'Ratchet up the mongrel': APRA vows to get tougher on the banks

This ends today's live coverage of the banking royal commission. We'll be back tomorrow morning for the rest of Mr Byers' testimony. He'll be back in the witness box from 9:45 am.

The APRA chief is the commission's  final witness as it wraps up its seventh and last round of public hearings tomorrow.

The commission is expected to deliver its final report to the Governor-General by 1 February 2019.

Who let the (watch)dog out? Woof, woof, woof, woof?

We’ve just seen an executive board paper for APRA. It shows APRA discussing its supervisory project of the Commonwealth Bank in 2017.

And it recommends that APRA shows a bit more bite. Or in APRA's terms, it becomes a “supervisory mongrel”. Mr Byers has just told the commission that APRA plans to “ratchet up the mongrel”.

Let’s have a look.

Under the heading of 'supervisory mongrel', the paper reads: “The CBA supervision team were aware of most of the issues identified by the CBA inquiry, with the inquiry providing absolute clarity of evidence to support the findings.”

It adds: “Stronger support of supervisory gut feel together with strengthened supervisor tenacity and more frequent use of sanctions can be considered. … Supervision mongrel is an attitude rather than a framework issue, senior leadership in APRA would need to set the tone on how this supervision mongrel would operate in practice."

Mr Hodge: "Do you have a view as to, without needing to put it in terms of supervision mongrel, whether there was a problem within the CBA supervision team with its willingness to act on gut feel and demonstrate tenacity in relation to CBA?"

Mr Byers: "I think the - so the CBA supervision team was actually, I think, demonstrated a great deal of tenacity. There were a raft of issues that they were pursuing, and they were at loggerheads with CBA on a number of fronts. So I - I would never in any way question the tenacity of the supervision team. They were doing a good job.

"And the CBA inquiry, I - I mean, obviously it went deeper and broader and so it found some extra things, but the starting hypotheses that the supervision team provided the panel as they went about their task were, I think, proved to be spot on."

Mr Hodge: "Well, the implication of what's written here may be that the problem is not so much at the supervision team level. The problem is at the senior leadership level in terms of the tone that is set. Do you have a view about that?"

Mr Byers: "Yes. I think - so perhaps I should just say that - that supervision mongrel phrase, we had the panel into the board, the meeting before that one. And the three of them came in and talked about their reflections and their observations, not just about CBA but as they had identified issues, they were obviously also alert to whether APRA had been aware of the issues, not aware of the issues.

"And so we talked through all of that. And generally they gave a good report card. But Dr Laker, the chair of the panel and my predecessor, finished the session with some parting words about just rallying the troops and the fact that we had had the inquiry shouldn't be seen to be in any way a failing of APRA, and that it was really important that supervision teams pursued issues aggressively, even when the institution concerned was pushing back quite aggressively."

Now we are hearing about the Australian Prudential Regulation Authority's work with the Commonwealth Bank after more than 60 per cent of shareholders voted against its remuneration report in 2016, earning the bank its first "strike".

APRA chairman Wayne Byres says CBA’s board was “pretty despondent” after earning the strike - a vote of more than 25 per cent against its executive pay report - which came after it kept executive pay sky high despite a litany of issues.

APRA was particularly critical of the board in its report on the prudential inquiry it conducted into CBA.

Here’s senior counsel assisting the commission, Michael Hodge QC, and Byres going through the issue, starting from APRA’s engagement with CBA on the issue in 2016.

Hodge: "And then do you know what it is that happened after this?"

Byres: "So I think those - a couple of things. I think at least some of those discussions were had. My understanding is a lot of - and - there was a view within CBA that many matters were on foot and hadn't been determined yet, CommInsure being an example. And, therefore, it wasn't necessarily appropriate to decide on an outcome until an issue had been fully investigated. So that was sort of one - one of the issues that came up. The other issue was that it just reinforced the need for us to do the broader industry work because I think what discussions inside of APRA concluded was that what we were seeing here, we were seeing elsewhere, perhaps to different degrees, and that we should commence the work which we ended up undertaking that led to the - the review across the industry."

Hodge: "One possibility would have been to raise this with the board of CBA?"

Byres: "Yes. So a couple of weeks before that we had had a meeting with some of the directors, including the chairman of the board. I think it was the day the - if I remember the file correctly, it was the day that the results had come out, and - and they talked about the fact that the CEO's remuneration in particular was a large number that year and offered some views on why that was. By the time - so we did this work, we looked at the issues. By the time we went back to the board again,  we went back in - my recollection is December of that year. But we often had a meeting with the CBA board at the end of the year, so I will say December. By that stage, they had had a strike against their remuneration report. It had been announced that the - the chairman was going and they were clearly having to have a pretty fundamental rethink about the way they approach remuneration. And so we used that opportunity in December to encourage them to rethink on some of these issues."

So we’re now we’re onto the debate about whether executives who lose bonuses should be named and shamed by APRA and the companies they work for. It’s a key issue. This week Commisisoner Hayne raised the question of whether publishing senior staff pay in annual reports has led to an “arms race”.
Here’s Wayne Byers and Mihael Hodge discussing the issue.
Mr Hodge: "Do you have a view about whether financial institutions should disclose more information about risk related adjustments to executive remuneration?"
Mr Byers: "I think there are pros and cons. It - it's a bit of a double-edged sword. So on one hand you would say if there's - if there's an expectation that rewards are disclosed, it might be reasonable to have more information to explain how those awards were determined.  "There will be sensitivity about these issues, obviously, and in some cases, the disclosure - I guess the thing that's in the back of my mind is the risk that the disclosure in and of itself actually detracts people from making adjustments, because of the, you know, external reaction to whatever that issue is. And that boards might - they may wish to penalise someone but they may not wish to have that broadcast more broadly.  "So that would be my only question mark. It's a bit like a disclosure of remuneration more generally. People think it's good but I think my observation would be disclosure of remuneration has meant across the system it has got higher and more generous. So the disclosure is good but an outcome has been a race to the top, and my reservation about more and more and more disclosure would be that question of whether it may actually lead boards to be more reticent to exercise discretion."
Mr Hodge: "Can we try to just pull out a few of the ideas you are talking about, just to make sure we've itemised them all. A point that you're making is if boards knew that whatever their reasons were for risk related adjustments were going to have to be made public, then they might be reticent about making those types of adjustments?"
Mr Byers: "It obviously depends on the level of detail, but the more and more detail, and particularly the more and more it becomes associated with individuals, and it becomes a - or an exercise in naming and shaming, boards may not feel that's appropriate.  "And then what seems to go along with that is it may ignore the potential consequences or the potential effects on the individual employee, and in particular, as you say, the amount of detail might vary, people might make assumptions about an individual's direct involvement in conduct when, in fact, they've been penalised because it was their group, for example, that has engaged in the conduct. I'm not saying they would be the outcomes, but that - that strikes me as a possible reasonable outcome, or possible outcome." Mr Hodge: "And on the flipside, a potential benefit for the company might be, as I think [CBA chairman Catherine] Livingstone said, it would send a powerful message about the way the institution responded to misconduct?"
Mr Byers: "Absolutely." 

Byers has flagged that APRA will be doing a lot more about conduct, including expanding its prudential oversight of all remuneration structures within a bank. Right now APRA administers the newly introduced Banking Executive Accountability Regime.

How staff are paid has been a key issue at the royal commission, including sale bonuses for front line staff. APRA has now recognised its importance, and its quite a bit of news!

Here’s Mr Hodge and Mr Byers discussing the issue.

Mr Hodge: "Do you have a view as to whether APRA should change its prudential standards and guidance to expressly address the potential for poorly designed and implemented remuneration systems to increase the risk of misconduct?"

Mr Byers: "Yes is the short answer. The longer - slightly longer answer is it is our intention to take those FSB supplementary guidance, the learnings from the CBA prudential inquiry, the learnings from this Commission, the learnings from a range of work that we've done and improve the current set of prudential standards."

Mr Hodge: "And is there a timeframe for doing that?"

Mr Byers: "So currently, we would certainly plan to be going out for consultation on something next year. There's internal work going on now, drawing together all of those things that I just talked about, the FSB work, the CBA inquiry findings, our own work on remuneration, the April paper that we talked about before, what we've observed through this Commission's process and findings, other international work, and trying to produce what we've called the paper that - so what does good look like, taking all of that together, what would a really good remuneration framework look like, and we envisage going out for consultation on that - I hesitate to put a date on it, but - because the staff will probably not be very happy at me, they're still working on it, but as soon as possible. Next year, certainly."

Mr Hodge: "And what role does ASIC have in relation to that?"

Mr Byers: "So we would be consulting with ASIC. The - the team that is driving the work is our governance culture and remuneration team, as you might expect. They are engaged in their - they engage quite regularly with their counterparts in ASIC who are looking at similar sorts of issues. So they would be - we would be getting the ASIC input and advice along the way."

Mr Hodge: "Your view is if there's going to be regulatory intervention on this issue, it has to be more targeted and concerned with just this issue?"

Mr Byers: "Yes. If I can be really blunt about it, I think what I am saying is to get change APRA will have to do it."

As APRA chief Wayne Byres is going deeper into the banking regulator's new focus on executive misconduct,  and how conduct issues could be managed by enforcing certain risk, culture and remuneration frameworks, Commissioner Kenneth Hayne jumps in with a philosophical question:

Commissioner: "There's a chicken and egg problem, isn't there, Mr Byres, whether remuneration is reflecting culture, whether culture is reflecting remuneration, whether governance is reflecting culture, culture is reflecting governance. They're all intermeshed at least to an extent, aren't they?"

Mr Byres: "That - I think that's right. And - no, absolutely that's right. And that's why we created a team on governance culture and remuneration rather than three teams because these things are inextricably linked and just fixing one - whatever fixing is - but just dealing with one without dealing with the other two will not solve the problem."

Commissioner: "But if your culture is driven by immediate financial year bottom line..."?

Mr Byres: "Yes."

Commissioner: "... it would not be surprising if the remuneration structure reflected that idea, and if governance is directed to that idea?... 

Mr Byres: "Or more - or if your remuneration is focused on that, it's inevitable your culture and governance... "

Commissoner: "Round you go?"

Mr Byres: "You have to have them - they have to be mutually reinforcing of one another.

Commissioner: "Yes?"

Mr Byres: ..."or they will be mutually undermining one another."

Commissioner: "Yes. Sorry, Mr Hodge. Go on."

We’re going into APRA’s views on executive remuneration. APRA is in charge of administrating new rules called the Banking Executive Accountabilty Regime, or the BEAR.

As such APRA has some views on the links between pay and conduct.

Wayne Byres says the banking regulator has started to look more into conduct issues. Credit: Internet

Byers has just told the commission that APRA is now thinking about conduct more. And he has said that serious cases of misconduct can have stability issues especially if the issue is systemic. This might sound dull, but it’s quite a shift for APRA, which has run one court action in the past 10 years.

Here is Mr Hodge taking Mr Byers through the issue.

Mr Hodge: "One of the things that APRA did last year was to commence a review of remuneration practices across a large - across a sample of large APRA regulated institutions?"

Mr Byers: "Correct."

We then see a report APRA wrote following the review.

It reads in part: “APRAs focus on remuneration is aimed at ensuring that remuneration practices, including the governance of remuneration outcomes, support prudent risk management and the long-term financial soundness of APRA-regulated institutions.”

Mr Hodge: "In other words, the prudential framework seeks to ensure that remuneration practices are supportive of a strong risk culture."

Mr Byers: "Yes."

We then see the document reads: "A number of recent reviews conducted by other financial regulators and industry bodies have also focused on remuneration, largely from the perspective of limiting the potential for misconduct. The link between remuneration and misconduct is also of interest to APRA as a prudential supervisor because conduct issues can provide additional insights into an organisation's attitudes towards risk more generally."

Mr Hodge: "And what I want to test with you is the extent to which this continues to represent APRAs view of the link between conduct and APRAs role?"

Mr Byers: "I think that's an area that's evolving. I think we started - as you said before, when our first standard was introduced with one that had a very traditional, for want of a better term, focus on traditional financial soundness issues.

"We've expanded our thinking into risk culture and how to think about culture within organisations and the connection between remuneration and risk culture. And consistent with the work that's been done internationally, thinking about how we, as a prudential regulator, should think about misconduct and the way those two things come together."

APRA’s Wayne Byers is giving evidence at the royal commission now, with senior counsel assisting the commission, Michael Hodge, QC, asking the questions.

We’re starting at the start and going through what Byers does and how the Australian Prudential Regulation Authority (APRA) works.

Which makes sense given there appears to be some confusion between what the royal commission thinks the APRA should do, and what APRA says it should do.

A key issue during the superannuation round was who regulates misconduct in the super industry. The corporate regulator, the Australian Securities and Investments Commission (ASIC), pointed the finger at APRA, and APRA pointed the finger at ASIC.

Upshot was, no regulator appears to think regulating conduct in the super sector is part of their remit.

As Mr Hodge asked in the superannuation round in August: "What happens when super funds are left alone in the dark with our money amid regulatory confusion?"

And so Wayne Byers is explaining the APRA’s members are like ASIC’s commissioners and have specific responsibilities for ensuring sector stability.

Here’s a snippet of what they are talking about.

Mr Hodge: "I think the way ASIC has framed it is that its Commissioners will no longer have day-to-day operational and executive responsibilities, and instead would adopt a strategic oversight review and external engagement role?"

Mr Byers: "Yes."

Mr Hodge: "That's the way in which you see APRA operating at the moment?"

Mr Byers: "Yes. So if I take - if I try and explain my role a bit more. I'm not involved in day-to-day supervision. I don't take day-to-day supervision decisions, delegated decisions, authority that we have to make decisions under the prudential standards, etcetera, delegated obviously important decisions to the executive general managers, but more routine decisions further down through the organisation.

"So I would not be as a member - and this applies to the other now three members as well - not doing the day-to-day supervision decisions. I would not be setting supervision strategies for individual organisations. I would not be doing - looking at approving individual risk assessments.

"My operation in respect of ADIs is trying to sit above that and think about the industry themes, the broader issues, how do we keep APRA fit for purpose, if you like, into the future."

Bendigo chairman Rob Johanson has finished his testimony and the commission is taking a lunch break.

The hearing resumes at 2pm with Wayne Byers, the head of the banking regulator APRA. 

 

We've just heard that Bendigo has a much smaller loan book to the other banks and has taken a different approach to home lending.

For instance, it has a low reliance on sourcing loans from mortgage brokers.

But while the bank pays fewer commissions to mortage brokers, its chairman Rob Johanson is not immediately in favour of stamping out trail commissions alltogether.

Commissions to brokers has been another hot topic at this banking royal commission with concerns raised they lead to poor customer outcomes.

Here’s Mr Johanson's exchange with counsel assisting Rowena Orr:

Ms Orr: "The people you are dealing with are not remunerated on a commission basis?"

Mr Johanson: "Yes."

Ms Orr: "With the conflicts that flow from remuneration on a - on a commission basis?"

Mr Johanson: "But I think -- and if I can say, I think that interesting paper on conflicts in the - in the - that the Commission has available shows the difficulty of actually structuring this in ways that achieves what I've said are the objectives. One is don't interfere with people's ability to choose the way they want to engage, don't interfere with the capacity of the system to continue to innovate and cut costs and those things, but deal with conflicts adequately. I mean, that shows how difficult it is.

"So I think the idea of an upfront commission, even a volume-based commission, if it's properly disclosed - if it's clear to the customer what the implications of that are for their loan, if the responsibility of the person who's getting the commission is clear, who are they working for - then I think that addresses a lot of those issues."

This led to Commissioner Kenneth Hayne asking: "Who do you think they work for?"

Mr Johanson: "I'm clear, they work for the customer."

But Mr Johanson stopped short of saying he backed the banning of trail commissions, expressing concern "that a banning of trails doesn't catch what I think are those - doesn't catch any of the other distribution systems that I described."

Ms Orr: "Is that a reason to keep trail commissions?"

Mr Johanson: "If it - if a result of banning trails we force customers only to deal through banks and bank branches, I think that would be a very bad outcome."

Ms Orr: "Why would that be the result of banning a trail commission?"

Mr Johanson: "It may not be the result, but I am - I am - you know, do we ban it entirely, let's not have those other extreme outcomes."

Ms Orr then asked: "Well, what do you see as the value that a customer gets in exchange for the trail commission?"

Mr Johanson: "Well, it could only be if the customer - and the problem at the moment is, I think, the customers are - even though there might be some formal disclosure system, the customer is unaware that trails are paid and the amounts are paid. Perhaps there ought to be a requirement that if - if a loan has a trail connected to it, the customer is made aware of it. Maybe the - maybe the adviser needs to do something in - actually in relation to that."