INSIGHT

APRA's revised Prudential Standard CPS 511 on remuneration frameworks and incentives for ADIs, superannuation funds and insurers

By Sean Cole
APRA Financial Services

A retreat back to a principles-based approach 8 min read

After 17 months of consultation and internal review, APRA has released its revised draft prudential standard on remuneration (CPS 511) seeking to regulate incentive structures across all APRA-regulated entities. The prudential standard will operate alongside and supplement the BEAR and proposed FAR regime. Significant financial institutions (SFIs) will be expected to undertake a self-assessment and develop an implementation plan from the second quarter 2021, ahead of a staged implementation of CPS 511.

How does it affect you?

APRA's Response Paper - Strengthening prudential requirements for remuneration and Revised CPS 511 sets out a phased implementation timetable for CPS 511:

  • 1 January 2023: for Authorised deposit-taking institutions (ADIs) that are SFIs (including groups headed by these SFIs).
  • 1 July 2023: for insurers and RSE licensees that are SFIs (including groups headed by these SFIs).
  • 1 January 2024: for all other entities (non-SFIs).

SFIs should be aware that, following the release of the finalised CPS 511 scheduled for second quarter of 2021, APRA expects SFIs to undertake a self-assessment and develop an implementation plan, which APRA may request copies of, in order to review these as part of its supervisory work.

Infrastructure to support remuneration review processes and information flow to substantiate variable remuneration outcomes, will require significant attention.

Some discretion is returned to Boards with signature reforms such as:

  • the 50% cap on the use of financial performance measures in variable remuneration arrangements across the regulated group being replaced with a principles-based approach; and
  • minimum deferral periods for variable remuneration components of senior executive remuneration and mandated clawback periods being lessened.

The extension of the Banking Executive Accountability Regime (BEAR) to all APRA-regulated entities, under the Financial Accountability Regime (FAR) will run concurrently with the implementation of CPS 511. The response paper does not provide any further guidance on the proposed timetable for implementation of FAR, other than stating that APRA is continuing to work with Treasury to ensure that there is appropriate alignment with CPS 511. Upon finalisation of the FAR legislation, APRA will review whether any changes to CPS 511 are required.

Will CPS 511 apply to existing remuneration arrangements?

Grandfathering will apply. APRA says in the Response Paper that the transitional arrangements in revised CPS 511 will not require renegotiation of existing employment contracts at the commencement date of the finalised standard, however, all new and renewing remuneration contracts entered after the implementation date must be compliant. Revisions to draft CPS 511 are less definitive and say that the prudential standard does not apply in respect of a person's variable remuneration  where 'the opportunity to earn the variable remuneration arose' before the relevant effective date(s). It is foreseeable that there may be a divergence in outcomes across the industry in the application of the grandfathering provisions, depending on the structure of the relevant employment contract and incentive plan terms being considered. It would be preferable if further guidance is provided by APRA on these transitional arrangements in its draft prudential practice guide that will accompany CPS 511.

What has the 50% cap on the use of financial measures been replaced with?

APRA has abandoned the proposed hard-caps for variable remuneration based on financial performance measures. The caps were previously set, such that measures linked to financial performance cannot exceed 50% of all performance measures, and each individual financial performance measure cannot comprise more than 25% of total performance measures. This move is in response to overwhelming feedback (over three-quarters of submissions were focused on this issue). 

In its place, APRA is now proposing a 'principles-based' approach to incentives, which calls for variable remuneration structures to:

  • give 'material weight' to non-financial metrics; and
  • be adjusted, potentially to nil, for adverse risk and compliance outcomes, based on clearly identified criteria.

This requirement applies to variable remuneration at all levels within an SFI (but it does not apply to non-SFIs). Individual performance-based remuneration criteria would need to satisfy both of these requirements – ie build-in incentives based on non-financial metrics (across both short-term and long-term awards), and also include risk and conduct modifiers which respond to adverse non-financial outcomes.

How should SFI's balance individual and entity-wide adverse risk and compliance outcomes?

The overarching requirement in CPS 511 is to ensure that variable remuneration is only paid or vested if a number of criteria covering prudential, conduct and risk management outcomes, as well as group-wide, divisional and individual performance results, are satisfied. This overarching requirement has been retained for SFIs. SFIs will need to balance how to appropriately reflect a systemic compliance failing in the remuneration outcomes of all variable remuneration recipients, even those who were not directly responsible for the failure.

What are the proposed SFI thresholds?

APRA has reaffirmed the proposed thresholds to classify APRA-regulated entities as  SFIs:

  1. ADIs with more than $15 billion in total assets;
  2. general and life insurers with more than $10 billion in total assets; and
  3. RSE licensees with more than $30 billion in funds under management.

In addition, APRA has proposed a threshold of $3 billion for private health insurers.

The thresholds will be stipulated in a new prudential practice guide to accompany CPS 511. However, APRA will retain ultimate discretion to determine whether additional entities should be treated as SFIs, having regard to factors such as complexity of the entity's operations, whether the entity provides critical services, and whether the entity is a member of a corporate group. APRA intends to notify relevant entities of their status as an SFI by the third quarter of 2021 – we assume this will be directed at entities assessed by reference to APRA's qualitative criteria.

What are the implications for SFIs?

SFIs will be subject to the annual and triennial review requirements, design requirements in relation the use of non-financial measures and conduct 'modifiers', and the prescriptive minimal deferral periods and clawbacks (see below).

APRA has reduced the requirements for non-SFIs even further than originally proposed, streamlining governance expectations, simplifying remuneration design requirements and removing the review requirements.

What does this mean for the Board's oversight of remuneration?

While the Board will remain ultimately responsible for the remuneration framework and its execution, APRA's previous expectation that the Board be directly involved in overseeing the remuneration arrangements and approving remuneration outcomes of persons falling within Special Role1 categories has been narrowed. The Board will have direct responsibility for approving remuneration outcomes of senior managers and executive directors, while remuneration outcomes for highly-paid material risk-takers2 (HPMRT), other material risk-takers and risk and financial control personnel can be approved on a cohort basis. 

Is the Remuneration Committee subject to the onerous review obligations originally proposed?

Yes. As originally proposed, the Remuneration Committee was tasked with ensuring that the findings of an annual remuneration framework review and triennial independent effectiveness are addressed and implemented. This has been retained in large part. APRA will permit the annual review to be conducted internally in the form of a self-assessment and it has tightened the scope of triennial reviews, with further guidance on APRA's expectations for the scope of these reviews to be released in a new prudential practice guide.

What will happen to mandated deferral periods and clawback?

Deferral periods have been reduced slightly, balancing feedback from stakeholders concerned about the impact on talent retention and competitiveness, the need to ensure alignment with BEAR and achieve consistency with international standards:

  • CEO remuneration: 60% of total variable remuneration will be subject to a deferral period of six years (down from seven years), with pro-rata vesting from year four.
  • Senior managers and executive directors: 40% of total variable remuneration will be subject to a deferral period of five years (down from six years), with pro-rata vesting from year four.
  • HPMRT: 40% of total variable remuneration will be subject to a deferral period of four years (down from six years) with pro-rata vesting from year two.

In relation to clawback, as originally proposed, variable remuneration would be subject to mandatory clawback for a period of at least two years from vesting (or, where a person is under investigation, a further two years). Instead, it is proposed that SFIs set criteria for, and take reasonable steps to apply, clawback in a range of circumstances which APRA describes in the Response Paper as 'exceptional circumstances'. The drafting of the clawback and malus provisions in CPS 511 have been aligned, therefore read in isolation of the Response Paper, CPS 511 suggests that clawback and malus should be applied to similar instances of misconduct (recognising that, in terms of practical enforcement, malus is a more effective measure in the first instance, given the inherent limitations and complexities of successfully enforcing clawback). 

How will CPS 511 be applied to service providers?

The revised CPS 511 says that the remuneration policy of an APRA-regulated entity must set out the process to identify and address inconsistencies that may result from the remuneration arrangements of a service provider, as compared to the prudential remuneration framework binding on the APRA-regulated entity. The drafting is not limited to a particular type of service provider. APRA says that it has clarified that entities are required to make an overall assessment of a service provider’s remuneration arrangements (they are not required to influence a service provider's remuneration arrangements). While that may be the case, it remains to be seen what level of information APRA-regulated entities can sensibly obtain from service providers (whether as part of due diligence or via other contractual means) to be in a position to make an assessment of this nature. APRA intends to provide further detail in the new prudential practice guide, which we hope will include sensible guidance on materiality and the scope of the assessment APRA expects entities to undertake on the remuneration arrangements of its service providers.

Remuneration disclosure – are further reforms on the way?

While APRA has conceded some of the more prescriptive elements of CPS 511 as originally proposed, the retreat back to a principles-based approach is being matched with increased disclosure requirements. The new disclosure requirements would apply to all APRA-regulated entities (including non-SFIs), in addition to listed entities, ADIs and RSE licensees, which are already subject to remuneration disclosure obligations under the Corporations Act and SIS Act, respectively.

The details are still being considered and consulted on by APRA, but it is proposed that remuneration governance and oversight arrangements, remuneration and design outcomes and consequence management (ie detailing of remuneration adjustments based on performance), would all be subject to new disclosure requirements.

What's next?
  • APRA will accept submissions on revised CPS 511 on or before 12 February 2021.
  • APRA also plans to release a new prudential practice guide to assist entities in implementing CPS 511, which APRA intends to consult on in the first quarter of 2021.
  • A final version of CPS 511 is scheduled for second quarter of 2021.

Footnotes

  1. Defined in the first draft of CPS 511 as senior managers, material risk-takers, and risk and financial control personnel.

  2. Means a material risk-taker whose total fixed remuneration (which includes salary, superannuation, allowances and benefits) plus actual (revised down from 'maximum potential') variable remuneration is equal to or greater than AUD1 million in a financial year.

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