The Hayne Royal Commission Final Report

What you need to know

• The Government yesterday released the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Final Report). The Government has said it proposes to implement nearly all of the 76 recommendations, while not appearing to support a recommendation that there be a complete ban on mortgage broker commissions from lenders.
• The recommendations in the Final Report as to policy and legislative change have, for the most part, been foreshadowed (at least as possibilities). Some key themes in the report include the extension, over time, of the Banking Executive Accountability Regime to all APRA-regulated entities, increased used of mandatory industry codes that have the force of law, and a more litigious approach to enforcement by regulators.
• It can be expected that future legislative change will be influenced by the philosophy expressed in the Final Report that financial services law should be simplified, in particular by removing exceptions to generally applicable norms of conduct. 

What you need to do

• Be ready for a raft of legislative change and a more litigious approach to enforcement from ASIC.

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In this Legal Update, we outline the key changes to the regulatory and enforcement landscape that appear likely to emerge as a result of the Final Report.  These are in the following areas:

• Banking (including responsible lending, credit licensing, mortgage broking, small business lending, Banking Code of Conduct, farm debts, and some changes to the Bank Executive Accountability Regime)
• Financial Advice
• Superannuation
• Insurance
• Culture, Governance and Remuneration
• Regulators
• Breach Reporting  

Banking

The Final Report recommends some significant changes, particularly to mortgage broker duties and remuneration, and removal of the point of sale credit license exemption. In other cases, the Commissioner has not made a potential recommendation, such as in relation to verification of borrowers' financial situations.

Responsible Lending

Assessment of 'unsuitability': The Commissioner was not persuaded that it is appropriate to change the current NCCP Act requirement to assess whether a proposed consumer credit contract is "not unsuitable" for the consumer.  The rejected alternative was to require an assessment that the credit contract is "suitable".

Verification of a borrower's financial situation: The Commissioner has stopped short of specifying the content of the requirement to take reasonable steps to verify the borrower's financial situation, noting this issue is the subject of current proceedings in the Federal Court.  The Commissioner noted a number of banks are taking steps to improve their verification processes and to reduce their reliance on the household expenditure measure.

Credit Licensing

Point of sale exemption: The Commissioner recommends the abolition of the point of sale exemption that currently allows retailers and dealers to conduct credit activities (such as by facilitating the provision of credit) without an Australian credit licence (ACL). This would involve a significant change for the industry.

Mortgage Broking

Mortgage brokers and best interests: The Commissioner recommends a legal duty on mortgage brokers to act in the "best interests" of the intending borrower (similar to the existing "best interests obligations" under the Corporations Act for financial advisers). This would be a civil penalty provision.

Fees for mortgage brokers: The Commissioner recommends that the borrower, not the lender, pay the mortgage broker's fee for acting in connection with a home loan.  This recommendation is aimed at avoiding conflicts of interest.

Banning payment of commissions to mortgage brokers: The Commissioner recommends addressing "conflicted remuneration" in the mortgage broking industry by prohibiting lenders paying commissions to brokers. The Commissioner proposes that the ban on commissions be introduced over a period of two to three years: first, by prohibiting lenders from paying trail commission to mortgage brokers in respect of new loans; then, by prohibiting lenders from paying other forms of commissions to mortgage brokers.  

In its response to the Final Report, the Government:

• has agreed to address conflicted remuneration for mortgage brokers, including by prohibiting the payment of trail commissions from lenders to brokers on new loans from 1 July 2020;
• appears not to have adopted the recommendation that payment of "other commissions" by lenders to brokers be prohibited, although it has not expressly rejected it. This is the only policy recommendation which the Government has not adopted in terms. 

Charging fees to customers who do not use a mortgage broker: The Commissioner discusses, but does not adopt, a proposal whereby banks would charge a fee to customers who do not use a mortgage broker, in order to create a "level playing field" between banks and brokers and maintain competition. Instead, the Commissioner has proposed this be considered by the Treasury-led working group (see below).  

Establishment of Treasury-led working group: The Commissioner recommends that a Treasury-led working group (to include representatives from the ACCC and APRA) should be established to monitor the impact of the changes to mortgage broker remuneration, including on interest rates and competition.

Mortgage brokers and financial advice: The Commissioner recommends that, after a period of transition, mortgage brokers be regulated in the same way as financial advisers (including, for example, requiring brokers to provide a written statement of advice and satisfy relevant educational requirements).

Mortgage broker misconduct: The Commissioner recommends that ACL holders should be bound by information-sharing and reporting obligations in respect of mortgage brokers' conduct.

Small Business Lending

No change to current regulation: The Commissioner recommends that the NCCP Act should not be amended to extend its operation so as to cover lending to small businesses.

Amendment of the Banking Code of Conduct

Informal overdrafts & basic accounts: The Commissioner recommends that the ABA should amend the Banking Code to provide that banks will not allow informal overdrafts on basic accounts without prior express agreement with the customer; and that banks will not charge dishonour fees on basic accounts. This will involve a significant change of practice.

Meaning of a 'small business': The Commissioner recommends that the ABA should amend the definition of ‘small business’ in the Banking Code so that the Code applies to any business or group employing fewer than 100 full-time equivalent employees, where the loan applied for is less than $5 million.

Farm Debt and Agricultural Loans 

Farm debt mediation: The Commissioner recommends that a national scheme of farm debt mediation should be enacted.

Distressed agricultural loans: When dealing with distressed agricultural loans, the Commissioner recommends that banks should:

• ensure that loans are managed by experienced agricultural bankers;
• offer farm debt mediation as soon as a loan is classified as distressed;
• manage every distressed loan on the footing that working out will be the best outcome for bank and borrower, and enforcement the worst;
• recognise that appointment of receivers or any other form of external administrator is a remedy of last resort; and
• cease charging default interest when there is no realistic prospect of recovering the amount charged.

Drought & disaster relief: The Commissioner recommends that the ABA should amend the Banking Code to provide that, while a declaration remains in force, banks will not charge default interest on loans secured by agricultural land in an area declared to be affected by drought or other natural disaster.

Prudential Standard APS 220 - Land Valuations

The Commissioner recommends that APRA should amend Prudential Standard APS 220 to:

• require that internal appraisals of the value of land taken or to be taken as security should be independent of loan origination, loan processing and loan decision processes; and

• provide for valuation of agricultural land recognising the likelihood of external events affecting its realisable value; and the time that may be taken to realise the land affecting its realisable value.

Industry Codes of Conduct

ASIC involvement in Industry Codes: The Commissioner recommends that the law should be amended to provide:

• that industry codes of conduct approved by ASIC include ‘enforceable code provisions’, contravention of which will be a breach of the law; and
• for the establishment and imposition of mandatory financial services industry codes.

The Commissioner has also recommended that the provisions of the Banking Code that ASIC approved in 2018 governing the terms of the contract between the bank and the customer or guarantor be designated as ‘enforceable code provisions’.

Banking Executive Accountability Regime (BEAR)

Product responsibility: There should be a new responsibility within ADIs subject to the BEAR for the design, delivery and maintenance of products offered to customers by the ADI (including remediation of those products).

Financial advice

The themes which have emerged from the Royal Commission report in relation to financial advice are:

• 'Fees for no service': ongoing advice fees being charged where no service was given to the client;
• 'Poor quality advice': where advice left consumers in a worse position than if it had not been provided;
• 'Fragmented discipline': which has resulted in ineffective disciplinary systems.

Fees for No Service

The Commissioner does not accept that fees for no service was as a result of poor IT systems and legacy system issues. While he acknowledges that inadequate systems and processes may have led to some of the fees for no service conduct, he considers that there were other drivers – the enticing call for profit, the uncertain content of what was promised and the capacity to deduct fees invisibly.

The Commissioner recommends that ongoing fee arrangements be renewed annually by the client, the arrangements record in writing the services the client is entitled to receive and the total fees which will be charged, and the arrangement not permit or require the deduction of fees from any account held by the client except with the client's express written authority (which must be renewed annually).

Poor Quality Advice

The Final Report considers the reason why inappropriate (or poor quality) advice is given, which it attributes to the adviser proposing actions which benefit the adviser or the licensee with whom the adviser was aligned or employed, the adviser lacking skill or judgment and the licensees being unwilling to find out whether poor advice had been given and take steps to remedy it.

The Commissioner considers that the Professional Standards reforms and the proposed design and distribution obligations (DDO) and product intervention powers (PIP) will not be sufficient to overcome those causes of poor advice. Instead the Commissioner recommends:

• Disclosure of non-independence: Advisers who would not otherwise be able to claim to be independent (without breaching section 923A of the Corporations Act) provide a written disclosure before providing personal advice to a retail client, explaining why they are not independent, impartial or unbiased.
• A review of the "best interests" duty: By no later than 31 December 2022, a review be conducted of the various measures introduced by the Government, regulators and financial services entities to improve the quality of financial advice. If it is not seen to be effective, then the Final Report proposes that the "best interests duty" safe harbour should be repealed.

Conflicts Arising from Commissions

The Final Report focuses on the consequences for financial advice quality in the face of conflicts created by financial benefits flowing to advisers. While the bans on conflicted remuneration appear on their face to be comprehensive, the Commissioner points out that conflicts have been perpetuated by the existence of exceptions. On grandfathered commissions, the Commissioner states that even if grandfathering exceptions could have been justified initially on the grounds that elimination of commissions would be disruptive, it is clear that they have outlived their usefulness.  

In line with these findings, the Commissioner recommends:

• The end of grandfathered commissions: grandfathered commissions should be repealed as soon as practicable.
• ASIC to consider reduction of life risk insurance commissions: when ASIC conducts that review in 2021, it should consider further reducing the caps on life risk insurance commissions (introduced on 1 January 2018) and unless there is clear justification for retaining those commissions, the cap should ultimately be reduced to zero.
• ASIC to consider other commission exceptions: the ASIC review of life risk insurance commissions be extended to the exemptions for general insurance and consumer credit insurance products and the exemptions for non-monetary benefits in section 963C of the Corporations Act.

Structural Separation

Taking a cost benefit approach, the Commissioner states that he is not persuaded that it is necessary to mandate structural separation between product and advice. This conclusion is consistent with that of the Productivity Commission, which concluded that 'forced structural separation is not likely to prove an effective regulatory response to competition concerns in the financial system' [Productivity Commission, Report 89, 29 June 2018, 272]. Rather, he prefers the Productivity Commission's proposal that the ACCC should undertake five yearly studies of vertical and horizontal integration in the financial system.

Individual Registration of Financial Advisers

The individual licensing of financial advisers was contemplated in the interim report. The Commissioner recommends individual registration.  

The Commissioner recommends:

• Mandatory reference checking and information sharing: mandatory reference checking and information sharing about advisers.
• Reporting of serious compliance concerns: that licensees report serious compliance concerns about individual advisers to ASIC.
• Investigation and client notification of adviser misconduct: that licensees undertake inquiries reasonably necessary to determine the full extent of an adviser's misconduct, to tell affected clients and to remediate those clients promptly. 

It is not clear what ASIC's functions would be in administering the register or the disciplinary arrangements. The Commissioner concludes that whether there would be additional functions for ASIC would be a matter for the Government.

Superannuation

The Commissioner highlights the importance of the industry as affecting, and even determining, the way individuals live after retiring.

The role of the trustee

In examining the best interests of members and conflicts of interest covenants, the Final Report suggests that some trustees have struggled with the "best interests of members" test. However, the Commissioner has found that the covenant is not hard to understand and can be achieved by keeping the members' interests "front of mind" at all times. When considering conflicts of interest in light of the "best interests" test, the Final Report has focused on dual-regulated entities and the difficulties that these structures present, concluding a trustee should be prohibited from assuming obligations other than those arising from or in the course of its performance as a trustee. 

The Commissioner recommends that the trustee of a Registrable Superannuation Entity (RSE) should be prohibited from assuming any obligations other than those arising from or in the course of its performance of the duties of a trustee of a superannuation fund.

Deduction of Advice Fees

The Final Report examines the deduction of advice fees and considers that payment for broad financial advice from a superannuation account is not consistent with the sole purpose test in section 62 of the SIS Act. Whilst acknowledging that no further amendment is necessary, the Commissioner recommends:

• No deduction of advice fees from MySuper: Deduction of any advice fee (other than for intra fund advice) from a MySuper account be prohibited.

• Limitations on deducting advice fees from choice accounts: Deduction of any advice fee (other than for intra fund advice) from superannuation accounts other than MySuper accounts be prohibited unless requirements about annual renewal, prior written identification of service and provision of the client’s express written authority in connection with ongoing fee arrangements are met.

Governance

The Commissioner acknowledges the need for the board of a trustee to be skilled and efficient in the proper supervision of the fund in the best interest of members, and that prescriptive rules about board composition do not necessarily mean this requirement is satisfied. Instead, the report emphasises the importance of board composition, change and renewal; prudential regulation by APRA; and recommends the BEAR regime be extended to the superannuation sector.  

Selling Superannuation Products

In general, the Final Report concludes that the unsolicited selling of a superannuation product is not in the interests of consumers.

The Commissioner recommends that such hawking of superannuation products to retail clients should be prohibited, except for offers made under an eligible employee share scheme. 

Default Fund Arrangements

To prevent the proliferation of superannuation accounts, the Commissioner recommends that machinery be developed to ensure default accounts are created once and then carried over, or "stapled", as members change employment.

Inducements for Employers

Funds compete to be selected as an employer's default fund where the default fund is not determined by an industrial instrument. This competition has led to funds investing in maintaining and strengthening relationships through spending on entertainment and sporting events, which the Final Report refers to as "treating" employers. The existing prohibition against inducements for employers in section 68A of the SIS Act is criticised for being ineffective. To remedy this, the Commissioner recommends legislative change to prevent trustees and their associates from (among other things) supplying or offering to supply goods or services where the act may reasonably be understood by the recipient to have a substantial purpose of having the recipient nominate the fund as a default fund or having one or more employees of the recipient apply or agree to become members of the fund. It is also recommended that the provision should be a civil penalty provision enforceable by ASIC.

Regulation

Recognising that super is a compulsory financial product and its performance directly impacts the public purse, the Final Report suggests a shift in the regulatory focus to outcomes. The Commissioner considers and rejects the suggested creation of a separate regulator for superannuation.   

The Final Report recognises that the covenants (set out in section 52 and 52A of the SIS Act with analogous obligations in sections 29VN and 29VO) are critical to the proper administration of a fund. The Commissioner recommends the introduction of civil penalty provisions for breach of the covenants and like obligations (as proposed by the Bill currently before Parliament (Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation Measures No 1) Bill 2017 (Cth), Sched 3)).

Finally, the Commissioner observes that it is essential that governance failures be identified and trustees of RSEs be held accountable for them. The Commissioner recommends that over time, directors and senior executives of large superannuation funds be subject to obligations similar to those imposed by the BEAR.

Insurance

The Final Report made three main types of recommendations in relation to insurance, being:

• new requirements for the selling of insurance products;

• additional requirements for insurers in relation to pre-contractual disclosure, claims handling and regulatory action in relation to breaches; and
• recommendations relating to the interaction between insurers and holders of group life insurance policies. 

Sales of Insurance Products

The Final Report found a number of instances where the practices relating to the selling of insurance led to poor consumer outcomes. A number of reforms have been recommended to directly address these issues, including applying the anti hawking provisions to insurance policies, banning the sale of add-on insurance other than as part of a deferred sales policy, introducing a cap on commissions for vehicle dealers for add-on insurance, and extending the unfair contract terms regime to insurance contracts.

The Final Report also suggested that, following ASIC's review of commission caps, ASIC should consider reducing the cap for life insurance commissions to zero, and consider whether to apply similar measures to commissions for general insurance products and consumer credit insurance.

Pre-Contractual Disclosure

In light of the complex legislative provisions around the duty of disclosure for customer insurance contracts, the Final Report recommends the replacement of the existing disclosure obligations with a duty to take reasonable care not to make a misrepresentation to an insurer. The Final Report also recommends limiting the circumstances in which insurers can avoid a contract of life insurance to where the insurer can demonstrate it would not have entered into a contract on any terms.

Claims Handling

The Final Report recommends that the handling of insurance claims should be included in the definition of financial services under the Corporations Act. This is because the value of an insurance product lies in the ability to make a successful claim when an insured event occurs.  

Industry Codes

As in some other areas, the Commissioner recommends that mandatory industry codes applicable to insurers contain legally enforceable provisions. 

Group Life Insurance

The Final Report has made a number of significant recommendations in relation to the relationship between insurers and the holders of group life insurance policies.

Standardisation of MySuper group life policies: In light of difficulties in assessing the differences between insurance policies, the Final Report recommends that Treasury, in consultation with industry, review the merits of standardising the terms of MySuper group life policies.  

Best interests certification: The Commissioner also recommends the introduction of certification for policies of group insurance taken out between related insurers and superannuation trustees. This should include a requirement to obtain a report from an independent firm certifying that the engagement is in the best interests of members, and otherwise satisfies all legal and regulatory requirements, prior to entering into the contract. 

Fair and reasonable requirement: The Commissioner also recommends there be a requirement for superannuation trustees to be satisfied that the rules by which statuses are attributed to members under group insurance policies, such as 'smoker' or 'blue-collar worker', are fair and reasonable.  

Culture, governance and remuneration

A key theme of the Final Report and the recommendations in relation to culture, governance and remuneration is that APRA should play a greater role in supervising misconduct, compliance and non-financial risks. The Final Report calls for APRA to receive additional funding  so that it can supervise culture itself, rather than merely asking whether boards are doing so.

BEAR

The Final Report recommends that the BEAR should apply to all APRA-regulated institutions over time.

Remuneration

APRA's role in remuneration: The Final Report does not make specific recommendations about remuneration structure or say that frontline employees or senior executives should only receive fixed remuneration. However, the Commissioner considers that entities can and should use remuneration to reduce the risk of misconduct. Therefore, the Final Report recommends APRA revise its prudential standards and guidance to better manage non-financial risks through remuneration systems. This includes setting limits on financial metrics in connection with long-term variable remuneration and providing for claw back of remuneration that has vested in appropriate circumstance.

Annual remuneration reviews: The Commissioner considers all financial services entities should conduct an annual review of the remuneration of frontline staff to ensure the entity focuses not only what staff do but how they do it. In addition, the recommendations of the 2017 Sedgwick Report commissioned by the Australian Bankers Association on retail banking remuneration should be fully implemented.

Regulators   

While not suggesting any wholesale change to the regulatory structure for enforcement, the Commissioner has endorsed the litigious approach to enforcement adopted in his interim report. In a context where licensees will have to breach report within 30 days under threat of increased penalties, and the Commissioner says their breach reports should often found the basis for proceedings against them, financial services licensees are likely to find the enforcement environment more challenging than ever. 

Increased Use of Litigation by ASIC

The Commissioner says that the starting point for ASIC should be litigation, not negotiation. While the twin peaks model of regulation should be retained (with some limited adjustments to responsibilities) and the Commissioner rules out transferring part of ASIC's remit to the ACCC, the Commissioner considers the enforcement culture of ASIC should change. ASIC stated in its response to the interim report that its approach was now, "why not litigate?". The Commissioner says this is the only acceptable approach.

While noting the risky and costly nature of litigation, the Commissioner stresses that regulatory litigation is public in nature and should start from the premise that the law should be enforced. Accordingly, if ASIC has reasonable prospects of proving a contravention of the law, the Commissioner says the starting point must be that the consequences of that contravention should be determined by a court. This does not preclude negotiation about resolving such proceedings. 

It is not entirely clear what the Commissioner means in this context by "reasonable prospects". This is a phrase which can refer to a case being arguable (being the legislatively mandated level of satisfaction of success before a party can properly institute damages proceedings in some jurisdictions), although sometimes the phrase is used to convey a higher level of satisfaction of a favourable outcome. The Commissioner is clear that some level of risk in failing on the facts should be acceptable, but there is little recognition in the report of the challenges of assessing prospects in complex regulatory matters, even for a regulator armed with ASIC's investigative powers.

ASIC's response: Over the past year ASIC has flagged that it will take a more vigorous approach to enforcement and has obtained additional funding for enforcement. (According to the government's response to the Final Report, it has increased ASIC's funding by $70.1 million to enhance its enforcement capabilities and $41.6 million to the DPP to fund prosecutions referred from ASIC.)

The Roles of ASIC and APRA

Twin Peaks: In recommending retention of the 'twin peaks' model of financial regulation, the Commissioner has made recommendations that would help reinforce the distinction between ASIC as a conduct regulator and APRA as a prudential regulator (consistently with the views of the Productivity Commission). For example, he recommends that (without reducing APRA's remit) ASIC be given power to enforce civil penalty and other provisions in the Superannuation Industry (Supervision) Act concerned with the relationship between RSE licensees and consumers, and that the ASIC be given oversight of those parts of the BEAR that concern consumer protection and market conduct matters. 

A BEAR for regulators: The Commissioner also recommends that regulators themselves should be subject to management accountability principles along the lines of the BEAR.

A regulator for the regulators: The Commissioner also recommends that there should be a new oversight authority with three part time members to assess the effectiveness of APRA and ASIC.

Specific Enforcement Options

Infringement notices: The Commissioner queries the use of infringement notices beyond instances of "lax administrative conduct", eg not lodging a filing in time. He considers their role should be minor. He disagrees with the ASIC Enforcement Taskforce's recommendation, reflected in the Treasury Laws Amendment (Strengthening Corporate and Financial Sector Penalties) Bill, which would expand the role of infringement notices. If the Commissioner's recommended approach to enforcement is adopted, it can be expected that infringement notices will have a very limited role, even where available. 

Enforceable undertakings: Enforceable undertakings should be used much less, as they can be seen as a cost of doing business and do not provide the necessary deterrence. Importantly, the Commissioner says that ASIC should only accept an enforceable undertaking if there is an admission of legislative breach. Perhaps surprisingly, there is no discussion of the potential benefits of using an enforceable undertaking precisely in those cases where establishing a breach is difficult or contestable.  

Negotiations: The Commissioner also suggests that to avoid regulatory capture, meetings with regulated entities about enforcement decisions and litigation on foot should be conducted independently of relationship meetings and with formality, such as through the parties' legal representatives.  

Compensation Scheme of Last Resort

The Commissioner recommends that the Ramsay Review's recommendation for a compensation scheme of last resort should be implemented for areas where there have been recurrent losses, initially specified forms of financial advice, to be funded by those firms providing the relevant kinds of services. 

Simplification of Financial Services Law

The Commissioner considers financial services law should be simplified, in particular by removing exceptions to generally applicable norms of conduct.

Breach Reporting

The Commissioner recommends that the breach reporting recommendations of the ASIC Enforcement Taskforce should be implemented. This means:

• Extension of the breach reporting regime to Australian credit licensees.

• Significant breaches (and suspected breaches still under investigation) to be reported with 30 days. The law is to be amended to clarify that significance is an objective concept. 
• Increased criminal penalties and new civil penalties for failure to breach report.  

Additionally, although not the subject of an express recommendation, the Commissioner says ASIC should publish breach report data by individual licensees, and those who deal with licensees should get access to the reports. There is no discussion in the report as to the pros and cons of making reports available in this way – in particular, there is no discussion of whether it might inhibit detailed reporting and diminish the flow of information to ASIC.  

 

Authors: Lisa Simmons, Partner; Andrew Carter, Partner; Philip Trinca, Partner; Con Tzerefos, Partner; Meredith Bennett, Partner; George Cooper, Partner; Thomas Storer, Senior Associate; Andrew Westcott, Senior Expertise Lawyer; and Stephen Moore, Lawyer.