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March 22, 2012

APRA report on progress of remuneration requirements implementation

APRA has published the results of its review of APRA-regulated institutions' progress on implementation of its prudential requirements in relation to remuneration.

APRA's comments include:

  • all of the Boards it met with "had well-established Remuneration Committees, with reasonably clear and robust governance arrangements. In most cases, the Chair of the Board attended meetings (either as a full or ex-officio member)...it was also pleasing to see a strong linkage between the Remuneration Committee and the Board Risk Committee: the most common model observed was for there to be at least two directors who sat on both committees (and often the Chair of the Risk Committee was a member of the Remuneration Committee)....
    We were pleased to see considerable evidence that, as appropriate, Remuneration Committees sought advice from external sources, independent of that obtained by management."
  • there was a "strong focus on the remuneration outcomes of the most senior executives. In a limited number of cases, there still seemed to be a degree of tension between the role of the CEO in determining the remuneration arrangements and awards for his/her senior executive team, and the requirement in the Prudential Standard that these arrangements be determined by the Board. While the CEO will rightly be a source of advice and input on these matters, ultimately it is the Board’s responsibility to determine both the structure of, and actual outcomes from, the remuneration arrangements of senior executives."
  • there were "some inconsistencies across the institutions in the extent of Board approval of the remuneration of material risk-takers below the senior executive level...Further, the remuneration arrangements of relevant staff of a related body corporate which provides material services to the regulated institution may also be subject to the requirements of the Prudential Standards."
  • "Most of the Remuneration Committees we met with have established performance assessment arrangements based on a scorecard approach, in which various quantifiable objectives and benchmarks are used to assess performance. However, the application of these scorecard-based approaches varied widely. Some scorecards contained fairly high level metrics only, with a high degree of judgement applied by the Remuneration Committee to convert key performance indicators (KPIs) into actual rewards....APRA does not advocate either of these approaches in their entirety, believing instead that good performance assessment requires both clarity of objectives to provide a sound basis for performance measurement, and the application of experienced judgement to reflect those aspects of performance which cannot be measured using readily quantifiable KPIs...We are wary of totally ‘mechanical’ or formulaic approaches to performance-based remuneration, which rely completely on the use of quantitative risk measures as a means of meeting the requirements within the Prudential Standard...Equally, we are wary of highly subjective approaches – they lack a sound basis on which to establish performance expectations or measure the adequacy of results, and rely too heavily on the judgement of the Remuneration Committee to ensure remuneration outcomes are appropriate."


In APRA’s view, practices across the industry need further development in four particular areas:

  • Do KPIs adequately reflect potential risk-taking by an individual as opposed to the wider management team? APRA considers it important that the quality of risk management is taken account of rather than the outcomes from the risk management process (i.e. the identification of failures as a result of poor risk management).
  • If the only adjustment to the remuneration arrangements for risk and financial control personnel is an increased proportion of remuneration as fixed salary, APRA queries whether the Remuneration Committee actively considered other ways to ensure incentives for such personnel are appropriate, given their particular responsibilities.
  • In the case of short-term incentives (STIs), there has been a tendency to:
    - lengthen the extent to which STIs are deferred (increasing from two to three years), and
    - increase the proportion of STIs which are deferred into shares.

    APRA supports both of these initiatives as consistent with the intent of the Prudential Standard to align performance-based remuneration with both risk (albeit institutional risk rather than any individual contribution), and the time needed to reliably measure performance.

  • As with STIs, the trend was for long term incentives (LTIs) to be extended in term, with a number of institutions now utilising vesting periods out to five years. Again, the extended period for vesting helps align remuneration with institutional outcomes of risk-taking.

    "All the institutions reviewed had some ability to withhold unvested STI and, to a lesser extent, LTI payments. Two issues were identified in the course of our discussions:
    a) The circumstances in which unvested payments can be reconsidered vary to quite a degree. Others have far less capacity, restricting themselves to instances of material financial misconduct, etc. Clearly, the narrower the capacity to withhold or adjust unvested payments, the more important it is that the initial performance assessment process is robust and fully considers the inherent risk within a given period’s financial and operational outcomes.
    For consideration: Are the conditions for withholding payments broad enough to adequately influence behaviour?
    b) A number of institutions do not have a capacity to withhold unvested LTIs, even if it was subsequently determined that the initial reward was based on an inaccurate assessment of performance. It was argued that, since LTIs were exposed to share price movements, this provided an element of risk adjustment to the value of the reward received by the employee. However, since this reflects only institutional outcomes, rather than individual outcomes, we are not convinced that relying solely on share price adjustments provides genuine alignment with the outcome of risk-taking by any given individual. We would like to see alternatives actively considered."

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    Posted 22nd March 2012 by admin in Risk management