Super funds will need a crash course in deferred remuneration

In moving to implement APRA’s proposed CPS 511 standard (see HERE), most large registrable superannuation entities (RSEs) are likely to have difficult remuneration policy decisions to make.

Those above the $30 billion funds under management threshold to be classed a significant financial institution (which APRA says it chose because these larger RSEs are more likely to have variable remuneration) will then also have to trudge down the same path ADIs have trodden before with the BEAR (see HERE), yet with more stringent requirements as regarding length of deferral, malus and clawback.

The BEAR forces Australian Deposit taking Institutions to defer a proportion of the remuneration of accountable persons for a period of up to four years, with the proportion depending on organisation size and the type of position. CPS 511 requires 60% of the CEO’s total variable remuneration will have to be deferred for seven years, with pro rata vesting from four years. Smaller proportions apply to other special category roles.)

Banks and insurers have been scrambling over the last 18 months to determine which classification the organisation and its employees fit into and meet deferral requirements. Superannuation funds were excluded, although the Hayne Royal Commission did recommend they be included. The rigour of having gone through the BEAR process will help the ADIs as they consider the question of which employees fit in special role categories.

RSEs meanwhile will be starting from scratch and will have precious little experience in this area. Very few super funds have implemented ANY deferral, even for their CEO. In recent work examining about 20 very large super funds, Guerdon Associates found the number of CEOs with a proportion of their bonus deferred can be counted on one hand. And the proportion deferred was more likely to be 25% – a far cry from 60%.

To suddenly change from no deferral (or not much) to 60% will almost have some CEOs, whose bird in the hand has suddenly disappeared into the bush, calling for a remuneration review to increase their pay. And as relativities work, this will generally mean increases at some point for most of the leadership team. An unintended consequence is that some funds may abandon incentive pay altogether. APRA likes incentive pay, so that some can be deferred, and then forfeited, if things go awry, or misbehaviour is discovered.

RSE’s exclusion from the BEAR (at least, so far) has likely supported super funds’ lack of deferred remuneration. Another reason for the lack is that superannuation entities generally do not have much performance pay to be deferred. In its review of financial and superannuation entities in 2018 (see HERE), APRA noted:

“As a general observation, the remuneration structures within RSE Licensees in the sample were simpler in structure. STIs were in the form of cash rather than shares, with a maximum deferral period of two years. No RSE Licensee in the sample incorporated an LTI component into its remuneration structure.

“Where STI arrangements were in place for RSE Licensees, the ratio of performance-based remuneration to fixed remuneration (for senior executives other than the Chief Investment Officer (CIO)) was significantly lower – at 10 per cent to 30 per cent – than seen at institutions from the other industries in the sample. However, staff working within investment teams, including CIOs, tended to have remuneration structures that included larger proportions of performance-based remuneration.”

Even the super funds that are not SFIs (who likely have few staff with variable remuneration) will face a heavy administrative burden. Despite the low number of staff, they will be required to go through the administrative backflips to meet requirements  (ensuring the remuneration framework for these few employees is altered to meet financial to non-financial hurdle ratios as well as checks and balances to make sure any investments were not made that damage the financial soundness of the institution or “compromise promoting the financial interest, and reasonable expectations, of beneficiaries”) will be onerous on what are likely understaffed HR teams.

The last check regarding the financial interest and reasonable expectations of beneficiaries is also only imposed on RSEs and might cover a range of ills – investment is, after all, a risky activity. What exactly does “reasonable expectations” imply?

Many superannuation boards will probably struggle too with the requirement in the standard to include in the remuneration framework the high level structure and terms of remuneration arrangements for employees of organisations it has service contracts with that “may affect the entity’s long-term soundness or materially affect the management of financial or non-financial risks, and where under the services contract, a material amount of the total payment to the body is based on performance”.

Given the outsourced nature of the funds held by many RSEs for their beneficiaries, this could be difficult if that involves extracting sensitive information from cagey investment managers. And once such information is within the framework, what is the response if the stated remuneration does not fit APRA’s idea of a responsible framework?

APRA does admit that there may be a need to adjust aspects of the proposed requirements for particular structures, such as fiduciary structures, primarily outsourced business models or entities with mutual ownership structures in order to avoid unintended consequence.  However, there is no guarantee changes will be forthcoming.

Given the above, it would not be surprising if some RSEs rethought the usefulness of variable remuneration to escape at least some of the burden of the standards. If it is only worth 10% to 30% for most employees, an increase in fixed remuneration would not be too onerous. Yet it is unlikely this will be possible for investment staff.

Super funds might be wishing they received special treatment as they have until now. CPS 511 will fill in the holes in super funds’ own prudential governance standard, SPS 510 (see HERE and HERE), and their own set of remuneration practice guidelines (SPG 511, see HERE) will be replaced. (The standards must be adhered to and the guidelines provide direction of how APRA expects the standards to be implemented.) While PPG 511 Remuneration is 21 pages including appendices, SPG 511 Remuneration is only 10.

© Guerdon Associates 2024
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