This article was written by Matt Egerton-Warburton and first appeared in Hong Kong Lawyer.
The Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services concluded in February. Below is a summary of some key themes and recommendations made by Commissioner Justice Hayne and an overview of subsequent legislation, regulation, prosecutions and regulatory actions.
The Australian government established a Royal Commission in late 2017 after a series of banking and financial scandals that had seen Australian banks pay more than A$1 billion in fines and remediation since the 2008/2009 financial crisis.
The central task of the Commission was to inquire into, and report on, whether any conduct of financial services entities might have amounted to misconduct and whether any conduct, practices, behaviour or business activities by those entities fell below community standards and expectations.
The Commission convened throughout 2018. During public examination, careers of many senior financial services executives were made and broken. As a result of the process, the reputations of some of Australia’s oldest and most respected financial institutions were significantly tarnished.
The Commission focussed on financial services provided to consumers and small and medium enterprises (excluding investment and corporate banking). It reviewed a wide range of activities including fees for no service, incentives not aligned with customer interests, trailing commissions, junk insurance products, conflicts of interest (especially for trustees of for-profit superannuation funds), failure of compliance systems and tardiness of breach reporting and remediation.
The final report was released on 4 February 2019 and is available for public review.
The Commissioner provided two key reasons for the misconduct (i) greed and (ii) misconduct not being sufficiently punished. The Commissioner lamented “the pursuit of short term profit at the expense of basic standards of honesty..... from the executive suite to the front line, staff were measured and rewarded by reference to profit and sales...”. He concluded that misconduct was the result of cultural deficiencies, not just a few bag eggs, and boards and senior management were responsible. The Commissioner drew clear links between remuneration and culture and governance and saw remuneration as the key to manage and improve the systemic misconduct within the financial services industry.
The Commissioner outlined the following 6 key principles which should govern the conduct of financial services providers (which seem self-evident, but the Commissioner obviously thought needed restating):
- obey the law;
- do not mislead or deceive;
- act fairly;
- provide services that are fit for purpose;
- deliver services with reasonable care and skill; and,
- when acting for another, act in the best interests of that other.
The report made 76 wide-ranging recommendations. These recommendations included:
- A ban on “hawking” financial products to retail clients – no cold calling or unsolicited meetings;
- Boards must set and assess firm culture and governance and APRA (the Australian banking regulator) must assess the culture of regulated entities;
- ASIC should initiate a “why not litigate” culture and rely less on enforceable undertakings and other “soft” penalties;
- The BEAR regime (in which individuals are accountable in an organisation for each division and product line) should be extended from banks to all APRA regulated financial institutions (including insurance and super);
- A ban on trailing commission for mortgage brokers – brokers should act in the best interests of consumers and only accept fees from consumers; and
- Industry codes of conducts to be enforceable.
Interestingly the Commissioner thought current legislation was sufficient – it was just not being enforced:
“The law already requires entities to ‘do all things necessary to ensure’ that the services they are licensed to provide are provided ‘efficiently, honestly and fairly’. Much more often than not, the conduct now condemned was contrary to law. Passing some new law to say, again, ‘Do not do that’, would add an extra layer of legal complexity to an already complex regulatory regime.”
Post Report Ramifications
Reaction to the report has been muted. The report was generally viewed by the legal, financial and political community as sombre, reasonable and conservative.
The report did not recommend significant new legislation, a break-up or shake-up of the regulators or any radical change of current business models (apart from the mortgage broking model which relies upon trailing commissions).
The Report made clear that the biggest challenge for government, regulators and boards will be to review, understand and reform the profit and sales culture within Australia’s financial services sector. The report provided evidence and guidance to commence this reform process.
The Commission did have some bite – the Commissioner made recommendations for prosecution and the Commonwealth DPP has been provided with extra resources to pursue criminal misconduct by banks and other financial institutions. More careers and reputations will be affected.
As a result of the Report, the boards of financial services companies in Australia, APRA (the banking, insurance and superannuation regulator), ASIC (the corporate regulator) and the government have committed to implementing the Report’s 76 recommendations. The government has and will introduce new legislation. APRA and ASIC are drafting new regulations. The new “why not litigate” culture of ASIC and APRA is ruffling feathers and the traditionally consultative relationship between regulators and the financial sector has been disturbed. Australian boards are wrestling with changes to their corporate governance and remuneration policies. Overall, the Australian financial services sector, its relationship with its regulators and the regulatory regime is in a state of flux and is yet to reach a new equilibrium.
Hong Kong Ramifications
The Report has some limited regulatory and commercial ramifications in Hong Kong.
On the regulatory front, both the Hong Kong Monetary Authority (HKMA) and Hong Kong’s Securities and Futures Commission (SFC) are aware of, and are instituting reforms in line with, the Commission Report. The Report and its recommendations are part of a global trend of increased regulation of financial institutions. Some Report recommendations may well find their way into HKMA and SFC regulations.
The HKMA has cited the findings of the Report in their own bank culture reform initiatives and supervisory measures. As part of the mandated culture self-assessment and review each Hong Kong Authorised Institution (AI) needs to conduct (which is made available to the HKMA), each Authorised Institutions needs to examine and report on misbehaviour incidents offshore (including incidents cited in the Commission Report) and their effect on culture within the AI in HK.
Australia’s previous BEAR regime only applied to banks, but the Report recommends expanding BEAR to non-bank financial institutions (which matches the scope of institutions covered by the SFC’s Manager in Charge (MIC) regime). The Australian legislation uses the BEAR regime as an enforcement tool (much like the UK’s Senior Management Regime), whereas the SFC is currently using the MIC regime as a 'roadmap' to identify senior individuals responsible for misconduct (but not necessarily for strict liability and enforcement purposes). The Report and BEAR amendments in Australia (coupled with the strong UK enforcement regime) may encourage the SFC to toughen liability and enforcement in the MIC regime in Hong Kong.
It is unclear whether the two reforms are related but recommendation 2.7 of the Report (which seeks information sharing between financial services companies in relation to termination of financial advisors) introduces a regime similar to that announced by the HK SFC on 1 February 2019. Both regimes aim to assist employers to identify “bad apples” as they seek new employment. Under the SFC regime, when a licensed individual ceases to act for a licensed corporation, disclosure is required of any investigations into that individual commenced (i) within six months preceding their cessation of employment or (ii) any time after their cessation of employment.
On the commercial front, Asia-Pacific fund managers based in Hong Kong are tracking compliance and regulatory costs associated with the Royal Commission as they typically allocate 30% of their capital to Australia and the big four Australian banks make up 25-30% of the Australian market. Having a working knowledge of the Royal Commission will assist HK funds lawyers to describe risks associated in this sector.
Finally, the Commission has weakened Australian banks and financial institutions, so opportunities for competition from Asian banks will arise and large assets will become available. Continued financial industry weakness and instability in Australia may produce substantial M&A, banking and finance work for Hong Kong lawyers.