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Executive remuneration and accountability – the revised APRA CPS 511 Remuneration

12 January 2021 | Australia
Legal Briefings – By Michael Vrisakis, Michael Gonski, Priscilla Bryans, Steven Rice, Tamanna Islam and Shan-Verne Liew

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On 12 November 2020, the Australian Prudential Regulation Authority (APRA) released a revised draft Prudential Standard CPS 511 Remuneration for consultation (Revised Draft CPS 511). The revised standard has moved away from the prescriptive requirements of the initial consultation draft, towards a ‘principles-based approach’, giving banks, superannuation funds and insurers greater latitude to determine and tailor their own remuneration thresholds. 

The key takeaways – What does this mean for APRA-regulated entities?

  • APRA expects all APRA-regulated entities to review their existing remuneration frameworks and develop an implementation plan within 18 months of the release of the final version of CPS 511, expected in Q2 of 2021. This will essentially be the first key deliverable for implementing CPS 511.
  • This review of existing remuneration frameworks should be conducted in conjunction with preparation of a project plan to implement the Financial Accountability Regime (FAR), which may ultimately commence before CPS 511. We explain below why implementing both FAR and CPS 511 in tandem can produce a more effective outcome.
  • CPS 511 is proposed to commence:
    • for ADIs that are Significant Financial Institutions (SFIs) (see below) – from 1 January 2023;
    • for general insurers, life companies, private health insurers and RSE licensees and NOHCs that are SFIs, and for all groups headed by an SFI – from 1 July 2023;
    • for all other APRA-regulated entities – from 1 January 2024.
  • All new remuneration arrangements will need to comply with CPS 511 from the relevant commencement date.
  • CPS 511 should not require a wholesale rewrite of existing governance arrangements for remuneration. Rather, existing governance arrangements can in many cases be updated to ensure that they align with the particular requirements in CPS 511. In particular, consequences for failure to meet expected standards of behaviour should be clear where they are not already.
  • CPS 511 will require APRA-regulated entities to review their variable remuneration arrangements, including scorecard metrics. The Revised Draft CPS 511 gives regulated entities the flexibility to tailor their remuneration framework to their business and particular business risks. When designing the remuneration structure, APRA-regulated entities should have regard to the financial and non-financial risks facing their businesses, and seek to reflect these risks in their remuneration structures. In revising variable remuneration and scorecard metrics, it will be important to ensure that the restrictions imposed by the conflicted remuneration regime are also adequately addressed, where relevant.

What is CPS 511?

CPS 511 will establish mandatory requirements for the remuneration of senior managers, material risk-takers, and risk and financial and control personnel in all APRA-regulated entities. In particular, CPS 511 seeks to impose requirements on the use of non-financial metrics in variable remuneration arrangements and the mandatory deferral of variable remuneration for executives. Greater transparency is also a key objective, with the imposition of additional disclosure requirements in respect of remuneration practices.

What are the proposed changes in Revised Draft CPS 511?

While a myriad of changes have been proposed in the Revised Draft CPS 511, the table below sets out some key differences between APRA’s Draft CPS 511 released in July 2019 (Draft CPS 511) and the Revised Draft CPS 511 released on 12 November 2020.

Draft CPS 511 Revised Draft CPS 511

CPS 511 to apply equally to all APRA-regulated entities.

No recognition of regulatory burden on smaller APRA-regulated entities.

CPS 511 to adopt a two-tiered approach. Entities will be classified as either Significant Financial Institutions (SFIs) or as non-SFIs, based on the complexity of the business and whether the entity’s size exceeds a particular threshold, as determined by APRA.

SFIs: requirements to:

  • establish a Board Remuneration Committee that meets specified requirements as to its composition and functions;
  • give material weight to non-financial measures in the course of designing performance-related remuneration, and adjust remuneration outcomes down if adverse risk and conduct outcomes occur;
  • review compliance with the remuneration framework annually, report results to the relevant oversight function, and conduct a comprehensive independent review every three years;
  • defer a portion of the variable-based remuneration of its CEO, senior managers, executive directors and highly-paid material risk takers;
  • claw back variable remuneration if specified events occur;

Non-SFIs: not subject to the above requirements.

This two-tiered approach mirrors Treasury’s consultation on FAR, which proposes to exempt entities that are smaller than a particular threshold, determined by the regulators, from the requirement to submit accountability maps and statements.

Financial performance measures must not comprise more than 50% of total measures used to allocate variable remuneration.1

Each individual financial performance measure must not comprise more than 25% of total measures.

SFIs: No maximum specified threshold for financial measures. SFIs must instead ‘give material weight to non-financial risks’ in the course of designing variable remuneration.

Non-SFIs: No requirement.
APRA-regulated entities apply CPS 511 to persons employed by (or contractors of) bodies corporate that are not related or connected to the APRA-related entity, if specified conditions are met.3

The Revised Draft CPS 511 does not extend remuneration frameworks to third party employees and contractors.

In our view, this is a significant positive change that recognises the complexity that would have arisen from a requirement on APRA-regulated entities to ensure that third party contractors are remunerated by their employers in accordance with the remuneration design requirements in CPS 511.

Instead, remuneration frameworks must include a process for conducting a risk assessment of the remuneration arrangements of service providers that are not related bodies corporate or connected entities of the APRA-regulated entity. This risk assessment must identify and address any inconsistencies between the remuneration arrangements of these service providers and the requirements for a compliant remuneration framework.4

Highly-paid material risk takers, whose remuneration is subject to additional requirements under CPS 511, are defined by reference to their ‘maximum potential variable remuneration’, among other factors:

‘a material risk taker whose total fixed remuneration plus maximum potential variable remuneration is equal to or greater than $1 million AUD in a financial year

The definition of a highly-paid material risk taker is now referrable to total fixed remuneration and actual variable remuneration in a financial given year of the entity.

These changes will reduce the number of persons who are caught by the definition, and improve certainty in determining whether a person falls within the definition.

Total Variable Remuneration (TVR) must be deferred for:5

  • CEOs – at least 60% of TVR over at least 7 years;
  • Other senior managers, executive directors and highly-paid material risk takers – at least 40% of TVR over at least 6 years;
For both categories, vesting of that percentage of TVR could only occur after four years from the time of inception and no faster than on a pro-rata basis.

SFIs:6

  • CEOs – at least 60% of TVR over at least 6 years, vesting no faster than on a pro-rata basis only after 4 years;
  • Senior managers and executive directors (except CEOs) – at least 40% of TVR over at least 5 years, vesting no faster than on a pro-rata basis only after 4 years;
  • Highly-paid material risk takers who are not senior managers – at least 40% of TVR over at least 4 years, vesting no faster than on a pro-rata basis only after 2 years.

We consider this to be a positive change. As highlighted by APRA, we note that pro-rata vesting from year four aligns more closely with the typical term and vesting period for many Australian CEOs.

Non-SFIs: No deferral requirement.
 

 

Boards or the relevant oversight function must individually approve the variable remuneration outcomes for:

  • senior managers;
  • material risk-takers; and
risk and financial control personnel.7

Variable remuneration outcomes must be individually approved individually for senior managers and executive directors, but on a cohort basis for material risk-takers and risk and financial control personnel.8

 
Certain executive and director remuneration must be publicly disclosed under the Corporations Act 2001 (Cth), superannuation legislation, and APRA’s implementation of the Basel 3 framework. In addition to existing requirements, APRA will consult on additional public disclosure requirements to improve the consistency, clarity, level of detail of disclosures about remuneration, particularly for material risk takers in APRA-regulated entities.9

Why is APRA working on CPS 511?

Remuneration was identified by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) as a key driver of poor conduct, and the topic has been front and centre on APRA’s agenda for several years. In characterising findings made by the Royal Commission with respect to remuneration, APRA Chairman Wayne Byres in a speech on 13 November 2020 referred to scathing remarks made by Commissioner Hayne that:10

“from the executive suite to the front line, staff were measured and rewarded with reference to profits and sales”, leading to “the pursuit of short term profit at the expense of basic standards of honesty.”

As recommended by Commissioner Hayne,11 APRA’s approach to the supervision of remuneration through CPS 511 in many ways appears to draw on the Principles for Sound Compensation Practices published by the Financial Stability Board in 2009,12 which (among other principles) recommended that the Board of financial services businesses must actively oversee the design and operation the compensation system of their organisation.

One key reason for this reform is a perception that businesses were not adequately managing non-financial risks. Accordingly, by bringing non-financial metrics into an organisation’s remuneration and incentive structure, key decision-makers are incentivised to better manage non-financial risks, in addition to financial risks.

While CPS 511 focuses on personnel that have a key-decision-making role in APRA-regulated entities, such as senior managers and risk and financial control personnel, CPS 511 does not deal with the remuneration arrangements for frontline sales staff, which was a focus of the Retail Banking Remuneration Review report released by Steven Sedgwick AO in April 2017. However, it is important to remember that CPS 511 can still have an impact on the remuneration of management personnel who supervise distribution and frontline sales teams.

How can APRA-regulated entities move forward with CPS 511 and FAR?

In its 2020–2024 Corporate Plan released on 31 August 2020, APRA highlighted the implementation of both CPS 511 and FAR as outcomes that it will seek achieve as part of its work to ‘transform governance, culture, remuneration and accountability across all regulated entities’. Both regimes will be closely intertwined.

As APRA Deputy Chairman Helen Rowell explained in a speech to the Australian Institute of Company Directors on 20 February:

“A good example of our approach is the introduction of a strengthened prudential standard on remuneration. Accountability and remuneration – especially variable remuneration – go hand in hand. If remuneration is the carrot, then accountability, in the form of remuneration being withheld, is the stick.”

APRA-regulated entities looking to effectively implement CPS 511 should consider performing their review of remuneration frameworks in conjunction with a review of possible accountable persons in preparation for FAR, and develop an implementation project plan that will ultimately deliver compliance with both regimes. This will allow APRA-regulated entities to escape the need to perform two separate reviews with respect to two regulatory regimes covering many of the same persons within an organisation.

As Helen Rowell’s speech makes clear, both regimes will go hand in hand, and in that regard it makes sense that a cohesive approach to implementing CPS 511 and FAR together will be more effective than commencing two separate implementation projects.

In particular, FAR will take the first step of requiring APRA-regulated entities to review, determine and document the accountabilities of their senior executives, and CPS 511 will take the next step by requiring businesses to consider the non-financial metrics that can be aligned to those accountabilities.

Project plans for implementing both regimes will include reviewing the roles of senior personnel, expanding APRA reporting protocols, revising frameworks for performance and disciplinary reviews, revising onboarding processes for senior personnel, and reviewing board charters.

Finally, a cohesive implementation approach will allow APRA-regulated entities to need to reconsider the terms (i.e. the accountabilities and remuneration) of their senior executive only once, and make a single round of required revisions to their governance arrangements.

Standardised public disclosure

APRA’s consultation paper (Second Consultation Paper), released together with Draft CPS 511, noted that ‘APRA is considering a standardised approach for entities to publis[h] certain, core quantitative disclosures’ about the remuneration of persons within APRA-regulated entities, particularly material risk takers.

In developing these requirements, we believe it would be helpful for APRA to articulate how it considers that public disclosure at a greater level than that currently in place would lift standards of practice and promote market discipline. We note that many of the obligations proposed in the Revised Draft CPS 511 already address concerns around remuneration practices.

What is the context of this 2nd consultation on CPS 511?

In July 2019, APRA released Draft CPS 511 and a consultation paper that attracted rigorous feedback from industry and other stakeholders, including 79 formal submissions. As a result, nearly every aspect of the Draft CPS 511 has been reconsidered in the Revised Draft CPS 511.

In our submission to APRA on the Draft CPS 511, we highlighted that one of the potential unintended consequences of the stronger regulations in the Draft CPS 511 was that APRA-regulated entities will be at a disadvantage in recruiting talent, particularly talent that can work in other sectors outside the financial services sector or in other jurisdictions outside Australia.

APRA appears to have responded to much of this kind of feedback from stakeholders. In its consultation paper (Second Consultation Paper) accompanying the Revised Draft CPS 511, APRA claims that the Revised Draft CPS 511 delivers a more principles-based approach, giving boards ‘more flexibility to strengthen remuneration practices in a way that is appropriate to their business model and particular risks’.

CPS 511 was originally intended to commence from 1 July this year. But given the significant changes that have been proposed, APRA has commenced a fresh round of consultation on the Revised Draft CPS 511, with a request for feedback by 12 February 2021.

Endnotes

  1. Draft CPS 511, para 38.
  2. Revised Draft CPS 511, para 37.
  3. Draft CPS 511, para 19(d).
  4. Revised Draft CPS 511, paras 20(c), 62(c).
  5. Draft CPS 511 paras 53–4.
  6. Revised Draft CPS 511 para 51.
  7. Draft CPS 511 para 50.
  8. Revised Draft CPS 511 paras 49, 71.
  9. Second consultation paper, chapter 10.
  10. https://www.apra.gov.au/news-and-publications/apra-chair-wayne-byres-speech-to-women-banking-and-finance-series-luncheon ; Interim Report xix.
  11. Recommendation 5.1: https://www.royalcommission.gov.au/sites/default/files/2019-02/fsrc-volume-1-final-report.pdf
  12. https://www.fsb.org/wp-content/uploads/r_0904b.pdf

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