On 17 June, the Financial Stability Board (FSB) released its sixth progress report on the adoption of the FSB’s Principles (see HERE) and Implementation Standards (see HERE) (Principles) for sound compensation practices. This report tracks how compensation practices around the world have adapted since the FSB’s Principles were first published in 2009 following the global financial crisis (the GFC).
The report acknowledges that, relative to other countries, there are aspects of financial services remuneration regulation and supervision that Australia needs to pay more attention to. To that end, financial services companies can expect more heat to be applied in both regulation and supervision.
This article identifies the areas of concern for board risk and remuneration committees to have on their agendas in the 2020 financial year.
Australian regulators have undertaken thematic or horizontal reviews that include the review of compensation practices before and after 2017. These have led to risk management and remuneration outcomes identified as an area for focus and strengthening. This is no surprise given the findings of the Hayne Royal Commission.
The following findings in the report will see wider application in Australia than just the banks. The insurance, asset manager and superannuation sectors are likely to have the same concerns:
- Concerns about overly complex scorecards that end up obscuring the incentives the organisation is trying to create
- Effective documentation of compensation outcomes reflecting a clear and robust process. The documentation of performance evaluation and risk adjustment processes generally need to be improved to ensure performance ratings and adjustments are supported by robust justifications
- Concerns about inconsistent implementation of group-compensation policies, including use of malus and clawback and the use of risk-adjusted performance criteria
- Need for organisations to develop systems to better track compensation and risk outcomes and to utilise some form of quality assurance process as part of monitoring programmes. This in turn could be used to indicate early warnings of misconduct. Importance of accountability processes, which are used following significant incidents e.g. the use of compensation tools following a major compliance breach.
Implementation of practices by boards
In a report that generally found Australia right up there with the other 25 FSB jurisdictions in effectively implementing the Principles, there were a number of standout negatives.
While the focus for Australia was on the five banks, the wider insurance, asset manager, superannuation and other bank sectors need to have regard for the findings. They will become a focus of APRA and ASIC as their supervisory resources and firepower have increased.
The FSB reported that Australian bank boards have a committee to oversee the compensation system’s design and operation and that it actively monitors and reviews the remuneration system to ensure it operates as intended. These remuneration systems were found to be subject to controls and periodic reviews to promote integrity.
However, and this was a real negative for Australia, the remuneration committees did not actively work with the board risk committee in the evaluation of incentives created by the remuneration policy. This assessment was based on reporting by APRA from the 2017-18 years.
Equally negative was the absence of regular reviews of compensation and risk outcomes for consistency with the intentions of the underlying compensation system.
Again, Australia was one of the few that reported monitoring systems to monitor and review compensation policies have not been set up and used.
Executive compensation for banks in Australia has a mix of cash, equity and other forms of compensation that is consistent with risk alignment. Most of the banks identify senior executives as well as other employees who have a material impact on the risk exposure of the firm. However, again Australia was one of the few to report that the banks do not adjust compensation for all types of risk (in other words, adjustments for non-financial risks were lacking).
Australia has supervisory requirements or expectations on compensation deferral for senior executives. These requirements or expectations do not apply to other material risk takers, similar to Canada.
This goes against the requirements and expectations of most other countries as they require or expect the remuneration deferral to be applied to other material risk takers as well.
Australia is among the 7 member jurisdictions which have conducted or are contemplating an effectiveness review of their regulatory regimes and the changes introduced.
While a number of Australian banks have conducted effectiveness review of their compensation regimes, it is noted that the larger banks with access to greater resources are more advanced. The smaller banks plus other financial services companies would also best to prepare for regulators to validate that considered internal reviews have been undertaken.
The full FSB report can be found HERE .© Guerdon Associates 2023 Back to all articles