The final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was published on 4 February 2019. Established on 14 December 2017 by the Governor-General, the Commission received over 10,300 public submissions and held 68 days of hearings. The recommendations made by Commissioner Hayne in his Final Report are now being digested and debated heavily by parliamentarians, Australian businesses and media.
In summary, the Final Report provides 76 recommendations for improvement to the Australian financial services sector across Banking, Financial Advice, Superannuation and Insurance. Recommendations are also made to strengthen the culture and governance of the industry, including recommendations for the conduct and governance of the primary regulators, ASIC and APRA.
Underpinning the recommendations are four observations about what was revealed by the Commission’s work:
- there is a connection between conduct and reward: in almost every instance reviewed by the Commission, poor conduct was driven by pursuit of profit or gain for both the financial institution and the individual. Achieving sales was valued and rewarded ahead of customer service;
- there is an asymmetry of power and information between financial service entities and their customers;
- in a system where clients often deal with financial institutions through intermediaries, there are inherent conflicts between duty and interest which can seldom be managed effectively. Self-interest will almost always trump duty, and the best interests of clients have been compromised; and
- too often the financial services entities and individuals that broke the law were not held properly to account.
Broadly, the Commission’s recommendations have bipartisan support with both sides of government. However, it is almost certain that no legislative response can be prepared or negotiated before the federal election which must be held by May 2019. Debate on the finer details of change will no doubt continue throughout the pre-election period.
Philippa Marshall, Mutual Trust’s Head of Legal, Risk & Governance and Graeme Bibby, Chief Investment Officer, discuss where the recommendations are relevant for Mutual Trust clients.
Philippa Marshall (PM): Of key importance, is to recognise that the recommendations are not advocating radical change to the legal structure or operation of the industry. The Commission noted that legislative protections largely exist today, but problems arose because they were not applied or enforced effectively. The current law is extremely complex and Commissioner Hayne saw base principles as compromised by too many exceptions and exemptions. A core principle of the report is that the legislative regime should be simplified, clearly identify the aims to be achieved and remove myriad exceptions.
That said, a number of key changes have been recommended, particularly to address the conflicts created by remuneration systems that have relied on the payment of commissions. These changes are intended to ensure that client interests are placed first. Key recommendations propose the banning of commissions for mortgage brokers and removal of remaining exceptions to conflicted remuneration for financial advisors. The Commission recommended that legislation to remove remaining trail commissions be implemented as soon as possible.
The Commission also acknowledged that industry bodies have an important role to play in the regulation and governance of the industry, and proposed that the Codes of Conduct should be made legally enforceable.
While banning commissions would not be directly relevant to Mutual Trust (whose advisors are remunerated by Mutual Trust and not by commission), adopting the Commission’s recommendations should strengthen the integrity, governance and stability of the industry overall. Mutual Trust believes that this can only benefit the industry and our clients in the long-term.
Graeme Bibby (GB): Commissioner Hayne’s recommendations will have impacts on the retail financial sector and particularly, mortgage brokers and the retail financial advice sector. While Commissioner Hayne did not recommend enforcing an end to vertical integration of financial services businesses, it was noted that further consideration must be given to whether the additional costs of separation would outweigh the benefits. In fact, the majority of the major Australian financial institutional groups have already commenced at least some element of separation of their businesses.
For Mutual Trust clients, in the short term, the primary significance of the report may be for investment in retail banks and financial institutions. Publication of the report has provided much needed certainty for the financial sector, however, as all the banks have noted, trust needs to be re-established. Rectification of past behaviour needs to be fully implemented. Longer term, bank operating costs are likely to increase, and the banks need to be more careful in balancing sales, profits and the service provided to customers.
We note there are no foreseeable tax implications from the recommendations made.
PM: The report’s focus on culture and governance and recommendations for reconsideration of remuneration structures are aligned to current Mutual Trust policy and practices. Acting in the best interests of our clients is at the heart of Mutual Trust’s ethos and our business of helping achieve what matters most to our clients. Mutual Trust had already undertaken significant work to ensure that a broad matrix of factors is taken into account in assessing both the company’s and individuals’ performance, including considering effective risk management and alignment to corporate culture. While we will look to the Commission’s recommendations to consider where we can improve, we do not anticipate any significant change if the Commission’s recommendations are adopted.
GB: The proposals include two aspects to improve regulatory effectiveness. The first is a new regulatory body to act as oversight to monitor the effectiveness of APRA and ASIC. The second is , one common professional regulatory body for advisors that will require compulsory registration, similar to doctors, lawyers and other professions. This professional body will be more effective and have the benefits of ensuring a code of ethics, proper discipline, client-first mentality is more consistently adhered to. The broader question will be how the funding model for the will work.
PM: Yes, we’re already seeing a user pays model with new ASIC charges so I would imagine a business paying will allow for greater enforcement and would be required with the introduction of a third regulatory body. What we have not seen and where many of the issues that have come to light through the Royal Commission has been a lack of litigation and enforcement. Both sides of parliament have cut funding to regulators over the years; For this to work the government will need to support this. I
would suggest that now, unlike other enquires these recommendations will be carried through. Public will to make them happen and funding needs to be considered.
GB: What will matter most for you? For our family business owners and multi-generational investors there is little in the recommendations that will have any direct effect. In general, the raising of standards is a good thing across the industry. As a result of the numerous incidents of “inappropriate advice” reviewed, one of the Commission’s significant recommendations is that there should be more stringent requirements around use of the terms “independent”, “impartial” and “unbiased” by financial advisors. Currently, while the law prescribes a number of factors which prevent an advisor stating that their advice is “independent”, there is no requirement for an advisor to alert their client to the fact, or explain to the client why they are not independent. The Commission has recommended that financial advisors giving personal advice to retail clients be required to give a written statement explaining simply and concisely why the advisor is not independent, impartial and unbiased.
While such an express requirement will not be directly relevant to the majority of our clients who are sophisticated investors, Mutual Trust strongly endorses, and already seeks to implement, the principles of transparency and disclosure on which this recommendation is based. Our manager due diligence and selection processes include a strong focus on looking for potential conflicts and assessing where there may be underlying relationships or payment structures that could prejudice a truly independent approach to achieving investment outcomes. We believe that enforcing such standards across the industry is an important element in increasing investor awareness and protection.
PM: One area which is likely to interest some of our clients, but which has generally received less publicity, is agricultural debt. The Commission heard from many agricultural enterprises who complained of harsh treatment from financiers in relation to agricultural loans and a number of significant recommendations were made. Importantly, these include recommendations regarding the valuation of land used as security; amending the Banking Code to provide that default interest not be charged on loans secured by agricultural land in an area declared to be affected by drought or other natural disaster; and principles for dealing with distressed agricultural loans, including adopting a principle that working out the loan will be the best outcome for both the borrower and the bank, and enforcement the worst.
Mutual Trust and our clients understand that the strain of distressed debt on the farming community is greater than the financial burden for the individuals alone. If financiers adopt stringent enforcement requirements or apply penalty interest on loans that are not recoverable, it not only deprives individuals of livelihood, but can have enormous emotional impacts, lead to serious mental health problems and cause broader consequences through the community. Even where these recommendations are not directly relevant to all of our clients, the benefits from these recommendations will be important to our farming communities – particularly those affected by drought – and well appreciated by Mutual Trust’s clients with rural interests.
GB: What happens now in the Australian investment space is perhaps of greater interest, as we see the outcomes from the Royal Commission’s final report providing much needed certainty to the financial sector, particularly for the banks as credit growth continues to slow.
We do not anticipate further tightening in lending standards, as the definition of responsible lending remains unchanged there is no change in the duty in the NCCP (National Consumer Credit Protection) Act, which requires banks to make an assessment about whether a loan is “not unsuitable”.
Mortgage brokers are proposed to face tougher regulations, be remunerated entirely by client fees, not commissions, and have a duty to act in the client’s best interests. This is likely to have a significant negative impact on the mortgage broking industry and give more pricing power to the major banks, that is, we can expect home loan interest rates to go up.
However, we would expect the banks to continue to face revenue headwinds, as the Australian housing market is likely to cool further, with a lower demand for loans slowing loan asset growth and net investment income of the banks.
Despite broad bipartisan political support, it seems unlikely that there will be time for any legislative steps to be taken to implement any of the recommendations before the federal election, with the Government indicating that over 40 pieces of legislation will be required. This is despite Labor’s push to extend parliamentary sitting days before the Federal Election. Ordinarily, the lapse of time before any concrete steps can be taken might lead to some watering down of legislative change, particularly as individual lobby groups seek to protect their own areas of interest. However, the strength of community interest in the Commission and outrage at some of the behaviours revealed, are likely to mean that these issues retain focus through the election period. There may also be some uncertainty with banks and listed companies affected by the changes, but we expect that a lot of this risk was already priced in within a couple of days of the Royal Commission final report.
As with all changes in financial services law, the “devil will be in the detail” and any real impact from specific changes will need to be assessed as proposed legislation is developed. For the present however, we support measures to strengthen the integrity of the industry, and do not anticipate any significant change for Mutual Trust or its clients.