APRA pay regulation

Submissions to APRA on its proposed new prudential standard regulating pay (CPS 511 – see HERE) are now closed .

Although not all submissions have been made public, those that are available appear to make similar points. Among these is that prescribing the types of performance measure to be used will not accommodate the nature of the organisation, reflect organisation priorities, or reflect the purpose of a position.

True enough.

However, none to our knowledge submit that the prescriptions fail to achieve what APRA wants, and none provide suggestions on how to reconfigure the prudential standard to give APRA what it needs.

What does APRA want to achieve?

We and other stakeholders who APRA consulted would know that APRA desires that misconduct risk be incorporated into remuneration frameworks. Funny that, because the draft standard does not say so. Rather it seems to be assumed that requiring at least 50% of incentives to be contingent on non-financial performance will lead to measures that include measures of behaviour. Not so. A bank can meet the standard by utilising absolute and relative TSR (mistakenly labelled a financial measure in the APRA discussion paper) and economic profit and return on risk-adjusted assets (which fall into the “non-financial measure” bucket, according to the standard). No behaviour to be seen here.

In fact, many frameworks that APRA may believe are desirable would not pass through the needle eye of their draft standard.

For example, let us take the idea of a conduct gate. This is an instrument dictating that any misconduct on an executive’s watch leads to zero incentives paid. There is a lot to like. It is simple. It involves behaviour. It tackles an element of risk that has been undercooked and overlooked. It is direct, and relates to an executive’s patch (aka a BEAR accountability map). It could have a lot of money riding on it and would therefore direct an executive’s focus.

Despite all these advantages, it would not comply with APRA’s proposed standard because it is binary, with 100% of an incentive riding on a single measure. Under the black letter law of the draft standard, gates cannot be used because any measure must constitute no more than 25% of all measures. A gate determines, in effect, 100% of the incentive payment.

So, now that it is established that the draft standard will not meet APRA’s own requirements, what is it to do?

We know what is required of APRA. The APRA Act requires APRA to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality, and, in balancing these objectives, promote financial system stability in Australia.

In effect, the desired outcomes of APRA regulation and supervision are a thriving, healthy, and safe financial services sector in banking, insurance and superannuation.

Within our firm we have debated how remuneration regulation should be configured to support these objectives. We have an answer. It is in our submission. But it is probably not as direct as APRA would like.

APRA already has the authority to get what it wants, it just lacks the evidence that remuneration is not fit for purpose.

That is, as a nicely symmetric counter-point to the risky and ineffective remuneration mess that APRA regulated listed entities suffer because of the 2-strikes law, APRA already has the power to remove directors that do not demonstrate competence. If it requires remuneration committee directors to provide evidence that their remuneration meets prudential remuneration guidelines, those who do not can receive a warning shot, and then be removed. APRA is full of well educated, numerate people. As are banks. Statistical analysis to prove or disprove the hypothesis that a bank’s remuneration framework is effective would not be difficult for a bank’s directors to require, a bank’s management to provide, and APRA to assess. And it could be made transparent, so that other stakeholders can also make their own assessment, and over time, standards of evidence and remuneration effectiveness would lift across APRA-regulated industries.

And it would be a nice change that remuneration policies be based on evidence about what works, rather than the belief systems prevalent behind prescriptions used by shareholders using the 2-strikes law.

See Guerdon Associates submission HERE .

© Guerdon Associates 2020
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