that the impact on the financial condition of the society and on its members has been considered.
Prudential Standard 6.3C (relating to audit)
Note: see subparagraph (1)(b) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that a friendly society incurs in its operations. Towards this end, to ensure that the auditor appointed by a friendly society is competent, adequately resourced and given sufficient scope to complete the duties imposed by the Friendly Societies Code. Further, to ensure that a friendly society is able to provide such certificates of audit as are required by its SSA as part of its supervisory role.
General Background
Section 332 of the Friendly Societies Code requires directors to ensure that the annual accounts and group accounts of friendly societies are audited. As well as the audit report attached to the published financial statements, a society’s auditor is to provide to the directors and to the society’s SSA a report on compliance with respect to internal controls. The auditor is also required to provide a number of reports on compliance under the Friendly Societies Code and these Prudential Standards.
Section 346(7) of the Friendly Societies Code requires a society’s auditor to report on the adequacy of systems adopted by the society to monitor and manage risks associated with its financial activities; and on any other matter prescribed in a Prudential Standard.
The intention of independent audit reviews is to lend credibility to the financial information presented in the annual report by the friendly society’s directors. In carrying out their supervisory responsibilities, AFIC and the SSAs rely largely on information presented by a friendly society. A properly planned and conducted audit should provide reasonable assurance that the financial statements are true and fair. In addition to the supervisory authorities, members should be able to place greater reliance on financial information where an audit has ascertained that the accounts are free of material misstatement and present a true and fair view of the entity.
Audit Standards
All audit work should be carried out in compliance with Auditing Standards and Auditing Guidance Statements prepared by the Auditing Standards Board of the Australian Accounting Research Foundation and issued by the Australian Accounting Research Foundation on behalf of the Australian Society of Certified Practising Accountants and the Institute of Chartered Accountants in Australia. Particular notice should be taken of the requirements within the Auditing Standards for proper planning and completion of audit techniques which take account of the nature and risks of a friendly society. Directors of a friendly society should be satisfied that its external auditor has sufficient understanding of the industry so as to enable the auditor adequately to plan the audit and assess audit risks.
The operations of a friendly society involve a large number of transactions. The audit approach, therefore, is to emphasise the importance of transaction testing. Adequate transaction testing is regarded as critical if audits are to satisfy the requirements of the Friendly Societies Code.
The audit approach is to set out how evidence will be gathered. Since that evidence is the basis of audit opinion, sufficient audit evidence is to be obtained to enable an opinion to be properly formed.
The responsibility for appointing an appropriately qualified auditor lies with the friendly society. A friendly society can expect that its SSA will communicate with its auditors annually or more frequently if it is deemed necessary. The purpose of this contact will be to establish the efficacy of audit techniques.
Audit
6.3.8 Audit Standards
6.3.8.g Pursuant to section 346(7) of the Friendly Societies Code, an external auditor of a society which has 1 or more benefit funds is to provide the society’s SSA, annual reports on the compliance and adequacy of the following risk management systems and internal controls:
liquidity risk management systems - Prudential Standard 6.1.1.a;
market risk management systems - Prudential Standard 6.1.2.a;
credit risk management systems - Prudential Standard 6.1.3.a;
transaction and technology risk management systems - Prudential Standard 6.1.4.a;
operations risk management systems - Prudential Standard 6.1.5.a;
derivatives and foreign currency risk management systems - Prudential Standard 6.1.6.b; and
internal controls within the above risk management systems.
Prudential Standard 6.4A (relating to subsidiaries)
Note: see subparagraph (1)(c) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that friendly societies incur in their operations. Towards this end, to ensure that a society is not exposed to undue risk as a result of the activities of subsidiaries.
General Background
A society may choose to establish and operate a subsidiary for a variety of reasons including as a means of diversifying activities and to provide products and services that meet the demands of members and other markets. While all financial intermediation should be conducted through the holding society, there are some non-intermediation financial activities that may be better conducted through subsidiaries. An example is the provision of non- benefit fund managed fund products[1].
The prudential concern is that the operations of subsidiaries are a potential source of risk to financial institutions and, where managed improperly, have contributed to their failure both in Australia and overseas.
Section 63 of the Friendly Societies Code requires a society to obtain approval from its SSA before holding a subsidiary. This is consistent with the requirement for a society to consult with its SSA before engaging in new activities. It is not the intention of either AFIC or the SSAs to prohibit the establishment or acquisition of subsidiaries. However, each society must give careful consideration to the potential risks that may arise from the operations of subsidiaries and be able to satisfy its SSA that policies and systems for reporting and control are adequate. Further, subsidiaries should not be overly large in comparison to the parent society, nor should there be a proliferation of subsidiaries. SSAs will be concerned with transactions between a society and its subsidiaries including, loans and extension of credit, purchase of assets, and the provision of guarantees and letters of credits. At the least, all transactions are subject to associated standards including capital requirements.
Prudential supervisors have similar concerns where a society invests in an associate[2].
The SSA will review each society, its subsidiaries and associates on a case-by-case basis to make an overall risk assessment of the society. The SSA may require additional internal controls, reporting or possibly capital, if there is undue risk arising from a lack of legal, economic or moral separation of the society from subsidiary operations.
Existing investments in a subsidiary or associate will be subject to a case-by-case review by the SSA to ensure compliance with the provisions of this Prudential Standard.
Subsidiaries
6.4.1 Operation of a Subsidiary
6.4.1.a In accordance with section 63 of the Friendly Societies Code, a society must obtain the approval of its SSA before establishing or acquiring a subsidiary.
6.4.1.b A society should also consult with its SSA before entering into a firm commitment in an associate as follows:
in the case of institutions in the field of finance, where the investment would create an interest in excess of 10%; or
in the case of non-financial businesses, where the investments in aggregate will exceed 5% of Tier 1 capital or an individual investment exceeds 0.25% of Tier 1 capital for the management fund; or 20% of benefit fund assets in terms of an aggregate investment and 5% of benefit fund assets in terms of an individual investment for a benefit fund.
6.4.1.c A society must satisfy its SSA that there are in place adequate systems, policies and procedures to manage, monitor and control any residual risk to the society arising from the subsidiary’s or associate’s activities. The SSA may also seek evidence that the subsidiary or associate has sound and prudent management aimed at achieving viability within the capital resources of the subsidiary or associate.
6.4.1.d A society must ensure that the operations of a subsidiary or associate are separated sufficiently, so that the society will not be obliged, morally or commercially, to support subsidiary’s/associate’s on-going operations. In particular, a society should not give a general guarantee of the obligations of a subsidiary or associate. Other dealings with associates should be on the normal terms and conditions that would apply to unrelated entities. The society must also ensure that a subsidiary or associate does not give any impression that the society’s resources stand behind, or could be called to stand behind, its operations.
6.4.1.e While a general guarantee is not appropriate, a society may choose to provide a specific guarantee. A society must consult with its SSA before providing a guarantee[3] of, or on behalf of, a subsidiary or associate. Where provided, guarantees are subject to Prudential Standard 6.4 C.
6.4.1.f A society must ensure that subsidiaries comply with any directions made by its SSA. The SSA must advise both the friendly society and its subsidiary of any directions.
Prudential Standard 6.4C (relating to guarantees)
Note: see subparagraph (1)(d) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that a friendly society incurs in its operations. Towards this end, to ensure that a friendly society is not exposed to undue risk as a result of guarantees made by or on behalf of the friendly society.
General Background
The provision of guarantees, sureties, indemnities and similar off-balance sheet facilities by a friendly society can generate additional income from a given asset base without the introduction of direct liabilities. A friendly society may also be obliged to provide guarantees or indemnities to access financial services for use by itself or its members. This off-balance sheet activity introduces contingent rather than direct liabilities that can nevertheless create risks for a friendly society. The dangers are particularly acute if guarantees are extended without full analysis of the potential risks.
For the purposes of the Prudential Standards, guarantees, indemnities or similar commitments, provided by a friendly society on its own behalf to access services, will not generally be treated as direct credit substitutes. Guarantees provided to members of a benefit fund, a subsidiary or other venture associated with the friendly society, or given on behalf of members, are to be treated as direct credit substitutes.
Where a friendly society provides guarantees or other off-balance sheet facilities, it is, as part of its risk management strategy, to maintain policies with respect to the provision of such facilities, and is to be able to demonstrate appropriate systems to identify and manage the individual and aggregate risks involved. Further, off-balance sheet facilities that are direct credit substitutes are subject to Prudential Standard 6.2.
The introduction of this Prudential Standard may see a society in breach of some of its requirements. For example, a guarantee may be in place that is a direct credit substitute but not for a limited amount. Where this is the case a society is to contact its SSA to agree a strategy and timetable for achieving compliance.
Guarantees
6.4.3 Granting of Guarantees by a Society
6.4.3.a Each friendly society is to have comprehensive written policies and procedures with respect to providing guarantees, indemnities or other off-balance sheet facilities; and is to satisfy its SSA that it has adequate systems and procedures for managing the risks involved.
6.4.3.b A society that issues an indemnity, guarantee or similar contingent liability is to ensure that the party relying on the facility is clearly aware of the specific fund or funds that back the obligation.
6.4.3.c AFIC may deem that certain types or classes of guarantees or other sureties are direct credit substitutes.
6.4.3.d A guarantee or other surety provided on behalf of a member is a direct credit substitute. Indemnities provided by a friendly society on its own behalf will not normally create direct credit substitutes.
6.4.3.e A guarantee that is a direct credit substitute:
is to be for a limited amount; and
will be treated as a loan for the purpose of the capital requirements in Prudential Standard 6.2.
An SSA may increase a friendly society's (or a specific fund’s) capital requirement if, in the opinion of the SSA, the guarantee, or guarantees in aggregate, add significantly to the overall risk of the friendly society (or the specific fund).
6.4.3.f Where a friendly society provides a guarantee to a subsidiary or associate which substitutes for capital that would otherwise be required (eg under SIS legislation), then the maximum exposure under the guarantee will be treated as an Inadmissible Asset under Prudential Standard 6.2. Other guarantees provided to a subsidiary or associate will be treated as a direct credit substitute under 6.4.3.e. A society is to obtain approval from its SSA before providing a guarantee of, or on behalf of, a subsidiary or associate.
6.4.3.g The provision of a guarantee from the management fund of a friendly society to a benefit fund or its members is of significant prudential concern. A society should discuss the capital implications of any existing guarantees with its SSA. A society is to obtain approval from its SSA before providing such a guarantee.
6.4.3.h The provision of guarantees and indemnities may create contingent liabilities which are to be disclosed in the friendly society’s financial statements to APRA in accordance with the applicable Australia Accounting Standards (as those standards applied in relation to reporting periods that began immediately before 1 January 2005).
Prudential Standard 6.4D (relating to service contracts)
Note: see subparagraph (1)(e) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that a friendly society incurs in its operations. Towards this end, to ensure that a society is not exposed to undue risk or unfair practices with respect to service contracts.
General Background
Under section 297 of the Friendly Societies Code, a society is to obtain prior written approval from its SSA before entering into a management contract. Management contracts are defined as arrangements whereby a third party performs the whole, or a substantial part, of the functions of the society; or the society agrees to perform the whole, or a substantial part, of its functions in a particular way, in accordance with the directions of any person, or subject to specified restrictions or conditions. The key feature of a management contract is the abrogation of total or substantial management control to a person or entity external to the society. Examples include situations where the day-to-day operation of the society is managed through entities controlled by directors or independent third parties.
Service contracts are other arrangements entered by a society to obtain services or products without the abrogation of management control. Each society is likely to enter a variety of such contractual arrangements for valid economic and efficiency reasons, especially where the society neither has, nor seeks, the expertise. While service contracts will cover a range of relationships with external parties, supervisors are concerned with those contracts that create additional risks, create conflicts of interest or require disclosure to members and shareholders.
A conflict of interest may arise where a society enters arrangements with a director or officer (or their associates) for the provision of services. AFIC recognises that some societies may face difficulty appointing suitably qualified directors who are not otherwise associated with the provision of services to the society in the normal conduct of business. AFIC does not intend to outlaw such arrangements but seeks to ensure arm's length dealings.
Financial and operating leases entered into in the ordinary course of business on an arm's length basis are not service contracts for the purposes of this Prudential Standard.
Service Contracts
6.4.4 Review of Service Contracts
6.4.4.a A friendly society is to demonstrate systems for selection, regular review and renewal of service arrangements that ensure arm's length dealings.
6.4.4.b A society is not to enter service contracts that:
diminish control of the society by the board;
diminish the SSA's ability to review and supervise the society; or
are contrary to the Friendly Societies Code.
6.4.4.c Before entering into a service contract a society is to consider the risks arising from the proposed arrangement. This includes an assessment of the impact of the contract on its operational and control environment, as well as the commercial risks that may arise from entering into the contract.
6.4.4.d Where a society enters into a contract (not being a management contract) that permits an external party to make decisions in its name, or on its behalf, then the society is to ensure there are adequate systems and controls in place to review the decisions made and ensure they are in accordance with its board approved policies and procedures.
6.4.4.e Where the society’s SSA has concerns with the ability of a society to comply with this Prudential Standard, it may require the society to consult with it before entering into some or all future service contracts.
6.4.4.f A society is to advise its SSA of any service contract under which payments in a current or future year are likely to exceed 5% of total operating expenses. It is to consult with its SSA in advance before entering into a service contract where the payments in a current or future year are likely to exceed 10% of total operating expenses. In this consultation process the society will need to demonstrate that the proposed contract will not expose it to excessive risk.
6.4.4.g A society is to retain a register of service contracts. At a minimum, this should include details of the parties to the contract, date of commencement, termination date, review date, fee structure, a brief description of the purpose of the contract, and a reference to the location of the detailed documentation.
Prudential Standard 6.4E (relating to overseas trading)
Note: see subparagraph (1)(f) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that a friendly society incurs in its operations. Towards this end, to ensure that a society is not exposed to undue risk as a result of undertaking operations overseas.
General Background
International supervisors acknowledge that major problems may develop when a financial institution engages in operations in a foreign country. In particular it can be difficult for a financial institution to effectively manage and oversee the foreign operations due both to physical factors such as the remoteness from head office, different time zones (which can affect the compilation of reports showing a society’s position) and cultural factors, such as differences in market practices, legal and regulatory environments.
The establishment of an overseas operation may also potentially affect the local operation if it results in a diversion of management time and effort, or of resources such as technology, accounting, audit and other controls.
SSA’s will seek to ensure that the development of overseas operations is done at a measured pace, and in a way which will not stretch a society’s capacity to continue to operate prudently in Australia.
Before a society can establish overseas operations it will need to obtain approval of its SSA. As well as needing to be satisfied that the society can address operational risks, an SSA will seek to ensure that the overseas operations are suitably quarantined from the society’s domestic operations.
Where overseas operations are to be conducted through a subsidiary, this will generally be achieved by meeting the requirements of Prudential Standard 6.4A. If an overseas establishment is to essentially act as a branch of the society then this would generally, at a minimum, require the establishment of a separate benefit fund.
In either case an SSA will seek to obtain an undertaking from the society that it will provide (subject to any limits imposed by overseas legislative restrictions) whatever information the SSA deems necessary to enable it to monitor the overseas operations, and that it will not object to the SSA conducting on-site examinations or other visits to the overseas operation.
The development of overseas operations can also lead to issues about the sharing of supervisory responsibility between the country of origin of the society and the host country for the overseas operation. The level and intensity of supervision in the host country will be a relevant factor in determining the extent to which an SSA will need to monitor or even examine an overseas operation. A society will be required to give an undertaking that will enable its SSA and/or AFIC to provide information concerning the society to an overseas supervisor or regulator as required.
Where a society has existing overseas operations, it will be subject to a case-by-case review by the SSA to ensure compliance with the provisions of this Prudential Standard. Within a timeframe agreed by the SSA, the society is to provide the undertakings required by Prudential Standards 6.4.5.c, 6.4.5.d and 6.4.5.f; to provide the information required by Prudential Standard 6.4.5.e; and to satisfy the SSA of the matters set out in Prudential Standard 6.4.5.a.
Overseas trading
6.4.5 Approval to Operate Overseas
6.4.5.a A society is to obtain approval from its SSA before it seeks to operate overseas. It is to demonstrate to the satisfaction of its SSA that:
it has adequate management and operational resources as well as control mechanisms to enable it to establish the overseas operation without any adverse impact on the domestic operations;
(ii) the overseas operation will have adequate policies, systems and procedures in place to manage and control the risks arising from its activities;
there are adequate reporting systems to enable the main office to monitor the overseas operation and its risk exposures;
(iv) the overseas operation will be sufficiently distanced from the society’s domestic operation, that any adverse developments in the overseas operations (eg losses) should not materially affect the society’s domestic operations; and
(v) it will be readily able to provide information that the SSA may require to monitor the overseas activity. The society is to identify any legislative or other restrictions which will affect the ability of the overseas operation to provide data to the SSA.
6.4.5.b Where a society establishes an overseas subsidiary, it will be required to meet all the requirements of Prudential Standard 6.4 A. If it establishes a branch or similar operation, unless specifically exempted by its SSA following consultation with AFIC, it will be required to maintain separate benefit funds for its domestic and overseas operations.
6.4.5.c A society establishing an overseas operation is to provide an undertaking to its SSA to provide (subject to legislative constraints) any information that the SSA may require from time-to-time to enable it to monitor the overseas operation. It is also to undertake to permit the SSA to conduct on-site examinations as well as any other form of visit to the overseas operation.
6.4.5.d A society will be required to undertake that, to the maximum extent possible under the law, it will seek to ensure that an overseas operation will comply with any directions made by an SSA.
6.4.5.e The information required by the society’s SSA on an overseas operation will depend, in part, on the extent of supervision that the overseas entity is subject to. A society that wants to establish an operation overseas should provide to its SSA details on the legal framework under which it will operate, as well as the prudential supervision or regulatory arrangements (if any) it will be subject to.
6.4.5.f An SSA and/or AFIC may seek to establish a Memorandum of Understanding (MOU) with an overseas supervisor or regulator under which there is an exchange of supervisory information to facilitate the supervision of the overseas operation. A society is to undertake to allow its SSA and/or AFIC to discuss its conduct, status and any other relevant issue with a supervisor or regulator of the overseas operation (whether pursuant to an MOU or not).
Prudential Standard 6.7 (relating to non-benefit fund based funds management and associated market activities)
Note: see subparagraph (1)(g) of regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
Objective
To protect and promote the financial integrity and efficiency of the state-based financial institutions scheme and to ensure that members of friendly society benefit funds are adequately protected from the risks that a friendly society incurs in its operations. Towards this end, to ensure that a society is not exposed to undue risk (particularly moral risk) as a result of involvement in non-benefit fund based funds management and associated marketing activities.
General Background
The conduct of funds management activities generally refers to the marketing, investment and/or administration of a pool of funds on behalf of third parties – retail or wholesale. These activities may range from advisory and sale through investing the funds to trustee or custodial services.
Traditionally, friendly societies have undertaken funds management activity through the benefit fund structure. With changes to regulation and taxation as well as changing market demand, some friendly societies may choose to diversify and seek to offer a range of related financial services beyond benefits offered through the benefit fund structure. This is already in evidence by the offer of superannuation, unit trusts and trustee services by some societies.
The general concern for prudential supervisors is that the risks that arise from involvement in these other funds management and marketing activities may prejudice the interests of members of benefit funds and the friendly society more generally. Of particular concern is moral risk, that is, the possibility that a friendly society will have a moral or commercial obligation to absorb losses arising from these activities to the cost of benefit fund members.
The Friendly Societies Code limits the direct participation by friendly societies in funds management activities. Under section 96, a society must not pay benefits resulting from the contribution of funds unless the activity is carried out through a benefit fund. Further, under section 66, a society must not act as a trustee or representative for the purposes of an approved deed under the prescribed interest provisions of the Corporations Law. A society may, however, act as a trustee or custodian for a superannuation entity within the meaning of the Superannuation Industry (Supervision) Act 1993 (SIS Act). Both the Friendly Societies Code and the Standards provide for a friendly society, subject to SSA approval, to establish a subsidiary to act as manager, trustee, custodian, responsible entity or undertake a similar role for a funds management vehicle[4] or other scheme.
The general approach applied under these Prudential Standards is that there is adequate separation and disclosure.
The balancing objectives are to allow flexibility for a society to develop and market services, while at the same time minimise the likelihood of recourse to the society, with losses borne by members if there is a problem in the funds management area. It is acknowledged that absolute separation of funds management activities from the remainder of the society is difficult given nature of product branding, ownership of the funds management vehicles and sales environment.
Some activities that would be classified as non-benefit fund based funds management or associated marketing activities may also be subject to other regulatory regimes, for example, superannuation activities governed by the SIS Act under the Insurance and Superannuation Commission and prescribed interests or offering of investment advice governed by the Corporations Law under the Australian Securities Commission. Generally, the requirements of this Standard will apply along side this other regulation.
Given legislative restrictions on a friendly society’s direct involvement in funds management activities, the Prudential Standards refer to the society, its subsidiary or associates as applicable. If a society or its subsidiary fails to meet these requirements, the SSA may, among other things, direct the society to rectify any shortcomings; direct the society to suspend these activities; or impose higher capital requirements.
The key activities covered by the Prudential Standard include:
PS 6.7.1 - dealing with matters to satisfy the separation of activities from the society and benefit funds.
PS 6.7.2 - disclosure requirements for funds management activities aimed at retail investors.
PS 6.7.3 - covering wholesale funds management on behalf of other funds management vehicles.
PS 6.7.4 – deals with the offering of investment advice and broking of securities.
PS 6.7.5 – provides for badging or co-branding where a society’s name, logo or trademark may be used to market products of third party institutions.
PS 6.7.6 – addresses dealing in securities issued by an associated funds management scheme.
While covering a society’s involvement in the major funds management activities, where a friendly society intends to undertake activities not covered by this Prudential Standard, the SSA should be consulted before firm commitments are made. The society should be prepared to demonstrate that any proposal is consistent with the provisions of the Friendly Societies Code and the principles of separation and disclosure contained in this Prudential Standard.
The prime responsibility for the prudent participation of a society or its subsidiaries in funds management activities rests with its board and management. A society must have in place clear strategies and board approved policies governing the participation in the activity. In addition, the society must maintain appropriate systems to identify, measure and control risks including potential conflicts of interests that arise from participation in funds management activities.
In this Prudential Standard, a reference to funds management does not include activities carried out through a benefit fund structure. Where a society is involved in non-benefit fund based funds management or associated marketing activities, it should review all activities against this Prudential Standard. Where a society is in doubt that some or all of these requirements are met, it should contact its SSA to agree a strategy and timetable for achieving compliance.
Non-Benefit Fund based Funds Management and Marketing Activities
6.7.1 Structuring Funds Management Schemes
6.7.1.a The policy principle governing funds management is that there is clear separation between the society and any involvement in funds management activities conducted outside the benefit fund structure. With the exception of being an approved trustee or custodian for the purposes of the SIS Act, a society itself must not act as a manager, trustee, custodian, responsible entity or similar role. Subject to SSA approval, any involvement in such activities must be through a subsidiary. Unless otherwise approved by the SSA, the society must not provide credit support, liquidity support, other lending, treasury or transaction facilities, or other financial facilities to a funds management vehicle, or underwrite the issue of units or securities in such a vehicle.
6.7.1.b An SSA may review a society’s other involvement in funds management and associated marketing activities and determine whether the structure satisfies the principles of separation and disclosure. The SSA may, on a case-by-case basis, impose additional requirements on a society as a result of the risk arising from the funds management activities.
6.7.2 Disclosure
6.7.2.a These disclosure requirements do not apply where a subsidiary of a society acts as a wholesale investment manager on behalf of other funds management vehicles in accordance with Prudential Standard 6.7.3.a.
6.7.2.b To safeguard against investor confusion, disclosure associated with non-benefit fund based funds management activity must ensure that investors are:
(i) given to understand clearly that their investment does not represent investments with the society or any of its subsidiaries (except as disclosed as an authorised investment); and
(ii) made aware of risks associated with the investment, including any risk of delay in repayment and loss of income and principal invested; and
(iii) unambiguously informed that neither the society nor its subsidiaries in any way stand behind the capital value or performance of the investment or of the assets held by the vehicle except to the extent permitted under this Prudential Standard and as specified in the disclosure documentation provided to investors.
6.7.2.c The disclosures in 6.7.2.b must be provided in a conspicuous manner to prospective investors and must appear in any marketing document[5]. A document inviting investment[6] must include the disclosures as a prominent (and preferably stand alone) item on the inside front cover. It is recognised that variations in the location and form of the required disclosures could be appropriate where regulatory or statutory requirements restrict the presentation or content of disclosures. Any proposal to modify the requirements set out above must be agreed with the society’s SSA.
6.7.2.d Investors must also provide a signed acknowledgment indicating that they have read and understood the required disclosures. To this end, the disclosures in 6.7.2.b should also appear in close proximity to the signature on the application form in any document inviting investment.
6.7.2.e More generally, a society must ensure that the marketing or promotion of a vehicle or scheme with which it is associated does not give any impression that could be construed as being contrary to the disclosure requirements of this Prudential Standard.
6.7.2.f It is possible that securities could be purchased in a paperless environment, for example, the Internet. Where this is envisaged, a society must discuss with its SSA procedures for ensuring that the spirit of the objectives of the disclosure requirements are met.
6.7.2.g Where a society has a limited involvement in a funds management scheme, its ability to ensure the required level of disclosure (and obtain signed acknowledgments) may also be limited. In such cases, compliance with the disclosure requirements may be relaxed by its SSA. This concession will not be available where the society, its subsidiary or associate permits the use of its name, badge, logo or any other identifier in the marketing of the funds management scheme.
6.7.3 Managing
6.7.3.a Where a subsidiary of a society acts as investment manager on behalf of other funds management vehicles, either related or external parties, as part of its risk management systems and controls, the society must ensure that:
(i) there is a written management agreement in place specifying the functions which the subsidiary as investment manager is required to perform and any performance standards. Such standards are to be reasonable and in accordance with normal market practice. The management agreement must make clear that:
the investment does not represent investments with the society or any of its other subsidiaries; and
the society or any subsidiary does not in any way stand behind the capital value or performance of the investment or of the assets held by the vehicle; and
the society or any subsidiary is under no obligation to buy back securities or units issued by the vehicle.
(ii) the management agreement is undertaken on an arms length basis and is subject to the society’s normal approval and review processes. The agreement must be undertaken on market terms and conditions (including remuneration to the manager).
(iii) the agreement is limited as to a specified time period. A fixed termination date need not be specified where the subsidiary as manager can, at its absolute discretion, withdraw from its commitments at any time with a reasonable period of notice.
(iv) subject to reasonable qualifying conditions, the external funds management vehicle and/or investors have the clear right to select an alternative party to provide the management services.
6.7.3.b The subsidiary may receive a performance related payment (or may benefit from any surplus income generated) for its role as manager, in addition to its base fee, provided that the base fee is based on market terms and conditions and any performance related payment does not commit either the subsidiary or society to any additional obligations. Such payment should be recognised for profit and loss (and capital) purposes only when it has been received.
6.7.4 Offering Investment Advice and Sale of Securities
6.7.4.a In its general operations, a society or a subsidiary may, subject to compliance with the Friendly Societies Code, approval from its SSA and any other appropriate regulatory approvals, offer advice to customers regarding investments (including funds management schemes and other products such as life and general insurance policies), act as a broker in obtaining securities (and other products) on behalf of customers, or market such products directly to customers.
6.7.4.b In conducting such business, there is a risk that investors may be confused as to the relationship between a society and the issuer of a security (or other product) with the possibility that the society creates some moral or commercial obligation to investors.
6.7.4.c To minimise associated risks, such activities:
(i) must be conducted with investors on an arm’s length basis and on market terms and conditions.
(ii) must provide for the customer alone to make any decision to invest in particular securities (or acquire other products) and that the customer is aware she/he alone bears the risks associated with the investment decision. There may, nevertheless, be an obligation on a society or its funds management vehicle to ensure that customers are aware of the level and type of risks associated with particular investments.
(iii) should be supported by policies and procedures to ensure that staff and agents dealing with customers are appropriately trained, and avoid misleading or confusing customers concerning the risks involved, or the society’s relationship with, or support for, investments recommended or offered for sale by the society.
(iv) Where a society or its funds management vehicle makes investment decisions or purchases securities for customers on its own initiative or discretion, then it will be deemed to be acting as a manager of the funds and the relevant provisions of this Prudential Standard will apply.
6.7.5 Badging
6.7.5.a Where a society or its subsidiary allows its name, logo or trademark to be used in marketing products of third party institutions, additional risks may arise. Under these circumstances,
the “name” or “badge“ of the party providing the product must also feature prominently in all advertising material, marketing documents and any documents inviting investment or participation in a product.
the respective roles of the parties must be explained clearly and prominently in any document inviting investment or participation in the product - including the extent to which each party is responsible for the safety and performance of the product.
the disclosure provisions of this Prudential Standard must be satisfied fully.
If these conditions are not met, the SSA may direct the association with the relevant product to be discontinued.
6.7.6 Purchase of Securities
6.7.6.a Where an entity within the friendly society group participates in a securitisation scheme, or other funds management scheme involving the issue of securities, there are no additional restrictions placed on the purchase of securities by other entities within the group. However, should an SSA come to the view that the pattern of a society’s or its subsidiaries’ purchases suggests that the society is supporting investments in a scheme, then the SSA may require additional capital to be held.
Notes to the Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999)
Note 1
Note: The Prudential standards for friendly societies (as in force under section 28 of AFIC Code immediately before 1 July 1999) (in force under regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999 and section 230A of the Life Insurance Act 1995) as shown in this compilation is amended as indicated in the Tables below.
Note: > Note: Table of Instruments
Year andNumber
Date of notificationin Gazette or FRLI registration
Date ofcommencement
Application, saving ortransitional provisions
Prudential standards for friendly societies (as in force under section 28 of the AFIC Code immediately before 1 July 1999) (F2008B00122)
(a)
1 July 1999
No. 1 of 2004(F2008B00457)
22 Dec 2004 (see Gazette 2004, No. GN51))
1 Jan 2005
—
No. 2 of 2006
10 May 2006 (see F2006L01459)
1 Oct 2006
—
Note: (a) This instrument is a collection of Prudential Standards for friendly societies (as in force under section 28 of the AFIC Code immediately before 1 July 1999) that became prudential standards for friendly societies administered by APRA under regulation 33 of the Financial Sector Reform (Amendments and Transitional Provisions) Regulations 1999.
[1] See Prudential Note 6.7 - Non-Benefit Fund Based Funds Management and Associated Marketing Activities.
[2] For the purposes of this Standard, ‘associate’ has the meaning in Accounting Standard AASB 1016 (as it applied in relation to reporting periods that began immediately before 1 January 2005).
[3] For the purposes of this standard, guarantee includes an indemnity, surety, warranty or similar contingent liability that supports an obligation of a subsidiary or associate.
[4] A “funds management vehicle” is an entity which holds assets, issues securities to and receives funds from investors to facilitate the management of investors’ funds. For the purposes of this Standard, a reference to a funds management vehicle is a non-benefit fund based funds management vehicle or scheme operated by a society through a subsidiary, trust or other structure.
[5] A marketing document is any leaflet, brochure etc which provides information to potential investors about the vehicle or securities issued by it. Advertising material associated with newspapers and television will not, unless specifically requested by an SSA, be required to detail the disclosures specified in Paragraph 6.7.2.b.
[6]. This includes a prospectus and any other document inviting the investment of funds.