Revised remuneration prudential standard released for consultation by APRA
APRA is proposing to move away from prescriptive remuneration requirements to a more principles-based approach to determining the minimum remuneration standards for APRA-regulated entities
What you need to know
- In response to industry feedback from an initial consultation in 2019, APRA has released a revised draft of Prudential Standard CPS 511 Remuneration (CPS 511) for consultation
- Revised CPS 511 is less prescriptive than the initial draft, affording APRA-regulated entities with greater flexibility to comply with the requirements having regard to their specific circumstances
- The 50% cap on financial measures for variable remuneration at Significant Financial Institutions (SFIs) has been replaced by the need to demonstrate that "material weight" has been given to non-financial risks
- The minimum deferral periods for variable remuneration for CEOs, senior managers and highly paid material risk takers (HPMRT) have been reduced
What you need to do
- Review your organisation's remuneration framework to consider whether it currently supports the objectives of revised CPS 511 and whether any changes are likely to be required to ensure compliance with the specific requirements in the standard. This includes reviewing your organisation's remuneration policy, consequence management arrangements and reporting for directors and senior executives on the outcomes of the remuneration framework
- Consider whether your organisation falls within the definition of an "SFI" for the purposes of the revised CPS 511. SFIs are subject to additional requirements under the standard
- Consider your organisation's current approach to non-financial risks and reflect on how the proposed requirement to give "material weight" to these risks in determining remuneration outcomes will impact your existing arrangements
- Ensure that any written submission you intend to make on the consultation is lodged with APRA by 12 February 2021
Background
On 12 November 2020, APRA released for consultation a revised draft of its proposed prudential standard relating to remuneration, CPS 511 (Revised Draft Prudential Standard).
As outlined in a previous Financial Services Update, CPS 511 is intended to be a standalone standard which governs the remuneration requirements of APRA-regulated entities. It responds to shortcomings identified in the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry by setting robust, minimum remuneration standards for APRA regulated entities. It amplifies many of the existing requirements in Prudential Standard CPS 510 Governance (CPS 510) and builds on the remuneration provisions of the Banking Executive Accountability Regime (BEAR).
APRA hosted over 40 industry engagements and received 76 submissions during the initial consultation phase, with the majority of feedback relating to APRA's previous proposal to impose a 50% limit on the use of financial performance measures to determine remuneration outcomes. Significant industry concern was also raised about the prescriptive nature of the proposed requirements, including the risk that they could result in the board's role shifting away from one of oversight of remuneration and prevent APRA-regulated entities from attracting and keeping talent.
In response to the feedback, APRA revised draft CPS 511 and is conducting a further consultation on the draft standard. Revised CPS 511 seeks to strengthen market practice through the setting of more principles-based minimum remuneration requirements, while it also reduces the regulatory burden on smaller and less complex APRA-regulated entities by reducing many of the existing requirements on a proportionality basis.
Overview of key changes
Following the initial consultation, the following key changes were made to draft CPS 511:
Provision |
Comments |
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Board oversight |
CPS 510 currently requires the board of an APRA regulated entity to approve and regularly review the entity's remuneration policy, which must meet certain requirements, and to make decisions in relation to the remuneration of specified senior individuals. The initial draft CPS 511 sought to engender improved board engagement in remuneration arrangements, though industry participants generally considered that the level of prescription in this draft could distract the board from its oversight role and make it less effective. APRA's revised draft CPS 511 removes some of the prescription that was contained in the initial draft, and instead provides that boards:
APRA explains in its consultation paper that the requirements on boards in revised draft CPS 512 require boards to comply with the following overarching principles:
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Remuneration framework –service providers |
The initial draft CPS 511 intended to strengthen an entity's oversight and risk assessment of remuneration arrangements with third-party service providers by:
A significant number of entities questioned the effectiveness of these proposals, noting that they could affect their capacity to contract with service providers. In particular, concerns were raised in respect of the apparent implication that entities would need to exert influence over the remuneration of third-party service providers. This was generally considered to be impractical, especially where contract sizes are immaterial relative to the third party's overall business or where the service provider is based overseas. APRA has clarified in its consultation paper to revised CPS 511 that entities are not required to influence the remuneration arrangements of third-party service provider employees or contractors. Rather, entities are simply required to make an overall assessment of a service provider's remuneration arrangements, which must include an assessment of any potential conflicts of interest. |
Remuneration design – non-financial measures |
There is currently no prescriptive requirement concerning the use of non-financial measures to determine remuneration. The initial draft CPS 511 aimed to balance financial and non-financial measures by requiring that:
This was a controversial proposal which raised concerns about the appropriateness of a prescriptive approach that could entrench scorecard-based remuneration models and preclude innovation in developing remuneration arrangements. There was also concern that the proposals placed excessive weight upon undefined non-financial measures. The revised draft CPS 511 attempts to address these concerns by providing greater flexibility to accommodate various remuneration structures. Specifically, draft CPS 511 now requires that entities demonstrate only that they are giving "material weight" to non-financial measures where a person's variable remuneration is performance related. Importantly, what constitutes "material weight" is not defined. |
SFI Deferral and clawback |
There are currently minimum deferral obligations for authorised deposit-taking institutions (ADIs) that are limited to "accountable persons" under the Banking Executive Accountability Regime (BEAR), which will soon become the Financial Accountability Regime (FAR). Similarly, CPS/SPS 510 and BEAR/FAR require that an entity's remuneration policy must provide for the adjustment of performance-based / variable remuneration downwards to zero in certain circumstances. Initial draft CPS 511 proposed that an entity must defer 60% of its CEO's variable remuneration for 7 years, 40% of its senior managers' and executive directors' variable remuneration for 6 years and 40% of its HPMRTs' variable remuneration for 6 years. Each of these arrangements would be permitted to vest after 4 years on a pro-rata basis. Clawback requirements, in the form of minimum clawback criteria and periods, were also proposed in respect of these persons in the initial draft CPS 511. In responses to the initial consultation, the deferral obligations were described as being long and weighted toward banking practice, while many considered that clawback would be legally costly to undertake. It was also noted that these proposals could inhibit an entity's ability to attract and retain talent. APRA has responded to industry feedback by reducing the deferral periods applicable to relevant individuals of an SFI, such that an entity must now defer:
APRA has also clarified that the policy intent is that clawback would only be considered in exceptional circumstances. |
Reviews |
APRA has observed that the current review requirements for remuneration policies contained in CPS 510 and SPS 510 do not sufficiently enable a view to be formed as to whether a policy is working as intended. It therefore proposed in initial draft CPS 511 that an entity's remuneration framework be subject to an annual compliance review and triennial effectiveness review, as well as that the board remuneration committee consider and address the findings of any such reviews. Stakeholders queried whether annual reviews of compliance were necessary and whether it would result in meaningful insights being drawn. Further, many questioned whether these requirements were appropriate for smaller entities due to the potential compliance burden. APRA has retained the annual compliance review requirement in revised draft CPS 511, noting that a routine appraisal of the remuneration framework against the standard will strengthen its operating effectiveness. However, under revised CPS 511, non-SFIs will not be required to undertake any effectiveness or compliance reviews. |
Disclosure |
Currently there are limited and high-level prudential requirements for transparency of remuneration practices that only apply to ADIs (see APS 330), while there are also additional general disclosure requirements contained in the Corporations Act 2001 (Cth) and the Superannuation Industry (Supervision) Act 1993 (Cth). In light of this, during the initial consultation for CPS 511, APRA outlined its plans to introduce reporting and disclosure requirements for all APRA-regulated entities during the initial consultation for CPS 511. The aim of the new requirements will be to reinforce accountability by having entities publicly demonstrate how they are satisfying the key obligations in the standard. Industry participants have highlighted that current disclosures can lack comparability and can be overly complex, while it has been suggested that the new obligations should focus on explaining how targets are chosen and met, why they are appropriate and the basis of any risk adjustments made. APRA is therefore considering requiring:
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When and how will CPS 511 come into effect?
APRA is requesting industry feedback on revised CPS 511 by 12 February 2021, with the intention of finalising the standard by the second quarter of 2021. Final CPS 511 will then come into effect for SFIs that are ADIs on 1 January 2023, for insurance and superannuation SFIs on 1 July 2023 and for non-SFIs on 1 January 2024.
APRA will also be reinforcing the policy objectives which underpin CPS 511 by:
- supervising entities' remuneration arrangements, commencing with a deep dive implementation review on a sample of entities once arrangements are in place;
- drafting a new prudential practice guide, which will facilitate implementation of the standard and APRA's ongoing supervision of the requirements;
- introducing the reporting and disclosure requirements, once finalised, in order to support the supervision focus of the standard; and
- reviewing the effectiveness of CPS 511 four years from its effective date to ensure the standard is delivering on intent.
Authors: Silvana Wood, Partner; Jennie Mansfield, Partner; Dominic Tran, Senior associate; and Jack Collins, Graduate.
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