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UK's Financial Times seeks DB & Associates' opinion on Twin Peaks

Australian banking scandal focuses spotlight on regulatory regime

Australia is in the grip of an explosive banking inquiry that is expected to be the catalyst for much-needed reform in financial regulation.

Australia's banking inquiry is making waves across the world, as sordid details emerge of unethical and illegal behaviour from some its biggest and supposedly most respectable financial institutions. The Royal Commission inquiry was announced in December 2017, and is scheduled to run until the end of the year. It can bring witnesses to the stand, propose legal reform and even advise criminal charges.

It's a bloodbath

So far it has unearthed stories such as Commonwealth Bank of Australia (CBA) charging dead people for financial advice, in one case for as long as a decade, National Bank of Australia (NAB) employees faking customer documents, and insurance giant AMP admitting to misleading the regulator. These are just a few examples. Examples of money laundering, interest rate rigging and poor customer advice have also surfaced.

Even though the Royal Commission will run for a year, the amount of evidence that emerged in the first 10 days was sufficiently "gobsmacking" for it to release its interim findings, says Dr Andy Schmulow from the University of Western Australia law school.

Mr Schmulow says: "It's been 11 years of scandals at a rate of about one major scandal every two months. It's been building and building, and we have got a federal government that has resisted and resisted and resisted. [Even] when the Prime Minister announced the Royal Commission, he said he did so with 'regret'."

AMP's chief executive and chairman and general counsel have resigned in the wake of a fees-for-no-service scam. The QC assisting the commission, Rowena Orr, detailed how the insurer could even face criminal charges for lying to the regulator, the Australian Securities and Investments Commission (ASIC).

Where it went wrong?

These revelations are all the more startling, given that Australia's banks weathered the financial crisis well and that finance is one of the nation's strongest industries. However, these observations are superficial at best. Australia's mining boom, coupled with robust economic growth in China in the years following the financial crisis, helped shield the nation from recession.

Moreover, the success of Australia's financial services industry is, to some extent, a result of the nation's compulsory superannuation rules. Australians are compelled to pay into their pension pots and, as such, the country is rich with savings and pension funds. The pension fund industry is quite large, relative to the size of its economy, says Nathan Lynch, the bureau chief for financial crime and risk in the Asia-Pacific region for Thomson Reuters.

"Unfortunately what happened was Australia spent a fair bit of time congratulating itself on its regulatory model. We didn't acknowledge [that] we were years behind [the] rest of [the] world. Australia has enormous consumer debt levels; we've got a massive re-set coming in terms of interest-only mortgages," he says.

"There has been so much complacency, that was essentially the trap the banks fell into. They hadn't read the international climate, the pressure to crack down on anti-money laundering."

Indeed, [complacency] was witnessed in the US and the UK around regulation in the run-up to the 2007-9 global financial crisis, which revealed dangerous levels of leverage, insufficient supervision and flawed regulatory frameworks,

Mr Lynch believes that it was only when Australian regulator AUSTRAC began to crack down on money laundering, that it started the ball rolling. Former CEO Paul Jevtovic instigated an investigation into money laundering at CBA; weeks after his successor Nicole Rose was announced, AUSTRAC expanded its civil penalty proceeding against the bank. It alleged more than a staggering 53,800 contraventions of the Anti-Money Laundering Counter-Terrorism Financing Act 2006.

"You can really see how that ripped through the whole sector. Now we have got major enforcement actions, we saw the final straw in terms of triggering a Royal Commission," says Mr Lynch.

Toothless regulators

"The regulator doesn’t say boo to a goose," says Mr Schmulow. "If the law won't get enforced and no one will take the banks to task, it is easy to push over the regulator."

Australia's two main financial regulators – ASIC and the Australian Prudential Regulation Authority (APRA) – did not wish to be interviewed for this piece. ASIC is the country's dedicated market conduct regulator; it was formed 20 years ago when Australia adopted a 'twin peaks' system, following a previous inquiry into its financial system. Countries with a twin peaks model were widely considered to have weathered the financial crisis well, and as such it was rolled out across countries around the world, including the UK. How did a dedicated market conduct regulator fail to live up to its name?

Former regulator Peter Oakes has his opinions. He worked as a senior officer at ASIC in the early 1990s, and has also worked in regulatory enforcement at the UK's Financial Conduct Authority as an investigator. In 2010, he was hired as director of enforcement and financial crime at the Central Bank of Ireland (CBI), and has since set up his own consultancy firm.

"The problem we have seen in the UK and Ireland is that financial services regulators can sometimes get too close to the industry they regulate. That has arguably contributed to many failures around the world, " says Mr Oakes.

"Even when I was director of enforcement at CBI, I said you can be a little bit prejudiced in questioning those you supervise and regulate. Always treat what you hear with a certain level of circumspect. That is your job as a regulator. I wonder if that has been forgotten."

He says that poor culture is almost always at the heart of banking crises; a bad attitude at the top can cascade down to staff on the front line. Mr Lynch describes the regulatory environment in Australia as "fairly passive" and "semi self-regulatory".

"When issues have come to light, ASIC has turned around and asked the regulated entities to rectify it – get an independent review and agree to an enforceable undertaking," he says.

Beefing up its powers

A previous Senate inquiry held four years ago ruled that ASIC was a "timid, hesitant regulator, too ready and willing to accept uncritically the assurances of a large institution". Former ASIC chairman Greg Medcraft said at the time that Australia was a "paradise" for white-collar criminals.

Historically, Australian regulators have lacked the power to slap high penalties on offenders. The average bank fine per regulator in the US and UK for Libor rigging was around $200m, compared with just $2m in Australia, according to data analytics firm Corlytics.

The penalties for individuals that commit wrongdoing are high in Australia, says John Byrne, CEO at Corlytics. "But the penalties against banks and regulated firms for wrongdoing has historically been one of the lowest in the world," he says.

To that end, in May 2017, Parliament voted to give APRA the power to impose fines of up to A$200m ($150m) for misconduct, as well as ban executives and change remuneration policies, under the Banking Executive Accountability Regime (BEAR).

Federal treasurer Scott Morrison has said that he will give regulators more enforcement powers and really "muscle them up", says Mr Schmulow, but the academic remains sceptical.

"APRA has power under the Banking Act to pluck people off the board of directors of a bank and say: 'You are responsible for conduct, we will take you off the board and put our own nominee [in place].' It has had this since 1988, and never used it in the last 20 years," he says.

"[This] is an exercise in absolute abject futility. The problem with enforcement to date has had nothing to do with lack of power, but to do with the lack of will."

The increase in fines also appears to be a drop in the ocean compared with Australian banks' profitability, which could render such fines simply a 'cost of doing business'. Last year, CBA posted a full-year, post-tax profit of almost A$10bn.

"You’ve got to ask yourself, is that size sufficient? A$200m doesn't really make a dent. It comes back to changing behaviours and imposing requirements on personnel," says Mr Oakes says.

One of the biggest reforms could be a recommendation from the inquiry to break up the banks, which would spell the end of the 'mega-bank'. A forced separation of financial services firms could be justified as ensuring they are not too-big-to-fail. The process has arguably already begun. Last year, CBA sold its life insurance unit to Hong-Kong based AIA Group.

Mr Lynch at Thomson Reuters says: "There is strong feeling emerging that [judge] Hayne will recommend breaking down the banks' 'vertically integrated' model and force organisations to move away from that 'mega-bank'.

Long-term reform

Critics argue that Australia needs deeper reform to bring about real change. ASIC has advised the Australian government on its current bill to strengthen whistleblowing laws, which are set to offer enhanced confidentiality and victim compensation. It is hoped that this will encourage more people to blow the whistle on misconduct, although critics argue that plenty of people blew the whistle over the years but were ignored.

However, it is the funding of ASIC, under the ASIC Fees Act, that has come under fire. It is partially funded by the industry in the form of fines, but it generates most of its revenue through its company registry and search function, which is akin to the UK's Companies House. It charges some of the highest fees in the world – making it a real money-spinner – but the problem is that most of that money leaves ASIC and ends up in the government coffers.

Figures from 2017 show that ASIC raised almost a billion Australian dollars – A$948m – in fees and charges, of which the vast majority came from registry and licensing fees (A$801m) and the remaining A$118m came from fines. But that was transferred to the government's central pot, and ASIC received just A$341m back in funding.

"Essentially we have a really old system around funding," says Mr Lynch. "[Former chairman] Greg Medcraft used to say regularly to the government that you can pay ASIC the level of funding you want, but just be mindful that the government and the public get the ASIC they pay for. This was never acted upon."

There are calls to spin off the company search function into a separate entity, as it does not really align with the core functions of a market conduct regulator.

Patricia McCoy is professor of law at Boston College Law School; back in 2010 she joined the US Treasury where she helped form the new Consumer Financial Protection Bureau (CFPB). It was created in response to the financial crisis, to boost consumer protection.

Her key piece of advice to any country that is pursuing regulatory reform is to avoid giving regulators conflicting missions. She also recommends ensuring the agencies are as independent and transparent as possible.

Ms McCoy says: "The CFPB is signed up to an 'ex parte' policy, which means that anytime anyone working at the bureau has a meeting with an outside member of the public like a consumer advocate or an industry rep, a written record of what happened at that meeting must be posted to a federal website available to the entire public."

Australia is also introducing new legislation to make it easier to start up a new bank, in the hope that it will break up the current monopoly of the big four banks. In the past two decades, only one new banking license has been issued in Australia. In contrast, 14 new banks have launched in the UK in the past three years. Australia's central bank governor, Philip Lowe, explained that high barriers of entry are stymieing competition, which typically comes from new entrants.

Robot revolution

Statistics suggest a deep-rooted behavioural problem lies at the root of some of Australia's issues, notably greed. ASIC carried out a review of products that financial advice licensees were recommending, from Australia's top four banks and insurer AMP. ASIC also looked at the quality of the advice given about these firms' in-house products.

Its review, which was published earlier this year, shows that almost four-fifths of financial products on these firms' approved lists were from outside their firm, and yet 68% of clients' funds ended up being invested in their own in-house products. Despite the figures suggesting that most clients would be better off choosing a product from outside their bank, most ended up being talked into buying products from their own bank.

One way to eliminate this type of bias might be to roll out robo-advisors. These give digital financial advice that is based on mathematical formulas or algorithms, with as little human involvement as possible. Ignite Wealth is one such provider, based in Sydney, that has been around for about 10 years, says its group CEO, Mark Fordree.

He says only the top end of the Australian population receive independent financial advice. Most people cannot afford it, especially if they are only looking to invest up to A$50,000.

"But technology is going to dramatically increase the 'advised population' by dropping the cost of delivering advice," says Mr Fordree.

He thinks that the future of financial services will revolve around accountability, auditability and compliance. "We don't think the industry will ever be the same again," he says.

Andy Schmulow is a Senior Advisor at DB & Associates

This article first appeared in The Banker , a service from the Financial Times


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