The Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (ARC) issued its final report on 4 February 2019. The ARC’s findings confirm significant and ongoing misconduct by Australian financial service businesses, banks in particular. The ARC has made wide-ranging recommendations for reform and further action. The ARC did not favour significant changes to regulation but did favour removing a significant number of exceptions that apply in some areas. The Australian Government has confirmed that it will implement most of the recommendations in full.
In this blog I consider some of the findings and recommendations in the report and their potential impact on law, and regulators, in New Zealand.
The ARC’s findings have already had an impact in New Zealand, through the ARC’s interim report issued in September 2018. Following the report the Reserve Bank of New Zealand (RBNZ) and the Financial Markets Authority (FMA) conducted their own, more limited, inquiries into the conduct & culture of banks and life insurance companies in New Zealand (many of which are owned by the institutions criticised by the ARC). Banks and life insurers are being required to take actions as a result. So, to a significant degree, the findings and recommendations in the final report of the ARC are already being acted on in New Zealand. Even before the ARC the FMA was focused on improving conduct and culture, which included investigating and reporting on bank incentive structures in November 2018.
The RBNZ/FMA report on banks did not identify any widespread misconduct of the type identified in Australia by the ARC, but it did identify significant concerns with the banks’ approach to identifying and remediating conduct issues and risks. The bank sales incentives report identified widespread sales incentives and concluded that the resulting conflicts of interest are not being adequately monitored or controlled. Significant issues were identified in the conduct and culture of life insurance companies in New Zealand. The high level of commissions paid to intermediaries was considered to be a significant issue, mirroring the findings of the ARC. The RBNZ and FMA have proposed areas for law reform and the government has indicated reform will be considered by Parliament next year.
Banks & Life Insurance Companies
The ARC recommends that some types of lawful “hawking” be banned, including the cross-selling of financial products (like superannuation & insurance) during a meeting or call with a person for another purpose. In New Zealand banks have been criticised for cross-selling, including of KiwiSaver schemes. The FMA incentives report did not address cross-selling. Some banks have already agreed to remove sales incentives for frontline staff. While a cross-selling ban is possible in New Zealand, it’s probably unlikely in the near term. A ban will be more likely if other initiatives fail to significantly improve conduct and customer outcomes.
The ARC was highly critical of the conduct of some institutions and highlighted failures in culture and leadership, noting that “Because it is the entities, their boards and senior executives who bear primary responsibility for what has happened, close attention must be given to their culture, their governance and their remuneration practices.”. It concluded that there was too little focus on regulatory, compliance and conduct risks (with the focus since the global financial crisis being on financial stability), noting that “Too little attention has been given to the evident connections between compensation, incentive and remuneration practices and regulatory, compliance and conduct risks.” It recommends that APRA (the equivalent of the RBNZ) mandate requirements for bank and insurance company remuneration systems, including placing greater focus on non-financial metrics, such as sound management of conduct risks, and provision for claw-back of payments. It also recommended that APRA places greater focus on requiring institutions to effectively manage conduct risks and to implement more effective governance.
Culture and governance are key themes considered by the RBNZ and FMA in their reviews. They have required individual banks and life insurers to improve their governance and management of conduct risks, and have asked them to respond with remediation plans by 31 March 2019 and 30 June 2019 respectively. RBNZ and FMA have also recommended changes to law, including the imposition of specific conduct obligations on banks and life insurers, which will require them to implement adequate systems and controls for management of conduct risks and potential individual responsibility on senior managers. These overlap, in broad terms, with the recommendations of the ARC. However, there is no specific focus on the impact of remuneration on conduct, though that is likely captured by systems and controls generally. Given the ARC’s significant focus on remuneration I think there’s a possibility New Zealand reforms will impose specific obligations in that regard.
Lenders (including banks)
The ARC didn’t propose any significant changes to the regulation of lenders relevant to New Zealand. The ARC focused particular attention on the role of mortgage brokers and on bank practices in relation to agricultural lending. The mortgage broker issues are less relevant in New Zealand, where brokers are already regulated as financial advisers. While bank practices with respect to agricultural lending have been the subject of criticism in New Zealand, the ARC appeared to respond to more deep-seated concerns about bank conduct in that regard.
New Zealand’s regulatory regime for lending is similar to that in Australia, including the imposition of lender responsibility obligations. The ARC did not recommend any significant changes to the Australian regime.
The regulation of lenders was reviewed recently in New Zealand and it’s likely that some changes will be made including caps on the value of “pay day lending” (high interest loans), clearer responsible lending obligations and higher penalties.
The ARC proposes some changes to special features of insurance contracts, including to the duty of utmost good faith. It proposes that insurance contracts be brought into the “unfair contract term” provisions at law.
In New Zealand a review of the century old insurance contract law is underway, which includes a proposal to bring insurance contracts within the scope of unfair contract term provisions in the Fair Trading Act. The ARC’s view will likely influence the review and final form of reform proposals.
Brokers & Financial Advisers
The ARC pulled no punches over the standard bank and insurance company practice of paying commissions to brokers and financial advisers for products they advise clients to purchase. The ARC concluded that “conflicts between duty and interest can seldom be managed; self-interest will almost always trump duty”. It recommends further reducing caps on life insurance commissions and to ultimately reduce them to zero, unless there was a clear justification for retaining commissions. In the case of mortgage brokers, the recommendation is that the customer pay the fee, which can be added to the loan being acquired. The Australian government has only committed to further reducing commission caps in some areas but not to removing commissions altogether, subject to review at a later date. The ARC also recommends that, if an adviser is not “independent, impartial and unbiased”, the adviser must prominently disclose that to the client. Any adviser who receives a commission will not be independent and will have to make that disclosure. That is a strong measure but may not, in itself, encourage a move to a fee for service model. The Australian government has agreed to implement that recommendation.
The RBNZ and FMA observed that high commissions appeared to be driving poor behaviour in the life insurance sector. In response the government has indicated that it plans to propose caps on commissions. A number of insurance companies recently announced that they plan to phase-out overseas trips as sales incentives. It seems inevitable that commission levels will be capped in New Zealand, the only real question being the nature and extent of the caps. It’s unlikely that bans on commissions will be introduced in the short to medium term.
Financial advice law is in the process of being comprehensively reformed in New Zealand- the new law is likely to be passed in the first half of 2019. Commission payments were well-debated during the law reform process. At the time the Government decided against placing any limits on commissions paid to mortgage and insurance advisers and instead focused on other controls including a clients’ interests first duty, disclosure, a code of conduct, and controls on the remuneration banks & insurers pay to staff who provide advice. The recent proposal to introduce caps on commissions somewhat cuts across the policy basis for those controls. The proposed reforms are already likely to significantly disrupt the financial advice sector. A cap on commissions (however formulated) will likely impose further disruption and costs. However, given the existing momentum for the reforms, I don’t think that there will be any reduction in the conduct obligations in the current draft law. Consultation on disclosure obligations in 2018 did not propose an obligation to disclose a lack of independence. I think it’s relatively unlikely that the ARC recommendation to disclose a lack of independence will be adopted in New Zealand.
The ARC report, and the recent report on New Zealand insurance companies, with their significant focus on aspects of adviser conduct, are likely to influence the development of the Financial Advice Code that will apply to all financial advisers and financial advice firms.
The ARC was critical of the Australian Securities and Investments Commission (ASIC), finding that “the law has not been obeyed, and has not been enforced effectively.” It states that “Too often serious breaches of law by large entities have yielded nothing more than a few infringement notices, an enforceable undertaking (EU) not to offend again (with or without an immaterial ‘public benefit payment’) or some agreed form of media release”. Its recommendations include that ASIC adopt an approach to enforcement that “takes, as its starting point, the question of whether a court should determine the consequences of a contravention” and separation, as much as possible, of enforcement and non-enforcement staff. In New Zealand regulator conduct has not been reviewed.
The ARC does not propose any significant changes to the “twin peaks” regulatory model in Australia. New Zealand has a very similar model. But it recommends that establishment of a body to oversee APRA and ASIC, independent of the Government. That body will assess their effectiveness in discharging their functions and meeting regulatory objectives.
Neither the RBNZ nor FMA have brought material court proceedings against a bank or insurance company. Like ASIC and other overseas regulators, the RBNZ and FMA have, when it comes to larger institutions, placed significant reliance on enforceable undertakings and other measures not involving litigation (e.g. warnings) in response to misconduct. In 2017 the IMF recommended that the RBNZ more pro-actively supervise, and take action against, banks and insurance companies. RBNZ and FMA have stated that the issues identified in New Zealand are less serious than those identified by the ARC, which may make it less likely that proceedings are brought against those institutions. However, I think the ARC’s conclusions regarding over-reliance on enforceable undertakings and other non-litigation tools may have an influence. In their reports on the banks and insurance companies the RBNZ and FMA indicated that they were considering the possibility of bringing proceedings. The reports do not indicate who would be the target of such proceedings.
In November 2017 New Zealand’s Supreme Court ruled unlawful a settlement agreement in relation to criminal proceedings by WorkSafe against the CEO of the Pike River mine (which resulted in a pay out to victims’ families). The Supreme Court noted that private interests (the interest of the families in a financial settlement) in such circumstances cannot outweigh the public interest in ensuring decisions to prosecute are made lawfully and reasonably in the public interest. The judgment doesn’t apply to the RBNZ or FMA’s non-criminal proceedings. However, the policy grounds that underlie the decision reflect key policy considerations noted by the ARC, so are relevant to all public bodies considering use of their enforcement powers.
Previous FMA corporate plans indicate that it has put significant effort into improving the effectiveness of its enforcement function. There may also be an impetus at FMA for greater separation of its enforcement function from its frontline supervision function (to the extent not already separate). The RBNZ under the leadership of Adrian Orr appears to be taking a more pro-active approach to its role.
I don’t think there will be any changes to the oversight of, or role of, the New Zealand regulators. A key question is which regulator will be given responsibility for overseeing the proposed new conduct obligations. Following the ARC approach it would be the RBNZ but it’s possible FMA may be given that mandate. It’s unlikely that the body proposed by the ARC to oversee APRA and ASIC will be adopted in New Zealand.