ADI boards can comply with APRA’s prudential standards and ensure compliance by responsible persons, with a specific focus on the establishment of a skills-based board.
APRA’s prudential standards for governance sets out the minimum requirements for an APRA-regulated institution. For example, paragraph 19 of Prudential Standard CPS 510 Governance, which covers entities in the deposit-taking, general insurance, life insurance and private health insurance industries, requires the board to:
…ensure that directors and senior management of the institution collectively have the full range of skills needed for the effective and prudent operation of the institution, and that each director has skills that allow them to make an effective contribution to Board deliberations and processes.
Under paragraph 30 of Prudential Standard CPS 520 Fit and Proper, directors must ‘possesses the competence, character, diligence, honesty, integrity and judgement’ to perform their duties. The focus on skills is simple, since APRA states, meeting the prudential obligations placed on boards:
…can be readily met by a well-functioning board that has an appropriate mix of skills and experience amongst its directors.
This applies not only to an APRA-regulated institution, but to all boards, with the balance of skills and experience required reflecting the organisation’s complexity. How does the board decide what skills it needs now and in the coming years? The answer is a skills analysis. This analysis should take a strategic perspective - for example, the board of a regulated entity should think about what is happening outside the organisation, such as regulatory or technological changes. This will enable the board to adapt to the organisation’s current and future environment, particularly given issues such as technological change in the financial sector, which may mean changes to board composition and a sharper focus on succession planning at the board level. eG has created a four step process for undertaking a board skills analysis:
- Step 1: Decide upon the desired competencies
- Step 2: Rate the current directors on each competency
- Step 3: Identify the skills gaps
- Step 4: Identify strategies to address gaps
Step 1: Decide upon the desired competencies
Firstly, the board skills analysis needs to establish the skills required by the board in the future. This is a critical first step, as if the appropriate competencies and skills are not correctly identified, the later stages of analysing the current competencies of the board, and the consequent skill gaps will have some significant deficiencies. Using a framework that covers four major areas of competency: industry, technical, governance and behavioural will greatly benefit the board. Every board will require the appropriate mix of competencies in each of these four areas.
The attributes and competencies enabling individual board members to use their knowledge and skills to function well as team members and to interact with key stakeholders.
The essential governance knowledge and understanding all directors should possess or develop if they are to be effective board members. Includes some specific technical competencies as applied at board level.
Technical/professional skills and specialist knowledge to assist with ongoing aspects of the board’s role.
Experience in and knowledge of the industry in which the organisation operates.
Step 2: Rate the current directors on each competency
The second step in a board skills analysis is to map the current skill set of the board. This can be done in several ways. The simplest way is for a person who knows the existing directors well to give them a grade for each of the agreed skill levels. This classification can be as simple as critiquing whether an individual possesses a skill. Alternatively, each director can be classified as to whether they have a primary skill in each skill area or a secondary skill. A primary skill would indicate extensive knowledge, training and experience in the skill level, while a secondary skill would indicate knowledge in the skill area but does not possess the extensive criteria for the skill. The classification could then be shared with the current directors to determine whether they agree with how they have been categorised.
Another approach is for each director to be asked to rate themselves with respect to each skill or competency. While such a rating could use the simple ‘possess/do not possess’ or the ‘primary/secondary’ categorisation, it is also possible to use detailed attributes for each competency level, which would be more effective for APRA-regulated boards to assess director skills. For example, the levels might be:
- advanced; and
Criteria is included for each level in each of the skills categories, such as financial markets or retail banking, to give the most accurate picture of what competencies each director currently possesses and what level of competence the board needs in the future. Competency grows with experience and training, for example, it would be expected that an expert in human resource management would have been in an executive position in human resources for an extended period, and have a higher degree.
Step 3: Identify the skills gaps
The third step in a board skills assessment is to determine the gaps between the board’s future skills requirements and the current skills as determined by the skills analysis. The outcome will detail the areas of skills and experience chosen by the board along with required skill level, number of directors required in the future, and whether this future requirement is currently being met.
Step 4: Identify strategies to address gaps
Finally, the board must identify how a particular skill gap will be met into the future. There are several options, depending upon the skill category identified as required. For some skills, such as cyber security, the answer will be to recruit a person with the skill at the required competency level. This of course will also require a determination as to whether additional directors are required for the board, or whether a current director will need to be replaced, either at the completion of their current term or through a managed board renewal process. For some skill areas, such as governance skills, it may be possible for existing directors to undertake education and training programs to acquire the desired level of competency for the board. It is also important to note that the board can include non-skills based criteria when considering board renewal, for example, gender, age and geographic or cultural diversity.
Board renewal is a healthy and professional exercise for any board, particularly following changes in strategic direction, legislative or regulatory updates, public policy influence and government and regulator focus. It often means logical and smart decisions by boards to replace directors and for that matter to ‘ensure directors and senior management of the institution collectively have the full range of skills for the effective and prudent operation of the institution’.
It is worth reflecting on the theme of the APRA Corporate Plan 2021 – 25, which says, ‘protected today, prepared for tomorrow’. This is focused on protecting bank deposit-holders, insurance policy holders and superannuation fund members and highlights the intent of APRA to promote prudent behaviour through robust prudential standards and guidance to boards and trustees.
In paraphrasing the former APRA Deputy Chair Helen Rowell, when thinking about diversity on boards, it is often simplistically thought of through a gender lens – but diversity goes beyond that.
Boards that have directors with a wide range of skills, experience and perspectives demonstrate clear advantages, enabling expansive thinking, deeper insights, better challenge and ultimately better decision making. In order to ensure defensible decision making, boards have to have the right people with the right skills and ensure the same exists within the executive team. Responsible persons within the APRA prudential standard definition require wide-ranging skills at the highest level.