Richard Harris assesses the challenges facing financial services businesses in Australia
The regulation of financial services businesses in Australia stands at an extraordinary confluence of separate but interrelated developments that represent a profound shift in the regulatory landscape.
Each of those factors in their own right would represent a significant and difficult regulatory burden for financial services businesses and those charged with their running. Together, they combine to create an unprecedented escalation in regulatory tension and risk for both financial services businesses and those running them.
These compounding factors include, foremost, the impact of the Hayne Royal Commission. While the impact of the Royal Commission into Misconduct in Banking and Financial Services was always thought likely to represent a watershed moment for Australian financial institutions, it is now clear the impact has been pronounced. The criticism in Kenneth Hayne’s final report of what he perceived to be a lax and overly permissive attitude by Australian regulators, in particular the Australian Securities and Investments Commission (ASIC), has caused a fundamental realignment of regulatory attitudes and approach.
Bolstered by material increases in funding and emboldened by Hayne’s encouragement, ASIC has substantially increased not just the number of investigations it is conducting, but also the depth, breadth and intensity of those investigations. ASIC is issuing more notices to produce documents and conducting more compulsory examinations of persons thought potentially relevant to the investigation than ever before. The burden and disruption such notices and inquiries cause cannot be overstated.
Coupled with the increasing number and ferocity of investigations comes ASIC’s response to one of the more memorable pronouncements from Hayne that regulators should consider much more frequently and deliberately whether to seek a court-based outcome in relation to potential contraventions. Both ASIC and the Australian Prudential Regulation Authority (APRA) appear to have embraced Hayne’s perception that court-based outcomes (ie, judgments and declarations from the court indicating wrongdoing) are the most effective deterrent for misconduct. ASIC sees that as particularly pertinent in relation to household-name financial services institutions. Whether one can accept that court-based outcomes represent a greater deterrent than other enforcement mechanisms (and there are good arguments that they do not), the burden and distraction of such proceedings are undeniable and now a feature of the Australian financial services environment.
‘The criticism in Kenneth Hayne’s final report of a lax and overly permissive attitude by Australian regulators has caused a fundamental realignment of attitudes and approach.’
Other collateral effects of the Hayne Royal Commission include the taste acquired by the Australian media for stories involving apparent financial services misconduct. Regulatory disputes and proceedings garner a great deal more publicity than ever before which, in turn, produces more incentive for regulators and more interest from politicians.
Politicians also clearly saw the opportunities to be extracted from banking misconduct and are more likely to seek mileage from breaking news which, in turn, increases the media interest.
The second key development in the Australian regulatory landscape has been the introduction in March 2019 of dramatically increased penalties associated with key aspects of the financial services legislation. Maximum penalties for contraventions of financial services laws have increased from AUS$1.8m up to 10% of the business’ revenue (to a potential maximum of AUS$525m per contravention). Penalties also now attach to much more subjective licensing conditions such as the obligation in section 912A of the Corporations Act for a financial services business to ensure that its services are provided ‘efficiently, honestly and fairly’. The increases in penalties and the lowering of the bar in respect of contraventions to which they can attach also add further incentive to regulators and can represent an existential threat to some financial services businesses.
Of course, it could be said, fairly, that the dramatic shift in regulatory approach to investigations and proceedings, and the potential burden of increased penalties, can all be avoided by compliance with the law. While that is doubtless true, the financial services legislative and regulatory regime in Australia is among the most complex in the world. There is a very good case to argue that the overwhelming majority of ‘misconduct’ examined during the Royal Commission appeared to be inadvertent and already the subject of widespread financial remediation by the institutions in question.
Widespread legislative reforms to address perceived inadequacies identified through the Royal Commission represent the third key new challenge. By way of example, legislation currently in the exposure draft phase (with a view to being introduced into Parliament by mid-2020) includes a significantly revamped breach reporting regime for financial services licensees which would require formal reporting to ASIC of breaches and potential breaches of financial services laws on a much more frequent and urgent basis and subject to a dramatically reduced significance threshold. Under that legislation, for example, a corporation (and any individuals knowingly involved) could be criminally liable in circumstances where the licensee fails to report in the requisite time frame an investigation into a potential breach of the obligation to ensure that the financial services of all credit activities of the institution are provided efficiently, honestly and fairly. Bearing in mind the pre-disposition to more investigations and more court proceedings, the reduced self-reporting thresholds represent much more than simply an increased administrative burden.
A fourth key driver of the boiling regulatory environment for financial services licensees is the emphasis by a number of regulators, including ASIC and APRA, on attributing liability to individuals for misconduct by the institution. There is significant pressure for financial sanctions, through remuneration adjustments and penalties, for individuals involved in contraventions of the financial services legislation or who failed to take reasonable steps under the Banking Executive Accountability Regime (BEAR) or Financial Accountability Regime (FAR) to ensure that the institution complies with its licence conditions.
The fifth key contributor is the proliferation of class action proceedings in Australia, driven by a favourable legislative and court rule environment and a propagation of class action funders and lawyers. Class action funders and lawyers in Australia enjoy a symbiotic relationship with regulatory investigations and prosecutions in that they produce a rich trove of investigative materials and declarations of misconduct that can be leveraged to support a class action.
It would be easy to conclude that Australian financial institutions are reaping what they have sown from the litany of legitimate deficiencies exposed during the Hayne Royal Commission. There is an undeniable kernel of truth in that proposition. That said, the shift in regulatory approach, complexity of legislative reform and pronounced increase in the exposure to risk of both the institutions and individuals involved has been far from incremental and combine to make the running of financial institutions, and ensuring their compliance with the myriad labyrinthine financial services laws, more difficult and dangerous than ever. What remains unclear is whether there will be a demonstrable consumer benefit associated with that shareholder pain.
Richard Harris is head of disputes and investigations at Gilbert + Tobin.