Key findings from the banking Royal Commission final report

Friday, 01 March 2019

Christian Gergis photo
Christian Gergis
Head of Policy, Australian Institute of Company Directors

    Boards will need discipline and focus in the wake of the Royal Commission final report. We recount the major findings and what they mean for directors.

    After a year of damning exposure, 76 recommendations and 24 referrals for further action in the forensic, nearly 1000-page final report by Commissioner Kenneth Hayne AC, there is one question that should be in the mind of all boards of directors: if our organisation was exposed to similar public scrutiny, how would our culture, governance and ethics fare? The Royal Commission final report, released on 4 February 2019, calls out the boards and senior management of the financial services industry directly.

    “There can be no doubt that the primary responsibility for misconduct in the financial services industry lies with the entities concerned and those who managed and controlled those entities: their boards and senior management,” Commissioner Hayne notes in the opening chapter.

    The Commissioner makes it clear the failings extended to organisational culture, governance and remuneration. Without deflecting blame from the organisations themselves, Hayne also had strong words for the regulators. “[T]he community expects that financial services entities that break the law will be held to account,” Hayne writes. The work of the commission has shown that not only has the law “not been obeyed”, it has also “not been enforced effectively”.

    Hayne affirms that the regulators have an important role to play in the supervision of culture, governance and remuneration. Supervision of non-financial risks is key to this.

    The final report also emphasises many of the key principles of good governance, especially: the importance of board challenge of management and having the right flow of information to the board in order for directors to discharge their duties.

    It is incumbent now on the governance community to learn the lessons of the Royal Commission and implement change, according to leading directors Peter Warne FAICD and Penny Winn GAICD.

    Warne, chair of Macquarie Group, says the final report is a warning to all that they just cannot accept the status quo. “We need to continue to challenge, to have a much bigger emphasis on compliance and to be 100 per cent sure we are doing the right thing, and not just assuming because we have policies and procedures in place that we are complying with the law,” says Warne.

    Royal Commission roundup

    During April and May, AICD MD and CEO Angus Armour FAICD and a panel of senior directors will lead a discussion on the critical issues for directors, after the banking Royal Commission, in all capital cities. Members will have the opportunity to provide feedback on how AICD can continue to advocate for good governance, and what, if anything, the AICD needs to do differently to strengthen governance settings.

    The key dates are: Brisbane, 3 April; Sydney, 4 April; Adelaide, 12 April; Melbourne, 29 April; Canberra, 30 April; Hobart, 2 May; Darwin, 9 May; and Perth, 10 May. 

    Winn, a non-executive director of Caltex Australia, CSE and Goodman and chair of Port Waratah Coal Services, says Hayne is sending a signal that “community expectations of corporate behaviour must be heard and acted upon in companies and boardrooms across Australia”. “If we’re not heeding that, we’re not doing our job appropriately,” she notes.

    While the report does not contain any recommendations that fundamentally disrupt Australia’s corporate governance model, it highlights where practice can and should be questioned. It also leaves in place the twin peaks model of financial regulation with APRA as prudential regulator, while ASIC is responsible for conduct and disclosure.

    Fears that the final report might shake confidence in a sector that remains fundamental to the functioning of the economy was misplaced. Indeed, bank stocks rallied after the release of the report, even though the misconduct revealed could end up costing the industry in excess of $7b, according to analysis by Shaw and Partners bank analyst Brett Le Mesurier.

    Challenging management

    In the report, Hayne underscores the importance of boards getting the right information and challenging management, cornerstones of Australia’s corporate governance model. Hayne draws on case studies concerning the Commonwealth Bank of Australia’s compliance with anti-money laundering and counter-terrorism financing laws and National Australia Bank’s charging of adviser service fees to superannuation fund members to make the point.

    In the CBA case, the board had not given sufficient attention to the non-financial risks associated with the bank’s compliance failings, nor did it do enough to ensure management fixed the problems in a timely manner. In the NAB case, the board received inadequate information about the seriousness of the issues. When it was apprised of the issues, the NAB board did not do enough to impress upon management the importance of making an appropriate proposal to ASIC in a timely manner so that customers would be remediated. “When management is acting in a way that is delaying the remediation of customers, and damaging the bank’s relationship with regulators, it is appropriate for the board to intervene and say, ‘Enough is enough. Fix this, and fix it now’,” Hayne writes.

    But while stressing the importance of boards getting the right information, Hayne notes this does not necessarily mean more information. “Often, improving the quality of information given to boards will require giving directors less material,” he says.

    The duty to challenge management should also not be mistaken as an exhortation to be involved in day-to-day operations — “the task of the board is overall superintendence”.

    Changing culture

    By its nature, culture cannot be prescribed or legislated, according to Hayne. A sustainable culture needs to come from within. Regulators have an important role to assess an entity’s culture, “hold up a mirror” to it and supervise change — but the hard yards must be done internally.

    While there is no best practice for creating a desirable culture, Hayne says one necessary aspect is adherence to six basic norms that have now been widely quoted:

    • Obey the law
    • Do not mislead or deceive
    • Act fairly
    • Provide services that are fit for purpose
    • Deliver services with reasonable care and skill
    • When acting for another, act in the best interest of that other.

    A key recommendation of Hayne is that financial services entities must be in what amounts to an always-on cycle to monitor culture. They should, as often as reasonably possible, take proper steps to:

    • Assess their culture and its governance
    • Identify any problems with that culture and governance
    • Deal with those problems
    • Determine whether the changes it has made have been effective.

    This exercise involves much more than “‘box-ticking”, according to Hayne. In his words, it takes “intellectual drive, honesty and rigour”. Hayne endorses the mantra that the tone is set from the top. But he also states that it must be echoed from the bottom and reinforced at every level of management.


    Remuneration is inextricably connected to culture. Remuneration and incentives tell staff what the company values. “Remuneration both affects and reflects culture,” Hayne says While avoiding more radical proposals on remuneration — such as banning variable remuneration which had been floated in the interim report — Hayne makes a number of recommendations including calling on APRA to have greater oversight and the need for entities to place higher regard on non-financial metrics.

    Additionally, all financial services entities should review at least annually the design and implementation of their remuneration systems for front line staff to ensure they focus not only on what staff do, but also how they do it.

    Boards will need to consider their role in this review and whether they have an appropriate level of oversight over remuneration practices — and the behaviours they drive — throughout their organisation.

    Six Ethical Principles

    Commissioner Hayne’s six ideas to inform the conduct of financial services entities:

    • Obey the law
    • Do not mislead or deceive
    • Be fair
    • Provide services that are fit for purpose
    • Deliver services with reasonable care and skill
    • When acting for another, act in the best interests of that other

    Hayne also calls into question the information being provided to boards and their committee about risk management and remuneration decisions. “While it is currently a requirement for a remuneration committee to assess the effectiveness of the entity’s remuneration policy, I have seen little evidence to indicate that these assessments provide the board with sufficient information about how the remuneration system is being applied in practice and whether it is having the desired outcomes,” he says.

    Kathleen Conlon FAICD, chair of the remuneration committees of Lynas Corporation, REA Group, Aristocrat Leisure and The Benevolent Society, says the Royal Commission report demonstrates directors need to understand all of the remuneration structures in the company and the systems, compliance and controls that go around those.

    “It’s asking yourself, ‘How do I know they’re working and how do I test that they’re working?’” she says.

    The pursuit of profit

    In many of the cases of misconduct revealed at the commission, the organisation in question had chosen the pursuit of profit over the interest of customers and above compliance of the law, according to Hayne. He then takes aim at simplistic versions of the shareholder primacy doctrine. Directors must act in the best interests of the corporation itself, Hayne says. While it is important to consider returns to shareholders, this is not the only consideration, according to Hayne.

    Further, deciding the best interests of a company is not a binary choice between customers and shareholders. Usually when these interests are opposed, it is because some shareholders have a short-term outlook. But the longer the time horizon, the more likely it is the interests of shareholders, customers, employees and the company’s other stakeholders will converge.

    Hayne’s framing is welcomed by Louise Davidson MAICD, CEO of the Australian Council of Superannuation Investors, a member organisation that aims to drive strong environmental, social and governance performance from companies on behalf of investors. The distinction between serving customers and focusing on profit is a “false dichotomy”, according to Davidson.

    Twin peaks and BEAR

    Although advocating for a retention of the “twin peaks” model of financial regulation, Hayne did push for significant changes to the way in which both ASIC and APRA operate. He recommends ASIC puts a much greater emphasis on enforcement, having criticised the regulator for not enforcing the law effectively and sometimes not at all. “Financial services entities are not ASIC’s ‘clients’,” Hayne chides, recommending ASIC takes “as its starting point, the question of where a court should determine the consequences of a contravention”, “recognises that infringement notices… will rarely be appropriate… beyond purely administrative failings”, and understands “the importance of deterrence in deciding whether to accept enforceable undertakings.”

    Hayne comes close to recommending that ASIC and APRA include non-executive directors (NEDs) on their boards. There was “no obvious reason” why ASIC would not benefit in the same ways that listed entities do from the inclusion of NEDs on their boards, noting benefits such as improving the scope and quality of internal oversight.

    He recommends that the BEAR (Banking Executive Accountability Regime), introduced in July 2018, be extended to other APRA-regulated institutions, including in the superannuation and insurance industries, with ASIC and APRA to have joint responsibility. The BEAR establishes accountability obligations for an institution’s senior executives and directors, providing both those in the company and regulators a clearer understanding of the responsibilities that attach to a particular position.

    This recommendation is in part to counter what Hayne sees as the basic ignorance of some superannuation trustees. “It should be concerning to regulators that professional [superannuation fund] trustees apparently struggle to understand their most fundamental obligation,” he writes. He accepts the role of a trustee in a super fund can be complex. However, he notes: “The concept of acting in members’ best interests is not hard to understand.”

    In addition to extending BEAR. Hayne also recommends an additional accountability under the regime for end-to-end management of product design, delivery, maintenance and, where necessary, remediation, leaving it then up to each institution to identify the relevant accountable person.

    The Commissioner addresses each of the case studies examined by the commission and notes that the instances of potential misconduct (including, by way of example, the conduct of various entities in connection with the payment of fees for no service, and the conduct of various corporate trustees including Colonial First State, IOOF and AMP in connection with the MySuper transition) have been reported to ASIC and/or APRA as relevant. Hayne also says it is a matter for the regulators to determine what, if any, further action should be taken.

    What the regulators say

    Australian Securities and Investments Commission chair James Shipton says ASIC will consider the report carefully, particularly its recommendations on regulatory and enforcement practices.

    These recommendations, and the federal government’s response, will inform ASIC’s priorities and strategic direction.

    The Royal Commission report identified ASIC’s enforcement culture, and an apparent reluctance to take large institutions to court, as needing change.

    ASIC notes the serious matters referred by the Royal Commission of possible breaches of financial services laws. Consideration of these matters will be prioritised.

    In its submission following the Royal Commission interim report, ASIC committed to accelerating enforcement, conducting more civil and criminal court actions against larger financial institutions and, as a starting point for all enforcement matters, asking the question, “Why not litigate?”

    Australian Prudential Regulation Authority chair Wayne Byres says the Royal Commission’s final report is a considered and fair assessment of failings in the financial system and a helpful roadmap for reform.

    The Royal Commission has identified a number of areas where APRA’s prudential and supervisory framework can and should be strengthened.

    APRA is reviewing its enforcement strategy with the assistance of an Independent Expert Panel. This review includes consideration of when to hold individuals to account.

    The Royal Commission highlights that APRA will play a central role in underpinning better behavioural standards and stronger accountability.

    The recommendations will require APRA to increase the breadth and depth of its supervision and that resources will be needed to do this.

    “Although the Royal Commission has assigned some important new responsibilities to APRA, our primary responsibility remains the safety and stability of the financial system, and to protect the financial wellbeing of the Australian community,” he says.

    “APRA is the only regulator with a primary focus on ensuring the safety and soundness of the financial system.

    “It is therefore important to reiterate that Australia’s financial system remains fundamentally sound. While there are areas where the financial sector clearly needs to make significant changes and improvements, the soundness and stability of the financial system has never been called into question by the Royal Commission.”

    Leading directors have shared their thoughts on the banking Royal Commission final report. Read what they have to say here. 

    The NAB fallout

    Commissioner Hayne singled out NAB’s leadership in the final report, calling out both National Australia Bank CEO Andrew Thorburn and chair Ken Henry AC.

    “Having heard from both the CEO and the chair... I am not persuaded that NAB is willing to accept the necessary responsibility for deciding, for itself, what is the right thing to do,” said Hayne.

    Three days later, Thorburn and Henry announced that they would resign. “We’re deeply sorry,” Henry told ABC’s 7.30. “In our departures, we are hoping we will contribute to the development of a better industry that’s capable of delivering better outcomes for customers. I would say the enduring legacy of this report will be that intense scrutiny is shone on financial institutions in the way it has forced senior people in those organisations to confront some really challenging things. There is a big gap. The [NAB] board has led a deep examination of our culture, governance and accountability. We are the only bank to publicly release our assessment, which clearly outlines 26 areas we are focusing on to be a better bank. It is our highest priority for everyone at NAB to put customers first. At NAB, we are determined to change and accept that we will ultimately be measured by the actions we take.”

    Before Thorburn resigned, he described the commission report as “comprehensive” and said NAB executives would “engage constructively” on any matters concerning the NAB Group which had been referred to the relevant regulator. This is naturally a difficult decision, but I believe the board should have the opportunity to appoint a new chair for the next period as NAB seeks to reset its culture and ensure all decisions are made on behalf of customers,” Henry said in the NAB ASX announcement of his and Thorburn’s resignation.

    The NAB board will actively look to bring on new non-executive directors “to increase diversity of thinking and experience for the challenges ahead,” he went on to say. The board will also establish a committee for customer outcomes.

    Board member and former ANZ and Westpac executive Phil Chronican will take the reins as acting chief executive on 1 March and NAB is looking for a new chair, with Henry to step down once a new CEO has been appointed.

    Henry and Thorburn joined Catherine Brenner (former AMP chair) and Craig Meller (former AMP CEO) as senior business leaders to have resigned in the wake of the Royal Commission.

    Media reports at time of publication suggest there will be further personnel changes at other institutions, as the sector seeks to signal a new era of enhanced accountability.

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