APRA to crack down on remuneration

The Australian Prudential Regulation Authority (APRA) has released a discussion paper, opening consultation on a new draft prudential standard (CPS 511) aimed at “clarifying and strengthening remuneration requirements” in APRA-regulated entities.

According to APRA, the newly proposed standard seeks to “align remuneration frameworks with the long-term interests of entities and their stakeholders”, which it said includes customers and shareholders.

The standard would introduce heightened requirements on entities’ remuneration and accountability arrangements and has come in response to evidence identified during the banking royal commission, which found that existing arrangements have contributed to poor consumer outcomes.

APRA stated that its proposals address recommendations 5.1 and 5.3 of commissioner Kenneth Hayne in the royal commission’s final report.   

The prudential regulator claimed that its package of measures is “materially more prescriptive” than its existing remuneration requirements.

Among the key reforms, APRA is proposing: 

• To elevate the importance of managing non-financial risks, financial performance measures must not comprise more than 50 per cent of performance criteria for variable remuneration outcomes; 
• Minimum deferral periods for variable remuneration of up to seven years will be introduced for senior executives in larger, more complex entities. Boards will also have scope to recover remuneration for up to four years after it has vested; and
• Boards must approve and actively oversee remuneration policies for all employees and regularly confirm they are being applied in practice to ensure individual and collective accountability.

According to APRA, it flagged its intention to strengthen prudential requirements on remuneration in April last year following its Review of Remuneration Practices at Large Financial Institutions, with the need for a strengthened approach further underlined by the findings of last year’s Prudential Inquiry into the Commonwealth Bank of Australia, as well as the recent industry self-assessments examining issues on governance, accountability and culture.

Commenting on the proposed reforms, APRA deputy chair John Lonsdale said: “Remuneration and accountability frameworks play an important role in driving employee behaviour. Where policies are poorly designed, or not followed in practice, companies may incentivise conduct that is contrary to the long-term interests of the company and its customers. 

“In the financial sector, APRA has observed an over-emphasis on short-term financial performance and a lack of accountability when failures occur, especially among senior management. 

“This has contributed to a series of damaging incidents that have undermined trust in both individual institutions and the financial industry more broadly. Crucially from APRA’s perspective, these incidents have damaged not only institutions’ reputations, but also their financial positions.”

Mr Lonsdale added that CPS 511 would, along with the Banking Executive Accountability Regime, lift industry standards of accountability and reduce the likelihood of misconduct.

“Limiting the influence of financial performance metrics in determining variable remuneration will encourage executives to put greater focus on non-financial risks, such as culture and governance. As our recent response to the industry self-assessments made clear, this remains a weak spot in many financial institutions,” he added.

“Introducing the minimum holding periods for variable remuneration ensures executives have ‘skin in the game’ for longer and allows boards to adjust remuneration downwards if problems emerge over an extended horizon.

“APRA will not be determining how much employees get paid. Rather, we want to empower boards to more effectively incentivise behaviour that supports the long-term interests of their entities. By reducing the risk of misconduct, we hope to see better outcomes for customers and higher returns for shareholders in the long term.”

Mr Lonsdale concluded: “We recognise that some aspects of this proposal are far-reaching and will require major changes to industry practices. APRA will listen closely to feedback from impacted stakeholders to determine if our proposed approach is correctly calibrated to achieve its intended outcomes.”

APRA has opened a three-month consultation period, which will conclude on 22 October, and intends to release the final prudential standard before the end of 2019, with a view to it taking effect in 2021 following appropriate transitional arrangements.

[Related: APRA addresses leadership questions]