Banking royal commission: soft enforcement link to regulatory capture

By David Donaldson

February 5, 2019

Culture, rather than rules, is the big problem at financial regulator ASIC, says Banking Royal Commission head Kenneth Hayne.

An “ineffective enforcement culture” at the Australian Securities and Investments Commission has contributed to the failings explored in the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, according to Commissioner Kenneth Hayne.

The agency’s culture has led to an overly soft approach to regulation, preferring negotiated settlements over litigation or public denunciation. This appears to have enabled a problematic corporate culture in financial entities.

When deciding how to respond to misconduct, “ASIC’s starting point appears to have been: How can this be resolved by agreement?” Hayne noted in the interim report, adding that “this cannot be the starting point for a conduct regulator”.

He points the finger at culture in particular — rather than policies, processes and procedures — because ASIC’s “stated policies about enforcement did not preclude it from taking much stronger steps than it did”.

In the final report, released publicly on Monday afternoon, Hayne emphasises the potential for regulatory capture such an approach creates:

“Financial services entities are not ASIC’s ‘clients’. ASIC does not perform its functions as a service to those entities. And it is well-established that ‘an unconditional preference for negotiated compliance renders an agency susceptible to capture’ by those whom it is bound to regulate. As one leading American scholar has written, ‘corporate behavior moves quickly to take advantage of any perceived softening. Social norms act less upon complex organizations than upon individuals’.”

This culture creates the sense that compliance with the law is optional, Hayne argues:

“All of these considerations show that improving compliance with financial services laws cannot be achieved by focusing only on negotiation and persuasion. Compliance with the law is not a matter of choice. The law is, in that sense, coercive and its coercive character can be neither hidden nor ignored. Negotiation and persuasion, without enforcement, all too readily leads to the perception that compliance is voluntary. It is not. All financial services entities must obey the law, not just those who are willing to do so. And all financial services entities must comply with all the laws that apply to them, not just with those bits of the law that they find to be commercially acceptable.”

Indeed, some entities may have continued to charge fees for no service, despite being investigated by ASIC, until the matters were publicly examined by the royal commission.

Why not litigate?

Hayne noted in September’s interim report there were signs ASIC may have already been changing its approach to enforcement, and ASIC accepted it needed to make changes.

ASIC says it accepts “that it must alter its enforcement priorities and practices within the financial sector — and particularly for larger financial institutions — so as to be more agile in initiating and prosecuting court action, and in many instances even commencing with it”.

The agency also “recognises that its enforcement priorities must change to emphasise deterrence and public denunciation more strongly in its use of various regulatory tools (inside and, where applicable, outside court) as mechanisms by which to change behaviours”, and now accepts that, when considering enforcement measures, it should start with the question ‘why not litigate?’.

Hayne is still cautious about how that will go, but adds, “It should be given time to demonstrate that changes can be made and to demonstrate that, once made, the changes are durable.”

Should ASIC not pick up its game, he believes the creation of a specialist civil litigation agency should be considered.

Creating a stronger firewall between ASIC’s enforcement division and regulated entities would also help, he thinks.

“As noted earlier, the risk of regulatory capture is well acknowledged. One means of avoiding regulatory capture affecting enforcement decisions is to have the enforcement arm of ASIC separated from day-to-day dealings with the entities it regulates to the greatest possible extent. … Enforcement staff should not be responsible for the general relationship between the regulator and the regulated entity.”

Both ASIC and the Australian Prudential Regulation Authority should be subject to capability reviews”at least” every four years, Hayne adds. The government has already announced Graeme Samuel, former chair of the Australian Competition and Consumer Commission, will lead a capability review of APRA.

Hayne also recommends the establishment of a new oversight authority for APRA and ASIC, independent of government, “to assess the effectiveness of each regulator in discharging its functions and meeting its statutory objects”, with Hayne suggesting the authority should be comprised of three part-time members and staffed by a permanent secretariat.

The government has agreed “to take action on” all 76 recommendations contained in the report, according to a joint media release by Prime Minister Scott Morrison and Treasurer Josh Frydenberg.

READ MORE: The finance royal commissioner thinks Ken Henry just doesn’t seem to get it

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