Royal Commission final report: Key Recommendations

The final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was released by the Government today. This alert focuses on some of the key recommendations for law reform. Our in-depth analysis of the final report and what you should do next will be published shortly.

Vertical integration not to be banned but distribution including commissions severely challenged

• Where possible, conflicts of interest and conflicts between duty and interest are to be removed. Several recommendations deal with specific conflicts.
• Grandfathering provisions for conflicted remuneration for financial products excluding insurance to be repealed on 1 January 2021 with any remaining commissions in place then to be paid to clients.
• ASIC to consider further reducing the cap on commissions for life risk insurance products and the exemptions for general insurance. Unless there is a clear justification, the cap should ultimately be reduced to zero.
• It is not necessary to mandate structural separation between product and advice. The ACCC to undertake 5 yearly studies on the effect of vertical and horizontal integration in the financial system.

Culture and governance: Boards and APRA to step up

• APRA to focus on encouraging supervised entities to build culture to mitigate conduct risk, manage conduct risk and improve governance
• Boards must assess culture and governance, identify cultural and governance problems and deal with them, and assess the effectiveness of changes
• The best interests of a company cannot be reduced to a binary choice and cannot be determined by reference only to the current or most recent accounting period. It is not right to treat the interests of shareholders and customers as opposed.

Out with financial metrics – in with risk

• APRA to extend its focus beyond the management of financial risk to address misconduct, compliance and other non-financial risks; and update its prudential standards accordingly.
• Remuneration systems to focus on non-financial risks and misconduct – not only financial metrics. APRA to set limits on the use of financial metrics. The tension with shareholder expectations and the operation of the "two strikes rule" in this context is for "others to undertake".
• APRA-regulated institutions to claw-back vested remuneration.
• Greater board scrutiny of remuneration outcomes and more meaningful information to be provided to boards.

Extension of BEAR and enforcement

• BEAR to be extended to apply to all APRA regulated financial institutions (including insurers and superannuation funds). The Government intends to extend the regime to AFSL and ACL holders, market operators and clearing and settling facilities as well.
• BEAR to be jointly administered by ASIC and APRA with ASIC overseeing consumer protection and market conduct and APRA overseeing prudential aspects.
• BEAR to be amended so that ADIs and accountable persons must deal with ASIC in an open, constructive and co-operative way.

Consumer and small business lending

• Lenders to be banned from paying commissions to mortgage brokers and aggregators (to be phased in over a 3 year period commencing with a ban on trail commissions from 1 July 2020).
• Mortgage brokers to be subject to the same laws that apply to financial advisers including a best interests duty.
• The unsuitability assessment under the NCCPA not to be changed at this stage.
• Draft design and distribution laws to be extended to credit.
• The point of sale exemption to be removed.
• NCCPA not to be extended to small business but the Banking Code of Practice to be extended to cover loans of less than $5 million.

Superannuation

• Trustees who fail their best interests duties to be subject to civil penalties enforced by the regulators.
• The only advice fees that can be paid from MySuper to be for intra-fund advice.
• Workers to be defaulted into super once.
• No recommendations about the Productivity Commission's proposed top 10 'best in show' list.

Insurance

• The focus of the recommendations is directed at the terms of consumer insurance policies and their sales model.
• Unfair contract terms regime to apply to insurance policies.
• The duty of disclosure obligation to be watered down for consumers to an obligation to take reasonable care not to make a misrepresentation.
• Remove the exemption for the handling and settlement of insurance claims from the definition of a financial service.

Changes to ASIC, APRA and ACCC and a new regulatory oversight body

• ASIC to be primary conduct and disclosure regulator and APRA to have prudential responsibility. Regulators to co-operate and quadrennial capability reviews – starting with APRA in 2019.
• Endorsement of new "why not litigate" approach to ASIC enforcement. Role of enforceable undertakings, infringement notices and non-enforcement contact to be limited. ASIC to have the power to approve industry codes and certain provisions to be "enforceable".
• Independently-chaired regulatory oversight body to be established, to apply accountability principles consistent with the BEAR to the regulators themselves.
• Jurisdiction of the Federal Court to be expanded to cover corporate criminal misconduct.

Increase focus on remediation

• Strengthen regulatory oversight of remediation, with AFCA facilitating the public reporting of remediation activities and ASIC to direct entities to undertake remediation.
• A compensation scheme of last resort to be established. It might impact class action activity.
• A strong recognition that regulators need to focus on both remediation and enforcement.
• All AFSL holders will be required as a condition of their licence to investigate misconduct of a financial adviser and inform and remediate clients where misconduct is identified.

The Government will be taking action on all 76 recommendations (and has announced additional measures). The vast majority of law reform recommendations are likely to be implemented, given they are supported by the major political parties. Although some recommendations will take more time to implement, the Government's plan is to implement reforms "efficiently and effectively". It will establish an independent inquiry in 3 years' time to "review and assess whether industry practices have changed following the Royal Commission". We hope there will be sufficient consultation on proposed law changes.

We are happy to assist you in considering the final report and how it impacts to your business. Please contact your usual KWM contact or Jim Boynton on 9296 2086 or james.boynton@au.kwm.com if you would like to discuss the report further.