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The release of the Final Prudential Practice Guide CPG 511 Remuneration

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In Brief

On 18 October 2021, APRA released its final Prudential Practice Guide CPG 511 Remuneration (CPG 511), following consultation on a draft earlier this year. The final CPG 511 aims to provide guidance to assist entities with the implementation of CPS 511 which comes into effect from 1 January 2023.¹

CPG 511 provides entities with examples for:

strengthening incentives for individuals to prudently manage risks they are responsible for;
applying consequences for poor risk outcomes; and
improving oversight, transparency and accountability on remuneration.

Following its initial draft, CPG 511 has been updated to align with the final CPS 511, the Government’s Financial Accountability Regime and to provide additional examples of better practice.

As it relates to the changes made in the final CPG 511, below we have outlined the major areas for which the practice guide has been revised and has helped provide clarification, and areas where we believe the industry might still be seeking further guidance.

In Detail

Firstly, in relation to the role of the Board, APRA now explicitly states that the Remuneration Committee ‘must consult’ with the Board Risk Committee and CRO to enable risk outcomes to be appropriately reflected in remuneration outcomes for specified roles i.e. simply having cross membership across committees is not prudent.

In relation to third party service providers, and aligned with the change provided in the final CPS 511, the guidance has been updated to better describe the action entities are expected to take in relation to third party remuneration arrangements i.e. to mitigate against material conflicts to the objectives of their remuneration framework that may result from the compensation of third party service providers.

In terms of remuneration design, APRA provides greater guidance on how variable reward needs to be calculated to determine the amount that requires deferral, particularly for remuneration approaches that include both an STI and LTI plan. For these approaches, variable reward is calculated as the sum of STI paid and LTI grant value. Clarification has also been given that Buyout awards will be explicitly included as one of the ‘common forms’ of variable remuneration.

For risk and conduct adjustments, reflecting the final CPS 511, APRA’s guidance includes a proportionate approach to applying adjustments instead of specifying the severity of a matter and the adjustment tool. This will provide entities with flexibility to use in-period adjustments (e.g. to STI) in the first instance, and then progress to other adjustment tools (e.g. malus, clawback) where the in-period adjustment is insufficient. Additionally, the severity of the criteria set out to trigger a downwards adjustment have been increased, such as “a failure of financial or non-financial risk management” has been uplifted to “a significant failure of financial or non-financial risk management” (emphasis added).

APRA has provided flexibility for the implementation of CPS 511 for entities as it relates to employees that join after the commencement date but before an entity’s new financial year. For these employees, their variable reward arrangements can comply with the CPS 511 requirements from the beginning of the new financial year. While APRA is taking this view as it relates to CPS 511, further guidance is needed on whether Treasury (and APRA) will take the same view as it relates to FAR deferral requirements for Accountable Persons who may join after the commencement date of FAR but before the new financial year.

There are still some notable aspects of the requirements that would benefit from additional guidance:

Whilst the CPG has provided criteria to inform a position on what would be considered a ‘material weight’ on non-financial metrics, in some cases the criteria may create more confusion than clarity e.g. how to apply “is robust and cannot be overshadowed or diminished by performance or outperformance on financial measures” is unclear given in common balanced scorecard mechanics, performance or outperformance on one financial measure could well diminish the outcome for underperformance on a non-financial measure (or on any other measure), given the reward would naturally be larger.
How one might go about making a “pre-emptive” adjustment in relation to risk, particularly in scenarios that result in less than 100% downward adjustment (i.e where a matter does not result in complete cancellation of an award), and therefore, the actual reward outcome won’t be known until year end. In this situation, it may be challenging to pre-emptively apply a proportionate downward adjustment for a risk event without knowing the value of the eventual award being adjusted.
For those organisations that do not have variable reward arrangements, no further clarity has been provided as to how organisations without variable pay can meet some of the requirements of CPS 511, particularly in relation to risk and conduct adjustments. This is particularly sought after for less serious matters (that may not result in termination).
For more complex variable reward arrangements e.g. for leveraged incentives (loan-based plans, equity options), APRA expects these to be subject to ‘more rigorous oversight and risk controls’. However, greater guidance would be beneficial as to how these are to be more controlled than other arrangements.

Actions to successfully implement CPS 511

(Review compliance) a revised/ updated review of compliance against CPS 511 and CPG 511 should be done to ensure a comprehensive understanding of gaps, which will inform directions for change required. When assessing areas for changes this should be considered in the context of strategy so that the changes align to regulatory requirements and also company strategy and its talent needs.
(Develop implementation plan) a detailed implementation plan should be developed. This is particularly important for SFIs to successfully deliver the significant changes required (and since APRA may request to review this).
(Design changes) changes to remuneration and governance practices need to be designed, including socialising and approving changes. Key areas for SFIs to design changes include: deferral; material weighting of non-financial measures; developing a robust consequence management framework; and governance practices and reporting to the Board.
(Implement changes) following approval of design, the changes need to be implemented, including updating the policy environment, employment contracts and communicating changes to stakeholders.

Non APRA regulated entities do not have to adhere to the requirements of CPS 511 or CPG 511. However, it would be prudent for these entities to be cognisant of the changes in financial services as this influences market practice in reward more broadly, and certain aspects, particularly relating to remuneration governance may become viewed as leading practice (regardless of the industry).

¹You can read more about the Final Prudential Standard CPS 511 Remuneration, here.