As financial institutions in Australia face into the culture and conduct storm that has engulfed the UK for the past decade, UK firms can be confident that they have already largely negotiated the regulatory waves which have followed the Banking Royal Commission in Australia. However, culture and customer treatment are themes that continue to be relevant on both sides of the world.
What Led To The Royal Commission?
Unlike counterparts in the UK and elsewhere, on the whole, Australian banks emerged strongly from the global financial crisis in 2008. However, in the subsequent years, a number of reviews and investigations uncovered misconduct and inadequate systems and controls in a range of areas. There were calls for a public inquiry. Speculation about further reviews and the commercial cost of general uncertainty prompted the leadership of Australia's four major banks to take the unusual step of calling on the government to hold a properly constituted inquiry. The government agreed and, on 14 December 2017, the Governor-General of the Commonwealth of Australia appointed former High Court Judge, the Honourable Kenneth Madison Hayne AC QC, to inquire into and report on misconduct in the banking, superannuation and financial services industry. The inquiry was established pursuant to the Royal Commissions Act 1902.
THE FINAL REPORT AND RECOMMENDATIONS
Commissioner Hayne's final report was published on 4 February 2019. With insight from over 10,000 submissions and seven rounds of public hearings,
his findings portray a picture of widespread poor customer treatment and resulted in 76 recommendations for change. All but one of these recommendations has been accepted by the Australian government.
The 76 recommendations are broadly encompassed within the following five themes:
- simplifying the law so that its intent is met;
- eliminating conflicts of interest;
- regulators and compliance;
- culture, governance and remuneration; and
- increasing protections.
Underpinning his Final Report (and his recommendations) are six "norms of conduct" which Commissioner Hayne had identified in his Interim Report:
- 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.
To anyone familiar with the regulatory regime in the UK, these "norms" resonate with the Financial Conduct Authority's (FCA) Principles for Businesses and the
Prudential Regulation Authority's (PRA) Fundamental Rules. Although not one of his recommendations, Commissioner Hayne appears to support the concept of a "principles-based" regulatory framework in his report:
"... it is time to draw explicit connections in the legislation between the particular rules that are made and the fundamental norms to which those rules give effect."
IMPLICATIONS OF RECOMMENDATIONS FOR UK FIRMS
The five key themes described above are certainly not new to UK regulated firms and indeed the specific recommendations that sit beneath them are also very familiar to a UK audience, many having been implemented already in the UK, including as a result of EU regulation and the FCA's Retail Distribution and Mortgage Market Reviews. By way of example:
- The Final Report recommends that the law be amended to provide that, when acting in connection with home lending, mortgage intermediaries must act in the best interests of the borrower. While there is of course an ongoing debate in the UK about the introduction of a general duty of care in financial services, in the context of mortgages, there already is a "customer's best interests" rule in MCOB 2.5A, as derived from the Mortgage Credit Directive.
- The Final Report also recommends that a financial adviser who is not "independent" must, before providing personal advice to a retail client, give the client a written statement explaining their lack of independence. This is akin to the requirements in the FCA's Conduct of Business sourcebook relating to disclosure of the nature of advice to be provided.
The Final Report also contains recommendations in relation to senior manager accountability which reflect the UK regime, namely the recommended expansion of the current Australian senior managers regime, the Banking Executive Accountability Regime (BEAR), beyond banks; and the recommendation that BEAR is administered jointly by the prudential (APRA) and conduct (ASIC) regulators. (BEAR is currently just administered by APRA).
There are however a small number of specific recommendations that are not part of the current UK regulatory regime:
- Mortgage commission: "borrower
- The Final Report proposed that borrowers, not lenders, pay mortgage intermediary commission.
- This is the one recommendation that the Australian government has not endorsed – instead this recommendation is to be revisited in three years to assess the impact of more immediate changes regarding trail commission and draw-down linked commission.
- In the UK, the FCA's Mortgages Market Study Final Report (March 2019) found that commercial arrangements between lenders and intermediaries did not appear to result in the customer paying more for a mortgage. It seems unlikely that the FCA will take a different position in light of Commissioner Hayne's report, particularly in circumstances where this is not a recommendation that is to be taken forward in the short term even in Australia.
- Deferred sales model for add-on
- The Final Report recommends that, other than comprehensive motor insurance, add-on insurance should be sold on a deferred sale basis.
- Add-on insurance has been the subject of an FCA Market Study. The remedies were published in September 2015 and did not include a general deferred sales remedy. There was however a deferred sales period introduced for GAP insurance (FCA PS15/13). Since then, the Insurance Distribution Directive has introduced a customer best interests' rule – which may give sufficient comfort that no further remedy is needed in this regard.
- Definition of "small
business" in Banking Code:
- The Final Report indirectly recommends the removal of the turnover test in the definition of "small business" in the Australian Bankers' Association's Banking Code of Practice – the recommendation being that the Banking Code applies to any business or group employing fewer than 100 full-time equivalent employees, where the loan applied for is less than AU$5m (approx £2.7m).
- Turnover is a key part of the small business test in the UK: in the UK Standard of Lending Practices for business customers, the threshold is for businesses with an annual turnover of up to £6.5m in their last financial year; and in the newly introduced FOS thresholds, SMEs have to be below an annual turnover threshold of £6.5m and below only one of either the headcount threshold of 50 employees or the balance sheet total threshold of £5m. Given the test in the UK has so recently been revisited, it seems unlikely to change again in the near term, in particular where, other than for simplification purposes, the rationale for change in Australia is not clear in the Commissioner's report.
The Royal Commission has introduced a new term into common parlance amongst the Australian regulated community,
public and media: "community standards and expectations". This phrase was used in the Commission's terms of reference and is prominent in the Final Report. At p 1, Commissioner Hayne says:
"The central task of the Commission has been 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 ... Very often, the conduct has broken the law. And if it has not broken the law, the conduct has fallen short of the kind of behaviour the community not only expects of financial services entities but is also entitled to expect of them." (emphasis added)
In the UK, we are accustomed to the concept of "treating customers fairly", based on Principle 6 of the FCA's Principles for Businesses. The UK FSA (as it then was) published a plethora of guidance, good practice and case studies in relation to the TCF Principle in the mid-2000s. The regulatory expectations of what "treating customers fairly" requires is of course also clear in the many regulatory enforcement notices issued to firms for breach of Principle 6.
"Community standards and expectations" however appears to be a significantly wider concept than TCF, not least because it is not limited to "customers", and, at least as yet, is not accompanied by the helpful guidance available in relation to TCF, thus making it a difficult concept with which to gauge and monitor compliance.
Another central theme of Commissioner Hayne's Final Report is "culture", which is mentioned 304 times.
The FCA has reiterated in its Business Plan 2019/2020 that firms' culture and governance remain a key priority for it too. As well as the themes of "purpose", leadership and management capabilities, and remuneration and incentives, in the coming year, the FCA will explore firms' assessment of culture. The focus on firms' assessment of their culture aligns with one of Commissioner Hayne's recommendations: he recommends that all financial services firms undertake a "self-assessment" of governance and culture "as often as reasonably possible". He is clear that:
"What the Recommendation requires is much more than an exercise in 'box‑ticking'. Its proper application demands intellectual drive, honesty and rigour. It demands thought, work and action informed by what has happened in the past, why it happened and what steps are now proposed to prevent its recurrence. Above all, it demands recognition that the primary responsibility for misconduct in the financial services industry lies with the entities concerned and with those who manage and control them: their boards and senior management."
However, without detracting from the message that the primary responsibility for culture lies with firms, both Commissioner Hayne and the FCA recognise the role of regulators in supervising culture. The Royal Commission's Final Report recommends that the Australian prudential regulator (APRA) builds a supervisory program with a focus on culture and assesses the cultural drivers of misconduct; while the FCA has said that "... in 2019/20 ... Through our supervision of individual firms, we will reach a judgement on the effectiveness of a firm's culture which may reduce the potential for harm".
The similarity of approaches to encouraging and assessing good culture indicate that, although the UK may be some years ahead of Australia in tackling misconduct, the pace when it comes to culture change is slower and, in the UK, more than a decade after the global financial crisis, remains work in progress.
This article was first published in Butterworths Journal of International Banking and Financial Law (JIBFL), June 2019.
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