Banking royal commission: Round 7 — policy and CEOs — Shayne Elliott, Robert Johanson and Wayne Byers

Documents reveal regulators knew they had to “ratchet up the mongrel” with the banks.

Senior counsel assisting the financial services royal commission Michael Hodge QC. Picture: Supplied.

Thanks for joining our live coverage of the seventh and final round of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, this week being held in Melbourne.

Today hearings resumed with senior counsel Rowena Orr continuing her questioning of ANZ chief executie Shayne Elliott.

Ms Orr began the day by questioning Mr Elliott on evaluating mortgages. After a longer discussion about the bank’s culture and feedback mechanisms, Mr Elliot stepped down.

Bendigo and Adelaide Bank chairman Robert Johanson was then questioned about the bank’s remuneration structures and broker relationships in what turned out to be a relatively brief appearance.

Chairman of banking regulator APRA, Wayne Byers, then answered questions from senior counsel assisting Michael Hodge QC.

Today’s key developments included:

• ANZ CEO Shayne Elliott said that a duty of care for mortgage brokers towards their clients needed to be backed with laws.
• ANZ’s latest survey of its staff shows that general perceptions of the banks leadership have turned less favourable since the last survey two years ago. Messages are often lost or muddied in middle management, it found.
• Bendigo and Adelaide Bank chairman Robert Johanson made a relatively brief appearance which centred mainly on the bank’s approach to remuneration.
• We heard Bendigo defers a portion of base pay to ensure long-term focus and has not had sales-based incentives for frontline staff for 14 years.
• APRA chairman Wayne Byers told the commission that while naming and shaming on remuneration could produce unintended consequences, the regulator should have moved earlier on CBA’s senior executive pay, with APRA acknowledging in needed more “mongrel” in its dealings with banks.

Join us tomorrow from 9.45am for the final day of the commission’s hearings.

4.19pm: Better informed boards

Turning to CBA chair Catherine Livingstone’s evidence, Mr Hodge points out that she had told the commission that the board did not have the appropriate level of information to make good decisions about remuneration.

Mr Byres says APRA will consider upgrading guides to make clearer what boards should be getting to empower them to make good decisions.

“I think all of these things, it’s a question of resourcing prioritisation... Certainly I think we could do more to spot-check those sort of things. Whether we would be doing it for every organisation every year, that would be a challenging task.”

Mr Hodge notes the time and suggests the hearing resume at 9.45am tomorrow. Comissioner Hayne agress and so that’s it for today.

4.09pm: ‘Supervision mongrel’

Mr Hodge tenders another document on APRA’s response to the CBA issue, describing an attitude change dubbed “supervision mongrel”:

“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,” the document says.

Mr Byres agrees that the problem was at the senior leadership level in terms of setting the tone, not the supervision team level.

“The way that I interpret that comment is simply that supervisors will be very ready to ratchet up the mongrel, so to speak, as long as it’s clear that senior management will support them when they are being more aggressive in their approach.”

Discussing his meeting with CBA after its AGM, Mr Byres says he “didn’t want to rub their nose in it”, that they had got the message from the results of the remuneration vote.

Mr Byres confirms that APRA has taken no action against a financial institution for failing to comply with CPS 510 on remuneration.

3.59pm: Didn’t challenge CBA

Mr Hodge tenders a document of reflections on the prudential inquiry into CBA, prepared by CBA supervision team principal analyst James Douglas.

Mr Douglas reflects that “APRA could and should have called out inadequate remuneration practices earlier (at least by late 2016)”.

In response to that statement, Mr Byres says the regulator didn’t have a lot of expertise in remuneration at that time.

“So the problem then seems to have been with actually challenging the institution,” Mr Hodge suggests.

“Yes,” Mr Byres concedes, adding that mortgages and credit risk is the prudential supervisor’s “bread and butter”, but “we didn’t have the same capability and skills and therefore confidence to push as hard as we would for what I would call a traditional prudential issue”.

3.46pm: CBA remuneration

Mr Hodge turns to the example of CBA’s executive remuneration in 2016, and particularly APRA’s “Principle 8”, which holds that: supervisory review of compensation practices must be rigorous and sustained and deficiencies must be addressed promptly with supervisory action.

Mr Hodge asks whether the regulator should have routinely collection information on the risk principles used to dock executive pay, and if it can be rigorous and sustained without that information.

“No, we clearly have to collect, if we want to be able to systematically analyse this sort of stuff for every institution every year, we would have to collect a lot more information and devote a lot more resources to it,” Mr Byres answers, describing it as a “resource prioritisation issue”.

“It’s all very well to put out the framework, but how you make sure it’s policed and adhered to, that’s a resourcing question that we are going to have to grapple with going forward.”

Mr Hodge prods Mr Byres further on why APRA didn’t raise its concerns on CBA’s remuneration with the CBA board at the release of the annual report.

He says by the time APRA looked at the issues CBA had received a strike against the board at its annual meeting and “so we used that opportunity in December to encourage them to rethink on some of these issues”.

Mr Hodge asks if, in hindsight, APRA should have moved earlier to raise its concerns to CBA.

“I guess it’s always possible with hindsight to say the issues could have been pushed harder.”

3.23pm: Naming and shaming

Mr Hodge asks whether financial institutions should disclose more information about risk-related adjustments.

Mr Byres describes it as a “double-edged sword”, saying it could put the board off because being seen to be “naming and shaming” an executive by cuttig pay might make the board less likely to take action.

“So the disclosure is good but my reservation about more and more disclosure would be that question of whether it may actually lead boards to be more reticent to exercise discretion.

“It’s a question of detail.”

3.19pm: No one wants to go first

Mr Byres says there is still too much focus, particularly in the long-term incentive measures, on the relative total shareholder return measure.

“I don’t think that’s conducive to the broader more holistic assessment of performance that I think we all would think desirable,” he says, going on to say that internationally, there was a shift away from financial metrics.

Mr Hodge turns to the two strikes rule and asks if it contributes too much on performance hurdles being weighted toward financial metrics.

“No one wants to go first. There’s a first move disadvantage here. So it’s a problem,” Mr Byers answers.

He makes a distinction between investors and shareholders, saying the former might not necessarily like the shift away from financial metrics but ultimate shareholders would have a different perspective.

“What I am saying is to get change APRA will have to do it,” he adds.

Prodding further on regulatory intervention, Mr Hodge asks whether it will mean rewriting the prudential standards.

“I think the current frameworks are still too focused on performance equals profit and share price moves. And performance of an executive or executive team is clearly more than those two things,” Mr Byres answers, and that the standard can’t be so prescriptive to not allow for the diversity of the industry.

3.06pm: The twin peaks model

Mr Hodge turns to a what some see as a potential issue with the “twin peaks” model that sees regulation split between ASIC and APRA.

“I think perhaps it’s not necessarily my concern and I don’t think actually that it’s Mr Shipton’s concern if he was here. We think we can work together but there is a lot of external commentary that the lines between APRA and ASIC are getting blurred,” Mr Byres answers.

He agrees that APRA has the power to set prudential standards but ASIC doesn’t and that if there were to be standards in relation to risk, culture, governance and remuneration those would be set by APRA.

Further, he says APRA is taking the FSB’s supplementary guidance, CBA prudential inquiry and royal commission findings to improve the current set of standards, with a plan to set consultation next year.

Mr Hodge suggests there might be a potential gap in that APRA understands remuneration systems, ASIC understands misconduct. But bringing those things together might be difficult.

“I think it’s like most things, most regulators would like to have more expertise, more resources to tackle whatever issue is on their plate,” Mr Byres answers.

3.00pm: Where should APRA focus?

Mr Hodge turns to culture and remuneration and how they have an effect on the financial stability of an institution. APRA’s work on remuneration was prompted by the Financial Stability Board (FSB) findings after the GFC.

He points out that the organisation was too narrow, largely focused on financial risk or soundness back in 2009 and 2010 - at the expense of conduct risk, with supplementary guidance for a wider focus only released this year.

Mr Byres says the regulator had set up a governance, culture and remuneration team in 2015, “because we felt we needed a deeper expertise in this area”.

Citing APRA’s review of remuneration practices, Mr Hodge highlights its relationship to remuneration:

“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.”

Commissioner Hayne suggests that there’s a “chicken and egg problem” involving remuneration, culture and governance.

“They have to be mutually reinforcing of one another, “ Mr Byres agrees, “or they will be mutually undermining one another”.

2.31pm: APRA structure

Mr Hodge draws comparisons between APRA and fellow regulator ASIC, highlighting how ASIC’s review noted its model inherently undermined accountability.

Mr Byres acknowledges that, and says that ASIC is moving to a model more similar to his own, where APRA’s commissioners are removed from day-to-day operation and instead having a strategic oversight review and external engagement role.

Mr Byers says that having one APRA member per industry sector is not an issue. This structure allows them to be APRA’s “lead face to the industry” and to makes sure that industry knowns who is in charge of their area of interest at APRA.

2.24pm: APRA chairman Wayne Byres appears

APRA chairman Wayne Byers appearing at the financial services royal commission in Melbourne. Picture: Supplied.

APRA chair Wayne Byres has taken the stand as the final witness for this week’s hearings, to be questioned by senior counsel assisting Michael Hodge QC.

Mr Hodge breaks down the operating model of the regulator, noting that each of the four executive board members has a primary focus along industry lines but has no processes or guidelines for determining what areas are considered by the whole board.

“It’s the nature or the materiality of the issue, and recognising that members sit on these groups, so there’s an opportunity if I think this is an issue that I think the other members would opine on, then I could weigh into the discussion and say “I think it should be escalated”.”

Mr Hodge “cuts to the chase” to ask how APRA’s structure compares to one with a formal CEO with an executive responsibility for the day-to-day administration of the organisation.

“If you look at the terms of reference for the executive board, it talks about all the sorts of issues that I think you are alluding to might normally be filled by the board of a regulated entity that we would supervise,” Mr Byres answers.

Mr Hodge goes on to take the Australian Competition Consumer Commission and the UK’s Prudential Regulation Authority as examples of similar bodies that instead had a CEO role.

Mr Byres says the organisation had tried with that structure but that a member model was the preferred structure.

Further, Mr Hodge highlights that an external review was recommended by the financial systems inquiry, what Mr Byres concedes has not been done to date.

12.55pm: Broker commissions

Turning finally to mortgage broker remuneration, Mr Johanson says less than 10 per cent of Bendigo and Adelaide’s loans come through brokers, who receive upfront and trail commissions.

“It may be why we’ve got so few but we’ve never participated in bonus schemes and some of those other systems or arrangements within the industry,” he says.

Ms Orr asks about Bendigo’s view on the reforms recommended by the Productivity Commission to ban trail commissions.

To answer, Mr Johanson details a number of its methods to get loans, its community bank network and online mortgage system.

“I think the idea of an upfront commission, even a volume-based commission, if its properly disclosed and made clear to the customer what the implications of that are for their loan then I think that addresses a lot of those issues,” he says further, adding that it should be made clear “that they work for the customer”.

On banning trail commissions, he says if it means forcing customers to deal through banks and bank branches it would be a very bad outcome.

“Brokers in their current form and third party distribution mechanisms have become an essential part of the financial system in Australia. And that’s largely as a result of customer choice. You wouldn’t want to impede customers being able to choose different access to lending.”

But he adds: “I’m not defending trails to brokers”.

Ms Orr completes questioning of Mr Johanson and the courtroom breaks for lunch, to resume at 2pm.

12.40pm: Two strikes has a flipside

Ms Orr turns to the two strikes rule, asking Mr Johanson if it should be modified.

“I think that the two strikes rule can mean that a relatively small proportion of the total shareholder group can have significant influence on the direction of the company,” he answers.

But there is a flipside, he suggests.

“My caution is that is has been a very effective way to have people focus on this stuff, so instead of just blindly assuming it away, people now work hard on this stuff,” further clarifying that the rule requires companies to engage with shareholders further.

Turning again to the differences between Bendigo and its peers, Ms Orr asks if its remuneration structure has had an effect on the conduct of its employees.

As part of his witness statement, Mr Johanson said he considers the approach to remuneration has assisted Bendigo to avoid some of the issues which have affected other banks, such as mis-selling of products.

And that’s “because we haven’t provided incentives for people for the short-term outcomes to participate in those behaviours”.

Further, he points out that the bank removed all sales-based incentives and commissions as early as around 2004-06.

12.30pm: Non-financial performance

Ms Orr looks to the conditions that need to be met for long-term incentive payments to vest, particularly the introduction of a customer hurdle in 2016, measured by the bank’s net promoter score.

“We think the way to create long-term value in our business is to be the most focused on customer outcomes. So one of the most important criteria then, consistent with that strategy, is: ‘What do customers think of us’,” Mr Johanson explains.

Ms Orr points out that weighting on that measure was increased from 30 to 35 per cent in September and asks why.

“In the very competitive banking market we now have, where the availability of almost unlimited credit has stopped, it’s becoming even more important that if we’re to continue to build our business and grow our business, we have to attract customers. So we want people to concentrate on customer outcomes.”

But in contrast to this, Ms Orr tenders a report issued by proxy adviser firm ISS Governance which recommended a vote against performance rights to chief executive Marnie Baker because “consumer-centric measures should be considered and assessed as part of a banking executive’s day job”.

Mr Johanson says its shareholder mix lends itself to differing objectives to remuneration. Its institutional shareholders, for example, focused more on short term financial outcomes.

Bendigo’s submission to the interim report further says that institutional shareholders and proxy advisers typically require executive remuneration to have a substantial weighting towards incentive-based pay that is directly exposed to financial performance and share price performance, and criticise remuneration structures that do not do so.

Going back to Ms Baker’s performance rights, Mr Johanson says 19.2 per cent voted against it, and that the resolution was passed, adding the report as a whole was also passed.

12.11pm: Just doing your job

Bendigo and Adelaide Bank chairman Robert Johanson appearing at the financial services royal commission in Melbourne. Picture: Supplied

Ms Orr highlights Bendigo’s single bonus pool, shared by all salaried employees of Bendigo, including senior executives.

She points to a comment from Mr Johanson that “short-term incentives should not be a payment to people for doing their job, that is the role of base remuneration”.

Talking through the creation of the pool - he says the bank looks at a range of measures, that behaviours have been consistent with risk appetite, risk weighted assets over total assets, return on equity and risk adjusted equity among other factors.

He says in the past nine years there have been two instances of a bonus pool not created, when earnings “were not good enough” - going on to say that the bonus pool is more of a profit sharing mechanism.

Ms Orr asks why Bendigo offers executives short-term variable remuneration at all.

“I think it’s seen as if we’ve had a good year, then it’s appropriate that we share some of the financial outcomes of that among other stakeholders.”

12.02pm: Bendigo and Adelaide bank’s Robert Johanson appears

After a brief break, the next witness to appear is bendigo and Adelaide Bank chairman Robert Johanson.

To begin, Ms Orr goes through in detail Bendigo’s practice of deferring part of an executives base salary, which Mr Johanson claims is unique in the industry.

“We think it’s better to have a large proportion of the total package in the form of base.. and as shareholders often tell me, they like to see executives and directors with skin in the game,” he says.

Ms Orr compares the remuneration of Bendigo’s executives to that of its major bank peers - what is markedly different.

She notes Bendigo’s chief financial officer’s maximum short and long term incentive opportunity are both set at 32 per cent, compared to far higher percentages at NAB, ANZ and Suncorp, where the financial officers get less than 100 per cent of the fixed remuneration.

Further, she highlights the bank’s chief customer officer against her peers.

Asked why, Mr Johanson says, “We believe we’re trying to build a business for the long term. We’re trying to establish a strategic position to be the bank of choice for Australians”.

“If you are concerned about profits, often individual transactions, that’s not the culture that we want. That doesn’t refect a behaviour that we think is going to be for the long-term betterment of the business and the stakeholder group.”

The early questions from Ms Orr appears to suggest that Mr Johnason may have been called as a counterpoint to the other banks, much in the same way that Macquarie CEO Nicholas Moore appeared to be last week.

11.40am: Fewer speaking up

Mr Elliott says a 3 per cent decrease his employee’s “speak up” culture is the biggest concern in results from the bank’s risk culture index.

“If we don’t have a culture where people feel free to speak, we will fail,” he says.

He says the matter has “actually got serious attention from our board” and will be fixed by empowering the bank’s managers.

“I think it takes obsessive, literally obsessive, focus by management to say that this is really important and to lead by example...I believe you can see shifts in culture in reasonable period in the medium term.”

Pressing further on culture, Ms Orr tenders results of a self-assessment from three senior executives, describing the culture as “in transition”.

After wrapping up the discussion on culture and feedback, Mr Elliott is allowed to step down.

11.11am: Communication breakdown

Ms Orr goes through the results of a survey into the perception of the banks leaders.

She notes that results of the most recent survey were lower across all categories compared to the previous survey done in 2016.

“It’s disappointing, but it’s a great source of data. It’s a rich source of data and it gives us the ability to see opportunity to do better,” Mr Elliott says of the results.

Probing further, Ms Orr points out that a significant number of respondents commented that the purpose and direction is clear from the top but that it gets lost in middle management layers.

Mr Elliott says he wasn’t surprised at that, going on to describe the organisation as a number of layers with at least 8000 of the workforce leading a team.

On how he’s changing that structure he begins on a military analogy referencing sergeant majors.

“I regret that analogy,” the Commissioner adds - in recognition of his use of the same terms in yesterday’s questioning.

Mr Elliott goes on to say the company has “big calls and multiple types of communication in order to convey the right message through its teams.

11.02am: Measuring culture

ANZ CEO Shayne Elliott appearing at the financial services royal commission in Melbourne. Picture: Supplied

Ms Orr turns to the way the company measures its culture, going through steps including online surveys and conducting focus groups.

Tendering the results of a cultural audit, Ms Orr points out that 69 per cent of finance managers were confident of an outcome of an issue they raised, 72 per cent only sometimes or do not share bad news due to fear of repercussions, and 39 per cent believe systems are designed to support decision making.

She asks how the results are used by higher management. Mr Elliott replies the leadership team develops an action plan over a three-month period.

Asked if the pilot program had effected culture so far, Mr Elliott says there had been a change across the group.

“What I have seen is there’s a change of the culture and the conversation at the most senior level of the bank... we pay attention and talk about this now.”

10.35am: Fees for mortgages

Mr Elliott says a mortgage broker should carry a duty of care and that notion should be reinforced by law. But clarifies that “I’m not a lawyer”.

“As a customer walking into a broker, I believe they are acting for me... and I think that should be codified in a way and there should be obligations that come with that.”

Turning to remuneration then, Mr Elliott says there is always risk that incentives might cause brokers to behave in ways that lead to poor customer outcomes.

Prodded on fixed broking fees, he says that “the difficulty with the fixed fee is it essentially is of major advantage to people who can afford, and have the financial position, to undertake large mortgages... it runs the risk of making broking a privilege for the wealthy”.

Commissioner Hayne suggests that the impost is already there, it’s just that the customer can’t see it as a discrete item.

Mr Elliott agrees that the fee could be capitalised into the loan, but says a fixed fee could also incentivise bad behaviour by encouraging brokers to borrow less and come back for more “top-ups”.

He estimates the total new loan volume at $50 billion a year, and so-called top-ups at $17 million.

10.17am: Relying on HEM for mortgages

ANZ boss Shayne Elliott is again facing questions from Senior Counsel Assisting Rowena Orr QC for the penultimate session of the public hearings.

Ms Orr begins with questions on the bank’s use of the Household Expenditure Measure (HEM) benchmark in assessing consumer loans.

Mr Elliott admits the bank does not use the full set of information it has on applications for its own customers, in what he says is an agreed area of improvement for which a fix is currently in the works.

He says that in percentage terms, the current use of the benchmark is within the mid-40s, with a goal to bring it down to a third of home loan applications by the end of financial year 2019, thanks to investment in technology.

“The branch channel actually has slightly higher usage or dependency on HEM as opposed to the broker,” he says, saying most people would find that result “counter-intuitive”.