Explanatory MemorandumCirculated by the Authority of the Parliamentary Secretary to the Treasurer, the Hon David Bradbury MP
Chapter 4 - Prohibiting hedging of incentive remuneration
Context of amendments
4.1 An important component of remuneration is 'incentive' remuneration (or 'at risk' remuneration). Incentive remuneration aligns the interests of management with the interests of shareholders. This is often achieved by providing equity-based remuneration, for example, shares and options.
4.2 Currently, however, it is possible for directors and executives to 'hedge' their exposure to incentive remuneration. Typically, this involves the director or executive entering into a third party contract (such as trading in derivatives) to reduce their current exposure and mitigate their personal financial interest in the company's success.
4.3 The effect of hedging incentive remuneration is to 'de-link' remuneration from company performance. The PC inquiry concluded that this practice is inconsistent with a key principle underlying Australia's remuneration framework that remuneration should be linked to performance. There is also a real, as well as perceived, conflict of interest with a director or executive entering into an arrangement where they stand to benefit if the company's share price falls.
4.4 In 2007, the Corporations Act was amended to require disclosure of the company's policy in relation to directors and executives hedging their incentive remuneration, and how the company enforces this policy. While this disclosure ensures that shareholders are informed about the company's policy on hedging incentive remuneration, it does not prohibit this practice.
Summary of new law
4.5 KMP and their closely related parties will be prohibited from hedging the KMP's incentive remuneration. This will ensure that KMP, and their closely related parties, cannot undermine the purpose of their incentive remuneration, which is to align remuneration with performance.
Comparison of key features of new law and current law
|New law||Current law|
|Prohibit KMP and their closely related parties from hedging remuneration that depends on the satisfaction of a performance condition.
As a result of the prohibition, the current disclosure requirement is redundant and is no longer required.
|KMP and their closely related parties can hedge the KMP's exposure to remuneration. The company's hedging policy must be disclosed in the annual report.|
Detailed explanation of new law
4.6 Under the new law, a KMP of a company that is a disclosing entity and the KMP's closely related parties, must not enter into an arrangement (with anyone) if it has the effect of limiting the KMP's exposure to risk relating to an element of the KMP's remuneration that is unvested (due to time or other conditions) or is vested but remains subject to a holding lock. [Schedule 1, Item 8, subsection 206J(1)]
4.7 The Bill provides a regulation making power to set out a non-exhaustive list of the types of arrangements that would, and would not, be considered to be a 'hedge' that would limit a KMP's exposure to risk [Schedule 1, Item 8, subsection 206J(3)] . This will provide flexibility to clarify specific cases that will, or will not, be considered to be a hedge, given the range of potential transactions that may be affected by the prohibition.
4.8 The Bill also provides that ASIC may make a declaration that the prohibition on hedging does not apply to a specified arrangement if it is satisfied that the prohibition would be unreasonable in the circumstance [Schedule 1, Item 8, subsection 206J(8)] . This will ensure that ASIC can promptly address any harsh or unintended outcomes. The written declaration made by ASIC is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act 2003 .
4.9 A KMP that hedges their exposure to risk commits an offence [Schedule 1, Item 8, subsection 206J(4)] . This offence is an offence of strict liability on the KMP as the KMP is responsible for any transaction that he or she may enter into in breach of these requirements [Schedule 1, Item 8, subsection 206J(5)] . The KMP also commits an offence where their closely related party hedges and the KMP was reckless as to the contravention [Schedule 1, Item 8, subsection 206J(6)] . This will ensure that the new law cannot be circumvented by the KMP having their closely related parties hedge their remuneration.
4.10 A closely related party of the KMP that intentionally contravenes this requirement commits an offence. [Schedule 1, Item 8, subsection 206J(7)]
Application and transitional provisions
4.11 The proposed prohibition on hedging applies to entry into arrangements on or after 1 July 2011, irrespective of whether the remuneration was for services rendered before, on or after 1 July 2011.