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Australia: the Royal Commission's final report at-a-glance

Chris Hamblin, Editor, London, 10 February 2019

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With an election looming, Australia's coalition government has vowed to fulfil 75 of the 76 recommendations to be found in the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. It is not, however, willing to go quite as far as Judge Hayne, the commissioner, wants it to go with regard to mortgage brokers.

The coalition government is led by Scott Morrison, the Liberal former Treasurer (2015-18) who voted against having a Royal Commission 26 times, calling it "regrettable" and "a populist whinge." Nevertheless, his administration says that it is backing every recommendation, albeit partially in the case of mortgage broker reform because it has not accepted the idea that borrowers, not lenders, should pay mortgage brokers fees for doing home lending business. Australian Labor, the opposition party, has announced its willingness to pass all Hayne's recommendations without demur. The next election must be held by 18 May for half of the Senate and on or before 2 November for the House of Representatives and Territory Senators. With both sides of the political spectrum in agreement, the vast majority of Hayne's recommendations are now inevitable government policy, assuming that no backsliding takes place.

Australia was the first jurisdiction to follow Dr Michael Taylor's "Twin Peaks" regulatory structure in 1997. Jurisdictions such as the United Kingdom, Holland and South Africa have since followed in its footsteps. It may be no coincidence that Australia fared better than any other G20 country during the global credit crunch of 2008. Prudential regulation in this system is the province of the Australian Prudential Regulatory Authority (APRA) and is largely (but not wholly) separated from 'conduct' regulation, which is largely the province of the Australian Securities and Investments Authority (ASIC). The Hayne commission is keen to keep this model in operation, but many of its recommendations for change are nonetheless substantial.

Banking reforms

On the banking front, the Royal Commission wants to impose a 'best interests' duty on mortgage brokers that obliges them to act in the best interests of people whom they represent who intend to borrow to buy homes. If they fail to do so, they ought to pay civil penalties. The borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending. Changes in brokers’ remuneration should be made over a period of two or three years, by first prohibiting lenders from paying trail commission to mortgage brokers in respect of new loans, then prohibiting lenders from paying other commissions to mortgage brokers. A Treasury-led working group will be monitoring the results and making changes if necessary. Eventually, mortgage brokers should be subject to the law that applies to firms that advise HNW/retail customers about financial products.

There is to be a compensation scheme of last resort, funded by the banks, for which the Government is already preparing legislation because the idea sprang from a different enquiry.

The paper tackles the subject of intermediated lending for vehicles and other consumer goods, for which retail dealers are exempt from the operation of the National Consumer Credit Protection Act 2009. The Government now wants to extend the Act to apply to them.

It is also Government policy to do more to include poor people in the banking system and help small businesses, especially farms - a stratagem that need not concern us here.

An Australian Credit Licence or ACL is a licence issued under the National Consumer Credit Protection Act 2009 that authorises a licensee to engage in particular credit activities.  Recommendation 1.6 says that ACL holders should be bound by information-sharing and reporting obligations in respect of mortgage brokers.

Recommendation 1.15 calls on the Government to change the law to extend ASIC’s power to approve codes of conduct to codes relating to all institutions regulated by APRA, the Australian Prudential Regulation Authority, and ACL holders. It also wants to stiffen the law to allow ASIC to turn contraventions against some parts of codes into statutory offences. In respect of the Banking Code that ASIC approved in 2018, the Government wants the ABA and ASIC to take all necessary steps to have the provisions that govern the terms of the contract made or to be made between the bank and the customer or guarantor designated as ‘enforceable code provisions’.

Follow the BEAR

The Banking Executive Accountability Regime is mentioned scores of times in the report. It is set out in Part IIAA Banking Act 1959 and was enacted in February last year by Scott Morrison, who at the time was trying desperately to ward off a Royal Commission. The BEAR, as it is called, establishes "accountability obligations" for authorised deposit-taking institutions (ADIs) and their senior executives and directors. It is administered by APRA (and, to some extent, ASIC) and is Australia's answer to the British Senior Managers and Certification Regime. Recommendation 6.8 calls for the extension of provisions modelled on the BEAR over time to all APRA-regulated financial service institutions, including those that deal with insurance and pensions/superannuation. Recommendation 6.12, interestingly, calls for the application of the BEAR to the regulators themselves - accountability maps and all. Judge Hayne has backed this up by stating elsewhere in the report: "There is no reason in principle or in practice to confine the reach of accountability provisions of the kind set out in the BEAR to the banking sector." This is the main proposal of his that will, if the Government acts on all his findings, extend ASIC's remit the most, although the enforcement of breaches of the Superannuation Industry (Supervision) Act will do so greatly as well.

Recommendation 6.6 seeks to make the two regulators' joint administration of the BEAR more explicit. ASIC, it says, should oversee those parts of Divisions 1, 2 and 3 of Part IIAA Banking Act that concern consumer protection and market conduct. APRA should oversee the prudential side of Part IIAA. The regulators ought to work more closely together than they have before to achieve this.

Financial advice

'Fees for no payment,' alongside a tendency to charge the dead, lay at the crux of the wrongdoing uncovered by the Royal Commission. To curb the chance of them being charged in future, the Government is promising (R2.1) to change the law to ensure that "ongoing fee arrangements" (whenever made):

  • must be renewed annually by each client;
  • must keep an annual written record of the services that the client will be entitled to receive and the total of the fees that are to be charged; and
  • may neither permit nor require the payment of fees from any account held on behalf of the client, except on the client’s express written authority.

This is to be backed up by R2.2, on the subject of disclosures of a lack of independence. The Government wants to change the law to require that a financial advisor who would contravene s923A Corporations Act by using any of the restricted words or expressions identified in s923A(5) (including ‘independent’, ‘impartial’ and ‘unbiased’) must, before providing personal advice to a retail/HNW client, give him a written statement that explains why the advisor is not independent, impartial  and unbiased. The Government wants to review the efficacy of these reforms in 2022.

Conflicted remuneration

'Grandfathering' arrangements allow for commissions to continue to be paid to intermediaries who sold financial products prior to the Future of Financial Advice (FoFA) reforms of 2012-15 that would otherwise be classified in s963A Corporations Act as "conflicted remuneration," a term that appears 65 times in the 530-page report. This source of revenue is known as a grandfathered commission.

Value-based commissions are a form of remuneration that can reasonably be expected to influence the choice of product that the advisor encourages the customer to have, or at least the nature of his advice. Hayne thinks that 'grandfathering' provisions for conflicted remuneration should be repealed as soon as is reasonably practicable. The Government wants ASIC to consider reducing the cap on commissions further in respect of life risk insurance products. It envisages the cap being reduced to zero, but leaves it open to future governments to 'fudge' this weakly expressed desire out of existence. It also wants the review of 2022 to 'consider' the removal of other exemptions to the ban on conflicted remuneration, especially as regards general insurance products and non-monetary benefits.

ASIC, which has proven itself many times to be a meek ally of Australia's large banks in much the same manner as the now-defunct Turnbull Government was, is on record as saying that it is "too early" to tell whether conflicted remuneration ought to be prohibited completely. Hayne is not quite of the same opinion, describing trail commissions (annual fees that customers pay to their financial advisors over the lifetime of products such as pensions, with-profits bonds and unit trusts) as "money for nothing." He agrees with the Productivity Commission's report of June last year, which said: "trail commissions have the effect of aligning the broker’s interests with those of the lender, rather than those of the borrower."

Hayne adds: "There should come a time within about 12 or 18 months when lenders are prohibited from paying trail commission to mortgage brokers in respect of new loans. Within a further 12 to 18 month period, lenders should be prohibited from paying any other commissions to mortgage brokers."

Discipline for financial advisors - a new regime

Recommendation 2.7 states that all financial firms should be required, as a condition of their licences, to give effect to reference checking and information-sharing protocols for financial advisors, to the same effect as now provided by the Australian Bankers' Association in its Financial Advice – Recruitment and Termination Reference Checking and Information Sharing Protocol. The protocol obliges banks that sign up to it to share information reciprocally in certain set ways; to follow a standard process and timeframes for the provision of references and information; to ask standard reference-checking questions; and to keep records. R2.8 calls on all financial firms, as a condition of their licences, to report ‘serious compliance concerns’ about named financial advisors to ASIC on a quarterly basis.

When a firm uncovers misconduct regarding financial advice to a retail customer, Hayne calls on it in R2.9 to make inquiries and, if there is evidence of misconduct, tell the affected customers and compensate them promptly. Recommendation 2.10 calls for a new disciplinary system, which will require an amendment to the law. Hayne wants to require all financial advisors who provide personal financial advice to retail clients to be registered; to subject them to a single, central, disciplinary body; to require financial firms to report "serious compliance concerns" about their advisors to that body; and to encourage customers to report information about the conduct of financial advisors to it.

In February 2017, the Government imposed compulsory educational requirements and "annual professional development obligations" on financial advisors, plus supervision for new advisors, a code of ethics for the industry and an industry-wide examination. The aforementioned disciplinary measures, if taken, will add more weight to the continuing "professionalisation" of advice in Australia, which takes its lead in this regard from the UK.

Insurance and superannuation - the 'no hawking' rule

Hawking, that is the unsolicited offer or sale of insurance or superannuation products, should be prohibited except to firms that are not retail clients and except for offers made under eligible employee share schemes. On the subject of superannuation, the report says that the trustee of a registrable superannuation entity should be prohibited from assuming any obligations other than those arising from or in the course of its performance of the duties of a trustee of a superannuation fund. Deduction of any advice fee (other than for intra-fund advice) from a MySuper account should be prohibited. (MySuper products are low-cost, simple superannuation products for people who make no active choice about their superannuation.) Everybody should have only one superannuation default account. Breach of the superannuation trustee’s covenants should be enforceable by action for civil penalty. BEAR-like provisions are to apply to the insurance and superannuation spheres in the fullness of time, as noted above.

The Insurance Contracts Act

A Treasury-led working group is to develop an industry-wide deferred sales model for the sale of any add-on insurance products (except policies of comprehensive motor insurance). The model should be implemented as soon as is reasonably practicable. Part IV Insurance Contracts Act should be amended, for consumer insurance contracts, to replace the duty of disclosure with a duty to take reasonable care not to make a misrepresentation to an insurer. The "unfair contract terms" provisions in the ASIC Act should apply to insurance contracts regulated by the Insurance Contracts Act. The handling and settlement of insurance claims, or potential insurance claims, ought to be classified as a "financial service."

The alignment of good compliance and executive remuneration

Prudential standards need not concern us here, except (as in the case of R5.3) when they pertain to executive remuneration. Recommendation 5.3 calls on APRA to require the firms it regulates to design their remuneration systems to encourage the sound management of non-financial risks (which include compliance and misconduct) and to reduce the risk of misconduct. It ought to require the board of each institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging the sound management of these non-financial risks, and reducing the risk of misconduct; it ought to set limits on the use of financial metrics in connection with long-term variable remuneration; it ought to require its firms "to provide for the entity, in appropriate circumstances, to claw back remuneration that  has vested"; and it ought to encourage them to improve the quality of information being provided to boards and their committees about risk management performance and decisions about remuneration.

ASIC’s approach to enforcement

Recommendation 6.2 states that ASIC should take an approach to enforcement that takes, as its starting point, the question of whether a court should determine the consequences of a contravention. It should recognise that it should principally use infringement notices in respect of administrative failings by entities. These notices ought rarely to be appropriate for provisions that require evaluative judgments and, beyond purely administrative failings, ought rarely to be appropriate enforcement tools in cases where the infringing parties are large corporation. ASIC also ought to recognise the relevance and importance of general and specific deterrence in deciding whether to accept an enforceable undertaking. Hayne also likes the idea of ASIC obtaining admissions in enforceable undertakings and, as far as possible, separating enforcement staff from non-enforcement-related contact with regulated entities. All these imperatives are now government policy.

Decrying "ASIC’s ineffective enforcement culture," Hayne wrote in his report that criminal penalties should be increased for failure to report as and when required and a civil penalty should be introduced in addition to the criminal offence for failure to report as and when required. He has also referred banks - but not executives - to the regulators for prosecution. The report does not, however, recommend fundamental legal change as the misdeeds it describes are generally illegal already; it is therefore more concerned with the way in which the authorities police the existing law.

Tinkering at the edges?

Treasurer Josh Frydenberg, whose hand Hayne declined to shake in front of TV cameras, told reporters on the day of the report's release: "In Commissioner Hayne's own words, there can be no doubt that the primary responsibility for misconduct in the financial services industry lies with the entities concerned and their boards and their senior management. The undeniable fact, Commissioner Hayne said, is that it is those who engaged in misconduct who are responsible for what they did and for the consequences that followed. This has resulted in the commissioner making more than 20 referrals to ASIC and APRA, covering a range of misconduct from fees for no service to 'best interests duty' breaches and misleading and deceptive conduct."

Even though the report is damning in its survey of misdeeds in the financial sector, there is much for the banks and the regulators who wilfully overlooked their misconduct to be grateful about. For a start, ASIC is not to be disbanded and will retain substantially the same profile. Indeed, it will become more powerful than today. The report does not propose structural separation or vertical or horizontal disintegration among the banking empires that it surveys. It is reluctant to accuse actual bankers of committing misdeeds or to go into a great deal of detail about whomever the authorities might want to take to court - a good sign that Hayne is essentially content to tinker at the edges of the system that has benefited the largest financial firms for so long. In the report, Hayne calls for the establishment by law of a new three-man "oversight authority" for APRA and ASIC whose job it will be to assess the effectiveness of each regulator, employing its own permanent secretariat and reporting to a minister at least biennially. This has the appearence of window-dressing, especially as Hayne goes out of his way to pretend, as so many government employees around the world do, that such state-owned and state-appointed bodies can be "independent of government."

The report declines to mention Craig Meller, who resigned as CEO of AMP after it emerged that his firm had charged customers for non-existent financial advice and misled ASIC several times. AMP's chair, Catherine Brenner, and its general counsel, Brian Salter, also resigned last April in the wake of the Royal Commission's revelations but receive no mention.

It just fell into my pocket, your honour

The press and public are not in a forgiving mood, however, and the resignations are continuing. National Australia Bank is now in a tumult, having accepted the resignations of CEO Andrew Thorburn and chairman Ken Henry, who told reporters that the pair were "deeply sorry." Both, like many other financiers who had to make humiliating testimonies to the Royal Commission, are mentioned in the report. Hayne draws attention to a question he asked Thorburn about money that "fell into the pocket of NAB accidentally." Thorburn’s response was: "I can’t disagree with that...it wasn’t intended to be ours but it became ours." On page 139 of the report Hayne writes: "Mr Thorburn sought to assert that no-one knew this was happening, the money just kept ‘falling into NAB’s pocket,’" and continues: "The amounts of money that just ‘fell into the pocket’ of so many large and sophisticated financial entities, the number of times it happened and the many years over which it happened show that it cannot be swept aside as no more than bumbling incompetence or the product of poor computer systems." According to Hayne, NAB's wealth management division charged about A$100 million in fees without providing services in return.

Market evacuation

Three of Australia's 'big four' banks are bailing out of wealth management to a considerable degree. Westpac, according to Hayne, is standing apart from the other three major banks by seeking to maintain at least some aspects of its wealth business. This might be because Westpac is the only one of the four (the others being National Australia Bank or NAB, the Commonwealth Bank of Australia or CBA and Australia and New Zealand Banking Group or ANZ) to be left out of Hayne's list of 24 referrals for potential prosecution. At the end of last week Bill Marynissen, Macquarie's head of wealth management, and Rob Johnston, the head of "wealth advisory," retired from the firm. Neither of the men are mentioned in the Royal Commission Report, but their bank was no doubt influenced by the travails of AMP at the hands of the commission when it decided to cut down its involvement in the wealth management and advice business in May. The result has been a mass exodus of private wealth advisors from its payroll.

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