The Australian Prudential Regulation Authority (APRA) has today released a consultation package on remuneration for authorised deposit‑taking institutions and general and life insurance companies. The package comprises a discussion paper, draft extensions to the governance standards already applying in these industries and a draft prudential practice guide (PPG).
APRA’s proposals on remuneration are designed to ‘endorse and implement the FSF’s tough new principles on pay and compensation’ to quote from the Declaration by the Leaders of the G20 at their April meeting in London, by giving effect to the Financial Stability Forum’s (FSF) Principles of Sound Compensation Practices. They deal with an important deficiency highlighted by the FSF’s work, in which APRA participated, namely the lack of alignment of remuneration with risk management in many financial institutions. APRA’s proposals also respond to the Prime Minister’s request in October 2008 that APRA consider the linkages between remuneration practices and the capital adequacy requirements of regulated institutions.
APRA is intending to take a principles‑based approach in this area, by requiring Boards of regulated institutions to have a remuneration policy that aligns remuneration arrangements with the long‑term financial soundness of the institution and its risk management framework; at the same time, Boards would be able to design remuneration arrangements that suit the structure of their own institution. The policy would extend beyond senior executives to all persons who, because of their roles, have the capacity to make decisions that could materially affect the interests of depositors or policyholders, and owners.
'APRA has not addressed the absolute level of remuneration but the need to align remuneration incentives with good stewardship of institutions. That is why the proposed remuneration requirements are contained in our governance standards,' APRA Executive Member John Trowbridge said. 'The risks associated with remuneration arrangements must be managed as part of the institution's risk management framework,' Mr Trowbridge added.
APRA also proposes that regulated institutions have a Board Remuneration Committee, comprising only independent directors with the appropriate experience and expertise. ‘Decisions relating to remuneration matters must be well founded and not influenced by conflicts of interest’, Mr Trowbridge said.
Boards of regulated institutions will be held accountable for compliance with APRA's prudential requirements for remuneration. APRA's principle-based approach, rather than the prescription required in most disclosure regimes, together with its active supervision of regulated institutions, will be aimed at ensuring compliance with both the intent and the substance of these requirements. Where the remuneration arrangements of a regulated institution are likely to encourage excessive risk‑taking, APRA has several supervisory options, including the power to impose additional capital requirements on that institution.
The PPG will assist regulated institutions to comply with the proposed requirements in the governance prudential standards and, more generally, will assist Boards in their consideration of prudent practice in remuneration. The PPG covers a number of issues, including the use of deferred compensation, the links between incentives and risk, the use of shares in incentive arrangements, the need to link incentive compensation to both forward‑looking and backward-looking risk measures, and the balance between cash and non‑cash incentives.
APRA is seeking submissions on the draft standards and PPG by 24 July. Subject to consultation, it is expected that the final prudential standards and associated PPG will be released in September 2009 and be effective from1 January 2010.
The consultation package can be found on the APRA website.