The AICD has provided a submission to the Financial Services Royal Commission in relation to matters raised in Commissioner Hayne's interim report.
In the submission, we express deep concern about the conduct revealed during the Royal Commission hearings held to date. We also agree with Commissioner Hayne’s conclusion that additional regulation is not the answer, and, indeed, that the complexity of the legal framework can obscure the following simple principles that must 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.
However, it is clear that significant change - both within financial services entities and within our financial services regulators – is needed.
Commissioner Hayne’s interim report raised a number of fundamental questions relevant to governance practices of financial services entities, including in relation to management of conduct risk, remuneration frameworks and corporate culture.
It also highlighted that there needs to be stronger and more proactive enforcement of existing laws and regulations.
The AICD response to these important issues was informed by significant consultation with members and other key stakeholders, as well as close reflection internally.
A high-level overview of the key elements of our submission is provided below, followed by further detail on a number of core themes and a brief overview of next steps.
At a glance
Key elements of the AICD submission included:
- acknowledging the role of the board in ‘setting the tone from the top’ on corporate culture;
- identifying key levers by which organisations can initiate cultural change including remuneration structures and internal controls and policies;
- highlighting the legitimate role which variable remuneration can play in driving corporate performance, while emphasising the need for organisations to review their pay frameworks to ensure they are driving the desired behaviours;
- supporting a more proactive approach to enforcement by ASIC, while noting the need for ASIC to retain its discretion to use the appropriate regulatory tools; and
- advocating for adequate funding of ASIC, given its increased remit and workload has not been matched by additional resourcing.
Conduct risk and corporate culture
In addition to commenting on the board’s role in ‘setting the tone from the top’, we pointed to the need for directors to take steps to properly understand the culture of their organisation, including the extent to which there are gaps between espoused culture and lived culture (ie, what happens in the business in practice). We would expect that these steps would include gaining greater visibility into employee, customer and other stakeholder engagement.
We also observed that directors have an important role to play in approving the governance policies and frameworks that drive behaviour throughout an organisation, and that these will need to be closely reviewed in light of the interim report.
Our submission addresses each of the key matters that should be considered as part of this process – including whether company values and codes of conduct are properly implemented, monitored and enforced; risk management and accountability frameworks are sound, well understood and complied with; and board reporting processes are robust.
Variable remuneration came under significant scrutiny in the interim report.
In Commissioner Hayne’s view, remuneration structures have driven much of the conduct that has come to light including by engendering cultures that prioritise profit over people. This led to the Commissioner questioning the appropriateness of variable remuneration for both frontline staff and senior executives.
The AICD believes that variable remuneration has a legitimate role to play in driving corporate performance, and we defended this position in our submission.
However, it is clear that organisations will need to review their pay frameworks to ensure they are driving the desired behaviours. This includes the processes for holding staff to account for poor customer or risk outcomes.
We also noted that it is important to recognise that remuneration is not the only lever to influence culture and behaviours – rather, remuneration policy sits within a broader system that includes other people-oriented processes (including recruitment and ongoing professional development and performance management programs), as well as ethical frameworks and risk controls.
In accordance with strong feedback from members, we highlighted the role that shareholders and proxy advisers play in relation to executive remuneration. Proxy advisers in particular have strong views on how executive remuneration should be structured (including a clear preference for financial targets), which can make it difficult to implement change – even where it may be necessary to drive cultural change. Our submission calls for further dialogue on this important issue, and the AICD will be looking to lead the debate with the director and investor community over the months ahead.
Role of the regulators
It is imperative that entities do not treat compliance with legal obligations as voluntary – or view the consequences for non-compliance as the ‘cost of doing business’.
We agreed that evidence presented during the hearings demonstrates that ASIC’s enforcement practice have not been sufficient to achieve deterrence. Bringing civil and criminal proceedings can send a strong signal to the market that certain conduct will not be tolerated, and we would support a greater focus on this aspect of enforcement going forward. At a system level, it is critical that market participants know that not every breach of the law can be resolved via negotiation.
That said, we argued strongly that ASIC should exercise its discretion on a case-by-case basis. In particular, we noted that enforceable undertakings, used in the appropriate circumstances, can be an effective regulatory tool, given their ability to produce timely and efficient customer remediation and compensation outcomes.
We also advocated for independent reviews of regulator performance; clarity from Government on their expectations of ASIC; and adequate funding, noting that ASIC must be properly resourced to carry out its enforcement priorities effectively (not only in terms of funding, but also in terms of internal capacity and expertise).
In relation to the role of APRA, we acknowledged that its prudential focus – and its core objective of promoting financial system stability – means that its regulatory scope is necessarily limited.
The November round of hearings held by the Royal Commission will focus on policy-related questions that have arisen out of the previous rounds of hearings. We expect that these hearings will involve a heightened focus on governance issues, and we understand that bank CEOs (and possibly Chairs) will give evidence. Commissioner Hayne’s final report is due to be handed to the Governor-General by 1 February 2019.
The Royal Commission has prompted a high degree of scrutiny of corporate governance generally in Australia, as well as broader debate regarding the role of business in society, and what constitutes legitimate community expectations of corporate behaviour. This debate has been reflected in significant public commentary and political focus, and its impacts are being felt across industries.
Looking ahead to 2019, a likely election year, corporate governance will remain in the spotlight, and it is incumbent on all organisations to look closely at their own practices, and consider whether their relationships with customers, communities and the broader body of stakeholders are both healthy and sustainable.
The AICD is committed to helping the director community to navigate these challenges, and will continue to listen to members and share key insights and learnings.
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