Each of the 11 banks in the conduct and culture review by the Financial Markets Authority (FMA) and the Reserve Bank of New Zealand (RBNZ) will receive a detailed report containing "specific" findings relevant to their organisation, with a requirement to report progress by the end of March 2019.
They have until the end of September to move their incentives programmes away from sales performance.
The review found that, while misbehaviour of the scale reported by the Hayne Inquiry in Australia was not present here, "issues relating to system or process weaknesses were more commonplace".
The review found that the RBNZ had all the powers it needed to conduct its prudential mission but that there were gaps in the FMA's remit. Options include:
- establishing basic legal duties on the banks to protect or enhance customer interests and outcomes
- requiring the banks to have adequate systems in place to govern, manage and remediate conduct risk
- providing regulators with sufficient supervision and enforcement powers and resources to ensure banks met these obligations, and
- clarifying accountability and individual responsibility for managing conduct, including the potential for direct liability for senior managers.
Finance Minister Grant Robertson has indicated that the Government will consider legislation unless the banks demonstrate a willingness to change, but that no decisions will be taken until later next year after the results of the Australian Royal Commission (ARC) are known.
Public expectations of the financial services industry have shifted so that, to maintain trust and confidence, banks need "to think and act beyond minimum legal and regulatory standards, and champion business models that focus on consumer interests".
This requires moving away from sales based pay structures as these tend to deliver "poor consumer outcomes". Many banks are in the process of making this change "although none go as far as we [the FMA and the RBNZ] consider necessary".
More broadly, what is needed is a shift toward more a consumer-centric culture and conduct. The review recommends a number of changes to improve oversight, controls and processes which it wants implemented by boards and senior management "with a sense of urgency".
- There are inherent conflicts of interest in the provision of financial services, particularly in vertically or horizontally integrated organisations.
- Conflicts of interest "play out" in the design of sales incentives, and in the lack of investment in systems and processes for measuring and reporting on customer outcomes.
- Significant information asymmetries exist where customers have to rely on bank staff to give them all the information they need.
- While some banks are already incorporating a strong customer focus into their product design, sales processes and how they treat vulnerable customers, significant progress is required in these areas by all banks.
- Across the banks, the focus is on short-term customer-satisfaction levels rather than long-term customer outcomes. Staff incentives are typically highly focused on driving sales, thereby increasing the risks of poor conduct.
- All banks need to improve their conduct governance: relevant reporting to Boards is weak and contains little about customer outcomes.
- Most small banks have only recently started to focus on conduct and culture.
- Frameworks to identify, assess and manage conduct and culture risks are variable and most banks need to improve their formal and informal reporting channels, and staff training.
Recommendations for in-house reform
The recommendations, to be implemented with "a sense of urgency", are clustered around five areas.
- Board ownership and accountability for conduct and culture: boards need to drive these changes and cannot rely on the absence of identified issues as an indicator of good conduct.
- Identify and remediate issues: remediation must be adequately resourced and given high priority.
- Strengthen processes and controls: all banks must strengthen the frameworks, processes and controls that prevent, detect and manage conduct and culture issues.
- Staff reporting channels: banks need to educate their staff on what good conduct and culture looks like and have effective mechanisms for employees to report deviation from this.
- Incentives: bank incentive structures need to be designed and controlled in ways that sustain good customer outcomes. This means reviewing their payments for frontline salespeople and through all layers of management, in particular, by removing incentives linked to sales measures.
The report notes that these recommendations apply to all 11 of the reviewed banks and should form the basis for their plans.
The review expects banks to:
- develop a forward plan to address these issues before the end of March 2019 and report on implementation progress. Any bank that has not committed to removing sales based payments will be required to explain how it will strengthen its control systems sufficiently to address the risks of any poor conduct which may arise
- implement changes to their incentives programmes no later than the first performance year after 30 September 2019, following the publication of the FMA's thematic review of the incentive structures of nine banks (expected later this month)
- proactively review the work of relevant regulators and related international examples to help identify potential conduct and culture issues
- continue with the work programmes arising from the Hayne Inquiry and determine whether they have similar issues that need to be addressed.
Keeping the pressure on
The report is mandatory reading for financial services providers and gives a clear insight into how the FMA and RBNZ will approach their legislative obligations following the ARC. The FMA/RBNZ will now provide individual feedback that is specific to each bank, along with their general observations.
Other observations regarding regulatory intentions made in the review are that:
- any remediation matters that warrant further investigation and potential enforcement action will be considered by the FMA, RBNZ or the Commerce Commission, depending on which has the relevant authority
- the FMA and RBNZ will share with the Commerce Commission information relating to the banks' adherence to the Responsible Lending Principles
- RBNZ will review banks' lending standards in due course, as part of its prudential mandate, and
- the FMA and /RBNZ will review the banks' progress with their response to the ARC.
Chapman Tripp's six part series on the Hayne interim report is available here.
The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.