SPG 114 Operational Risk Financial Requirement

Operational risk incidents expose members to the risk of financial loss and disruption that may also deprive them of a financial gain. For the purposes of this guidance, a reference to members may include both current and former members.

The primary purpose of the ORFR financial resources is to provide an unrestricted commitment of financial resources to address losses, and potential losses, arising from operational risks in a timely manner.

The ORFR is intended to ensure RSE licensees will have sufficient available financial resources to:

spread the cost of operational risk incidents fairly over time and across different cohorts of members; and

maintain critical operations within tolerance for severe disruption where this exposes members to a material risk of loss.

APRA expects a soundly run RSE licensee, that has implemented an effective risk management framework, to have an ORFR target amount no less than specified in the table below:

Where an RSE invests in a Pooled Superannuation Trust (PST) within the same RSE licensee’s business operations, or another entity outside of the RSE licensee’s business operations which is subject to SPS 114 or another financial requirement relating to operational risk (other entity), APRA expects that the ORFR target amount would be at least 0.10% of FUM of the PST or the other entity.

An RSE licensee of a newly registered RSE or an RSE with very low FUM (e.g. an RSE in the process of winding down or transferring some or all beneficiaries and assets to another fund) is expected to determine an appropriate target amount, above the guidance on minimum target amount.

APRA expects it will be difficult for an RSE licensee to be able to demonstrate that it can confidently rely upon a material service provider to directly address the cost of all operational risk incidents related to that service. In such circumstances, a prudent RSE licensee would also consider matters such as the coverage of the service provider agreement and the financial capability of the service provider in varying scenarios.[2] 

An RSE licensee may attribute its ORFR target amount, and the ORFR financial resources, to different parts of its business operations, to enable it to meet the requirements in a way that reflects its operating model. This may be necessary to provide clarity on monies held for different RSEs, sub-funds, critical operations and components that are required to be covered. Attribution may facilitate efficient and equitable funding, management, usage and replenishment of the total ORFR target amount over time and across different cohorts of members.

APRA expects that an RSE licensee of a hybrid fund would have particular regard to member equity in relation to its method to fund the ORFR target amount (and use of these financial resources) across accumulation and defined benefit member divisions.[3]

APRA expects that an RSE licensee’s tolerance limit below its target amount of financial resources would be appropriate and readily measurable.

The tolerance limit is intended to enable an RSE licensee to utilise the ORFR for less significant amounts and to manage immaterial fluctuations below the ORFR target amount without the need for a replenishment plan. APRA envisages that the circumstances leading to immaterial fluctuations could include a small payment or payments out of the financial resources held to meet the ORFR target amount, or an insignificant underperformance of the ORFR financial resources amount against an RSE licensee’s investment objectives for the financial resources.[4] 

APRA expects an RSE licensee would document the specific types of circumstances where it would use ORFR financial resources under its ORFR strategy. APRA considers that it would be appropriate to use ORFR financial resources in, but not limited to, the following circumstances:

remediation activities to address losses sustained or deprived gains because of an operational risk incident;

remediation activities, including addressing an identified vulnerability or weakness that presents a material risk that may impact the maintenance of critical operations, addressing the root cause of an operational risk event;

costs associated with the prevention of losses and disruption from operational risk incidents in response to an identified material operational weakness. For example, where the RSE licensee has determined that, if not addressed, there is a material risk of an operational risk event occurring that could cause members to sustain a loss or be deprived of a gain to which they otherwise might have been entitled; and

executing, or supporting the execution of, a business continuity plan, or a recovery and exit plan, or the orderly exit from a service provider agreement which is in response to an operational risk incident.

APRA considers that it would generally not be appropriate to use ORFR financial resources for expenses including, but not limited to:

routine and business as usual costs, such as funding the development, maintenance and enhancement of the operational risk management framework, or investing in new systems, processes and technology where this is not in response to, or to prevent, an operational risk incident (or near miss) or an identified material weakness;

paying a premium for an insurance policy that may provide cover for certain operational risks, payment of any levies, payments addressing losses relating to investment underperformance; and

the payment of financial penalties incurred by an RSE licensee, RSE licensee directors or any other use that is inconsistent with restrictions that preclude a trustee from being indemnified out of the operational risk reserve held as an asset of an RSE.

A change in the risk profile of the RSE licensee’s business operations, a reduction in membership or change in FUM, a successor fund transfer or wind-up or positive investment performance have the potential to create a surplus of financial resources. In these circumstances, an RSE licensee may decide that the ORFR target amount is too high in the new circumstance and requires downward adjustment.

APRA expects an RSE licensee would seek appropriate independent advice and implement a fair and transparent response to a surplus situation that has regard to how the surplus of financial resources has arisen and the RSE licensee’s legal duties and obligations.

When members of an RSE are being transferred under a successor fund transfer, an RSE licensee may determine it appropriate to transfer an amount of the ORFR financial resources to a receiving RSE licensee or for those monies to be allocated to member accounts prior to transfer.

If an RSE licensee intends to materially reduce a surplus in financial resources, APRA expects the RSE licensee would engage with APRA before a decision is made.

APRA expects an RSE licensee would ensure that the assets in an operational risk reserve have an appropriate risk profile and are sufficiently liquid to achieve this objective. ORFR financial resources, held either in an operational risk reserve within the RSE or as trustee capital, must be unrestricted and readily available to be used in a timely manner, including in a time of entity stress.

An RSE licensee may decide to implement an investment strategy for its operational risk reserves that mirrors the investment strategy of the RSE. This approach may assist it to maintain the ORFR financial resources at an appropriate level over time, provided that the RSE’s investment strategy has sufficient regard to liquidity and that the risk profile is appropriate to meet the purpose of the ORFR.

APRA expects investment earnings from the investments of an ORFR risk reserve to be allocated to the ORFR risk reserve.

Where an RSE licensee holds some or all of its ORFR financial resources as operational risk trustee capital, APRA expects an RSE licensee would be able to demonstrate it has appropriate processes and controls in place to:

quarantine the capital for the sole purpose of meeting the ORFR target amount; and

monitor the value of its capital against both the portion of the ORFR target amount that the RSE licensee has determined should be held as trustee capital, and other liabilities of the RSE licensee.

If circumstances change during the replenishment period such that the proposed funding method, or the ORFR target amount itself, is adjusted, APRA expects that the replenishment plan would be reviewed and updated as needed. A replenishment plan may take into account an anticipated payment from a compensation arrangement on which an RSE licensee believes it can reasonably rely.

APRA expects the annual review of the ORFR target amount and tolerance limit would be conducted by individuals with suitable experience, qualifications, capacity and understanding of the objectives of the ORFR to perform a robust, objective, timely and forward-looking review. Personnel from the risk management function and other suitably qualified and appropriate expert advisers may play a role in the review process.

Following a review of the ORFR, an RSE licensee may determine that it is appropriate to adjust its ORFR target amount, tolerance limit or any other aspects of an RSE licensee’s ORFR strategy, including how the ORFR financial resources are held and invested.

In addition to its approach to monitoring operational risks under Prudential Standard CPS 230 Operational Risk Management (CPS 230), a prudent RSE licensee would implement forward looking triggers and reporting processes that alert the Board to matters that may need pre-emptive action or response in relation to the ORFR. These may relate to the funding, management, investment and use of the ORFR financial resources and the appropriateness of the ORFR target amount itself.

APRA expects that an RSE licensee would maintain appropriately comprehensive records relating to the use or potential use of its ORFR financial resources. This may include records of where the RSE licensee has considered but has decided against using the ORFR financial resources. APRA’s view is that, over time, such information, together with insights on material operational risk incidents and near misses, would assist an RSE licensee in the development, review and monitoring of its ORFR strategy by providing a comprehensive record of when the RSE licensee decided to use or not use the ORFR financial resources.