Australia: The Financial Services Royal Commission final report

What it can mean for Culture and Governance in all entities

The Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was released on Monday February 4, 2019.

As predicted, Commissioner Hayne delivered a lengthy report and a comprehensive set of recommendations across the banking, financial advice, superannuation and insurance sectors (FS sectors) as well as on culture, governance and remuneration (CG&R) and on the regulators. These have already been, and will remain, the subject of intense scrutiny by all stakeholders in the weeks and months ahead.

In light of the principles and issues that Commissioner Hayne has outlined in his report, his recommendations and supporting commentary should be viewed as relevant not only, of course, to financial service entities but also to entities operating in the non-financial corporate space. The content of the report has universal application especially on culture and governance.

Importantly, any interpretation of what Hayne is recommending or requiring, whether on CG&R or in relation to the FS sectors, must be informed by the clear approach that he has taken to key questions, underlying principles and general rules.

Hayne's approach

The Commissioner's central objective in the Final Report is to examine what can be done to avoid the misconduct in the FS sectors being repeated.

He starts with some key observations that has guided the Commission's work. In the context of CG&R, he observes that:

  • The misconduct was driven by the relevant entity's pursuit of profit and also by the individual's pursuit of gain, whether in the form of remuneration for the individual or profit for the individual's business.

He identifies a number of key questions that will be the basis of any policy response to the misconduct and shortcomings that prevailed in the FS sectors and which the Commission has publicly exposed. On the subject of CG&R, he asks:

  • What more can be done to achieve effective leadership, good governance and appropriate culture within financial services firms so that firms comply with six basic norms of conduct being
    • Obey the law
    • Do not mislead or deceive
    • Be fair
    • Provide services that are fit for purpose
    • Deliver services with reasonable care and skill
    • When acting for another, act in the best interests of that other

Hayne sees these six "very simple ideas" as being the building blocks for the proper conduct of financial service entities. They also support a number of general rules including, in the CG&R space, that "culture and governance practices (including remuneration arrangements), both in the industry generally and in individual entities, must focus on non-financial risk1, as well as financial risk".

The Report's recommendations all relate to, and respond to, one or more of his key questions and reflect one or more of the six norms. This is especially so in his commentary and recommendations on CG&R.

Primary responsibility

Hayne's final preliminary observation is stark. The Commissioner makes it very clear with whom primary responsibility for misconduct should lie – this is with the entities concerned and those who managed and controlled those entities: their boards and senior management.

He therefore sees the serious misconduct uncovered before and during the Commission hearings as resulting from a significant failure in corporate culture and governance.

Culture, Governance and Remuneration

Hayne explains his recommendations on CG&R in Chapter 6 of the report.

He starts by stating that every entity must ask itself the questions provoked by APRA's Prudential Inquiry into CBA (the final report of which is very much aligned with the recommendations that Hayne makes):

  • Is there adequate oversight and challenge by the board of emerging non-financial risks?
  • Is it clear who is accountable for risks and how they are to be held accountable?
  • Are issues and risks identified quickly, referred up the management chain and then managed and resolved urgently? Or does bureaucracy get in the way?
  • Is enough attention being given to compliance? Or is it just "box ticking"?
  • Do remuneration practices recognise and penalise poor conduct? How does remuneration apply when there are poor risk or customer outcomes? Does senior management feel the sting?

These are questions that any corporate entity could, and should, honestly ask itself on a continuous basis.

Hayne analyses with great clarity the interlinked nature of culture ("what people do when no-one is watching"), governance ("the structure and processes by which an entity is run") and remuneration (something, he says, that "tell[s] staff what the entity rewards"). He concludes with a thought that may resonate for some time:

"Culture, governance and remuneration march together. Improvements in one area will reinforce improvements in others; inaction in one area will undermine progress in others."

In short, if what has happened in the past is to be avoided in the future, then entities have no choice but to continuously grapple with CG&R. All three are inextricably linked. Each works with the others as a driver of behaviour (good or bad).

We will now look at some specific matters of culture and governance to assess the meaning and significance of Commissioner Hayne's recommendations and commentary on these critical topics.

Culture

In Hayne's view, there is no single "best practice" for creating a good culture, but one necessary aspect of a good culture is adherence to his fundamental six norms (a very good example of Hayne making an important comment and tying it back to a straightforward point of principle).

Culture may not be prescribed or legislated but it can – and must - be assessed both by the financial service entities themselves and also by the appropriate regulators, in this case ASIC and APRA. This is a clear message to those who have claimed that matters of culture are not the preserve of regulators.

Recommendation 5.6 states that all financial service entities should, as often as reasonably possible, take proper steps to assess the entity's culture, identify any problems with that culture, deal with those problems and determine whether the changes it has made have been effective.

These steps must be taken by the board and senior management.

Hayne emphasises that these steps should be taken by every financial services entity, named or not named in the Commission proceedings. A key point here is that these are actions to be taken continuously ("as often as reasonably possible"). Culture is never "fixed" – entities must keep on examining their culture.

Recommendation 5.7 deals with the external supervision of culture and governance on financial service entities. This states that APRA should set up a supervisory program around how APRA-regulated institutions build culture that mitigates misconduct risk and that APRA should assess the cultural drivers of misconduct in entities.

This is a clear requirement for this financial regulator to include consideration of organisational culture in its supervision activities.

Governance

Recommendation 5.6 makes the same point about governance – boards and senior management must constantly assess the quality of their organisation's governance.

And, as with matters of culture, Hayne is concerned that some external supervision is exercised over governance. So, Recommendation 5.7 requires APRA to encourage entities to give proper attention to the sound management of conduct risk and improving entity governance. His choice of words here is instructive – he uses the term "improving" because there is always room for improvement. Again, he is implying that the task of working on governance is never complete.

This suggests that entities should reserve a continuous board agenda item on the assessment of culture and governance. Alternatively, boards may need to widen the customary remuneration committee to include matters of culture and governance, to ensure continuous monitoring over these inter-limited issues. It would also focus the minds of committee members on the particular information they will need to monitor an organisation's performance in these areas. It should also ensure that questions of remuneration are firmly tied into relevant questions of culture and governance.

A crucial element in the assessment that Hayne recommends is whether a company has been effective in managing the organisation's risks – both financial and non-financial. It is, of course, the responsibility of the board and senior management to identify, assess and manage risks to the organisation.

Hayne hones in on two very practical features of governance that are critical to managing risk and that were particularly lacking in a number of financial services entities:

  • The need for boards to get the right information about emerging non-financial risks. This requires the board to:
    1. seek further or better information if what they have is deficient; and
    2. use that information properly in order to robustly challenge management's approach to managing these risks.
    If the board does not have the right information, it simply cannot effectively challenge management and properly discharge its functions.
    He notes that the evidence before the Commission showed that boards frequently did not get the right information about emerging non-financial risks. He also emphasises the need for the right information and not more information – quality not quantity.
    Hayne firmly lays the responsibility for getting the right information on boards and senior management.
  • The need for boards and senior management to be clear who within the financial services entity was accountable for what.
  • The evidence before the Commission showed frequent uncertainty or ignorance within financial service entities as to who was responsible for what actions or tasks. Such uncertainty destroys any form of effective accountability.
    Clear accountability is intrinsic to good governance. It ensures that problems are resolved effectively. It fosters a culture where risks are managed soundly. It is accountability that determines what consequences must follow when things go wrong (and where credit is due where things go right).
    These are matters of importance for any corporate entity. The consequences of not properly addressing these two needs can be, and were in the case of certain financial services entities, particularly adverse.

The Commissioner ends the chapter on CG&R by commenting on the willingness (or not) of certain boards to recognise and accept responsibility for the misconduct that occurred. He comments that there is a reluctance in some entities to form and then give practical effect to their understanding of what is ethical, of what is honest and fair, and of what is the "right thing to do".

The point he is making here is that boards and senior management:

  • Have to make judgments, or arrive at views, on what is ethical, honest and fair, and indeed on all aspects of non-financial risk – they cannot subcontract this responsibility to advisers and by so doing seek to avoid it; and
  • Must authentically accept responsibility for misconduct that has occurred in an entity which they have a duty to supervise – and then take effective steps to address that misconduct.

Closing points

In the same way that the APRA CBA Report could be usefully read by all corporate entities for clear guidance on culture and governance matters, Hayne's final report and particularly his recommendations and comments on CG&R provide firm guidance for all of corporate Australia.

Hayne is not advocating a novel or revolutionary approach, whether through changes in the law or changes in the conventional view of what amounts to good practice. Rather, he has re-emphasised the areas of good governance that were either ignored or de-prioritised by experienced boards who were responsible for overseeing financial services businesses.

He is clearly saying in his recommendations and his explanations that the board's and senior management's task of developing good culture and governance is never complete and is constantly evolving. Continual assessment of the fundamental pillars of good governance must happen. In short, complacency in the ranks of the board and senior management must be identified and addressed.

We should finish with some words from the Commissioner. He recognises that the necessary generality of the words of a recommendation (for example, Recommendations 5.6 and 5.7 referred to above) might allow some to too easily say that it "does not apply to us".

"But it does", he says, and "to ignore the recommendations...would be ignorant because those who will not learn from history will repeat it."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions