Pay deals in Australian financial services sectors were so badly structured they incentivised employee behaviour that prioritised ‘the pursuit of short-term profit at the expense of basic standards of honesty’.
That was the view of Australia’s 2017 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, also known as the Hayne Royal Commission, which was convened following a series of financial services sector scandals.
The Royal Commission published its 1000 page report in 2019 detailing numerous examples of malpractice in the financial services sector, such as a father’s desperate attempts to cancel a life insurance policy his disabled son had been pressured into buying.
The report’s 76 recommendations spurred a number of consumer reforms in areas such as mortgage broking and responsible lending, as well as a strengthening of the Banking Code of Practice.
The commission also led to new regulatory frameworks to hold senior executives personally responsible for failings at their institutions.
The Banking Executive Accountability Regime (BEAR) was brought in 2018, it was enforced by APRA, and as the name implies it focussed purely on the banking sector.
In a succession of acronyms, BEAR was replaced on 15 March 2024 by the Financial Accountability Regime (FAR). This was initially aimed just at banks before being expanded 12 months later to include insurers and superannuation funds and is jointly administered by the prudential regulator and ASIC.
The FAR requires firms to review their internal frameworks and report these to regulators, with enhanced notification requirements being applied to insurers with assets over A$10bn (approx. US$6.3bn).
Most importantly it includes what Australian authorities have been touting as some of the toughest rules on deferred pay for senior executives globally.
Llinos Kent
Partner at KennedysIncreased exposure
According to Llinos Kent, Sydney-based Partner at law firm Kennedys, FAR’s expansion in March will have a material effect on the Australian D&O insurance market — one which could leave carriers looking for additional cover.
Insurers (like their insureds) need to check they have the appropriate D&O and PI cover in place now that FAR is in force because it potentially brings a lot of personal exposure for directors, as well as for the entities,” Kent says.
“Accountable persons should be concerned about the changes FAR brings, not just because of the personal liability involved but also because FAR’s obligations for directors and officers go beyond that in the Corporations Act and are untested in Australia.
This will have a knock-on effect on the D&O insurance market in Australia in relation to terms and pricing,” she adds.
The FAR standardised BEAR’s rules on deferred pay for key executives — known as accountable persons — with the minimum deferral rate to 40% of variable remuneration for at least four years for those whose discretionary pay is over A$50,000 a year.
To give an indication of just how much money is at risk of being deferred, a 2019 survey by the Australian Council of Superannuation Investors put the average ASX CEO bonus at A$1.61m – meaning close to A$700,000 of each chief executives pay in that year would be at risk of deferral under the current rules.
Despite the numbers at stake, Kent gave short shrift to (Re)in Asia’s suggestion that the deferred pay changes could spur some executives to push for pay rises given the risk that a substantial portion of their pay could be deferred.
“I just can’t see that getting signed off, because executives in those roles are already getting very good salaries.
And the board would likely say ‘we are already paying you a lot of money to make sure the governance is right’. So, no. I don’t think FAR will lead to salary inflation.” Kent says.
In any case Raymond Giblett, Sydney based Partner at law firm Norton Rose Fulbright was more circumspect on FAR’s potential impact on Australia’s D&O insurance market, saying that, while the new accountability regime involved large amounts of internal work and investment, the biggest penalties are regulatory, not legal.
“Pricing often just comes down to capacity and what is happening in the litigation and particularly the class action scene.
That’s the major scary point but I don’t think FAR is going to trigger a wave of class actions — it will trigger regulatory actions, so I can’t see it making a massive difference to the D&O market,” Giblett says.
The raft of regulation which has followed the Royal Commission in Australia is in addition to the overhaul of global banking regulation in the decade following the global financial crisis which Australian authorities broadly implemented in full.
Raymond Giblett
Partner at Norton Rose FulbrightDean Carrigan, Consultant at Clyde & Co says that while FAR involves a number of additional responsibilities, oversights, and restrictions which will have a significant impact on internal operations and increase exposures for D&O underwriters, these will be limited.
“The FAR does increase exposure for D&O insurers but it doesn’t do so exponentially. I don’t think it materially moves the dial.
I say that because the existing Australian regulatory framework and network of legislation, regulatory oversight and obligations in Australia, which apply to those operations are already extensive and stringent and I don’t think FAR significantly increases the overall burden,” Carrigan says.
Dean Carrigan
Consultant at Clyde & CoLucky eight
The FAR isn’t the only new regulatory standard dealing with governance and executive pay that the Australian authorities are rolling out.
APRA published an eight point governance code ten days before FAR was expanded to the insurance and superannuation sectors, and it brought in Prudential Standard CPS 511, which looks at remuneration, on 1 January 2024.
Giblett says that FAR needs to be considered as one regulatory change among a broader package of reforms that Australian authorities are bringing in to remedy failings in the financial service sector’s dealing with consumers.
“The FAR isn’t necessarily going to be a game changer but instead it was a necessary step after the Royal Commission.
As with APRA’s recent governance proposals it all feeds into the approach of trying to make sure that accountability goes to the top, because as the saying goes, ‘a fish rots from the head’,” Giblett says.
According to Giblett, FAR’s obligations are in addition to the long list of compliance changes the Australian insurance sector has had to comply with since 2019 which include changes to: unfair contract terms, product design and distribution obligations, deferred sales models, and the licensing of claims handling.
“All of these areas have had significant compliance overhauls in recent years, and this in turn changed the way Australian insurers do business,” Giblett says.
Raymond Giblett
Partner at Norton Rose FulbrightAccording to Giblett, implementing FAR was a complex and expensive process for insurers, involving mapping out all internal reporting lines and responsibilities to identify the key accountable people.
Carriers then had to cross reference this against employment contracts which in turn needed to be amended to meet FAR’s deferred pay rules, though firms were able to meet the requirements of CPS 511 simultaneously.
“There were a number of gaps in firms’ preparation for the FAR roll-out — and that is to be expected when it comes to a new regime.
But identifying matrices of responsibility and making sure that that was all mapped and appropriately allocated to appropriately experienced and senior executives, has been a challenge across the board,” Carrigan says.
Dean Carrigan
Consultant at Clyde & CoNon-financial consequences
All insurers may have faced the same obstacles to implementing FAR but Jane Stanton, Sydney-based partner at Grant Thornton, says the regulation, and the closely related prudential standard CPS 511, posed an idiosyncratic challenge for smaller firms with respect to the deferred pay element.
“We have observed that many smaller insurers do not have a variable remuneration component and that all employees, including Executives have fixed remuneration with no “at risk” component. In the context of FAR and CPS 511, for these entities it means that non-financial consequences may be required,” Stanton says.
Jane Stanton
Partner at Grant ThorntonFinancial consequences will remain front of mind for most Australian insurers when it comes to implementing FAR and Kent says that firms need to be aware the limits contained within D&O insurance policies could erode quickly if regulators pursue an investigation.
She warns this is a particular concern if a number of individuals from the same firm find themselves dealing with regulatory action in relation to FAR and she suggests using the current market conditions to expand their limits and secure favourable pricing.
“It’s a soft market at the moment because there is a lot of capacity. D&O insurance premiums are lower now than they have been in recent years so there are favourable conditions for insureds to negotiate terms to account for the risks presented by FAR.”
Kent points out that, not only will the current soft market inevitably harden at some point, she also expects a number of FAR related investigations to emerge once APRA and ASIC become familiar with the next framework.
“APRA and ASIC are getting up to speed themselves on FAR — the securities regulator didn’t have a role in regulating its predecessor regime, BEAR.
They took a light touch issuing observations in 2024 on FAR’s implementation in the banking industry, and when investigations start to emerge it could have an impact on the cost of D&O insurance in Australia.” Kent says.
