Revised remuneration prudential standard released for consultation by APRA

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:

• are ultimately responsible for an entity's remuneration framework and its effective application; and
• must establish a Board Remuneration Committee that, among other things, oversees the design, operation and monitoring of the remuneration framework. It must consult the Board Risk Committee and the Chief Risk Officer or person in a similar role to enable risk outcomes to be appropriately reflected in remuneration outcomes for persons in specified roles, and must also obtain comprehensive reporting that will allow it to determine whether remuneration outcomes of all remuneration arrangements are aligned to draft CPS 511.

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:

• take an entity wide view to effectively govern implementation and outcomes of the remuneration framework;
• improve oversight of incentives and how behaviour may drive or impact the entity; and
• understand how different elements within the remuneration framework interact to appropriately govern and support prudent remuneration practices.

The initial draft CPS 511 intended to strengthen an entity's oversight and risk assessment of remuneration arrangements with third-party service providers by:

• addressing the gaps in the existing CPS 510 and SPS 510 requirements by explicitly capturing the employees of third-party service providers rather than setting the requirement at the service contract level;
• expanding the focus of performance-based remuneration from supporting the long-term financial soundness of an institution and the institution's risk management framework so as to also include risk, sustainable performance and long-term soundness; and
• requiring an assessment of third-party service provider remuneration arrangements to be part of the entity's remuneration framework.

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.

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:

• financial measures do not exceed 50% of the total performance criteria used to determine variable remuneration; and
• individual financial measures do not comprise more than 25% of the total measures used.

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.

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:

• 60% of its CEO's variable remuneration for 6 years, with pro-rata vesting permitted from year 4;
• 40% of its senior managers' and executive directors' variable remuneration for 5 years, with pro-rata vesting permitted from year 4; and
• 40% of its HPMRTs' variable remuneration for 4 years, with pro-rata vesting permitted from year 2.

APRA has also clarified that the policy intent is that clawback would only be considered in exceptional circumstances.

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.

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:

• qualitative information about an entity's remuneration governance and oversight;
• quantitative information, aggregated for groups of employees and specified roles, regarding remuneration design and outcomes; and
• qualitative information, aggregated for groups of employees and specified roles, in relation to an entity's consequence management policies and procedures.