This article is Part One in a series. Subscribe to Financial Services Updates to receive each part of our Royal Commission Series. Parts Two, Three and Four can be found at the bottom of this article.
The Interim Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Interim Report) was released on 28 September 2018 and provides a summary to date of the issues, case studies and evidence provided during the first four public hearings of the Royal Commission.
The Royal Commission was established in December 2017, after years of public pressure from whistleblowers, consumer groups, the Greens, Labor, and some Nationals MPs and a direct request from a group of banks. Its first public hearings began on 13 March 2018 and have run at irregular intervals throughout 2018.
Commissioner Hayne was tasked by the Letters Patent of the Royal Commission with reviewing the conduct by financial services entities which may have amounted to misconduct, and whether any of that conduct fell below community standards and expectations. The Letters Patent also asked the Commissioner to consider if sufficient mechanisms were in place to compensate victims.
The Interim Report addressees a series of interrelated issues which have come to light from the submissions and evidence given; it does not provide any draft recommendations or even get close to suggesting any. Rather Commissioner Hayne has drawn attention, in some cases, to evident conclusions, and makes, in some cases, observations of improper conduct (from both financial institutions and the regulators) and poses a significant number of questions in relation to the issues highlighted. While some seem to have obvious conclusions from the discussions in the Interim Report, others have been left for further exploration, as we outline below.
The Landscape of the Interim Report
The banking sector is the largest part of the Australian financial system, and a key cornerstone of the Australian economy, comprised of 147 authorised deposit-taking institutions (ADIs) which collectively hold around 55% of the assets of Australian financial institutions.
Australia’s seven largest ADIs (including the big four banks) hold roughly $4.6 trillion in assets – around two and a half times the size of Australia’s $1.8 trillion economy, as measured by nominal GDP. The major banks hold approximately 75% of the total assets held by ADIs in Australia, making the compliance culture within those banks of particular interest in the Interim Report and its associated case studies.
The financial services industry is the largest contributor to real industry gross value added and provides a wide range of services to Australian consumers and businesses, which the terms of reference expressly provided scope for Commissioner Hayne to review with the phrasing of “meeting community standards and expectations.” The terms of reference focused almost exclusively on the conduct and culture of financial institutions in providing products and services to the consumer, rather than the behaviour, education and training of consumers in relation to the products and services being provided by these institutions.
With a national election on the cards, it is likely that the questions posed by the Interim Report will become bargaining chips on the electoral platform with the party most likely to pacify both consumers and vocal industry groups winning the next election.
But what might future reforms look like based on the questions posed in the Interim Report?
Issues Identified So Far
There were four rounds of public hearings identified by the Interim Report which focused on the following:
- Consumer Lending
- Provision of Financial Advice
- Small and Medium Enterprises including specialist lending
- Agricultural Lending
Regulation, governance and compliance and the role of the regulators were recurring themes throughout. Some of these key topics are addressed below and will form the subjects of our Royal Commission Series.
Provision of Financial Advice
The questions that the Interim Report raised in relation to the provision of financial advice related to:
- adequate management of conflicts of interest which arise from conflicted remuneration, and the structure of the financial advice industry through vertical integration and investment platforms
- the culture of compliance and the practices of licensees supervising and monitoring their financial advisors, both employees and authorised representatives;
- the approach of the regulators in ensuring licensees and their financial advisors are meeting their legal and regulatory obligations, especially through their oversight of breach reporting where misconduct is identified.
The most interesting discussion raised by the Interim Report in this area was in relation to the inherent conflict between financial advice provided in a culture of incentives, bonuses and commissions, based on recommending certain products, and the duty of financial advisors to act in the best interests of the client. The Interim Report asked the question whether such an inherent conflict can ever be truly “managed” as indicated in the FoFA reforms or whether grandfathering provisions should simply be abolished?
The questions that were raised regarding consumer lending related to:
- intermediaries and the confusion of their roles in the eyes of the consumer
- compliance with the responsible lending obligations, notably the failure to verify consumer expenditure
- communications with a consumer about realistic expectations of products or services bought.
The most interesting discussion raised by the Interim Report in this area was the examination of the tension between responsible lending obligations and the products and process used by the financial services industry as a staple part of providing business e.g. add-on insurance, the use of the Household Expenditure Measure for credit risk analysis, and pre-approved credit increases. The Interim Report also examined the role of internal misconduct or fraudulent actions and how this could impact on the consumer perception of the financial services industry and its compliance with the law.
Regulation and the Regulators
The issues identified by the Interim Report regarding regulation and the regulators focused on the following:
- whether both ASIC and APRA’s responses to current reporting of misconduct have been appropriate
- whether the regulatory architecture, as currently established, has been effective in regulating misconduct
- whether the responses of the financial entities as evidenced in the cases studies (as representative of the industry as a whole) were sufficient to respond to the misconduct identified
The most interesting discussion raised by the Interim Report in this area was the role of the regulators and their overriding obligation to uphold a compliance culture within the financial services industry as a whole. In particular, Commissioner Hayne focused on the prevention of inappropriate responses to misconduct in the future and what could be done to strengthen the regulators’ powers in this area.
Reactions to the Interim Report
The Interim Report identified the ‘moving target’ nature of the inquiry because some financial service entities, in particular the big banks, announced some sort of change in their products, processes or services in response to the public hearings.
The Commonwealth Bank, National Australia Bank and ANZ have already announced they will either de-merge or sell their financial planning businesses, a succession of financial products no longer exists, and ASIC has agreed to a number of enforceable undertaking as a consequence of the conduct in question.
The Prime Minister, Scott Morrison in addition to dealing with the final recommendations when released, is drawing attention to the action being taken, including the appointment of a new chair and a deputy commissioner of ASIC, the latter, whose remit is to prosecute wrongdoers and the increase in ASIC’s powers, penalties and resources. With the final recommendations likely to become a political football, it is yet to be seen how these changes translate into effective outcomes for the community in the short term.
The Interim Report is a lengthy document and poses many questions for the financial services industry as a whole. Our brief overview of the Interim Report here will be followed throughout the week with in an depth look at the issues in our Royal Commission Series.
Other articles in this series: