1.2 Executive remuneration

Regulatory and other bodies considering the links between remuneration practices and misconduct have given particular attention to the remuneration of executives because it is the board and senior management of financial services entities who are responsible for, and have the greatest degree of control over, the way that risks – including compliance risk, conduct risk and regulatory risk – are managed within those entities.

To put that in more concrete terms, it is the board and senior management of financial services entities who are responsible for, and have the greatest degree of control over:

  • whether the entity has a culture that encourages good customer outcomes and the sound management of risk – a culture in which employees ask, ‘what should I do?’ instead of ‘what can I do?’, and feel comfortable speaking up when they see that something is not right;
  • whether the entity ensures that compliance issues are identified, escalated as required, and addressed promptly and effectively; and
  • whether the entity has an open, transparent and constructive relationship with regulators.

When remuneration arrangements are designed or implemented in a way that sees executives rewarded with large bonuses despite their poor management of risks, those remuneration arrangements increase the likelihood that the entity will engage in misconduct, or conduct that falls below what the community expects. By contrast, when remuneration arrangements are designed and implemented in a way that properly takes into account the way that executives have managed risks – including compliance risk, conduct risk and regulatory risk – those remuneration arrangements will decrease the likelihood that the entity will engage in misconduct, or conduct falling below community standards and expectations. As I said earlier, an entity’s remuneration arrangements, especially variable remuneration programs, tell staff what the entity rewards and what the entity values.

I referred above to the way that remuneration arrangements are ‘designed’ and the way that those arrangements are ‘implemented’. Both the evidence before the Commission, and the work of APRA and the FSB, have shown that problems can arise in each of these areas. A well-designed system can be undermined by poor implementation. Equally, a well-implemented but poorly-designed system is unlikely to achieve good results. And, a poorly-designed system is even less likely to achieve good results however competently it is implemented. The two areas (design and implementation) present different issues, and require separate consideration.

The issues demonstrated by the evidence before the Commission were often more about implementation than design. This is, perhaps, unsurprising, given that the focus of APRA’s standards in relation to remuneration has been on the design of remuneration systems, and the focus of APRA’s work on remuneration has, until recently, been on monitoring compliance with those standards of design.[1]

1.2.1Issues of design

The Commission received a large body of evidence about the design of executive remuneration systems in Australian banks and some other financial services entities. Unsurprisingly, the systems differed from entity to entity, but there were some features common to all the banks that gave evidence in the seventh round of the Commission’s hearings.

  • First, each system rewarded executives with a combination of fixed remuneration and variable remuneration. The proportion of fixed and variable remuneration varied depending on the role of the particular executive – for example, staff in risk and compliance roles often had a higher proportion of fixed remuneration compared to staff in other roles. The proportion of fixed and variable remuneration varied between entities. Notably, Bendigo and Adelaide Bank had a much higher proportion of fixed remuneration than the other entities,[2] and Macquarie had a much higher proportion of variable remuneration.[3]
  • Second, each system deferred part of the executives’ variable remuneration. Notably, Bendigo also deferred part of its executives’ fixed remuneration.[4] Since 1 July 2018, for large ADIs, the minimum proportion of variable remuneration that must be deferred, and the minimum period of deferral, have been prescribed by the Banking Executive Accountability Regime (BEAR).
  • Third, many systems distinguished between short-term variable remuneration and long-term variable remuneration. The key differences between these types of variable remuneration tended to be that:
  • the amount of short-term variable remuneration that was payable depended on criteria assessed over the most recent financial year;
  • the amount of long-term variable remuneration that was payable depended on criteria assessed over several years;
  • while a proportion of short-term variable remuneration was often deferred, all long-term variable remuneration was always deferred; and
  • generally, only the most senior executives were eligible to receive long-term variable remuneration.
  • Fourth, each system allowed the board of the entity to adjust executives’ variable remuneration to reflect their management of risk. All systems allowed for this to occur through in-year adjustment of short-term variable remuneration, and through forfeiture of deferred remuneration that had not yet vested (referred to as ‘malus’). Some systems also allowed for deferred remuneration that had already vested to be clawed back. I will consider how these mechanisms were applied in dealing with issues of implementation.[5]

Those common features help to provide a framework within which to examine issues relating to the design of executive remuneration systems. There are four issues about which I will say something further:

  • experimentation in the design of remuneration systems;
  • the proportion of fixed and variable remuneration;
  • the design of variable remuneration; and
  • the availability of clawback.

Experimentation in the design of remuneration systems

It was apparent from the evidence before the Commission as well as international work in this area and unsurprising that noone has identified an ‘ideal’ or ‘optimal’ system of executive remuneration for financial services entities. Many have identified particular features of executive remuneration systems for those entities that are desirable – perhaps even necessary – to ensure that the remuneration systems of those entities properly reward and encourage good risk management, and contribute to reducing the risk of misconduct. I will say something further about some of those features below. But there being no agreed ‘ideal’ or ‘optimal’ remuneration system, there are limits to what can or should be regulated or prescribed. And it must be recognised and accepted that it may never be possible to identify a single ‘ideal’ or ‘optimal’ system. As the FSB said in its Principles, ‘financial firms differ in goals, activities and culture, as do jobs within a firm’.[6] One size does not fit all.

This is not necessarily a bad thing. Experience shows that better outcomes – and valuable information – often emerge only through trial and error. Financial services entities must be able (within limits) to try different forms of remuneration and incentive systems.

The qualification – ‘within limits’ – is, of course, critical. But those limits have been identified in the work of the FSB: in its Principles and in its Supplementary Guidance. As the Principles say, ‘[c]ompensation must be adjusted for all types of risk Risk adjustments should account for all types of risk, including difficulttomeasure risks such as liquidity risk, reputation risk and cost of capital’.[7] That is, financial metrics must not determine remuneration. Risk of all kinds, including reputation risk, compliance risk, and conduct risk, must be taken into account in both designing and implementing the remuneration system.

Within those limits, different forms of remuneration and incentive systems will be devised and applied. But trying new or different systems will have value only if:

  • the systems are genuinely directed to encouraging good risk management and reducing the risk of misconduct; and
  • the results of applying the system are reliably identified and, if possible, measured.

I say measured ‘if possible’ not only because the FSB’s Principles acknowledge that some risks are difficult to measure, but also because, in the end, what is being assessed is not just what people do but how they do it. ‘What’ can be measured; ‘how’ cannot.

APRA has an important part to play.

Mr Byres said that APRA was in the process of updating its prudential standards and guidance in relation to remuneration.[8] He said that, in doing so, APRA would incorporate lessons learned from the review that led to its information paper on remuneration practices in large financial services entities, as well as the Prudential Inquiry into CBA, and the FSB’s Supplementary Guidance.[9]

This work is important. It must be completed as soon as reasonably possible. I make three points about it.

First, the prudential standards should expressly require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks, and to reduce the risk of misconduct. There may be several ways to do that. At a minimum, it could be added to the existing requirement that performance-based components of remuneration must be designed to encourage behaviour that supports an institution’s long-term financial soundness and risk management framework.[10]

Second, the prudential standards should expressly require the board of a financial institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks, and reducing the risk of misconduct. While it is currently a requirement for a remuneration committee to assess the effectiveness of the entity’s remuneration policy,[11] I have seen little evidence to indicate that these assessments provide the board with sufficient information about how the remuneration system is being applied in practice and whether it is having the desired outcomes.

Third, APRA (and, where appropriate, ASIC) should do more to gather information about the way that remuneration systems are being applied in practice, and about whether those systems are actually encouraging sound management of non-financial risks, and reducing the risk of misconduct. I will say more about the approach that APRA has taken with respect to supervision of remuneration arrangements later in this section. For now, it is sufficient to observe that documents like the report of the Prudential Inquiry into CBA, and APRA’s information paper on remuneration practices in large financial institutions, have great value in showing entities what good and bad remuneration practices look like. Further work of that kind will be important.

Proportion of fixed and variable remuneration

Effective management of the risk of misconduct does not depend on an entity dividing fixed and variable remuneration in one way rather than another. Here, too, there is no single ‘right answer’. But if remuneration is to be divided between fixed and variable, the purposes of allowing variable remuneration must be clearly understood both by those who are to decide what should be paid and those who are to receive the payment.

Is part, or all of the variable remuneration to be paid unless there are disqualifying reasons? Or is part or all of it to be paid only if certain conditions are met? Effective management of risk, in all its forms, will depend on, among other things, how those questions are answered. In particular, effective management of risk will depend upon the criteria that will be applied in determining variable remuneration.

Design of variable remuneration

All of the four large banks, and both Macquarie and Bendigo, have remuneration arrangements under which:

  • the performance of executives is assessed against a range of measures, including management of risk; and
  • the board is able to make adjustments to the variable remuneration of executives to reflect their management of risk.

But each bank gives effect to those principles in different ways in respect of both shortterm and longterm variable remuneration. The particular detail of the differences need not be described. But it is important to make some observations about longterm variable remuneration and, in particular, the conditions that determine whether an employee receives this part of the remuneration.

In its information paper on remuneration practices at large financial institutions, APRA observed that:[12]

[F]or the majority of cases, the conditions which allow [long-term variable remuneration] to vest focused wholly on annual investor return measures such as total shareholder return (TSR) and return on equity (RoE). No apparent links to measures of long-term financial soundness or risk adjusted performance measures (such as metrics relating to risk-adjusted return on capital) were observed.

Mr Byres described the current structure of long-term variable remuneration in Australia as being ‘particularly problematic in this regard’, and ‘out of step with how best practices in remuneration are evolving internationally’.[13] He considered that there was too much focus on ‘relative total shareholder return’ measures in determining whether long-term variable remuneration should vest, and described that as not being conducive to a broader, more holistic assessment of performance’.[14] He said that, internationally, APRA was seeing a shift away from financial metrics towards a greater emphasis on non-financial metrics.[15]

In the last few years, some financial services entities in Australia have attempted to give greater weight to non-financial measures in the design of their long-term variable remuneration arrangements. It is instructive to take CBA as an example.

For many years, senior executives at CBA were entitled to participate in a long-term variable remuneration scheme. At the end of the financial year, each executive who was eligible to participate in the scheme would receive a particular number of reward rights. At the end of a four-year ‘performance period’, a determination would be made about whether those rights would vest. That determination depended on whether particular ‘performance hurdles’ had been met.[16] If the reward rights vested, they would be converted to CBA shares.

In the 2016 financial year, there were two performance hurdles:

  • The first was a relative total shareholder return hurdle. This hurdle determined whether 75% of the reward rights would vest. It involved comparing CBA’s total shareholder return over the four-year performance period with the total shareholder return of the 20 largest ASX-listed companies (excluding resources companies). If CBA was below the 50th percentile, none of the reward rights attributable to this hurdle would vest. If CBA was at or above the 75th percentile, all of the reward rights attributable to this hurdle would vest. In between those two figures, there was a sliding scale that determined how many reward rights would vest.[17]
  • The second hurdle was a customer satisfaction hurdle. This hurdle determined whether the other 25% of the reward rights would vest. It involved comparing CBA’s performance on a customer satisfaction survey to the performance of other financial services entities.[18]

In its 2016 remuneration report, CBA announced that it planned to make changes to these performance hurdles for the 2017 financial year. In particular, it planned to reduce the share of the reward rights to which the relative total shareholder return hurdle applied from 75% to 50%, and to add a new ‘people and community’ hurdle that would apply to 25% of the reward rights. The people and community hurdle would ‘measur[e] long-term progress in the areas of diversity and inclusion, sustainability and culture’.[19]

At CBA’s annual general meeting in 2016, more than 50% of the votes cast on the resolution to adopt the remuneration report were against the adoption of that report.[20] Ms Catherine Livingstone, now Chair of CBA, attributed that result, in part, to the proposed changes to the structure of CBA’s long-term variable remuneration arrangements.[21] The following year, CBA abandoned that proposal, and replaced its customer satisfaction hurdle with two different non-financial measures, each applicable to 12.5% of the reward rights.[22] That year, more than 92% of the votes cast on the resolution to adopt the remuneration report were in favour of the adoption of that report.[23]

Each year, a listed company must prepare a remuneration report,[24] and give its shareholders the opportunity at the company’s annual general meeting to vote on a resolution to adopt that report.[25] If more than 25% of the votes cast on that resolution are against the adoption of that report at two consecutive AGMs, the company must put to the vote a resolution calling for a spill of board positions.[26] This is referred to as the ‘two strikes’ rule. It is intended to align the interests of the board (in setting the remuneration policy) and managers (via the incentives created by the remuneration policy) with the interests of the shareholders.[27]

Several witnesses were asked whether they considered that the ‘two strikes’ rule was impeding boards from adjusting their remuneration policies to encourage positive outcomes not only for those shareholders looking to realise profit on sale of their shares but also customers and longerterm shareholders.

Ms Livingstone observed that some institutional shareholders appeared not to be using the vote on the remuneration report for its intended purpose. Instead, they used that vote, and the two strikes rule, to register dissatisfaction with other matters, not related to remuneration.[28] However, she observed that it was possible, with some work, to convince shareholders that ‘appropriate non-financial measures can be included in the long-term variable remuneration plan’.[29]

Dr Kenneth Henry, Chair of NAB said that he considered that the ‘two strikes’ rule requires boards to focus too much on financial measures in the design of their remuneration systems, at the expense of measures directed to things like reducing the risk of misconduct or ensuring good outcomes for customers.[30]

Mr Robert Johanson, the Chair of Bendigo and Adelaide Bank observed that because institutional shareholders are more likely than other shareholders to vote at annual general meetings, they can have a significant influence on the direction of the company.[31] However, like Ms Livingstone, he indicated that with work, boards could convince institutional shareholders to support the use of non-financial measures. Fewer than 5% of votes cast on the resolution to adopt Bendigo and Adelaide Bank’s 2018 remuneration report were against the adoption of that report, despite the fact that Bendigo increased the weighting given to the non-financial performance measure for its long-term variable remuneration scheme from 30% to 35%.[32]

Given that the ‘two strikes’ rule applies to all listed companies, any question about modifying that rule is beyond my Terms of Reference. Any review of its operation would be for others to undertake.

There remains, however, the point made by Mr Byres – that focusing only, or largely, on a measure of total shareholder return when deciding whether longterm variable remuneration should be paid does not allow consideration of all relevant aspects of the executive’s performance. In particular, I would add, it does not allow consideration of how the executive has managed risk.

APRA has been considering whether, in its prudential standards, it should set limits on the use of financial metrics in connection with long-term variable remuneration.[33] Consistent with what I have said about the principles that must inform the proper design of variable remuneration arrangements, and with international best practice, I consider that, in its revised prudential standards dealing with remuneration, APRA should set limits on the use of financial metrics in connection with long-term variable remuneration.

Availability of clawback

The final issue can be addressed briefly. Although the remuneration arrangements examined by the Commission generally allowed for the board to take the decision to forfeit part or all of the unvested portion of deferred remuneration, they very rarely provided for remuneration that had vested to be clawed back.

In many of the case studies considered by the Commission, the relevant misconduct was revealed only after some or all of the accountable executives had left, and their deferred remuneration had vested. This was a particular issue in relation to fees for no service conduct, where the full scale of the issue only became apparent many years after the introduction of ongoing fee arrangements.[34] Where entities lacked arrangements to claw back remuneration from those accountable executives, there was no step that they could take.

This could have been avoided if entities had made provision to claw back remuneration that had vested. I can see no reason why every financial services entity should not have such arrangements. Doing so would be consistent with the FSB’s Supplementary Guidance. And it would be consistent with the report of the Prudential Inquiry into CBA:[35]

Clawback is not a feature of remuneration frameworks in financial institutions in Australia but this tool, were it designed to be readily exercised, would help to drive behaviours that avoid unsound risk management and strengthen accountability for senior management and other material risk-takers. The FSB Supplementary Guidance sets out eight recommendations, one of which includes clawback as a tool for how remuneration can be used to promote ethical behaviours and good conduct. The Panel believes that as part of adopting these recommendations, clawback could be a particularly effective tool for cases of serious misconduct.

In its revised prudential standards dealing with remuneration, APRA should require all APRA-regulated institutions to provide for the entity to claw back remuneration that has vested, in appropriate circumstances.

In this, as in all other aspects of remuneration, the effectiveness of the provision will depend on how it is applied.

1.2.2Issues of implementation

Although good design of remuneration arrangements is critical to reducing the risk of misconduct, the issues demonstrated by the evidence before the Commission were often issues of implementation rather than design.

There are three issues connected with implementing remuneration arrangements about which I will say something further:

  • risk-related adjustments to remuneration;
  • supervision of the implementation of remuneration arrangements; and
  • disclosure of the fact of, or reasons for, risk-related adjustments to remuneration.

Risk-related adjustments

Several of the problems that can arise in connection with the implementation of risk-related adjustments to remuneration were demonstrated by the evidence about the process by which CBA’s board determined the remuneration of the CEO and Group Executives in the 2016 financial year.

CBA released its 2016 remuneration report in August 2016. At that time, both ASIC and APRA had continuing investigations into CBA’s life insurance business. CBA was aware of a number of other issues that became public over the course of the following year. These included: the anti-money laundering and counter-terrorism financing (or AML/CTF) issues that resulted in the Australian Transaction Reports and Analysis Centre (AUSTRAC) commencing a civil penalty proceeding; the ‘fees for no service’ issues; and the mis-selling of credit card insurance.[36] Further, in late 2015, APRA had expressed concerns to CBA about the effectiveness of its operational risk management framework.[37] APRA was concerned about a number of persistent significant risk issues that were not being dealt with effectively.[38]

Despite those issues, in that financial year, CBA’s board rated the CEO and all but one of the Group Executives as having ‘fully met’ relevant requirements in relation to the management of risk.[39]

How did that come about?

The Chief Risk Officer told the board remuneration committee (and thus, the board) that he did not believe there were any risk issues or risk behaviours that would suggest that the short-term variable remuneration of the CEO or any of the Group Executives should be modified in any way.[40] That opinion was supported by information that Ms Livingstone described in her evidence as ‘not sufficient’ and ‘inadequate’.[41]

Based on that opinion, the CEO recommended to the remuneration committee that there be no risk-related adjustment to the variable remuneration of any of the Group Executives in the 2016 financial year.[42] Despite the inadequacy of the information provided by the Chief Risk Officer, and the fact that the issues referred to above were known to the board, the remuneration committee accepted the Chief Risk Officer’s recommendation not to modify the shortterm variable remuneration of the CEO or any of the Group Executives, subject to one change – it made a 5% reduction to the variable remuneration of one of the Group Executives, to reflect the CommInsure matters.[43] The board accepted the remuneration committee’s recommendation.

Ms Livingstone described the process that led to those remuneration outcomes as ‘significantly inadequate’,[44] and said that the outcomes themselves were ‘patently inadequate’ and ‘inappropriate’.[45] I agree.

What went wrong?

First, the information made available to the board about the risk management performance of the senior executives was plainly deficient. Among other things, it did not adequately inform the board of the nature or seriousness of issues that had been identified. It did not identify to the board who, among the Group Executives, was accountable for the issues. It made no real assessment of whether those executives had behaved in a way that exemplified the sound management of risks.

It is concerning that the information made available to the board was deficient in those ways. It is more concerning that the board did not seek more detailed information.

In subsequent years, the quality of the information provided to CBA’s board about the risk management performance of CBA’s executive has improved.[46]

But I cannot say that the problem may not exist in other entities. As recently as April 2018, APRA observed in its information paper on remuneration practices at large financial institutions that its review ‘noted instances of poor quality, incomplete or inadequate documentation’ about risk management performance being provided to board committees.[47]

All financial services entities, not just the largest, must examine carefully the findings set out in the report of the CBA Prudential Inquiry, and in APRA’s information paper. All entities must consider, and keep considering, how they can improve the quality of information provided to boards and their committees in connection with remuneration decisions. And in this regard, as in all other aspects of board governance, ‘quantity’ of information is not the same as ‘quality’ of information. APRA should consider how it can require and encourage APRA-regulated institutions to improve the quality of that information when it updates its prudential standards and guidance in relation to remuneration.

The second point to make about CBA’s treatment of remuneration in 2016 is more general. Up to and including 2016, the CBA board appears to have been unwilling to make any significant adjustment to variable remuneration as a result of risk-related matters. Between the 2011 financial year and the 2016 financial year, there were only seven instances, involving five executives where an executive’s short-term remuneration was reduced as a result of a risk issue.[48] With one exception, the reductions were 20% or less.[49] And, in each case, the reason given for the reduction was damage to CBA’s reputation.[50] That is, it appears that, unless and until risk and compliance issues became publicly known, accountability for those issues was not reflected in adjustments to executive remuneration.

Of course, all of that changed at CBA in the 2017 financial year, when the short-term variable remuneration for the CEO and all Group Executives was reduced to zero, following the filing of AUSTRAC’s proceeding alleging significant breaches of AML/CTF laws.[51] Further, less dramatic reductions were made in the 2018 financial year.[52]

In the 2016 financial year, none of ANZ, NAB or Westpac made significant risk-related adjustments to the remuneration of its senior executives. By contrast, in the 2018 financial year:

  • ANZ’s board reduced the variable remuneration of four senior executives, including its CEO, for reasons related to risk, compliance or conduct.[53]
  • CBA’s board reduced the short-term variable remuneration of all of its Group Executives by 20% for reasons relating to the findings of the Prudential Inquiry. CBA’s CEO offered to forego all of his short-term variable remuneration for the 2018 financial year, and the board accepted this offer. Further reductions were applied to other senior executives for reasons related to risk compliance or conduct.[54]
  • NAB’s board reduced the variable remuneration of its senior executives by 10% to 75% for reasons related to risk, compliance or conduct.[55]
  • Westpac’s board reduced the short-term variable remuneration of the CEO, Brian Hartzer, by 15%, and of all other Group Executives (except two) by 10%. It also made further reductions to the variable remuneration of three Group Executives.[56]

It is encouraging to see that boards appear to have grasped the importance of implementing their remuneration policies in a way that encourages the sound management of non-financial risks, and reduces the risk of misconduct. It remains to be seen whether boards continue this practice in the coming years, where issues of remuneration and misconduct are not subject to the same public scrutiny as they have been during the life of this Commission.

Supervision of implementation

One way to ensure that boards continue to implement their remuneration policies in a way that encourages the sound management of non-financial risks, and reduces the risk of misconduct, is to ensure that there is ongoing and effective supervision of the way that boards discharge that responsibility.

In the case of APRA-regulated institutions, that supervision is properly the role of APRA. However, the evidence before the Commission indicated that, in the past, APRA’s supervision of remuneration practices has been lacking.

Mr Byres explained that APRA’s supervision teams do not normally collect information about the way that the remuneration arrangements of APRAregulated institutions are applied in practice.[57] This is despite the fact that as long ago as 2009, the FSB’s Principles stated that ‘[s]upervisory review of compensation practices must be rigorous and sustained and deficiencies must be addressed promptly with supervisory action’.[58] When APRA did collect information about the way that remuneration arrangements were applied in practice – in the context of the review that led to its information paper on remuneration practices at large financial institutions, and in the course of the Prudential Inquiry – it identified serious deficiencies in the way that those arrangements were being implemented. However, both of those reviews occurred in 2017 and 2018. For most of the period that APRA’s standards and governance in relation to remuneration have been in force, APRA has not collected detailed information about the way remuneration arrangements have been applied in practice.[59]

As noted above, in November 2018, the FSB published its ‘Recommendations for National Supervisors: Reporting on the Use of Compensation Tools to Address Potential Misconduct Risk’. The Recommendations complement the FSB’s Supplementary Guidance by setting out the types of data that can support improved monitoring by supervisory authorities on the use of remuneration arrangements to address the risk of misconduct in financial services entities.[60]

APRA should increase the intensity of its supervision of the way APRA-regulated institutions implement their remuneration frameworks. This will require APRA to collect more information about the way those frameworks are applied in practice, including information of the kind described in the FSB’s Recommendations.

I recognise that increasing the intensity of supervision in this area will require additional resources. Mr Byres noted several times in his evidence that APRA’s supervisory resources were limited, and that it was necessary for APRA to prioritise particular activities.[61] Mr Byres explained that the Government had recently provided APRA with additional resources to undertake this sort of work.[62] As the work of FSB shows, supervisory review of compensation practices should be rigorous and sustained. It is an essential part of the prudential supervisor’s work and that should be reflected in the way in which APRA is funded.[63]

In addition to the activities and processes associated with the monitoring of remuneration arrangements, the work of FSB also shows that increased supervision of remuneration practices must be supported, where necessary, with prompt supervisory action.[64]

Mr Byres said that since APRA introduced remuneration requirements into its prudential standards in 2010, it had never taken action against an APRA-regulated institution for failing to comply with those requirements.[65]

I have already described the course of events about CBA’s 2016 determination of variable remuneration for the CEO and senior executives. Mr Byres rightly accepted that APRA could, and should, have done more than it did in response to these events.[66] He said that APRA did not take these steps because it was an area in which APRA did not yet have ‘sufficient expertise to really be confident challenging [CBA]’.[67]

It is to be hoped that, following its more recent work in the Prudential Inquiry, and its review of remuneration practices at large financial institutions, APRA does now have the confidence and expertise that Mr Byres felt it lacked in 2016. If it does not, APRA should seek to develop that confidence and expertise as quickly as possible. As I have said, this is a necessary part of the prudential supervisor’s work.

Disclosure of consequences

The final issue can again be addressed briefly. Should entities disclose more information about risk-related adjustments to executive remuneration?

At the moment, listed companies are required to disclose prescribed information about executive remuneration in their annual reports, including the total amount of variable remuneration received by senior executives. Companies are not required, however, to disclose information about whether risk-related adjustments have been made to the remuneration of senior executives, and therefore are not required either to set out why the board made particular risk-related adjustments to executive remuneration.

When asked about that situation, Ms Livingstone said that ‘there would probably be merit in [disclosing] more detail on an individual basis as to what the risk-adjusted outcomes were’,[68] and agreed that that would send a powerful message about the way that CBA responds to misconduct.[69]

Mr Byres described disclosure of this kind of information as a ‘double-edged sword’.[70] His chief concern was that public disclosure of that kind might deter boards from making risk-related adjustments, if explaining the reasons for doing so would require the board to disclose risk-related issues that were otherwise known only within the institution.[71]

As I have said, the remuneration arrangements of an entity show what the entity values. If the board reduces the variable remuneration of executives for their poor management of non-financial risks, and tells other staff that the variable remuneration of those who are accountable for particular events or forms of conduct has been reduced, it sends a clear message to all staff about both accountability and what kinds of conduct the board regards as unacceptable. No public disclosure should be required.

Recommendation 5.1 – Supervision of remuneration – principles, standards and guidance

In conducting prudential supervision of remuneration systems, and revising its prudential standards and guidance about remuneration, APRA should give effect to the principles, standards and guidance set out in the Financial Stability Board’s publications concerning sound compensation principles and practices.

Recommendations 5.2 and 5.3 explain and amplify aspects of this Recommendation.

Recommendation 5.2 – Supervision of remuneration aims

In conducting prudential supervision of the design and implementation of remuneration systems, and revising its prudential standards and guidance about remuneration, APRA should have, as one of its aims, the sound management by APRAregulated institutions of not only financial risk but also misconduct, compliance and other nonfinancial risks.

Recommendation 5.3 – Revised prudential standards and guidance

In revising its prudential standards and guidance about the design and implementation of remuneration systems, APRA should:

  • require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks, and to reduce the risk of misconduct;
  • require the board of an APRA-regulated institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks, and reducing the risk of misconduct;
  • set limits on the use of financial metrics in connection with long-term variable remuneration;
  • require APRA-regulated institutions to provide for the entity, in appropriate circumstances, to claw back remuneration that has vested; and
  • encourage APRA-regulated institutions to improve the quality of information being provided to boards and their committees about risk management performance and remuneration decisions.


[1]Transcript, Wayne Byres, 29 November 2018, 74012.

[2]See generally Exhibit 7.141, Witness statement of Robert Johanson, 7 November 2018.

[3]See generally Exhibit 7.60, Witness statement of Nicholas Moore, 19 November 2018.

[4]See generally Exhibit 7.141, Witness statement of Robert Johanson, 7 November 2018.

[5]Exhibit 7.108, Witness statement of Lynda Dean, 2 November 2018, 78 [23(c)], 27 [87(f)].

[6]FSB, Principles, 1.

[7]FSB, Principles, 2.

[8]Transcript, Wayne Byres, 29 November 2018, 7402.

[9]Transcript, Wayne Byres, 29 November 2018, 7402.

[10]APRA, Prudential Standard CPS 510, July 2017, [54].

[11]APRA, Prudential Standard CPS 510, July 2017, [68(a)].

[12]APRA, Information Paper, Remuneration Practices at Large Financial Institutions, April 2018, 18.

[13]Exhibit 7.145, Witness statement of Wayne Byres, 27 November 2018, 109 [448].

[14]Transcript, Wayne Byres, 29 November 2018, 7403.

[15]Transcript, Wayne Byres, 29 November 2018, 4703.

[16]Transcript, Catherine Livingstone, 21 November 2018, 6758.

[17]Transcript, Catherine Livingstone, 21 November 2018, 6758–9; CBA, Annual Report, 2016, 55.

[18]Transcript, Catherine Livingstone, 21 November 2018, 6759; CBA, Annual Report, 2016, 55.

[19]Transcript, Catherine Livingstone, 21 November 2018, 6759–60; CBA, Annual Report, 2016, 56.

[20]Transcript, Catherine Livingstone, 21 November 2018, 6757.

[21]Transcript, Catherine Livingstone, 21 November 2018, 6757.

[22]Transcript, Catherine Livingstone, 21 November 2018, 6764.

[23]CBA, Results of 2017 Annual General Meeting (16 November 2017) CBA <www.commbank.com.au/content/dam/commbank/about-us/shareholders/pdfs/2017-asx/2017-annual-general-meeting-results.pdf>.

[24]Corporations Act s 300A.

[25]Corporations Act s 250R.

[26]Corporations Act ss 250U, 250V.

[27]See Explanatory Memorandum, Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Cth), [8.30].

[28]Transcript, Catherine Livingstone, 21 November 2018, 6761–2.

[29]Transcript, Catherine Livingstone, 21 November 2018, 6761.

[30]Transcript, Kenneth Henry, 27 November 2018, 7184.

[31]Transcript, Robert Johanson, 29 November 2018, 7375–6.

[32]Transcript, Robert Johanson, 29 November 2018, 7376–7.

[33]Transcript, Wayne Byres, 29 November 2018, 7403–5.

[34]See, eg, Transcript, Kenneth Henry, 27 November 2018, 71212, 7130–2. See also Exhibit 7.80, Witness statement of Andrew Thorburn, 19 November 2018, 58 [201].

[35]CBA Prudential Inquiry, Final Report, 78–9.

[36]Transcript, Catherine Livingstone, 21 November 2018, 6745.

[37]See Exhibit 7.31, 24 December 2015, Letter APRA to Narev Concerning Operational Risk Framework and Attached Report.

[38]Transcript, Wayne Byres, 29 November 2018, 7409.

[39]Transcript, Catherine Livingstone, 21 November 2018, 6752, 6757.

[40]Transcript, Catherine Livingstone, 21 November 2018, 6749.

[41]Transcript, Catherine Livingstone, 21 November 2018, 6748.

[42]Transcript, Catherine Livingstone, 21 November 2018, 6752.

[43]Transcript, Catherine Livingstone, 21 November 2018, 6754.

[44]Transcript, Catherine Livingstone, 21 November 2018, 6746.

[45]Transcript, Catherine Livingstone, 21 November 2018, 6754, 6755.

[46]See Transcript, Catherine Livingstone, 21 November 2018, 6767–9.

[47]APRA, Information Paper, Remuneration Practices at Large Financial Institutions, April 2018, 26.

[48]Transcript, Catherine Livingstone, 21 November 2018, 6767.

[49]Transcript, Catherine Livingstone, 21 November 2018, 6767.

[50]Transcript, Catherine Livingstone, 21 November 2018, 6767–8.

[51]CBA, Annual Report, 2017, 67.

[52]CBA, Annual Report, 2018, 98–100.

[53]Exhibit 7.120, Witness statement of Shayne Elliott, 22 November 2018, 289 [115].

[54]CBA, Annual Report, 2018, 98.

[55]NAB, Annual Report, 2018, 39.

[56]Westpac Group, Annual Report, 2018, 48.

[57]Transcript, Wayne Byres, 29 November 2018, 7410.

[58]FSB, Principles, 3.

[59]Transcript, Wayne Byres, 29 November 2018, 7410.

[60]FSB, Recommendations for National Supervisors: Reporting on the Use of Compensation Tools to Address Potential Misconduct Risk, 23 November 2018.

[61]See Transcript, Wayne Byres, 29 November 2018, 7411.

[62]Transcript, Wayne Byres, 29 November 2018, 7411.

[63]FSB, Principles, 3.

[64]FSB, Principles, 3.

[65]Transcript, Wayne Byres, 29 November 2018, 7422.

[66]Transcript, Wayne Byres, 29 November 2018, 7417.

[67]Transcript, Wayne Byres, 29 November 2018, 7418.

[68]Transcript, Catherine Livingstone, 21 November 2018, 6782.

[69]Transcript, Catherine Livingstone, 21 November 2018, 6782.

[70]Transcript, Wayne Byres, 29 November 2018, 7407.

[71]Transcript, Wayne Byres, 29 November 2018, 7407.

97 thoughts on “1.2 Executive remuneration”

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