On 4 February 2019, just over a year since it was established, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (“RC”) delivered its final report and recommendations. As expected, given the RC focused on consumer lending, financial advice, superannuation and insurance, the majority of the recommendations were related to these industry subsectors. It is worth noting however that the funds management industry was not immune to the RC’s broader recommendations.
The RC’s “Six General Rules”
A framework for considering the RC’s recommendations are the principles it applied that it called its “Six General Rules”. The “Six General Rules” are:
- The law must be applied and its application enforced;
- Industry codes should be approved under statute and a breach of key promises made to customers in the codes should be a breach of the statute;
- No financial product should be hawked to retail clients;
- Intermediaries should act only on behalf of, and in the interests of, the party who pays the intermediary;
- Exceptions to the ban on conflicted remuneration should be eliminated; and
- Culture, governance and remuneration practices, both in the industry generally and in individual entities, must focus on non-financial risk, as well as financial risk.
While some of these “rules” are not applicable to fund managers, the key implications of the Six General Rules as well as specific applicable recommendations to the funds management industry are set out below:
The RC report recommended that superannuation trustees (RSEs) should be prohibited from assuming any obligations other than those arising from or in the course of its performance of the duties of a trustee of a superannuation fund. The RC said of the conflicting duties between a RSE and responsible entity (RE):
“Taking on those obligations [acting as RSE and RE] may be seen as yielding some commercial convenience for the group of companies concerned. But those considerations do not outweigh the practical consequences for the trustee’s performance of its duties to its members”
We expect that this will lead to greater consideration of the use of independent REs such as Evolution Trustees where there is a potential for conflicts by an entity also acting as a RSE.
We expect that a greater level of supervision activities will be conducted by ASIC, with litigation to be pursued where previously enforceable undertakings would have been considered sufficient. Given the potential consequences of ‘non-compliance’ this should encourage funds managers to make further investments in compliance training, processes and systems.
While the RC did not recommend the end to ‘vertical integration’ and the inherent conflicts that this generates, fund managers can expect a greater focus on conflicts. In a number of contexts, the RC report was clear that it was preferable to avoid conflicts rather than attempt to manage them so where possible, fund managers should seek to eliminate conflicts from their business models. There is a general acknowledgement however that conflicts of interest are a part of many businesses, so we expect a greater regulatory focus on how these conflicts are disclosed to investors and managed internally.
Governance and Culture
The RC report included a recommendation that applied to all financial services entities on governance culture recommending that they should, as often as reasonably possible, take proper steps to:
- assess the entity’s culture and its governance;
- identify any problems with that culture and governance;
- deal with those problems; and
- determine whether the changes it has made have been effective.
It is not clear how this requirement be legislated or enforced in practice, but our expectation is that some form for formal ownership of ‘culture’ by boards will be required, and that additional checks and balances (and documentation) will be needed to be implemented by fund managers in future.
Compensation scheme of last resort
The RC recommended the implementation of a ‘compensation scheme of last resort’. While the RC recommends this should initially be focused on financial advice failings and is silent on funding, we think it is likely that a broader scheme will be implemented and it will be industry funded, increasing fund managers cost bases.