In his findings, Commissioner Hayne nominated six norms of conduct underpinning any regulation to include: obey the law; do not mislead or deceive; act fairly; provide services that are fit for purpose; deliver services with reasonable care and skill; and, when acting for another, act in the best interest of that other.
Drawing upon these norms or principles, in recommendation 5.3 of the Hayne Report, it stated that APRA should require financial institutions to “decide their remuneration systems to encourage sound management of non-financial risks and to reduce the risk of misconduct”. It was also recommended that APRA should upgrade its remuneration requirements to ensure that: sufficient attention is given to financial risks including misconduct; limits are set on the use of financial metrics associated with long-term equity-based remuneration; Boards play a more active role in assessing remuneration outcomes; and there is more scope for clawbacks of rewards.
In response to these and other issues arising during the Commission’s Hearings, in late 2018, APRA produced the Banking Executive Accountability Regime (BEAR). While shareholders are not at ease with many of the subjective elements incorporated in BEAR, regulatory oversight is being broadened while remaining focussed.
Since then, APRA has been consulting on the design, governance and outcomes of remuneration practices in Australia’s prudentially regulated firms. In July 2019, APRA proposed an upgrade to the prudential framework for remuneration, which includes: a cap (proposed 50%) on the use of financial metrics and elevation of the importance of non-financial metrics in determining remuneration outcomes; more active involvement at the Board level in determining remuneration outcomes; and longer vesting periods (plus malus and clawback provisions) to promote the long term interests of the company and its shareholders.
These proposals have been met with significant criticism and opposition, particularly the proposed cap on financial metrics, with many arguing that it places undue weight on non-financial metrics which may not be as transparent or reliable as profit-based measures. There has also been criticism of the undue burden created by the expanded role of the Board in remuneration decisions, where traditionally this has been the domain of senior management.
Subsequently, again reflecting the Commission’s findings, we understand that Treasury with input from ASIC is developing a consultation paper due for release at the end of 2019 and draft legislation to facilitate ASIC’s use of the law in a more aggressive manner. There has also been suggestion by Treasury that BEAR will be extended not only to all prudentially regulated entities but also to non-prudentially regulated financial firms, with a major focus on business conduct.
In October 2019, ASIC received judicial guidance on the application of the fairness standard if business conduct as set out in section 912A(1)(a) of the Corporations Act 2001, which provides that financial services licensees must do all things necessary to ensure that their services are provided “efficiently, honestly and fairly”. The Full Court of the Federal Court of Australia recently allowed ASIC’s appeal of a 2018 decision which found that Westpac’s recommendations to customers to switch super funds did not constitute “personal financial advice.” In its judgment, the Court stripped the Hayne principles back to one core business conduct principle, “be fair”. In addition to providing clarity on the division between financial and general advice, this case also serves as a test case for ASIC and may form the basis of future investigations and/or prosecutions in the financial services sector and beyond.
We understand that banks today are required to create and register accountability maps which specify which members of their senior staff are accountable for every function. The purpose of this initiative is to allow regulators to know whom to target when something problematic arises and is brought to their attention. It is intended that the emerging regime will create subjective standards for banks to act with honesty, integrity, due skill, care and diligence and to deal with regulators in an open, constructive and co-operative way.
Comment emerging with the conduct of AGMs and votes on Remuneration Reports are increasingly focussing on the basic or core accountabilities of KMPs incorporating the Board, Chief Executive Officer and senior executives.
Questions are also arising, given the level of fixed remuneration, as to whether the principles being articulated in the emerging role of the regulators’ oversight should act as gateways or modifiers in determining annual bonus or incentive payments in particular, rather than being a source of additional payment where in the view of many shareholders and institutional investors under the BEAR regime management could well be receiving significant incentives for fulfilling their core accountabilities while not enhancing shareholder value.
Critical comment has also arisen at AGMs in relation to management receiving special or supplemental bonus payments associated with acquisition or divestment initiatives, which many would believe represent a core and recurring obligation of the KMP population for which they receive their basic remuneration.
The graphs below highlight the proportionality of reward of CEOs and KMPs managing with oversight of businesses with revenues exceeding >$15 billion down to those with revenue of <$100 million. The data is drawn from the constituency of the ASX 500.
In terms of total reward, small organisations with revenues of less than $100 million reveal more a partnership model on average though a corporate model at the median. Again, it is the top quartile that is driving this distortion. Among the major corporates, the average total reward of a KMP approximates 50% of that of the CEO. In the next band of companies with revenues between $500 million and $15 billion, the median level of total reward compared to the CEO is less than 40%, with the average exceeding that in the larger revenue band. In companies with revenues below $500 million, the average total reward for KMP exceeds 50% in all categories, with the median exceeding 50% other than in groups with revenues between $250 million and $500 million.