APRA proposed to revise CPS 511, the prudential standard on remuneration for all APRA-regulated institutions. The draft standard has moved to a more principles-based approach that is designed to be risk-based and proportionate, with more comprehensive requirements for larger, more complex regulated entities, also known as significant financial institutions. The consultation period ends on February 12, 2021, with the standard expected to be finalized in mid-2021. The standard is proposed to come into effect for significant financial institutions that are authorized deposit-taking institutions on January 01, 2023, for insurance and superannuation significant financial institutions on July 01, 2023, and for non-significant financial institutions on January 01, 2024.
The new draft standard responds to industry feedback from the initial consultation, sets robust minimum standards for APRA-regulated entities, and addresses the relevant Royal Commission recommendations. APRA also published a response paper that sets out its response to the industry feedback on the initial proposals released in July 2019. Increased transparency is a key component of this reform. Entities will be subject to greater public disclosure of their remuneration practices to demonstrate compliance with APRA requirements. The specific disclosure requirements will be defined through a future consultation process, expected to be conducted in late 2021. The proposed standard sets key requirements for sound remuneration practice, to ensure that an entity’s framework includes the components to promote effective risk management, sustainable performance, and long-term soundness. For significant financial institutions, the core elements of the proposed CPS 511 representing the strongest areas of reform relative to the current market practice include the following:
- Governance. The revised CPS 511 will lift expectations of significant financial institutions boards and introduce new review requirements to enhance board oversight of the remuneration framework. To meet the requirements of APRA, boards will need to be more engaged on remuneration decisions and outcomes.
- Non-financial measures. The boards of significant financial institutions will be required to ensure incentives give material weight to non-financial measures to encourage a more balanced approach to risk management in the pursuit of financial performance. Short-term and long-term incentive arrangements that have predominantly relied on financial objectives must now incorporate non-financial measures. Another revision involves replacing the 50% cap on financial measures for variable remuneration with a requirement that material weight be assigned to non-financial measures, combined with a risk and conduct modifier that can potentially reduce variable remuneration to zero. This measure will represent the greatest change from current practices, among all the changes.
- Risk-adjustment. Entities will be required to have a process to adjust remuneration outcomes of individuals to zero, if appropriate, where they are found to be responsible for risk and conduct incidents. Existing practices, typically implemented through modifiers, will need to be tightened to ensure effective and consistent application.
- Deferral. The boards of significant financial institutions across all industries will be required to lengthen minimum four-year deferral periods set by the Banking Executive Accountability Regime (BEAR) and proposed under the government’s Financial Accountability Regime (FAR). Reduction will be in the minimum deferral periods for variable remuneration from seven to six years for CEOs, from six to five years for senior managers, and from six to four years for highly paid material risk-takers.
- Disclosure. To reinforce accountability, APRA proposed to require entities to publicly demonstrate how they are satisfying the key principles in the standard. APRA plans to enhance disclosure requirements and is considering proposals that would have entities publish aggregated details of remuneration outcomes and adjustments for material risk incidents. These are intended to complement the Corporations Act 2001 requirements.
These measures will be reinforced with stronger market discipline and heightened supervision. While many regulated entities have already made progress to improve remuneration frameworks, further change is required to entrench the minimum standards set out in the draft CPS 511. While draft CPS 511 included some elements of proportionality, APRA further reduced requirements of non-significant financial institutions in the revised standard. Under the revised standard, smaller entities will not be subject to a number of elements impacting variable remuneration, including material weight for non-financial measures, a risk and conduct modifier, minimum deferral periods, and claw-back. To further ease compliance costs, smaller entities will not have to conduct annual compliance checks or tri-annual effectiveness reviews of their remuneration frameworks.
Comment Due Date: February 12, 2021
Effective Date: January 01, 2023/July 01, 2023/January 01, 2024
Keywords: Asia Pacific, Australia, Banking, Insurance, CPS 511, Remuneration, Operational Risk, Governance, Disclosures, Significant Financial Institutions, Non-Significant Financial Institutions, Proportionality, BEAR, APRA
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