The Australian Prudential Regulation Authority (APRA) has stated it has adopted a principles-based executive pay regulatory approach focused on structure and incentives.

This will not only be important for the pay of APRA regulated companies, as such an approach could, over time, be applied through various mechanisms to all listed companies.

On October 23 the chairman of APRA, John Laker, told the Senate Standing Committee on Economics that the issue of executive remuneration was not entirely new to the regulator, which last year prepared a paper for a Reserve Bank conference in which it had referred to agency risk – the risk that the interests of management might not be aligned with the interests of shareholders and creditors. You can find that paper HERE.

Note that this was 8 months before the International Financial Stability Forum raised the issue to a global level (see our article HERE).

Dr. Laker said the paper also referred to the manner in which executive remuneration arrangements could accentuate this risk in sustained, good economic times. “Our view then, and now, is that executive remuneration that helps to deliver strong returns on capital over time, adjusted for the risks involved, or that rewards genuine out performance of competitors, does not, of itself, raise prudential issues,” Dr. Laker said.

He said for a regulator, agency risk issues arose if remuneration arrangements encouraged management to focus on a shorter-term horizon than the long-term approach that would also be in depositors’, policyholders’ or fund members’ best interests. Dr. Laker said incentives to generate short-term profitability or drive up the share price more rapidly could tempt management to pursue aggressive trading or growth strategies, or ‘hollow out’ the institution by paring back capital buffers or cutting costs, particularly in middle and back-offices, where risk management functions reside.

Dr Laker’s testimony to the standing committee can be found HERE. 

However, there is more to come. An APRA source has told us that they have already provided advice to the government on banker pay regulation, so now it is only a matter of time before we know if the government will, or has, accepted that advice.

APRA’s thinking is likely to be similar to the UK’s Financial Services Authority (FSA). On 13 October the head of the FSA, Hector Sants, wrote to the CEOs of UK banks suggesting fairly specific good and bad remuneration practices. Most of the suggestions are, in fact, sensible and not a bad guide for bank (or other capital intensive companies’) board remuneration committees (see HERE).

These could form the basis of the principles Dr. Laker mentioned.

Interestingly, the FSA and its sister organisation, the Financial Reporting Council (FRC) have not gone overboard in responding to the crisis with excessive regulation, unlike their other European and (to an extent) their US counterparts.

Paul Boyle, chief executive of the FRC, which oversees corporate governance, accounting and auditing issues said on 24 October that weaknesses in banks’ corporate governance raise more questions about executives’ use of the existing standards than about the need for new rules. The head of the corporate reporting watchdog said that the FRC’s preliminary conclusion is that the primary questions should not be about the standards of corporate governance in these institutions but rather the practice of it.

The comments come amid widespread expectations that the current crisis will lead to a tightening of regulation, particularly for the financial sector, and fears that these moves could go too far.

Mr. Boyle pointed to existing standards such as the Combined Code on corporate governance (the nearest UK equivalent to the ASX Corporate Governance Council’s principles), which was introduced in the wake of the corporate scandals earlier this decade and is designed to act as a blueprint of good practice on issues including board composition, remuneration and relations with shareholders. In the FRC’s press release (HERE) Mr. Boyle said, “Our view is that the standards set out in the FRC’s Combined Code remain comprehensive. We expect that directors of banks and other financial institutions are already reviewing their governance and risk management practices. We currently believe that the recent difficulties in the financial sector do not require a generalised tightening of governance standards across the UK corporate sector.”

It is curious to note that both the FSA and FRC direct their comments on executive pay to bank executives and not board chairmen.

We await government pronouncements in regard to APRA’s advice with interest. We suggest readers check out our website periodically for updates.

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