One year on from Australia's Royal Commission on Banking
The report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Report), was published one year ago.
In that time, the Australian banking industry has felt a backlash from regulators and consumers, with 2019 ending with a politician lambasting the banks for representing the "face of unconscionable greed" at an annual shareholder meeting held in December 2019.
What was once seen as a chance to draw a line under the scandals has led to accusations that a golden opportunity to right the wrongs identified in the report, may have been let slip. Despite the inclusion of damning indictments of sales practices, management and governance throughout the 530 pages of the report, only five of the Report's 76 recommendations have been implemented. As one commentator put it, there have been more books published about the Report than recommendations actually enacted.
To mark the anniversary, the government has announced a package of draft legislation which is expected to take up much of the legislative agenda for the rest of the year. This includes proposals to establish a Financial Regulator Assessment Authority and an industry-funded compensation scheme of last resort, both recommendations in the Report.
The Report had much to say about a sales-driven culture which saw scandals such as ‘fees for no service’, where customers (even those deceased) were made to pay a fee without a service provided; a mortgage ‘introduction’ programme which went off the rails, netting introducers thousands of dollars in fees, with cash bribes given to brokers to encourage them to overlook fraudulent applications; and where financial services entities that broke the law were not held to account.
It was a climate in which the Queensland MP who led the inquiry into the collapse of a failed investment adviser, Bernie Ripoll, lambasted the financial planning industry for being without "professional standards, a code of conduct, defined educational standards and the commitment to a fiduciary type duty to customers that real professions have".
For Australia's corporate regulators, the report was universally hailed as a wake-up call, with the Australian Prudential Regulation Authority (APRA) admitting during hearings that it had not commenced court proceedings in the superannuation sector for over ten years. A former head of Australia's competition body severely criticised the APRA over its weak enforcement over the banking sector, calling it "extremely inadequate". It was revealed that major banks were taking an average of 1,726 days (or more than four-and-a-half years) to identify and report significant breaches of the law with regulators failing to step in.
So how have the Report's conclusions fared one year on?
The Report's findings
The Report found that in almost every case, the conduct in issue was driven not only by the entity's pursuit of profit but also by certain individuals' pursuit of gain. Sales became all important, with providing a service to customers relegated to second place. This behaviour was incentivised and rewarded by bonus and commission schemes that "measured sales and profit, but not compliance with the law and proper standards."
There was a marked imbalance of power and knowledge between those providing the services and those customers acquiring them. Individuals perpetuated this behaviour because they could. This was due to the fact that customers had very little understanding of the proposed transaction put in front of them as well as hardly any power to negotiate the terms.
Consumers often dealt through a financial intermediary assuming that the intermediary had their best interests at heart. But in reality, the intermediary was often paid by the provider and acted in the provider’s interests.
Financial services entities that broke the law were not properly held to account. The Report said that misconduct would only be deterred "if entities believe that misconduct will be detected, denounced and justly punished." The payment of compensation is not enough and "wrongdoing is not denounced by issuing a media release."
Practical tips for financial institutions
The implications of the Report will resonate for banks and financial services entities worldwide.
Going forward, financial services institutions should pay as much attention to governance as to risk. In particular, focus on mapping out the connections in your organisation between remuneration and incentive practices, as well as conduct, regulatory and compliance risks. One major bank in Australia has announced it is scrapping bonuses for frontline staff, after the Report blamed the bonus culture for much of the wrongdoing.
Make clear the role of intermediaries so that the customer knows whose side they are on. The Report suggests a general rule that should apply throughout the financial services industry. An intermediary who is paid to act as an intermediary:
- acts for the person who pays the intermediary;
- owes the person who pays a duty to act only in the interests of that person; and
- ordinarily owes the person who pays a duty to act in the best interests of that person.
In meetings, ensure the customer is fully aware of what they are there to discuss. For example, a meeting or telephone call to discuss one type of financial product should not stray into discussing another unsolicited type of product without further agreement.
The drive towards new codes of practice and use of plain English in banking documentation will continue apace. Banks in Australia in July 2019 introduced a new Banking Code of Practice and have trained more than 130,000 staff on the Code's requirements. Many thousands of documents have been redrafted to make them easier to read in plain English and to require banks to give proper notice when the conditions of a loan are changing.
The new Code puts an onus on banks to exercise special care when dealing with vulnerable customers, requiring them to ensure such customers are treated with dignity and respect. The newly-created Australian Financial Complaints Authority (AFCA) will assess complaints against the new Code, whether or not the particular bank has signed up to it.
And it's the creation of AFCA that points the way towards more responsive handling of customer complaints. AFCA is a ‘one-stop shop’ government agency formed from the merger of three former departments, including the credit ombudsman, the financial ombudsman's office and the superannuation complaints tribunal. The new agency is receiving nearly 1,500 complaints a week, a 50% rise on the total number of complaints sent to the three former agencies. AFCA has started to ‘name and shame’ the firms involved in its determinations and says it will do so on a continuous basis.
What can Australian institutions learn from the UK?
The misconduct revealed in the Australian financial services industry by the Report - misconduct by mortgage brokers and financial advisers, the unsolicited sale of insurance products and failings in compensation practices and organisational culture - is not dissimilar to that which came to light at the time of the 2008 global financial crisis.
Similar to the APRA, the UK financial services conduct regulator, the Financial Services Authority (subsequently replaced by Financial Conduct Authority (FCA)), was criticised for its failure to supervise UK financial institutions closely enough, to stop them building up huge liabilities and taking on excessive risk, in the years preceding the fallout. The regulator subsequently moved to impose increased financial penalties on banks found to be involved in misconduct – including unprecedented total fines of just under £1.5 billion in 2015 in relation to the LIBOR matter – sending out a clear message of zero tolerance for misconduct to the UK's financial services industry.
Central to the FCA's regulatory and enforcement approach has been – and still is – its strategy of ‘credible deterrence’: it will take tough and significant action against firms and individuals who break its rules, reinforcing proper standards of market conduct, ensuring firms put customers at the centre of their business and securing redress for those affected. Since the financial crisis it has sought to do this in a number of ways, including by:
- Focusing on individual accountability. In 2016 the Senior Managers & Certification Regime came into force and, as of the beginning of 2020, now covers the whole of the UK regulated sector. The regime imposes a duty of responsibility on identified Senior Managers, meaning that if a firm breaches a FCA requirement, the Senior Manager for the relevant area could be held accountable if they did not take reasonable steps to prevent or stop the breach1. In Australia, the similar Banking Executive Accountability Regime (BEAR) came into full effect on 1 July 2019. It establishes heightened standards of accountability among authorised deposit-taking institutions and their most senior executives and directors.
- Focusing on the identification and management of conduct risk. The FCA wants firms to ensure good conduct at every level of their organisation. Firms must develop their own conduct risk strategy tailored to their business's specific risks and needs.
- Emphasising the need for the right culture and governance which is directed by the ‘tone from the top’. More recently, the FCA has focused on diversity and its role in preventing groupthink and creating a healthy culture which allows individuals to speak out. The FCA considers diversity to be a ‘commercial imperative’ and has made clear that non-financial misconduct should also be taken into account when assessing an individual's fitness and propriety. In his speech in December 2018, Christopher Woolard, the FCA's Executive Director of Strategy and Competition (recently announced as the new interim Chief Executive of the FCA) said that "[The FCA's] message is clear: non-financial misconduct is misconduct, plain and simple."
- Focusing on the treatment of vulnerable customers, which has also been an area of reform in Australia. The FCA has published draft guidance on what its Principles for Business (being the fundamental obligations on firms as set out the FCA Handbook) require of firms involved in the supply of products or services to retail customers who are actually, or potentially, vulnerable. The FCA has consulted on the draft guidance, and, at the time of writing, its proposals are awaited.
- Ensuring that more users of financial services have a free, independent route for complaints. The jurisdiction of the UK's Financial Ombudsman Service (FOS) was extended in April 2019 to include small to medium enterprises (SMEs), as well as some charities and trusts, and personal guarantors of loans to businesses in which they are involved. Prior to this, only individual consumers and micro-enterprises could refer disputes to the FOS. The FOS's award limit was increased in April 2019 from £150,000 to £350,000, and its jurisdiction was also expanded to receive new categories of complaints In addition, in November 2019 the Business Banking Resolution Service (BBRS) was launched in the UK. This is a free, independent dispute resolution service, supported and funded by various banks to resolve disputes between them and eligible SMEs, who are not eligible to use the FOS. Still in its inception, its success as an avenue for dispute resolution is yet to be seen. AFCA may look to the UK FOS model and, indeed, keep a keen eye on the progress of the BBRS, to assess the reach of its own jurisdiction and award remit.
- Exploring the possibility of a duty of care on financial services providers. In 2019, the FCA consulted on a new overarching duty of care on financial services providers, either in the form of a statutory duty or one that is enshrined in the FCA's Principles – and possibly one that is actionable in the courts. Under Australia's Corporations Act 2001, as amended in 2012, financial services providers that provide product advice to retail clients have an obligation to act in the best interests of clients – and must follow a number of statutory steps when giving advice. Depending on the direction taken by the FCA, firms in the UK could end up with a duty that is not just informed by the processes which a financial institution follows, but on the outcomes achieved. The FCA is due to publish a further paper, seeking views on specific options for change which, at the time of writing, is awaited.
- Becoming increasingly interventionist. New powers enable the FCA to impose temporary product intervention rules without consultation where it considers it necessary to advance its objectives of consumer protection, market integrity and healthy competition. The most recent example of this is the FCA's ban on the promotion of high risk speculative mini-bonds to most retail consumers, which is in force for the whole of 2020. And investigations are started not necessarily as a means to enforcement, but as a ‘diagnostic tool’ to get under the skin of the facts at an early stage.
- Becoming more creative with its enforcement powers, impacting the commercial side of a firm's business by imposing recruitment bans and restrictions on acquiring new clients, in addition to, or as opposed to, imposing a financial penalty.
Given the current climate in Australia, it will be interesting to see the extent to which Australian financial regulators draw from the FCA's post-financial crisis approach. And, indeed there may be areas where the UK can also learn from Australia. For example, amendments to the Australian Corporations Act 2001, which came into force in July 2019, provide for a corporate whistleblowing regime which is, in some respects, stricter than the current (statutory and FCA) regime in the UK. Each jurisdiction should take the opportunity to learn from each other, to further better their own financial services regulatory regime.
Hogan Lovells Financial Services Disputes practice
Our Financial Services Disputes Practice has extensive experience advising major banks and financial institutions on a wide range of issues arising from the financial crisis. We acted for clients in the highest profile investigations of the time, such as the Libor investigations and follow-on litigation, FX benchmark manipulation and the Madoff fraud. As well as guiding clients through contentious investigations or representing them in litigation, having ‘seen it all before’ we are well placed as risk advisers to clients facing similar issues, and we would be happy to discuss with clients any of the matters covered in this briefing.
1. The FCA recently confirmed that it has enforcement actions open into 15 individuals who hold Senior Management functions (including in relation to culture and governance, financial crime, market protection and conduct rules).
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