Financial Services Thinking
Issue 2, February 2019
Banking Royal Commission Final Report – tough medicine for a broken culture?
Following release of the Final Report of the Royal Commission into the banking and financial services industry, the financial press reported large institutions would be bruised but not broken. And smaller financial services stakeholders are probably thinking things could have been a lot worse.
While Commissioner Hayne's Report is not pretty reading, it is interesting for what it doesn't recommend: no forced separation of product manufacturing from financial advice divisions; retention of the authorised representative regime rather than pushing that sector into holding their own AFS licences; and, as anticipated, the consumer credit rules won't be extended to small business lending.
Still, significant change is afoot and we share a summary of our initial thoughts on the Report below. As regulatory and political responses to the Report unfold in the coming weeks and months, we will continue to provide more detailed analysis on the Report and its implications.
Conflicted remuneration repealed
In what few will find as a surprise, the Report recommends the repeal of grandfathered conflicted remuneration provisions. It says even if the arguments relied on by industry to justify these exceptions were valid when the exceptions were introduced, they have now outlived their validity. This goes to one of the threshold themes of both the interim and final reports, being the reduction or elimination of conflicts of interest.
The major banks started switching off grandfathered provisions throughout 2018 and other industry participants may do so before the inevitable legislative change is implemented.
Disciplinary system for financial advisers
The Report includes a focus on the disciplinary system for financial advisers. Among other things, it recommends all AFS licensees must, as a condition of their licence, report 'serious compliance concerns' about individual advisers to ASIC on a quarterly basis. This will include an adviser engaging in dishonest, illegal, fraudulent, deceptive or grossly negligent behaviour – so, true to label, the concerns held by licensees must be serious before a report is required.
Further recommendations affecting advisers and their licensees include these:
- If a licensee detects an adviser has engaged in misconduct in giving advice to a retail client, then the licensee must make reasonable enquiries, and if the evidence suggests such misconduct, tell and remediate the affected clients.
- All advisers providing personal advice to retail clients must be registered with ASIC.
Financial services industry code
The Report states industry codes are expressed as promises made by industry participants. If those promises are to be made seriously, then they must be kept and must be enforceable by the recipient of the promise – the customer acquiring products or services.
For the financial services sector, the Report recommends the establishment and imposition of mandatory industry codes, with breach of what ASIC determines to be enforceable code provisions amounting to a breach of the law.
The Commissioner's comments about ASIC
ASIC's enforcement culture, not the size of its remit, should be the focus of change. Commissioner Hayne believes there is a deeply entrenched culture in ASIC of negotiating outcomes rather than insisting upon public denunciation of and punishment for wrongdoing. He supports ASIC's new approach which is to ask "Why not litigate?"
Creating a new specialist civil enforcement agency
There has been a proliferation of civil penalty provisions across the legislation administered by ASIC. Civil penalty provisions were first inserted into the Corporations Act in 2002 to apply to offences relating to market misconduct. By 2015 there were 50 civil penalty provisions and by November 2018 there were 72. The recommendations of the ASIC enforcement review are being implemented which will add a further 37 civil penalty provisions.
The Report stops short of recommending the establishment of a separate civil enforcement agency that removes from ASIC its enforcement team. However, ASIC's reform of its enforcement function will be closely monitored and if it becomes obvious ASIC is not sufficiently enforcing the law, or it is not able to run litigation appropriately, then further consideration will be given to the establishment of a separate civil enforcement agency.
The Report acknowledges litigation is uncertain, takes time, costs money and requires great effort with many resources. In those circumstances, it is understandable for the regulator to have, in many cases, decided to settle for alternative regulatory outcomes. However, the Report is clear litigation by ASIC is the exercise of public power for a public purpose. It is litigation by a public authority to enforce the law. ASIC should be using its powers to pursue litigation to judgment because Parliament, not the regulators, sets the law and it should be obeyed and enforced.
The Report recommends curtailing the use of infringement notices for anything other than purely regulatory matters. If the issue involves contestable matters of judgment, for example an alleged breach of the prohibition on false and misleading conduct or the duty of utmost good faith, the issue of an infringement notice will rarely, if ever, be an appropriate regulatory response.
New oversight body to be established
There is no current oversight of ASIC to determine how well it discharges its statutory functions or exercises its powers.
The Murray Inquiry recommended a financial regulator assessment board be established but that recommendation was not adopted.
The Commissioner has come to the view that a permanent oversight body is required. The role of the new oversight body should be to assess—
- the effectiveness of ASIC and APRA in discharging their functions and meeting their statutory objectives
- the performance of the leaders and decision makers, and
- how the regulator exercises its statutory powers.
The new oversight body should be constituted by three part-time members and those members should be supported by permanent staff capable of advancing the work of the authority on a day-to-day basis. It should be established by legislation and be independent of government.
Efficiently, honestly and fairly
The underlying principles forming the basis of the Report and all of the recommendations reflect six norms of conduct—
- obey the law
- do not mislead or deceive
- act fairly
- provide services that are fit for purpose
- deliver services with reasonable care and skill, and
- when acting for another, act in their best interests.
The requirement that financial services are provided "efficiently, honestly and fairly" is understood to embrace all six of those norms.
Simplification of the law
The Commissioner accepted simplification and clarification of the law would be a long and difficult task but suggested two basic things need to be undertaken—
- reduce the number and operation of special rules, exceptions and carve outs, and
- connect the rules and the legislation to the six norms of conduct outlined above.
Failings of organisational culture, governance arrangements and remuneration systems lie at the heart of most of the misconduct. The bottom line: culture, governance and remuneration march together.