Three steps to enhance CPS 511 readiness

In a post-royal commission environment, as regulators work to improve the remuneration governance structures in financial service organisations, risk and remuneration are becoming increasingly linked.

To help strengthen remuneration practices across all Australian Prudential Regulation Authority (APRA) regulated entities, the prudential standard CPS 511 has been issued.

What can organisations do to enhance their readiness for CPS 511?

By studying potential pitfalls in effective implementation of CPS 511 and discussing practical next steps, risk and compliance teams can take to ensure a holistic approach to CPS 511.

In a recent address, APRA General Manager of Governance, Culture, Remuneration and Accountability, Stuart Bingham said both the spirit and letter of the law require attention for effective CPS 511 compliance.

‘For APRA supervisors, it is about getting to the root cause of an issue. Understanding what and how is important, but we firmly believe that fixing an issue or managing a risk requires an understanding of why,’ Mr Bingham said.

The ‘why’ behind Standard CPS 511 has been brewing for more than a decade. Since the global financial crisis (GFC) and more recently the 2019 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, there has been a determined effort from regulators to improve the remuneration governance structures in financial services organisations.

This focus on the cause, and not just the symptoms, could be driving the regulator’s emphasis on risk culture.

‘We expect to see questions being asked and answered internally by these entities well before a problem arises and APRA comes calling,’ Mr Bingham said.

Finding the balance between risk and reward

To meet a higher standard of governance, APRA has increased its focus on prudent risk management by encoding the entity’s risk management framework into the entity’s remuneration framework through CPS 511. The new standard means boards will need to demonstrate that they ‘bring rigour and challenge’ in their oversight of the remuneration framework, decisions and outcomes, having not been sufficiently engaged in the past, according to APRA. The regulator has adopted a proportionate approach, outlining more comprehensive requirements for regulated entities classified as Significant Financial Institutions (SFIs).

Box tickers be warned – It’s about more than remuneration design

To date the spotlight has been firmly fixed on SFIs that must meet specific variable remuneration design requirements. However, those organisations that have ticked the boxes on deferral requirements, non-financial performance measures and aligned their policy wording to CPS 511 might still be in for a surprise when they undertake an independent effectiveness review, required every three years for SFIs.

APRA’s definition of remuneration framework is ‘the totality of systems, structures, policies, processes and people within an entity that identify, measure, evaluate, monitor, report and control or mitigate all internal and external sources of risks relating to remuneration’. CPS 511 is holistic in focus requiring key components of business strategy, risk management framework, performance framework, remuneration design and consequence management to be integrated.

The tone is set from the top

Under CPS 511 (at paragraph 21), the board is ultimately responsible for an entity’s remuneration framework and its effective application. Boards will need to ensure that remuneration practices are well supported by broader frameworks and policies that influence behaviour beyond financial rewards. This includes clear accountability, effective consequence management and a strong tone from the top on risk culture.

Boards will also need to meet heightened oversight requirements, including approval of remuneration for Specified Roles annually. For SFIs, consultation with the board risk committee and chief risk officer is required to ensure remuneration outcomes for Specified Roles are based on holistic performance assessments that reflect risk outcomes.

With an expanded scope for oversight, it is imperative that boards ensure quality reporting and information flows (including possibly additional Remuneration Committee meetings) are in place to allow them to meet their responsibilities.

What steps can you take now?

CPS 511 presents an opportunity to ensure that policies, systems, processes and practices are fit for purpose, as well as aligned to stronger standards of governance.
Some immediate steps you can take now include:

1. Board and executive awareness training — ensure key stakeholders are clear on their role and their accountabilities.
2. Conduct a gap analysis on your remuneration framework — many entities require fine tuning of each of the separate policies and practices that form part of the broader risk management framework and the remuneration framework to demonstrate the risk and reward linkages.
3. Review your remuneration strategy — take this opportunity to ensure that remuneration strategy continues to align to your organisation’s overarching vision, purpose and strategy. This will help you to ensure that your remuneration strategy fulfils broader organisational objectives beyond regulatory compliance. The ability to articulate your ‘why’ will also enhance your readiness for greater transparency and disclosure under the proposed reporting standard CRS 511 in due course.

As the financial services sector operates in a shifting governance and competitive landscape, it is imperative risk leaders consider Standard CPS 511 in the context of developing a robust risk culture alongside effective risk management.

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