Phillip Hawkins, Economic Policy
Implementing the findings of the Financial Services Royal Commission will mean some significant changes to Australia’s financial system and a changed focus for Australia’s regulatory bodies during this term of parliament.
The Government announced the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission) on 30 November 2017 and its terms of reference on 18 December 2017. The Government appointed Kenneth Hayne AC QC as commissioner (Commissioner Hayne).
The Royal Commission held seven rounds of public hearings between 13 March 2018 and 30 November 2018. These hearings covered issues related to lending to consumers, small businesses and rural customers, financial advice, superannuation and insurance as well as the conduct of the primary financial sector regulators, the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC).
The final report of the Royal Commission was handed to the Government on 1 February 2019 and publicly released on 4 February 2019. Commissioner Hayne made 76 recommendations across the banking, financial advisory, superannuation and insurance sectors as well as in relation to ASIC and APRA. It also recommended 24 referrals for potential criminal prosecution.
The Government released its response to the Royal Commission on 4 February 2019, committing to act on the majority of the recommendations, with the most significant exception being some of the recommendations relating to remuneration practices in the mortgage broking industry (discussed, further below).
What behaviours occurred?
The conduct examined by the Royal Commission is outlined in detail in the case studies published with the final report. The conduct occurred across multiple institutions and multiple product areas. The types of misconduct can be broadly described as:
- financial institutions and their intermediaries selling products or services to customers that were inappropriate to their circumstances
- financial institutions charging customers for services that were not provided and, in some cases, that were never intended to be provided
- financial institutions failing to identify misconduct or, where it was identified, failing to stop it occurring or to report it to regulators
- financial institutions failing to deal with customers fairly and openly, particularly in regards to remediation.
In nearly all cases examined the behaviour involved providers of financial services failing to act in the best interests of their customers and often in the advance of their own, or their institutions’, interest.
Why did these behaviours occur?
In the final report, Commissioner Hayne pointed to a problematic culture that exists in the financial sector where the pursuit of profit is put ahead of the interests of customers. This includes remuneration practices being primarily aimed at rewarding sales and profitability. As Commissioner Hayne noted in the final report:
… in almost every case, the conduct in issue was driven not only by the relevant entity’s pursuit of profit but also by individuals’ pursuit of gain whether in the form of remuneration for the individual or profit for the individual’s business. Providing a service to customers was relegated to second place (pp.1-2).
Commissioner Hayne also highlighted widespread failures of governance and compliance in banks and other financial institutions that led to failures to detect and address misconduct internally, as well as failures to report misconduct to the regulators in a timely manner and, in some cases, failing to report it at all.
The conduct of financial sector regulators was also criticised. Commissioner Hayne argued that the regulators had failed to properly hold institutions to account for misconduct. ASIC, in particular, has rarely commenced legal proceedings to seek penalties for misconduct, preferring to negotiate outcomes (interim report, p. 271). Commissioner Hayne asserted that some entities developed a mind-set that regulatory compliance was merely a ‘cost of doing business’ rather than a mandatory or minimum standard for conducting their business (interim report, p. 67).
Finally, the Commissioner argued that a highly concentrated financial sector has limited the competitive pressure on institutions to behave appropriately (interim report, pp. 268-269).
Summary of reforms
The 76 recommendations of the Royal Commission cut across multiple sectors. Some of the key recommendations include:
- amending the way that mortgage brokers are remunerated, to require borrowers to pay up-front fees
- requiring clients to approve any ongoing financial advisory fee arrangements on an annual basis and ban ‘conflicted remuneration’ arrangements
- requiring financial advisers to disclose any lack of independence when providing financial advice
- establishing a new, national disciplinary body for financial advisers
- requiring holders of financial services licences to investigate adviser misconduct and, if discovered, report it to the disciplinary body, advise their clients and remediate them promptly
- establishing a national farm debt remediation body to resolve farm debt disputes
- extending the Banking Executive Accountability Regime to cover the entire prudentially-regulated sector, including superannuation and insurance
- introducing civil penalties for trustees of superannuation funds that fail to act in the best interests of fund members
- banning the ‘hawking’ of superannuation or insurance products
- several recommendations to improve the effectiveness of the financial sector regulators.
The Government has accepted the majority of these recommendations (with the primary exception being changes to the remuneration arrangement for mortgage brokers).
Implementation of many of these reforms will require the passage of legislation. A number of these reforms are discussed further below.
The Government has already increased criminal and civil penalties for financial sector misconduct through the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Act 2019.
Remuneration of financial advisors
The issues that have arisen in relation to the remuneration of financial advisers were perhaps best highlighted in the Royal Commission by the ‘fees for no service’ scandal, whereby multiple financial institutions (including the four major banks, Macquarie and AMP) and smaller advisory firms charged customers ongoing financial advisory fees without providing ongoing financial advice.
ASIC has been pursuing financial institutions for compensation for fees for no service. ASIC’s latest update on the compensation program discloses that AMP and the four major banks have, to date, paid out around $350 million in compensation to consumers and have provisioned a further $800 million towards potential compensation.
Commissioner Hayne recommended that all ongoing financial advisory fees should be subject to annual renewal by the client, that the services to be tendered are to be fully documented and all forms of conflicted remuneration be banned, including those grandfathered from the Future of Financial Advice reforms (which commenced on 1 July 2013 and were later amended in 2016). The Government has agreed to these recommendations.
Prior to the 2019 federal election, Treasury released an exposure draft of legislation to ban grandfathered conflicted remuneration arrangements for financial advisers from 1 July 2021.
Remuneration of mortgage brokers
The Royal Commission examined practices in the consumer lending sector, including loan arrangements through intermediaries such as mortgage brokers. The Commissioner argued that remuneration incentives for intermediaries and frontline staff in the consumer lending sector have rewarded sales and profitability over the interests of consumers.
Mortgage brokers act on behalf of borrowers in arranging and negotiating loan terms, but are typically paid by the lending institution. This, Commissioner Hayne argued, creates uncertainty regarding who the mortgage broker is acting for.
Commissioner Hayne made a number of recommendations in relation to the mortgage broking sector. These seek to ensure that it is clear that brokers are acting on behalf of borrowers, notably:
- introducing a fiduciary duty in the Corporations Act 2001 for mortgage brokers to act in the best interests of borrowers (similar to financial advisers)
- introducing potential civil penalties for brokers who breach this duty
- altering remuneration arrangements so that customers pay mortgage brokers for their services, rather than lenders and
- banning trailing commissions on new loans. Trailing commissions can endure for many years after a transaction has occurred despite no-ongoing service.
The mortgage broking industry argued that the changes to remuneration arrangements would impact on small independent mortgage brokers, and lessen competition in the lending sector by entrenching the market power of the major banks that are able to rely on their internal broking channels.
The Treasurer, Josh Frydenberg, announced on 12 March 2019 that the Government will not ban trailing commissions on new loans, but will task the Australian Competition and Consumer Commission with reviewing trailing commissions in three years’ time.
The Bank Executive Accountability Regime
The Government also agreed to a recommendation to extend the Banking Executive Accountability Regime (BEAR) to the entire prudentially-regulated sector (including insurers and APRA-regulated superannuation funds) (Government response, p. 33).
The current BEAR was legislated in February 2018 through the Treasury Laws Amendment (Banking Executive Accountability and Related Measures) Act 2018. The BEAR commenced on 1 July 2018 for large banks and will apply to smaller banks from 1 July 2019.
The BEAR established ‘accountability obligations’ for senior executives of banks and allows APRA to seek the imposition of financial penalties on banks or executives that fail to meet these obligations. APRA may also disqualify an executive who fails to meet their accountability obligations. The BEAR also requires a bank to be able to recover a proportion of an executive’s remuneration if the executive fails to meet their accountability obligations.
APRA and ASIC
APRA and ASIC oversee Australia’s financial system under a ‘twin peaks’ model of financial regulation. Under this model:
- APRA is Australia’s ‘prudential regulator’ and is responsible for the stability of the financial system and for preventing (and resolving) the failure of entities within the system
- ASIC is responsible for market conduct and consumer protection in the financial sector. It is responsible for taking action, including legal action, against entities which breach Australia’s financial laws.
The Royal Commission considered whether the twin-peaks structure remained appropriate and ultimately recommended retaining it, with APRA and ASIC maintaining the same broad responsibilities.
However, Commissioner Hayne has been critical of ASIC’s historical approach to enforcing the law and made a number of recommendations that seek to change its approach to enforcement (chapter 7.3, final report). The Royal Commission recommended that ASIC’s progress in reforming its enforcement function should continue to be monitored and if it is unable to improve its effectiveness, that consideration could still be given to establishing a separate enforcement agency (final report, p. 431).
ASIC released its planned actions in response the recommendations of the Royal Commission in February 2019, fully committing to implementing them. In particular, it has adopted a ‘why not litigate?’ enforcement stance with a stronger focus on pursuing court based outcomes.
The Government has also agreed with a recommendation of the Royal Commission to establish a new oversight authority for APRA and ASIC to assess their effectiveness and report to the relevant Minister and to establish an accountability regime for regulators similar to the BEAR.
Final Report: Royal Commission into Misconduct in the Banking Superannuation and Financial Services Industry, Canberra, 2019.
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