Government’s views on controlling the appointment, termination and pay of bankers

Government’s views on controlling the appointment, termination and pay of bankers


The Australian federal government has released a consultation paper for the Banking Executive Accountability Regime (BEAR) announced on budget night. Unfortunately, Treasury only provided three weeks to 3 August for the consultation period.


Who is covered?


First up, we should note that the proposed scope of the BEAR goes beyond bank executives. It includes directors and subsidiaries of non-banks that are owned by banks.


So, as we suspected in our initial assessment of BEAR after its announcement, it will also capture insurers, superannuation funds, fund managers, fund administrators, custodians, and virtually anyone else unfortunate enough to have a banking parent. This may seem perverse, because if you are a director or an executive of one of these and not owned by a bank, you do not have a government appointed entity with the power to appoint, terminate or pay you (at least so far – one has only to look at the UK to see that these have also been captured by regulation).


It seems that an underlying premise is that ADI executives have behaved badly, or at least did not act to prevent others behaving badly. This may, or may not, be the case. However, it can be said that bad behaviour is not limited to ADIs. In fact, most bad behaviour appears to be evident in non-APRA regulated entities.


Apart from being anti-competitive, some of these subsidiaries are also prudentially regulated. All are ASIC regulated, which is separately tackling the broader cultural issues which many have contributed to poor customer outcomes, whether they be owned by an ADI or not. The issue of executive accountability extends beyond ADIs, and in fact, beyond other regulated entities. It would seem a solution is required that has broader application than the BEAR, and should not be confined to ADIs, or indeed, other APRA regulated entities as has been suggested by others.

In addition, under the BEAR, a bank executive in charge of one of these non-bank businesses would have to be paid more than a non-bank executive running these businesses because of the risks associated with accepting a provisional appointment, keeping the job, having more pay deferred, and having more risk of losing pay. It also seems odd that a manager in an APRA regulated business has his/her remuneration framework determined by law because the parent company is a bank, and a direct competitor with a non-bank parent, does not.

Treasury’s rationale for including subgroups with an ADI parent within the scope of the BEAR is that consumers will often associate the wide range of financial services and activities that are provided by the subsidiaries with an ADI brand. Treasury maintains that poor behaviour in the subsidiaries has the potential to undermine confidence in the ADI itself.

Whether, in effect, Treasury is concerned with a run on the bank or not, the government paper fails to provide a compelling argument. However, if it proceeds as described, it is another reason banks may want to consider off-loading these non-bank businesses.


What are the conduct expectations?


In response to the government’s issues with poor culture, the consultation paper attempts to describe the behaviour that is expected of responsible persons.


While ASIC will be the regulator of conduct, the BEAR will apply where there is poor conduct or behaviour of a systemic and prudential nature. To that end, it appears that APRA will focus on behaviours associated with prudential matters, and not broader cultural issues that have been the focus of ASIC.


This approach appears contrary to the rationale for coverage of executives in subsidiaries that are not ADIs. This may explain why the scope of conduct expectations in the paper is cast in very broad terms. It is not possible to get any concrete idea as to what will meet these expectations.



What can happen to remuneration?


The remuneration elements of the BEAR ensure there are financial consequences for conduct that does not meet the new expectations.


Like other aspects, the BEAR is intended to build on, rather than replace APRA’s existing prudential standards on remuneration.


The remuneration aspects only apply to executives, not directors in oversight roles.


The prudential standards will continue to apply more widely than to executive accountable persons and Treasury is currently undertaking further work in this area. In other words, Treasury is considering extending the remuneration requirements of the BEAR to material risk takers not covered by responsible persons defined in the BEAR.


At least 40% of variable remuneration is to be deferred for 4 years. The deferral of 60% of variable pay will apply to CEOs only. However, Treasury will consider submissions increasing the extent of deferral to other senior executives, as in the UK.


The deferral period is 4 years. There will be a number of questions as to precisely how the four year deferral should operate.  For example, what happens if employment ends before the end of the four year period?  Can tranches of the deferred amount vest over the period, or must there be a deferral of the full amount?


There is no mention of clawback (i.e. recovery of monies paid).


Other related matters include enhanced directive powers for downward adjustments in instances of inappropriate behaviour.


On balance, there is too much emphasis on variable pay, and not on remuneration as a whole. This is not unlike the UK senior manager regime on which it is modelled. One unintended outcome has been a reduction in UK performance pay and an increase in fixed pay.


The Treasury paper does pose some questions on causes for concern.


The questions Treasury asks include:

  1. Would deferring variable remuneration be likely to result in a shift from variable to base remuneration?


GA answer – Yes


Would this be problematic?


GA answer – Yes, for these reasons:

  1. A pay component that is variable with results buffers a bank from dipping into its capital, ensuring it is more robust. Limiting or reducing this for any staff is not a positive development. The European experience shows us that variable pay is likely to be converted to fixed pay once regulation focuses on limiting variable pay.
  2. With the emphasis on variable pay and none at all on other pay, APRA would be relatively powerless to consider adjustments if banks just move to fixed pay. The focus should not be limited to variable pay.
  3. Variable pay has a direct and powerful impact on behaviour. As such, it could be a mechanism for effective prudential outcomes, i.e. it could vary with prudential results/quality. Its reduction or elimination would rob the board, regulators, depositors and owners with a powerful tool to focus executive attention.
  4. ADIs will be less able to attract executives with otherwise suitable experience from non-ADIs, or countries with less onerous regulation. A reduction of the talent pool will be detrimental to all stakeholders.


If so, can anything be done to prevent this outcome?


GA answer – No . It is a function of the economic utility of the remuneration package in a competitive banking environment. We saw this in Europe and UK when a maximum incentive pay was mandated to 1 times fixed pay, and the requirement under CRD IV to defer a significant proportion of remuneration for up to 5 years. The outcome was a reduction in incentive pay opportunity and large increases in fixed pay. 

2) What are the complexities in defining variable remuneration, including in relation to non-cash remuneration?


GA answer – Not complex. Many confuse the vehicle of remuneration with its primary purpose. The payment vehicle may be cash, equity or no-monetary benefits. The purpose is either to guarantee a level of pay sufficient to attract suitably qualified executives, or to focus executives on prioritised outcomes with a reward conditional on these outcomes.

3) Does the proposed principles-based definition of variable remuneration provide sufficient clarity as to the application of the BEAR to current and potential future remuneration structures? The definition in the Treasury paper is that it includes “that part of total remuneration that is discretionary and conditional upon performance and the delivery of results, including individual and business performance and results.”


GA answer – the Treasury definition is poorly drafted, and could be simplified. For example, remove a few words so that the definition is simply: “that part of total remuneration that is conditional upon performance”. This is all that needs to be said.

4) Is the proposal for deferring 60 per cent of the variable remuneration of certain executive accountable persons appropriate?

GA answer – no, it is not appropriate. It is too prescriptive. For example, if a bank already defers a part of fixed pay in equity (e.g. The CEO of Bendigo and Adelaide Bank has 40% of fixed pay deferred), does it need to defer any variable pay? One advantage of deferring pay is that it can be forfeited in specified circumstances (i.e. malus is applied). The source of deferral i.e. fixed pay or variable pay, need not necessarily be a concern. Another example is where an executive has accumulated a majority of his/her net personal wealth in bank equity, savings deposits or bank bonds. Would it be as necessary for this executive to have as much remuneration deferred?

APRA already has powers to compel a bank to amend pay policy, and its PPG 511 has well-regarded guidelines. Given that ADIs number in the tens, and not thousands, this is not too much to get across, while it enables banks to tailor policies to meet strategic ends and apply good prudential controls given their circumstances.

5) Are the proposed enhancements to APRA’s remuneration powers appropriate?


GA answer – not enough information has been provided in the Treasury paper on what these powers could be.


Guerdon Associates suggestions

1) Do not require a mandatory deferral of variable pay, as variable pay may reduce, with unintended consequences for accountability and prudential management.

2) Require APRA to consider all elements of executive and risk taker remuneration for prudential risk management purposes, rather than just variable pay, to better cope with changes in remuneration frameworks stemming from regulatory and market forces.

3) Request APRA amend PPG 511, which currently suggests deferral of variable remuneration for later ex-post facto adjustment in light of excessive risk taking. Replace with a preference for deferred remuneration (either fixed or variable) which can be reduced if outcomes from poor prudential management come to light. This is a broader application that goes beyond “excessive risk taking” to the key focus of better prudential management. This amendment would reflect evidence from behavioural research that indicates people are more likely to respond more strongly to the risk of loss than the opportunity of gain, all else being equal. The guidelines may also require that a bank consider the extent that an individual executive is personally exposed to bank risk (e.g. through the proportion of net assets in savings deposits, equity or bonds; time to retirement etc.).

4) Rather than blanket mandatory deferral and deferral periods, require APRA to certify that each ADI’s executive remuneration framework and policy encourages sound prudential management[1]. That is, ADI’s will be freer to develop remuneration frameworks that suit their circumstances, which APRA would compare against the data is has collected to ensure it addresses areas of concern or weakness. This will require APRA to develop and apply a certification process to take into account the many factors that could contribute to excessive risk-taking, or conversely, sounder prudential management. It will also take time and resources to certify remuneration for the 144 Australian ADIs currently supervised. However, Guerdon Associates believes that this tailored approach will result in more effective prudential management than a mandated “one size fits all” remuneration requirement irrespective of ADI circumstances.

5) In order for APRA to meet the requirement in (5) above, authorise APRA to mandate the provision of data from ADIs to permit a more effective and nuanced approach to each ADI’s executive remuneration. This data may include personal data from executives in addition to the data for “fit and proper” assessment, such as a register of pecuniary assets. For example, a bank CEO who has 60% of his/her personal wealth in bank equity will have a different perspective on bank risk taking than a bank CEO with 5% of his/her personal wealth in equity. The data are necessary for the formulation of an effective policy tailored to each bank. In the examples above, the first bank would not require the executive to defer as much pay into equity, while the second bank may need to require both a much more significant payment in deferred equity (or bank bonds) and the imposition of a high CEO share ownership requirement. These and other data that behavioural research has shown to have major influences on risk taking behaviour are currently not collected or considered by prudential authorities, or most bank boards. The specific data requirements based on behavioural research will be subject to refinement over time, as more research becomes available. For this reason, the specific data required should not be hard wired in legislation.


Guerdon Associates acknowledges that the suggested approach for the BEAR to require APRA to take into account each ADI’s circumstances for certifying its remuneration is appropriate, and will require more resourcing than is currently the case. However, this tailored approach would result in better executive accountability for prudential management than mandating a “one-size fits all” method of paying key executives.


The Treasury paper can be found HERE.


[1] We acknowledge that some remuneration frameworks that provide for the most effective prudential framework may not meet publicly listed entities’ shareholder requirements for remuneration report and equity grant voting purposes. However, Guerdon Associates believes that there will be sufficient “APRA certifiable” alternatives for each entity that would also receive sufficient confidence from shareholders, providing there are good levels of engagement between stakeholders.

© Guerdon Associates 2024
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