Regulator says make executives accountable, and vary their pay – a stark message for all board remuneration committees
07/05/2018
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Guerdon Associates newsletters and articles may appear, recently, to be consumed with financial services sector governance and regulation. This is not only a reflection of stakeholders’ current focus. Governance practice changes in financial services have a tendency to be harbingers of change for companies in other sectors of the economy. We have already seen this in the application of short term incentive deferral, and the application of malus in executive remuneration across most ASX 200 companies. Change will not stop at this. Indeed, in a speech on 2 May 2018, APRA’s chairman Wayne Byers indicated that he expects much more of bank governance, and fundamental changes to executive accountability and pay.

He acknowledged that modern large financial institutions (and we venture to say other large ASX listed companies) have complex organisational structures, with a separation of product manufacturing, distribution, and operations, that makes it challenging to ensure it is clear who is responsible when things are not as they should be. If there was a message in Mr Byers’ speech it is this – get over it. Make individuals accountable. And that, indeed, is what the BEAR requires of banks.

Once that hurdle has been overcome, remuneration becomes easier. It is not uncommon for performance metrics within executive scorecards to be weighted more heavily to the performance of the company rather than the individual. While this promotes a collegiate whole-of-organisation focus, it can also permit poor risk outcomes in a particular business line to be ‘averaged out’ across the business as a whole. This reduces the impact on executives most accountable, undermining effective risk management. Clearer accountabilities should allow for more targeted scorecards, and thereby greater alignment between the outcomes an individual delivers and the rewards he or she receives.

This has been a consistent theme from APRA, and featured in the CBA review (see HERE). That is, individual executives’ pay did not vary much as a result of unsatisfactory outcomes within their area of accountability. By being clear what they are accountable for, there is no excuse to not make their pay directly aligned with results. And results should also encompass poor risk management.

Mr Byers said that banks (and, we suggest, eventually other APRA regulated entities, and then other large ASX listed companies) will change the way they pay. Specifically, executives will have more skin in the game for a longer period of time than is typically the case now and this will place greater pressure on boards, when adverse outcomes occur, to explain how that has been factored into remuneration outcomes.

Alongside APRA’s recent remuneration review of 12 regulated entities (see HERE), the BEAR provides an opportunity to fundamentally rethink remuneration frameworks and achieve a stronger alignment with long-term financial safety and a strong risk culture. Mr Byers believes it will be a lost opportunity if everyone just defaults to the minimum. In other words, BEAR compliance will not be enough. APRA does not like the way pay is structured. It wants change.

If APRA’s perspectives hold sway, complex remuneration frameworks that try to pay homage to all stakeholder requirements are out. Simpler, cleaner, and more consistent frameworks that are required for strong, sustainable, companies will be on the way in. Banks will be able to achieve this better than other ASX listed companies because they will have APRA’s backing. These will be the forerunners of change across all sectors.

Mr Byers speech can be found HERE.

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