Shaping the future with confidence: Your business post-Financial Services Royal Commission
Hayne report – first impressions
Commissioner Hayne's recommendations may initially seem somewhat modest - they do not undo vertical integration, impose limits on executive remuneration or ban bonuses and they do not recommend that directors prefer the interests of their customers. But, while it is true that the recommendations are not radical, there is much in the report that will mean some real changes for financial services companies, their Boards and their executives, as well as for their regulators and advisers. The Federal Government has said that it agrees with (or supports) all of the recommendations.
After defending his decision not to recommend an extension to the Commission (which might suggest the Commissioner also thinks the recommendations are modest), the report starts with the same point that he makes in the interim report – the law applying to banks, insurers, superannuation trustees and other financial services providers might be complex and difficult – but the underlying principles reflected in the law are clear and sound. They are:
- Obey the law
- Do not mislead or deceive
- Act fairly
- Provide services that are fit for purpose
- Deliver services with reasonable care and skill
- When acting for another, act in the best interests of the other.
These 'norms' are, he says, well established, widely accepted and easily understood, and he was critical of submissions that relied on the complexity of the law as a defence to misconduct or a failure to meet community standards or expectations.
The Commissioner then goes on to say that these norms lead to some 'general rules' and it is these rules:
- The law must be applied, and its application enforced;
- Industry codes must be incorporated into the law;
- No financial product should be hawked to retail clients;
- Intermediaries should only act in the interests of and behalf of those who pay them;
- Exceptions on the ban on conflicted remuneration should be eliminated; and
- Culture must focus on non-financial risk as well as financial risk.
These are the 6 rules that underpin his 76 recommendations.
A few thoughts on some of them:
One might say that mortgage brokers already comply with the general rule that intermediaries should only act in the interests of those who pay them (the lenders). But here, the Commissioner says that mortgage brokers' customers (or are they clients?) rely on them for advice and that, like any other financial adviser, they should be required to act in their customers' best interests. And, like any other fiduciary, they should not be put in a position where their personal interest conflicts with their duty to their customer. And so to comply with the rule, he recommends that fees must be paid by customers (not lenders), and with that, he says no more commissions (upfront and trail).
As expected, Commissioner Hayne says that grandfathered commissions should be terminated, soon (although not immediately), and that ASIC should look at phasing out commissions in life insurance and general insurance.
Commissioner Hayne is a very plain speaker, and does not buy the industry arguments about insurance needing to be sold not bought – in fact, it is fair to say that whenever the industry has defended existing positions based on arguments about disruption to businesses, reduction in competition, tightening of credit or 'the constitution', he has made very short shrift of them.
Having said this, given the Commissioner's dim views about conflicts and his view that the law would be simplified and better if there were fewer exceptions, it is slightly odd that he does not recommend banning all commissions now.
He repeatedly says that conflicts cannot be adequately managed and instead should be avoided (a person cannot 'stand in more than one canoe'), and he criticises (as he also did in the interim report) the formulation of the adviser's best interests duty in the Corporations Act. He particularly dislikes the safe harbour. However, he does not recommend its removal (at this stage). He also does not recommend any separation of advice, distribution and product manufacture. Vertical integration survives, again. However, there are a couple of exceptions.
Commissioner Hayne recommends that superannuation trustees 'not be able to assume any obligations other than those arising from or in the course of its performance of the duties of a trustee of a superannuation fund'. This would, for example, stop a trustee also being the responsible entity of a managed investment scheme. Now, this is one for much more discussion – especially how broadly it would apply, but in the meantime it is worth noting that, not that long ago, this was a condition imposed on a trustee's RSE licence by APRA and that somewhere along the way it disappeared.
The Commissioner has recommended that the anti-hawking laws in the Corporations Act 2001 (Cth) be expanded to stop a financial services licensee speaking to a customer about superannuation unless the customer initiates the conversation. It is fair to say that this will have a much greater impact on the industry than the difficult arguments about the line between personal advice and general advice.
He says the same prohibitions on unsolicited selling should apply to insurance. He combines that with a recommendation that add on insurance should only be able to be sold on a deferred basis, that is after the car is bought. It is not entirely clear how those two things can work together.
In Commissioner Hayne's view, financial services entities should be doing much more on culture, governance and remuneration to promote good conduct, and APRA should be taking a much closer interest, starting with requiring APRA-regulated entities to design remuneration systems to encourage sound risk management of non-financial risks and reduce the risk of misconduct, and for boards to regularly review the effectiveness of both. He has not recommended any caps on remuneration or any split between variable and fixed remuneration, but he does recommend APRA impose standards that would limit the use of financial measures for long-term variable remuneration and require clawback of remuneration where things have gone wrong.
All financial services entities should, according to the Commissioner, regularly review their culture and, he further recommends, APRA should assess the culture of APRA-regulated entities. He says that this is 'an essential part of prudential supervision [and] APRA must have the resources to do it'. We hope that this is not just more work for the consultants.
Regulators and enforcement
The Commissioner has not changed his mind about the importance of regulators bringing proceedings against financial services entities for breaches of the law. He quotes the Productivity Commission and says that 'Strategic conduct litigation is missing in action in the superannuation industry' and notes that ASIC's role is not merely to see that consumers are compensated for losses they have suffered because of misconduct. It is fair to say that the Commissioner is highly critical of ASIC for being too slow to bring civil and criminal proceedings, and he sets out examples of cases from the hearings where he says they should be brought.
Commissioner Hayne says that administrative errors are part and parcel of running a financial services business on the one hand, but then seems somewhat sceptical on the other. This brings to mind the saying that: 'there were no such thing as accidents, only carelessness'. In this case, the Commissioner says that that carelessness needs to be much more carefully managed – in the first instance, he queries whether products or terms and conditions should be offered if they might lead to errors, and then he queries whether it is misleading or deceptive to send a statement to a customer that does not alert them to the fact that there may have been errors. Finally, he wants a new accountable person under the Banking Executive Accountability Regime – someone who is responsible for the whole product chain: design, delivery, maintenance and any necessary remediation. That, of course, comes with personal responsibility and accountability – this is one of the most surprising parts of the report.
Key Contact: Michelle Levy