ANZ will no longer factor in sales incentives while calculating bonuses for its financial planners and boot them out if they fail an audit twice, the bank announced today.
As ANZ attempts to revive its advice business after Royal Commission hearings and ahead of IOOF acquisition, chief executive Shayne Elliott admitted the bank had failed some of its financial advice customers.
“We know it has taken too long for changes to occur, so where we see solutions we will act. That’s why we are getting on with these initiatives now,” he said.
On April 23, it was revealed ANZ kept a “leaderboard” that ranked advisers on the revenue they brought in.
It changed its revenue-centric adviser remuneration on April 12 – less than two weeks before the RC’s questioning of ANZ chief risk officer and head of digital and wealth Australia, Kylie Rixon. The bank then limited revenue-based measures to only 15% of compensation criteria and abolished the leader board, Rixon said.
Today, ANZ said it has removed all sales incentives for bonuses and will now only asses performance on customer satisfaction, risk and compliance standards and ANZ values.
To keep its adviser pool clean of inappropriate planners, ANZ is promising to boot out planners if they fail an audit twice.
It is also placing higher expectations on the qualifications of its advice professionals after last month, senior counsel assisting Rowena Orr revealed that only 35% of all financial advisers have completed a bachelor degree or above.
Financial planners looking to work with ANZ will now need to have a relevant undergraduate degree and industry certification.
The bank said it will push existing planners to enrol in further training by January, 2019.
ANZ is promising to compensate 9000 clients who received unappropriated advice from ANZ professional, by the end of the year.
Earlier last month, ANZ footed a $50 million bill in compensating its fee-for-no-service bungle for its Prime Access Clients, also copping an enforceable undertaking from ASIC.
At the time, ASIC said the compensation program was “nearing completion”.
ANZ anticipates $50 million in legal costs stemming from the Royal Commission for the year ending September , it revealed in an earnings report.
The bank’s wealth business is set to be acquired by IOOF.
On April 24, IOOF announced that it has cleared all regulatory hurdles in acquiring OnePath’s pension and investments and four aligned dealer groups.
The deal was announced in September 2017 and at the time IOOF would pay about $975 million.
On May 2, Financial Standard reported that IOOF had updated the market on ANZ’s 1H18 financial results, ahead of the acquisition.
ANZ’s 1H18 results reveal that cash profits in its wealth division slid by 24% to $44 million. ANZ said this was because of a non-recurring lenders mortgage reinsurance profit share being included in the 1H17 results, strengthening of claims provisioning in 1H18 and lower new business volumes in ANZ Financial Planning.
The bank is also offering a no-cost advice review to all its financial planning customers who “may have concerns about their current financial position”, it announced today.
Welcome to our latest digest of finance and property news to 5th May 2018.
Read the transcript, or watch the video.
We continue to be bombarded with news of more issues in the banking sector. CBA admitted that they have “lost” customer data contained on two tapes relating to almost 20 million accounts. The event happened in 2016, and they decided not to inform customers, as the data “most likely” had been destroyed. This is likely the largest data breach for a bank in Australia and goes again to the question of trust. So much customer data in a single tape drive, and passed to a third party for destruction. But there was no record of the tape arriving, and the data has not been recovered. Angus Sullivan Head of Retail at CBA said, an investigation suggests the tape were destroyed, and they chose not to inform customers at the time, despite discussing with the regulators.
We think they had a duty of care to disclose this to customers at this time, but they chose not to, because they did not put customers first. Such rich transaction data would be very valuable to criminals. I have a CBA account, and I feel uncomfortable. Why should I trust them with my data?
And of course CBA featured in the report which was published this week following a review into their culture. We discussed this in detail in a separate video “CBA’s World of Pain and The Regulators’ Wet Lettuce response”. The report says CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. APRA has applied a $1 billion add-in to CBA’s minimum capital requirement.
Over the past six months, the Panel examined the underlying reasons behind a series of incidents at CBA that have significantly damaged its reputation and public standing. It found there was a complex interplay of organisational and cultural factors at work, but that a common theme from the Panel’s analysis and review was that CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. This dulling was particularly apparent in CBA’s management of non-financial risks, i.e. its operational, compliance and conduct risks. These risks were neither clearly understood nor owned, the frameworks for managing them were cumbersome and incomplete, and senior leadership was slow to recognise, and address, emerging threats to CBA’s reputation. The consequences of this slowness were not grasped. So CBA agreed to put a plan in place to address the issues raised, and circulated the report to their top 500 executives, and other banks and corporates should also read the report in detail. The core message is simple, a fixation on superior financial performance at all costs, can destroy the business and customer confidence. Oh, and APRA’s $1bn capital add-in is little more than a light slap to the face.
We got results this week from Macquarie Bank who managed to lift their profitability yet again, mainly thanks to significant growth in their Capital Markets Business, plus ANZ and NAB who both revealed pressures on margin and higher mortgage loan delinquencies. They are literally banking on home loans and warned that if funding costs continue to rise they will need to lift rates. NAB’s profit was down 16% on the prior comparable period. We discussed their mortgage delinquency trends as part of our video on Mortgage Stress “More On Mortgage Stress and Defaults”. Both banks are seeking to reduce their exposure to the wealth management sector, and focus more on selling more mortgages. Interesting timing, given the Royal Commission, and tighter lending standards.
And Genworth, the Lenders Mortgage Insurer, who underwrites loans about 80% (or 70%) in some cases also reported higher losses again. The delinquency rate increased slightly from 0.48% in 1Q17 to 0.49% in 1Q18, driven mainly by Western Australia and New South Wales (NSW). Delinquencies in mining areas are showing signs of improving. In non-mining regions there are indications of a softening in cure rates, in particular in NSW and Western Australia.
Our own latest research showed that across Australia, more than 963,000 households are estimated to be now in mortgage stress (last month 956,000). This equates to 30.1% of owner occupied borrowing households. In addition, more than 21,600 of these are in severe stress, up 500 from last month. We estimate that more than 55,600 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.
But there was one item in the NAB results which peaked my interest. They included this slide on the gross income distribution of households in their mortgage portfolio. Gross income is defined as total pre-tax unshaded income for the application. This can include business income, income of multiple applicants and other income sources, such as family trust income. And it relates to draw-downs from Oct 17 – Mar 18. ~35% of transactions have income over 200K for owner occupied loans, and ~47% for investment loans. Now, I recognise that NAB has a skewed demographic in their customers, but, the proportion of high income households looked odd to me. So I pulled the household income data from our surveys, including only mortgaged households. We also ask for income on a similar basis, gross from all sources. And we plotted the results. The blue bars are the household gross income across the country for mortgaged households. The next two are a replication of the NAB data sets above. Either they are very, very good at targetting high income customers, or incomes in their system are being overstated. We discussed this in a separate video “Mortgage Distribution By Income Bands”.
AMP published a 28 page response to the issues raised by the Royal Commission. They made the point that the fees for no service issue is old news. In addition, they down played the preparation of a Clayton Utz report into the issue and the firms misleading representations to ASIC. They did unreservedly apologise for their financial advice failings relating to service delivery to customers and spoke about extensive action aims to ensure these issues “never happen again.” But I am not sure they have really understood the implications for their business of the findings, despite the Chairman Catherine Brenner, following the CEO out of the door. And I am not sure they have clarity around their strategy.
But they also announced that David Murray, a well-respected financial services insider to take over the Chairman’s role. He of course was the CEO at CBA during its massive expansion into Wealth Management, and significant vertical integration – the very issues which are at the heart of the Royal Commission Inquiry. And He led the Financial Systems Inquiry, which forced capital ratios higher, but which was also very light on customer centricity. So he will be a safe pair of hands, but we wonder if he can truly transform AMP to a customer focussed business. They have a massive amount to do to deal with potential fines, repair the damaged brand and chart a path ahead. But there are in my mind some critical questions about the role and shape of the board, and how they truly inject a customer first focus. This question should be occupying the minds of all CEO’s and Boards in the sector, not just AMP.
And I have a suggestion. I think the financial services companies should have a customer board – a group of customers of the bank, who would be engaged and involved in the operations and strategic direction of the business. A strong customer Board would be able to ensure the voice of the customer is heard and the priority of customer centricity placed firmly on the agenda. And remember, there is strong evidence that companies who truly put their customers first can create superior and sustainable value for shareholders too.
Of course there are structural options too. I think is likely that the financial services sector will see a bevy of break-ups and sell-offs. NAB, for example will be selling off their MLC wealth management business, marking the end of their mass-market wealth experiment. They will retain their upper end JBWere business as part of their Private Bank, for the most affluent customers. Other players are also divesting wealth businesses, partly because they never really generated the value expected, (and frittered away shareholder funds in the process) and because of the higher risks thanks to the FOFA “Best Interests” requirement. So it raises the question of whether financial advice will be available to the masses, even via robots, and indeed whether they really need it anyway. For most people generally the approach would be pretty simple (but your mileage may vary, so this is not Financial Advice). Pay down the mortgage as fast as you can. Make sure you have adequate insurance. Don’t use consumer credit and save via an appropriate industry fund. Hardly need to pay fees to an adviser for that guidance I would have thought. Financial Advice has been over-hyped, which is why the fees grabbed by the sector are so high. Mostly it’s an unnecessary expense, in my view.
Another option to fix the Banking System would be to bring in a Glass-Steagall type regime. Glass-Steagall emerged in the USA in 1993, after a banking crisis, where banks lent loans for a long period, but funded them from short term, money market instruments. Things went pear shaped when short and long term rates got out of kilter. So The Glass-Steagall Act was brought in to separate the “speculative” aspects of banking from the core business of taking deposits and making loans. Down the track in 1999, the Act was revoked, and many say this was one of the elements which created the last crisis in the USA in 2007.
Now the Citizens Electoral Council of Australia CEC (an Australian Political Party) has drafted an Australian version of the Glass-Steagall act, and Bob Katter has announced that he will try to bring the legislation as a Private Member’s Bill called The Banking System Reform (Separation of Banks) Bill 2018. And Bob Katter has form here, in taking the lead in Parliament on Glass-Steagall, as he did on the need for a Royal Commission into the banks in 2017.
The 21st Century Glass-Steagall Act has been updated to prohibit commercial banks from speculating in the specific financial products that caused the 2008 global financial crisis, which didn’t exist in 1933, such as financial derivatives. These updates are reflected in the Australian bill. Aside from specific practices, the overriding lesson of the 2008 crash is that commercial banks should not mix with other financial activities such as speculative investment banking, hedge funds and private equity funds, insurance, stock broking, financial advice and funds management. The banks have gone far beyond traditional banking, into other financial services and speculating in derivatives and mortgage-backed securities. Consequently, they have built up a housing bubble, which is heading towards a crash and an Australian financial crisis.
The bill also addresses the question of the role and function of APRA, the financial regulator, which we believe has a myopic fixation on financial stability at all costs, never might the impact on customers, as the recent Productivity Commission review called out.
Two points. First there is merit in the Glass Steagall reforms, and I recommend getting behind the initiative, despite the fact that it will not fix the current problem of the massive debt households have. Banks were able to create loans thanks to funding being available from the capital markets, and so bid prices up. Turn that off, and their ability to lend will be curtailed ahead, which is a good thing, but the existing debts will remain. Second, some are concerned about the CEC, and its motives. The CEC, is an Australian federally registered political party which was established in 1988. From 1992 onward the CEC joined with Lyndon H. LaRouche and you can read about his policies and philosophy here. But my point is, if you need a horse, and a horse appears, ride the horse and worry less about which stable it came from. I applaud the CEC for driving the Glass Stegall agenda.
But to deal with the debt burden we have, there are some other things to consider. For example, at the moment the standard mortgage contract gives banks full recourse — if you default the bank can not only sell the property, but also get a court judgment to go after your other assets and even send you bankrupt. In the USA some states have non-recourse loans, and recent research showed that borrowers in these non-recourse states are 32 per cent more likely to default than borrowers in recourse states. This is because if the outcome of missing your mortgage payments is losing pretty much everything you own and being declared bankrupt, you will do just about anything possible to keep paying your home loan. And banks will be more likely to make riskier loans when they have full recourse. So I wonder if we should consider changes to the recourse settings in Australia, which appear to me to favour the banks over customers, and encourage more sporty lending.
Then finally, there is the idea of changing the fundamental basis of bank funding, using the Chicago Plan. You can watch our video “Popping The Housing Affordability Myth” where we discuss this in more detail and “It’s Time for An Alternative Finance Narrative” where we go into more details. Essentially, the idea is to limit bank lending to deposits they hold, and it offers a workout strategy to deal with the high debt in the system and remove the boom and bust cycles. This is not a mainstream idea at the moment, but I think the ideas are worthy of further exploration. This is something I plan to do in a later video and look at how a transition would work.
But my broader point is that we need some fresh thinking to break out of our current dysfunctional banking models. Today, they may support GDP results as they inflate home prices more, but we are at the point where households a “full of debt”. So we see higher risks in the system as the latest RBA Statement On Monetary Policy, which we discussed in our video “The RBA Sees Cake – Tomorrow”. They called out risks relating to the amount of debt in the household sector, and the prospect of higher funding costs, a credit crunch, and lower consumption should home prices fall. And the latest data shows that prices are falling in the major centres now, and auction results continue lower. I believe that the RBA’s business as usual approach will lead us further up the debt blind alley. Which is why we need more radical reform in the banking system and the regulators if we are to chart a path ahead.
AMP has announced that David Murray, former CBA chief executive and chair of the Financial System Inquiry, has been appointed as the new chairman of AMP.
Mr Murray will join the AMP board as chairman after the AMP 2018 annual general meeting on Thursday 10 May, on or before 1 July 2018.
Current executive chairman Mike Wilkins will return to the position of acting chief executive officer on that date.
Mr Murray was the chair of the Financial System Inquiry, which reported to the government in December 2014. He was also the chief executive officer of CBA between 1992 and 2005.
Mike Wilkins said: “We’re delighted to welcome a person of David Murray’s outstanding calibre to the Chairman’s role. His appointment brings strong and experienced leadership to the company, strengthening our governance and our commitment to change.
“David has deep experience of financial services, particularly banking and wealth management, as well as the industry’s regulatory environment through his leadership of the Financial System Inquiry.”
“He brings a strong risk mindset and a clear appreciation of community expectations for AMP as well as the wider financial services industry. This is part of the reset that is necessary for the company and I look forward to working with David, the Board and management to rebuild public confidence in the company and to restore shareholder value,” he said.
David Murray said: “AMP employs almost 6,000 people many of whom are Australians serving its customers across wealth management, superannuation, financial advice, life insurance, asset management and banking.”
“It is a significant financial institution and needs to play a role within the Australian financial system which supports the building of trust and confidence in that system in the community. I look forward to working with the Board and executive management to support AMP’s people in achieving that outcome,” he said.
“As part of this, I am committed to meaningful board renewal but recognise the process must be measured so as to maintain the stability of AMP in the immediate future. Restoring trust and confidence is not easy and does not happen overnight, but I am confident this can be achieved,” Mr Murray said.
AMP has published a 28 page response to the issues raised by the Royal Commission. They make the point that the fees for no service issue is old news. In addition, they down play the preparation of a Clayton Utz report into the issue and the firms misleading representations to ASIC.
They did unreservedly apologise for their financial advice failings relating to service delivery to customers and spoke about extensive action aims to ensure these issues “never happen again.”
The wealth management giant said fees for no service is an industry-wide issue and AMP has been the subject of an ongoing ASIC investigation since 2015. As part of the investigation, extensive details were disclosed to the regulator in October 2017, AMP said.
Fees for no service include instances where AMP charged fees due to an administrative error and through the practice of retaining fees during buy back arrangements known as “ring-fencing” and “the 90-day exception”.
“Between 2010 and 2016, of the 2417 register transactions that took place, 39 were Buyer Of Last Resort (BOLR) transactions which involved application of the 90-day exception,” the AMP submission said.”We have apologised to and refunded the fees to all customers impacted by the 90-day exception. The remediation totalled $850,000. To date, for the broader licensee fees for no service issue, we have remediated 15,712 customers, a total of $4.7 million.”
AMP acknowledged the process has been too slow and is committing additional resources to accelerate remediation.
The Clayton Utz report
AMP has reiterated to the Royal Commission that there is no evidence to suggest its board, including the former chairman and former chief executive, acted inappropriately in relation to the preparation of the a Clayton Utz report into fees for no service.
The board commissioned the report on 5 June 2017. It entailed interviews with 27 current and former employees, and a review of documents, AMP said.
“The report is an uncompromisingly direct 87-page review of the conduct of the advice business in relation to fee for no service matters,” AMP said.
“The board were not aware of the nature and extent of the interaction during the preparation of the report.”
There is also no evidence that Clayton Utz made any changes to the report that it did not agree with or that it did not stand behind the report.
“The extent of interaction between AMP and Clayton Utz has been overstated,” AMP said.
Misleading ASIC
AMP has accepted its communications to ASIC have been misleading. The communications regarded fees of certain customers not being switched off in connection with adviser buy-back arrangements and the 90-day exception.
“AMP accepts that any misrepresentation, even if inadvertent, to ASIC is unacceptable and must be corrected as soon as it becomes apparent. However, the number of separate misrepresentations referred to in the Royal Commission has been overstated,” it said.
“There were seven misrepresentations (in 12 communications). These were not new ‘news’. We had reported them in detail to ASIC in October 2017 and then to the Royal Commission.”
In terms of accountability, AMP pointed to its chief executive and chair stepping down; board directors taking a 25% pay cut for the remainder of 2018; and the strengthening of its advice governance framework in 2017 among other internal measures.
On Tuesday, the Australian Prudential Regulation Authority (APRA) released the results of its prudential inquiry into Commonwealth Bank of Australia, which cited its concerns about the bank’s management of non-financial risks and made recommendations to address those issues. APRA also will apply a capital adjustment by adding AUD1 billion to CBA’s operational risk capital requirement until it is satisfied that CBA has addressed the recommendations. APRA’s inquiry results are credit negative for CBA because it exposes the bank to reputational damage and costs associated with addressing its shortcomings. Additionally, the capital adjustment will lower CBA’s Common Equity Tier 1 ratio to a pro forma 10.1% as of year-end 2017 from an actual 10.4%.
APRA’s report noted that CBA’s continued financial success negatively affected the bank’s ability to manage its operational, compliance and conduct risks. In particular, the report highlighted the board and its committees’ inadequate oversight of emerging non-financial risks; unclear accountabilities, starting with a lack of ownership of key risks; weaknesses in how issues, incidents and risks were identified and escalated and overly complex and bureaucratic decision-making processes. The report cited an operational risk-management framework that worked better on paper than in practice, supported by an immature and under-resourced compliance function. In addition, APRA criticized the bank’s remuneration framework, which before the prudential inquiry began in August 2017, had few consequences for senior management for poor risk management and compliance performance.
The report made 35 recommendations to strengthen the bank’s governance, accountability and culture, and gave the bank 60 days to provide a remedial action plan to APRA. An independent reviewer will be appointed to provide quarterly updates to APRA on CBA’s progress. The recommendations are focused on five key areas: more rigorous board- and executive-committee-level governance of non-financial risks; exacting accountability standards reinforced by remuneration practices; a substantial upgrade of the authority and capability of the operational risk management and compliance functions; questioning the appropriateness of all dealings with and decisions on customers; and cultural changes that aim for best practices in risk identification and remediation.
APRA began the inquiry after a number of incidents that have negatively affected the bank’s reputation. In August 2017, the Australian Transaction Reports and Analysis Centre began proceedings against CBA for non-compliance of the Anti-Money Laundering and Counter-Terrorism Financing Act. The same month, the Australian Securities and Investments Commission (ASIC) announced that CBA would refund more than 65,000 customers a total of approximately AUD10 million after selling them unsuitable consumer credit insurance. In March 2016, the bank’s life insurance business, CommInsure, was accused of deliberately avoiding or delaying paying claims to its customers (ASIC cleared CommInsure of any breaches of the law in March 2017). In 2014, CBA announced a review into the poor quality of advice and compliance breaches by its financial planning businesses.
The report comes against a backdrop of the ongoing Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which has identified conduct and culture challenges at some of Australia’s largest financial institutions. We note that the franchise dominance of Australia’s major banks and their exceptionally low credit costs during an extended period of low interest rates may have elevated the risk of complacency in their approach to operational and governance risks.
More bad news relating to CBA. They have confirmed the loss of data relating to almost 20 million accounts. The event happened in 2016, and they decided not to inform customers, as the data “most likely” had been destroyed.
The Commonwealth Bank has confirmed it lost the historical financial statements of almost 20 million accounts, but insists its customers’ information has not been compromised.
The statements, containing customers’ names, addresses, account numbers and transaction details from 2000 to 2016, were stored on two magnetic tapes which were lost by sub-contractor Fuji-Xerox last year.
When the bank became aware of the incident, it said, it ordered an independent “forensic” investigation to figure out what had happened and informed the Office of the Australian Information Commissioner (OAIC).
The inquiry, conducted by KPMG, determined the tapes had most likely been disposed of.
Commonwealth Bank’s Angus Sullivan described the incident as “unacceptable” but said the tapes did not contain any passwords or PINs that could compromise customers’ accounts.
CBA said:
Following recent media reports detailing an incident in May 2016, we want to reassure you there is no evidence of your information being compromised and you do not need to take any action.
Here is what you need to know:
There is no evidence that any customer information was compromised.
In May 2016 we were unable to confirm the scheduled destruction of two magnetic tapes used by a supplier to print bank statements. These tapes contained information including customer names, addresses, account numbers and transaction details.
They did not contain passwords or PINs which could enable fraud.
We deployed enhanced reporting and ongoing monitoring of customer accounts to ensure customers were protected. These protections are still in place today.
This was not cyber-related. CommBank’s technology platforms, systems, services, apps and websites were not compromised.
CommBank offers you a 100% security guarantee against fraud for all your accounts, where you are not at fault. We cover any loss should someone make an unauthorised transaction.
A report on the Commonwealth Bank’s governance, culture and accountability has stripped away the bank’s delusion that it is well run and a model of good governance.
The report by the Australian Prudential Regulation Authority (APRA) is a damning indictment of every aspect of CBA management, from the board of directors to executive management and even the lower levels of the bank. However, APRA has done little more than rap CBA on the knuckles.
Responsibility for fixing up CBA has been turned over to the bank itself. More could have been done, including placing conditions on CBA’s banking licence and removing board members and executives.
APRA has applied a A$1 billion add-on to CBA’s minimum capital requirement. These are the financial assets that the Commonwealth Bank is required to hold to ensure a stable banking system.
APRA has also accepted an enforceable undertaking from the CBA. This is essentially an agreement under which CBA accepts the report’s findings (but does not expressly agree with them) and promises to prepare a plan to respond to its recommendations.
There are indications in the APRA report that there will be further investigations of the conduct of bank employees.
What penalties?
The A$1 billion add-on to CBA’s capital requirements is not a penalty, despite commentary to that effect. APRA can and does require top-ups of this kind from time to time under the Banking Act to ensure security and confidence in the banking sector.
Given the Commonwealth Bank’s size and leading role in the sector, the additional capital requirement is prudent but hardly controversial. The funds will be returned to CBA when it completes the actions proposed by the enforceable undertaking.
That leaves the CBA enforceable undertaking as the principal outcome from the APRA report.
The enforceable undertaking is mostly a procedural document. For instance, CBA must submit its remedial action plan by June 30 2018.
It must have a clear and measurable set of responses and a timetable for each response, and must nominate a person responsible from the CBA executive team. CBA must also appoint an independent reviewer, approved by APRA, to report to APRA on compliance with the enforceable undertaking and the completion of items in the plan. CBA must report separately on executive pay issues.
In essence APRA has handed over the responsibility for cleaning up the management mess found at the CBA to the bank itself, despite finding that it is culturally unfit to properly manage itself.
Why should anyone take comfort from that arrangement?
APRA’s report also makes clear that the problems at the Commonwealth Bank do not stem from one specific issue. The problems affect the whole organisation of more than 45,000 employees with A$967 billion in assets.
An independent reviewer will vet what is being done and report on its success or otherwise to APRA. But that report will be made to APRA, not to the general public. We may never know what measures the bank implements as APRA has no obligation to disclose anything.
What else could have been done?
An enforceable undertaking can save the regulator the time, cost and uncertainty of taking legal action, as well as enable it to craft specific remedial actions to fit the circumstances.
But there is very little tailoring in the Commonwealth Bank’s enforceable undertaking. APRA has opted to wait and see what remedial action the bank comes up with. The regulatory touch is so light that even describing it as featherweight would be an exaggeration.
APRA could have done much more than it did. Banks require a licence and APRA is empowered by Banking Act to place conditions on these licences that restrict or limit how banks can operate.
APRA could have used this power to place immediate restrictions on CBA’s business practices, including on the size and calculation of executive compensation. One of the major findings of APRA’s report is that CBA executive compensation schemes did not provide sufficient incentives for senior executives to account for risk in their decision-making. Certainly, the criticisms of CBA management in the APRA report are sufficient to warrant this kind of action.
APRA should have queried whether these changes were sufficient. Perhaps this is part of the wait-and-see approach implied in the enforceable undertaking.
The APRA report highlights systemic problems in Australia’s leading company and premier bank, including a culture of complacency, defensiveness, insularity and overconfidence. But for all of that, and despite the financial and emotional costs borne by the Australia community, APRA’s response appears to be no more than “wait and see”.
Author: Helen Bird, Course Director, Master of Corporate Governance & Research Fellow, Swinburne Law School, Swinburne University of Technology
Wayne Byers, APRA Chairman spoke on ‘Beyond the BEAR Necessities‘ at the UNSW Centre for Law Markets and Regulation Seminar in Sydney. Timely, given recent events. He looks at the BEAR, which is due to commence formally from 1 July 2018. He also touched on the relative roles of APRA and ASIC, and potential overlap.
But note BEAR is NARROW – it applies only to ADI groups, and deals primarily with matters related to the prudential standing and reputation of the ADI. So the broader customer issues are off radar! This will not be sufficient to deal with the issues at hand.
He argued that trust is the corner stone of a financial business, that the Australian financial system is “financially sound” but are far less trusted to “do the right thing”. He regards this a less fatal flaw than lack of financial soundness (which tells you something about APRA’s DNA)!
Financial institutions operate in a privileged position in society, and yet consumers have difficulty in assessing financial products which are often require long term commitments, and consumers are forced to use them, – for example super.
So, he says, “That combination of compulsion, opacity and materiality generates, as a quid pro quo, a heightened expectation that financial institutions will exhibit high standards of behaviour in the way they operate.”
The community will be far more likely to maintain its trust that the sector will do the right thing if it is evident there is accountability when it does not.
APRA has had an increasing interest in the risk culture of financial institutions (and admits there is some cross-over with ASIC).
ASIC, reflecting its own mandate, will take an interest in shortcomings that lead to damaging outcomes for consumers and markets. APRA, on the other hand, has an interest in failings in governance, culture and accountability that indicate a lax attitude to risk-taking, which might ultimately impact the soundness of the financial institution itself (and thereby jeopardise the interests of depositors, policyholders and superannuation fund members).
Which brings me to the BEAR, which imposes substantially strengthened requirements in relation to accountability within banking organisations. In its design, the BEAR draws its inspiration from the Senior Manager Regime (SMR) in the UK. However, the BEAR is narrower in coverage: the BEAR applies only to ADI groups, and deals primarily with matters related to the prudential standing and reputation of the ADI. For this reason, the BEAR is naturally administered by APRA. The joint administration between the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) that occurs the UK reflects the wider range of institutions and behaviours that are covered by the SMR. Were the BEAR to be broadened at some stage in the future, a similar joint administration might well be appropriate in Australia. Until then, it is framed with a prudential focus and hence administered by a prudential regulator.
Bringing the BEAR to life
The BEAR formally comes into effect very shortly: 1 July 2018. In practice though, implementation occurs over time. The new regime applies to the largest banks from day one; other ADIs have a further year before they are subject to the BEAR. There are also additional transitional provisions within the legislation: from a requirement that allows ADIs three months to register their accountable persons, to allowing until the end of 2019 to accommodate the remuneration requirements in pre-existing executive employment contracts. So it will be some time before the BEAR is in full force.
Broadly, there are five main elements to the BEAR and I’d like to say a few words about each: registration, obligations, accountabilities, remuneration and sanctions. In each case, I’ll talk about the new requirements, and what’s changing from the regime in place today.
The first element is registration.
The BEAR prescribes a set of ‘accountable persons’. These are essentially the directors and senior executives responsible for an ADI’s overall health and well-being. The BEAR requires accountable persons to be registered with APRA before they can perform their duties.
Accountable persons are deemed registered 14 days after they have lodged their registration. Unlike the UK SMR, there is no scope for regulatory approval of appointments, nor any process of interviews. That is a deliberate choice: it maintains accountability for senior appointments where it rightly belongs – with the Boards and senior executive teams that are making the appointments. However, unlike the current process which only requires an ADI to notify APRA after an appointment, the BEAR requires an executive to be registered prior to taking up duties. While APRA will not be vetting all appointments, the pre-appointment registration does provide an opportunity, should we be aware of information that might make an appointee unsuitable, to discuss any concerns with the individual or the employing ADI.
The second element of the BEAR is obligations.
New statutory obligations apply to both accountable persons, and ADIs. These obligations require each to (i) act with honesty and integrity, (ii) with due skill, care and diligence, and (iii) deal with APRA in an open, constructive and cooperative way. In doing so, they must also take reasonable steps to prevent matters arising which would undermine the ADI’s prudential standing and prudential reputation.
Are these new obligations onerous? I personally don’t think they are notably more onerous than the existing requirements in our Prudential Standards, which requires that ‘responsible persons’ possess the competence and character to perform their roles.6 Of course, there’s no explicit obligation at present to be open and cooperative with APRA, or any formal obligation to prevent matters arising that would undermine the ADI’s prudential standing and reputation. But I hope no one wants to claim they require senior executives to do something they shouldn’t naturally do!
The third element of the BEAR is the requirement for accountability maps and statements.
Each accountable person needs to have an accountability statement, setting out the aspects of an ADI’s operations for which they are accountable. Each ADI must have an accountability map, showing how the statements come together to cover the totality of an ADI’s business and risks. Together, the map and accompanying statements establish clarity on the allocation of accountability across the executive team within an ADI.
To the person in the street, this wouldn’t seem particularly difficult. After all, all executives have some kind of role statement that sets out their broad responsibilities, and they have staff reporting to them that undertake various functions and that they oversee. But this is probably the most important element of the BEAR. In many ADIs, there is often collective responsibility for various aspects of its business: for any given process or product, there are often hand-offs of responsibility (including, at times, to external partners and suppliers). But this creates the risk of collective responsibility leading to no individual accountability. Clarity of accountability – the foundation of the BEAR – goes to the heart of a strong risk culture.
In speaking with some executives and directors in the largest ADIs – not all of whom, I must admit, were fans of the BEAR – they acknowledge the benefits that the accountability statements and maps can bring them from a business perspective. The complexity of organisational structures, with the separation of product manufacturing, distribution, and operations, makes it challenging to ensure it is clear who is responsible when things are not as they should be. Clearer accountabilities can only be beneficial.
Clearer accountabilities can also improve remuneration outcomes. As we noted recently, it is not uncommon for performance metrics within executive scorecards to be weighted more heavily to the performance of the institution rather than the individual. On a positive note, this promotes a collegiate whole-of-organisation focus but, on the other hand, can also permit poor risk outcomes in a particular business line to be ‘averaged out’ across the business as a whole, reducing the impact on the executive(s) most accountable and potentially undermining effective risk management. Clearer accountabilities should allow for more targeted scorecards, and thereby greater alignment between the outcomes an individual delivers and the rewards he or she receives.
Which brings me to the fourth element: the remuneration requirements.
The BEAR requires ADIs to defer a minimum proportion of an accountable person’s variable remuneration – generally 40 per cent for executives, or 60 per cent for the CEO, of a large bank – for a minimum of four years. It also requires ADIs to have remuneration policies that provide for the reduction in variable remuneration should an accountable person fail to comply with their obligations, and to exercise the provision should circumstances warrant it. Contrary to some beliefs, however, the BEAR does not grant APRA any power to determine what amount of remuneration an individual should receive.
The basic requirements of the BEAR – a remuneration policy, and provision for the reduction of variable remuneration when warranted – are in place today. But compared to today, the BEAR introduces the prescribed minimum deferral amounts and terms, and creates a stronger link to the statutory obligations I referred to earlier.
The BEAR will therefore mean accountable persons have more skin in the game for a longer period of time than is typically the case now and will place greater pressure on ADIs, when adverse prudential outcomes occur, to explain how that has been factored into remuneration outcomes. As a result, the BEAR will require many ADIs to restructure their remuneration frameworks. As I did a few weeks ago, I’d encourage all ADIs to think more holistically about the right structure for performance-based remuneration – the BEAR’s ’40 per cent for four years’ formula is not necessarily the right mix for all. Alongside our recent remuneration review, the BEAR provides an opportunity to fundamentally rethink remuneration frameworks and achieve a stronger alignment with long-term financial safety and a strong risk culture. It will be a lost opportunity if everyone just defaults to the minimum.
The fifth and final element of BEAR are the sanctions.
These apply at two levels: the ADI and the individual. For ADIs, the BEAR provides a penalty regime in instances where the ADI has failed to meet its obligations under the legislation – put simply, failing to operate with integrity, skill, care and diligence, or preventing the prudential standing or reputation of the ADI from being materially undermined.
I’d like to point out here, in response to some misunderstandings that seem to exist, that APRA cannot impose the fines unilaterally: APRA must make a successful case before the Courts. That will require APRA to have a belief as to its reasonable grounds for success, and that the offence is material.
For individuals, the financial sanctions for any failure to fulfil their obligations will be addressed via the ADI’s remuneration policy. APRA’s sanction is a disqualification power – the power to remove an accountable person from their role, and in the most extreme cases, prevent them for taking on any similar role in the industry in the future. This is obviously not a power that will be used lightly, but appropriate and useful where necessary to eliminate known poor behaviour endangering prudential safety.
APRA’s role
I want to finish by noting another concern that some have raised about the BEAR: that it somehow changes APRA’s role. I hope I’ve been able to point out today that that’s not the case. Many aspects of the BEAR are already present in APRA’s prudential framework, and the BEAR has been framed from a prudential perspective. In that sense, the BEAR should be viewed as a major strengthening of APRA’s prudential framework, not an expansion of its mandate. And the BEAR is not dissimilar to a number of other management responsibility/fitness and propriety regimes that are administered by APRA’s prudential peers in other jurisdictions.
The BEAR certainly provides for a strengthening of after-the-event sanctions that could apply if things go seriously wrong in an ADI. But its real value, I hope, will be to support APRA’s preventative role by promoting strong and clear accountability, and ensuring directors and executives who have the primary responsibility for the safe and sound operation of an ADI stay focussed on that task. Indeed, that has been the experience in the UK: despite the SMR’s extensive penalty regime, the UK authorities have only needed to use it sparingly because the industry itself has lifted its game.
The chairwoman and CEO of AMP have resigned after the company admitted to charging for advice never provided and lying to clients and regulators. But no banking CEOs have been toppled despite the Financial Services Royal Commission unearthing instances of fraud, bribery, impersonating customers, failures to report misconduct to regulators and other poor behaviour.
Similar conduct in the United States has resulted in bank executives and directors being forced to resign. That this is not happening in Australia shows how the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) aren’t using their full powers to take action on the banks’ bad behaviour.
APRA already has the power under the Banking Act to remove someone from a bank board and install its own nominee. The recently enacted Banking Executive Accountability Regime has given APRA more power to remove directors and install new ones.
So ASIC and APRA are not bedevilled by a lack of power, but by a lack of willpower.
In 1998 the Wallis Inquiry hived off the consumer protection and market conduct functions from the Australian Competition and Consumer Commission (ACCC) and gave these to ASIC. Professor Ian Harper, a member of the inquiry, now concedes that may have been an error.
The ACCC is an excellent regulator, with a long history of being a tough cop. Handing the consumer protection and market conduct function back to the ACCC is a step that federal Treasurer Scott Morrison should take now.
Indeed, Matt Comyn, who was responsible for this division from 2012 onwards, has been promoted to Commonwealth Bank CEO. Former CEO Ian Narev has been permitted to sail off into the sunset with bonuses intact.
Despite United States authorities being widely regarded as weak in standing up to their banks, American CEOs are being held accountable.
Take the example of John Stumpf, chairman and CEO of Wells Fargo, the biggest retail bank in the US. Under his direction Wells Fargo staff had been opening multiple accounts for clients, with neither their knowledge nor their consent, and then charged account-keeping fees.
No one is suggesting Stumpf knew about the fraud, or that Comyn knew that CBA was charging fees for advice to dead people. But Stumpf’s misstep caused his departure. Why is no one suggesting Comyn must go?
This is the true state of the Australian financial sector: bank executives and CEOs who could be facing criminal charges, and should have resigned, don’t even acknowledge the buck stops with them.
Regulatory failure
And if there is any doubt about the need to get cracking, here is the knockout blow: UBS has downgraded Westpac shares because the royal commission revealed that the percentage of “liar loans” in the bank’s A$400 billion loan book may be much higher than stated, or even than Westpac itself is aware of.
This is the culmination of ten years of cowboy behaviour in a financial system that now resembles the Wild West.
This is what happens when compliance culture breaks down, which in turn is a function of regulatory oversight and enforcement. Put differently, our regulators have failed to act for so long that the problem is assuming systemic proportions.
What will be interesting to see is whether the APRA inquiry is another whitewash. I half suspect that if it failed to excoriate CBA it would look pretty silly.
Let’s hope the panellists understand that. But if they don’t, then they must be called out.
Author: Andrew Schmulow, Senior Lecturer, Faculty of Law, University of Western Australia
Commonwealth Bank of Australia (CBA) today confirmed it will implement all the recommendations contained in the Report of the Prudential Inquiry released this morning by the Australian Prudential Regulation Authority (APRA).
The Capital “hit” is 29 basis points, and reduces CBA’s 31 December 2017 CET1 ratio from 10.4% to 10.1%.
CBA Chairman Catherine Livingstone said: “Addressing the findings of the Report is a key focus for the Board and management to ensure that our governance, culture and accountability frameworks and practices are significantly improved and meet the high standards expected of us.
“Changes have been underway throughout 2017 at Board and operational levels, and have continued this year, helping to rebuild customer and community trust. This includes the process of Board renewal. Together they represent a significant change program and the APRA Report provides us with a clear roadmap for the hard work still ahead of us.
“The Board will now oversee a comprehensive response to APRA, using the Report to assess the adequacy of steps already underway, and to address the additional improvements needed to implement all its recommendations. We will also appoint an agreed, independent reviewer to report to APRA on our progress.
“We understand the scale of change which is necessary and its seriousness in order for us to become a better, stronger bank for our customers, staff, regulators and shareholders.”
CBA Chief Executive Officer Matt Comyn said: “We have embraced the Report as a critical but fair assessment of the issues facing us and we will act on its recommendations, and the requirements of the Enforceable Undertaking, in an open, transparent and timely way.
“Our current change priorities are consistent with the Report’s recommendations. We now have a detailed roadmap for ongoing change and we will work with APRA to ensure we implement all of the Report’s 35 recommendations.”
APRA Prudential Inquiry into CBA: Overview of Recommendations and CBA Change Priorities
APRA Levers of Change*
CBA Change Priorities
· More rigorous Board, Executive Committee level governance of non-financial risks.
· Development of exacting accountability standards reinforced by remuneration practices.
· Undertaking a substantial upgrading of authority and capability of the operational risk management and compliance functions.
· Injection into CBA’s DNA of the “should we” question in relation to all dealings with and decisions on customers.
· Cultural change that moves the dial from reactive and complacent to empowered, challenging, striving for best practice in risk identification and remediation.
· Strengthening the governance and management of non-financial risks at the Board and executive level.
· Changes to remuneration policies and practices to ensure greater accountability for risk, compliance and customer outcomes.
· Strengthening capability in operational risk and compliance throughout the Group supported by positive, transparent regulatory relationships.
· Renewed focus on listening to customers and improved systems and procedures for reporting and resolving customer complaints.
· Empowering staff with the tools and processes they need to manage risk better including embedding three lines of accountability as a consistent operating model.
* APRA Prudential Inquiry into CBA, p4. The full APRA Prudential Inquiry Report can be found at www.apra.gov.au.
In response to the Report, Commonwealth Bank has also entered into an Enforceable Undertaking (EU) with APRA. The key terms of the EU involve:
1. Remedial Action Plan
· Establishing an APRA-agreed remedial action plan within 60 days with clear and measurable responses to each of the Report’s recommendations supported by a timeline and executive accountabilities for completing each remedial action.
· Appointing an independent reviewer, approved by APRA, to report to APRA every three months commencing 30 September 2018, on compliance with the EU and on those items in the remedial action plan that CBA considers are nearing completion.
2. Remuneration
· Reporting to APRA by 30 June 2018 on how the findings of the Report have been reflected in remuneration outcomes for current and past executives.
· Ensuring accountability for completing items in the remedial action plan is given significant weight in the performance scorecards of the senior executive team and other staff as relevant.
3. Capital Adjustment
· APRA will apply a capital adjustment to CBA’s minimum capital requirement by adding $1 billion to the Bank’s operational risk capital requirement. The effect of this adjustment equates to 29 basis points of Common Equity Tier 1 capital and reduces CBA’s 31 December 2017 CET1 ratio from 10.4% to 10.1%.
· CBA may apply for removal of all or part of the capital adjustment when it believes it can demonstrate compliance, to APRA’s satisfaction, with the specific EU undertakings and the commitments in the remedial action plan.
Mr Comyn said: “Change starts with acknowledging mistakes. I apologise to the Bank’s customers and staff, our regulators, our shareholders and the Australian community for letting them down.
“We will make the necessary changes to become a better bank and we will be transparent about our progress. This includes establishing a much higher level of accountability and consequence for our actions and the impact we have on customers. This starts with me.”
CBA will release its Third Quarter Trading Update on 9 May 2018. In early July, subject to finalisation with APRA, CBA will provide a public update on its agreed remediation plan. An estimate of the expected financial cost of this program for the 2019 financial year will be disclosed as part of CBA’s Annual Results announcement on 8 August 2018.
CBA will report on its progress in addressing the recommendations of the Prudential Inquiry’s report. The form of this public reporting is subject to agreement with APRA on reporting mechanisms.
Commonwealth Bank remains in a strong financial position as acknowledged by the APRA Report which notes: “the undoubted financial strength and acumen of CBA, its global standing and avowed commitment of staff to servicing customers.”
Since it was announced in August 2017, APRA’s Prudential Inquiry into CBA has received the Bank’s full co-operation and active support.
