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APRA on remuneration and incentivisation

But is it enough?

APRA has taken steps to encourage organisations to incentivise the right behaviours.

According to an official release from the Australian Prudential Regulations Authority (APRA), both discussion paper and Prudential Standard CPS 511 and discussion paper Strengthening Prudential Requirements for Remuneration are looking to better align the interests of entities and stakeholders. This initiative includes consumers and speaks directly to Recommendations 5.1 to 5.3 from the final report of the Royal Commission into Banking, Superannuation and Financial Services.

Royal Commission Recommendations 5.1 to 5.3

APRA should give effect to the principles, standards and guidance set out in the Financial Stability Board’s publications concerning sound compensation principles and practices.

APRA should have, as one of its aims, the sound management by APRA-regulated institutions of not only financial risk but also misconduct, compliance and other non-financial risks.

APRA should:

  • require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks, and to reduce the risk of misconduct

  • require the Board of an APRA-regulated institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks and reducing the risk of misconduct.

  • set limits on the use of financial metrics in connection with long-term variable remuneration.

  • require APRA-regulated institutions to provide for the entity, in appropriate circumstances, to clawback remuneration that has vested.

The discussion papers also indicate that CPS 511 will bring about greater alignment with the Financial Stability Board’s (FSB) recommendations.

APRA Deputy Chair, John Lonsdale, said this new standard would complement the Banking Executive Accountability Regime (BEAR), the second phase of which came into force on the first of this month.

In an official statement earlier this week, Lonsdale said, “Remuneration and accountability frameworks play an important role in driving employee behaviour. Where policies are poorly designed, or not followed in practice, companies may incentivise conduct that is contrary to the long-term interests of the company and its customers.”

​Key reforms highlighted by the regulator from the draft standard:

  • To elevate the importance of managing non-financial risks, financial performance measures must not comprise more than 50 per cent of performance criteria for variable remuneration outcomes;

  • Minimum deferral periods for variable remuneration of up to seven years will be introduced for senior executives in larger, more complex entities. Boards will also have scope to recover remuneration for up to four years after it has vested; and

  • Boards must approve and actively oversee remuneration policies for all employees, and regularly confirm they are being applied in practice to ensure individual and collective accountability.

Another key highlight from the Report is that APRA-regulated entities will be expected to conduct an annual compliance review, as well as be reviewed by an independent person with at least three years’ experience.

The regulator’s approach will be proportional to the size and complexity of the entity.

APRA…still not good enough

While Professor Elizabeth Sheedy from Macquarie University remains a strong supporter of the BEAR as a regulatory tool, she agrees with the recent capability review that the prudential regulator has more work to do.

Nor does Sheedy believe the recent draft guidance goes far enough.

“There are some positives in the report, but I’m disappointed that APRA still apparently puts so much faith in the balanced scorecard! As you will remember from our study last year, we found a lot of problems with it—that is, more misconduct, worse culture.”

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