APRA commences consultation on draft practice guide for prudential remuneration standard
Interested entities can provide feedback until 23 July 2021.
What you need to know
- APRA has issued for consultation draft Prudential Practice Guide CPG 511 Remuneration.
- The draft practice guide is designed to assist regulated entities to comply with APRA's new prudential standard on remuneration, CPS 511.
- In its 22-page draft practice guide, APRA has sought to pay particular attention to areas where greater clarity has been requested. That includes setting out illustrative examples of how entities can define non-financial measures of performance.
- Interested entities can provide feedback on the draft practice guide until 23 July 2021.
What you need to do
- If your organisation will be regulated by prudential standard CPS-511, consult the draft practice guide and understand APRA's expected approach to compliance.
- If you identify areas of concern or ambiguity, consider providing feedback to APRA by 23 July 2021.
Background
On 30 April 2021, APRA released for consultation a draft Prudential Practice Guide CPG 511 Remuneration (draft practice guide). This provides guidance to regulated entities on the Prudential Standard CPS 511 Remuneration (prudential standard).
The draft practice guide can be accessed here.
As outlined in our previous Financial Services Update, APRA's incoming prudential standard will govern the remuneration practices of APRA-regulated entities. A draft prudential standard was initially released for consultation in July 2019. A revised version of the standard was issued for a further round of consultation in November 2020. That revised standard adopted a more principles-based approach in response to concerns that some of the requirements initially proposed were too prescriptive.
APRA's draft practice guide is intended to assist entities to comply with the requirements in the prudential standard by describing principles and examples of better practice.
Overview
Key guidance contained in the draft practice guide includes the following:
| Topic | Guidance |
|---|---|
| Significant Financial Institutions |
APRA has set out the minimum asset size for an entity to be a Significant Financial Institution (SFIs). Under the prudential standard, SFIs are subject to additional regulation.
|
| Board oversight | APRA reaffirms the role of the Board and an entity's Remuneration Committee (or other relevant oversight function) in determining appropriate variable remuneration outcomes. Boards should be actively engaged in the oversight of key remuneration decisions, providing robust challenges, particularly in unusual or exceptional circumstances, such as material cases of adverse risk or conduct outcomes, or "periods of stress" in which an entity experiences negative financial performance or "is provided with exceptional public sector support". This would appear to be a reference to government support programmes such as JobKeeper. Boards are also expected to use their discretion in a timely manner. That may mean that variable remuneration is reduced pre-emptively, and not only on the basis of realised outcomes. APRA also indicates that assessment of performance and risk should include direct input from senior risk management personnel. Risk and internal audit executives may be expected to present a comprehensive assessment of key risk and audit metrics on at least an annual basis for this purpose. Key considerations in operationalising Board oversight requirements In order to enable the Board and remuneration committee to effectively determine variable remuneration outcomes, organisations will need to ensure that:
|
| Remuneration framework |
APRA describes the key components of a typical remuneration framework that entities can adopt to meet the requirements of the prudential standard. Those components include board oversight, policy design, performance management, consequence management, reporting and disclosure. Key considerations in operationalising remuneration framework requirements
Other metrics such as arrangements with service providers should not be considered in isolation. Instead, the organisation should seek to provide "one view" of all metrics, with corresponding analytics which clearly draws linkages and interdependencies. This will enrich the quality of Board discussions and enhance the quality of remuneration outcomes. |
| Remuneration design | APRA has set out common forms of variable remuneration that may form part of an entity's remuneration arrangements. They include cash, non-cash and equity-based remuneration, short and long terms incentives, and deferred awards that may remain on foot following termination. APRA has also described more complex arrangements that it indicates should be avoided. They include:
Guidance is provided on how non-financial measures are used to assess performance. Non-financial measures should be easily understood, and have the potential to impact all components of variable remunerations. Key considerations in operationalising remuneration design
Organisations will need to ensure that they have robust data and reporting capabilities which are well embedded as a part of their risk management systems. Where possible, organisations should draw on existing non-financial risk reporting to the Board, to maximise efficiencies in implementing CPS 511. Where organisations have a natural bias of better capability for financial metrics, first, second and third lines of defence should collaborate to ensure a balanced and fit for purpose of approach to financial and non-financial metrics. |
| Risk and conduct adjustments | APRA has reiterated that entities must have appropriate arrangements in place to ensure in-period adjustments, malus and clawback for serious risk issues and consequences, including those that emerge several years after the event. These design features are anticipated to be built into relevant employment contracts to provide the necessary legal basis for any action. Downward adjustment is expected to be considered for all variable remuneration, including current year, deferred and amounts subject to clawback. Such adjustments should occur outside the regular performance cycle if they are to be considered in a timely manner. APRA has also said that where employees at lower levels receive downward adjustments for adverse risk and conduct outcomes, corresponding adjustments should be considered for executive employees to recognise overall line or functional accountability. More generally, APRA has suggested that good practice would be for entities to develop a severity scale, including example cases, to guide decision-making on the level of severity and indicative remuneration impacts should result. This would support Boards, including in applying consistency across different cases. Where the extent of an issue has not fully emerged, APRA has proposed that entities make an initial adjustment to reflect timely action, before proceeding to a final adjustment when the full impact is understood. Typically, individuals under investigation would have any vesting or payment of variable remuneration suspended until the conclusion of the investigation. Key considerations for risk and conduct adjustments The development of a severity scale will ensure that organisations have a risk-based approach to risk and conduct adjustments. This risk-based approach should include case studies from within the organisation. It should also include clear principles which are linked to the organisation's code of conduct as well as other standards. Organisations should take care to develop a risk based approach which will remove bias towards or against key functions and individuals. This approach should also enhance the balance between the voice of risk, the voice of finance and the voice of the customer. Organisations should ensure that this risk-based approach is aligned to their decision-making frameworks, and that decisions made as a result of this approach would pass the "pub test". |
| Review of remuneration framework | SFIs are required to conduct an annual compliance review and a triennial effectiveness review of their remuneration frameworks. The annual review should be conducted by staff with appropriate skills and experience, and be subject to appropriate independent challenge. To avoid conflicts of interest, the review would be conducted by staff that were not involved in, or reporting to those involved in, the design of the remuneration framework. The triennial review should be a deeper and broader assessment of the remuneration framework, and provide recommendations to improve the effectiveness of the framework where relevant. These recommendations should take into account any changes to the organisation, its strategy, market trends and the findings of investigations and annual reviews. The scope of the triennial review would encompass the role of the Board, the design of remuneration arrangements, and the effectiveness of risk and conduct adjustments. This would include any key design features, such as the definition of material risk-takers and the application of non-financial measures. The Board and management should leverage the expertise of specialised independent advisers in performing these reviews. This will also ensure that inherent conflicts of interests are mitigated. Remuneration framework reviews should take into account the operating environment, best practice as well as sector and industry trends. The outcome of this review should serve the dual purpose of meeting regulatory requirements and enabling continuous improvement for the organisation. |
It is important to note that the above represents guidance only, and that what is appropriate for an entity will depend on an entity’s size, complexity and risk profile.
Next steps
APRA is requesting feedback on the draft practice guide by 23 July 2021.
It intends to finalise the guide, and the prudential standard, in the second half of 2021.
How we can help
We would be happy to assist if you are interested in finding out more about the draft practice guide, or would like to make a submission to APRA on its content.
Authors: Jennie Mansfield (Partner); Silvana Wood (Partner); Elena Lambros (Partner) and Daniel Fawcett (Senior Associate).
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