In response to the magnitude of the recent global financial crisis and the unprecedented financial-sector bailouts by some countries, the G20 Summit in London on 2 April 2009 agreed on a number of matters concerning changes to the regulation of the financial system that addressed, amongst other things, the issue of executive remuneration and compensation schemes.
FSB Principles The G20 endorsed the Financial Stability Board’s Principles for Sound Compensation Practices (FSB Principles) issued on 2 April 2009, which provide as follows:
- A company’s board of directors must be actively involved in the design, operation and monitoring of the compensation system for the entire organisation.
- Staff engaged in financial and risk control must be independent and be compensated in a manner that is commensurate with their key role in the company.
- Compensation must be aligned with prudent risk-taking.
- There must be effective supervisory oversight and engagement with stakeholders, through disclosure of clear, comprehensive and timely information about compensation, and rigorous and sustained review by regulators.
To strengthen adherence to the FSB Principles, the Implementation Standards were issued in September 2009 and also endorsed by the G20. These standards include specific guidelines on remuneration structuring for executives; for example, that ‘a substantial proportion of variable compensation, such as 40 to 60%, should be payable under deferral arrangements over a period of years......A substantial proportion, such as more than 50%, of variable compensation should be awarded in shares or share-linked instruments.’ There are also specific guidelines on bonus clawback and proscription of guaranteed minimum bonuses, except in the context of hiring new staff, payable only in the first year.
Many countries in the Asia-Pacific region have taken steps to implement the FSB Principles into their domestic legal framework.
Implementation by countries in the Asia-Pacific region
In Australia, there has been increased scrutiny of executive remuneration, which has resulted in a strong commitment by the Australian Government to implement policies that promote transparent, accountable and responsible remuneration practices.
1 Legislative changes
The Corporations Amendment (Improving Accountability on Termination Payments) Act 2009 (Cth) (Amendment Act), which came into operation on 24 November 2009, has implemented measures which are intended to address concerns about director and executive termination benefits. This legislation is directed to director and executive termination benefits generally, not just in the banking sector.
Key features of the new regime include:
- Termination benefits for company directors and executives exceeding one year's average base salary are subject to shareholder approval. Previously the Corporations Act 2000 (Cth) (Corporations Act) allowed for termination benefits up to seven times a director’s total annual remuneration package before shareholder approval was required.
- The scope of the requirements relating to termination benefits is expanded to include senior executives or key management personnel of a disclosing entity, rather than only the company directors, as previously provided under the Corporations Act.
- The definition of what constitutes a ‘benefit’ is broadened.
- New regulations specifying what types of payments are, or are not, a termination benefit, and defining ‘base salary’.
- The obligation to immediately repay unauthorised termination benefits.
- The retention of the existing requirement for the giving of the benefit to be approved by a resolution passed at a general meeting.
- Increases to the penalties for breaches of these provisions.
The Amendment Act is not retrospective and only applies to employment and service contracts which are entered into, renewed, extended or varied after the Amendment Act commenced on 24 November 2009.
2 Australian Prudential Regulation Authority
The Australian Prudential Regulation Authority (APRA), which is the prudential regulator of the Australian financial services industry and is responsible for regulating banks in accordance with the Banking Act 1959 (Cth), has extended its governance standards to implement prudential requirements on remuneration for authorised deposit taking institutions and general and life insurance companies.
The revised APRA governance standards came into effect on 1 April 2010 and require the boards of authorised deposit taking institutions to adhere to two conditions:
- To have in place a Remuneration Policy that covers various matters including alignment of remuneration arrangements with the long-term financial soundness of the regulated institution and its risk management framework, and explains who is covered by the policy.
- To establish a Board Remuneration Committee comprised entirely of independent directors with the requisite skills and knowledge to perform its functions which, at a minimum, are to review the Remuneration Policy periodically and make recommendations to the Board on the policy and the remuneration of executives.
APRA has also released a Prudential Practice Guide for remuneration, which has the objective of helping Boards comply with the extensions of APRA’s governance standards. Subject to meeting the prudential requirements as set out by APRA, regulated institutions have the flexibility to establish their remuneration arrangements in a manner that best suits each individual institution’s business objectives.
3 Productivity Commission
On 16 April 2010, the Australian Government responded to the Productivity Commission's final report on Executive Remuneration in Australia (Report). The Report examined Australia’s corporate law, considering the existing regulatory framework governing director and executive remuneration for companies that are disclosing entities under the Corporations Act, including shareholder voting, disclosure and reporting practices and reflected the FSB Principles.
In the Australian Government’s response to the Report it stated that it will:
- Introduce legislation this year to implement many of the Productivity Commission's recommendations, including the ‘two strikes’ proposal (ie if 25% or more of shareholders vote against the Board remuneration report on two consecutive occasions, then the directors must stand for re-election at an extraordinary general meeting of the company).
- Consider an additional proposal for clawback of bonuses paid to directors and executives in the event of a material misstatement in the company's financial statements, to ensure that, to the extent that pay packets are inflated by incorrect information, that money is returned to shareholders.
The Monetary Authority of Singapore (MAS) issued a consultation paper on 18 March 2010 (MAS Consultation Paper) that sets out proposals to amend the 2007 MAS Corporate Governance Framework. The MAS Consultation Paper only applies to locally-incorporated banks, financial holding companies and direct insurers.
The main focus of the MAS Consultation Paper is to emphasise the importance of the role of the company’s Board and the need for directors to be equipped with the appropriate skills and commitment to oversee the operations of financial institutions.
In respect of remuneration arrangements implemented by financial institutions, Proposal 8 of the MAS Consultation Paper incorporates the FSB Principles by proposing to amend the Corporate Governance Framework as follows:
- Including additional components and factors that the Remuneration Committee must consider in the design and operation of the remuneration framework.
- Requiring that the Remuneration Committee ensure that the remuneration practices of the Boards of Financial Institutions are aligned and accord with the remuneration framework.
- Requiring that the Remuneration Committee review the remuneration practices annually.
- Requiring that the Remuneration Committee have unfettered access to information of the Boards of Financial Institutions for the purposes of carrying out its responsibilities.
The consultation period closed on 19 April 2010 and MAS expects that if the proposals are adopted, implementation will take effect from the first Annual General Meeting of each impacted financial institution held on or after 1 January 2011.
The Hong Kong Monetary Authority has issued a Guideline on a Sound Remuneration System (HKMA Guideline) which reflects the FSB Principles.
The main objective of the HKMA Guideline is to ensure that all Authorised Institutions’ remuneration systems are consistent with, and promote, effective risk management that does not create incentives towards inappropriate and excessive risk-taking.
Key areas covered by the HKMA Guideline include the following:
- The establishment and role of remuneration committees.
- The balance of the constituent elements in a remuneration package.
- The measurement of employees’ performance and the alignment of remuneration payouts to the time horizon of risks.
The HKMA Guideline also aims to strengthen market discipline through timely disclosure by the financial industry of information in relation to their remuneration systems.
The HKMA has stated that the Boards of the Authorised Institutions should promptly arrange for a review of their institutions' remuneration systems and take action to bring them into line with the risk management principles set out in the HKMA Guideline by the end of 2010.
Japanese Company Law (JCL) requires listed companies to disclose basic information about their corporate governance systems in their securities reports.
The Financial Services Agency (FSA), which is responsible for overseeing the banking, securities and exchange, and insurance sectors in Japan, implemented amendments to the JCL which came into effect on 31 March 2010. These amendments require listed companies to disclose the remuneration of Directors and statutory auditors in their securities report as follows:
- For each of their directors/statutory auditors whose remuneration for the relevant fiscal year is JPY 100 million or more, the amount of remuneration and his/her name, and a breakdown by the type of payments (eg, salary, bonus, stock option, and retirement payment). If a director/statutory auditor of a company is also a director/statutory auditor of any of the major subsidiaries of the company, the remuneration amount he/she has received from such subsidiaries must also be added to the amount of the remuneration he/she has received from the company.
- The total amounts of remuneration paid respectively to inside directors, outside directors, inside statutory auditors, and outside statutory auditors, and a breakdown by the type of payments for each class.
- An explanation of the company’s remuneration policies for its directors/statutory auditors, and the way they are decided, if such policies are put in place.
Implication for employers
All employers, but particularly those in the banking and financial sectors, should immediately review their remuneration systems and policies to ensure compliance and consistency with applicable laws and standards.