As in many other industries, performance-based remuneration has increasingly become the norm in the financial sector, with monetary incentives and accountability mechanisms used to motivate and influence employees’ behaviour. Remuneration frameworks and the outcomes they produce are important barometers and influencers of an organisation’s risk culture, providing insights into the extent that risk-taking is likely to be conducted within reasonable bounds. The global financial crisis in 2008 laid bare the potentially disastrous consequences of getting the balance of incentives and accountability wrong, by encouraging practices by individuals that were detrimental to the long-term interests of the financial institutions that employed them. A combination of misaligned incentives and ineffective accountability created poor risk cultures and undermined risk management, leading to unbalanced and ill-considered decision-making.
Though Australia was largely spared the worst impacts of the global financial crisis, APRA nevertheless sought to encourage improved remuneration practices. The foundation for this are the requirements within Prudential Standard CPS 510 Governance and Prudential Standard SPS 510 Governance (for superannuation licensees), and accompanying prudential practice guides. The core objective of APRA’s requirements is that performance-based components of remuneration should encourage behaviour that supports the effective risk management and long-term financial soundness of the institution.
To better determine whether this objective was being met, APRA undertook a review of remuneration policies and practices across a sample of large APRA-regulated entities. The review, which was primarily undertaken in 2017, examined in particular how the stated remuneration frameworks and policies were translating into outcomes for senior executives.
The review found that remuneration frameworks and practices across the sample did not consistently and effectively meet APRA’s objective of sufficiently encouraging behaviour that supports risk management frameworks and institutions’ long-term financial soundness. Though all institutions had remuneration structures that satisfied the minimum requirements of APRA’s prudential standards, the frameworks and practices often fell short of the sound practices set out in the relevant prudential guidance, and were therefore some way from better practice.
The review focused on three main themes:
- design of risk management performance measures;
- remuneration outcomes; and
- Board Remuneration Committee oversight.
Amongst other things, the review found room for improvement in:
- ensuring practices were adopted that were appropriate to the institution’s size, complexity and risk profile;
- the extent to which risk outcomes were assessed, and weighted, within performance scorecards;
- enforcement of accountability mechanisms in response to poor risk outcomes; and
- evidence of the rationale for remuneration decisions.
Based on these findings, there is considerable room for improvement in both the design and implementation of executive remuneration structures within the Australian financial system. Just as institutions are expected to operate with a prudent buffer over their minimum financial requirements, APRA does not believe institutions should be satisfied with simply meeting the minimum requirements on remuneration. Well targeted incentive schemes and firmly enforced accountability systems should be viewed not simply as a matter of regulatory compliance, but as essential for sustained commercial success.
APRA’s preference is that boards and senior executives consider the findings of this review and take action to better align their remuneration arrangements with good risk management and the long-term soundness of their institutions. Indeed, some institutions have already informed APRA that they have made or are making changes to the remuneration framework to address identified areas for improvement. However, APRA also intends to strengthen its prudential requirements on remuneration to better support this outcome. This will take account of the forthcoming introduction of the Banking Executive Accountability Regime (BEAR) for ADIs, as well as insights from international practice.
Any revisions to the prudential framework will be subject to APRA’s usual practices of stakeholder consultation and engagement. Until proposals are made, APRA encourages all regulated institutions to review their remuneration frameworks and address any areas where APRA’s findings indicate room for improvement.