The interim report drew attention to the root cause of the issues in the financial services industry being greed and the observation that “all the conduct identified and criticised in this report [concerns] conduct that provided a financial benefit to the individuals and entities ...”. The final report recommends changes to the way individuals in the industry are remunerated and rewarded.
APRA focus on remuneration is not fit for purpose and lags behind international standards
The Commissioner recommends that APRA’s prudential standards and guidance on remuneration should move beyond a focus on prudential risks to more directly address the management of non-financial risks and misconduct. In particular, APRA’s prudential standards and guidance should be guided by international standards and adopt the guidance prepared by the G20’s Financial Stability Board (FSB). The FSB’s principles require adjustments to remuneration for all forms of risk and not just financial metrics.
APRA should refocus its efforts on: (a) developing its prudential standards and guidance on remuneration to identify and manage reputational, compliance, conduct and other risks; and (b) requiring boards to assess the effectiveness of remuneration systems by gathering more information about how remuneration systems actually work in practice. These recommendations are consistent with recent APRA initiatives and commentary and do not come as a surprise.
The financial services industry can expect APRA to set limits on the use of financial metrics in long-term variable remuneration. The Commission has not sought to prescribe specific requirements.
Clawback of variable remuneration
All financial services entities should implement clawback of vested remuneration (backed by APRA standards). This is a significant step further than the remuneration frameworks utilised by many financial institutions, which operate mechanisms to enable the downward adjustment of in-year short-term variable remuneration, and unvested deferred short-term and long-term variable remuneration.
Unlike the prudential inquiry into the CBA, the final report does not address the practical and legal difficulties associated with clawing back vested remuneration, including:
- how a company will claw back vested securities;
- the interaction with limitations in the Fair Work Act 2009 which limit an employer’s ability to make deductions to employees remuneration, and require payments from employees; or
- the practical reality that the implementation and enforcement of a clawback mechanism can only be achieved through the pursuit of costly litigation.
Absent serious law reform, or the implementation of a statutory regime for the clawing back of remuneration (which the Commissioner does not recommend), significantly increased litigation can be expected where clawback mechanisms are built into existing contractual based remuneration arrangements.
Closed door remuneration adjustments
The Commissioner does not propose public disclosure of remuneration adjustments. While this avoids imposing further disclosure obligation on companies, it seems at odds with other recommendations designed to increase transparency.