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Harbour's View: What the Australian Royal Commission means for the industry

The Australian Royal Commission will reshape the financial services industry and has significant implications, Harbour Asset Management says. The report has already had strong political support.

Tuesday, February 5th 2019, 11:43AM 2 Comments

by Harbour Asset Management

Andrew Bascand

After a year long review the Hayne Royal Commission (RC) into Misconduct in Financial Services has laid out recommendations. This reshaping of the financial services industry has significant implications and received strong political support, ahead of a likely election by 18 May 2019. It is possible that the Labor Party may have a harsher interpretation of potential changes than the RC recommends.

The final RC has been widely anticipated and the development of Hayne’s views have been consistently in the public domain from day one. Perhaps the continued surprise has been the focus on wealth management more than actual banking practices. As a result, the final report’s recommendations are relatively hard-hitting on wealth management firms that lack independence where material industry change seems highly likely. The regulatory structure also gets a significant overhaul with a new super oversight authority. Banks seem to get little in the way of fresh issues to deal with at this stage.

Vertical integration maintained (just)

The report recommends structural change to address issues of greed, skewed incentives and a lack of consumer focus. But in contrast to expectations, the report recommended against the removal of vertically integrated business models. Instead a tighter set of rules around vertical integration in the wealth management and financial advice sector will make it tougher to inappropriately incentivise and sell financial products through purely aligned channels. Banks are addressing how they might divest wealth management and mortgage broker businesses. The report says that changes in remuneration practices should be made over two to three years. The RC says that lenders will be prohibited from paying trail commissions to mortgage brokers and that mortgage brokers should be subject to financial product advice laws.

Wealth managers face tougher issues to ensure advisers place clients first. Specifically, advisers must, when “providing personal advice to a retail client, give to the client a written statement (in or to the effect of a form to be prescribed) explaining simply and concisely why the adviser is not independent, impartial and unbiased.”

Responsible consumer lending

A key focus of the RC was the extent of inappropriate lending, and aspects of the RC hearings are still making their way through the courts creating a grey area to address. The RC has observed that lending practices have improved significantly over the last two years, albeit further recommendations are made with respect to using intermediaries and understanding living expenses. However, the RC final report continues to embolden the regulators to place scrutiny on lending. The ability to automatically cross-sell insurance and up-sell other “value-add” services will be under tighter scrutiny.

The report says:

“Both income and expenditure must be considered in first inquiring about, and then verifying, the customer’s financial situation. I said in the Interim Report that I consider that verification means doing more than taking the customer at his or her word. I do not consider this to be a novel proposition.
Since the first round of the Commission’s hearings, a number of banks have altered their lending processes and procedures by introducing additional inquiries about a borrower’s financial situation and by taking some further steps to verify that situation.”

No recommendation is made to change the NCCP Act (National Consumer Credit Protection Act 2009). Instead banks and the regulators should apply the law as it stands. However, Commissioner Hayne recommended 24 referrals for prosecution of institutions.

Fees for service (or no service) and conflicted remuneration

Banks have already set aside provisions for historical fees charged for no service. More provisions (manageable for the banks) are likely. In addition, the RC recommends the withdrawal of grandfathered commissions (which most of the banks have addressed). The removal of incentives for sales (or volume sales) is an obvious negative for some wealth management practices that rely on commissioned-based sales. Further ASIC should consider further reducing the cap on commissions in respect of life risk insurance products. Unless there is a clear justification for retaining those commissions, the cap should ultimately be reduced to zero.

The Australian Treasurer, Josh Frydenberg, has responded to the Royal Commission report confirming that the payment of grandfathered commissions will be outlawed from 1 January 2021. This is likely to result in a flow of advisors, and client wealth, from conflicted platforms to the independent platforms. The two-year timeframe for implementation will allow for an unwinding, or revision, of advisors’ contractual terms.

Beefed-up regulation

A key recommendation in the RC is a stronger regulatory presence, higher fines and more litigation. The report recommends retaining the twin regulatory approaches of APRA (Australian Prudential Regulation Authority) and ASIC (Australian Securities and Investments Commission) with increased powers of co-regulation, with ASIC focusing on conduct and APRA licensing and prudential supervision. In addition, the report recommends a new oversight authority for APRA and ASIC required to report to the Minister.

Remuneration and culture

Unsurprisingly, the report focuses on leadership and governance practices to enshrine change at the top. In particular, in revising its prudential standards and guidance about the design and implementation of remuneration systems, APRA should:

  • require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks, and to reduce the risk of misconduct;
  • require the board of an APRA-regulated institution (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks, and reducing the risk of misconduct;
  • set limits on the use of financial metrics in connection with long-term variable remuneration;
  • require APRA-regulated institutions to provide for the entity, in appropriate circumstances, to claw-back remuneration that has vested; and
  • encourage APRA-regulated institutions to improve the quality of information being provided to boards and their committees about risk management performance and remuneration decisions.

Overall the final report has seen the wealth management sector facing significant pressure to continue to pivot a total focus to client outcomes. These changes tend to favour new business models which see specialisation and an upending of longstanding remuneration and business models. The big four banks have emerged relatively unscathed in terms of their core operations although further changes for remuneration of mortgage brokers will see change over a two to three-year period. The key regulators will get more clarity, more money and their own oversight body. As Australia moves into an election cycle there is plenty of potential for the Hayne report to continue to provide headlines, as one commentator has noted, this is the end of the beginning*.

 

*Matthew Wilson, Deutsche Bank. Hayne Royal Commission: End of the Beginning, 5 February 2019.

By: Andrew Bascand (Managing Director) & Simon Momich (Investment Analyst)

This does not constitute advice to any person. See www.harbourasset.co.nz/disclaimer

Important disclaimer information

Tags: Harbour Asset Management Royal Commission

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Comments from our readers

On 5 February 2019 at 1:06 pm dcwhyte said:
With regard to life insurance commissions, the Government has not accepted Hayne's recommendation to reduce the cap to nil eventually. Instead, the response document supports the ASIC review process in 2021 which, in the absence of a significant improvement in the quality of advice on life insurance risk products, will see a mandated move to a level commission structure. This makes practical sense and should be an indicator for raising the bar in NZ.
On 6 February 2019 at 10:02 am Carey Church said:
Thanks for clarifying that David, it is important to read the Royal Commission findings in conjunction with the Government response (https://treasury.gov.au/publication/p2019-fsrc-response/).

It is also important to note that the 'nil commission' target proposed by the Royal Commission is in the context of '70% of insurance being provided through superannuation schemes' - which is quite a different environment to New Zealand. Of course doesn't mean that people in Australia are adequately insured.

There is also a significant difference between the Australian Superannuation landscape and KiwiSaver. In Australia superannuation is funded and provided for (for the most part - excluding SMSF's) by the employer/unions.

Whereas in NZ you are only able to have one KiwiSaver provider and it is up to the individual to choose that provider.

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Lender Flt 1yr 2yr 3yr
ANZ 5.19 4.19 4.25 4.49
ANZ Special - 3.69 3.75 3.99
ASB Bank 5.20 4.25 4.19 4.39
ASB Bank Special - 3.75 3.69 3.89
BNZ - Classic - 3.69 3.75 3.99
BNZ - Mortgage One 5.90 - - -
BNZ - Rapid Repay 5.35 - - -
BNZ - Std, FlyBuys 5.30 4.45 4.35 4.55
BNZ - TotalMoney 5.30 - - -
Credit Union Auckland 5.95 - - -
Credit Union Baywide 6.15 4.95 4.95 -
Lender Flt 1yr 2yr 3yr
Credit Union North 6.45 - - -
Credit Union South 6.45 - - -
Finance Direct - - - -
First Credit Union 5.85 - - -
Heartland 6.70 7.00 7.25 7.85
Heartland Bank - Online - - - -
Heretaunga Building Society 5.75 4.80 4.95 -
Housing NZ Corp 5.19 4.29 4.29 4.49
HSBC Premier ▼5.79 ▼3.65 ▼3.69 ▼3.85
HSBC Premier LVR > 80% - - - -
HSBC Special - - - -
Lender Flt 1yr 2yr 3yr
ICBC 5.65 3.85 3.95 3.89
Kiwibank 5.80 4.30 4.40 4.74
Kiwibank - Capped - - - -
Kiwibank - Offset 5.15 - - -
Kiwibank Special - 3.55 3.65 3.99
Liberty 5.69 - - -
Napier Building Society - - - -
Nelson Building Society 5.70 4.69 4.79 -
Resimac 5.30 4.86 4.14 4.19
RESIMAC Special - - - -
SBS Bank 5.29 4.85 5.05 5.49
Lender Flt 1yr 2yr 3yr
SBS Bank Special - 3.78 3.78 3.99
Sovereign 5.30 4.35 4.29 4.55
Sovereign Special - 3.85 3.75 4.05
The Co-operative Bank - Owner Occ 5.15 3.79 3.84 3.99
The Co-operative Bank - Standard 5.15 4.29 4.34 4.49
TSB Bank 6.09 4.65 4.59 4.85
TSB Special 5.29 3.85 3.79 4.05
Wairarapa Building Society 5.70 4.85 4.99 -
Westpac 5.34 4.69 4.79 5.19
Westpac - Offset 5.34 - - -
Westpac Special - 3.69 3.75 3.99
Median 5.50 4.29 4.25 4.19

Last updated: 23 August 2019 8:51am

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