APRA takes aim at executive pay schemes

The Australian Prudential Regulation Authority (APRA) wants to toughen disclosure in the area of executive remuneration across all parts of the financial system as well as making sure our prudential disclosures are in line with those overseas.

In a consultation process launched yesterday the regulator says it is trying to fill a gap exposed by the Hayne Royal Commission on the way executive pay is constructed and reported in banks and other financial groups.

This and the second proposal are aimed at improving “transparency and market discipline within the financial system,” according to the regulator.

“One consultation will focus on proposed new remuneration disclosure and reporting requirements for all banks, insurers and superannuation funds regulated by APRA, while the other focuses on APRA’s proposals to update bank prudential disclosures to align with international standards and the new bank capital framework.”

The regulator wants to see and expose just how CEOs and other senior managers (and no doubt board members) are being paid – not the base salaries but the way add-ons in the form of bonuses and performance pay are structured and awarded.

APRA thinks that by adding this to the existing requirements on remuneration in the financial sector, it will expose those payment practices and force changes to situations where the pay structures encourage too much risk taking and not enough prudence.

Some analysts think APRA is really aiming at the way executives in home lending, for example, are remunerated and whether this encourages the executives to go too hard in selling home loans. Equally APRA wants to make sure that fund manager remuneration in super funds and other financial groups it oversees does not encourage too much risk taking which could in turn trigger problems in a downturn.

APRA says it also wants to see what happens to executive pay and remuneration if there are “poor outcomes” for the institution.

APRA said the proposed remuneration requirements will support the cross-industry Prudential Standard CPS 511 Remuneration (CPS 511), which was introduced last year to strengthen remuneration practices across the banking, insurance and superannuation industries.

APRA’s key proposals are:

  • APRA-regulated institutions will be required to publicly disclose information on how their remuneration arrangements are designed, and how risk is factored into remuneration outcomes for key executives. This will ensure transparency on how executives are rewarded and incentivised, and on consequences where risk is managed poorly;
  • large and complex financial institutions will be required to disclose how they have placed a material weight on non-financial metrics (such as risk management and conduct) and remuneration outcomes for the Chief Executive Officer, other key executives and material risk-takers;
  • APRA will publish centralised statistics to provide greater comparability of remuneration outcomes across APRA-regulated entities, supported by reporting requirements that are proportionate to their size and complexity; and
  • the proposed remuneration disclosure and reporting requirements will take effect after the implementation of CPS 511 in 2023 for large entities and 2024 for smaller entities.

In the second discussion paper released yesterday, APRA said it was proposing “to align public disclosure requirements for banks with international standards and with APRA’s framework for capital strength.

“As part of the proposed revisions to Prudential Standard APS 330 Public Disclosure (APS 330), APRA would also introduce a centralised publication of key prudential risk metrics to facilitate the comparison and analysis of the capital positions and risk profiles of local banks.”

APRA said it further proposes to remove disclosure requirements relating to prudential risk metrics for smaller authorised deposit-taking institutions (ADIs). Instead, APRA will use the centralised publication to promote transparency and to reduce disclosure requirements for this segment of the banking industry.

The removal of disclosure requirements for small ADIs will take effect in 2023 to align with the new bank capital framework. The disclosure requirements for large banks will take effect from 2024.

In Wednesday’s statement, APRA Deputy Chair John Lonsdale said the agency was looking for greater transparency for the financial system, while minimising complexity for smaller entities.

“Transparency is important to a well-functioning system. APRA’s proposed disclosure requirements will ensure investors and the community can see how key executives are rewarded, and that consequences are applied where there are poor risk outcomes.

“The planned update to bank disclosures will also give investors, depositors and the broader community the information they need to assess the prudential health of individual ADIs and the industry overall,” Mr Lonsdale said.

This all sounds innocuous but it will allow first-time investors, super fund members and others to find out how much risk banks and other groups allow in setting their executive remuneration plans.

APRA has also made sure that non-executive personnel and others who get paid well are captured by including the phrase “material risk takers”. Now that could be a foreign exchange or bond dealer or someone in charge of deals down the line at an investment bank who is known as a ‘rainmaker’ or ‘big producer’.

They are not necessarily an executive senior enough to be caught up in the formal remuneration pay plans but APRA wants them included.

The key phrase from the APRA statement is its demand that it wants to reveal that “remuneration is aligned with performance and risk”.