The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Financial Services Royal Commission) seventh and final round of public hearings commenced on 19 November and ran until 30 November. The focus of the hearings was on the causes of misconduct and conduct falling below community standards and expectations by financial services entities (including culture, governance, remuneration and risk management practices), and on possible responses, including regulatory reform. In addition, the hearings considered the role of the regulators, the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) in supervising the actions of financial services entities, deterring misconduct by those entities, and taking action when misconduct may have occurred.
A high level overview of some of the issues explored in the course of questions to ANZ CEO Shayne Elliott, Chair of Bendigo and Adelaide Bank Ltd (Bendigo) Robert Johanson and APRA Chair Wayne Byres is below.
[Note: For coverage of the some of the issues to arise in the first week of Round 7 hearings (see: Governance News 26/11/2018; and week 2 see: 03/12/2018]
No submissions: Unlike in previous rounds of hearings, Counsel Assisting did not identify any particular findings as being open on the evidence. There is also no process for the entities involved in this round of hearings to make further submissions to the Commission. Rather, Counsel Assisting said that the matters raised over the course of found 7 would inform the recommendations in the Commission's final report.
Timeline: The Commission is due to release its final report on 1 February 2019.
Questions to ANZ CEO Shayne Elliott included questions concerning the need (or not) for regulatory reform in relation to breach reporting and remediation, the topic of bank closures (and whether lenders have any obligation to keep uneconomical branches open) and remuneration (among other issues).
Breach Reporting (need for regulatory intervention or not)
- More specific guidance from ASIC on what constitutes a significant breach would be useful: Mr Elliott was asked a number of questions on the topic of breach reporting, remediation and changes being implemented at the lender to address past issues. Counsel Assisting asked for his views on whether amending s912D of the Corporations Act 2001 (Cth) in line with the ASIC Enforcement Taskforce Recommendation would address 'uncertainty' around when breaches should be reported. Mr Elliott said that this would 'certainly help' in that it would make it 'far easier if there was an objective measure of significance' though he qualified this by adding 'I don’t want for a minute to suggest that that’s the only solution. I mean, I think as an organisation there’s an onus on us to be clear about how we define significance'. Noting that number of customers and financial impact are 'all matters referred to in the legislation already', Counsel Assisting queried what further information he would like to be included in a 'formal definition' of a significant breach. Mr Elliott responded that he would like to see more specificity, 'it does not give me a number and suggest that is significant…Those I believe, is what we're talking about when we're talking about more objective measures, given some guidance to help us determine that this has now become significant' he said. Asked whether it would be 'unrealistic to legislate particular figures attached to number of customers' or to 'amount of remediation necessary' Mr Elliott agreed, stating 'I’m not suggesting that it necessarily needs to be legislative change, but perhaps just guidance from the regulator or some best practices, some guidelines. Anything that can give greater clarity would be helpful'.
- Should banks form their own criteria, rather than relying on legislative/regulatory reform? Commenting that 'control is in the drafting', Commissioner Hayne asked Mr Elliott whether it would be 'useful, important, desirable, for entities like ANZ to form their own criteria' for assessing the significance of a breach, to which Mr Elliott agreed. Asked whether formalising these sorts of criteria to assist the organisation in assessing the significance of a breach, going forward, was part of ANZ's existing breach reporting project, Mr Elliott said it would be one of the things considered. 'I believe we do need to do that work ourselves and then I think it would be responsible and prudent for us to share that with our regulators for comment' he added.
- Shorter timeframes for reporting? Counsel Assisting asked Mr Elliott for his views on other ASIC Enforcement Taskforce Review recommendations in relation to s912D. Asked for his views on shortening the timeframes for reporting (to require that significant breaches and suspected breach investigations be reported within 30 days) Mr Elliot said that 'we support the concept…whether it’s 30 days or 20 or 40, I – you know, I don’t know. But the general idea, I think, is a good one'.
- Expanding the range of penalties? Asked for his view on increasing criminal penalties and adding a civil penalty option for noncompliance with s912D, Mr Elliott said that 'there is a role for penalties in any governance system. And if they are balanced and if they are thoughtful in terms of their – the setting of the appropriate levels, then I completely understand that there’s a role for increasing the penalties'. He added that 'if we set penalty too high and too draconian we always run the risk of driving behaviour underground. That people are less reluctant to speak up because they now fear personal penalty'.
- Approach to remediation: The Commission heard that historically it has taken the lender on average more than four years to identify an incident that’s later determined to be a significant breach, which Mr Elliott attributed in the main to the complexity and decentralised structure of the business, and limitations of the systems and processes in place to proactively identify breaches. The Commission also heard that the lender has not met remediation timelines given to the Commission. Mr Elliott then described changes being implemented to address this, including moving towards a three month timeframe for remediating customers.
Product design processes: could improvements at design stage, prevent future issues?
Commissioner Hayne questioned whether the work of reviewing and decommissioning certain products had assisted the lender 'in product design processes within the organisation to redesign products', which Mr Elliott agreed to be the case. The Commissioner then queried whether issues could be resolved at product design stage, 'I am struck by both the number and size – industry-wide, not confining this to ANZ Banking Group – I am struck by the number and size of so called processing or administrative errors. Now, the immediate response I have is why was this not fixed before the event, why is it coming out after the event. Now, is that – no doubt it is a naive and simple approach to it but are these things that can and should be picked off at product design level?' he asked. Mr Elliott agreed that they could be, adding that having a 'single point of accountability' will also assist (in the case of ANZ).
- Factors in determining whether branches should be closed: Mr Elliott was asked a number of questions in relation to the closure of branches and the factors taken into account by the lender when determining when a branch should be closed. The Commission heard that there is little economic justification for keeping branches open. Asked whether the demographics of an area, or the availability of internet services are factors in determining whether to close a branch Mr Elliott said that the assumption that older people are less comfortable with technology was not necessarily true, and that consideration is not currently given to the availability of internet services though he added 'I think we should take it into account'.
- Public interest reasons for keeping branches open? Counsel Assisting asked whether there are 'circumstances in which banks should continue to operate branches in regional or remote locations, even when those branches are not profitable?' Mr Elliot responded that though consideration had been given to the question, it's 'not an easy topic'. He went on to say, 'I'm not convinced that ANZ is very good at it, in terms of running regional and remote branches' due to the complexity of understanding customer needs in remote communities, and the difficulties of finding 'appropriate' employees.
- Actions to assist Aboriginal and Torres Strait Islander customers living in remote regions: Mr Elliott was asked a number of questions in relation to ANZ's commitments to improving services to remote Indigenous customers. Planned changes include: reworking security questions, provision of training to assist staff in assisting Indigenous customers, the decision to cease providing informal overdraft facilities on transaction accounts where the customer is in receipt of certain Centrelink benefits (so that certain Centrelink recipients will be unable to unintentionally overdraw their transaction accounts except in limited circumstances), the decision to cease charging dishonour fees on pensioner advantage accounts and taking additional steps in relation to ensuring compliance with the 90% arrangements (the principle that recipients of government benefits should be able to retain at least 90% of those benefits in any fortnightly period).
Remuneration and incentives
Mr Elliott was asked a number of questions in relation to the approach ANZ takes to remuneration, including in relation to a project to implement the Sedgwick recommendations. The Commission heard that there is an 'unapproved plan' across the ANZ group to decrease variable remuneration and to increase fixed remuneration 'for everybody at ANZ. This is not just frontline'.
- Move from individual to group financial targets for frontline staff: The Commission heard that ANZ is conducting a pilot to test whether having team financial targets (rather than individual targets) would improve customer experience and banker experience without negatively impacting business performance. The Commission heard that the results are 'encouraging' in that: a) there was 'no material drop in financial performance, b) customers 'appear to be achieving better outcomes or certainly better experience' and; c) frontline staff 'say they prefer it'. He went on to say that moving away from individual targets would require a 'shift' in thinking for some staff and that investment in 'mechanisms' to recognise team achievement, and reward individuals in a 'broader sense rather than just money' would be needed to support the change. The Commissioner suggested that the success of the change would depend on the 'quality of your junior leaders' to which Mr Elliott agreed.
- There is a role for sales targets/incentives: The Commission heard that ANZ has undertaken a number of pilot programs to test the impact of removing and/or reducing variable remuneration for frontline staff. In the pilot where all financial metrics were removed (for frontline staff and their managers), the commission heard that while customer outcomes were good, financial performance 'fell off'. Mr Elliot explained that customer outcomes is not the only measure of the right outcome, given the bank is a commercial enterprise, 'I would rather our customers were happy with the experience than not but that in and of itself does not define the right outcome' he said. He added that as a commercial enterprise, ANZ's position is that there is a role for sales targets and incentive plans that take into account 'whole of role performance through a balanced scorecard approach'.
- Level of detail in the remuneration report — should remuneration reports include information about why remuneration was reduced? A number of questions to Mr Elliott concerned the level of detail appropriate to include in remuneration reports concerning decisions to reduce executive remuneration due to compliance issues. Counsel Assisting suggested that remuneration reports should include more information about why executive remuneration had been reduced, as an accountability mechanism and as a means of communicating the consequences of misconduct. Mr Elliott said that though he could 'understand that perspective to give a richer evaluation or – or a summation of how decisions were made or how to make linkages between the outcomes and performance', there 'could be unintended consequences' of publishing the information. He maintained that there is a distinction between publishing the reasons for reducing CEO remuneration, and publishing the reasons for reducing the remuneration of senior executives on the basis that the CEO is ultimately accountable. He said: 'I’m the ultimate accountable person beside our board for this. I have a higher degree of responsibility and accountability than anybody else in the company. What comes along with that is more public scrutiny and involvement in – in – in this case shareholder – requiring of shareholder approval. I think that’s entirely appropriate. Could it go deeper in the organisation? That’s open to discussion. But I think I am – it is different for the chief executive'.
- No clawback mechanism: The Commission heard that ANZ does not currently have a clawback mechanism to reclaim remuneration already delivered/paid to executives, but that it is 'the subject of debate at the moment' within the lender. 'I can’t tell you there’s an active working group on it but I know that we talk about it at that – at that review group and certainly at the HR committee I’m sure we will continue to – to do so' he said.
- The two strike rule: Asked for his views on whether the two strike rule impedes creating a remuneration structure that prioritises, in the view of the organisation, good customer outcomes, Mr Elliott said that he is 'concerned that shareholders today, irrespective of their size, have very few avenues for expressing their perspectives to a company. And understandably, I think we’ve seen shareholders use that to have a voice on other issues. So I am concerned about – about that'.
- Broker remuneration: The Commission heard that Mr Elliot supported considering alternative models for broker remuneration to ensure that the current model remains appropriate and better than any alternative. However, Mr Elliot said that moving to a flat fee model would incur the risk that people seeking smaller loans would no longer use a broker (because it would not be economical to do so) and that as a result, 'a broker becomes a service for the wealthy, much like financial planning has become).
- Benchmarking information: Mr Elliott was asked a number of questions in relation to the culture at ANZ, the work being undertaken to create a 'speak up culture' and measures being implemented to assess and monitor culture at the lender. Among other things, Counsel Assisting asked for his views on whether 'benchmarking information' in relation to culture — 'information how your culture compares to the culture of other banks' — would be useful. Mr Elliott said that there's 'always value in getting external data. I think there’s a danger – and, again, only hearing this, essentially, for the first time – I think there’s a danger in some benchmark reviews, in that they imply there is the right answer, that – that somehow there is – we’ve defined perfection and we measure you. Culture is situational. It depends on your business and your strategy and what you are trying to achieve'.
- Role of the regulators in 'assisting' with culture: Asked for his views on the role of regulators in 'assisting' entities in relation to culture, Mr Elliott said that they have a role in 'giving us guidance and a – a perspective. I don’t know that they – again, given that culture is situational, it does depend on what you are trying to achieve. I think their role should be more advisory and perhaps giving guide rails, rather than being prescriptive, like they might well be with capital, for example'. Asked whether they should have a role in 'calling out poor culture', Mr Elliott agreed that they should. Asked at what level of the organisation, regulators should be providing this feedback, Mr Elliott said that it should be provided to the board and the executive committee level but that 'at the end of the day, the executives are the ones who have to operationalise [any feedback]…so that feedback should also be direct to them.'
Bendigo and Adelaide Bank Ltd
Questions to Chair of Bendigo and Adelaide Bank Ltd (Bendigo) Robert Johanson focused on the theme of remuneration at both executive and frontline level, and more particularly, the way in which remuneration is structured at Bendigo.
- The Commission heard that the approach taken to remuneration at Bendigo differs from that of other banks in that: a) Bendigo has historically, and continues to weight its executive remuneration not towards variable remuneration but towards the base pay or fixed pay of executives; b) includes a non-financial 'hurdle'; and c) part of executives' fixed remuneration (base salary) (as well as part of short term, and long term incentives) is deferred, and can be clawed back by the board, during the deferral period. Asked whether there are disadvantages flowing from this system, Mr Johanson said that there were none, 'it has worked very well for us' he said. Asked why short term variable remuneration for executives was lower than at other banks, Mr Johanson said that it is aimed a focusing the business on 'the long term'. In addition, the Commission heard that no bonuses are paid unless the bonus pool is created (it is created at the discretion of the board depending on financial performance of the institution among other considerations), that the size of the bonus pool is then capped and that the size of the maximum bonus that individual executives are eligible to receive is also set. Asked whether this approach makes it difficult to attract talent, Mr Johanson said that it didn't. 'We have a terrific group of people working for us. We’ve been able to recruit – continue to recruit people' he said. Asked whether the differences in the remuneration model made the business less competitive, he said that 'it’s not the remuneration model that determines our competitiveness. And, indeed, given that our strategy, our – how we choose to compete is on service and trust, it actually complements that'. He added that the remuneration model at the bank had, in his view, assisted the lender to avoid some of the issues identified over the course of the commission because of the lack of financial incentive to pursue short term outcomes.
- Why pay variable remuneration at all? Asked why variable remuneration is paid at all at Bendigo given the 'strong views' that the bank appears to have about the risks associated with remuneration weighted towards short term performance, Mr Johanson 'I think it's seen as it we've had a good year, then it's appropriate that we share…that — some of the financial outcomes of that amongst other stakeholders' he said.
- Long term incentives: The Commission heard that eligibility for long term incentives is limited to the senior management group (15-20 people). Mr Johanson maintained that they have a role in this context, stating: 'it has become accepted through the…corporate world that incentive programs are an essential part of packages for senior executives. But I think, properly structured and properly managed, they can provide the – the mechanism to get employees to think about not just their job and their particular concerns, but also the interests of other stakeholders. Now, the way we structure our long-term incentive program, of course, for senior – is not the only way we give them exposure to that, but it’s one way and it’s an important way'. Asked whether he would consider reducing variable incentives, Mr Johanson said that it is considered 'every year' by the organisation. 'I’m sure we will continue to – to check that the behaviours we’re measuring and rewarding are the ones that are really the ones we want for the long-term growth of the business' he said.
- Shareholder support for Bendigo's approach to executive remuneration: A number of questions to Mr Johanson focused on the issue of shareholder support for the approach taken to remuneration at the bank, including whether investors supported the inclusion of non-financial measures. Mr Johanson maintained that the approach had been supported, though the Commission heard that proxy firm ISS has not been supportive.
- Two strikes rule: Asked for his views on whether the two strikes rule should be modified, Mr Johanson said that he agreed it should be, but qualified this, by saying that it has some value, 'my caution is that it has turned out to be a very effective way to have people [within companies] focus on this stuff' through for example, engaging with shareholders, proxy advisers, shareholder groups.
- Removal of sales based incentives for frontline staff: The Commission heard that the Sedgwick recommendations to remove all sales-based incentives and commissions to frontline staff were implemented in 2004 or 2006. Asked whether this was a 'significant decision' for the lender Mr Johanson said: 'I don’t think it was, at the time, particularly shocking. It was consistent with the way we had run the business' he added that the change had not negatively impacted employee motivation stating: 'They get – they get their satisfaction from being trusted and customers, you know, feeling they’re doing a good job'.
- Mortgage brokers: The Commission heard that a low proportion of loans come through mortgage brokers (less than 10%), and that Bendigo remunerates mortgage brokers by paying upfront and trail commissions. Mr Johanson said that changes need to be made to these arrangements to address the inherent conflicts but did not appear to agree that they should be banned outright. Asked whether there was a reason to keep trail commissions he said: 'if a result of banning trails we force customers only to deal through banks and bank branches, I think that would be a very bad outcome...Let’s not have those other extreme outcomes.' He went on to say that he was 'not defending trails to brokers. But I – but the package for brokers in their current form have become, as I say, an essential part of the distribution network for a lot of players in this market.' Referring to Mr Elliott's comments on the same issue, he also did not appear to support the payment of a fixed fee by the borrower as an alternative to trail commissions.
Australian Prudential Regulation Authority (APRA)
Questions to APRA Chair Wayne Byres included (among others) questions in relation to the way in which the regulator manages/delegates its responsibilities internally, the role of the regulator in overseeing culture and remuneration in the entities it regulates and the approach the regulator has taken and should take in future to oversight/enforcement.
APRA's internal governance structures
- Dealing with overlapping issues/broader view of risk? A number of questions concerned the approach taken to delegation of responsibility, and oversight of issues within APRA, and APRA's internal governance more generally. The Commission heard that APRA presently commissioners within the regulator have responsibility for particular areas and that APRA does not have any processes or guidelines to determine whether a matter in one member’s area of responsibility should be considered by the whole board. However, increasingly, the regulator is finding that issues overlap: 'I mean, I think some of the issues – you know, one of the issues we’re grappling with is actually prudential issues and conduct issues, I think, in the – what I call the traditional view. They sat in different boxes. And, increasingly, it’s clear that, in fact, issues overlap with one another, and that prudential requirements – and you’ve said we’re going to come back to BEAR – and this might be a good example – where a prudential requirement potentially also has significant benefits in relation to limiting or helping mitigate the risk of misconduct' Mr Byres said. The Commissioner suggested that 'there's a chicken and egg problem…Whether remuneration is reflecting culture, whether culture is reflecting remuneration, whether governance is reflecting culture, culture is reflecting governance. They're all intermeshed, at least to some extent aren't they?' he queried, to which Mr Byres agreed.
- Rethink/evaluation of APRA's governance structure? Counsel Assisting drew a comparison between APRA's structure and the structure of other prudential regulators, in particular, the UK Prudential Regulation Authority (PRA) which has the equivalent of a CEO, and a board that includes non-executive directors. Asked whether APRA would benefit from having non-executive directors or members of the board, Mr Byres responded that APRA had had non-executive members of the board in the past but that it was 'deemed not to be an effective governance structure'. Counsel Assisting suggested that an external review (capability review) of the governance structure at the regulator to evaluate whether the current approach is 'the optimal way to govern APRA' would be of use. Mr Byres said that APRA is 'always open to having helpful advice'. APRA's decision to conduct a review of its enforcement approach internally was also questioned, Counsel Assisting querying why the review work itself is not being conducted by an external group. APRA Chair Wayne Byres said that this is because it is viewed as the most 'efficient and effective way to do it' and that though the external advisory panel (comprising former NSW Supreme Court Judge Robert Austin, ACCC Commissioner Sarah Court and MinterEllison Chair of Risk, Professor Dimity Kingsford Smith) would not be conducting the review they will be 'challenging what's coming out of the…team and the process.' Mr Byres reiterated that he has no objection to 'opening APRA up to eternal scrutiny in the form of an external capability and enforcement review'. Mr Byres said: 'We’ve said many – we’ve been asked this many times, do we have a fundamental objection to a capability review. The answer is no.'
- APRA's role in supervising culture/remuneration is evolving: The Commission heard that APRA's role in supervising culture is 'evolving'. Though APRA believes that it is important that it continues to ensure prudential considerations are a primary consideration in remuneration design and decision-making, Mr Byers acknowledged that 'thinking needs to continue to evolve and a broader examination of the issue is required'. Commenting on the current guidance on remuneration, Mr Byres said that APRA had in the past 'had a very traditional…focus on traditional financial soundness issues. We’ve expanded our thinking into risk culture and how to think about culture within organisations and the connection between remuneration and risk culture. And, consistent with the work that’s been done internationally, thinking about how we, as a prudential regulator, should think about misconduct and the way those two things come together'.
- Review and rewrite of prudential standards: The Commission heard that APRA is currently reviewing its prudential standards and guidance to 'expressly address the potential for poorly designed and implemented remuneration systems to increase the risk of misconduct'. Counsel Assisting queried whether the review would entail 'rewriting the prudential standards in order to limit the extent of links between long-term variable remuneration and financial returns or pure financial returns' to which Mr Byres answered in the affirmative. Mr Byres also said that the revised standards would 'probably' be 'more prescriptive than it is today'.
- Long Term Incentive (LTI) plans: Mr Byres said that in APRA's view there remain too much focus on total shareholder returns (TSR) as a performance measure, and that a shift towards use of non-financial metrics would be preferable: 'I think that there is still too much focus, particularly in the long-term incentive measures, on particularly the relative TSR measure. I don’t think that’s conducive to the broader more holistic assessment of performance that I think we all would think was desirable. So that’s a specific issue to Australia. And then in relation to internationally, we are seeing a shift away from financial metrics towards a greater weighting given to non-financial metrics. Sometimes voluntarily, but often because of new regulation that’s imposing that shift'.
- Two strikes rule: Asked to comment on whether the two strikes rule is contributing to performance hurdles for long-term variable remuneration being excessively weighted towards financial metrics, Mr Byres said: 'I don’t know if I could blame the two strikes rule, but it is – when we talk to boards – and most of my engagement has been with the large banks – we talk to them about the findings that were in that April 2018 paper. They didn’t push back greatly. Many actually recognised they would like to move. But many – some have had a strike, obviously. Some are in the process of moving. And, you know, it’s a likely prospect that they will get a strike. And others are very wary a strike. There’s – to use a phrase that has appeared in this Commission elsewhere, no one wants to go first. There’s a first mover disadvantage here. So it’s a problem'. Ultimately, the Commission heard that in APRA's view, change could be accomplished through issuing a 'more prescriptive' prudential standard.
- Level of detail that should be included in remuneration reports: Asked for his views on whether boards should disclose more information in remuneration reports about risk related adjustments to executive remuneration, Mr Byres responded that 'there are pros and cons. It – it’s a bit of a double-edged sword. So on one hand you would say if there’s – if there’s an expectation that rewards are disclosed, it might be reasonable to have more information to explain how those awards were determined… And my reservation about more and more and more disclosure would be that question of whether it may actually lead boards to be more reticent to exercise discretion'. Mr Byres went on to say in his view, the benefit of additional disclosure (instilling an ethical standard within a company) could be achieved without the need to name executives, if it is 'clear on the numbers' that the 'relevant executive had clearly been penalised' it would not be necessary 'to write chapter and verse' in the remuneration report he said.
- Lack of willingness to act? A number of questions were asked in relation to APRA's approach to oversight and enforcement of remuneration practices, Counsel Assisting questioning APRA's delay in responding. Mr Byres said that in the past, the regulator 'didn't actually have a good enough view of what good practice was' and 'didn't have a lot of expertise in remuneration' as it is 'not the natural forte of a prudential supervisor'. Given this, he said, APRA was not (in the past) in a position to challenge remuneration practices with confidence. Counsel Assisting alleged that a lack of willingness at senior leadership level within the regulator to support aggressive action in this context, meant that action on the issue was delayed. Mr Byres maintained that this was due to lack of 'confidence about the judgement about remuneration practices' and agreed that 'it’s important for leadership to signal, if – if there is to be a ratcheting up of supervisory aggression, for want of a better term, it has got to be clear that when there’s pushback from institutions, that the organisation from the top down will back that'.
- Oversight of remuneration practices: In terms of oversight of remuneration practices more generally, the Commission heard that if APRA were to 'systematically analyse' compensation practices, it would need to collect considerable more data and devote significantly more resources to analysing it. The Commission heard that to date, this has not been prioritised (for lack of resourcing) but that additional funding from the government would enable additional focus going forward. APRA is currently determining, as part of the broader work being undertaken in relation to remuneration, the scope of what information would be collected, for which institutions and 'how far down in the organisation' APRA will go. Having said this, Mr Byres said that ensuring the framework is 'policed and adhered to' raised further resourcing questions that the regulator would 'have to grapple with going forward'. Asked whether APRA would consider following the UK Financial Conduct Authority's (FCA's) approach — the FCA reviews individual remuneration adjustments at large firms on a line by line basis for misconduct events to ensure policies are being consistently applied — Mr Byres said that 'it’s a question of resourcing prioritisation. Certainly, I think we could do more to spot-check those sort of things. Whether we would be doing it for every organisation, every year, that would be quite a challenging task'.
- Role of boards and management in 'ensuring' appropriate culture — need for APRA to provide more explicit guidance on the role of management: A number of questions to Mr Byres centred around APRA's approach to overseeing culture, and the efficacy of that approach including relation to the development, and monitoring/enforcement of compliance with Prudential Standard CPS220: Risk Management (CPS 220). The Commission heard that directors had raised concerns regarding APRA's initial proposal in relation to the role of the board and more particularly the board's role in 'ensuring' culture, and that in response, APRA had amended the standard to recognise that as 'part-time non-executive directors, it will be management ultimately that sets the tone from the top, manages the business day-to-day, sets and has the most influence on the culture'. Asked how APRA approaches enforcing compliance with the standard, Mr Byres said that 'as with remuneration' APRA is 'trying to learn ourselves in this area because it’s not an area where we had the – the natural great wealth of knowledge'. Asked by the Commissioner, whether APRA is at a point where it 'could, should, needs to, must – let’s not hook ourselves up on the particular verb – do something about prudential standards concerning risk beyond existential financial risk?' Mr Byres agreed that this is the case. More particularly, he acknowledged that in the current standard, there is 'nothing that explicitly articulates that role of management. So it has got a role for board in overseeing something, but the "something" is not clear. It’s sort of taken for granted. And maybe, if you want to start more firmly enforcing an obligation, you’ve got to be clear about what the obligation is' he said. The Commissioner commented, 'If you – if you’re going to be enforcing the obligation, there has got to be no doubt about what the obligation is'.
- 'Long journey to repair' culture and conduct in Australia's financial institutions? Referencing the latest paper from the G30, the Commissioner asked Mr Byres to comment on whether he agreed that repairing the culture/conduct of Australia's financial institutions would be a 'long journey' and for his views on APRA's role in that process. Mr Byres agreed that 'there is a long journey to go' and highlighted a number of ways in which APRA will play a role through:
- 'thinking harder' about the issue of accountability and strengthening accountability (eg in relation to BEAR);
- strengthening the focus on audit and compliance within the prudential framework to help ensure issues are identified more quickly, 'It’s probably fair to say that the prudential framework, if you look for references to compliance and internal audit, they’re fairly cursory and short and we will need to think about how we give them more prominence in our assessment of risk management… audit and compliance have to be at the very forefront';
- a stronger focus on incentives and consequences.
In identifying these areas of focus, Mr Byres noted that APRA 'can't find all this stuff. We can't be the first line of defence'.
Banking Executive Accountability Regime (BEAR)
- No information on how APRA will approach breaches of BEAR? Counsel Assisting questioned why APRA had not released or explained its approach to breaches of the BEAR before 1 July 2018 (when it came into effect for the big four). Mr Byres said though it 'would be been nice to do', that it was due to the fact that the regulator has 'been caught up as part of the broader review of enforcement strategy' and 'it didn’t make sense to put out something on BEAR if then subsequently we were going to change that in some way'. He added that it was also a question of resourcing. 'I mean, BEAR has been an extremely demanding process for us to get up and running on day one. The timetable was relatively short, and we wanted to make sure that we had a credible implementation on day one, recognising that inevitably we would adapt and evolve as need be. But resources were applied to the primary task of getting the accountability statements, the accountability maps, the registration all in order so that at least the system was operational on 1 July 2018' he said.
- Adoption of the UK model? Noting that APRA's submission to the Commission's Interim report advocated the extension of the BEAR in line with the UK model (i.e. to apply to a broader range of financial services entities and to a wider range of misconduct), Mr Byres was asked whether it would necessitate in his view, joint administration between ASIC and APRA. Mr Byres responded that joint administration would be required were the regime broadened. Asked by the Commissioner whether the arrangements could be left at a 'high level' of whether it 'requires a deal of refinement' Mr Byres said that it could be left at a high level.
- Learnings from the Commission in terms of APRA's enforcement approach? Mr Byres was asked to reflect on some of the issues identified over the course of the Commission (eg fee for no service issues) and the implications for the regulator, in terms of the effectiveness of its role. Mr Byres said that in the past the primary focus had been on the existence of policies and procedures, and a reliance on audit and compliance functions, rather than a focus on testing/monitoring outcomes, 'I think there’s a sense that we have looked at robustness of frameworks, we’ve looked at policy documents, we’ve looked at procedures, and we’ve relied on audit and compliance functions to do the detailed testing, both internal and external. And – and conceptually, that if you have a good set of frameworks and policies and you – your audit and compliance function are doing their job to make sure that exceptions to those are being picked up, then actually things should broadly work as intended. But – so my general lesson, which applies to fees for no service but I think also applies to some of those other issues I have talked about is we have to think more about how do we get deeper, potentially doing more transaction testing or other things, or asking other people to do it on our behalf that would help us more readily identify these issues earlier' he said. Counsel Assisting suggested that after the Round 5 hearings, APRA amended its approach to focus more on the 'actual outcome of the application of those processes and identifying that the outcome is deficient' which Mr Byres agreed was the case.
- Narrowing of APRA's remit? Counsel Assisting was critical of the regulator's approach to supervision, and more particularly the regulator's approach to enforcement, in the superannuation sector, suggesting that 'it's difficult to believe [given the lack of enforcement action] that any superannuation entity thinks there’s a credible threat that APRA would ever launch any proceeding against them'. Counsel suggested particularly in relation to BEAR and to superannuation, whether there 'are tensions between, on the one hand, being a good prudential regulator and on the other hand being a good conduct regulator' and if so, whether 'it would be better to make some shift so that you only need to be one or the other rather than being in that position of tension'. Mr Byres acknowledged there was tension, but maintained that ultimately, in the context of superannuation no narrowing of APRA's remit was necessary, 'There will inevitably be issues that have both prudential and conduct dimensions to them. And in the superannuation space, it has been said, well, APRA should take carriage of those' he said.
- Appropriate to leave FFNS issues to ASIC? Counsel Assisting asked a number of questions in relation to APRA's lack of action on fee for no service issues (among others) and the reasons behind it. Counsel Assisting questioned why APRA made the decision to take no action given ASIC has no mandate in respect of breaches of relevant duties under the legislation and given breaches were reported to APRA. Mr Byres said where there is already another regulator investigating the same facts, documents, actions and people, it's 'actually inefficient and sometimes unhelpful to have two regulators' investigating. Mr Byres denied that there was a 'failing' to analyse or evaluate the industry-wide issue given while ASIC has been investigating, APRA has been continuing to 'focus on strengthening governance, strengthening risk management, pushing trustees to give more attention to what are the learnings from these exercises'.
- Lack of public action? Asked whether the lack of public enforcement action against superannuation entities for breach of s52 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) is an issue, Mr Byres said that the limited sanctions available (eg no civil penalties to accompany a declaration of breach) are a factor in APRA's approach, and that APRA's focus is primarily on preventing the problems occurring. Counsel Assisting questioned whether if civil penalties were available, taking that form of enforcement action would 'fit very readily with APRA's approach. Mr Byres said 'There are obvious tensions there. And if we were – if we were taking lots and lots of enforcement action, I would probably have to conclude we were a poor prudential supervisor because ideally we should be trying to head these things off'.
[Sources: 28 November 2018 - Draft Transcript for Day 67; 29 November 2018 - Draft Transcript for Day 68; 30 November 2018 - Draft Transcript for Day 69]