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financial services update 02 Oct 2018 Hayne Royal Commission Interim Report - Key themes 

Key themes and issues raised in the interim report

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 What you need to know

  • The interim report of the Hayne Royal Commission was released on Friday 28 September 2018.
  • The 3 volume report outlines issues identified by the Commission in relation to consumer lending, financial advice, loans to small and medium enterprise and experiences with regional and remote communities.
  • The interim report does not provide formal recommendations, but identifies a series of observations and questions about the structure of the financial services industry, potential reforms and simplification to the law, and how current legislation is interpreted and enforced.
  • The practices of ASIC and APRA have been closely scrutinised, with the Commission stating that neither body has marked and enforced the bounds of the law in a way that has prevented the conduct described in the report.
  • The final round of the Commission's public hearings will take place in November. The Commissioner's final report is due by 1 February 2019.

Release of interim report

On 28 September 2018, Commissioner Kenneth Hayne AC QC submitted an interim report covering Rounds 1-4 of the Financial Services Royal Commission to the Government. The interim report was released to the public shortly afterwards.

A snapshot of the report was published in our Financial Services Disputes Alert on Friday, and a more detailed summary of some of the key issues and questions for resolution that are identified in the report is provided below.

The Commissioner has not at this stage provided formal recommendations. Instead, the interim report makes several observations and asks a series of pointed questions to guide the industry in its reflection of the issues raised over the course of the hearings.  

Matters such as the remuneration of financial advisers and mortgage brokers, vertical integration within advice giving entities and the performance of the regulators have received particular scrutiny in the interim report, indicating that recommendations for change in these areas could be delivered as part of the final report, due by 1 February 2019.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was established on 14 December 2017. Six rounds of public hearings into specific issues have now been heard over 59 days, with the seventh (and expected final) round scheduled for 19-30 November 2018. As at 28 September, the Commission received over 10,000 public submissions. The Commissioner's responses to Round 5 (Superannuation) and Round 6 (Insurance) are not included by the interim report. 

General themes from the interim report

As noted above, the interim report does not include particular recommendations, but rather proceeds with an extensive list of questions on which the industry is expected to reflect. Nevertheless, there are a number of key themes which emerge from the report.

  • Use by regulators of enforcement powers – the interim report notes that historically the regulators, ASIC and APRA, have tended to shy away from legal proceedings seeking civil or criminal sanctions, in favour of administrative proceedings and agreed enforcement outcomes such as through enforceable undertakings, supported by voluntary remediation programs. It is reasonable to expect that ASIC and APRA will respond through a greater preparedness to take court proceedings in future.
  • Conflicts of interests – re-positioned as conflict of duty of provider and interest of customer –the interim report seeks to recast that concept of the management of conflicts of interest, by re-positioning the issue as one which involves not merely managing a conflict between the interests of a provider and the customer, but rather addressing a conflict of duty of a provider and the interests of the customer. It poses the question as to whether all intermediaries should be subject to a best interest duty (not just financial advisers, where the statutory obligation was introduced through FOFA). It is also in this context that questions are asked in relation to topics such as vertical integration, remuneration of intermediaries and employees. 
  • Culture, governance and accountability – the interim report unsurprisingly focuses extensively on the culture and governance of the financial institutions. It states "the conduct that is at the heart of the Commission’s work is inextricably connected with remuneration practices, with deficiencies in governance and risk management and with the culture of the entities concerned". It questions whether the industry, and regulators, are doing enough to manage conduct risk. It also poses the question as to whether the BEAR should be extended beyond the banks. It is clear that conduct risk, culture, governance and accountability will continue to be key drivers of regulatory responses in, and following, the final report.
  • The complexity of regulation – the interim report describes the regulatory regime as labyrinthine and overly detailed. The interim report considers that the conduct of institutions should be informed by a series of simple ideas, being: (a) obey the law; (b) do not mislead or deceive; (c) be fair; (d) provide services that are fit for purpose; (e) deliver services with reasonable care and skill; and (f) when acting for another, act in the best interests of that other. The interim report suggests that simplicity points firmly towards a need to simplify the existing law rather than add some new layer of regulation. One response from Government to this, from a policy perspective, might be a regulatory regime which is more principles, rather than rules, based – a recent example of which is the BEAR regime, where accountabilities are cast in broad, yet relatively simple, terms.

These themes are reflected in each of the specific areas covered in the interim report – consumer lending, agricultural consumer lending, financial advice, loans to small and medium enterprise and experiences with regional and remote communities.

Summary of issues raised in the interim report

Round 1 - consumer lending

Topic Issue Observations/Questions
Responsible lending

Interpretation and application of the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) (eg: requirement to verify a customer's financial situation)

              

Are current processes used by lenders meeting the requirements of the NCCP Act? 

Tension between responsible lending and the use of long sold products and processes, such as add-on insurance and pre-approved credit limit increases

Are certain types of add-on insurance, by their nature, poor value propositions for customers?

Are credit limit increases suitable for customers in the absence of verification of the customer's financial situation? 

Appropriateness of the Household Expenditure Measure (HEM) as a benchmark for repayment capacity

What steps should a lender take to verify a borrower's expenses? 

Should the HEM continue to be used as a benchmark for borrowers' living expenses?

Intermediaries (eg:
mortgage brokers,
mortgage aggregators,
introducers, financial
advisers, authorised representatives of
AFSL holders and representatives (at point of sale) of credit licensees)

Confusion about the roles of intermediaries, and who they are acting for

What duties does (and should) an intermediary owe a borrower?

What should be disclosed to a borrower about an intermediary's obligations to the lender and the borrower? 

How can a lender's systems be improved to provide better oversight and to better detect breaches of responsible lending obligations by intermediaries?

 

Round 2 - financial advice 

Topic issue observations/questions
Culture and
incentives

Concerns over how industry participants are paid and the impact this has on an entity's culture

Should any part of remuneration be dependent on value/volume of sales? 

Should all financial advisers (including those who now act as authorised representatives of an advice licensee) be licensed by ASIC?

"The unstated premise for so much of the debate about remuneration of both bank staff and intermediaries, that staff and intermediaries will not do their job properly and to the best of their ability without incentive payments, must be challenged."

"The simplest and most comprehensive severance [of the connection between individual conduct and entity profit] may be the adoption of a flat share of a variable pay pool that varies with overall entity performance."

Conflicts of interest
and duty/confusion over roles 

Management of conflicts of interests and meeting the best interests duty

Can conflicts of interest be effectively managed?

How can employers encourage provision of sound financial advice?

Grandfathered commissions (pre-FOFA reform) Should the grandfathered exceptions to conflicted remuneration now be changed?
Structure of advice giving entities 
Concerns over vertical integration – ie an entity manufacturing and selling products while at the same time advising customers what products to buy

How far can (and should) there be separation between providing financial advice and manufacture or sale of financial products? 

Should product manufacturers be permitted to provide financial advice at all, or to retail clients?

Regulator effectiveness  Appropriateness of responses to conduct examined in the Commission's hearings

Should negotiation and settlement be the main approach for a regulator?

Should self-reported breaches of the Corporations Act generally attract legal sanctions unless special circumstances exist? 

Should banning orders continue to be preferred to civil penalty proceedings in the case of misconduct? 

Should there be greater focus on criminal proceedings against licensees rather than individual advisers? 

Round 3 - loans to small and medium enterprises

Topic Issue Observations/Questions
Responsible lending to
small and medium
enterprise (SMEs)
Adequacy of the legal framework for lending to SMEs
Should lending to SMEs come within the NCCP Act? 
Code of Banking Practice
Differing views on the bounds and content of obligations within the Code, eg: the requirement that a lender will exercise the care and skill of a prudent banker, and assess a SMEs capacity to repay a loan

What inquiries should a lender make when deciding whether to lend to a SME?

Does 'forming an opinion about the customer's ability to repay' involve bringing critical analysis to the cash flow forecasts and other business plan documents? 

Third party guarantees 
Disconnect between how the law and lenders treat third party guarantors and the reality of the role played by many (if not most) guarantors to SMEs (eg family members) 
Should lenders be required to give potential guarantors more information about the borrower or proposed loan? 
Role of External Dispute
Resolution Schemes (eg Financial Ombudsman
Service (FOS) and the Australian Financial Complaints Authority (AFCA))
Dissatisfaction by customers to the resolution of claims by FOS/AFCA

What remedies should be available to borrowers (eg restoration to position had loan not been made, or possible award of compensation for loss?) 

Are there circumstances where a borrower's debt should be waived? 

 

Round 4 - experiences with regional and remote communities

Topic Issue observations/questions
Difficulties in obtaining access to banking services and support

Banks' power to close down/sell farms 

Should distressed loans be managed only by experienced agricultural bankers? 

Application of Banking Code of Practice to agricultural businesses Does the Code provide adequate protection to agricultural businesses? 
Revaluation of securities
Difficulty in accurately valuing property offered as security 
How and by whom is a valuation to be undertaken?
Changes to conditions of lending

Effects of events beyond the control of the individual 

How are borrowers and lenders to deal with the consequences of uncontrollable and unforeseen external events?

Application of default interest Should this be waived in circumstances, such as borrowers in drought-declared areas?
Enforcement by appointment of external administrators Circumstances of appointment

Should appointment of an external administrator be the enforcement measure of last resort? 

Should there be a national system for farm debt mediation? 

Communication with customers in remote communities  Concerns with communication problems for uncomplicated relationships (eg: account opening) Do financial services entities have appropriate policies and procedures to address communication barriers and obstacles when dealing with Aboriginal and Torres Strait Islander people?

Other - regulation and the regulators

Topic Issue Observations/questions
Current laws and regulatory framework

Complexity of the law governing financial services





Does the law impede effective conduct risk management?

Does the law impede effective regulatory enforcement? Is it too complicated? 

"I begin from the premise that no new layer of law or regulation should be added unless there is a clearly identified advantage to be gained by doing that. And I begin from the further premise that very simple ideas must inform the conduct of financial services entities." 

Appropriateness of responses to misconduct identified by the Royal Commission Has ASIC/APRA's response to misconduct been appropriate? If not, how can inappropriate responses be prevented? 
ASIC / APRA 
Remit and practices of the financial services regulators

Are ASIC/APRA's enforcement practices satisfactory? Should the default position be that ASIC starts enforcement proceedings where there is a reasonable prospect of proving a contravention? 

Is ASIC's remit too large? Are some tasks better detached from ASIC?

Does the conduct identified in the report call for reconsideration of APRA's prudential standards on governance? 

Is there a case for a new supervisory body to be established? 

What's next?

Policy submissions on the interim report and Round 6 (Insurance) are now invited and can be made until 26 October and 25 October 2018, respectively.  Submissions can be made using the form available from the Commission's public submissions page. 

The next round of hearings (Round 7) will focus on policy questions arising from Rounds 1-6. Round 7 will be held in Sydney from 19 November and Melbourne from 26 November 2018. Topics and case studies to be heard will be published prior to the hearings commencing. 

The Commissioner's final report is currently required to be delivered by 1 February 2019.

 

Authors: Jonathan Gordon, Partner; Andrew Carter, Partner; Corey McHattan, Partner; Silvana Wood, Counsel; and Charlotte Ryan, Senior Associate.

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Read our Financial Services Disputes Alert

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Financial Services Disputes Alert

Interim report delivered by the Hayne Royal Commission

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The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions.

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