Draft APRA Prudential Standard CPS 511 Remuneration: Strengthening prudential requirements for remuneration
There has been a lot of discussion recently in the media about remuneration of bank directors and senior executives following on from the recommendations of the banking royal commission.
The key royal commission recommendations on remuneration were that APRA should require its regulated institutions to:
- design their remuneration systems to encourage sound management of non-financial risks and reduce the risk of misconduct
- ensure their boards make regular assessments of the effectiveness of the remuneration system
- set limits on the use of financial metrics in connection with long-term variable remuneration
- claw back remuneration that has vested in appropriate circumstances
- review at least once each year the design and implementation of their remuneration systems for front line staff to ensure that the design and implementation of those systems focus on not only what staff do, but also how they do it.
In response to these recommendations, APRA issued a new draft prudential standard on remuneration (CPS 511) and has asked for stakeholder feedback.
The core elements of the new standard, which APRA states are materially more prescriptive than its existing remuneration requirements, are aimed at:
- Strengthening governance of remuneration frameworks and outcomes, in particular through an expanded board role.
- Setting overarching remuneration objectives.
- Limiting the use of financial metrics.
- Setting minimum deferral periods (up to seven years) for senior executives to provide more ‘skin-in-the-game’ through better alignment to the time horizon of risk and performance outcomes.
Governance Institute lodged a submission in response to the proposed new standard on 23 October 2019.
Our members consider that a number of aspects of the standard will bring improvements to accountability and remuneration governance and assist in addressing issues identified by the Final Report of the Prudential Inquiry into the Commonwealth Bank of Australia and Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
However, in our view the proposed standard takes a ‘one-size fits all’ approach to remuneration in APRA-regulated entities which may be appropriate for large Australian listed entities with the resources to implement it, but may prove more difficult for smaller APRA-regulated entities. We consider that an ‘if-not, why not’ approach, particularly for smaller entities with less complex governance arrangements, is preferable.
We also consider that the standard adds a further layer of complexity to an already overly complicated remuneration regulatory regime, particularly for listed entities
In our submission, we recommended that APRA:
- Reconsider the drafting of the standard to ensure the important demarcation between the board and management is maintained and that the drafting does not inhibit boards’ ability to rely on information and advice provided by others.
- Reconsider the overly prescriptive nature of the standard, particularly as it will relate to smaller APRA-regulated entities.
- Include a recommended percentage of financial metrics in the standard and require entities to report on an ‘if not, why not’ basis against the recommended percentage, rather than impose a ‘hard cap’.
- Reconsider the length of the deferral period so that variable remuneration operates as a real, rather than an illusory incentive.
- Consider alternatives such as an appropriate deferral period and malus provisions in place of claw back.
We also consider that the standard adds a further layer of complexity to an already overly complicated remuneration regulatory regime, particularly for listed entities. One significant issue with the standard identified by our members is how its requirements interact with the Banking Executive Accountability Regime (BEAR) which will ultimately extend to all APRA-regulated entities. In some areas the standard duplicates some of the BEAR requirements and it will be extremely important for the two regimes to be consistent with each other. Areas of potential duplication include the roles in scope and the length of remuneration deferral periods — there are some slight differences in the wording of some clauses that will have an impact. This may create a situation where entities must comply with different provisions for different classes of employees. This is both administratively burdensome and may lead to employee uncertainty about their terms of employment.
We recommended that the alignment of the BEAR with the standard be settled and agreed before the standard commences.
Our submission also considered the issue of the timing of the implementation of the standard. We argued that it would be preferable for the implementation date of the new requirements to align with entities’ financial years, rather than the ‘hard’ start date currently contemplated by APRA. Alignment with an entity’s financial year will allow a smoother start to the new requirements, particularly given that many entities may have to amend existing contractual arrangements and transition to the new requirements. Allowing entities to adopt the new requirements from the commencement of a new financial year will avoid the complexities and potential inequities created by changing existing performance plans mid-stream. Our submission also pointed out that there may need to be some grandfathering of existing arrangements given the potential disruption created by implementing APRA’s requirements during the course of an incentive plan.
We also mentioned the unintended impact the deferral and other requirements may have on the ability of APRA-regulated entities to attract suitably skilled staff and for the Australian financial services sector to remain globally competitive.
The remuneration requirements imposed by the standard, particularly the lengthy deferral periods for incentives, potentially make the financial services sector less attractive for employees. Candidates are likely to favour industries not operating under these constraints. For example, those working in areas such as human resources, company secretariat and legal may prefer to work in a non APRA- regulated entity where their remuneration will not be subject to the clawback and malus provisions imposed by the APRA standard. Similarly those working in superannuation may find the funds management industry a more attractive proposition.
Governance Institute also considers that it would also be undesirable if one of the consequences of the standard were to make Australia a less attractive option for those working in financial services. At the senior executive level the employment market, particularly in significant financial institutions, is global and the constraints imposed by the standard potentially make the Australian financial services sector less competitive when compared to other financial centres in the region.
Governance Institute also met with representatives of APRA to discuss our members’ concerns about the proposed standard.
APRA intends to publish the final standard in late 2019 or early 2020. It expects the new standard to come into effect on 1 July 2021 but will consider any feedback received as part of this consultation before finalising the start date.
We will continue to provide updates to members on this important issue.