Thank you Sandy (Easterbrook, of CGI Glass Lewis) for that introduction. And thank you to Guerdon Associates and CGI Glass Lewis for the invitation to give this keynote address to your remuneration forum this morning.
While Australia's executive remuneration framework is relatively strong, the global financial crisis exposed the dangers of remuneration structures that rewarded excessive risk-taking and that did not appear to be connected to the performance of a company.
The Government set out on its reforms to strengthen our system of executive remuneration by improving transparency and the accountability of directors to shareholders.
Our reforms are a sensible and balanced set of measures that build on the strengths of our existing system. They are measures that we hope will promote a culture of responsible remuneration practices.
Central to the reforms is the strengthening of the non-binding vote to give shareholders a greater say over remuneration.
Boards are responsible for the setting of executive pay, but they must also be accountable to shareholders for the decisions that they make.
Shareholders are the owners of companies; by investing their capital, they share in the profits and losses. Our reforms give those shareholders more power to have their say over the remuneration of directors and executives.
By strengthening the non-binding vote, shareholders will be able to hold boards to greater account for their remuneration decisions and encourage boards to work even more assiduously to address shareholder concerns over executive remuneration decisions.
We also think that greater transparency around the process of setting remuneration, particularly around the use of remuneration consultants, will help to reduce real and perceived conflicts of interest and engender a greater faith in the integrity of remuneration setting processes.
Development of the Executive Remuneration Reforms
The reforms that we currently have before the Parliament were the subject of a long and thorough process of consultation.
In March 2009, the Government asked the Productivity Commission to undertake a broad review of Australia's executive remuneration framework.
The Productivity Commission's terms of reference were very broad, encompassing all aspects of the remuneration framework, including the non-binding shareholder vote; the role of remuneration consultants; the disclosure of remuneration details; and potential conflicts of interest that arise in the remuneration-setting process.
The Productivity Commission undertook a thorough and comprehensive inquiry, engaging with a diverse range of stakeholders throughout the nine-month review process.
The Commission released an issues paper in April 2009, followed by a discussion document in September 2009, before completing its final report in December 2009.
Overall, the Commission received a total of 170 submissions and conducted a number of roundtables and public hearings.
While the Commission found the Australian executive remuneration framework to be highly ranked internationally, it did make a number of recommendations on how it could be further strengthened.
These recommendations were designed to improve the capacities of boards, reduce conflicts of interest, and encourage stakeholder engagement in determining remuneration.
The Government formally released its response to the Productivity Commission report in April last year, supporting and strengthening the majority of the Commission's recommendations.
- the "two-strikes" test to strengthen the non-binding vote;
- the regulation of remuneration consultants;
- a prohibition on the hedging of remuneration;
- a prohibition on key management personnel from voting their shares on remuneration-related resolutions;
- the "no-vacancy" rule; and
- the prevention of "cherry picking" by proxy holders.
The Executive Remuneration Bill
In announcing the Government's response to the Productivity Commission's recommendations, my predecessor Minister Bowen indicated that it would be the Government's intention to consult widely before introducing an enacting Bill into the Parliament.
On 20th December last year, as the new Parliamentary Secretary to the Treasurer, having responsibility for corporate law, I released for public consultation an exposure draft setting out the first tranche of the Government's response to the Productivity Commission's review as well as a discussion paper on proposals to "clawback" remuneration in the event of a material misstatement.
On 23rd February 2011, I introduced into the House of Representatives the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011. This Bill will be the subject of further debate in the Parliament this week.
The consultation over the draft Bill built upon the work undertaken by the Productivity Commission and, when viewed together, represents a lengthy and detailed process of consultation.
The Government received nearly 50 submissions in response to the exposure draft of the Bill and I have also personally met with a range of stakeholders to hear their views.
This was a genuine consultation, and while we were committed to the central tenets of the reforms, we did make some refinements to the Bill to address some of the concerns raised during the consultation period.
Before turning my attention to some of the areas of the Bill that were the subject of refinement, I want to comment in some detail on the two areas of the draft Bill that received the most discussion through the consultation process, being the "two-strikes" test and the use of remuneration consultants.
The two-strikes test
Arguably the most significant aspect of the suite of reforms is the new "two-strikes" test. This proposal was put forward by the Productivity Commission as a way to give shareholders more power over boards that were not listening and responding to their concerns on remuneration issues.
Many submissions to the Productivity Commission inquiry noted that the introduction of the non-binding vote on the remuneration report has resulted in increased dialogue between listed companies and shareholders on remuneration issues.
The Commission concluded that, while many boards, particularly those of larger companies, have generally responded adequately to shareholder concerns on the remuneration report, there are still concerns with the small number of boards that are not responsive to feedback from shareholders.
In particular, there were concerns that under the existing system, a board could proceed with its remuneration proposals despite a significant protest vote. Although shareholders can start action to remove a director if they are dissatisfied, there have been very few instances where shareholders have voted to remove a director for remuneration-related reasons.
To address this, the Productivity Commission recommended the introduction of a "two-strikes" and re-election process.
The first strike would be triggered where a company's remuneration report receives a "no" vote of 25 per cent of more at the company's Annual General Meeting (AGM).
If this occurs, the company would need to explain, in its subsequent remuneration report, the action it has taken or intends to take in response to the first strike, or if no action has been taken or is proposed, provide an explanation of its decision to not take any action.
If shareholders are still dissatisfied, and the company receives a second consecutive "no" vote of 25 per cent or more at the next year's AGM, the second strike would be triggered.
Once the two strikes have been recorded, shareholders are then presented with an opportunity to decide whether or not to spill the entire board of directors and force a fresh election of directors within 90 days.
Unlike the two-strikes, which only require 25 per cent or more of the vote, a "spill resolution" requires more than 50 per cent of the vote to be carried.
The Productivity Commission proposed the separate re-election resolution, which in the Bill we have called the "spill resolution", to create a clear delineation between the 'non-binding' votes on the remuneration report, and the "spill resolution", which is the vote on whether directors should be required to stand for re-election.
This separation is intended to give shareholders who are still unhappy with the remuneration report after the first strike but do not want to spill the board, the opportunity to continue to express their dissatisfaction with the remuneration report whilst opposing any motion to spill the board.
The Government believes that this separation is important in helping to maintain the effectiveness of the non-binding vote as a feedback mechanism on remuneration matters.
The Productivity Commission consulted extensively on this proposal, particularly on the 25 per cent threshold level. The Commission concluded that a threshold of 25 per cent for each of the strikes was appropriate, as this was in line with the level of support required for special resolutions, where a 75 per cent majority is required for the resolution to pass.
The Government supported this recommendation, as we believe that it provides greater accountability for directors and increased transparency for shareholders.
I know that there are a range of views among stakeholders on the merits of the "two-strikes" test. Some stakeholders assert that it will lead to the destabilisation of boards by minority shareholder interests, while others assert that the prospect of triggering a board spill will make shareholders so risk averse that they will no longer be willing to use the non binding vote on the remuneration report to express their dissatisfaction. We believe that we have struck the right balance.
In response to the concern of destabilising boards, I would say that the Corporations Act already provides a mechanism for shareholders to fast-track the election of directors, through the 100 member rule.
This rule allows 100 members, or 5 per cent of shareholders, to put forward a resolution at an AGM, including a resolution to remove directors, but it has rarely been invoked, despite this power being available to shareholders.
In response to claims that shareholders not wanting to spill the board will become more risk averse and will not vote 'no', we believe that shareholders will be able to properly distinguish between the non-binding vote and any spill motions that arise and accordingly will continue to make their views on remuneration matters known through the non-binding votes.
The use of remuneration consultants is another aspect of the remuneration framework that has attracted a strong degree of interest, particularly around the potential for conflicts of interest.
The main concern that stakeholders expressed to the Productivity Commission around the use of remuneration consultants was the potential for conflicts of interest.
It was argued that a conflict of interest may arise where remuneration consultants must advise on the remuneration of officers who may be able to affect future decisions about engaging that consultant's services.
In addition, there were concerns that the use of remuneration consultants can "ratchet up" remuneration levels.
The Government's reforms supported and strengthened the recommendations of the Productivity Commission and are based on greater transparency and accountability.
Through the consultation period over the exposure draft, a number of concerns were raised in relation to the administrative burden imposed upon non-executive directors, the breadth of the definition of "remuneration advice" and the potential for this definition to restrict the free flow of information between the remuneration consultant and key management personnel.
In this regard, our principal policy objectives have been to ensure that information surrounding the payment and identity of remuneration consultants is properly declared, and that the recommendations of a consultant are independent of management.
Refinements contained in the Bill
It is worth commenting on some of the areas, where refinements were made to the proposals released for consultation in the exposure draft Bill.
Notable amendments to the Bill relate to the "two-strikes" rule, remuneration consultants, and preventing key management personnel from voting undirected proxies.
In relation to "two-strikes", the final Bill clarifies that companies will not be required to respond to all individual comments made by shareholders at the AGM if a first strike is triggered. Instead, the Bill requires the company to provide a consolidated overview of their proposed action, if any, in response to the first strike.
The Bill has also been changed so that if a spill meeting is to be held, the automatic cessation of office for directors would occur just before the end of the spill meeting, rather than before the commencement of the spill meeting. This will ensure that the company has directors available to chair the spill meeting.
Several changes have also been made to the provisions in the Bill that relate to remuneration consultants.
Stakeholders commented that the definitions of "remuneration consultant" and "advice" in the exposure draft Bill were too broad, and could potentially capture a range of other information and interim discussions between remuneration consultants and company management.
The final Bill clarifies the definition of "remuneration advice" to include recommendations that relate only to the quantum and composition of remuneration for key management personnel and will not capture legal or taxation advice.
The requirement that a contract between a company and a remuneration consultant be executed by a non-executive director has also been removed to ensure that there are no undue administrative burdens placed on non-executive directors.
The final Bill instead has a requirement that the Board or remuneration committee approve the engagement of the particular remuneration consultant.
However, to ensure independence of the consultant's recommendations, both the board and the consultant must now make a declaration that the remuneration advice was provided free from any undue influence from management.
Remuneration consultants will also be required to provide the remuneration recommendation only to the non-executive directors on the Board or the remuneration committee, rather than to executive directors, or other employees of the company.
While the exposure draft prohibited key management personnel from voting undirected proxies on remuneration-related resolutions altogether, the legislation has been amended to provide an exception to allow the Chair to vote undirected proxies on remuneration-related resolutions where shareholders have provided informed consent.
Other Government initiatives to strengthen Australia's remuneration framework
Of course, these reforms build upon the Government's 2009 reforms limiting the granting of 'golden handshakes' without shareholder approval to termination payments under one year's base salary instead of the old threshold of seven years' total remuneration.
This has significantly strengthened the power of shareholders to reject excessive termination benefits.
On the international stage, Australia has played a key role in developing new global standards on pay in the financial sector. These standards have been implemented in this country by the Australian Prudential Regulation Authority (APRA) and ensure that remuneration arrangements don't lead to excessive risk-taking in our financial institutions.
The standards require institutions to put in place both a remuneration committee and a remuneration policy. The regulations also require performance-based remuneration to be aligned with prudent risk taking, and allow performance-based remuneration to be adjusted to zero if it is unvested.
The APRA standards formally took effect in April last year, applying to all ADIs, general insurers and life insurers.
The Government is also undertaking several other initiatives to further strengthen Australia's remuneration framework.
One of these initiatives relates to efforts addressed at improving the disclosures contained in the remuneration report.
Under the Corporations Act, all disclosing entities are required to prepare an annual remuneration report. This report is a key source of information for shareholders on how executive remuneration is determined and is likely to take on even greater importance in the context of our proposed 'two-strikes' test.
Concerns have been raised about the increasing length and complexity of remuneration reports. In particular, there are concerns that shareholders can sometimes find the reports incomprehensible and possibly even misleading.
In considering these matters, the Productivity Commission recommended that remuneration reports should include a plain English summary of the company's remuneration policies, actual levels of remuneration received by the individuals named in the report, and the total company shareholdings of the individuals named in the report.
In acting on the Productivity Commission's recommendation, my predecessor Minister Bowen, tasked the Corporations and Markets Advisory Committee (CAMAC), to undertake a review on how best to revise the disclosure requirements contained in the Corporations Act and the supporting regulations.
The Government also broadened CAMAC's terms of reference to include the making of recommendations on how the incentive components of pay could be simplified. This is because the length and complexity of remuneration reports is partly due to the increasing complexity of the underlying remuneration arrangements.
CAMAC released an information paper last July and after considering submissions from stakeholders is currently in the process of finalising its report, which is expected to be delivered to the Government in the coming months.
In addition to these matters, the Government has also released a consultation paper regarding a proposal to "clawback" remuneration in the event of a material misstatement.
Under this proposal, which was an additional proposal put forward by the Government and was not recommended by the Productivity Commission, the remuneration of executives could be clawed back where it was subsequently revealed that the company's financial statements were materially misstated.
Currently, shareholders are able to recover overpaid amounts paid to directors and executives only through legal proceedings. There is currently no legislative requirement that provides for clawing-back bonuses or other remuneration in the event of material misstatement by the company.
The discussion paper seeks comments on whether a clawback policy should be implemented in Australia, and if so, how it should be implemented. The comment period closes on 30th March this year and I encourage you to participate in the consultation process.
We are committed to genuine and sensible reform of Australia's executive remuneration framework.
We want to have a framework that allows Australia to maintain its international competitiveness while at the same time encourage a greater level of transparency and accountability to shareholders.
These objectives are not mutually-exclusive and we believe that the Bill currently before the Parliament achieves these objectives.
I look forward to working with you all to implement these reforms, and I look forward to seeing these reforms drive cultural change in our companies through improved accountability of our boards and enhanced shareholder engagement.