In July 2019, APRA commenced consultation on its draft prudential standard on remuneration, CPS 511. APRA’s objectives in developing the draft prudential standard CPS 511 were “enhancing board oversight, increasing the use of non-financial measures in remuneration design and ensuring there are appropriate financial consequences for poor risk management”.
Grant Thornton agreed with the core elements of the proposed standard with its focus on trust and enhancing accountability as an important step for the industry. However, we felt greater clarity on certain key concepts and definitions within the standard and most importantly, a more proportionate approach aligned to the size, complexity, remuneration approach and risk profile of each financial institution was needed. This feedback was provided within our submitted response on 23 October 2019.
APRA has now released the results of the consultation, details of which are outlined below. Key changes in the revised CPS 511 include:
- Enhancing the principles-based approach to enable greater flexibility and alignment with a regulated entity’s strategy and values.
- Revision of remuneration deferral period downwards by 1 to 2 years to better align with international practice.
- Adjusting the measure of variable remuneration from potential to actual to reduce the number of individuals that could fall within the scope of the requirements.
- Further reduction of requirements for non-Significant Financial Institutions (SFIs) including the need to meet minimum deferral, clawback and review requirements to reduce the regulatory burden on less-complex financial institutions.
What you can do now to prepare
Larger financial institutions are expected to be compliant with by 2023 and non-SFIs by 2024. There are a number of things that entities can put in place now so that they are embedded and operational by this time. These include:
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Things to focus on now in preparation for CPS 511
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Management of non-financial risks
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A consistent theme for all recent regulatory reform is a great emphasis of the management of non-financial risks including Strategic Risk and Conduct Risk. Entities should review their risk management frameworks to ensure that non-financial risks are considered, identified and measured. These processes should be embedded and effective and risk owners identified to enable remuneration outcomes to be measured.
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Role of the Board
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Review the Board’s Charter, Operating Rhythm and Reporting to consider whether there is a sufficient focus on remuneration including KPIs and holding Executives to account where these are not met. If the Board does not have a Remuneration Committee then consideration should be given to whether this is necessary to enable the Board to meet its requirements under CPS 11.
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Disclosure
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Entities are required to publicly disclose how they satisfy the requirements of CPS 511. As changes and enhancements are made to the remuneration framework and governance over this, entities should review and where necessary update the remuneration disclosure in their financial statements and websites. This can be an iterative process over the implementation period.
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There continues to be areas of non-alignment with other requirements, in particular BEAR which has a minimum deferral period of four years and classifies financial institutions as small, medium or large. These inconsistencies also apply to the proposed Financial Accountability Regime (FAR). APRA has maintained its focus on the management of non-financial risks which is focused not only for setting remuneration but the effectiveness and appropriateness of risk frameworks.
Material Risk-takers
Material Risk-takers
Grant Thornton together with many other respondents was concerned that the definition of highly-paid material risk-takers (HPMRTs) was too broad and would potentially capture too many specialist roles. An outcome that would significantly increase compliance costs, was disproportionate to risk and may distract from the intended focus on remuneration outcomes for key executives and authority holders.
Although APRA retained the one million dollar threshold it adjusted the variable measure from “maximum potential variable remuneration” to “actual variable remuneration”. APRA anticipates that fewer individuals will fall within the scope of CPS 511 as a result of the change. Specialist roles such as traders and advisors tend to have a far higher proportion of their total remuneration at risk or variable and therefore are now less likely to full within the scope of the standard.
APRA has also provided more specific examples for terms and definitions used in the standard such as variable remuneration and specified roles. In our submission to APRA on the draft standard, we sought clarity on the treatment of “golden hellos”. The updated standard specifies objectives for variable remuneration including “performance criteria, service requirements and the passage of time”. These objectives cover past rather than future performance. If there are any contingencies attached to the payment of a “golden hello” such as time served it is likely to be captured as variable remuneration. If there are no contingencies, they are likely not to meet the definition of variable remuneration. This may be an area that could be open to manipulation.
Governance
Governance
We were consistent with other respondents in seeking better guidance regarding the role of the Board and Remuneration Committees. APRA’s view was that “boards have not been sufficiently engaged on remuneration and focused on compliance”. The previous version of CPS 511 was quite prescriptive and therefore did not allow for a proportionate approach to determining an appropriate approach to governance. This is now replaced with overarching principles which better enable an entity to tailor an approach that is consistent with their size and the complexity of their remuneration structures.
APRA has promised further guidance on the role of the Board when it releases a draft Practice Guide which is expected by the end of March 2021.
We were consistent with other respondents in seeking better guidance regarding the role of the Board and Remuneration Committees. APRA’s view was that “boards have not been sufficiently engaged on remuneration and focused on compliance”. The previous version of CPS 511 was quite prescriptive and therefore did not allow for a proportionate approach to determining an appropriate approach to governance. This is now replaced with overarching principles which better enable an entity to tailor an approach that is consistent with their size and the complexity of their remuneration structures.
APRA has promised further guidance on the role of the Board when it releases a draft Practice Guide which is expected by the end of March 2021.
Grant Thornton will participate in the consultation process for the Practice Guide.
Proportionality
Proportionality
We have long been an advocate of proportional regulation. Compliance cost can be a significant barrier to entry for new participants however a stable financial system enables consumers to have genuine a choice of provider. Whilst Grant Thornton and other respondents sought greater alignment between the classifications used in CPS 511 and BEAR, we acknowledge that the revised standard goes some way towards adopting a proportionate approach.
Appropriate governance and remuneration structures designed to take account of financial and non-financial risks are the minimum requirements for all regulated entities regardless of size. Elements such as deferrals and clawbacks are more appropriate to larger financial institutions where accountability is shared across a greater number of roles and there are a greater number of products offered. There is therefore a far greater likelihood that the requirements of CPS 511 can be managed within existing governance frameworks however Grant Thornton would like to see guidance on this included in the CPS 511 Practice Guide.
Our preferred position was for Restricted ADIs (RADIs) and Profit-to-members entities (Mutuals) to be exempt from CPS 511. This is a function of less complex business models and in the case of Mutuals, a commitment to return profits to members.
The equitable outcomes flowing from a proportionate approach to regulation apply not only to CPS 511 but to all prudential, conduct, industry, data and competition requirements. To this end, Grant Thornton will continue to advocate for this approach.
Next steps
There is greater clarity to support compliance with the standard and the requirements for non-SFIs are more aligned to the nature of their operations and risk profile. However, we are of the view that further guidance is necessary to clarify the role of the Board and will look to the draft Practice Guide to provide this.
The consultation period on the revised draft prudential standard is open until 12 February 2021.
APRA also intends to issue its draft Practice Guide for CPS 511 by late March 2021.
Grant Thornton is focused on supporting the resilience of the financial institutions it services through partnering with them to design and embed a culture, governance systems and remuneration structures commensurate with this objective. We will continue to engage on and participate in the consultation process.
