Banks given a decade of work to change their culture and governance

Some of the big hits failed to materialise, but the banking royal commission final report still lays out serious challenges for the industry, say experts from the UNSW Centre for Law, Markets and Regulation.

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The royal commission report into banking and financial services is careful, considered and very legal, according to experts based at the UNSW Centre for Law, Markets and Regulation (CLMR).

Commissioner Kenneth Hayne made 76 recommendations in the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which was released by the federal government yesterday.

“Commentators were speculating about a great many things in the lead-up to the report but in the end it is quite measured, and with few surprises,” CLMR Director Dr Scott Donald said.

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CLMR Director Dr Scott Donald

“The regulation of banking remuneration, split up of vertical integration, ban on political advertising by not-for-profit super funds – none of these happened.  

“But what is there is measured and important, especially around practices that target the vulnerable, fees for no service and the like.”

However, Dr Donald said, the report was “not soft”, having made 24 referrals of entities and individuals to the regulators for further investigation and possible prosecution.

The report also takes aim at Commissioner Hayne’s main concerns: remuneration of banking intermediaries (mortgage brokers and insurance agents and brokers); and conflicts of interest – especially in superannuation and in applying, obeying and enforcing the law.

“It gives banks and their regulators a decade of work to hopefully change banking governance and culture and the way customers are treated.”

‘The law must be applied, obeyed and enforced’

The MinterEllison Chair in Risk and Regulation, and Deputy Director (Research) of CLMR, UNSW Law, Professor Dimity Kingsford Smith, said Commissioner Hayne referred entities and individuals for further investigation and recommended that regulators litigate and enforce more.

“It is, of course, hard to know whether the government will accept and implement these recommendations – but their purpose is to remove legal complexity; facilitate greater consumer understanding and ability to make better decisions; and to assist regulators with enforcement,” she said.

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Professor Dimity Kingsford Smith.

Professor Kingsford Smith said that along with the role of variable remuneration as an incitement to misconduct, “the second pillar of Commissioner Hayne’s approach is that the law must be applied, obeyed and enforced”.

“This is reflected in a return to anchoring regulatory rules in broader principles: be honest, be fair, sell financial products fit for purpose and act in the customer’s best interests.”

There were recommendations “to stop the special rules and exceptions for various financial functions (banking different to insurance, different again to financial advising) that makes it easier to justify poor practices”.

Professor Kingsford Smith said this approach in the report was an antidote to complexity which “makes the law uncertain, hard to comply with, hard for customers to know what their rights are and hard for regulators to enforce”.

The recommendations were designed to make what the law meant and its application and enforcement more transparent to customers and providers, she said.

“One example of how this plays out in practice, is Commissioner Hayne’s recommendation to end commissions for mortgage brokers, and go to up-front fees paid directly by consumers who then know what they are meant to be paying for,” Professor Kingsford Smith said.

This simplifying approach means that insurers, their brokers and agents, and financial advisers (which have been banned from conflicted remuneration for nearly a decade) will also lose commissions over time; all are to have a duty of best interests to customers or like duty.

Will retention of the ‘Twin Peaks’ model of financial regulation be effective?

Professor Pamela Hanrahan, CLMR member and Professor of Commercial Law and Regulation at UNSW Business School, said the final report rejected the option of consolidating consumer protection in the financial sector in a dedicated agency.

Instead, she said, this responsibility stayed with ASIC, along with additional enforcement expectations in relation to superannuation and the Banking Executive Accountability Regime (BEAR).

“In September, the Commissioner’s significant concerns about ASIC’s lacklustre enforcement record under its previous Chair were apparent,” she said.

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Professor Pamela Hanrahan.

“The Commissioner's interim report said: ‘There are signs that ASIC may be seeking to alter its approach to enforcement. Even so, I remain to be persuaded that it can and will make the necessary changes.’ ”

Professor Hanrahan said it seemed Commissioner Hayne was persuaded: in making recommendation 6.1, to retain the ‘twin peaks’ model of financial regulation, “he is effectively recommending a doubling-down on the existing regulatory architecture”.

“The Commissioner said that ‘detaching significant parts of ASIC’s remit and transferring them to another agency would disrupt the processes of responding to what has happened’ and that ‘the costs of that disruption outweigh the potential benefits’,” the former ASIC Regional Commissioner for Queensland said.

The final report instructs ASIC to be more litigious in its approach to enforcement, and recommend the establishment of a new oversight authority for ASIC and its fellow regulator, APRA, she said. 

The authority was to comprise three part-time members, independent of government, whose job was to report to the Minister periodically on the regulators’ effectiveness.

While pragmatic, the concern was that this approach “just kicks the can down the road”, according to Professor Hanrahan.

“I think there are tensions in ASIC’s broad regulatory remit that are hard to resolve, and that the Australian public would be better served by a properly-resourced regulator with a clear focus on consumer protection in the financial sector,” she said. 

“Nevertheless, we hope that enhancements to ASIC’s powers and resources, and proper governance and scrutiny of ASIC, will deal with the significant shortcomings identified in the Commission’s case studies”.

Vertical integration is the elephant in the room in the superannuation sector

“The question was whether Commissioner Hayne would tackle head-on the vertical integration seen in the major banking and financial advisory groups. He didn’t,” Dr Donald, from UNSW Law, said.

“He declined to find that the conflicts of interest inherent in the institutional structures of such groups are insurmountable,” Dr Donald said.

Instead, the Commissioner identified and referred to regulators a set of specific transactions where he felt organisations had failed to deal effectively with conflicts.

“He also recommended that the trustees of superannuation funds be prohibited from engaging in any other business, a move implicitly designed to limit them from acting as trustee of managed investment schemes (MIS), a structure in which they might face conflicting duties to multiple sets of beneficiaries,” Dr Donald said.

'Notably, Commissioner Hayne was silent on the controversial ‘best in show’ allocation process for default funds recommended by the PC.'

Key changes to the superannuation system included that individuals would have a single default fund for life, which was also a recommendation of the Productivity Committee (PC).

“Notably, Commissioner Hayne was silent on the controversial ‘best in show’ allocation process for default funds recommended by the PC as a partner to its single default fund recommendation,” Dr Donald said.

The Banking Executive Accountability Regime (BEAR) would be extended to superannuation and insurance executives, and there would be limits on advice fees being paid out of superannuation funds.

He confirmed that APRA remained the key regulator for super, but prosecutions for market conduct transgressions should be more clearly the responsibility of ASIC.

The Commissioner also recommended that there be no ‘treating’ of employers by funds to direct default members their way; and made a breach of the statutory covenants in s52 a contravention of a civil penalty provision.

Is ASIC now a regulator with a bite?

Senior lecturer at UNSW Law, Dr Marina Nehme, said the Australian Securities and Investments Commission (ASIC) had been criticised by the royal commission for doing too little to curb the misconduct that had taking place within the financial services sector.

Accordingly, she said, some of the recommendations that were put forward were designed to change ASIC’s enforcement culture, but were “to be embraced with both excitement and trepidation”.

“Time will tell whether this is a viable enforcement strategy in the long run,” Dr Nehme said.

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Dr Marina Nehme

For example, the Commissioner recommended changes to the regulator’s use of Enforceable Undertakings (EUs), which are a form of negotiated sanction that allows ASIC to deal with misconduct while targeting the source of the breach.

“When applied properly, the sanction is designed to prevent similar breaches from occurring in the future, but the royal commission has recommended that that ASIC should first consider litigation,” Dr Nehme said.

“While all this is good, the reality remains that litigation is an expensive and lengthy process where a positive outcome is never guaranteed.”

The Commissioner also recommended the separation between enforcement team and non-enforcement related contact with regulated entities.

“This measure is designed to keep the enforcement team independent from the influence of regulated entities,” Dr Nehme said.

“In view of the stakeholder model ASIC currently adopts, and the regulator’s funding regime, this recommendation should limit instances of regulatory capture.”

On proactive litigation, Commissioner Hayne recommended that litigation be viewed as an “exercise of public power for public purposes”.

'While all this is good, the reality remains that litigation is an expensive and lengthy process where a positive outcome is never guaranteed.'

“It is designed to send a message to the industry about conduct that is deemed unacceptable by regulators,” Dr Nehme said.

The recommendation that there be limited use of infringement notices was welcomed, Dr Nehme said, as “there is an acknowledgement of the fact that this sanction has very little deterrent effect”.

The recommendation also highlighted that regulators should only use the sanction to deal with administrative failings, she said.

The job is just starting

Dr Scott Donald said the report was dense and would reward careful reading, “but the job is not done, it is just starting”.  
 
“Firms will need to consider not just the legal implications but also what the report means for the way they do business generally,” he said. 

“So too, the regulators. It is impossible to know precisely what that the future may hold but this is a once in a generation wake-up call for all involved.” 

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