Directors' Report
The Directors of the Commonwealth Bank of Australia submit their report, together with the financial report of the Commonwealth Bank of Australia (the ‘Bank’) and of the Group, being the Bank and its controlled entities, for the year ended 30 June 2004.
The names of the Directors holding office during the financial year and until the date of this report are set out in Our Directors together with details of Directors' experience, qualifications, special responsibilities and organisations in which each of the Directors has declared an interest.
Directors' Meetings
The number of Directors' meetings (including meetings of committees of Directors) and number of meetings attended by each of the Directors of the Commonwealth Bank during the financial year were:
Directors' Meetings
| Director | No. of Meetings Held(1) | No. of Meetings Attended |
|---|---|---|
| JT Ralph | 11 | 11 |
| JM Schubert | 11 | 11 |
| DV Murray | 11 | 11 |
| NR Adler | 11 | 11 |
| RJ Clairs | 11 | 11 |
| AB Daniels | 11 | 11 |
| CR Galbraith | 11 | 11 |
| SC Kay | 11 | 11 |
| WG Kent | 11 | 11 |
| FD Ryan | 11 | 10 |
| FJ Swan | 11 | 9 |
| BK Ward | 11 | 9 |
(1) The number of meetings held during the time the Director held office during the year.
Committee Meetings
| Risk Committee | Audit Committee | Remuneration Committee | Nominations Committee | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Director | No. of Meetings Held(1) | No. of Meetings Attended | No. of Meetings Held(1) | No. of Meetings Attended | No. of Meetings Held(1) | No. of Meetings Attended | No. of Meetings Held(1) | No. of Meetings Attended | |
| JT Ralph | 8 | 8 | 8 | 8 | 2 | 2 | |||
| JM Schubert(2) | 4 | 4 | 7 | 7 | 2 | 2 | |||
| DV Murray | 8 | 8 | 2 | 2 | |||||
| NR Adler(2) | 4 | 3 | 7 | 7 | |||||
| RJ Clairs(2) | 4 | 4 | 8 | 8 | |||||
| AB Daniels(2) | 4 | 4 | 8 | 8 | |||||
| CR Galbraith | 8 | 8 | |||||||
| SC Kay | 8 | 8 | |||||||
| WG Kent | 8 | 8 | |||||||
| FD Ryan(2) | 4 | 4 | 7 | 7 | |||||
| FJ Swan | 8 | 7 | 2 | 2 | |||||
| BK Ward(2) | 4 | 3 | 7 | 7 | |||||
(1) The number of meetings held during the time the Director was a member of the relevant committee.
(2) Directors appointed to Risk Committee in April 2004.
Principal Activities
The Commonwealth Bank Group is one of Australia's leading providers of integrated financial services including retail, business and institutional banking, superannuation, life insurance, general insurance, funds management, broking services and finance company activities. The principal activities of the Commonwealth Bank Group during the financial year were:
Banking
The Group provides a full range of retail banking services including housing loans, credit cards, personal loans, savings and cheque accounts and demand and term deposits. The Group has leading domestic market shares in home loans, personal loans, retail deposits and discount stockbroking and is one of Australia's largest issuers of credit cards. The Group also offers a full range of commercial products including business loans, equipment and trade finance, and rural and agribusiness products. For our corporate and institutional clients, we offer a broad range of structured finance, equities and advisory solutions, financial markets and equity markets solutions, transactions banking, and merchant acquiring. The Group also has full service banking operations in New Zealand and Fiji. The Group has wholesale banking operations in London, New York, Hong Kong, Singapore and Tokyo.
Funds Management
The Group is Australia's largest fund manager and largest retail fund manager in terms of its total value of funds under administration. The Group's funds management business is managed as part of the Investment and Insurance Services division. This business manages a wide range of wholesale and retail investment, superannuation and retirement funds. Investments are across all major asset classes including Australian and International shares, property, fixed interest and cash.
The Group also has funds management businesses in New Zealand, UK and Asia.
Insurance
The Group provides term insurance, disability insurance, annuities, master trusts, investment products and household general insurance.
The Group is Australia's third largest insurer based on life insurance assets held, and is Australia's largest manager in retail superannuation, allocated pensions and annuities by funds under management.
Life insurance operations are also conducted in New Zealand, where the Group has the leading market share, and throughout Asia and the Pacific.
There have been no significant changes in the nature of the principal activities of the Group during the financial year.
Consolidated Profit
Consolidated operating profit after tax and outside equity interests for the financial year ended 30 June 2004 was $2,572 million (2003: $2,012 million).
The net operating profit for the year ended 30 June 2004 after tax, and before goodwill amortisation, appraisal value uplift, shareholder investment returns and costs related to initiatives including Which new Bank was $3,078 million. This is an increase of $404 million or 15% over the year ended 30 June 2003.
On 19 September 2003, the Group launched its Which new Bank customer service vision. This is a three year transformation programme and involves the Bank in additional expenditure in the key areas of staff training and skilling, systems and process simplification, and technology. In the period to 30 June 2004 such expenses and provisions have totalled $749 million and principally comprise redundancies, expensing of previously capitalised software of $219 million, process improvements and branch refurbishment. The outstanding provision for Which new Bank costs at 30 June 2004 is $208 million.
The principal contributing factors to this profit increase were a growth in net interest income reflecting continued strong housing loan growth together with growth in commissions, and a decrease in charge for bad and doubtful debts. Underlying operating expenses have increased by 4% over the year, primarily due to salary increases and increases in volume related expenses. Funds management and insurance income rose which reflects the effect of rising equity markets for most of the year and improved underwriting and claims management.
Dividends
The Directors have declared a fully franked (at 30%) final dividend of 104 cents per share amounting to $1,315 million. The dividend will be payable on 24 September 2004 to shareholders on the register at 5pm on 20 August 2004. Dividends paid since the end of the previous financial year:- As declared in last year's report, a fully franked final dividend of 85 cents per share amounting to $1,066 million was paid on 8 October 2003. The payment comprised cash disbursements of $865 million with $201 million being reinvested by participants through the Dividend Reinvestment Plan;
- In respect of the current year, a fully franked interim dividend of 79 cents per share amounting to $996 million was paid on 30 March 2004. The payment comprised cash disbursements of $808 million with $188 million being reinvested by participants through the Dividend Reinvestment Plan; and
- Additionally, quarterly dividends totalling $37 million for the year were paid on the PERLS preference shares; $15 million on the PERLS II (for distributions in March 2004 and June 2004); $40 million on the Trust Preferred Securities; and $9 million on the ASB Capital preference shares.
Review of Operations
An analysis of operations for the financial year is set out in the Review of Operations and Business Overview.
Changes in State of Affairs
During the year, the Bank made significant progress in implementing a number of strategic initiatives under the Which new Bank program launched in September 2003.
The program is designed to ensure a better service outcome for the Bank's customers.
The major initiatives undertaken during the year included:- Changes to the home loan process, which make applying for a new loan much simpler and easier;
- The refurbishment of 125 branches to a modern layout conducive to effective customer service;
- A continued emphasis on reducing customer waiting times and changes to frontline customer service roles designed to ensure a greater proportion of staff time is spent serving customers; and
- A restructure of funds management back office services to reduce costs and provide simpler processes.
In May 2004 the Bank announced the merger of its Premium Financial Services and Institutional and Business Services divisions to form Premium Business Services. This merger did not result in any significant change in the nature of the business activities.
There were no other significant changes in the state of affairs of the Group during the financial year.
Events Subsequent to Balance Date
The Directors are not aware of any matter or circumstance that has occurred since the end of the financial year that has significantly affected or may significantly affect the operations of the Group, the results of those operations or the state of affairs of the Group in subsequent financial years.
Future Developments and Results
Major developments, which may affect the operations of the Group in subsequent financial years, are referred to in the Message from the Chairman. In the opinion of the Directors, disclosure of any further information on likely developments in operations would be unreasonably prejudicial to the interests of the Group.
Environmental Regulation
The Bank and its controlled entities are not subject to any particular or significant environmental regulation under a law of the Commonwealth or of a State or Territory, but can incur environmental liabilities as a lender. The Bank has developed credit policies to ensure this is managed appropriately.
Directors' Shareholdings
Particulars of shares in the Commonwealth Bank or in a related body corporate are set out in a separate section at the end of the financial report titled ‘Shareholding Information’ which is to be regarded as contained in this report.
Options
An Executive Option Plan ("EOP") was approved by shareholders at the Annual General Meeting on 8 October 1996 and its continuation was further approved by shareholders at the Annual General Meeting on 29 October 1998. At the 2000 Annual General Meeting, the EOP was discontinued and shareholders approved the establishment of the Equity Reward Plan ("ERP"). The last grant of options to be made under the ERP was the 2001 grant, with options being granted on 31 October 2001, 31 January 2002 and 15 April 2002. A total of 3,007,000 options were granted by the Bank to 81 executives in the 2001 grant. During the financial year, the performance hurdles for the August 1999 and September 2000 EOP grants were met. During the financial year and for the period to the date of this report 1,837,600 shares were allotted by the Bank consequent to the exercise of options granted under the Executive Option Plan and Equity Reward Plan. Full details of the Plan are disclosed in Note 5 to the financial statements. No options have been allocated since the beginning of the 2001/02 financial year.
The names of persons who currently hold options in the Plan are entered in the register of option holders kept by the Bank pursuant to Section 170 of the Corporations Act 2001. The register may be inspected free of charge.
For details of the options previously granted to the Chief Executive Officer, being a director, refer to Note 5 of the Financial Statements.
Directors' Interests in Contracts
A number of Directors have given written notices, stating that they hold office in specified companies and accordingly are to be regarded as having an interest in any contract or proposed contract that may be made between the Bank and any of those companies.
Directors' and Officers' Indemnity
Article 19 of the Commonwealth Bank's Constitution provides: "To the extent permitted by law, the company indemnifies every director, officer and employee of the company against any liability incurred by that person (a) in his or her capacity as a director, officer or employee of the company and (b) to a person other than the company or a related body corporate of the company. The company indemnifies every director, officer and employee of the company against any liability for costs and expenses incurred by the person in his or her capacity as a director, officer or employee of the company (a) in defending any proceedings, whether civil or criminal, in which judgment is given in favour of the person or in which the person is acquitted or (b) in connection with an application, in relation to such proceedings, in which the Court grants relief to the person under the Corporations Act 2001, provided that the director, officer or employee has obtained the company's prior written approval (which shall not be unreasonably withheld) to incur the costs and expenses in relation to the proceedings".
An indemnity for employees, who are not directors, secretaries or executive officers, is not expressly restricted in any way by the Corporations Act 2001.
The Directors, as named in Our Directors, and the Secretaries of the Commonwealth Bank, being JD Hatton and HJ Broekhuijse are indemnified under Article 19 as are all the executive officers of the Commonwealth Bank.
Deeds of Indemnity have been executed by Commonwealth Bank in terms of Article 19 above in favour of each Director.
Directors' and Officers' Insurance
The Commonwealth Bank has, during the financial year, paid an insurance premium in respect of an insurance policy for the benefit of those named and referred to above and the directors, secretaries, executive officers and employees of any related bodies corporate as defined in the insurance policy. The insurance grants indemnity against liabilities permitted to be indemnified by the company under Section 199B of the Corporations Act 2001. In accordance with commercial practice, the insurance policy prohibits disclosure of the terms of the policy including the nature of the liability insured against and the amount of the premium.
Remuneration
This report outlines the remuneration arrangements for Directors and executives of the Bank. In compiling this report, the Bank has taken into account the requirements of the Government's Corporate Law and Economic Reform Program ("CLERP 9") which is to take effect for reporting periods commencing from 1 July 2004. Whilst the Bank is not required to report under the new CLERP 9 framework for the year ended 30 June 2004, the Bank believes that this report will assist in meeting the intent of these reforms and will ensure that these requirements are met for future reporting periods.
Remuneration Committee
The Bank's remuneration arrangements are overseen by the Remuneration Committee of the Board. The Committee considers changes in remuneration policy likely to have a material impact on the Bank and is informed of leadership performance, legislative compliance in employment issues, industrial agreements and incentive plans operating across the Bank.
The Committee also considers senior appointments and remuneration arrangements for senior management. The remuneration arrangements for the CEO and his direct reports are approved by the full Board.
The policy of the Board is that the Committee shall consist entirely of independent Non-Executive Directors. The Chief Executive Officer attends Committee meetings by invitation but does not attend in relation to matters that can affect him.
The Committee engages an external consultant to advise it directly in relation to the remuneration of executives.
Non-Executive Director Remuneration
The Constitution and the ASX Listing Rules specify that the aggregate remuneration of Non-Executive Directors shall be determined from time to time by a general meeting. An amount not exceeding the amount determined, is divided between the directors as they agree. The policy of the Board is that the aggregate amount should be set at a level which provides the Bank with the necessary degree of flexibility to enable it to attract and retain the services of directors of the highest calibre. The latest determination was at the Annual General Meeting held on 28 October 1999 when shareholders approved an aggregate remuneration of $1,500,000 per year. The Nominations Committee reviews the fees payable to Non-Executive Directors. Directors' fees do not incorporate any bonus or incentive element.
In August 2000, the Board approved the introduction of the Non-Executive Directors' Share Plan which requires the acquisition of shares by Non-Executive Directors at market price through the mandatory application of 20% of their annual fees. Details of this Plan were set out in the Notice of Meeting to the 2000 Annual General Meeting.
Under the Directors' Retirement Allowance Scheme, which was approved by shareholders at the 1997 Annual General Meeting, Directors accumulate a retirement benefit on a pro-rata basis to a maximum of four years' total emoluments after twelve years' service. No benefit accrues until the Director has served three years on the Board. In 2002 the Board decided to discontinue the Directors' Retirement Allowance Scheme without affecting the entitlements of then existing Non-Executive Directors. After that time new Directors are not entitled to participate in the scheme. As part of a proposed arrangement relating to remuneration, the Board will be seeking shareholder approval at the 2004 Annual General Meeting to terminate accrual of further benefits under the Scheme and freeze the entitlements of current members until their respective retirements. This approach will result in remuneration arrangements being expressed in a more transparent manner which does not include retirement benefits (other than compulsory superannuation).
Remuneration Principles and Structure
The Bank's remuneration systems complement and reinforce its leadership and succession planning systems.
The Bank's remuneration framework aims to reward executives with a mix of remuneration appropriate to their level in the organisation and incorporates a significant weighting towards variable ("at risk") pay linked to performance, both short term and long term. This focus aims to:- Reward executives for bankwide, business unit and individual performance against targets set by reference to appropriate benchmarks;
- Align the interests of executives with those of shareholders;
- Link executive reward with the strategic goals and performance of the Bank; and
- Ensure total remuneration is competitive by market standards.
In determining appropriate levels of executive remuneration, the Remuneration Committee engaged an external consultant to provide independent advice both in the form of a written report detailing market levels of remuneration for comparable executive roles as well as the participation of the independent consultant in the meeting from which the Committee makes its recommendations to the Board.
Remuneration and terms and conditions of employment are specified in an individual contract of employment with each executive which is signed by the executive and the Bank. Remuneration of the Bank's executives consists of three key elements:- Fixed Remuneration;
- Short Term Incentive ("STI"); and
- Long Term Incentive ("LTI").
The relationship of fixed remuneration and variable pay (potential short term and long term incentives) is established for each level of executive management by the Remuneration Committee.
Currently, the variable component of remuneration is in the general range of around 35% to 80% of an executive's total potential remuneration depending on their level in the organisation. As a result of the review with the external consultant of developments in the market, and benchmarking against peer organisations, the distribution of total potential remuneration for executives is being modified in the current year so as to increase the percentage for the STI component and decrease the percentage for the LTI component. For senior executives, including the CEO, the maximum STI potential available will generally be an amount equal to fixed remuneration.
The structure for some specialists differs from that which applies generally to executive management. With specialists, a greater proportion of the variable component of remuneration may be in short term rather than long term incentives but the overall mix of remuneration is still heavily weighted towards ‘at risk’ pay.
Fixed Remuneration
Fixed remuneration is competitively set so that the Bank can attract, motivate and retain high calibre local and international executive staff.
Fixed remuneration is reviewed annually by the Remuneration Committee through a process that considers bankwide, business unit and individual performance, relevant comparative remuneration in the market and internal and, where appropriate, external advice on policies and practices. As noted above, the Committee has access to external advice independent of management.
Fixed remuneration consists of base remuneration (which is calculated on a total cost basis and includes any FBT charges related to employee benefits including motor vehicles) as well as employer contributions to superannuation.
Variable Pay — Short Term Incentive ("STI")
Actual STI payments for executives depend on the extent to which operating targets set at the beginning of the financial year are met.
These targets consist of a number of Key Result Areas ("KRAs") covering both financial and non-financial measures of performance. Included are measures such as contribution to net profit after tax, customer service, risk management, product management, and leadership/team contribution.
Depending on the executive's level within the organisation, any actual STI payments received are based on a combination of bankwide, business unit and individual performance.
On an annual basis, after consideration of performance against KRAs, an overall performance rating for the Bank and each individual business unit is approved by the Remuneration Committee. Individual performance is assessed by the executive's manager based on the Bank's performance management system.
Executives who are not meeting the expectations of their role will generally not receive a payment.
The aggregate of annual STI payments available for executives across the Bank is subject to the approval of the Remuneration Committee. In the case of the Chief Executive Officer and his senior direct reports, individual payments are subject to the approval of the Board.
STI payments to executives are usually delivered in two components:- Fifty percent made as an immediate cash payment; and
- Fifty percent deferred in the form of shares in the Bank.
Shares are acquired under the mandatory component of the Bank's Equity Participation Plan, more details of which may be found in Note 5 to the Financial Statements. The shares acquired vest in two equal instalments of one and two years respectively. Dividends on the shares are not paid to the executive unless and until the shares vest. Generally, the executive will need to be an employee of the Bank at the relevant vesting date to receive the shares.
Variable Pay — Long Term Incentive ("LTI")
LTI grants to executives are delivered in the form of Reward Shares under the Bank's Equity Reward Plan ("ERP").
LTI grants are only made to executives who are able to influence the generation of shareholder wealth and thus have a direct impact on the Bank's performance against the relevant hurdle. Participation is thus restricted to executives who, in a reporting sense, are no more than three levels removed from the Chief Executive Officer.
The quantum of grants made to each executive depends on their level within the organisation and has regard to the desired mix between fixed remuneration, short term and long term incentive as well as the performance and potential of the individual executive.
No value will accrue to the executive unless the Bank's Total Shareholder Return ("TSR") at least meets the median of a peer comparator group of companies. To receive the full value of the LTI grant, the Bank's performance must be in the top quartile of the peer group. The table below provides a summary of the ERP grants that were in operation during the 2003/04 year.
| 2000 Grant | 2001 Grant | 2002 Grant | 2003 Grant | |
|---|---|---|---|---|
| Commencement Date | 13 Sep 2000 | 3 Sep 2001 | 2 Sep 2002 | 1 Sep 2003 |
| First Possible Vesting Date | 14 Sep 2003 | 4 Sep 2004 | 3 Sep 2005 | 2 Sep 2006 |
| Final Possible Vesting Date | 13 Sep 2005 | 3 Sep 2006 | 2 Sep 2007 | 1 Sep 2008 |
| Performance Hurdle | TSR vs Peer Group. If the performance hurdle is not reached after three years the options may nevertheless be exercisable or the shares vest, only where the hurdle is subsequently reached within five years from the commencement date. | TSR vs Peer Group. Where the rating is at least at the 50th percentile on the third anniversary of the grant, the shares will vest at a time nominated by the executive, within the trading windows, over the next two years. The vesting percentage will be at least that achieved on the third anniversary of the grant and the executive will be able to delay vesting until a subsequent half yearly window prior to the fifth anniversary of the grant. The vesting percentage will be calculated by reference to the rating at that time. Where the rating is below the 50th percentile on the third anniversary of grant, the shares can still vest if the rating reaches the 50th percentile prior to the fifth anniversary, but the maximum vesting will be 50%. | ||
| Vesting Scale | < Weighted Average of Peers = 0% Weighted Average of Peers = 100% |
< 50th percentile = NIL 50th — 67th percentile = 50% — 75% 68th — 75th percentile = 76% — 100% |
||
| Status as at 30 June 2004 | Vested on 31 Mar 04 | Not yet vested | Not yet vested | Not yet vested |
| Peer Group (GIO and BankWest were included prior to 19/01/00 and 26/08/03 respectively) |
|
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The use of a relative TSR based hurdle is currently market best practice as it ensures an alignment between comparative shareholder return and reward for executives.
In assessing whether the performance hurdles for each grant have been met, the Bank receives independent data from Standard & Poors which provides both the Bank's TSR growth from the commencement of each grant and that of the peer group (excluding the Bank). The Bank's performance against the hurdle is then determined as follows:- For grants prior to 2002, the TSR of each company in the peer group is weighted by market capitalisation to form an index against which the Bank's TSR is compared; and
- For grants in 2002 and 2003, each company in the peer group and the Bank is ranked in order of TSR growth from the commencement of each grant. The Bank's percentile ranking is determined by aggregating the weighting within the peer group (based on market capitalisation) of each company ranked below the Bank.
The peer group chosen for comparison reflects the Bank's current business mix.
Further details of the ERP may be found in Note 5 to the Financial Statements.
Severance Arrangements
The Bank's executive contracts generally provide for severance payments of up to six months in the case of retrenchment. The contracts generally provide for a four week notice period.
On exit from the Bank, executives are entitled to receive their statutory entitlements of accrued annual and long service leave as well as accrued superannuation benefits.
Executives who leave the Bank during a given performance year (i.e. 1 July to 30 June) will generally not receive an STI payment for that year except in the circumstances of retrenchment, retirement or death. In those circumstances a pro-rated payment may be made based on the length of service during the performance year.
Deferred shares from previous STI grants are usually forfeited where the executive resigns or is dismissed. In circumstances of retrenchment, retirement and death any unvested shares will generally vest immediately.
LTI grants are generally forfeited where the executive resigns or is dismissed. In circumstances of retrenchment, retirement or death the executive or their estate may, at Board discretion, retain a pro-rated grant of long term incentives. Vesting of any long term incentives retained by the executive will still be subject to the performance hurdle relevant to that grant.
Chief Executive Officer Remuneration
The remuneration of Mr Murray (Chief Executive Officer) is fixed by the Board, pursuant to the Constitution, as part of the terms and conditions of his appointment. Those terms and conditions are established in a contract of employment with Mr Murray which was effective from 2 July 2001, with remuneration subject to review, from time to time, by the Board.
Mr Murray's remuneration arrangements are in line with other executives except in relation to the need to seek shareholder approval of LTI grants.
At the 2004 Annual General Meeting ("AGM"), the Board will be seeking the approval of shareholders for a maximum of 250,000 shares to be allocated to Mr Murray under the ERP in two tranches prior to the 2006 AGM. Mr Murray was granted 110,000 shares in 2002 and 90,000 shares in 2003 from the 200,000 shares approved at the 2001 AGM. At the 2001 AGM, shareholders also approved 1,000,000 options to be granted to Mr Murray. In line with the Bank's decision to cease granting options to executives in 2002 none of the 1,000,000 options approved by shareholders were allocated and it is not intended to allocate these options.
The severance arrangements in Mr Murray's contract, other than for misconduct, provide for a notice period of six months and a pro-rata payment of the average of the previous three years short term incentive payment, payable in the event of termination by the Bank, after 1 May but before 30 June each year. In such circumstances, Mr Murray may exercise all vested options and obtain vested shares (including those that vest within two years from the Termination Date) within a period of three years from the Termination Date.
Individual Remuneration details for Directors and Specified Executives
The CLERP 9 reforms mentioned earlier in this report require that individual remuneration details of Directors and Specified Executives be included in this report. These requirements duplicate those of Accounting Standard AASB 1046 which requires these same details to be set out in the notes to the accounts. To avoid duplication, individual remuneration details of Directors and Specified Executives are set out in Note 5.
Incorporation of Additional Material
This report incorporates the Review of Operations, Our Directors, Business Overview, Corporate Governance and Shareholding Information sections of this Annual Report.
Roundings
The amounts contained in this report and the financial statements have been rounded to the nearest million dollars unless otherwise stated, under the option available to the Company under ASIC Class Order 98/100 (as amended by ASIC Class Order 04/667).
Signed in accordance with a resolution of the Directors.
JT Ralph, AC
Chairman
DV Murray
Managing Director and
Chief Executive Officer
11 August 2004
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