AICD's response to the banking Royal Commission interim report

AICD reflects on Commissioner Hayne's banking Royal Commission interim report and where to now for Australian governance.

This year has seen governance make the headlines, and not always for the right reasons. The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has driven the debate. As members know through Company Director, webinars and updates, the AICD has been following the Royal Commission closely. The AICD has also made submissions in response to the interim report and policy issues raised on insurance and superannuation to date.

Interim report: profit before people?

In September, Commissioner Kenneth Hayne AC QC released an interim report with observations on evidence from the initial four rounds of hearings and posing questions for feedback. The Commissioner suggests that entities and individuals have been motivated by financial gain or short-term profit at the expense of standards of conduct and honesty. In the report, the Commissioner comments that entities appear to have treated the law as applying only when and if they choose to obey it.

The report suggests merit in simplification of the legal framework rather than more regulation, noting that complexity can obscure the principles that must inform the conduct of financial services entities. In Commissioner Hayne’s view, these “very simple ideas” are:

• 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.

While each financial services entity is responsible for its own conduct, the interim report raises issues with the regulators and seeks options to improve and strengthen enforcement. The report also poses policy questions on issues such as remuneration, culture, accountability and risk management.

AICD response at a glance

The AICD response to the interim report expresses deep concern about the conduct revealed in hearings held to date. While we agree with Commissioner Hayne’s conclusion that more regulation and new laws are not the answer, it is clear that change — within financial services entities and regulators — is needed. The AICD response was informed by consultation with members and other stakeholders, as well as close reflection internally.

The AICD’s submission on the interim report:

• Highlights the role of the board in “setting the tone from the top” on corporate culture
• Identifies key levers that drive cultural change including remuneration and internal controls
• Argues the legitimate role for variable remuneration in driving corporate performance, while acknowledging the importance of balanced measures incorporating non-financial risks
• Supports a more proactive enforcement approach by ASIC, while advocating discretion for a range of regulatory tools
• Recommends adequate funding and resourcing of regulators, to support a proactive approach.

Corporate culture and the board

The AICD acknowledges the critical role of boards in “setting the tone from the top” and the importance of boards focusing on corporate culture. We point 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 — and to be visible in setting expectations on culture.

Our submission addresses some of the matters that should be considered by boards — 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. It also identifies levers that can drive cultural change including remuneration structures and internal controls and policies.

Remuneration frameworks

Variable remuneration comes 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 in hearings. This led to the Commissioner questioning whether any customer-facing employee should be paid variable remuneration. If the answer to this is “no” or “some should not”, the Commissioner asks, why should their managers and senior executives be remunerated in this way?

The AICD argues that variable remuneration has a legitimate role to play in supporting corporate performance. However, pay frameworks must balance non-financial factors with financial performance. Our submission notes that a greater focus on accountability in remuneration outcomes across all measures (not just revenue or profitability) is needed.

Remuneration is not the only lever to influence culture and behaviour. In the AICD’s view, it is just one lever in a broader system that includes other people processes such as recruitment, professional development and performance management, ethical decision-making and risk controls.

Drawing on feedback from members, the AICD submission also highlights the role that shareholders and proxy advisors play in relation to executive remuneration, including the market’s emphasis on financial performance in remuneration votes. We called for further dialogue and debate on these issues.

Role of the regulators

The AICD has backed a more proactive approach to enforcement by regulators, including greater use of civil and criminal proceedings. It is imperative that entities and their officers do not treat compliance with legal obligations as voluntary — or view the consequences for non-compliance as the “cost of doing business”. However, we argue that the Australian Securities and Investments Commission (ASIC) should retain a broad toolkit of regulatory options and the discretion to apply these (for example, enforceable undertakings on a case-by-case basis).

The AICD has called for adequate and increased resourcing for regulators including ensuring that ASIC has the financial and staffing resources necessary to support a proactive regulatory approach.

In relation to the role of the Australian Prudential Regulation Authority (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 AICD also calls for independent reviews of performance and clarity from the government on expectations of ASIC and APRA.

Going forward

The November round of hearings will be on policy-related questions from all previous rounds of hearings. At the time of writing, we expect these to include a focus on governance issues. 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 in Australia and broader debate around the role of business in society. The AICD will continue to engage closely with the Royal Commission and these broader debates.

Read further coverage into the Royal Commission here.