Embrace BEAR and fix remuneration says APRA Chair

10 mins  09.09.2018

Overview of APRA Chair Wayne Byres' recent address to the Annual Risk Management Association CRO Conference: Helping Regain the Trust.

Australian Prudential Regulation Authority (APRA) Chair Wayne Byres has said APRA will focus on how well the Banking Executive Accountability Regime (BEAR) has been implemented in practice, and has called on banks to make improvements in the design and implementation of executive remuneration to rebuild trust.  


Key takeouts


Insufficient focus and value given to non-financial risk: Commenting generally on the approach taken to managing risk, Mr Byres reiterated that 'risk – and hence risk culture – has too narrowly been looked at through a financial lens (‘what will it cost our bottom line?’), without regard to reputational impacts (‘what will it cost our good name and standing?’). The latter has been materially underestimated. This will need to change if the industry is to regain the trust, but it will challenge the risk (and regulatory) profession because it will require skills, expertise and insights that may not be in the domain of a traditional risk manager'.

 

APRA to focus on BEAR implementation: Mr Byres said that APRA will be looking to ‘see how well the allocated responsibilities [under BEAR] work in practice’ adding that the regulator is ‘quite open to revisiting these as we learn from experience’. Mr Byres added that APRA will be ‘looking to see how accountable persons understand and oversee their areas of accountability in practice – to repeat a point I have made already, having the paperwork in good shape is not enough’. 

 

Industry’s approach to the design and implementation of remuneration must change to address the issues previously identified in APRA’s remuneration review.  In particular, poor risk outcomes need to be reflected in executive pay (as well as at lower levels); board remuneration committees need to exercise stronger oversight; and excessive focus on financial measures in performance assessment needs to be addressed.

 

The theme of Australian Prudential Regulation Authority (APRA) Chair Wayne Byres' address to the Annual Risk Management Association CRO Conference this year was 'regaining the trust'.  Though the task of rebuilding trust can only be accomplished by firms themselves, Mr Byres said, there are 'range of regulatory and supervisory activities that APRA is pursuing' to assist in the task such as ensuring that the Banking Executive Accountability Regime (BEAR) is implemented in practice, and that improvements are made to the design and implementation of executive remuneration. 

General remarks

  • Insufficient focus on non-financial risk: The issues that have led to the loss of public confidence (eg issues brought to prominence that the Financial Services Royal Commission) were attributed by Mr Byres, in part to 'miscalculation of the risk-return trade-off in the way business has been conducted. Reputation and trust have been undervalued in that calculation, and therefore squandered' he said.   In concluding his speech he expanded on this theme stating: ‘With hindsight…it’s open to question whether the ‘quantification’ of the risk management profession has created something of a blind spot for those types of risk that are difficult to quantify. The finance industry, and the risk profession that serves it, has a natural affinity for measuring things in dollars and cents, percentages and basis points. But that means the conventional risk management frameworks and processes find it difficult to grapple with difficult-to-quantify risks, such as those relating to behaviour and reputation. If what gets measured gets managed, then I suspect that has played some role in bringing the industry to where it is today’.  He added that this would be a key challenge going forward. 
    [Note: Insufficient focus on non-financial risk was a key finding in the recent APRA report into CBA culture.  See: Governance News 04/05/2018.]
  • APRA’s role: Mr Byres said that 'it is not the regulators' job to regain that trust for you' but rather a task for industry to 'earn and sustain the community's trust through its own actions'.  Commenting on APRA's role in overseeing risk culture, Mr Byres drew a distinction between the Australian Securities and Investments Commission (ASIC) approach and that of APRA.  He said that APRA’s work on ‘culture should be focused on those areas that are naturally of interest to a prudential regulator’ adding that this means that ‘we view it very much through a risk lens’ whereas ASIC will have a different perspective.  Mr Byres also said that APRA views ‘culture as a critical but underappreciated component of the post-crisis regulatory response’ and that ‘understanding attitudes to risk – the risk culture – are fundamental to gaining confidence that an institution has robust risk management and is likely to remain in a sound financial position’ as without culture to reinforce them, well documented policies and procedures were unlikely to be effective.
  • Risk culture is a job for the board: Mr Byres said that 'in the same way that we [APRA] don’t prescribe the business models and strategies that financial institutions must adopt, we don’t seek to prescribe the risk culture either. We expect executives and their Boards to establish and maintain the risk culture that they consider (and note, we do expect a conscious consideration) to be appropriate to their organisations, given their strategy and risk appetite. As set out in CPS220, we also make clear that it is the Board’s job – but inevitably supported by management – to form a view as to whether their risk culture is appropriate, and insist on changes when they consider it not to be the case'.

Areas of specific focus for banks (and for APRA): BEAR implementation and Remuneration

Banking Executive Accountability Regime (BEAR) – how well has it been implemented in practice?  

Mr Byres said that feedback to APRA has been that the set up process created some organisational challenges including debate about where accountability properly lies within institutions.  Commenting on this he said that in his view, clarification of accountabilities was itself a useful exercise. 
He went on to say that now the system is operational APRA will shift its attention to how well it has been implemented and more particularly that APRA will be looking to ‘see how well the allocated responsibilities work in practice’ adding that the regulator is ‘quite open to revisiting these as we learn from experience’. Mr Byres added that APRA will be ‘looking to see how accountable persons understand and oversee their areas of accountability in practice – to repeat a point I have made already, having the paperwork in good shape is not enough’.
Mr Byres also encouraged ADIs not already subject to BEAR ‘start your preparations now if you haven’t already done so. The obligations of BEAR are significant, so it’s important that you take the time to get them right’.
Mr Byres said that he hoped that over time, BEAR would have a positive impact in terms of forcing industry to hold itself to account ‘much more firmly and quickly than has been the case to date’ as it appears to have done in other jurisdictions with similar regimes. 

Remuneration

On the topic of remuneration Mr Byres noted that earlier this year APRA released the findings from its review of remuneration policies and practices across a sample of large APRA-regulated entities (see: Governance News 06/04/2018) observing that the review ‘found that remuneration frameworks and practices across the sample did not consistently and effectively meet our [APRA's] objective of sufficiently encouraging behaviour that supports risk management frameworks and long-term financial soundness. Though all institutions had remuneration structures that satisfied minimum requirements, implementation was often some way from better practice’.

Three specific areas for improvement

He then highlighted three areas in which ‘improvement is needed’ (and which were previously flagged in APRA’s remuneration review), noting that though APRA has previously said that it intends to strengthen prudential requirements in this area, ‘boards and senior executives shouldn’t wait to take action to improve the design and implementation of remuneration frameworks’.

  1. Executive accountability for poor risk outcomes: Mr Byres said that though employees at lower levels received downward adjustments to remuneration ‘overall, senior executives seemed somewhat insulated from the consequences of poor risk outcomes. This must change’.
  2. Performance metrics need to evolve in line with best practice: Though financial metrics should be part of performance assessment Mr Byres said, excessive weightings risk driving the wrong behaviours. ‘One reason that there seemed to be a misalignment between outcomes and remuneration was that measures by which performance was judged are too focused on shareholder metrics such as return on equity (RoE) and total shareholder return (TSR). The current structure of long-term incentives in Australia is particularly problematic in this regard, and is out of step with how best practices in remuneration are evolving internationally. This will also have to change’.
  3. Board Remuneration Committee oversight is weak: ‘From insufficient challenge to insufficient documentation, it was clear that stronger governance of executive remuneration is needed’ Mr Byres said.  He added that for ADIs the BEAR will require that this occur, but it will also require a more ‘structured and systemic contribution from the risk functions within banks’.  

[Sources: APRA Chair Wayne Byres speech, Annual Risk Management Association CRO Conference, 04/09/2018; [registration required] The AFR 04/09/2018]

Queries regarding this article?  For queries or feedback regarding this article, please contact Kate Hilder.

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