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15 major HR implications of APRA’s proposed CPS511

Executive Compensation
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By Shai Ganu and Ewan Taylor | August 21, 2019

APRA released CPS 511 Remuneration with the intention to strengthen the prudential requirements around remuneration.

On 23 July 2019, APRA released a draft new prudential standard on remuneration (CPS 511) with the aim of ensuring the remuneration arrangements of APRA-regulated entities produce appropriate incentives and outcomes.

The new standard will replace the remuneration requirements for all authorized deposit-taking institutions (ADIs)s, general insurers, life insurers, private health insurers and Registrable Superannuation Entity licensees currently contained in CPS 510 and SPS 510.It will require companies to have a remuneration framework that includes a remuneration policy with prescribed content (expanded from CPS 510 and SPS 510), annual compliance reviews and comprehensive independent effectiveness reviews at least every three years.

The new standard imposes remuneration design and outcomes requirements for all employees, with additional requirements for persons in "special role categories" i.e. senior managers, material risk-takers (including highly-paid material risk-takers) and risk and financial control personnel. There are also deferral and clawback prescriptions for the CEO, senior managers and highly-paid material risk-takers of the largest APRA regulated entities, as defined by asset size ("significant financial institutions" or SFIs).

Much of the draft new CPS 511 is a more comprehensive and explicit statement of obligations under the current prudential standards. Some requirements are restated – for example, ensuring that variable remuneration is aligned with prudent risk taking, aligning awards commensurate with performance and risk outcomes, and making adjustments downwards, to zero if appropriate, to protect the financial soundness of the organisation. But there are some significant new developments, with Willis Towers Watson's initial review of CPS 511 suggesting the following material changes:

  1. Remuneration policy coverage

  2. Current
      • Remuneration policy covers senior executives and MRTs
      • Note that the Banking Executives Accountability Regime (BEAR) now requires that the remuneration policies of large, medium and small ADIs allow for minimum 4-year deferral of, and reductions in, variable remuneration for 'accountable persons'

    Minimum deferral and clawback requirements will apply for special role category employees in 'significant financial institutions'.

    In the future
      • Remuneration policy to cover structure and terms of remuneration for all employees
      • Specific requirements for 'special role category' employees in all APRA-regulated entities
      • CPS 511 also sets additional minimum deferral and clawback requirements for special role category employees in 'significant financial institutions'; i.e. 40+ of the largest APRA-regulated entities (including major banks and ADIs, foreign ADIs, superannuation entities, general insurance and life insurance companies).
      • The CPS 511 deferral periods for SFIs exceed the BEAR deferral requirements – see below.
  3. Special role categories and new definitions of 'material risk taker' and 'highly-paid material risk taker'

  4. Current
      • Remuneration requirements apply to: senior executives, other persons who may have a material impact on the entity's financial soundness and risk and control functions
      • Material risk takers defined as all persons other than senior executives for whom a significant portion of total remuneration is based on performance and whose activities individually or collectively may affect the financial soundness of the entity

    The new category of "highly paid material risk taker" is defined as material risk takers whose total fixed remuneration plus maximum potential variable remuneration is equal to or greater than AUD1 million in a financial year.

    In the future
      • Continues the existing categories, now termed 'special role categories', with some refinements, including replacing 'senior executive' with 'senior manager' to better align with fit and proper standards and BEAR
      • Material risk takers now defined as all persons other than senior managers whose activities have a material potential impact on the entity's performance, risk profile, long-term soundness
      • Introduces the new category of "highly paid material risk taker" i.e. material risk takers whose total fixed remuneration (which includes salary, superannuation, allowances and benefits) plus maximum potential variable remuneration is equal to or greater than AUD1 million in a financial year
  5. Board accountability

  6. Current
      • Board and remuneration committee responsible for remuneration framework for senior executives and special role employees
    In the future
      • Board must "actively oversee" remuneration policy (including the structure and terms of remuneration arrangements) for all employees and contractors.
      • For large companies, this may involve monitoring of up to 25 or 30 different remuneration structures and incentive arrangements.
  7. Added approval responsibilities

  8. Current
      • Remuneration committee recommendations for CEO, direct reports, material risk takers
      • Most boards would approve the individual pay outcomes for top 10 to 15 MRTs and key management personnel (KMP).
    In the future
      • Remuneration committee to recommend and board to approve individual remuneration arrangements and variable remuneration outcomes for all senior managers and highly paid MRTs
      • Recommendations and approvals on a collective basis for all other MRTs and risk and financial control personnel
  9. Remuneration committee workload

  10. Current
      • No prescription
    In the future
      • Remuneration committee must obtain comprehensive reporting to allow it to assess whether remuneration outcomes of all remuneration arrangements (i.e. for all employees) align with the entity's remuneration objectives.
  11. Financial metrics capped at 50% for all employees

  12. For all employees, at least 50% of variable remuneration will have to be allocated on the basis of non-financial performance measures.

    Current
      • No prescription
      • Incentive plans currently mostly reflect financial KPIs.
    In the future
      • 50% cap on financial measures in variable remuneration
      • 25% cap for any one financial performance measure
  13. Deferral for special role categories in significant financial institutions (SFIs)

  14. Current
      • No prescription
    In the future
      • CEO: Deferral of 60% of total variable remuneration for at least 7 years, with vesting only permitted after 4 years and no faster than on a pro-rata basis over the next 3 years
      • Senior managers and highly-paid MRTs: Deferral of 40% of total variable remuneration for at least 6 years, with vesting only permitted after 4 years and no faster than on a pro-rata basis over the next 2 years (Deferral and vesting requirements do not apply if variable remuneration is less than $50,000 in a financial year)
      • May require setting of 4 to 7 year targets for non-financial KPIs, with meaningful threshold and stretch levels of performance
      • Potentially 3 to 5 KPIs for LTI plans will be set
  15. Clawback for special role categories in SFIs

  16. Current
      • No prescription
    In the future
      • Minimum clawback period of 2 years from date of payment or vesting, or 4 years if an investigation is underway
      • Specific clawback criteria include material misstatement of financial statements on which variable remuneration outcomes were determined
  17. Post-employment vesting

  18. Current
      • No provision
    In the future
      • No accelerated vesting of variable remuneration on cessation of employment (except on death, serious incapacity, serious disability or serious illness); same vesting conditions to apply as for continuing employees
  19. Criteria for reductions in variable remuneration – all employees ("malus")

  20. Current
      • Not specified
    In the future
      • Unvested deferred variable remuneration must be reduced for criteria including: a significant downturn in financial performance; significant adverse outcomes for customers or beneficiaries
  21. Review of remuneration framework

  22. Current
      • Remuneration committee to conduct "regular" reviews of and make recommendations to the board on effectiveness and compliance of remuneration policy
    In the future
      • Must review compliance of remuneration framework with CPS 511 at least annually
      • And must be a comprehensive independent review of effectiveness of remuneration framework at least every 3 years
      • Results of reviews to be reported to remuneration committee, which must address and implement review findings

     

    Although not explicitly stated in the standard, we anticipate that these changes will impact the following:

  23. Cost of governance

  24. There may be increases in the number of remuneration committee members and in the fees for remuneration committee membership. Non-executive director (NED) fees and associated cost of governance may increase. We may also see an increase in fees to compensate for increased reputational risks for NEDs.

  25. Deleveraging of pay

  26. Institutional deleveraging of pay may occur – with higher fixed and lower variable pay levels. We have seen this happen in other jurisdictions when regulators have tried to limit incentive compensation.

  27. Significant changes to compensation frameworks

  28. We are already beginning to see some companies eliminate sales incentives, or move away from individual incentives and towards team-based incentive structures.

    We are already beginning to see some companies eliminate sales incentives, or move away from individual incentives and towards team-based incentive structures. These could have significant implications for compensation frameworks across financial services, and eventually impact other industries as well.

  29. Talent pool implications

  30. Global executives may be less attracted to move to Australia. Conversely, Australian talent may have more impetus to seek opportunities overseas or to move to other industries.

Process wise, APRA intends to finalise the prudential standard in late 2019 or early 2020 with the requirements proposed to commence for most regulated industries (including superannuation) from 1 July 2021. The remuneration requirements in CPS 510/SPS 510 will be repealed at that time. A prudential practice guide and reporting and disclosure standards will be developed for consultation in early 2020.

Given the significance of the proposals and potential industry impact, APRA intends to conduct a review of the effectiveness of the prudential standard three years from its initial effective date.

Some aspects of the proposed changes are significant and would require major changes to industry practices. As a result, APRA intends to conduct an intensive three-month consultation process to ensure the views of all impacted stakeholders are carefully considered before the prudential standard is finalised. In addition to accepting written submissions, APRA will conduct a series of webinars designed to further explain their thinking, answer questions and listen to industry feedback. Consultation closes on 23 October 2019.

  • For your reference, you can find the draft standard here
  • And the discussion paper can be found here

Although we do not expect any immediate implications for Asian banks or insurance companies in the coming 2-3 years, this may signal some directional changes for the entire global financial services industry. Also, as we have seen in the past, compensation practices that start from financial services eventually permeate, to some extent, to other industries. Indeed, if approved, CPS 511 will likely have significant implications for compensation and talent management arrangements across the region.

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