KPMG Law Overview: Financial Services Royal Commission Interim Report

KPMG Law Overview: Financial Services Royal Commission Interim Report.

T he Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry released its Interim Report on 28 September 2018. KPMG Law provides an overview of the five broad themes in the Interim Report.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Commission) released its Interim Report on 28 September 2018 (Interim Report). To date, much of the news around the Royal Commission has centred on the three areas of misconduct acknowledged by financial services entities, being:

• fees for no service – where licensees or advisers were charging fees to clients for financial advice that was not provided
• inappropriate advice – financial advice that does not comply with the ‘best interests’ obligation, or advice that does not take proper account of a client’s circumstances
• improper conduct by advisers – falsifying documents, misappropriating customer funds, and engaging in misleading and deceptive conduct in relation to clients.

1. Intermediaries and confusion of roles
The Commission examines the role of mortgage aggregators and mortgage brokers (along with other intermediaries) between lenders and borrowers. It concludes that, even if an intending borrower believes or expects an intermediary to be acting in their best interests, in most cases the intermediary owes no general duty to the borrower to seek out the best and most appropriate deal. Moreover, submissions indicate that, at least in the eyes of some lenders, the broker’s task is to sell that lender’s products.

2. Communication with customers
The Commission evaluates the conversations between financial services entities and their customers, observing that a ‘conversation’ with a customer is treated as an opportunity to sell, gather information about the customer, and too often involves the entity’s representative telling the customer what he or she needs.

3. Responsible lending
In its assessment of lending practices, the Commission observes that:
• lending was not treated as unsuitable if the customer was likely to default
• the banks make no inquiry about the customer’s circumstances, requirements, or objectives (i.e. by relying on statistical benchmarks for expenditures to inform credit risk assessments)
• issues often classified as ‘processing errors’ by financial institutions amount to failures to deliver on the promised features of products sold.

1. Conflicts of interest
In its assessment of conflicts of interest in the context of financial advice, the Commission concludes that the conflict may be better seen as a conflict between the financial interests of the adviser or licensee, and the duty that each owes to the client. The Commission goes on to note that the choice between interest and duty is too often resolved in favour of the adviser’s self-interest. In a possible indication of the Commission’s direction on this question, the Interim Report indicates that a fundamental premise of the Future of Financial Advice (FoFA) reforms (the notion that conflicts of interests can be ‘managed’ by introducing the best interests duty) is flawed.

2. Conflicted remuneration, grandfathering and culture
The Commission notes that, while the prohibitions on conflicted and other forms of banned remuneration may appear to be comprehensive, there are exceptions relating to general insurance, life risk insurance products, and basic banking products, along with provisions permitting grandfathered benefits. On this point, the Commission appears unequivocal in its acceptance of ASIC’s position that 'any exception to the ban on conflicted remuneration, by definition, has the ability to create misaligned incentives, which can lead to inappropriate advice'. It also emphasises that, in an environment where the major banks have already begun to abolish grandfathered commissions, the onus is on the sector to demonstrate why the provisions should remain.

3. Vertical integration
In its commentary on the vertical integration of financial product manufacture with financial product sale and advice, the Commission observes that the internal efficiency of the ‘one stop shop’ does not necessarily produce efficiency in outcomes for customers. It also acknowledges that, from the banks’ perspective, vertical integration always promised the benefit of cross-selling financial products. This observation, coupled with the Commission’s dismissal of past characterisations of what has occurred as a 'few bad apples', indicates that the Commission may be contemplating a recommendation designed to address systemic issues associated with vertical integration.

1. Multiple definitions of SMEs
The Commission notes the wide range of statutory definitions of SMEs within the Australian regulatory landscape, and indicates that harmonisation of the existing definitions may both make the law easier to administer and understand, and reduce challenges in supervision and enforcement.

2. SME Lending
The Commission’s commentary on SME lending brings into question the fact that the responsible lending provisions of the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) do not currently apply to lending for SME business purposes.

3. Code of Banking Practice (Code)
The Commission observes that while the 2019 Code requires a bank to:
• exercise the care and skill of a diligent and prudent banker where it is considering the provision of a new loan or an increase in loan limit; and
• assess whether a small business customer can repay a loan based on their financial position and account conduct,
it does not resolve the bounds and content of these obligations.

4. Third party guarantors
In its discussion of voluntary guarantees, the Commission observes a disconnect between how the law, and lenders, treat third party guarantors. This is instructive given the Commission’s acknowledgement that most voluntary guarantors for SMEs are family members assisting their loved ones.

5. Dispute resolution
In assessing the outcomes of the Financial Ombudsman Service (FOS) and Australian Financial Complaints Authority (AFCA) proceedings, the Commission highlights that customers who were wholly or partly successful in their claims nonetheless failed to achieve what they believe to be a satisfactory outcome. The Commission goes on to question whether AFCA should be empowered to award compensation for losses or harm caused.

1. Revaluation of securities
There is a pattern whereby banks are revaluing land or other assets held as security, resulting in a decrease in the land-to-value ratio (LVR), which in turn is used as a non-monetary default allowing the bank to call up the loan.

2. Difficulties obtaining access to services and support
Farmers are having difficulty obtaining access to banking service and appropriate support for a number of reasons, including but not limited to a failure by the banks to recognise ordinary seasonal variations in cash flow.

3. Changes to lending conditions
Submissions have indicated complaints about changes to lending conditions that are detrimental to the borrower, including increasing interest rates or altering the terms of overdrafts and other facilities.

4. Enforcement by external administration
In relation to the conduct of receivers or external administrators appointed by the banks, the Commission notes that a forced sale is rarely in the best interests of the customer, and that an appointment of an external administrator should be an option of last resort only.

5. Basic accounts, informal overdrafts and dishonour fees
The Commission observes that:
• lower cost ‘basic accounts’ are unnecessarily difficult to access in remote communities
• informal overdraft arrangements and dishonour fees are not suitable in certain circumstances.


6. Identification issues
Aboriginal and Torres Strait Islander people may not always be able to readily assemble the documentary proof of identity that is required to comply with their Anti-Money Laundering and Counter-Terrorism Financing Act (AML/CTF) obligations, and bank employees should be trained to apply the Australian Transaction Reports and Analysis Centre (AUSTRAC) guidelines and assist such customers.

7. Funeral insurance
The Commission calls attention to ASIC’s identification of inappropriate sales practices regarding the sale of funeral insurance products to Aboriginal and Torres Strait Islander people, and questions whether funeral life and funeral expense insurance policies might be better classified as financial products under Chapter 7 of the Corporations Act 2001 (Cth).

1. ASIC
The Commission highlights ASIC’s expressed preference for negotiated outcomes over civil proceedings, observing that ASIC’s enforcement approach to date has not had the desired deterrent effect. The Interim Report goes on to question whether ASIC’s remit should be reduced or detached.

2. APRA & BEAR
The Commission notes that APRA’s chief focus is governance and risk culture, and considers the impact of its report on governance, culture and accountability within the Commonwealth Bank of Australia (CBA) group. The Interim Report also questions whether the newly-introduced Banking Executive Accountability Regime (BEAR) should be extended.

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