On Friday morning, Kenneth Hayne drove to Yarralumla to provide Governor-General Sir Peter Cosgrove a copy of the Final Report (the Report) of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Royal Commission).
In spite of the (relatively) meagre resources afforded to the Commissioner and the oppressive timeframe, few could have imagined quite how much the Royal Commission has unearthed.
The headlines have been eye watering - the deceased being charged premium for life insurance and fees for financial planning services, rampant fee gouging, hidden commissions, widespread conduct falling below expected community standards.
Earlier this afternoon, just after the financial markets had closed for the day in Sydney, the Report was released to the public. The Report is voluminous, stretching to some 1,133 pages with annexures, and we set out below:
- the themes and ‘general rules’ emerging from the Report;
- a table containing the Commissioner’s 76 Recommendations for change to the law for Australian financial institutions (together with our comments);
- the Government’s immediate reaction to the Report.
The Commissioner identified a series of general rules (at paragraph 1.5.2 of the Report) which inform many of the individual recommendations as to the changes to be made to the regulatory and legal framework in which financial institutions trade. The Report identified these general rules as:
- the law must be both applied and enforced;
- industry codes should be approved under statute and any breach of a key promise made to customers in the codes should be a breach of statute;
- no financial product should be ‘hawked’ to retail clients;
- intermediaries should act only on behalf of, and in the interests of, the party who pays the intermediary;
- exceptions to the ban on conflicted remuneration should be eliminated;
- culture and governance practices (including remuneration arrangements), both in the industry generally and in individual entities, must focus on non-financial risk, as well as financial risk.
Against this background, the Commissioner’s Report makes 76 individual recommendations as to how the environment in which financial institutions operate in Australia can (and should be) improved.
We have compiled a table, at the foot of this article, setting out all 76 recommendations and our preliminary comments.
Some immediate highlights for insurers engaged in the financial lines industry, should the recommendations be adopted, include:
- insurance contracts will be subject to the unfair contract term regime. Further, claims handling will be considered a ‘financial service’ (it was previously exempt) meaning that penalties will potentially apply for claims handlers’ breaches.
- the industry’s Insurance Code of Conduct is likely to be fortified, approved and monitored by ASIC and consumers may choose to contest breaches to the Code under internal dispute resolution mechanisms or via the Courts;
- ASIC and APRA, will likely be provided with greater powers and increased mandate to enforce regulatory breaches. These regulatory bodies will also be subject to greater scrutiny by an overseer body as well as twice-annual reviews and direct instructions to collaborate and share information;
- there will be a big move towards ‘fee for service’: grandfathered commissions will be banned for financial advice, and ongoing fees will be outlawed unless agreed to on an annual basis.
The Federal Government has already been quick to publicly accept all of the recommendations in the Report. This afternoon, Treasurer Josh Frydenberg promised to immediately put in place “the legislative framework which provides the regulators with the powers and the resources to hold those who abuse our trust to account”.
75 of the 76 Recommendations look set for adoption by the Morrison Coalition Government. The one exception appears to be that that banning of commissions to mortgage brokers may be excluded (on the basis that a number of other reports have questioned the potential impact this may have on competition).
Whilst it remains to be seen what can be achieved between now and the next election (beyond the inevitable attempts at political point scoring), in circumstances where Labor has also provided its support for all of the recommendations, we anticipate that legislative changes will begin to occur later this year.
Recommendations & Commentary
The NCCP Act should not be amended to alter the obligation to assess unsuitability
The Commissioner considers that the banks are already making changes so that they are less reliant on benchmarks. In his view, tightening of credit can be absorbed by housing market and ensuring legal compliance should overall enhance macroeconomic performance not detract from it
Intermediated Home Lending
The law should be amended to provide that, when acting in connection with home lending, mortgage brokers must act in the best interests of the intending borrower. The obligation should be a civil penalty provision
The obligation will give statutory recognition to what borrower's currently expect of brokers. It is not an obligation that should affect the practices of lenders and, accordingly, it is not a change that should affect the price or the availability of credit, whether to consumers, small business borrowers or others.
The borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending.
The present system of remunerating mortgage brokers is conflicted remuneration - it can reasonably be expected to influence the broker’s recommendations about choice of lender, amount to be borrowed, the terms on which the amount is borrowed, and the influence is in favour of the party paying the commission (i.e. the lender). This is contrary to the borrower's belief that they come to a broker for advice that is in their best interests.
A Treasury-led working group should be established to monitor and, if necessary, adjust the remuneration model referred to in Recommendation 1.3, and any fee that lenders should be required to charge to achieve a level playing field, in response to market changes.
The working group should include representatives from the ACCC and APRA and pay particular attention to the effect of the changes on interest rates; the effect of the changes on competition between lenders; the effect of the changes on competition between lenders and brokers; and developments in the residential mortgage market that mean that the changes proposed should be re-evaluated
After a sufficient period of transition, mortgage brokers should be subject to and regulated by the law that applies to entities providing financial product advice to retail clients.
Whilst this would bring with it additional requirements for brokers, including the need to provide written statements of advice and educational requirements expected of other financial advisers, there is no valid reason why mortgage brokers should be treated any differently to financial advisers, so as to justify the current carve outs
ACL holders should:
For the same reasons, to the extent that these requirements have been recommended for financial advisers, they should also be requirements for mortgage brokers
Intermediated Auto Lending
The exemption of retail dealers from the operation of the NCCP Act should be abolished.
This is aimed at ensuring that retail dealers are subject to entry or conduct standard, so that ASIC can exclude those that engage in conduct that is dishonest or incompetent; they have responsible lending obligations; and consumers can obtain remedies for their conduct
Access to Banking Services
The ABA should amend the Banking Code to provide that banks will work with customers who live in remote areas or
This recommendation appears aimed at avoiding some of the worst instances of banks taking advantage of rural and indigenous communities.
Lending to small and medium enterprises
The NCCP Act should not be amended to extend its operation to lending to small businesses.
This is designed to ensure small business continue to have access to credit: extending the responsible lending provisions in the NCCP Act would likely increase the costs of credit for small business and reduce the availability of credit.
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.
As above, this is designed to ensure small businesses will have access to credit: the change in definition will reduce complexity as to what constitutes a 'small business' from the current 3 part test in the Banking Code
A national scheme of farm debt mediation should be enacted.
A series of methods were suggested to address common issues faced by those in regional or rural communities. unify state based schemes to ensure fairness to farmers in financial distress
APRA should amend Prudential Standard APS 220 to ensure fairer and holistic valuations of rural land is required by Banks
Revising land valuation methodology to be employed by Banks
Banks should not charge default interest on agricultural loans in an area declared to be affected by drought or other natural disaster.
This will reduce the potentially punitive effect of defaulting to an higher interest rate when a rural area is effected by natural disaster
Banks dealing with distressed agricultural loans should ensure that those loans are managed by experienced agricultural bankers and include recourse to various methods (including recommendations 11-13 above)
Enforceability of industry codes
The law should be amended to provide that ASIC’s power to approve codes of conduct extends to codes relating to all APRA-regulated institutions and ACL holders. Also, that industry codes of conduct approved by ASIC may include ‘enforceable code provisions’, which are provisions in respect of which a contravention will constitute a breach of the law and for the establishment and imposition of mandatory financial services industry codes.
This signals a move away from relatively passive industry self-regulation model of 'codes of conduct' towards proactive heightened role for ASIC in approving and enforcing industry codes of conduct,
In respect of the Banking Code that ASIC approved in 2018, the ABA and ASIC should take all necessary steps to have the provisions that govern the terms of the contract made or to be made between the bank and the customer or guarantor designated as ‘enforceable code provisions’
The Banking Code may extend to providing a private right to choose whether to enforce a breach of an enforceable code provision through internal dispute mechanisms or through the courts
After appropriate consultation, APRA should determine for the purposes of section 37BA(2)(b) of the Banking Act, a responsibility, within each ADI subject to the BEAR, for all steps in the design, delivery and maintenance of all products offered to customers by the ADI and any necessary remediation of customers in respect of any of those products.
This is designed to render Banking executives more accountable for processing and administrative errors and engage in remediation programs where breaches have occurred
Superannuation & Insurance
The trustee of an RSE should be prohibited from having another role or office
This suggestion is primarily aimed at reducing the potential for trustees to develop conflicts of interest
Deduction of an advice fee from a MySuper account should be prohibited
This would prevent unreasonable fees being charged on MySuper superannuation products
Deduction of any advice fee other than MySuper accounts should be prohibited absent the client’s express written authority
This would implement the above recommendation in relation to non-MySuper funds
Hawking of superannuation products should be prohibited
A significant recommendation, which would curtail uninvited approaches from superannuation funds
Nominating Default Funds
A person should have only one default account.
This recommendation appears aimed at avoiding situations where individuals are members of multiple funds and pay multiple fees
Under threat of civil penalty, trustees of a regulated superannuation fund should be prohibited from enticing
Aimed at avoiding situations where employers are "bribed" to ensure their employees enter into a particular super fund
Breaches by a trustee of sections 52, 29VN, 52A or 29VO of the SIS Act should be enforceable by action for civil penalty
The roles of APRA and ASIC with respect to superannuation should be adjusted.
The Commissioner recommends that APRA be responsible for establishing and enforcing Prudential Standards and ASIC focus on the relationship between RSE licensees and individual consumers.
Over time, provisions modelled on the BEAR should be extended to all RSE licensees, as referred to in Recommendation 6.8.
Ongoing fee arrangements
Legislative amendments to provide that ongoing fee arrangements be renewed annually by the client, record in writing the services to be received by the client for the year and total of fees to be charged. The payment of fees from any account can only be done with the client's express written authority.
Changes to the substance of ongoing fee arrangements rather than the form in which these arrangements are given effect.
Lack of independence
Legislative amendments to require a financial advisor who would contravene 923A Corps Act by assuming or using restricted words (independent, impartial and unbiased), must before providing personal advice give to the client a written statement explaining why the advisor is not independent, impartial and unbiased.
At present there is no requirement for a financial advisor who does not satisfy those requirements to explain to a retail client that they are not independent.
Quality of advice
Government review in three years time in consultation with ASIC as to the effectiveness of the measures implemented by the Government, regulators and financial services entities to improve the quality of financial advice (by 30 June 2022 and no later than 31 December 2022) including whether it is necessary to retain the 'safe harbour' provision in s961B Corps Act.
This review should consider changes in law, changes in the practices of regulators and financial services entities whether made in response to changes in the law, or otherwise. Further changes will be necessary in the event these initial changes have not sufficiently improved the quality of advice provided by financial advisors.
Grandfathering provisions for conflicted remuneration should be repealed as soon as reasonably practicable.
Grandfathering provisions can no longer be justified and have generally outlived their validity with each of the major banks already announcing steps to reduce or eliminate payments of grandfathered commissions.
As part of ASICs review of conflicted remunerations relating to life risk insurance products and the operation of the ASIC Corporations (Life Insurance Commissions) Instrument 2017/510, ASIC should consider further reducing the cap on commissions in respect of life insurance products unless there is a clear justification for retaining those commissions. ultimately the cap should be reduced to zero.
Unless the reduction in life insurance commissions can be shown to contribute significantly to underinsurance, there is no justification for allowing this form of conflicted remuneration to continue to be paid. Ultimately the decision lies with ASIC, and should commission continued to be paid and received in relation to life insurance products, there should be clear evidence to demonstrate that the harm that would flow from abolishing such commissions would outweigh the harm that already flows from allowing this form of conflicted remuneration to continue.
The review referred to in 2.3 above should also consider whether each remaining exemption to the ban on conflicted remuneration remains justified including the exemptions for general insurance products and consumer credit insurance products and the exemptions for non-monetary benefits set out in s963C Corps Act.
By the time of the review referred to in 2.3, the exemptions for general insurance, consumer credit insurance and non-monetary benefits will have been in place for 10 years. If these exemptions are still in place at this time, it will be appropriate for ASIC to consider whether each of them remains justified.
Professional discipline of financial advisors
All AFSL holders should be required as a condition of their licence to give effect to reference checking and information sharing protocols for financial advisors, to the same effect as now provided by the ABA in its 'Financial Advice - Recruitment and Termination Reference Checking and Information Sharing Protocol'.
Creation of a formal mandatory reporting system for serious compliance concerns which will form an important part of a unified disciplinary system for financial advisors and to ensure the nature and full extent of any misconduct is uncovered and acted on appropriately.
All AFSL holders should be required as a condition of their licence to report 'serious compliance concerns' about individual advisors to ASIC on a quarterly basis.
All AFSL holders should be required as a condition of their licence to take the following steps when they detect that a financial advisor has engaged in misconduct in respect of financial advice given to a retail client: make whatever inquiries are reasonably necessary to determine the nature and full extent of the advisors' misconduct, and where there is sufficient information to suggest that an advisor has engaged in misconduct, tell affected clients and remediate those clients promptly.
Legislative amendments to establish a new disciplinary system for financial advisors that:
The aim of the disciplinary system is to ensure that advisors who engage in misconduct face appropriate consequences, and that where appropriate, the consequences imposed on advisors extends beyond their association with a particular licensee. The system of mandatory notifications is necessary to overcome the
Manner of Sale: Hawking
The hawking of insurance products to be prohibited
funeral expense policies to be classed as financial products
(making it clear such policies are subject to the ASIC Act)
working group should be established to develop best practice model for sale of 'add-on insurance'
ASIC should impose a cap on commission to vehicle dealers to add-on insurance products
Part IV of the Insurance Contracts Act should be amended for consumer contracts, to replace the duty of disclosure with a duty to take reasonable care not to make a misrepresentation to an insurer (and consequential amendments to the remedial provisions of the ICA)
A significant recommendation for insurers, these amendments (if made) would limit insurers' ability to avoid policies of insurance (or limit their exposure) in instances of non-disclosure
Section 29(3) of the ICA should be amended so that an insurer may only avoid a contract of life insurance on the basis of non-disclosure or misrepresentation if it would not have entered into a contract on any terms
A further limitation of insurers' ability to limit their exposure to claims in instances of non-disclosure and/or misrepresentation
Unfair Contract Terms
Unfair contract terms provisions of the ASIC Act should apply to insurance policies regulated by the ICA.
This provides an extra layer of protection to insureds, above and beyond the principle that an insurer must act in the utmost good faith
The handling and settlement of insurance claims or potential insurance claims should not be excluded from the definition of a 'financial service'
This is another significant recommendation. In a practical sense, such a change would appear to mean that the claims handling process of insurers would come under far greater scrutiny. The failure to handle or settle an insurance claim in a fair, reasonable and defensible manner may now bring ramifications for the insurer and claims handler.
Status of Industry Codes
The establishment and imposition of mandatory industry codes with enforceable provisions by the Financial Services Council, the Insurance Council of
Such changes will provide a further mechanism for ensuring best practice on the part of insurers
The Life Insurance Code of Practice and
External Dispute Resolution
Section 912A of the Corporations Act amended to require AFSL holders to co-operate with AFCA in its
This recommendation would provide AFCA (still a fairly new body) with increased powers to deal with insurance disputes
Provisions modelled on the (Banking Executive Accountability Regime) BEAR should be extended to all APRA-regulated insurers
This would involve the production of "accountability maps" for senior insurance executives to ensure the maintenance of prudential standards
Group Life Policies
Consider legislating universal key definitions, terms and exclusions for default MySuper group life policies.
Require Registerable Superannuation Licensees (RSE) that engage a related party to provide group life insurance, to provide APRA independent certification that the policies satisfy legal and regulatory requirements.
RSE licensees to be satisfied that the rules by which a particular status is attributed to a member are fair and reasonable.
Culture, Governance & Remuneration
APRA to incorporate Financial Stability Board Principles, effective governance of compensation, alignment of compensation with prudent risk taking and effective supervisory oversight and engagement by stakeholders.
APRA should aim not only manage financial risk, but also misconduct, compliance and other non-financial risks
APRA to require remuneration schemes manage non financial risks, limit use of financial metrics for long-term remunerations, recover vested remunerations and encourage quality of information given to boards
Mandate financial services entities to review their remuneration systems for front line staff focusing on how things are done
Banks should fully implement Sedgwick Review recommendations
A 2017 report which made 21 recommendations, relating to governance, culture and performance management.
Culture and Governance
All financial services entities should assess, identify problems and rectify problems
APRA to build a supervisory body focused on implementing cultures which mitigate risk of misconduct using a risk-based approach.
The suggestion is to encourage environments where cultural drivers of misconduct are discouraged and entities are encouraged to mange and improve governance.
Twin peaks' model of financial regulation should be retained
In short, APRA should continue to be responsible for prudential regulation and ASIC for regulation of conduct and disclosure.
ASIC enforcement practices
ASIC should firstly ascertain if a court should determine consequences of contraventions and avoid issuing infringement notices for anything but administrative failures of small corporations.
APRA's role is to establish and enforce Prudential Standards and Practices, while ASIC oversees the relationship between RSE licensees and individual consumers
ASIC to be empowered to enforce SIS ACT relating to civil penalty provisions or those giving rise to a cause of action against an RSE licensee or director. The regulations to be co-regulated by ASIC and APRA
APRA should retain its current functions, including those related to RSE licensees
The BEAR: Co regulation
ASIC and APRA should jointly administer the BEAR.
Amend Banking Act to make it clear an accountable person must deal with APRA and ASIC in a open, constructive and co-operative way
Provisions modelled on the BEAR should be extended to all APRA-regulated financial services institutions and be jointly managed by ASIC and APRA.
Co-ordination and information sharing
Amend legislation to facilitate ASIC and APRA co-operation through sharing information and notifying of breaches
Memorandum drafted by ASIC and APRA stating how they will co-operate and reports by each entity on compliance to be drafted annually. This document is to be reviewed biennially.
ASIC Act amended to address issues of time and place of meetings, quorum requirements, presiding members and voting processes.
ASIC and APRA, with proposed external oversight body, should internally formulate and apply accountability principles similar to those established by the BEAR.
APRA and ASIC should be subjected to quadrennial capability reviews, with APRA requiring a review as soon as reasonably practicably.
One of the few recommendations aimed are ensuring the regulators continue to improve
Independent oversight body established to assess effectiveness of each regulator, with reports to the Minister biennially.
Again, another mechanism for ensuring the regulators operate at an acceptable level
Other Important Steps
External Dispute Resolution
Implement recommendations by governmental panel to establish a compensation scheme of last resort
A significant development, a recommendation that the Government establish a fund from which victims of financial misconduct (unable to recover elsewhere) can be compensated
ASIC Enforcement Review Taskforce Government Response
Implement ASIC Enforcement Review Taskforce recommendations relating to self-reporting by financial services and credit licensee's
Simplification so that the law's intent is met
Eliminate exceptions and qualifications to generally applicable norms of conduct found in legislation governing financial service entities
Legislation governing financial services should identify what fundamental norms are being pursued, when detailed rules are made relating to subject specific matters