After 12 months of sometimes tortuous testimony and a continuous parade of chastened senior executives and regulators from the financial services sector, Kenneth Hayne has finally released his report.
The report pulls no punches about the performance of the banks and other large financial institutions in the sector over recent decades. He also singled out the regulators – the Australian Securities and Investments Commission(ASIC) and the Australian Prudential Regulation Authority (APRA) – for being asleep at the wheel in terms of their responsibilities for supervising and regulating the sector.
Notably, he reports that there is, by and large, adequate existing legislation and regulations already in place. A key problem, he reports, is the egregious lack of proper enforcement of the rules and regulations particularly for larger institutions who should understand their obligations and have little excuse for gaming the system. Time to take the gloves off and impose serious penalties for breaching the rules at both an institutional and individual level. The risk of a jail term for a senior executive in a financial services business is a very effective way to sharpen their focus towards the best interests of customers.
Hayne recommends extending some of the existing regulations to areas previously exempted such as life and general insurance and mortgage broking. This would result in the dramatic reduction or removal of all commissions currently paid on life and general insurance products and mortgages, which is a massive change to long-entrenched practices. The commissioner felt that there was significant potential for ongoing conflict in these areas while commissions continue to be paid.
By and large, recommendations provide a common-sense approach and a much needed focus on areas where self-interest has trumped ethics for too long. The existing rules and regulations are already so complex that it has made the cost of obtaining proper financial advice relatively expensive. Hayne quite rightly understands that adding even more layers of rules and regulation would be counter-productive for consumers of financial services.
There was much debate about whether Hayne would recommend a prohibition on what is known in the industry as “vertical integration”. This is where the same company manufactures financial products and services and also provides financial advice to clients. In vertically integrated businesses (like the big banks and AMP), employees are likely to be encouraged to use the financial products and services of their employer, thus creating fertile ground for conflicts of interest.
Whilst not banning this structure outright, Hayne has recommended that advisers in these businesses will need to give to a client a written statement explaining simply and concisely why the adviser is not independent, impartial and unbiased. This is a bit like cigarette packet advertising – “using our services could be injurious to your financial health”. Notwithstanding this, the CBA, NAB and ANZ have already started to unwind their existing structures to reduce or eliminate the vertically integrated model. Westpac has decided to “stay in the game”. (Interestingly, Westpac was the least criticised bank in the report).
A huge issue during the royal commission was the issue of charging fees for no service.
This in particular has been a shocking blight on the financial services industry. It should be clear that many financial advisers do provide excellent value for the fees they charge, however, it is clear that in many cases there has been either little or no value for fees which have been paid. In fact, many clients were blissfully ignorant of the fact they were even paying fees. Whilst not banning ongoing advice fees outright, the report recommends that ongoing advice fee arrangements must be renewed in writing by the client every year after being provided with details of the fees and services provided. This gives clients the clear option to decide whether or not they are receiving value for money and allow them to opt out of any arrangement.
Additionally, there is a recommendation to ban all advice fees which are taken from MySuper accounts. Furthermore, the issue of ‘grandfathered’ commissions on older financial products was dealt with in the report. In 2012, the government passed the future of financial advice (FOFA) legislation banning all commissions on financial products, however, it allowed the ongoing payment of certain commissions on older style products which is referred to as grandfathered commissions. Quite clearly the report recommends banning of these commissions as soon as practicable. The payment of these commissions in my view has continued to foster some of the less desirable cultural problems in the sector. The sooner they go the better.
Hayne also recommends a new, single disciplinary system for financial advisers. I believe this, combined with the recent announcements in relation to minimum education standards for financial advisers, is an extremely important step forward in improving the quality and consistency of advice and dramatically changing the culture of the sector. Hayne did not make any specific recommendations about remuneration structures in the sector, but he did state that remuneration arrangements would need to be reviewed by management every 12 months. Importantly, he noted that there needs to be significantly less focus on sales targets in remuneration arrangements.
These types of changes are undoubtedly in the best interests of consumers of financial advice and should help rebuild trust in the sector over time.
Hayne also recommended a range of technical changes in relation to the role of trustees of superannuation funds that will necessitate significant changes in the structure of trustee boards of superannuation funds right across the sector.
This is a very short summary of a very detailed report. The report runs to some 496 pages and contains 76 specific recommendations. The Coalition government has agreed with all but one of the recommendations and Labor says it will accept all of them.
The Coalition is concerned that the immediate removal of commissions on mortgage broking will significantly reduce competition in the sector and greatly advantage the four big banks. Currently, almost 60 percent of mortgages in Australia are written by mortgage brokers and they provide the capacity for smaller banks and non-bank financial institutions to compete in the sector. It will be interesting to watch developments in this space.
Also, the report will provide ongoing ammunition to both sides of politics about who can be the meanest cop on the block when it comes to policing the banks. I suggest we will be sick and tired of hearing about this report before too long.
All in all, I believe this royal commission has been an important watershed in dealing with long-entrenched cultural and ethical problems in the financial services sector. I’m very hopeful that effective implementation of the recommendations, together with proper supervision of the sector by the regulators, will result in a continuous improvement in outcomes for consumers of financial services and ultimately will help rebuild the massive loss of trust which has occurred over the last few years.
Patience will be needed as the legislative framework needed to support the changes, as well as the necessary realignment of both financial services organisations and the regulators will take a number of years to work through.