In July, the Australian Prudential Regulation Authority (APRA) released proposed new pay regulation standards for its regulated entities. The proposals include:
The board will be expected to oversee the organisation’s remuneration for all employees, including its remuneration policy and outcomes for an expanded number of roles, such as senior managers, material risk takers and some service providers. This will substantially expand the board’s role.
A limit on financial metrics of 50 per cent being used to assess variable remuneration with any individual financial measure to comprise not more than 25 per cent of total measures used. This applies across the entire organisation and across the total amount of variable remuneration. It includes revenue, profit, volume-based and capital-based measures, such as return on equity measures, as well as market measures such as total shareholder returns.
APRA noted many investors have traditionally supported a heavier weight for financial targets; consumer advocates prefer customer-focused measures such as customer service and loyalty; executives favour a remuneration arrangement reflecting their skill and expertise. “No approach will satisfy all stakeholders, but in APRA’s view, financial targets have had too prominent a place in executive remuneration in some sectors of the financial industry.”
Boards will also have scope to claw back variable remuneration for up to four years after vesting or payment.
Longer deferral periods
Minimum deferral periods for CEOs in larger organisations of up to seven years for 60 per cent of their total variable remuneration. For senior managers and material risk takers, up to 40 per cent of total variable remuneration will be deferred for up to six years (with pro rata vesting from year four).
Annual compliance and triennial effectiveness reviews of the remuneration framework. APRA will also intensify supervision of remuneration practices focusing on design, implementation and outcomes.
APRA deputy chair John Lonsdale PSM says remuneration in many entities is not incentivising the right behaviours. “Where policies are poorly designed, or not followed in practice, companies may incentivise conduct contrary to the long-term interests of the company and its customers.”
Proxy adviser response
Daniel Smith, general manager CGI Glass Lewis, says there is likely to be a knock-on effect from APRA-regulated entities to board practices at other large listed companies. “Many directors of financial services boards sit on boards of other companies, so at a minimum, I’d expect a degree of influence or information flow across sectors.”
He notes the new standards will mean a heavy list for boards and rem committees. “Is the size of the board right to meet the increasing demands? If directors overall are required to do more heavy lifting, there may be an argument for increasing the size of the board or at least the size of the remuneration and risk committees to shoulder that responsibility.
A corollary of that is to increase the size of the secretariat to support that. Is there a risk of the pendulum swinging too far to the other side where such a heavy focus on remuneration potentially crowds out directors’ capabilities to exercise their oversight functions on other areas of risk management or strategy?
“One of the key lessons from the financial services Royal Commission is that a lot of the conduct issues had a slow burn. One of the challenges we are dealing with this is how do you design schemes with significant deferral periods that allow boards to dial down a bonus?
"You have issues in pushing out vesting periods, which is worth a lot less in cash today, but there is zero appetite for pay packages to increase to reflect that time value of money issue.”
Smith says a major challenge with the focus on non-financial metrics is deciding on appropriate ways to measure. “If you are putting more expectations on boards to ensure a greater focus on non-financial measures, you want to set boards up for success. You need to have clear measures and targets they are setting for the executives.”
Company Director magazine will include more detailed coverage of non-financial measures in the November issue.
The AICD View
The AICD supports APRA in its aim to engage in stronger supervision of remuneration frameworks and focus on non-financial risk management, but “has expressed concern about the unintended consequences of high levels of prescription and looks forward to being an active participant in the consultation”.
The AICD has been consulting closely with impacted members and key stakeholders and will provide a submission to APRA on the proposed standard.
Responses to the draft will close on 23 October. The standard will be finalised in late 2019 or early 2020 and it is expected to come into effect on 1 July 2021.
At a principle level, the AICD believes that variable remuneration, when designed appropriately and properly implemented, has the capacity to effectively drive performance in accordance with company strategy.
More information here.