APRA’s revised Prudential CPS511 10 minutes on…
8
10 minutes on… APRA’s revised Prudential Standard on remuneration: CPS511 November 2020
Transcript of APRA’s revised Prudential CPS511 10 minutes on…
10 minutes on… APRA’s revised Prudential Standard on remuneration: CPS511
November 2020
PwC
On 12 November 2020, APRA released a revised standard on remuneration (CPS 511), which APRA describes as ‘more principles-based minimum requirements’ relative to the initial draft that was released in July 2019. To accompany the standard, APRA also released a Response Paper: Strengthening prudential requirements for remuneration. Overall, we expect organisations will welcome many of the changes reflected in the revised standard particularly the removal of a prescriptive cap on financial measures, and the reduction in the requirements for institutions that are not classified as significant financial institutions (SFIs).
The consultation period for the revised CPS 511 standard will close on 12 February 2021, with a finalised standard expected in mid-2021. Staggered effective dates are as follows:
● 1 Jan 2023 for SFIs that are authorised deposit-taking institutions (ADIs)● 1 July 2023 for SFIs that are insurance and superannuation entities, and● 1 Jan 2024 for non-SFIs.
The revised standard states that ‘this Prudential Standard does not apply to a person’s variable remuneration if the opportunity to earn the variable remuneration arose before the relevant commencement date’ which we take to mean that remuneration arrangements will need to be compliant if covering performance years on or after the commencement dates. For example, for an SFI that is an ADI with a 1 July financial year, STI and LTI arrangements with performance periods commencing 1 July 2023 will be the first arrangements needing to be compliant.
APRA notes in their Response Paper that they have collaborated with the Australian Securities and Investment Commission (ASIC) in relation to the findings of their Executive Remuneration taskforce, and that they ‘continue to work closely with’ Treasury to ensure there is appropriate alignment between the Financial Accountability Regime (FAR) and CPS 511. And there does appear to be a number of requirements that now more closely align to FAR remuneration related requirements.
The revised standard has the same intent as the prior version, and is risk-based and proportionate. It is designed to deliver:● stronger incentives for individuals to proactively prevent and manage non-financial risks;● appropriate financial consequences where material risk incidents have occurred; and● increased transparency to drive stronger board accountability for remuneration outcomes.
As part of the consultation process on the ‘draft standard’ in July 2019, APRA hosted over 40 industry engagement sessions and received 76 submissions. The most substantial feedback was received in relation to the cap on financial measures (as it was believed to limit choice in terms of remuneration design), and then secondarily on Board remit (thought to be leading to more than an oversight role) and deferral periods (negatively impacting ability to attract and retain talent). In addition the administrative burden for smaller and less complex companies was frequently raised. The revised standard responds to this feedback.
Overview1
2
PwC 3
The revised Prudential Standard CPS 5112Revised standard requirement Key implications of change from July 2019
draft standard
Covers remuneration arrangements for all employees and third party service providers.
‘Remuneration arrangement’ includes measures of performance, the remuneration mix, and the timing of eligibility to receive payments (regardless of where, or from whom, the remuneration is sourced).
Higher requirements for SFIs and ‘Specified Roles’.
Scope Requirements for third party service providers have been refocused to an overall risk assessment, and no longer suggests board accountability for third party employee arrangements.
Many requirements no longer apply to non-SFIs.
An organisation is an SFI if it meets size criteria: ● Authorised deposit taking institutions (ADIs) >15B AUD● General insurers and life companies >10B AUD ● Registrable superannuation entity (RSE) licensees >30B
AUD, and● Private Health Insurers (PHIs) > 3B AUD.
OR is determined by APRA as an SFI having regard to matters such as complexity in its operations or remuneration practices, or its membership of a group.
SFI definition An asset threshold for PHIs has now been defined of 3 billion AUD.
Refined qualitative criteria to include complexity of operations and remuneration practices may mean some entities that don’t meet the size threshold are captured. Companies will be advised by Q3 2021 of their status as an SFI.
Specified roles‘Specified roles’ are broadly aligned with prior special role categories (with some narrowing of definitions):
● CEO● Senior Managers (meaning given in Banking/Ins/Life Ins Act,
or SPS 520 for RSEs)● Executive Directors (a Director that isn’t a NED)● Highly Paid Material Risk Takers (HPMRTs) (Max actual Total
Remuneration (TR) >= $1M)● Material Risk Takers (MRTs)● Risk and financial control personnel (RFCP)
More consistency in terminology across regulations, e.g. Senior Managers and Executive Directors under revised CPS 511 will generally be responsible persons under CPS 520 and SPS 520 and accountable persons under the BEAR.
Narrower definition of HPMRTs from maximum potential TR equal to or greater than $1M to maximum actual TR being equal to or greater than $1M.
Clarification on arrangements for RFCP that their VR not be unduly influenced by the performance of the business activities they control (the word ‘unduly’ is an addition).
Proportionality Non-SFIs do not need to comply with requirements:
● to establish a board remuneration committee;● material weight to non-financial measures;● risk and conduct modifiers;● deferrals;● clawbacks; and● annual compliance or triennial effectiveness reviews.
Differentiated requirements reduces burden for smaller less complex entities, and in some cases is a lower requirement than in current CPS 510 or SPS 510.
PwC 4
The revised Prudential Standard CPS 5112
Board to approve individual remuneration outcomes for CEO, Senior Managers, and Executive Directors.
Board to approve remuneration outcomes in aggregate for HPMRTs and MRTs.
For SFIs an annual compliance review and a triennial effectiveness review is required.
The RemCo/relevant oversight function must follow a documented process to consult with the Board Risk Committee and CRO/similar role on how remuneration outcomes reflect risk outcomes.
Governance HPMRT no longer requires board approval on an individual basis but on a cohort/aggregate basis.
Compliance and triennial reviews are no longer required for non SFIs.
A sharper focus for triennial reviews, with less prescription attached to the requirements of the triennial reviews (eg omission of reference to back testing of remuneration outcomes against remuneration design and performance and risk outcomes).
Requirement for consultation with Board Risk Committee/CRO used to be at Board, now at RemCo level or to be completed by a ‘relevant oversight function’ .
Specifically for SFIs, their remuneration frameworks must A. Give material weight to non financial measures within
each incentive plan
And
B. ensure that VR can be adjusted, potentially to nil, for adverse risk and conduct outcomes, based on clearly identified risk criteria (i.e. to bolster A. not in place of A.). Mechanic assumed to be a risk and conduct modifier applied to STI outcome and impacting LTI grant value
Financial measures
Requirement no longer applies to non SFIs.
No longer includes a prescribed weighting (50% max on financial, and 25% max on any single financial measure).
Now specifies that this requirement should be reflected in each incentive plan (e.g. within the STI and LTI).
A risk and conduct modifier will now be expected to apply to variable remuneration outcomes.
Refined definition of financial measure to include measures that are based on revenue, sales, profit, and share price, or other measures that directly affect those.
Variable remuneration (VR) is defined as the amount of a person’s total remuneration that is conditional on objectives, which include performance criteria, service requirements, or the passage of time.
Variable remuneration
definition
Definition clarified and specifically refers to including ‘performance criteria, service requirements or the passage of time’.
This definition now appears to capture remuneration components such as retention or sign-on bonuses (eg that could be solely subject to service requirements).
Revised standard requirement Key implications of change from July 2019 draft standard
PwC
5
The revised Prudential Standard CPS 5112
Deferral periods for SFIs apply only where deferred VR is more than AUD $50,000 in a financial year
● 60% for 6 years for a CEO (pro-rata vesting from year 4)● 40% for 5 years for a senior manager and executive director
(pro-rata vesting from year 4)● 40% for 4 years for HPMRTs (pro-rata vesting from year 2)
Deferral proportion and
periods
Deferral threshold is no longer linked to total VR amount but rather deferred VR amount.
Reduced periods for all: from 7 to 6 years for CEO, from 6 to 5 years for senior manager and executive director, and from 6 to 4 years with vesting commencing from year 2 (rather than year 4) for HPMRTs.
Partial vesting to cover the tax amount at termination is allowed.
The response paper also:
● explicitly sets out an expectation that deferred pay will remain on foot post termination; and
● clarifies that deferral period for STI commences on day 1 of the annual performance period, and for LTI the period over which the performance is assessed and any service period required.
Remuneration adjustment
Remuneration adjustment tools to include:● In period adjustment (adjustment made to VR during the
period set for measuring performance) - applicable for all● Malus (adjustment to reduce the value of all or part of VR
before it has vested) - applicable for all● Clawback (recovery of some or all of an amount that has
already been paid to a person) - required for SFIs only
Needs to be supported by a ‘downwards adjustment process’ with clearly identified ‘triggers’.
Malus and clawback criteria aligned and refined with specific inclusions.
Clawback definition refined to include ‘some or all’ variable remuneration.
Clawback extension of 2 years more for a person under investigation has been removed, only applies now for 2 years from date of payment.
The circumstances in which malus and clawback are expected to apply is narrowed, and now omits reference to (for malus) a significant downturn in performance or evidence of misconduct / negligence leading to losses; or (for clawback) responsibility for material financial losses.
Clawback and malus criteria are aligned, with a materiality threshold for clawback to illustrate should only be used in exceptional circumstances.
Revised standard requirement Key implications of change from July 2019 draft standard
PwC6
Transitioning to the new standard3
6PwC
Reinforcing the standardPreparation for implementationTransition arrangements (contracts)
These measures in the new standard will be reinforced with stronger market discipline and heightened supervision including:● a deep dive implementation review on
a sample of entities once arrangements are in place
● a new draft prudential practice guide (consulted on in Q1 2021)
● new reporting and disclosure requirements (data study to be conducted in Q1 2021 and approach consulted on concluding Q4 2021)
● review of the effectiveness of CPS 511 four years from its effective date.
Revised CPS 511 will not require renegotiation of existing employment contracts at the commencement date of the finalised standard. However, all new and renewing remuneration contracts entered after the implementation date must be compliant.
While APRA intends to provide at least 18 months between the final standard and the implementation dates, following the release of the finalised standard, APRA is expecting SFIs will undertake a self assessment and develop an implementation plan, which may need to be shared with APRA’s supervision team.
PwC7
Key focus areas and activities for organisations4
7PwC
Where do we anticipate organisations will have to spend most of their redesign effort?
Given current market practice, we anticipate most work will be driven by these reforms:● SFIs:
○ Incorporating new deferral periods and portions into VR frameworks;○ Ensuring there are non-financial measures with ‘material weight’ within
LTI arrangements where the majority of entities will be coming from a zero weighting;
○ Developing a risk/conduct modifier to apply to LTI grants in addition to STI awards;
○ Refining the now multiple risk adjustment mechanisms required so that each distinct purpose is clear (e.g. how do non-financial measures vs. the risk/conduct modifier vs. board discretion vs. the consequence policy each work as individual elements, and how do they work together?); and
○ Establishing the process for the annual compliance and triennial effectiveness reviews.
● Non-SFIs: ○ Refining remuneration policy (and possibly frameworks) to explicitly
describe how the remuneration framework ‘supports the prevention and mitigation of conduct risk’;
○ Developing a documented ‘downwards adjustment process’ with clear triggers; and
○ Incorporation of specified adjustment tools.● Both SFIs and non-SFIs:
○ Where there is service provider that is not a related body corporate or connected entity, establishing the process to identify whether the remuneration arrangements are inconsistent with key requirements of the standard.
Further clarifications
In our view, further clarification is still warranted in the following areas:● Clawback and malus criteria have identical criteria but
for the materiality of ‘significant’ vs ‘material’ (e.g. can it be assumed clawback is the last resort if adjustment quantum can’t be recouped via in period adjustment plus malus?).
● There are still differences between fundamental aspects of FAR and CPS 511, e.g. proportion of CEO VR to be deferred.
● The intent of the risk modifier applying to LTI grant rather than LTI at the vesting point.
● Whether further guidance is required on what might constitute a ‘material weighting’ on financial measures to force change (i.e. is there a middle ground between a principles based position and the prior level of prescription)?
● Without a prescriptive cap on financial measures, it will be left to entities to navigate with proxy advisors and investors a number of whom are less supportive of incorporating non financial measures in incentive arrangements.
● The extension of the definition of VR to include service period requirements and the passage of time.- Would sign on bonuses need to be deferred for the
same periods as set out for specified roles in SFIs?- Would restricted equity be captured if they are
considered as part of fixed pay?
PwC
8
How can PwC help?
To have a deeper discussion about these issues, please contact:
Melbourne
Andrew CurcioPartnerPh: (03) 8603 1685Email: [email protected]
Sarah RyanSenior ManagerPh: (03) 8603 2959Email: [email protected]
Sydney
Emma GroganPartnerPh: (02) 8266 2420Email: [email protected]
Frederick GuanzonSenior ManagerPh: (02) 8266 6326Email: [email protected]
Reward Advisory Services
Our Reward Advisory Services business helps our clients to realise and discover the potential of their people:• Reward strategy• Transaction and deals• Incentive plans (local and global plans)• Performance metric selection and
calibration• Reward modelling and valuation• Tax, regulatory and accounting advice• Employee share trusts• Performance management• Research, data analytics and
benchmarking• Communication and change• Board advisory and corporate governance• Remuneration reports and disclosure
Cassandra FungDirectorPh: (02) 8266 2183Email: [email protected]
Michael BierwirthDirectorPh: (03) 8603 4835Email: [email protected]
© 2020 PricewaterhouseCoopers Consulting (Australia) Pty Limited. All rights reserved. PwC refers to PricewaterhouseCoopers Consulting (Australia) Pty Limited, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. Liability limited by a scheme approved under Professional Standards Legislation.
pwc.com.au
