APRA releases the final version of Prudential Standard CPS 511 (Remuneration) with further regulation of remuneration disclosures to follow

Dual-track implementation of CPS 511 and FAR for APRA-regulated entities 8 min read

APRA has released the final version of its prudential standard on remuneration (CPS 511), seeking to regulate incentive structures across all APRA-regulated entities.

We discussed the major reforms proposed by APRA in its consultation draft of November 2020 here. The prudential standard will operate alongside the proposed Financial Accountability Regime (FAR). APRA-regulated entities that classify as Significant Financial Institutions (SFIs) will be expected to undertake a self-assessment and develop an implementation plan, ahead of a staged implementation of CPS 511 from 1 January 2023.

How does it affect you?

The final version of CPS 511 remains largely in line with the draft version of the prudential standard that APRA released for consultation in November 2020. In the final version, APRA made three key changes in response to industry feedback:

SFI thresholds

APRA amended the quantitative asset threshold for classifying authorised deposit-taking institutions (ADIs) as SFIs from $15 billion to $20 billion. This is intended to maintain consistency with the proportionality requirements in other parts of the ADI framework.

APRA also clarified that for superannuation funds, the $30 billion asset threshold will apply at the RSE licensee level, and will therefore be assessed by the aggregate asset value of all RSEs of an RSE licensee.

The asset thresholds for each industry are as follows:

APRA has also confirmed that foreign branches will be classified as non-SFIs unless they are determined to be SFIs based on qualitative factors. Under the final CPS 511, foreign branches with assets above the SFI threshold will be required to defer the variable remuneration of highly-paid material risk-takers (persons with total fixed and variable remuneration equal to, or greater than, $1 million), in line with the requirements of SFIs.

APRA has indicated it will notify designated SFIs and additional entities that are determined to be SFIs (based on qualitative criteria) of that status by no later than 30 October 2021.

Downward adjustments to variable remuneration

APRA revised the requirements for downward adjustments to a person's variable remuneration for adverse risk and conduct outcomes. Instead of linking the severity of risks to particular variable remuneration adjustment tools (such as linking the application of malus to 'significant' adverse risk and conduct outcomes, while linking clawback to 'material' adverse risk and conduct outcomes), the final version of CPS 511 requires APRA-regulated entities to ensure that adjustments to variable remuneration are 'proportionate to the severity of risk and conduct outcomes'. This provides entities with greater flexibility on the type of adjustment tool to be used. In its Response Paper: Strengthening prudential requirements for remuneration dated 27 August 2021, APRA indicated that in some instances, using an in-period adjustment alone may be appropriate, while for more significant events, an entity may also consider malus. Where in-period adjustments and malus are not sufficient, clawback should be considered where there has been a more severe risk or conduct incident.

Remuneration arrangements for service providers

APRA has revised the drafting of CPS 511 to say that an APRA-regulated entity's remuneration policy must set out the approach to identifying and mitigating material conflicts with the objectives of the entity's remuneration framework which may result from third-party service provider compensation arrangements. APRA previously required the remuneration policy to set out the process the entity would use to identify and address inconsistencies with the objectives of their remuneration framework that may result from the remuneration arrangements of a service provider.

In its Response Paper, APRA used volume-based commissions of a service provider as an example of an arrangement giving rise to a material conflict with the regulated remuneration objectives of an APRA-regulated entity. To mitigate this conflict, APRA has suggested that business written by such third parties could be subject to additional oversight and controls such as tighter approval criteria, increased reviews or more frequent and detailed monitoring.

Other possible mitigants identified by APRA include:

• entities implementing changes to the design of variable remuneration for accountable persons who oversee third-party business, and
• seeking assurances from third-party service providers.

APRA has confirmed in its Response Paper that it does not expect changes to a third-party service contract or termination of an arrangement where a regulated entity has put effective mitigants in place. While the drafting of CPS 511 does not limit the types of (or the materiality of) the service being provided by a third-party, the draft Prudential Practice Guide on CPS 511 released in April 2021 did at least suggest that a materiality threshold could be used to identify the scale of service providers and the nature their services that are likely to present a conflict or risk, provided that the thresholds have been approved by the Board.

Alignment to the FAR

Reduction of variable remuneration

The approach to reducing a person's variable remuneration under CPS 511 and the proposed FAR are broadly aligned. Under the proposed FAR, an accountable entity must have a remuneration policy that requires the variable remuneration of accountable persons to be reduced if they have failed to comply with their accountability obligations. The accountable person's variable remuneration must be reduced by an amount that is proportionate to their failure to comply with the obligation. This may be a reduction to zero (so that the accountable person does not have any variable remuneration left after the reduction).

Similarly, CPS 511 requires an APRA-regulated entity's variable remuneration arrangements to incorporate adjustment tools that can reduce variable remuneration, potentially to zero, for adverse risk and conduct outcomes. The total downward adjustment to a person's variable remuneration must be proportionate to the severity of the risk and conduct outcome. An APRA-regulated entity can use in-period adjustments, malus and clawback to ensure the reduction of variable remuneration appropriately reflects severity.

Deferred remuneration

The proposed FAR requires all accountable entities to defer at least 40% of the variable remuneration of their accountable persons for a minimum deferral period of four years.

However, under CPS 511, SFIs are required to maintain the following longer deferral periods for a person's variable remuneration than proposed under the FAR:

In its Response Paper, APRA indicated that a key element of CPS 511 is proportionality. This means that SFIs are subject to heightened prudential requirements compared to smaller and less complex entities. APRA confirmed that it will take a risk-based approach by maintaining longer minimum deferral periods than are proposed under the FAR for SFIs, the largest and most complex APRA-regulated entities. APRA noted that it has aligned the deferred remuneration requirements for SFIs under CPS 511 to international best practice.

APRA has also confirmed it is working with Treasury to ensure that there are no inconsistencies in definitions and terminology across CPS 511 and the FAR, particularly for deferral and variable remuneration. APRA will include aligned wording to the final FAR in Prudential Practice Guide CPG 511 Remuneration (CPG 511), which will be released in October 2021. APRA has also indicated it may make additional consequential amendments to CPS 511 or CPG 511 if this is necessary to achieve alignment with the FAR.

Remuneration disclosure

APRA confirmed it intends to require APRA-regulated entities to demonstrate publicly how they are meeting key CPS 511 requirements. In its Response Paper, APRA noted industry feedback that the design of disclosure requirements needed to carefully balance the benefits of transparency on remuneration decisions with commercial-in-confidence information and the privacy of individuals. APRA is currently conducting a data study, with a sample of regulated entities across all industries, to inform the design of reporting and disclosure requirements. APRA will release its proposed disclosure requirements for consultation in early 2022.

Timeframe for implementation

The timeframe for transition to the new requirements under CPS 511 is consistent with the timeframe proposed in APRA's November 2020 consultation. The phased approach to implementation is as follows:

*In the final CPS 511, purchased payment facility providers have been excluded from the 'ADI' category and are not subject to the requirements under CPS 511.

CPS 511 does not apply to a person's variable remuneration 'if the opportunity to earn the variable remuneration arose before the relevant commencement date'. In its Response Paper, APRA clarifies that in practice this means an ADI SFI with a 30 June financial year-end must have incorporated CPS 511 requirements into variable remuneration arrangements from 1 July 2023. APRA expects all variable remuneration arrangements to comply with CPS 511 requirements within the first 12 months of the implementation date.

APRA has confirmed it will repeal the remuneration components of Prudential Standards CPS 510 (Governance) and SPS 510 Governance to ensure there is no duplication with the new CPS 511.

Pre-implementation review

APRA indicates that over the next 18 months, it will have a strong supervisory focus on the industry's implementation of the new CPS 511 requirements. In addition, for a 'subset of entities', it will undertake a more detailed review of implementation progress, including benchmarking against peers. APRA will publish the thematic findings from this review in early 2023 to assist all entities with implementation. APRA will begin engaging with entities that will be included in this review in late 2021.

What's next?

• APRA is finalising Prudential Practice Guide CPG 511 Remuneration, which will be released in October 2021. CPG 511 will outline examples of 'better practice' to assist entities in meeting the requirements in CPS 511.
• APRA will ensure appropriate alignment between CPS 511 and the proposed Financial Accountability Regime. APRA may make additional minor amendments to CPS 511 once the proposed FAR is finalised.
• APRA will be consulting on the new disclosure requirements for remuneration in early 2022.