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The release of the Final Prudential Standard CPS 511 Remuneration

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Last Friday, 27 August 2021, APRA released its final Prudential Standard CPS 511 Remuneration, and an accompanying Response Paper to consultation submissions. This comes more than two years since it first began consultation on the new standard, and is the third and final iteration.

Submissions for the revised standard were significantly less in number than those received in relation to the first draft (41 vs. 70+), were mostly supportive, and focussed mostly on points of clarification. Consequently, overall, the final Prudential Standard CPS 511 reflects minimal change from the revised draft standard released in November 2020.

The new standard finalises APRA’s heightened expectations for regulated entities to establish and maintain:

stronger incentives to manage the risks that individuals are responsible for (a sole focus on financial metrics in determining variable remuneration will be unacceptable);
appropriate consequences for adverse risk and conduct outcomes (with longer deferrals combined with provisions for in-year, malus, and clawback adjustments); and
increased board oversight, transparency and accountability on remuneration.

Significant Financial Institutions (SFIs) have more prescriptive requirements in relation to the above, whereas non SFIs have simpler requirements but the same principles remain relevant.

Which entities will be impacted and when?

CPS 511 will begin to come into effect from 1 January 2023, with a phased implementation starting with SFI authorised deposit-taking institutions (ADIs). Effective dates are staggered by institution type:

ADI SFIs from 1 January 2023
Insurance and RSE licensee SFIs from 1 July 2023
Non-SFIs (across all APRA-regulated industries) from 1 January 2024

Variable remuneration arrangements will need to be ‘compliant’ for the first performance year commencing immediately on or post the effective date. For example, if an ADI SFI has a 30 June financial year end, arrangements will need to be compliant from 1 July 2023. (and must be compliant within 12 months). There is an opportunity for further clarity regarding whether this is how APRA will assess compliance with other aspects of CPS 511, or whether the ‘effective date’ stands (e.g. Board governance requirements).

CPS 511 comes into effect after the Financial Accountability Regime (FAR) which commences from 1 July 2022, for ADIs and all non SFIs insurers and RSE licensees, but comes into effect at the same time for insurance and RSE licensee SFIs (on 1 July 2023).

What are the biggest changes?

There are only three minor revisions:

Introducing a risk-based approach to the oversight of third party service providers remuneration arrangements, such that entities must focus on identifying and mitigating the material conflicts to the objectives of the remuneration framework that may result from third-party service provider remuneration arrangements. Mitigation strategies may include, for example, introducing additional oversight requirements, tighter controls, and even changes to the variable remuneration for an accountable person who oversees the third party business.
Removing the prescription associated with the use of risk and conduct adjustment tools. The finalised standard now adopts a principle based approach to allow entities flexibility in determining the adjustment tool used. The standard adopts similar language to the FAR, in that downwards adjustments must be “proportionate to the severity of risk and conduct outcomes”. This change simplifies the requirements and provides for a single set of criteria prompting consideration of an adjustment (there are no longer specific criteria for malus versus clawback). There is no change to the types of adjustment tools that should be available - that is all SFI APRA-regulated entities must subject a person’s variable remuneration arrangement to malus and to clawback, whereas clawback is optional for all non SFI APRA regulated entities.
Increasing the quantitative asset threshold for ADIs for determining SFIs, and clarifications for RSE licensees and foreign branches. To ensure consistency across its prudential framework, APRA has amended the quantitative asset thresholds¹ for determining SFIs. It has clarified that the asset thresholds are not indexed or averaged (as was allowable under BEAR), but that they will be revisited periodically. The asset thresholds are as follows:
1. AUD $20 billion in the case of an ADI (increased from $15b)
2. AUD $10 billion in the case of a general insurer or life company (no change)
3. AUD $3 billion in the case of a private health insurer (no change)
4. AUD $30 billion in the case of a single RSE operated by an RSE licensee, or if the RSE licensee operates more than one RSE where the combined total assets of all RSEs exceeds this amount (no change in the quantitative asset threshold, but a clarification in how it applies where there are multiple RSEs under a single RSE licensee).

Furthermore, it has clarified that foreign branches will be classified as non SFIs, unless they are determined as SFIs based on factors other than asset thresholds. However, for foreign branches with assets above the SFI asset thresholds, they will be required to defer variable remuneration of their highly-paid material risk takers in line with the requirements applicable to SFIs.

What happens next?

APRA will have a strong supervisory focus on implementation of the new CPS 511 requirements across industry over the next 18 months.

Identification of SFI entities	APRA will advise entities determined to be SFIs based on either the quantitative asset thresholds or other criteria, no later than 30 October 2021.
Finalisation of the Prudential Practice Guide	APRA expects to finalise the Prudential Practice Guide CPG 511 Remuneration in the coming months (October 2021 according to its Response Paper) to assist entities in meeting their new requirements under CPS 511.
Potential for minor updates following the finalisation of the FAR	APRA has flagged that it may make minor updates to CPS 511 and/or CPG 511 for deferral definitions, to align with the FAR once finalised.
Consultation on disclosure requirements	APRA has not provided any further clarity regarding the requirements for public disclosure (including how entities are satisfying the key principles of the standard, aggregated details of remuneration outcomes, and adjustments for material incidents). Its timeline for releasing proposed disclosure requirements for consultation has pushed back again, to early 2022.
Pre implementation review of CPS 511 readiness and implementation plans	From late 2021, APRA will undertake a detailed review of the implementation plans at a subset of regulated entities. This will include benchmarking against peers, highlighting examples of better practice and areas requiring further focus. It plans to publish thematic findings in early 2023. Additionally, APRA will regularly engage with SFIs regarding their CPS 511 readiness.

What should I do next?

As an APRA-regulated entity:

Self assess readiness for CPS 511 and the FAR, identify gaps, and develop an implementation plan to address such gaps;
Be ready to submit your implementation plans to APRA for its thematic review, if requested;
Start engaging with relevant stakeholders, including shareholders and proxy advisers, regarding (a) the types of non-financial measures that may be incorporated into variable remuneration arrangements (particularly for Long Term Incentives where they are much less common), and their weight; and (b) approach used to meet the deferral requirement, including consideration of performance period, holding locks and restriction periods; and
Continue to bolster board oversight of remuneration, including adjustment policies and practices, to align with the new expectations ahead of CPS 511 coming into force.

Non-regulated and non-FS companies are not required to make any change. Nevertheless, the standard sets a new expectation for remuneration governance and accountability, and so it would be a valuable exercise to consider changes that align with the intent and principles of the new standard.

¹Total assets is derived from Reporting Standards ARS 322.0 Statement of Financial Position, ARS 323.0 Statement of Financial Position, GRS 300.0 Statement of Financial Position, LRS 300.0 Statement of Financial Position, HRS 602.0 Financial and Capital Data and SRS 320.0 Statement of Financial Position.