In the final report for the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which was handed to the Governor-General on Friday (1 February) and publicly released on Monday (4 February), Commissioner Kenneth Hayne addressed concerns around culture, governance and remuneration, which he said “march together”.
This means “improvements in one area will reinforce improvements in others”, while “inaction in one area will undermine progress in others”, the commissioner added.
While culture, governance and remuneration are the responsibility of financial services entities, the commissioner noted that regulators, such as the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC), have an important role to play in the supervision of these areas.
He noted that until quite recently, “there has only been limited overt attention given in Australia, by entities or by regulators, to issues about conduct and culture.”
“In the past, supervision has focused on financial soundness and stability. But, as events here and overseas show, that is too narrow,” the commissioner wrote in his final report.
“Supervision must extend beyond financial risks to non-financial risks, and that requires attention to culture, governance and remuneration.”
The royal commission’s recommendations pertaining to culture and governance include that “all financial services entities should, as often as reasonably possible, take proper steps to: assess the entity’s culture and its governance, identify any problems with that culture and governance, deal with those problems, and determine whether the changes it has made have been effective”.
He was in favour of the Financial Stability Board’s (FSB) toolkit, presented in its Strengthening Governance Frameworks to Mitigate Misconduct Risks: A Toolkit for Firms and Supervisors report, as well as its November 2018 Recommendations for National Supervisors that are “‘intended to support supervisors in their dialogue with firms and to foster the development of better practice”.
The commissioner suggested that APRA implement the FSB’s recommendations, which include that supervisors:
- build a supervisory program focused on building culture that deters misconduct;
- use a risk-based approach to the review of financial services firms or groups of firms that display significant cultural drivers of misconduct;
- use a broad range of information and techniques to assess the cultural drivers of misconduct;
- engage firms’ leadership regarding observations on culture and misconduct; and
- encourage firms to place importance on soundly managing conduct risk and improving governance.
Commissioner Hayne referenced 2015 research from the G30 Consultative Group on International Economic and Monetary Affairs, saying he agrees with the view that “supervisors should look on cultural questions as root cause analysis and intervene when they see demonstrably serious problems”.
Noting APRA chairman Wayne Byres’ claim that the regulator’s supervisory resources are limited and therefore it needs to prioritise certain activities, he argued that it’s “essential that there be enough supervision resources, and with the right skill sets/seniority and expert support if needed, to engage constructively with banks on these issues.”
“The work of the FSB, G30, and international practice more generally shows that this work is essential to the proper prudential supervision of banks and, in my view, other large APRA‑regulated institutions,” Commissioner Hayne wrote.
“Because it is an essential part of prudential supervision, APRA must have the resources to do it.”
He continued that the main objectives of prudential supervision should be “early problem identification and bank-led corrective action.”
“Conduct and values should be part of mainstream supervisory processes as opposed to a separate add-on,” the commissioner wrote in his report.
He acknowledged that APRA’s Prudential Inquiry into the Commonwealth Bank (CBA) “marked a watershed in [its] approach to issues of governance, culture and remuneration”, further noting Mr Byres’ admission that the prudential regulator’s “ordinary supervisory activity had not been fully effective at addressing these issues, or bringing about cultural change at CBA”.
“For the first time, APRA took public steps to examine a regulated institution’s ‘frameworks and practices in relation to governance, culture and accountability’,” the royal commission report states.
“One of the particular matters the panel was required to examine was whether CBA’s remuneration frameworks, or their implementation, were conflicting with ‘sound risk management and compliance outcomes’.”
The major bank agreed to implement the 35 recommendations that were made following the inquiry around leadership, risk management and compliance, issue identification and escalation, financial objectives and prioritisation, accountability, remuneration, and remediation initiatives.
“But the value of the inquiry goes beyond its application to CBA. The report provides a very valuable, publicly available account of the ways in which failings of culture, governance and remuneration can act as drivers of misconduct. And it explains how those problems can be addressed,” Commissioner Hayne wrote.
He also outlined what should be the responsibilities of financial services entities when it comes to culture and governance, recommending that they “should, as often as reasonably possible, take proper steps to: assess the entity’s culture and its governance, identify any problems with that culture and governance, deal with those problems, and determine whether the changes it has made have been effective.”
The Governance Institute of Australia in its submission to the royal commission’s interim report stated that “conduct is the manifestation of culture” and that an “ethical framework should sit at the heart of a company’s governance structure to serve as a common and authoritative point of reference for all decision-makers and give shape to culture”.
It suggested that company boards have a role to play in “setting the ‘tone from the top’ and modelling that tone as well as monitoring culture”, and that “boards must consider how to avoid setting policies, building systems or establishing practices that might drive conduct that is at odds with the declared ethical framework, particularly in the area of remuneration and incentives”.
Find out more about what the final report from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry means for the broking industry, and what the next steps are, by attending the Better Business Summit 2019.
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