Just about everyone agrees it is time for a re-think on remuneration. The fat pay packets and multi-million-dollar bonuses of many corporate executives have attracted heated criticism in recent times. Politicians from both sides of the fence are now weighing in on the issue. And it’s not just executive pay in the firing line.
The Hayne royal commission concluded poor remuneration practices for front line staff, as well as executives, had driven much of the shocking misconduct exposed among banks and retail super funds. In the blunt words of Commissioner Hayne, ‘poor remuneration and incentive programs can lead, and have led, to poor customer outcomes’.
So it’s good to see that remuneration reform across the financial services sector is firmly on the agenda of the Australian Prudential Regulation Authority. Back in July, APRA released a draft standard, containing a package of reforms with the aim of better aligning incentives with desired outcomes, providing a more holistic assessment of performance across a range of dimensions and greater accountability for performance.
APRA’s approach to remuneration is now more prescriptive, and its proposals have generated a lot of interest in some quarters and angst in others. More than 70 industry stakeholders – including AIST – consulted with APRA on the proposed reforms, with the regulator conceding that there was “no shortage” of negative feedback.
In a recent speech to the banking sector, the chair of the prudential regulator, Wayne Byres, said while there was broad agreement that change was needed, there was no consensus on what improvement looked like.
The core elements of APRA’s proposals would require significant change to established in remuneration practices, including practices among super funds. They include more active board involvement in determining remuneration outcomes, longer vesting to retain more ‘skin in the game’ and, a 50 per cent cap on the use of financial metrics when determining remuneration outcomes..’
While AIST is supportive of the need for a remuneration re-think and more robust regulation, we do have some concerns with the draft standard. Chief among them is that the content of the draft standard is based exclusively on variable remuneration practices, which while prevalent in banking and insurance, are inconsistent with the practices of many funds in the profit-to-member superannuation sector. While variable remuneration is becoming more common in our sector (particularly with the move to more in-house investment teams), it remains less prevalent and less complex than in other financial institutions whose remuneration structures were found wanting by the royal commission.
The standard appears to have been drafted without a firm understanding of remuneration practices across profit-to-member funds and therefore it is unclear what problems the proposed regulation is seeking to address.
Moreover, where variable remuneration does exist within a profit-to-member fund, APRA’s proposals for deferral of variable remuneration are only applicable to entities that pay equity incentives, something not possible with a profit-to-member fund that has no commercial shareholders. This highlights the challenges associated with consolidated standards across industries and sectors that are vastly different from one another.
With consultation now closed, the industry is awaiting a second draft of the new standard. Importantly, APRA has taken on board industry feedback and has stressed it is not locked in to specific proposals. In light of the lessons we learnt in the royal commission, reforming remuneration practices is warranted. But the ultimate aim is getting the balance right in incentive structures between appropriate rates and structures of pay and promoting the right kinds of behaviour. APRA’S first draft doesn’t achieve that aim, but I hope the second draft of the new standard will. If the right balance isn’t struck, in funds where the wrong types of behaviour are incentivised, members may pay the price.