WRITER: Ron McIver
It’s a well-worn phrase – more dollars than sense – but in the wake of The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry the relevance of these words resounds.
THE STATUS QUO
The final report of The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry identified multiple failures among Australia's financial institutions and their regulators. But what's really being done to work towards repair?
Massive failures in trust demand institutional change at all levels: economic, legal, regulatory, governance, and political, as well as significant shifts in governance and ethical behaviour. How they will play out, we will just have to wait and see.
The long-awaited final report of the banking royal commission (released on 19 February this year) identified multiple failures among Australia’s financial institutions and their regulators, particularly in their inability to undertake or discharge their designated functions appropriately.
Some big take-outs from the royal commission relate to regulatory capture – the failure of regulatory bodies to act in the public interest – as well as weak enforcement of regulations, poor corporate governance and misplaced ethics, and, more broadly, the need for a stewardship and a stakeholder focus in the banking, insurance, superannuation and financial planning sectors.
In the words of the former Prime Minister Malcolm Turnbull, who was at the helm when the government was resisting calls for a royal commission, the issue is “really about trust”. Yet, while banks and financial institutions should have been working in the interests of their customers, the reality proved otherwise. It’s a well-worn phrase – more dollars than sense – but in the wake of The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry the relevance of these words resounds.
The lowest cost or, potentially, most practical responses to these failures require institutional change – economic, legal, regulatory, governance, and political – including improved regulation, regulator enforcement, and shifts in governance and ethical behaviour.
Australia’s major regulators – the Australian Securities and Investment Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) – received considerable attention from the royal commission, which elicited significant concerns about their regulatory responses. For example, consider ASIC’s extensive use of infringement notices in lieu of legal action when dealing with large corporations; or, how it reported regulation breaches without naming the company that committed the offence. While regulator reluctance to engage in legal action may have reflected a resource constraint – suggesting a political, rather than industry failure – a failure to name companies breaching regulations limits consumer access to information, reduces market transparency and efficiency, and the likelihood of market discipline.
Unsurprisingly, the royal commission’s report incorporated some big conclusions about ASIC’s and APRA’s effectiveness. Many of these recommendations have been accepted, with announcements of $550 million of increased funding in the 2019 Federal Budget to support ASIC and APRA operations.
A financial regulatory oversight authority will also replace the Financial Sector Advisory Council, reporting at least twice a year to the government on ASIC’s and APRA's performance. Regular reviews of APRA and ASIC will also be conducted, with an independent inquiry set to investigate changes in regulator behaviour following the royal commission. Each of these actions will ensure both their accountability and fulfilment of their expected functions and responsibilities. However, concerns may still exist around the potential diversion of ASIC and APRA organisational resources to report to this new ‘regulator of regulators’, potentially imposing financial constraints on the undertaking of legal actions.
The responsibilities of ASIC and APRA have also been clarified. APRA retains its responsibility for prudential regulation, while ASIC regulates a financial corporation’s conduct and disclosure. ASIC and APRA have also received extra power in the superannuation arena, through new civil penalties that will be enacted if trustees and directors breach their legal obligations. Additionally, the extension of the Banking Executive Accountability Regime (BEAR) to the superannuation sector should add greater clarity around the legislated norms of expected conduct in the governance structures of financial service firms.
Stronger attention on legal rather than administrative redress of executive conduct will have a significant impact on board and executive decision making. The latter is reflected in Justice Hayne’s conclusions that appropriate punishment of corporate officials is needed to ensure greater compliance with legal and regulatory requirements. To support this, the Federal Court will gain expanded resources and powers to cover corporate criminal misconduct in cases brought by the regulators, thereby reducing incentives to engage in behaviours that are detrimental to both customers and the longer-term interests of shareholders.
The royal commission also identified a need to address the substantial cultural and governance deficiencies in financial institutions. This is key to generating a more sustainable financial sector. Core recommendations include the need for companies to assess their own culture and governance, the annual review of remuneration systems, with APRA, as supervisor, being charged with ensuring its supervisory program elicits cultural changes that will reduce the risk of misconduct and enhance governance in support of this agenda.
Also apparent is the need for boards to shift their focus from short-term shareholder returns to a longer-term perspective, to recognise their broader responsibilities to other stakeholders, including employees and customers.
These broader changes align well with contemporary debates about the need for a wider set of boards to take a stewardship role within corporations. Broader recognition of this stewardship role is likely to ensure longer-term sustainability of financial corporations, avoidance of the high level of fines and charges for misconduct evidenced in recent years, as well as improved investment returns to shareholders over the long term.
How this unfolds in the months and years to come, we’ll just have to wait and see.
THE FUTURE OF FINANCIAL PLANNING
WRITER: GEOFF PACECCA
As a financial planner with over 30 years’ experience in financial services, I believe that good, non-conflicted advice is valuable and necessary for a person’s financial health. Yet, following The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, fundamental changes are afoot. While some of these are already underway and others are yet to unfold, the overarching environment for financial planners is one of change.
Ultimately, the goal is to address and deliver client goals through customer-centric, professional advice, free of conflict and supported by technical and specialist expertise and processes. It’s a move away from the conflicted and revenue-driven business models of old, yet as with all change, it comes with a cost.
So, let’s talk costs. With greater compliance demanded across the profession – including increased requirements for licensing financial planners – the cost of providing financial advice will inevitably increase. Concurrently, financial planning revenues will decrease as grandfathered commissions (trail commissions on old investment products) and ongoing advice fees are abolished.
But what does this mean? Well, for the customer, it unavoidably translates into higher prices: in a world of higher costs and lower back-end revenue streams, financial planners have no choice but to charge more in order to survive.
For financial planners, there are more complexities. Firstly, it’s possible that increased compliance costs will make it unprofitable for companies to provide licensing services to financial planners – a key driver for the divestment by banks of their wealth management arms. The result: likely fewer wealth management arms in banks and similar institutions, meaning that many financial planners will need to either find a new home or self-license.
The jury is still out on how these changes can be done profitably on both fronts. It’s likely that scale will be important in the future, leading to fewer smaller licensees and 1-3 person boutique financial planning businesses. In fact, over the next five years we’re likely to see significant drops in the number of financial planners (from 25,000 to around 15,000) as they not only struggle to operate in a changed environment, but also adhere to newly established education standards that come into effect by January 2024, requiring minimum standards for practising and new financial planners.
The bottom line is that financial advice will cost more and there will be fewer financial planners to deliver it.
Yet there is a silver lining: financial planners with the capacity, skills and education to deliver advice will benefit from a market comprising fewer planners, especially as demand for financial advice is expected to increase, and finally, customers will benefit from transparent, non-conflicted professional advice. Just as it should be.
THE PROPERTY FALLOUT
WRITER: DR SIMON COTTRELL
The shake-up from the banking royal commission is impacting many sectors, with Australia’s property market now feeling the effects.
Of the numerous standards called into question by the royal commission, the very generous and, in most cases, arbitrary Household Expenditure Measure was front and centre. Lending institutions use this benchmark to approximate a loan applicant’s annual expenses, which invariably determines their borrowing capacity. Yet, as the royal commission has shown, this process was never properly verified or reported on loan applications, resulting in a false representation of an applicant’s borrowing capacity.
With applicants being able to borrow far larger amounts than they could otherwise service, many were coerced into an interest-only structure on the advice of their brokers. Low interest rates, negligent lending practices and a record amount of foreign investment became major contributors of excessive growth rates in Australia’s property prices.
In 2016, investment bank UBS estimated that up to a third of Australian mortgages – or around $500 billion of the near $2 trillion mortgage market – are made up of ‘liar loans’, based on factually inaccurate information. And this systemic mortgage fraud in Australia has very similar characteristics to sub-prime loans written by US financial institutions that triggered the 2008 Financial Crisis.
A new benchmark for household expenditure is currently being developed by an industry working group to comply with the Australian Prudential Regulation Authority’s (APRA) sound lending practices guidelines. According to analysts at UBS, this is likely to reduce a new loan applicant’s borrowing power by up to 40 per cent.
Furthermore, many interest-only borrowers will be forced to switch to a principal and interest only repayment structure, further reducing the ability to service a mortgage. A recent report by multinational investment bank Morgan Stanley, estimated around 650,000 borrowers with outstanding loans totalling $230 billion are trapped in their interest-only loans, and may be forced to sell their properties in an already deteriorating property market, if they’re not able to extend the payment arrangements with their bank.
Finally, given the Australian banking sector’s heavy reliance on international funding, any increase in global interest rates will likely translate into higher bank funding costs and passed onto borrowers via higher mortgage rates – once again exacerbating the risk of falling property prices.
LOOK AT THE FLIP SIDE
WRITER: DR HAO ZHOU
While coverage of the banking and finance sector has been undeniably negative, it’s interesting to see that positives can still be found, with a closer look at the big four banks revealing the royal commission report could be the best news the banks have had for years.
Since the release of the final report by the banking royal commission on 4 February 2019, the big four Australian banks (ANZ, Commonwealth Bank, NAB and Westpac) have gained nearly $30 billion market value, including a combined $20 billion (or 5.7 per cent) on 5 February, the first day of trading post the report. Given the massive negative publicity during the commission, the surge can seem puzzling. So, what’s been going on?
The report is not as negative as feared: there was widespread fear that the report might recommend stringent measures such as separating banking and financial advice businesses. The recommendation of limiting trail commissions is expected to severely impact the mortgage brokerage business: good news for the big four since they stand to gain further bargaining power.
Most of the bad news has happened before the report: since launch of the commission in November 2017, the big four banks have seen their market value drop by nearly $80 billion (or by 19 per cent). A series of public hearings has uncovered countless unethical practices. Consumer confidence was at all time low in 2018. According to the Deloitte Trust Index, only one in five customers believes that banks have their customers’ interests at heart.
Fear of uncertainty is worse for the market: research shows that the prospect of bad news may be more damaging to the market than the bad news itself. People are generally averse to ambiguity and uncertainty. Businesses require a clear picture of the future to better plan their investment. The resolution of the royal commission enquiries is a booster to market confidence.
LICENSING REFORMS & EDUCATION
In response to the fallout of the royal commission, the Financial Adviser Standards and Ethics Authority (FASEA) has imposed new standards for ethical behaviour and practice for financial planners. By 2024, existing practitioners will also be required to complete an FASEA approved education program in order to continue practising, while those looking to enter the industry need to study a FASEA approved undergraduate or postgraduate degree program from January 2019.
UniSA was the first institution in South Australia – and one of the first nation-wide – to provide financial planning programs that meet the new educational requirements set by FASEA.