Observers of Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry would have known from early on that it was likely to be a prickly affair; it was there, written into the title of the Commission and its brief. In the UK, Canada, New Zealand and Australia, Royal Commissions are a mechanism for formal public inquiry into substantial and controversial matters, similar to a commission of enquiry (or inquiry) in places like Hong Kong.
Many column inches have relayed troubling accounts of the worst offences: fees for no service, boiler-room tactics pressuring the intellectually disabled, reporting breaches, fraudulent documentation and so on. As a practitioner in the industry, my interest is primarily in the grey, more nuanced management and governance areas of concern that Commissioner Kenneth Hayne highlights in his interim report, and what can be done immediately and into the future to reform the industry and restore public trust in it. It is here that there are a number of key lessons for the financial services sector in other markets within the Asia Pacific region.
Client-centred: One of the more controversial and stark of Hayne’s findings is in various institutions’ apparent lack of care for the clients they were supposed to serve. In repeated instances, institutions were shown to have placed product throughput, commissions (often hidden) and short-term gain above the needs of customers, with risk to reputation ignored. This builds on a theme highlighted in May by APRA (the Australian Prudential Regulatory Authority) in the CBA Prudential Inquiry Final Report, which found inadequate oversight by CBA’s Board and its committees of non-financial risks, and weaknesses in how management measured and monitored major client incidents and concerns.
From a strategy perspective, there are several key issues this touches upon. First, a long-term client-centred strategy is important and needs to be communicated and understood across whole organisations. Having worked within a number of industries, I am often struck by how the degree of compartmentalisation in financial services organisations can work against leadership efforts to develop a consistent culture and how easy it can be for certain parts of a firm to lose sight of the intended strategic direction of the broader organisation. Second, for observers of the Royal Commission it is also a reminder to boards and management teams of the imperative of having and communicating a clear overarching strategy that communicates the value the firm seeks to bring to the communities and clients it serves in the first place.
Decision Making: A clearly communicated long-term client-centred corporate strategy is a vital first step in how large organisations can ensure client-facing staff and representatives appropriately respond to the ‘should we?’ problem first raised by APRA:
… banks must strike the right balance between short and long-term objectives and appropriately navigate the tension between the potentially competing interests of different stakeholders. In a large organisation such as CBA, trade-off decisions are made every day at all levels. When making such decisions, a balance is required between, on the one hand, financial discipline and shareholder value considerations (the ‘voice of finance’) and, on the other, considerations of risk management, including aspects of a conduct and reputational nature (the ‘voice of risk’), and of good customer outcomes (the ‘customer voice’). Importantly, these latter considerations include the ‘should we?’ reflection in decisions CBA makes, especially with regard to customers.
Indeed, the fourth of APRA’s five key recommendations is ‘injection into CBA’s DNA of the “should we” question in relation to all dealings with and decisions on customer’, while Hayne is similarly troubled by poor staff decision making in the industry which he links to inappropriately structured rewards, penalties and incentives:
The customer’s ‘needs’ are formed by reference to what the entity has to sell. And often it is the entity’s representative that tells the customer what he or she ‘needs’. That is why the banks have rewarded and continue to reward staff and intermediaries for ‘cross-selling’ products … for most of the last decade, remuneration arrangements for third party intermediaries and for all staff, both frontline staff and senior executives, have rewarded sales and profitability. Doing the ‘right thing’ has not been rewarded. And even in the more recent past, ‘balanced scorecards’ and ‘conduct gateways’ have too often used doing the ‘wrong thing’ as a disqualifying criterion. But penalising default is not the same as rewarding the right and proper performance of a task. Penalising default encourages hiding mistakes; it does not encourage doing the ‘right thing’. It does not encourage the intermediary or the employee to ask, ‘Should I, should the Bank, do this?’
Long-term: For company boards looking to protect long-term shareholder value, addressing this vital issue of how firms interact with and take into account the needs of their clients is critical. What we have seen through the lens of the Royal Commission so far is employees and organisations as a whole placing emphasis on short-term gain, falling back on legalistic interpretations of fine print T&Cs when it suits, at the expense of client experience and long-term reputation. This is a point that, in the context of consumer lending, does not escape Hayne:
As commercial enterprises, each of the entities whose conduct was considered in the first round of hearings rightly pursues profit. Directors and other officers of the entities owe duties to shareholders to do that. But the duty to pursue profit is one that has a significant temporal dimension. The duty is to pursue the long-term advantage of the enterprise. Pursuit of long-term advantage (as distinct from short-term gain) entails preserving and enhancing the reputation of the enterprise as engaging in the activities it pursues efficiently, honestly and fairly.
To this extent, managers and employees working against the interests of their clients for short-term gain and incentives, are not only working against the longer term interest of their organisations but, indeed, their shareholders as well. Doing so calls into the question the sustainability of such profits. Moreover, poor conduct and bad decision-making is often too readily framed simplistically as a tension between shareholders and customers. In my own practice and experience, particularly within financial services, I have seen incentives, hiring, and performance management practices that encourage staff and management to act too much in their own self-interest, with shareholders and customer needs placed at a too distant second and third priority.
Management by Measurement: In his findings, Hayne also suggests there is too much performance-based pay that is defined and measured in volume terms, when other measures of success would be more appropriate. In particular, he takes aim at adviser commissions in the consumer lending space:
Put shortly, if crudely, sales staff can be rewarded by commission; advisers should not be. … Likewise, if licensees engage representatives as advisers, rather than as sales staff, why should the remuneration of the adviser be tied, to any extent, to the volume or value of sales?
In fact, Hayne also calls into question at what he calls ‘management by measurement’, which is increasingly pervasive in many modern organisations as they assume the simplistic notion that management can be undertaken effectively using a paint-by-numbers approach, to their broader detriment:
Banks have sought to manage their staff by measurement. From the most senior executives to the most junior employee …. a large part of the short term incentive payment has been payable if the employee has performed satisfactorily … Management by measurement assumes, wrongly, that measurement can capture all that matters in dealings between bank and customer. It cannot and does not. So much was illustrated most clearly in the financial advice cases considered by the Commission.
Too often I hear even senior leaders pronounce sagely, ‘If you can’t measure it, you can’t manage it’, which is at best a misquote of the late management theorist, Peter Drucker, and at worse a myopic and harmful way to manage the day to day functions of an organisation (in fact, Drucker only said ‘If you can’t measure it, you can’t improve it’. Indeed, Drucker also argued that a company’s primary responsibility is to serve its customers, and that profit is only a means to this end). This is especially important for boards and management as they think about performance management incentives across their organisations.
Data Management: For boards and management, the Royal Commission is also reminder of the imperative for good risk management and governance, and supporting data management systems and information flow (both good and bad news) across all parts of the organisation. With frustration, Hayne notes the following in relation to his requests for data on compliance breaches relating to consumer lending, packing a powerful punch in the very last sentence:
The difficulties raised by NAB, and by others, about meeting the Commission’s requests suggest that those entities deal with regulatory compliance piecemeal rather than comprehensively. Approaching compliance piecemeal does not readily permit identification of underlying Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry causes. Particular events are too readily seen as isolated departures from an assumed norm caused only by aberrant behaviour of individuals. Deeper causes and connections remain unconsidered and unidentified.
This was also an important theme raised by APRA in its CBA Prudential Inquiry Final Report, where it noted both inadequate oversight by the bank’s board and its committees of non-financial risks and ‘weaknesses in how issues, incidents and risks were identified and escalated through the institution and a lack of urgency in their subsequent management and resolution’ . This resulted in ‘a widespread sense of complacency’ throughout CBA, from the top down, in relation to customer outcomes. CBA’s first ranking on many measures, including financial performance and average client satisfaction scores, ‘created a collective belief within the institution that CBA was well run’ while a substantial number of serious and unresolved customer complaints got lost in the system and ignored, eventually surfacing in a way that has not been good for the firm’s reputation.
In summary, exposed misconduct at the heart of these inquiries has done little to preserve the Australian community’s trust in its financial services sector. There are key lessons to be learnt by institutions, regulators and policymakers in other markets, if similar problems are to be avoided.
A recalibration of management, corporate strategy and governance in Australia’s institutions, along with a large dose of transparency and openness in how they deal with their customers, is required to reform the industry and restore the community’s trust in it. Although I have not dealt with it here, I also think a re-evaluation of Australia’s market structure and competition settings (there is an argument that the market is too concentrated and some of the market’s institutions have become too big to manage) is required, along with a review of industry and regulatory frameworks under which the industry is overseen.
I also suspect generational change and recruitment of staff from outside the big four gene pool is required to bring on the cognitive diversity needed to move these organisations forward. There are too many people who have grown up in with no other experience, like-minded in their inability to imagine a different way of conducting business and envisage the required path forward.
While we have seen piecemeal changes to organisational structures and institutions exiting particularly problematic businesses, addressing industry-level group think and substantial cultural inertia is a big part of the shift ultimately required, and bold steps are necessary. Markets elsewhere should take heed.
Matthew Chan GAICD is Principal at Rainhoffer Advisory, advising boards and management in Asia Pacific on financial services strategy and operations. He has worked as a practitioner in international capital markets, financial technology, FMCG and government policy, and is a regular contributor to Regulation Asia.