The Australian Prudential Regulation Authority (APRA) has released a consultation on new rules aimed at clarifying and strengthening remuneration requirements in APRA-regulated entities. The consultation period will close on 23 October 2019 and APRA has indicated that it intends to release the final rules before the end of 2019 or in early 2020, with a view to the rules taking effect on 1 July 2021.
The proposed rules are materially more prescriptive than APRA’s existing remuneration requirements, which are considered to have not delivered satisfactory outcomes. This is demonstrated by the recent high-profile issues suffered by the Australian financial services sector and evidence that existing remuneration arrangements have been a factor driving poor consumer outcomes.
APRA hopes that the new rules will create a remuneration framework that better aligns with the long-term interests of firms and their stakeholders, including customers and shareholders. The proposed reforms also address recommendations from the recent Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
- To limit the focus on financial metrics and to put greater focus on non-financial risks (e.g. culture; governance), financial performance measures (e.g. revenue, profit and volume based measures; certain share-based measures) must not comprise more than 50% collectively or 25% individually of the performance criteria used to allocate variable remuneration.
- The firm must set specific criteria for the application of malus for variable remuneration, including the minimum criteria set out in the draft rules.
- For firms determined by APRA to be ‘significant financial institutions’, certain structural rules will apply, including requirements that: (a) a minimum of 60% of the total variable remuneration of the Chief Executive Officer must be deferred for at least 7 years, with no vesting before year 4 and vesting no faster than pro-rata after that; (b) a minimum of 40% of the total variable remuneration for a senior manager (other than the CEO) and for a highly-paid material risk-taker, must be deferred for at least 6 years, with no vesting before year 4 and vesting no faster than pro-rata after that; and (c) the variable remuneration of a senior manager or a highly-paid material risk taker must be subject to clawback for at least 2 years from the date of payment or vesting and, in circumstances involving a person under investigation, at least 4 years from the date of payment or vesting. Specific criteria must be set for the application of clawback, including the minimum criteria set out in the draft rules.
- 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. The Board must also ensure risk outcomes are reflected in remuneration outcomes.
- The remuneration policy needs to be subject to annual compliance reviews and triennial effectiveness reviews of the remuneration framework need to take place.
APRA has indicated that it also intends to consult on a ‘practice guide’ in 2020 to support the implementation of the new rules, as well as possible additional disclosure requirements.
The approach that APRA proposes to take will bring APRA-regulated firms closer to the style of regulation that entities regulated by the European Union are subject to. It is worth noting, however, that APRA did stop short of simply matching the onerous approach taken by the EU. For example, APRA has noted that they have chosen not to include a ‘bonus cap’ or to prescribe specific types or forms of variable remuneration on the basis that they have not seen evidence of these approaches being effective in promoting better outcomes. Although these two requirements are not included in APRA’s proposals, the proposed reforms will materially impact the remuneration structure for APRA-regulated firms, particularly due to the onerous deferral, malus and clawback requirements that will be imposed on certain employees.
In case these rules are finalised, firms should consider how these changes may impact any policies and award documentation, and also how the extended deferral periods, and malus and clawback arrangements, will be implemented and communicated. As an initial step, firms should consider whether to participate in the consultation process ahead of the 23 October 2019 deadline.
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