Supervisory Guideline Number RBA 2: Implementation of Risk Based Supervision for Better Governance and Administration of All Schemes

SUPERVISORY GUIDELINE NUMBER RBA 2 SUPERVISION DEPARTMENT IMPLEMENTATION OF RISK BASED SUPERVISION FOR BETTER GOVERNANCE AND ADMINISTRATION OF ALL SCHEMES

In accordance with section 55(3) of the Retirement Benefits Act the Authority hereby issues a Statutory Guideline on the implementation of Risk Based Supervision for better governance and administration of all retirement benefits schemes. The Guideline describes the risks schemes are faced with, the pre-requisite conditions for implementation of risk based supervision, the standards of risk based supervision and the way forward in the implementation of risk based supervision.

1. CURRENT RISKS TO WHICH OCCUPATIONAL PENSION SCHEMES ARE EXPOSED Occupational retirement benefits systems vary in benefit design and mode of benefit payment. Notwithstanding the variations in schemes, there is a degree of commonality regarding the risks facing the retirement benefits sector, as well as risks facing individual retirement benefits schemes and scheme members. The Authority has identified the risks which need to be examined and which form the basis for introduction of risk based supervisory framework. There are three broad categories of risk faced by retirement benefits sector in Kenya; namely: Systemic risk, Portfolio risk, Agency risk.

i. SYSTEMIC RISK Systemic risk arises when all retirement benefits schemes are affected by financial meltdowns or other economic catastrophes. This is likely to take the shape of large numbers of schemes being unable to receive contributions and severe arrears building up. A further aspect of systemic risk is liquidity risk or "run on the scheme". Schemes should generally have sufficient liquid assets to be able to meet reasonable cash flow requirements. The sector will face the risk of fiscal sustainability if contributions are irregular and inadequate to fund promised benefits. Another systemic risk in the sector is that of erosion of the whole pension system.

ii. PORTFOLIO RISK Portfolio risk can be caused by: Inappropriate risk profiles; Inadequate returns in relation to the income targets; Cyclical risks in interest markets affecting annuity purchase; Actuarial risk on the liability side.

iii. AGENCY RISKS Apart from financial risks related to investments and funded ratios, the key risks that the Authority will be concerned about, and the risks that are most susceptible to regulatory intervention, will be agency risks. These can be classified into three broad areas: Excessive fees and expenses; Conflicts of interest; Fraud, misappropriation and misallocation.

2. PRE-REQUISITES FOR A RISK-BASED APPROACH TO SUPERVISION This section is intended to be a more practical guide on how to put in place the necessary pre-requisites for a risk-based approach to supervision. (a) Familiarizing all Parties with Best International Practices (b) Implementing a Screen Based System of Triage (c) Implementing electronic filing (d) Reviewing Act, Regulations and other Statutory Instruments to Ensure they are Consistent with Risk Based Supervision.

3. RISK-BASED STANDARDS It is important to note that a change from a compliance based approach to a risk-based approach requires a change in mind-set in all players. The Authority has now resolved to shift to risk based supervision. This approach is often called the "supervisory ladder" approach as it considers five risk levels (0 to 4).

4. PROCEDURE FOR RISK-BASED SUPERVISION This model of supervision will work if each party to a scheme plays its role effectively. Supervisory oversight is performed in three stages: Off-site inspection, On-site inspection, and Intervention, if necessary.

WAY FORWARD Schemes are required to take note of the above processes which will be applied by the Authority in implementing risk based supervision. In the meantime, schemes are required to fill truthfully and accurately the interrogatories which will provide the basic information for assessment of the scheme's risk level. The interrogatories will be filled annually by all schemes.