APRA consults on guidance for a remuneration regulation not yet final

The draft Prudential Practice Guide CPG 511 Remuneration sets out principles and examples of better practice to assist banks, insurers and superannuation licensees comply with prudential standard CPS 511 Remuneration.

APRA is seeking feedback on a guide to implement its pay regulation when the pay regulation itself has not been finalised. This assumes that a regulation that has not been finalised is one that has not been released. So perhaps this assumption is incorrect, and APRA has finalised CPS 511, and for reasons it keeps to itself, wants it kept a secret. Or maybe it forgot. Whatever the case, we are being asked to comment on a guide for putting into practice a final regulation that we have not seen.

APRA released a draft new pay regulation on 23 July 2019, applicable to all APRA-regulated entities (see HERE). The revised draft remuneration regulation was released in November 2020 (see HERE).

Following feedback, the key revisions for the draft regulation included:

  • Replacing the 50 per cent cap on financial measures for variable remuneration with a requirement that material weight be assigned to non-financial measures, combined with a risk and conduct modifier that can potentially reduce variable remuneration to zero; and
  • A reduction in the minimum deferral periods for variable remuneration from seven to six years for CEOs, from six to five years for senior managers and from six to four years for highly paid material risk takers.

The final version of the regulation will not be released until after mid-year 2021, as APRA considers feedback (see our submission HERE).

This draft prudential practice guide will help entities to comply with the new standard by:

  • Outlining examples of better practice in board oversight, including robust challenge and independent scrutiny;
  • Setting out frameworks for defining non-financial measures and determining material weight for use in calculating variable remuneration; and
  • Setting out principles for downward adjustments of variable remuneration where there have been poor risk outcomes.

A reading of the draft suggests that APRA has made decisions on aspects of the regulation that some, including Guerdon Associates, wanted changed (see HERE). For example, the draft guide assumes that the regulation will retain a requirement for a “material weight” to be given to non-financial measures for significant financial institutions (SFIs) (see paragraph 43). Our submission argued for an “appropriate balance”, similar to a UK regulation (see HERE). That is, the proportion of variable remuneration dependent on non-financial measures would depend on the context. The draft guide actually refers to “balance” (hooray – see for example, paragraph 38). It also recognises context, which was the point of our submission in this regard. See for example, how balance would be adjusted (e.g. paragraphs 32 and 47). Further, our submission argued that the “balance” can be tested through applications of stress tests. The latter the draft guide infers (see for example paragraph 15), but does not quite nail. The actual guidance for how to determine a material weight (paragraphs 54 to 59) are vague.

Throughout, the guide suggests that gateways and modifiers are carved out from determining whether there is “material weight” to non-financial measures. If it will impact behaviour, as these will, there is no reason for them not to be included and that they contribute to determining a material weight. To deny it would be delusional, and/or alarmingly ignorant of the behavioural sciences underlying effective remuneration. It remains difficult to fathom why APRA has this view.

The draft guide still defines variable remuneration as that which may be contingent on service. Pity. Our submission pointed out that salary is contingent on service. It appears that this has not quite sunk in. Or if it has, the inference is that all remuneration is in fact variable remuneration. This may be what they mean, because on pages 13 and 14 of the guide, they describe VR as cash, non-cash or equity remuneration, which covers just about everything, including the free lunch in the board room. So, if APRA means everything, why use the word “variable”?

Interestingly, the guide refers to a form of variable remuneration not at all captured by the regulatory definition, overly extensive as it is. This is something called “complex remuneration”, such as loans to acquire equity, which acts as leveraged remuneration.

APRA Chairman Wayne Byres’ speech to the Committee for the Economic Development of Australia noted “late in 2021 there will be new disclosure requirements which will compel institutions to explain how the incentives were designed, the reasons behind KPI weightings in scorecards, more detail on highly paid material risk takers and circumstances where consequence management was applied with how much was forgone and why.”

This guidance is aimed at removing ambiguity surrounding the draft proposals. It aims to help boards that “want to get on and make changes to their arrangements now.”

See the draft CPG 511 HERE. The draft CPG 511 and a consultation letter to industry are available on APRA’s website (see HERE).

Implementation is targeted for 2023.

Written submissions are requested by 23 July 2021.

© Guerdon Associates 2021
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