Early February in Australia had everything.
It had the most uncomfortable photo call in recent memory, as Kenneth Hayne, in handing over his Royal Commission report into banking, declined the requests of the press pack to shake the hand of Australian treasurer Josh Frydenberg.
It had a top banking executive who, at the precise moment of the report’s formal launch, was out selling The Big Issue. It had the ousting of both the chairman and chief executive of National Australia Bank simultaneously.
It had everything, in fact, except the promise of genuine reform to the Australian banking system.
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, to give it its full title, concluded with the presentation of a 1,000 page report from commissioner Hayne to Frydenberg on Friday, February 1. The report’s release to the public – and the banks who were in it, who had had no advance peek – came the following Monday.
It contained 76 recommendations across a range of fields. In particular, mortgage broking will be reformed, with conflicted commission structures removed; in financial advice, where this was already supposed to be the case, any grandfathered incidences of trail fees will be outlawed; banks will no longer be allowed to sell superannuation funds; and the regulators will be strongly encouraged to prosecute more and prevaricate less.
But the single most important anticipated change did not happen. Many had expected that banks would be forced to sell their wealth management businesses. That measure did not come.
People are disappointed, says Carden Calder, founder of communications group BlueChip, by a “toothless, bloodless ending”.
And when the dust settles the banking industry is likely to end up looking a great deal like it already does.
If the Royal Commission provided one thing, it was a public forum for bank bashing. And they deserved it.
At the retail level, bad things had been happening in financial advice, particularly sales of life insurance products, for years. Some of the evidence to the Royal Commission was difficult to hear, none more so than a cold caller who pressured a young man with Down’s syndrome into buying an insurance policy and the extraordinary efforts required by his father to terminate the policy. The agent demanded the son state clearly: “I want to terminate the policy”. Intellectually disabled, he was barely able to say the words, let alone understand them.
That was just the most evocative of a range of dishonest activities that painted a picture of an industry driven by greed and without ethical standards.
The practice of charging fees for advice that was never given – including a Commonwealth Bank of Australia (CBA) adviser who charged a dead client’s estate for more than a decade and thousands of dead AMP superannuation customers who continued to be charged for life insurance despite AMP knowing there was no longer a life left to insure – was so widespread that compensation for it is likely to touch A$1 billion ($711 million).
One particularly contentious practice was targeting Aboriginal people with poor literacy and pushing them aggressively to take funeral insurance and unnecessary high-interest loans.
Without powerful recommendations, we are concerned that ensuring lasting cultural change over the years may be difficult, especially as management and boards rotate- Jonathan Mott, UBS
The Royal Commission was not about investment banking or much about corporate banking. Macquarie was called only to explain the behaviour of its private wealth division and Citi, having prepared laboriously to give evidence, was never called after the Commission ran out of time. This was all about abuse of the public.
The evidence heard along the way brought down some of the industry’s leading lights well before the commission ever reported. Terry McMaster, the director of Dover Financial Advisers, collapsed while giving evidence; Dover had its financial services licence removed and McMaster has left the industry.
The first big names to go were at AMP. Craig Meller, the chief executive, went first, back in April, after it emerged that AMP had misled the corporate regulator, Asic, on charging customers for (no) advice. AMP ousted Meller, apologized unreservedly and within weeks went further and hoofed out its chair, Catherine Brenner.
But it was only the publication of the full report that took down the management of a ‘big four’ bank. Ian Narev at CBA, who left because of similar reputational hits, was gone before the Royal Commission began. His successor, Matt Comyn, was somewhat immunized from fault by the timing of Narev’s departure; Comyn took advantage of that during the commission by painting himself as a reformer who wasn’t listened to.
When Hayne delivered his report, he reserved particular and personal ire for National Australia Bank’s chief executive, Andrew Thorburn, and chairman, Ken Henry. In a parting shot, he named both men and accused them of not taking the whole thing seriously.
Hayne said NAB “stood apart” from the three banks, which is some achievement, given some of the criticism CBA in particular has attracted.
Andrew Thorburn, former chief executive of NAB Group, understands accountability
“Having heard from both the chief executive, Mr Thorburn, and the chair, Dr Henry, I am not as confident as I would wish to be that the lessons of the past have been learned,” Hayne said in the report. “Most particularly, I was not persuaded that NAB is willing to accept the necessary responsibility for deciding, for itself what is the right thing to do, and then having its staff act accordingly.”
Henry, he said: “Seemed unwilling to accept any criticism of how the board had dealt with some issues.”
And on Thorburn. “I thought it telling that Mr Thorburn treated all issues of fees for no service as nothing more than carelessness combined with system deficiencies.”
NAB and related entities are likely to have to repay more than A$100 million because of fee-for-no-service indiscretions.
Hayne voiced his concern that, in the same week Thorburn and Henry were to give evidence, one of NAB’s staff was emailing bankers urging them to sell at least five mortgages each before Christmas.
“Overall, my fear – that there may be a wide gap between the public face NAB seeks to show and what it does in practice – remains,” said Hayne.
Both men came out fighting, Thorburn, who the following day recorded a video to the bank’s customers promising change, in particular. That day the two men gave a statement to the Australian Securities Exchange stating their intention to remain and Thorburn hit the local radio and TV circuit, saying he believed his attitude to be the “polar opposite” of how Hayne described it.
“I found that upsetting and hard to read,” he said. “I did feel it was harsh.”
The public and media mood was utterly toxic by now, however, with even the stately Australian Financial Review calling Henry a “smug prick” in its Rear Window column, surely the first time that particular turn of phrase had been used of a blue-chip chairman in that newspaper’s 68-year history.
By Thursday February 7, it had become clear that the mood could not be turned and at the close of trading, NAB announced that both men were going – Thorburn on February 28 and Henry once a new permanent chief executive is appointed. In the interim, Philip Chronican, who serves on the NAB board as head of the risk committee and has a storied career in Australian banking, including running the retail and commercial businesses of ANZ and the institutional ones of Westpac, will take over as chief executive.
“I acknowledge that the bank has sustained damage as a result of its past practices and comments in the Royal Commission’s final report about them,” said Thorburn in the statement. “As chief executive, I understand accountability.”
Henry, in the same statement, said: “I am enormously proud of what the bank has achieved and equally disappointed about what the Royal Commission has brought to light in areas where we have not met customer expectations. Andrew and I are deeply sorry for this.”
So heads have rolled. The Commission and the public have their scalps (although there is some discomfort in the industry about Thorburn’s demise in particular and rumblings over whether or not it was necessary for Hayne to name him).
But what has really changed?
Jonathan Mott, banking analyst at UBS, responded to the report with the headline ‘Tough talk. Soft recommendations.’
The commission’s report “was disappointing, in our view,” he says. “There was much discussion around misconduct within the banks and the need to change culture. However, the final recommendations fell well short of market expectations.”
Mott says he doesn’t believe any of the 76 recommendations will “have a material financial impact” on the banks.
“The large amount of misconduct publicly exposed will likely ensure the banks change their behaviour near term,” he says. But despite the regulators getting greater oversight, “most of the cultural change will be self-enforced. Without powerful recommendations, we are concerned that ensuring lasting cultural change over the years may be difficult, especially as management and boards rotate.”
There will be costs. Before the appearance of the final report, it had become clear that banks will have to pay compensation of around A$1 billion over fee for service misdemeanours, but, as Brian Johnson at CLSA says, “that’s not material in terms of capital or earnings” and furthermore it has largely been provisioned for.
The biggest thing that isn’t in the report is an expected forced separation of vertically integrated businesses in banks, which in practice would have required them to sell their wealth management businesses. In fact, the industry was well advanced in imposing this practice anyway, whether out of expectation of being forced to or just a sense that the compliance side of advice is just getting too costly.
The fact that we are seeing changes at the top at one of the large banks is an indication that things will change, though perhaps slowly- Jun Bei Liu, Tribeca Investment Partners
ANZ announced the sale of its pensions and investments business, OnePath, to IOOF for A$975 million in October 2017, although that deal has still not been completed following a series of regulatory issues and other delays – not helped by the disqualification of three IOOF executives and two of its directors.
Last June, CBA said it would demerge its wealth management and mortgage broking businesses, and subsequently agreed to sell the international arm of that business, Colonial First State Global Asset Management, to Mitsubishi UFJ Trust and Banking.
And NAB has pledged to offload its wealth division, MLC, either through a sale or through a public market exit.
The ones that benefit the most from the absence of this forced reform are Westpac – which says it is committed to its BT wealth management business – and financial services groups AMP and IOOF, which would have had to restructure their entire operations.
Opinion is mixed on the absence of this provision. Jonathan Steffanoni, principal consultant for legal and risk at consulting firm QMV Solutions, thinks the recommendations: “Sensible and prudent, recalibrating the focus on managed systemic risk to a focus on consumer protection.
“The report didn’t go so far as it could have done,” he says. But the decision not to enforce structural separation was “sensible in not disrupting the sector too much.”
The fact that three banks were already selling may have influenced the final recommendations.
“I tend to agree with the approach Hayne has taken in focusing the recommendations towards measures which might not be as blunt as an outright requirement for structural separation but could be effective if implemented and adopted by the industry,” says Steffanoni.
In this reading, what matters is the greater strength given to the regulators – “they will become more adversarial and we are likely to see more litigation,” he says – the heavy focus on remediation programmes for mis-selling and, in particular, the move to more principle-based regulation, rather than one where banks have routinely sought loopholes to circumvent the spirit of the law.
Jun Bei Liu, portfolio manager at Tribeca Investment Partners, calls the report: “A first step into a restructure of this industry. It’s good to see the regulators will receive more funding and be more empowered to step up and punish those who are pursuing inappropriate and aggressive lending practices.
“For far too long, when something goes wrong it has been the junior executives who lose their jobs, without real change in the structure of the organization. The fact that we are seeing changes at the top at one of the large banks is an indication that things will change, though perhaps slowly."
Clearly, the Royal Commission will have consequences for management and strategy at all of the big financial institutions. AMP and CBA changed their management well before the final report and, in CBA’s case, before the commission even started.
Comyn was to some extent tarnished by having been running the retail bank during the bad times at CBA, but he was able to suggest that he had been attempting to change things internally and had been thwarted by top management, principally Narev. Most of the changes that CBA urgently needed – getting rid of the life insurance business and separating itself from its Colonial First State wealth business – are already done or well underway.
In AMP’s case, given how bad the impact of the evidence period of the commission was for it, the outcome could have been a lot worse. If the commission had insisted upon the separation of wealth and banking businesses, AMP would have been hardest hit; its whole business model could have fallen foul of the commission. It did not and Francesco de Ferrari, the new chief executive who previously ran private banking for Credit Suisse in Asia, gets to start with a clean slate, untarnished by anything that has gone before.
Westpac came out in the best condition. It is generally agreed that through the Royal Commission and the parliamentary hearings that preceded them, Brian Hartzer presented the best of the big four banks’ chief executives. Westpac is thought to be the only big bank not to have had any allegations of misconduct referred to the regulators for prosecution, although it was grilled for being the only one not to have attempted to sell its wealth business, BT.
Westpac Bank's chief executive Brian Hartzer prepared best among the CEOs of the big four
ANZ’s Shayne Elliott, a relatively recent arrival, having replaced Mike Smith as chief executive in January 2016, also came out of the commission reasonably well. It probably helped that ANZ was the first of the big four to make public its intention to exit the wealth business.
Macquarie, now under new chief executive Shemara Wikramanayake (her predecessor Nicholas Moore gave what little evidence was required), barely even featured in the report. It is in any case revamping its private bank and private wealth businesses with a new focus on wealthier clients, steering clear of troublesome retail.
NAB is now the one with questions about its leadership. When Euromoney wrote in 2017 about possible successors to Thorburn, the top two names were Andrew Hagger, then the head of consumer and wealth, and Antony Cahill, the chief operating officer.
Both are now gone; Hagger because of the sense during the hearings that he tried to downplay the scale of fees-for-no-service misdemeanours at the bank, while Cahill opted to leave not only the bank but Australia during 2018. He is now in the UK.
So NAB’s bench strength at the senior management level has been badly hit. It will be interesting to see what it means for Mike Baird, former premier of New South Wales, who became NAB’s chief customer officer for corporate and institutional banking in 2017.
Are we likely to see significant change in the model of the dominant four banks? If you look through the lens of deposits and lending, no- Jonathan Steffanoni, QMV Solutions
NAB is only partway through a three-year plan Thorburn announced in November 2017, which involves cutting 6,000 jobs while hiring 2,000 people with digital skills and a mandate to simplify the bank.
Will the next candidate continue with that half-achieved plan? Should Henry be involved in selecting the person to do it? The planned exit of the wealth business, MLC, through public markets has already been pushed back to the 2020 financial year.
Several names are being mentioned, starting with the obvious one, Chronican. However he is on the board and the NAB board has come out of the whole affair in poor reputational shape. But to set against that, Chronican has run retail banking at ANZ, institutional banking at Westpac, has been a CFO (again at Westpac) and has at least been hands-on with risk management and remuneration committees at NAB, even if neither will be seen as an endorsement right now.
“We rate Chronican highly,” says Johnson at CLSA. “It’s hard to think he will not be the next chair. He is a seasoned banker with experience of customer management while delivering shareholder value.”
But not chief executive?
“We think an external chief executive appointment is preferable,” he says.
Johnson points to former NAB man, Craig Drummond, who was group executive, finance and strategy at NAB before becoming chief executive of Medibank, as a candidate. “Drummond knows what needs to be done.”
Several other Westpac alumni are being talked about, among them Gail Kelly and David Morgan, both former Westpac chief executives. But not everyone thinks it is essential to find an external hire.
Mott at UBS says Baird is “a lead contender”. He also expects Chronican to become chairman, and calls him “well regarded and highly experienced”.
The smaller banks have been looking on with interest. Melos Sulicich, chief executive of MyState Bank, is part of a group of chief executives of smaller banks who feel they are unfairly disadvantaged against the bigger players. In particular, there is a large differential between the capital and risk weights applied to smaller banks and larger ones; Sulicich says he is required to hold 56% more capital against a loan than a big-four bank would.
The Royal Commission wasn’t asked to look at this perceived imbalance, but the recommendations on mortgage broking may have a big impact on this end of the sector.
“The regulatory burden falls much harder on smaller banks than it does on larger ones,” says Sulicich.
“We are concerned for the mortgage broking industry. It needs to be economically viable,” he says. “There are 20,000-odd small businesses operating as mortgage brokers, and if that industry were to become economically unviable and you couldn’t distribute mortgages through mortgage brokers, then competition for home lending in the country would reduce and customers would ultimately pay more.”
It would also advantage the big four, which have bigger branch networks.
And that, he says, would be unfair: “The commission has done a lot of work over the last 12 months. It had the ability to go and investigate anything and everything. He seemed to find there was more dirty laundry in the larger organizations than the smaller.”
In the industry at large, there is not yet consensus about whether all this is good or bad for the banks. For example, two of the most highly rated bank analysts in Australia, Johnson and Mott, have diametrically opposed views on NAB. Johnson says it is a buy with a A$28 price target, Mott says it’s a sell with a target of A$23. (At the time of the recommendations NAB was trading at A$24.62.)
And Australian banking has more to deal with than reputational issues.
“NAB and the other major banks face a number of material challenges going forward as house price deflation accelerates and economic activity slows,” says Mott.
Speaking as an investor, Liu at Tribeca adds: “When I look at the entire industry, I am very wary. There are going to be tighter lending standards, earnings are going to grow more slowly and the increase in transparency and accountability simply means the costs are going to get higher as better systems are put in place.
“Earnings are already very tough for those businesses and it’s hard to see that improving any time soon.”
The next federal election will take place on May 11 or May 18. This means parliament has only 10 sitting days beforehand, which is obviously not enough time to put 76 recommended changes into legislation. And the outcome of the election will have a big impact on the government’s attitude to banking.
One reason the current Liberal government (roughly equivalent to republican or conservative parties in other nations) has so quickly promised to implement almost every change from the Hayne commission is that the public mood is so toxic against banks, and the Liberal party is seen as being pro-banking, having resisted a royal commission from the outset.
A Labor government, on the other hand, would be far less friendly to banks. It has policies on dividend franking reforms and negative gearing on residential property – both staples of Australian personal finance – that are considered bad for the banks.
Still, the appearance of the report removes one uncertainty from the outlook for banks.
“The risk of the credit squeeze turning into a credit crunch is real and rising, with the housing market now falling sharply and economic data deteriorating,” says Mott. In that context: “The soft recommendations of the Royal Commission final report is a clear win for the banks.”
Steffanoni says: “In the short to mid term, at least we will see the risk appetite of the big four banks contracting. There will be more spending on compliance and regulatory risk management, as well as repairing reputations.
“But are we likely to see significant change in the model of the dominant four banks? If you look through the lens of deposits and lending, no.”
We will, however, see more unwinding of businesses beyond lending and deposits, principally wealth and insurance.
“You’re going to see the big four retreating back to the core businesses, around deposits and lending and payments,” says Steffanoni.
The Royal Commission report contained 76 specific recommendations, 75 of which the government has agreed to implement and the last of which it is considering.
• Mortgage brokers must act in the best interests of borrowers, with a civil penalty for failing to do so. Mortgage broker commissions will be banned over a two- to three-year period, first by banning trail commissions on all new loans and then all other commissions. Mortgage brokers will be subject to the same laws that apply to financial advisers.
• The report recommends (but this is the one the government is not sure about) that advice for mortgage broking be paid for by the end consumer to eradicate conflicts of interest.
• Grandfathered commissions for financial advice – which survived a previous round of financial reform banning trail fees on new advice – will be ended.
• Banks will not be allowed to actively sell superannuation products (this ban also applies to insurance products). The MySuper account, a simple and low-cost default pension option for many people, will not be allowed to charge an advice fee. Super trustees will not be allowed to assume any obligations unrelated to being trustee of that fund. Employees will have only one default superannuation fund.
• There are a range of suggestions around bank remuneration governance, with Apra, the bank regulator, required to ensure sound management, although no limits were set on bank pay.
• The securities regulator, Asic, is encouraged to be active in enforcement and is to be given more power to do so. It should take “as its starting point, the question of whether a court should determine the consequences of a contravention.”
• A new oversight authority will be established for the two regulators, independent of government.
• Hayne referred 24 instances of alleged wrongdoing to the regulators to see if they wish to prosecute, which may lead to criminal proceedings. He did not name the people or institutions involved.