Understanding the connections : how great operational risk management can unlock capital
With all the activities underway to implement the new CPS230 (operational risk management) by 1/7/25, Super Trustee’s can’t forget that this must happen alongside the biggest changes to Trustee operational risk capital management requirements since the introduction of SPS114 (operational risk financial requirement, or ORFR) in 2013.
It is no co-incidence the new CPS230 and updated SPS114 are being implemented with the same effective date of 1/7/25. Member protection from unexpected incidents comes through the virtuous combination of effective risk management and the holding of an appropriate level of financial resources to cover the risks you have chosen to accept. APRA want to see this packaged uplift to member protection (both risk management and capital protection) in place mid-year.
At Entregar Partners, we have been turning our minds to how the regulator will expect Trustees to approach these changes. To help you cross check against your own SPS114 implementation, our resident expert Tim Gorst summarises seven high level compliance criteria, with an eighth criteria dedicated to making sure an RSEL Board has confidence the regulatory change has been implemented effectively. He also outlines some key changes and activities required by 1/7/25 to confirm compliance.
1. ORFR Purpose & Strategy
The RSEL must have a Board-approved ORFR Strategy, for the purpose of protecting beneficiaries from losses due to operational risk that relate to the RSEs within its business operations.
Key Changes: an updated purpose with a new, direct relationship with CPS230, requiring an update to the objective of the ORFR Reserve. New CPS230 related definitions are required.
Output: ORFR Strategy updated with Board approval - aligned to SPS114, CPS230 and SPG515
2. ORFR Target & Tolerance Limit (T&T) % and Amount Determination
The RSEL must determine a target amount of financial resources, and a tolerance limit below the target amount, to give some allowance for day-to-day immaterial fluctuations in the level of ORFR financial resources relative to the target amount.
Key Changes: New minimum 0.175 ORFR Target % where FUM is > $135b, on the assumption the RSEL is run soundly, and has implemented an effective risk management framework. There is no change to the minimum 0.10% guidance in relation to captive PST’s and you must continue to notify APRA before any material change in ORFR target amount.
Output: ORFR T&T approach rebuilt and updated T&T review informed by operational risk profile
3. ORFR Uses & Disclosure
The RSEL must maintain processes and parameters for determining when and how the ORFR financial resources can be used, aligned to the definition of operational risk defined in CPS230, and the new updated purpose of the ORFR Reserve.
Key Changes: Greater allowable range of uses of the ORFR financial resources including prevention of CPS230 related operational risk incidents or material operational weaknesses, with added clarity on exclusions. APRA will no longer require SPS114 notifications prior to use of a material amount of ORFR, replaced by material incident notification under CPS230.
Output: APRA notification process updated and contractual, disclosure & other legal documents reviewed and updated
4. ORFR Structures
ORFR financial resources, held as either Trustee capital or RSE Reserves must be separately identifiable, sufficiently liquid with an appropriate investment risk profile and readily available to be used in a timely manner, particularly a time of entity stress.
Output: Reserve investment strategy reviewed and related capital & reserve structure reviewed and updated (alignment to ORFR changes).
5. ORFR Surplus Management
An approach to managing surplus ORFR financial resources, including in the event of a SFT in or out, must be determined by the RSEL for inclusion in the ORFR Strategy and / or associated procedures.
Key Changes: Only material excess financial resources will be available for release and in the event an RSEL intends to materially reduce a surplus in financial resources, APRA guidance is the RSEL “engage with APRA before a decision is made”.
Output: Defined material excess financial resources for surplus release purposes
6. ORFR Shortfall Management
A Board approved replenishment plan must be developed and implemented where the level of ORFR financial resources falls below the tolerance limit amount.
Key Changes: SPS114 notification to APRA if the ORFR falls below the tolerance limit is no longer required.
7. Reporting, Review & Audit
The ORFR Strategy must be periodically reviewed, with the T&T amounts reviewed at least annually or more regularly if required. This review should be supported by satisfactory internal audit procedures, external audit arrangements and SPS114 related record keeping.
Key Changes: A focus on forward looking ORFR triggers and monitoring (aligned to CPS230), reporting and record keeping processes. A material incident or change in business operations will require a review of T&T and any findings from any reviews must be reported to Board
Output: ORFR reporting & record keeping process updated; Audit Plans Updated (ORFR Review) and a material incident for SPS114 review trigger purposes defined.
8. Project Change, Readiness Assurance and Close
An SPS114 regulatory change implementation project must be successfully delivered, assured and handed over to BAU.
Key Changes: The updated SPS114 must be implemented alongside the new CPS230 requirements (both effective 1/7/25) with key inter-dependencies (e.g. operational risk profiling and definition of operational risk) managed.
Output: SPS114 project change, readiness assurance and close.
Time is running out for Trustee’s to shore up their SPS114 implementation plan. If you need assistance with delivery, assurance or implementation support such as the build of a new target and tolerance review approach and model, please contact Entregar for a discussion.