The Australian Prudential Regulation Authority has softened its stance on the most controversial aspect of its new remuneration standard for financial institutions – the imposition of a hard limit on the use of financial performance measures for determining remuneration outcomes.
The regulator has issued a revised standard for consultation, following an initial round of consultation last year. It has set a deadline of February 12 next year for submissions and plans to have the standard finalised by the middle of next year, with implementation to be phased in from January 2023.
APRA’s initial draft included a 50 per cent limit on the use of financial performance measures to determine remuneration outcomes. Its aim is to increase the focus on incentives for management of non-financial risks.
Industry submissions complained that the proposal was too prescriptive and limited remuneration design.
In the revised standard released yesterday, APRA said it has maintained its focus on non-financial risks but rather than impose a hard limit it is requiring financial institutions to give “material weight” to non-financial measures in remuneration design.
Financial institutions will be required to adjust variable remuneration for adverse risk and conduct outcomes.
APRA rejected submissions arguing that total shareholder return and return on equity captured all relevant financial and non-financial risks.
“Historical experience has shown that TSR and ROE reflect entity-wide assessments of performance and do not reinforce individual accountability for effective management of non-financial risk,” it said.
Financial institutions will be required to make an assessment of its service providers’ remuneration arrangements, as well.
Another contentious issue was APRA’s proposed minimum deferral period for variable remuneration of seven years for chief executives, six years for senior managers and “highly paid material risk takers”.
Industry complained about what it saw as overly long deferral periods that could make it difficult to attract talent.
In response, APRA has reduced the deferral period from seven to six years for CEOs, six to five years for senior managers and six to four years for highly paid material risk takers. And it has included pro rata vesting.
For example, under the revised proposal a board must defer 60 per cent of a CEO’s variable remuneration for six years, with vesting on a pro rate basis in years four, five and six. The rules vary for senior managers and highly paid material risk takers.
Another change from the initial proposal is greater proportionality, with reduced requirements for “non-significant financial institutions”. Non-SFIs will not have to meet minimum deferral, clawback or review requirements.
Submissions criticised the clawback provisions in the initial proposal as too broad and open to interpretation and said inclusion of financial loss in the clawback criteria would limit innovation and risk-taking. Industry respondents said clawback should be for fraud and severe misconduct.
In response, APRA has clarified the clawback criteria, saying it would only be used in exceptional circumstances.