28/01/2021

The regulation of financial services businesses in Australia stands at an extraordinary confluence of separate but interrelated pressures that continue to make the business of dealing with financial service regulation particularly fraught.

Each of those factors in their own right would represent profoundly complex challenges for financial services businesses. Together, they combine to create an unprecedented escalation in regulatory tension and risk for both financial services businesses and those running them.

The compounding factors include, foremost, the continued impact of the Hayne Royal Commission. While the impact of the Royal Commission was always thought likely to represent a watershed moment for Australian financial institutions, it is now clear the impact has been profound and will be long lasting. The criticism in Kenneth Hayne’s final report of what he perceived to be a lax and overly permissive attitude by Australian regulators has caused a fundamental realignment of regulatory attitudes and approach. 

Bolstered by material increases in funding and chastened by Commissioner Hayne’s critique and other political comment ASIC has substantially increased not just the number of investigations it is conducting, but also the depth, breadth and intensity of those investigations. ASIC is issuing more notices to produce documents and conducting more compulsory examinations of persons thought potentially relevant to the investigation than ever before. The burden and disruption such notices and inquiries cause to financial services businesses is hard to overstate.

Coupled with the increasing number and ferocity of investigations comes ASIC’s response to one of the more memorable pronouncements from Hayne that regulators should consider much more frequently and deliberately why they should not seek court based outcomes in relation to potential contraventions. Regulators appear to have embraced the perception that court based outcomes (i.e. judgments and declarations from the court indicating wrongdoing) are the most effective deterrent for misconduct. Whether or not one can accept that court-based outcomes represent a greater deterrent than other enforcement mechanisms (and there are good arguments that they do not), the burden and distraction of such proceedings are undeniable and now a feature of the Australian financial services environment.

Other collateral effects of the Royal Commission include the taste acquired by the Australian media for stories involving apparent financial services misconduct. Regulatory disputes and proceedings garner a great deal more publicity than ever before which, in turn, produces more incentive for regulators and more interest from politicians.

Politicians also clearly saw the opportunities to be extracted from banking misconduct and are more likely to seek mileage from breaking news which, in turn, increases the media interest.

The second key development in the Australian regulatory landscape has been the introduction in March 2019 of exponentially increased penalties associated with key aspects of the financial services legislation. Maximum penalties for contraventions of financial services laws have increased from A$1.8 million up to 10% of the business’ revenue (to a potential maximum of A$525 million per contravention). Penalties also now attach to much more subjective licensing conditions such as the obligation in section 912A of the Corporations Act for a financial services business to ensure that its services are provided ‘efficiently, honestly and fairly’. The increases in penalties, and the lowering of the bar in respect of contraventions to which they can attach, add further incentive to regulators and can now represent existential threats to some financial services businesses.

Of course, it could be said, fairly, that the dramatic shift in regulatory approach to investigations and proceedings, and the potential burden of increased penalties, can all be avoided by compliance with the law. While that is doubtless true, the financial services legislative and regulatory regime in Australia is among the most complex in the world. There is a very good case to argue that the overwhelming majority of ‘misconduct’ examined during the Royal Commission appeared to be inadvertent and already the subject of regulatory attention and widespread financial remediation by the institutions in question.

Legislative reforms, including a new Banking Code, to address perceived inadequacies identified through the Royal Commission represent the third key new challenge. By way of example, The Financial Sector Reform (Hayne Royal Commission Response) Act 2020 (Cth) was assented to in December 2020, with many of its provisions having a start date of 1 January 2021.  Much of the new legislation is intended to overhaul the industry and ramp up regulatory oversight and enforcement. For example, the significantly revamped breach reporting regime for financial services licensees requires formal reporting to ASIC of breaches and potential breaches of financial services laws on a much more frequent and urgent basis and subject to a dramatically reduced significance threshold. Under this legislation, a corporation (and any individuals knowingly involved) could be criminally liable in circumstances where the licensee fails to report in the requisite timeframe an investigation into a potential breach of the obligation to ensure that the financial services of all credit activities of the institution are provided efficiently, honestly and fairly. Bearing in mind the predisposition to more investigations and more court proceedings, the reduced self-reporting thresholds represent much more than simply an increased administrative burden.

A  fourth key driver of the febrile regulatory environment for financial services licensees is the emphasis by a number of regulators, including ASIC and APRA, on seeking to identify and attribute liability to individuals for misconduct by the institution. There is significant pressure for financial sanctions, through remuneration adjustments and penalties, for individuals involved in contraventions of the financial services legislation or who failed to take reasonable steps under the Banking Executive Accountability Regime (BEAR) or Financial Accountability Regime (FAR) to ensure that the institution complies with its license conditions.

The fifth key contributor is the proliferation of class action proceedings in Australia, driven by a favourable legislative and court rule environment and a proliferation of class action funders and lawyers. Class action funders and lawyers in Australia enjoy a symbiotic relationship with regulatory investigations and prosecutions in that they produce a rich trove of investigative materials and declarations of misconduct that can be leveraged to support a class action.

While the surge in class actions and the impact of funding arrangements was the subject of investigation by the Parliamentary Joint Committee on Corporations and Financial Services Report on Litigation Funding and the regulation of the Class Action Industry whose report was released on 21 December 2020, those recommendations are yet to have been put in place and will, in any event, be unlikely to fundamentally alter the overarching attractiveness of class actions for funders and plaintiff law firms alike.  Countervailing forces like the introduction of contingency fees for lawyers running class actions has already caused a surge in that jurisdiction.

It would be easy to conclude that Australian financial institutions are reaping what they have sown from the litany of legitimate deficiencies exposed during the Hayne Royal Commission. There is an undeniable kernel of truth in that. That said, the shift in regulatory approach, complexity of legislative reform and pronounced increase in the exposure to risk of both the institutions and individuals involved has been far from incremental and combine to make the running of financial institutions, and ensuring their compliance with the myriad labyrinthine financial services laws, more difficult, dangerous and expensive than ever. What remains dubious is whether there will be a demonstrable broad-based consumer benefit associated with that current and future shareholder pain.

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