APRA consults on remuneration

On Thursday 28 May 2009, the Australian Prudential Regulation Authority (APRA) released a consultation package on remuneration for authorised deposit‑taking institutions and general and life insurance companies.

Guerdon Associates has reviewed the package and compared it with the packages published elsewhere in the world, as well as with an earlier draft made available to us for comment and discussion with APRA some weeks ago.  While we have no doubt some of the sector’s executives will grumble at the implications for their pay, the chorus of complaint should be muted in comparison to the response from London’s bankers to their FSA requirements.  This is simply because, on the whole, APRA has done an excellent job.

Consider what they have had to do:

  • Respond to Prime Minister Rudd’s agenda requiring APRA to constrain remuneration through leveraging capital requirements against “unrestrained capitalism and greed”
  • Be consistent with FSF principles for regulator implementation on a global basis (see HERE)
  • Maintain a principles based approach to allow flexibility for our insurance and banking industries to vary their remuneration for competitive advantage

We do have quibbles, which we will address in our response to APRA’s request for feedback due by 24 July 2009.  But these will in effect be requests for refinements on an approach that, even as it stands now, is probably the world’s best.

APRA’s proposals on remuneration are designed to ‘endorse and implement the FSF’s tough new principles on pay and compensation’. They deal with the possible lack of alignment of remuneration with risk management in many financial institutions.  APRA’s proposals also respond to the Prime Minister’s request in October 2008 that APRA consider the linkages between remuneration practices and the capital adequacy requirements of regulated institutions.
APRA is intending to take a principles‑based approach in this area, by requiring boards of regulated institutions to have a remuneration policy that aligns remuneration arrangements with the long‑term financial soundness of the institution and its risk management framework; at the same time, boards would be able to design remuneration arrangements that suit the structure of their own institution.  The policy would extend beyond senior executives to all persons who, because of their roles, have the capacity to make decisions that could materially affect the interests of depositors or policyholders, and owners.
‘APRA has not addressed the absolute level of remuneration but the need to align remuneration incentives with good stewardship of institutions.  That is why the proposed remuneration requirements are contained in our governance standards,’ APRA Executive Member John Trowbridge said.  ‘The risks associated with remuneration arrangements must be managed as part of the institution’s risk management framework,’ Mr. Trowbridge added.
APRA also proposes that regulated institutions have a Board Remuneration Committee, comprising only independent directors with the appropriate experience and expertise.  ‘Decisions relating to remuneration matters must be well founded and not influenced by conflicts of interest’, Mr. Trowbridge said.
The Prudential Practice Guide will assist regulated institutions to comply with the proposed requirements in the governance prudential standards and, more generally, will assist boards in their consideration of prudent practice in remuneration.  The PPG covers a number of issues, including the use of deferred compensation, the links between incentives and risk, the use of shares in incentive arrangements, the need to link incentive compensation to both forward‑looking and backward‑looking risk measures, and the balance between cash and non‑cash incentives.
The consultation package can be found HERE 

The package comprises a discussion paper, three draft prudential standards, and a draft Prudential Practice Guide for Remuneration in APRA-regulated institutions.

Helpfully, proposed extensions to the existing prudential standards are highlighted in yellow within the text of each Draft Standard.  The three Standards are very similar except that they appropriately reflect differences in each of the industries they cover (e.g. Authorised Deposit-taking, General Insurance, and Life Insurance).

  • Draft Prudential Standard APS 510 Governance (see HERE).
  • Draft Prudential Standard GPS 510 Governance (see HERE).
  • Draft Prudential Standard LPS 510 Governance (see HERE).
  • Draft Prudential Practice Guide (see HERE).

APRA commented in its release that “The guidance provided in this prudential practice guide conforms to the FSF Principles of Sound Compensation Practices”, released on 2 April 2009. It is also consistent with, but not limited to, the requirements of the Corporations Act 2001 relating to disclosure, Principle 8 of the ASX Corporate Governance Principles and Recommendations (2nd Edition) and the guidelines published by the Australian Institute of Company Directors (AICD) in February 2009.

The main headings in the Practice Guide are:

Governance of remuneration arrangements

Board Remuneration Committee

• Use of external consultants

Remuneration Policy

• Risk and financial control personnel
• Adjusting remuneration for risk
• Measuring performance
• Using capital to adjust financial performance measures for risk
• Retrospective adjustments to performance-based remuneration
• Adjusting for performance outcomes of the whole entity
• Fixed and variable remuneration components

Other considerations for executive remuneration

• Equity-related components
• Incoming and terminating payments
• Hedging equity exposure
• Perquisites and fringe benefits

There will be a need for APRA-regulated organisations, and especially both the board remuneration and risk committees, to read and absorb the guidelines, and determine how to respond to them.  They provide more detail on some of the key areas covered already by the FSA and FSF. 

APRA is careful to point out that it is a principles-based approach in which each organisation needs to determine the best policies for its own operations, and interact with APRA to explain its reasoning.  

In broad summary, the Principles require organisations to have a remuneration committee, a written remuneration policy, and to develop and implement remuneration practices which provide a clear balance of the various important factors, generally including  incentive, risk, reward, stakeholder interests, sustainable performance over various timeframes, and use of capital. 

APRA is seeking submissions on the draft standards and PPG by 24 July.  With the need to respond to so many government “initiatives” this year we sometimes have to remind ourselves that we are not government employees.  Nevertheless, Guerdon Associates will definitely be making a submission.  In the meantime, if you have issues you would like to discuss or that you think should be raised, please do not hesitate to call us at either our Melbourne or Sydney offices.

We will provide more detail on the aspects that are of concern on our website over the next few weeks, and in next month’s newsletter.

Subject to consultation, it is expected that the final prudential standards and associated PPG will be released in September 2009 and be effective from 1 January 2010.

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