6 August, 2019
What you need to know
- APRA has, in response to the Royal Commission into Misconduct in the Financial Services Sector, released a proposed new Standard regarding remuneration paid or payable by APRA-regulated entities.
- The draft Standard amplifies many of the existing requirements of CPS 510, as well as introducing a number of new, notable requirements.
- APRA has called for submissions by 23 October 2019.
What you need to do
- Review the proposed new Standard and consider any difficulties and issues that may arise with its implementation in your organisation.
- Consider whether you are a "significant financial institution" (SFI) and the additional requirements regarding deferral of variable remuneration and clawback that apply to SFIs.
- Consider making a submission to APRA.
- Prepare and lodge a submission with APRA by 23 October 2019, if you intend to do so.
Background
APRA has released a draft prudential standard relating to remuneration across APRA-regulated entities.
Draft Prudential Standard CPS 511 Remuneration (Draft Prudential Standard) is intended to be a standalone standard governing the remuneration requirements of APRA-regulated entities. The Draft Prudential Standard amplifies many of the existing requirements in Prudential Standard CPS 510 Governance (CPS 510) as well as introducing a number of new, notable requirements.
The Draft Prudential Standard is intended to give effect to recommendations 5.1 to 5.3 of the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), which were directed to APRA and concerned its prudential supervision of remuneration systems.
The Royal Commission identified shortcomings in remuneration systems and practices as a significant contributing factor leading to the misconduct in the sector that was inquired into and reported by the Commission.
The Draft Prudential Standard also builds on the provisions of the Banking Executive Accountability Regime (BEAR) dealing with remuneration. The BEAR was introduced in 2018 and whilst it currently only applies to "authorised deposit-taking institutions" (ADIs), the Government intends, pursuant to recommendations of the Royal Commission, to extend the BEAR to other entities in the financial services sector.
This new Standard was foreshadowed in our previous Alert: Putting pay to misconduct.
Overview of key changes
The key proposals of the Draft Prudential Standard as against CPS 510 and the BEAR are as follows:
| Current Standard / BEAR | Proposed Standard | |
| Remuneration framework | Remuneration policy for senior executives and limited additional staff. | Expanded remuneration framework including remuneration policy covering all remuneration arrangements. |
| Review | Remuneration policy must be reviewed on a regular basis. | Annual compliance review and triennial independent comprehensive review of effectiveness. |
| Board oversight | The Board must approve the remuneration policy, and has responsibility for reviewing and approving remuneration recommendations for senior executives and limited additional staff. | The Board must approve the remuneration policy, actively oversee the remuneration framework, approve the remuneration of senior executives and an expanded category of other roles, and ensure risk outcomes are reflected in remuneration outcomes. |
| Remuneration outcomes | Remuneration policy must allow the Board to adjust variable remuneration downwards to zero if appropriate for employees in special categories. | Remuneration outcomes must be commensurate with performance and risk outcomes, and be influenced by tools including in-period adjustments, malus, clawback and discretion. |
|
Variable remuneration design (see further below) |
Variable remuneration for special categories of employees must be designed to allow adjustments to reflect business outcomes, risks inherent in business activities and incorporate appropriate time for performance to be realised. |
Minimum design requirements for all employees, which promote prudent risk management and support remuneration objectives. Financial measures limited to 50 per cent overall, and each financial measure capped at 25 per cent. |
|
Deferral of variable remuneration (see further below) |
There are no specific deferral requirements under CPS 510. Under the BEAR, ADIs must defer a prescribed percentage of an "accountable person's" variable remuneration for a minimum period of four years, where the variable remuneration is $50,000 or above. The amount to be deferred under the BEAR is the lesser of: (a) 40 per cent of the variable remuneration, and (b) 10 or 20 per cent of total remuneration (depending upon the size of the institution). |
For a "significant financial institution" (SFI), where variable remuneration is $50,000 or above: – The SFI must defer 60 per cent of the variable remuneration of its CEO for at least seven years. Vesting of this 60 per cent may only occur after four years from the time of inception and no faster than on a pro-rata basis. – The SFI must defer 40 per cent of the variable remuneration of a senior manager other than its CEO, and a highly-paid material risk-taker, for at least six years. Vesting of this 40 per cent may only occur after four years from the time of inception and no faster than on a pro-rata basis. |
|
Clawback of variable remuneration (see further below) |
There are no clawback requirements under CPS 510 or the BEAR. | SFIs must subject the variable remuneration of a senior manager or a highly-paid material risk-taker to clawback for at least two years, and in some cases four years, after the relevant remuneration has vested. |
* The above table partly reflects a comparative table contained in APRA's Discussion Paper: Strengthening prudential requirements for remuneration, relating to the Draft Prudential Standard.
Limit on financial measures for variable remuneration
Under the Draft Prudential Standard, financial performance measures e.g. revenue, profit and return on equity (ROE) measures, must not comprise more than 50 per cent of total measures used to allocate variable remuneration. Each individual financial performance measure must not comprise more than 25 per cent of total measures.
This is a significant proposal. In practice, "long term incentives" or LTIs are commonly wholly or mainly based on financial performance measures, even if "short term incentives" or STIs are not. For listed entities, in particular, shareholders have historically been supportive of financial performance measures. The Draft Prudential Standard does not distinguish between LTIs and STIs and would impose strict limits on financial performance measures for variable remuneration generally.
Deferral and clawback of variable remuneration in significant financial institutions
Significant financial institutions
The Draft Prudential Standard applies to all APRA-regulated entities but imposes further requirements on a new category of larger and more complex APRA-regulated entities termed "significant financial institutions" (SFIs).
APRA proposes to define SFIs according to asset size as follows:
| Industry | Asset Size |
| ADIs | > $15 billion |
| General and life insurers | > $10 billion |
| RSE licensees | > $30 billion |
| Private health insurers | Not applicable |
APRA has indicated there would currently be 21 ADIs, eight general and life insurers and 17 RSE licensees covered by these definitions.
SFIs are required to subject the variable remuneration of persons categorised as a "senior manager" or "highly-paid material risk-taker" to deferral rules and clawback.
A "senior manager" is:
- a director; or
- a person who exercises senior management responsibilities, within the meaning of Prudential Standard CPS 520 Fit and Proper and for an RSE licensee, Prudential Standard SPS 520 Fit and Proper, for the entity in their capacity other than as a director.
A "highly-paid material risk-taker" is a person:
- whose activities have a material potential impact on the entity’s risk profile, performance and long-term soundness, and in addition for an RSE licensee, means a person whose activities have a material potential impact on promoting the financial interest, and reasonable expectations, of beneficiaries; and
- whose total fixed remuneration plus maximum potential variable remuneration is $1 million AUD or greater in a financial year.
Deferral of variable remuneration
Where variable remuneration is $50,000 or above in a financial year:
- An SFI must defer 60 per cent of the total variable remuneration of its CEO for at least seven years. Vesting of this 60 per cent may only occur after four years from the time of inception and no faster than on a pro-rata basis.
- An SFI must defer 40 per cent of the total variable remuneration of a senior manager other than its CEO and a highly-paid material risk-taker for at least six years from the time of inception. Vesting of this 40 per cent may only occur after four years and no faster than on a pro-rata basis.
Clawback of variable remuneration
An SFI must subject the variable remuneration of a senior manager or a highly-paid material risk-taker to clawback for at least two years, or at least four years in circumstances involving a person under investigation, after the relevant remuneration has vested. Prescribed criteria for the application of clawback must be included in the remuneration policy.
Interaction with the BEAR
For ADI's that are SFIs, the Draft Prudential Standard extends the requirements of the Banking Executive Accountability Regime (the BEAR) in respect of deferral of variable remuneration. As set out in the table above, the Draft Prudential Standard:
- provides for different mechanics for the calculation of the percentage of variable remuneration to be deferred, which could be higher under the Draft Prudential Standard;
- prescribes longer deferral periods (minimum four years under the BEAR); and
- requires a mechanism and the setting of specific criteria for clawback, whilst the BEAR does not deal with clawback.
The criteria for application of malus also differ as between the Draft Prudential Standard and the BEAR.
Due to the potential difficulties in the interaction between the Draft Prudential Standard and the BEAR, APRA is seeking feedback on this issue and intends to work with the Government to seek legislative amendments to the BEAR in implementing the proposed deferral requirements, as necessary.
What's next
Consultation period
APRA are calling for written submissions on the proposals in the Draft Prudential Standard by 23 October 2019.
Businesses should consider making submissions on:
- the feasibility of implementing the new requirements and any practical difficulties they may present;
- the effect of the proposals on their ability to offer competitive remuneration packages and to attract and retain talent at the executive level;
- the interaction of the new requirements with the BEAR; and
- the risk that increased prescription and onerous requirements regarding variable remuneration may lead businesses to eschew variable remuneration in favour of higher fixed remuneration.
Implementation of the proposed standard
APRA intends to finalise the new Standard in late 2019 or early 2020 and expects it will come into force from 1 July 2021. For private health insurers, APRA does not expect the new requirements to apply until 2022.
APRA also intends to develop a prudential practice guide and reporting and disclosure requirements for consultation in early 2020.
For further information, please contact:
George Cooper, Partner, Ashurst ADTLaw
george.cooper@ashurst.com
