Implications of the Banking Royal Commission

Our nation has had its fair share of Royal Commissions of Inquiry over the years, and few can deny their importance in bringing about change in key areas of our national life. So it’s only natural that a lot of people – disenchanted, we might add – are pinning their hopes on the Financial Services Royal Commission to bring about change in the financial services industry.

Set up by the Australian government in late 2017, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, is tasked with investigating alleged misconduct in the financial services industry, and boy, what a ride it’s been!To date, the Commission has unearthed issues like irresponsible consumer lending practices (echoes of the US subprime mortgage disaster, anyone?); conflicts of interest in financial planning and wealth management services, and misconduct relating to small and medium business financing.

The questioning of executives of Australia’s largest financial institutions – and the resulting fallout – has dominated media coverage for months, and quite understandably, people are upset about the revelations that have come out. To say that much is riding on the work of Justice Kenneth Haynes is to put it mildly. At Transition Wealth,we understand that there are still people who do not quite understand the implications of the Commission, and in this blog, we’ll be shedding some light on that.

Why a Royal Commission?

It’s fair to say the Royal Commission has been a long time coming. The government’s decision to establish one came about after misconduct by Australian banks was exposed – and in some cases proved – in a series of scandals over the last few years. These incidents came to light through a mixture of investigative journalism, consumer complaints and whistle-blowers from within the industry.

Some complaints were followed up by the Australian Securities and Investments Commission (ASIC), leading to tighter regulation and punitive measures in a few cases. It also led to attempts at self-regulation within the banking industry and millions of dollars’ worth of reimbursements to affected customers. But a lot of consumer-protection organizations, politicians and sections of the media felt that the response by ASIC and the banks themselves was inadequate, and opposition politicians from the Labor and Green partiesbegan calling for a Royal Commission in 2016. Worried about damaging the reputation – and profitability – of Australia’s banking and finance industries, government resisted the pressure until the second half of 2017, when the demand for a Commission reached across party lines, and the Royal Commission was establishedin November 2017.

What can the Royal Commission do?

Often, Commissions can be toothless bureaucratic bulldogs with no powers. Not the Royal Commission. It has the power to compel anyone providing financial services in Australia to appear before it and give evidence in person or to submit written evidence. This includes banks and any companies or individuals with a license to provide financial services (financial advisors, insurers, mortgage providers and superannuation providers). The Commission can also authorise the federal police to execute searchwarrants and compel financial institutions or individuals to provide documents. And perhaps best of all for our democracy, anyone can make a submission to the Commission through its website.

From the evidence obtained, the Commissionmust then decide several things, including:

• Whether the activities of a bank or financial services provider are criminal and need to be referred to the relevant authorities.
• Whether the activities of a bank or financial services provider fall below community standards.
• Whether criminal or sub-standard practices are the result of a particular culture within companies or industries.
• Whether change in the law are required to protect consumers from the misconduct of banks or financial service providers.
• Whether the current regulators (ASIC and APRA) are adequately regulating banking and financial products and services.
• Whether the complaints and compensation procedures for customers of banks and financial service providers are adequate.

While the Commission certainly covers a wide scope and enjoys a high degree of powersthere are some limitations of note. It cannot, for example, intervene in individual consumers’ claims of misconduct against banks or financial service providers, nor can it investigate short-term ‘payday’ loan providers, or providers of in-store credit for consumer goods.

What’s happened so far?

Anyone who’s been paying even cursory attention will have noticed that quite a lot has happened in the short time the Commission has been active. Given the breadth of issues to cover, it has divided its activities into five rounds of hearings, focusing on different aspects of its mandate. Each round has sent shock waves around the industry.

In Round One (March 2018), the Commission focused on consumer lending, including residential mortgages, car financing and credit cards. As a result:

• Two of Australia’s biggest banks, Westpac and ANZ, admitted to the Commission that they had not verified the expenses of people they provided with credit for homes and cars.
• The Commonwealth Bank of Australia (CBA), Australia’s largest bank and most valuable company, admitted to paying sales-based commission to mortgage brokers which encouraged them to provide customers with larger loans than they could afford.
• National Australia Bank (NAB) admitted fraudulent practices, including bribery and document forgery, by some of their staff.

Round Two (April 2018) focused on financial advice, including investigations into advisers charging fees for no service and other improper conduct by financial advisers. A direct fallout of that was the resignation of the chief executive of AMP,one of the biggest providers of financial services in Australia and New Zealand, after the Commission heard that the company profited by deliberately charging customers for financial advice they never received. Celebrity financial adviser Sam Henderson was the next casualty, after recordings of one of his staff impersonating a client were played at the Commission. He was also criticised for giving ‘disastrous’ financial advice. And one of the most far-reaching impacts was felt when the Dover Financial Advisors had its financial services licence revoked by ASIC and ceased operating. The tremors caused by these events are still reverberating.

Fortunately, Round 3 (May/June 2018) which focused on loans to small and medium businesses, including investigations of unfair contract terms and responsible lending practices gave us some respite. This has been the least damaging and controversial of the hearings so far, but there were some notable happenings too. ANZ, Westpac and the BANK of Queensland were criticized for their conduct in individual cases of loans to small businesses, but the Commission did not find that there was systemic misconduct on the same scale as in personal finance. The Commission also found that there was no reason to expand or strengthen the regulations on lending to small businesses, only that the regulator ASIC should be more active in cases of misconduct.

Farming Finance and the Interaction of financial service providers with indigenous Australians were the focus of Round 4 (June/July 2018).Several Banks were strongly criticized for their conduct in relation to farm financing. Their conduct was linked to a culture of reward for meeting sales targets which led to financial losses and hardship for rural businesses. They also received stern rebukes and criticism for their conduct in relation to Aboriginal and Torres Strait Islander people. This included mis-selling funeral insurance, irresponsible lending and high bank fees. Ultimately, the Commission decided that ASIC’s role should be expanded to bring farming finance under regulatory control.

We Australians are passionate about our Supers, so it’s no wonder that Round 5 (August 2018) which focused on Superannuation generated a lot of interest. The Commissionfocused on the conduct of Australia’s largest Super providers and the role of APRA and ASIC in regulating them. It found issues like superannuation providers deducting from peoples’ superannuation funds for unnecessary insurance and financial advice services that were not provided, and providers using funds to further their own interests rather than acting in the best interests of their clients.

Round 6 of the hearings will take place in September 2018 and will focus on insurance. Following that, the Commissioner will send an interim report to the Governor-General of Australia on 28 September. A seventh and final round of hearings is scheduled for November and the Commissioner will submit a final report to the Governor-General by 1February 2019.

Some interesting questions to ponder

Throughout the hearings, some interesting questions were raised, and some of the answers revealed the deep divide between the views held by banks and financial services institutions and those who regulate them. For example, one of the more contentious issues was the status of grandfathered commissions going forward. Grandfathered commissions are those commissions paid by clients to financial advisors on investments they made before 2013 when many kinds of commission were outlawed in Australia. The largest banks (CBA, NAB, and Westpac) admitted that they rely heavily on grandfathered commissions for their financial advice sections to remain profitable, and asked that they should be given more time to end them.ASIC on the other hand, felt that grandfathered commissions are unfair to clients and should be ended at the earliest opportunity. Questions also explored whether clients receive meaningful benefits from ongoing service arrangements and whether or notvertical integration serves the interests of clients.

The likely outcomes

You don’t need a crystal ball to envisage some of the likely outcomes of the Commission’s work, particularly in view of the revelations. The banking, financial services and superannuation industry will no longer be left to regulate itself, and we at Transition Wealthforesee – and welcome – tighter regulation. While some think that tighter regulation will slow down the economy, we see a lot of positives and believe in the long-term benefits of more responsible lending and more suitable financial advice that may arise from stricter rules. We believe that this will give people the incentive they need to take a more active role in their personal finances, including seeking out the best independent advice rather than always placing their trust in the country’s largest operators.

We also envisage changes on the issue of vertical integration. Although it will not disappear from financial services, there will a greater separation of advice and product, which will lead to higher-quality advice for consumers.

The Royal Commission has made it likely that there’ll be reforms to regulateongoing commissions or fees paid to financial advisors. This could mean that the up-front cost to clients of financial advice could rise significantly, but as firm believers that clients should always receive value for their money, we believe that financial advisors must find ways of helping their clients with these costs, while ensuring that their investments do not suffer. Ultimately, we see a stronger, fairer and more robust financial services industry resulting from the work of the Commission.