Regulators to focus on misconduct in 2019

Financial regulators will be focusing on adopting a proactive approach to managing risks and behaviours in the financial services sector this year, according to a new Deloitte report, especially after revelations of misconduct across APAC countries in recent years, combined with the growing introduction of personal accountability regimes.

The report, Asia-Pacific Financial Services Regulatory Outlook 2019: Trust, Technology, and Transformation, claims that APAC regulators have been questioning the efficacy of traditional methods of risk management, particularly given the litany of abuses that have been exposed recently in countries like Japan, South Korea, as well as Australia, through the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

The CEO of Commonwealth Bank Matt Comyn himself acknowledged during a royal commission hearing that a reactive approach to misconduct led to its recurrence at the major bank.

As such, according to Deloitte, regulators in the APAC region have begun to “shift away from point in time supervision towards a dynamic model that allows them [to have] a more holistic picture of a firm’s activities”.

It expects that APAC regulators will want to see the impact of the “tools” they have started implementing – such as individual accountability regimes and reformed incentive structures that align with the interests of customers – to deter acts of misconduct.

According to the accountancy firm, financial institutions will need to consider: reviewing their definition of risk culture; clearly articulating conduct risk in a Risk Appetite Framework; enhancing risk management initiatives; developing a database on misconduct cases from inside and outside the organisation as well as regulatory developments to help “track the future trajectory of the issue”, and using technology to monitor risks and behaviour. 

When reporting the impact of their personal accountability regimes to regulators, Deloitte said financial firms will need to consider, for example, whether improvements in staff behaviour can be measured, whether documentation could be provided to regulators demonstrating the effectiveness of the regime, and what incidents have been mitigated or prevented altogether as a result of the regime.

“In 2019 and onwards, firms must be ready to engage proactively and constructively with regulators in this project to create industry-wide high standards for behaviour,” Deloitte’s report states.

Australia has implemented programs through the Banking Executive Accountability Regime (BEAR), which serves as an accountability framework, imposing higher standards of behaviour on banks and their senior executives and directors. The regime came into effect for the big four banks on 1 July 2018 and will come into effect for other Authorised Deposit-Taking Institutions (ADIs) on 1 July 2019.

The Deloitte report cites comments from Wayne Byres, the chairman of the Australian Prudential Regulation Authority (APRA), who said the effectiveness of the BEAR regime depends on how “accountable persons understand and oversee their areas of accountability in practice... having the paperwork in good shape is not enough.”

Hong Kong is similarly placing pressure on both senior and middle management to take responsibility for conduct failures, having fully implemented the Managers in Charge Regime. 

“Regulators [in Hong Kong] are keen to see how a firm’s business strategy impacts the conduct risks it faces and how existing controls and monitoring process are being adjusted accordingly to address it,” the Deloitte report states. 

Meanwhile, Malaysia maintains its commitment to establishing the Responsibility Mapping system, while Singapore has expressed its interest in introducing a similar personal accountability regime.

Further, while the Reserve Bank of New Zealand (RBNZ) claimed that the systemic issues uncovered in Australia were not found in New Zealand, it acknowledged that there are weaknesses in the governance and management of conduct risks in the country and made recommendations to lenders, the Deloitte report notes. Lenders will need to report their progress in addressing these weaknesses to the Financial Markets Authority and the central bank by the end of March 2019.

The report also notes that remuneration is closely related to personal accountability, as remuneration structures that don’t align with the interests of customers can “create a breeding ground for aggressive sales and unethical conduct”.

“Firms need to pay especially close attention in a regulatory environment that is concerning itself with personal accountability. This may be an opportunity to review compensation schemes to judge their fit for their operating jurisdictions,” the Deloitte report suggests.

In Australia, royal commission revelations have prompted lenders to reassess remuneration structures that reward frontline staff for reaching or exceeding targets without there being proper safeguards in place to restrict how staff achieve their targets.

Despite bank executives claiming that short-term variable remuneration works as a motivator for staff to do their best, a study of 318 financial services workers by Macquarie University into the impact of remuneration structures on the performance and compliance of financial sector staff, submitted to the royal commission, concluded that performance-based remuneration practices, especially those based on balanced scorecards do not significantly improve productivity and instead decreases compliance.

A number of lenders have also decreased the pay package of senior executives, with a reduced focus on short-term and short-medium-term incentive payments.

Further, in an attempt to deter misconduct, the Australian federal government in October 2018 introduced legislation into parliament that would see harsher financial penalties and imprisonment terms administered for corporate and financial sector contraventions. The legislation is yet to pass the Senate. 

[Related: The biggest threat to the Australian mortgage industry]