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APRA releases draft CPS 511 Remuneration guidance

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Written by Miriam Kleiner and Andrew Gray

On 30 April 2021, APRA released a draft practice note ("Guidance") to support Prudential Standard CPS 511 Remuneration ("CPS 511"). The Guidance sets out APRA's expectations for entities to design and maintain prudent remuneration arrangements that promote effective risk management, sustainable performance and long-term soundness.

The Key Takeaways

  • Boards should be actively engaged in the oversight of key remuneration decisions, providing robust challenge and independent scrutiny
  • Boards should ensure that the remuneration committee is composed of members with the appropriate skills, experience and expertise to exercise competent and independent judgment. This includes a clear understanding of what constitutes good risk management
  • The assessment of performance and risk should include direct input from senior risk management personnel, and not be based on self-assessments alone
  • APRA expects an entity to define non-financial measures that best suit their particular strategy and risk objectives, and reflect their specific risk profile
  • APRA expects entities to clearly define how material weighting is applied in the design of variable remuneration arrangements, and quantify the impact that non-financial measures can have on remuneration outcomes
  • APRA expects considerations of in-period risk adjustments to be made on a timely basis and that Boards will consider risk adjustments outside of the regular performance assessment cycle in response to information about misconduct or adverse risk outcomes
  • APRA expects that an SFI's annual compliance review would typically include a self-assessment against CPS 511 requirements, examining both the design and outcomes of the remuneration framework

More details

A summary of some of the key elements of the Guidance is set out below. As the Guidance is very detailed, we encourage you to read the Guidance carefully and contact us with any questions.

CPS 511 requirement

CPS 511 guidance

Responsibility for remuneration framework

Under CPS 511, the Board is ultimately responsible for the entity's remuneration framework and its effective application.[1]

APRA expects Boards to ensure that remuneration practices are well supported by broader frameworks and policies that influence behaviour, beyond financial rewards. The Guidance states specifically that this should include clear accountabilities and expectations for risk management, effective consequence management and a strong tone from the top on risk culture.

APRA expects that a prudent Board would ensure that its remuneration committee is composed of members with the appropriate skills, experience and expertise to exercise competent and independent judgment. This includes a clear understanding of what constitutes good risk management.

While the Board of a non-SFI is not required to establish a remuneration committee, it must put in place arrangements to meet the requirements of CPS 511 and ensure that due consideration is given to the oversight of the remuneration framework and key remuneration decisions.

Aligning remuneration and risk

An APRA-regulated entity must design all variable remuneration arrangements to align with paragraph 19 of CPS 511 and must incorporate certain items in its variable remuneration arrangements.[2]

APRA expects that the assessment of performance and risk would include direct input from senior risk management personnel, and not be based on self-assessments alone. Good practice would be for risk and internal audit executives to present a comprehensive assessment of key risk and audit metrics on at least an annual basis, to inform remuneration considerations.

The use of joint meetings with the Board Risk Committee can also be an effective mechanism for providing insights into risk considerations for the RemCo. It would not be prudent to rely on cross-membership between the RemCo and the Board Risk Committee as the sole means of providing a view on risk.

Board oversight and discretion

An APRA-regulated entity must design all variable remuneration arrangements to align with paragraph 19 of CPS 511 and must incorporate appropriate remuneration adjustment tools, that include but are not limited to overriding board discretion at each decision point, in-period adjustments, malus and where appropriate clawback, which are supported by a downward-adjustments process: (i) with clearly identified triggers to make a downward-adjustment; (ii) that determines the appropriate adjustment tools to use; and (iii) that determines the amount of downward-adjustment, to nil if appropriate.[3]

The Guidance acknowledges that there may be occasions where the Board would need to exercise its discretion to challenge and override remuneration recommendations, and make downward adjustments for individuals, cohorts or all personnel.

APRA expects Boards to be actively engaged in the oversight of key remuneration decisions, providing robust challenge and independent scrutiny. Board oversight and discretion to adjust variable remuneration would be particularly relevant in unusual or exceptional circumstances.

It is important that the Board uses its discretion in a timely manner, rather than acting only on the basis of realised outcomes. APRA states that it could be appropriate for a Board to reduce pre-emptively variable remuneration during a period of stress, rather than waiting for losses to be realised. It is not acceptable to act only once risk issues are made public, to adopt management recommendations without challenge, or to excuse poor risk outcomes on the basis of good intent.

Board reporting

The Board Remuneration Committee, or relevant oversight function, must obtain comprehensive reporting that will allow it to determine whether remuneration outcomes of all remuneration arrangements align with paragraph 19 of this Prudential Standard.[4]

It is the responsibility of the Board and Remuneration Committee to guide management on the reporting it needs to fulfil its role.

For ADIs, good practice is to take a forward-looking approach to reductions in discretionary bonus payments to staff, before being formally required to by the constraints imposed by the capital conservation buffer regime as set out in Prudential Standard APS 110 Capital Adequacy.

Boards should challenge any adjustments to quantitative metrics. This would include in particular any adjustments to statutory profit that could affect whether hurdles for variable remuneration are met.

Remuneration framework and specified roles

An APRA-regulated entity must design all variable remuneration arrangements to align with paragraph 19 of CPS 511 and must incorporate certain items in its variable remuneration arrangements.[5]

The Board, or relevant oversight function, must approve the variable remuneration outcomes for persons in specified roles as follows:(a)individually for senior managers and executive directors; and(b)on a cohort basis for highly-paid material risk-takers, other material risk-takers and risk and financial control personnel.[6]

APRA expects that an entity's remuneration policy would record the particular specified roles for the entity, and summarise the remuneration arrangements for these roles. Specified roles are defined in CPS 511 and are intended to capture those individuals and cohorts who can have a material influence on the performance and risk profile of the entity, in both the short and long-term.

As set out in CPS 511, the variable remuneration outcomes of all material risk-takers must be approved by the Board on a cohort basis. An entity is expected to consider a range of factors in identifying material risk-takers, including analysis of their potential impact on the entity's risk profile. This could be through the use of quantitative indicators, or qualitative criteria.

The Guidance recommends considering the identification of groups of material risk-takers as well as individuals, including those that may collectively affect financial soundness.

A prudent Board should also closely monitor the remuneration of all risk and financial control personnel as a cohort, to ensure arrangements are adequate to attract and retain suitably qualified, skilled and experienced staff.

Service Providers

The remuneration framework must include a documented remuneration policy which at minimum sets out: the process to identify and address inconsistencies with paragraph 61 of this Prudential Standard that may result from the remuneration arrangements of a service provider that is not a related body corporate or connected entity of the APRA-regulated entity.[7]

A prudent entity would take reasonable steps to identify which service providers may give rise to conflicts or risks. Where an entity has identified a potential conflict in the remuneration arrangements of a service provider and the intent of its own remuneration framework, CPS 511 requires an entity to take steps to address this risk.

Remuneration design

An APRA-regulated entity must align variable remuneration outcomes with performance and risk outcomes.[8]7

An entity should carefully consider the balance between fixed and variable remuneration, to ensure there are appropriate incentives for performance and risk management. Entities may decide not to offer variable remuneration, if this does not support their objectives or business model.

The form of variable remuneration is also important. A prudent entity should consider the appropriate mix between cash, benefits and equity, in line with its overall remuneration objectives.

In the design of variable remuneration arrangements, it is important to distinguish clearly between financial and non-financial measures of performance.

Defining non-financial measures

The determination of each component of a person's variable remuneration must give material weight to non-financial measures where the remuneration is performance related.[9]

APRA recommends that in incorporating non-financial measures into the design of variable remuneration arrangements, good practice would be to ensure a number of factors including that the impact of non-financial measures on individual variable remuneration can be easily understood.

The use of gateways, modifiers and other remuneration adjustment tools can be effective, but would be unlikely to meet the expectations above if used only in cases of significant adverse risk and conduct outcomes.

APRA expects an entity to define non-financial measures that best suit their particular strategy and risk objectives, and reflect their specific risk profile. A prudent entity would be able to demonstrate how non-financial measures support their desired risk culture, and promotes the prudent management of key risks.

An entity should be able to demonstrate how non-financial measures incentivise risk management, and should not rely only on metrics such as strategic goals.

Determining a material weight

The determination of each component of a person's variable remuneration must give material weight to non-financial measures where the remuneration is performance related.[10]

APRA expects entities to clearly define how material weighting is applied in the design of variable remuneration arrangements, and quantify the impact that non-financial measures can have on remuneration outcomes. In assessing whether material weight is being applied effectively in the design and determination of variable remuneration outcomes, a prudent Board should consider a number of factors including whether the weighting is a sufficient incentive to influence an individual's behaviour, priorities and decisions.

To assess whether the weighting for non-financial measures is driving intended behaviours and outcomes in practice, Boards should consider how effectively risk and conduct is managed.

Deferral

An APRA-regulated entity must defer variable remuneration as set out in CPS 511.[11]

To determine the amount to defer and the vesting schedule, SFIs should use the total value of variable remuneration awarded in the financial year. For equity-based remuneration, good practice is to use the number of shares rather than dollar value for the vesting schedule. Good practice is to apply deferral to each material component of an individual's variable remuneration including, for example, any one-off payments such as sign-on awards and buy-outs.

Risk and conduct adjustments

An APRA-regulated entity must design all variable remuneration arrangements to align with paragraph 19 of this Prudential Standard and must incorporate in its variable remuneration arrangements .. appropriate remuneration adjustment tools, that include but are not limited to overriding board discretion at each decision point, in-period adjustments, malus and where appropriate clawback, which are supported by a downward-adjustments process.[12]

APRA recommends that Boards should consider a wide range of evidence and ensure appropriate mechanisms are in place to escalate issues. APRA expects considerations of in-period risk adjustments to be made on a timely basis and that Boards will consider risk adjustments outside of the regular performance assessment cycle in response to information about misconduct or adverse risk outcomes.

Where employees at lower levels have received downward adjustments to variable remuneration for adverse risk and conduct outcomes, a prudent entity should consider whether corresponding adjustments at an executive level are appropriate to recognise overall line or functional accountability.

Entities should record all adjustment decisions, including where an adjustment was considered but ultimately decided against.

Review of the remuneration framework

An APRA-regulated entity must review compliance of the remuneration framework against the requirements of this Prudential Standard at least annually.[13] In addition to the annual review of compliance, the effectiveness of the remuneration framework must be subject to a comprehensive review by operationally independent, appropriately experienced and competent persons at least every three years.[14]

APRA expects that an SFI's annual compliance review would typically include a self-assessment against CPS 511 requirements, examining both the design and outcomes of the remuneration framework. The annual compliance review should be conducted by staff with appropriate skills and experience, and be subject to appropriate independent challenge. To avoid conflicts of interest, the review should be conducted by staff that were not involved in, or reporting to those involved in, the design of the remuneration framework.

Implementation timeline

The Guidance is open for consultation until 23 July 2021 and APRA plans to finalise it in the second half of 2021. Entities will be expected to comply with the new CPS 511 requirements beginning from 1 January 2023, under a staged implementation approach.

We will keep you informed of developments in this area.

For links to our prior alerts regarding CPS 511, please click here.

[1] Paragraph 21, Draft CPS 511

[2] Paragraph 13, Draft CPS 511

[3] Paragraph 36C, Draft CPS 511

[4] Paragraph 19, Draft CPS 511

[5] Paragraph 13, Draft CPS 511

[6] Paragraph 49, Draft CPS 511

[7] Paragraph 20(c), Draft CPS 511

[8] Paragraph 70(a), Draft CPS 511

[9] Paragraph 37(a), Draft CPS 511

[10] Paragraph 37(a), Draft CPS 511

[11] Paragraph 51, Draft CPS 511

[12] Paragraph 36(c), Draft CPS 511

[13] paragraph 31, Draft CPS 511

[14] Paragraph 32, Draft CPS 511

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