The final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was released in February. It highlights conduct by financial services entities “over many years” that has caused substantial loss to consumers, has fallen short of legitimate community expectations, and has often broken the law.

Anthony Harper’s previous article summarising the recommendations is available here.

The New Zealand response

Prompted by the Australian Royal Commission, the Financial Markets Authority and Reserve Bank of New Zealand jointly investigated conduct in New Zealand’s banks and large life insurers. The purpose of these reviews was to understand whether there are widespread conduct and culture issues in New Zealand.

The report on banks was issued in November 2018, and the report on life insurers was released in January 2019. Neither report identified widespread misconduct or poor culture. However, FMA and RBNZ made a number of recommendations for change. Banks have until the end of March to report back to FMA and RBNZ on their plans to address the feedback, and insurers have until the end of June.

Separately (but having had regard to the FMA and RBNZ reviews) the Government has signalled its intention to consult in May on law reforms in the area. Commerce and Consumer Affairs Minister Kris Faafoi has said:

‘There are gaps in the regulation of the sector that are exposing consumers and we are going to address them. We need a regime where banks and insurers are focused on good outcomes for the consumer and are not conflicted by sales rewards’.

Key implications for New Zealand

So what, then, are the key implications for the New Zealand financial services sector?

Culture

An organisation’s culture can either drive misconduct, or discourage it. Cultural problems are generally seen as the root cause of the misconduct identified by the Australian Royal Commission (and, it follows, the lesser issues identified in New Zealand). All financial services businesses should reflect on their culture and ask whether it enhances customer outcomes, or detracts from them.

Culture needs to be led from within, starting with the “tone from the time”, and can’t really be prescribed by law. However, for many the best place to start in understanding expectations will be FMA’s February 2017 good conduct guide.

Governance

One key observation of the Australian Royal Commission is that companies have preferred profits over good customer outcomes. Similar themes emerged from the FMA and RBNZ reviews. Financial returns are important – but they are not the only consideration. Focusing solely on shareholder returns (particularly in the short term) is not necessarily in the best interests of the company, and many did not meet Companies Act directors’ duties: a more holistic approach is required.

Similarly, the clear feedback is that boards haven’t focussed enough on conduct and other non-financial risks. There is a need to review governance and reporting arrangements to ensure that boards receive timely, quality information about the right issues, and that there are clear lines of accountability. Boards also need to be more prepared to challenge management where required.

Remuneration and oversight of intermediaries

Remuneration structures are an easy way to test culture, because they show what an organisation values. The FMA and RBNZ expectation is that banks and life insurers will remove incentives linked to sales for salespeople and their managers, and revise incentive structures through all layers of management. If not, they will need to show how their controls are strong enough to address the risks of poor conduct. Those in other parts of the sector should also consider their arrangements.

Insurers have also been asked to review commission structures and incentives for intermediaries who sell their products. The issues here are much more complicated. Most consumers do not want to pay for advice, so commissions sustain many intermediaries’ businesses.

Unlike in Australia, a full ban on commissions is not on the cards – both FMA and the Government have discounted it, with Kris Faafoi saying he wants to have a “mature consultation”. We still expect some regulation. Regulation of soft commissions and volume-linked incentives seems inevitable, and on balance we also expect some limits on up-front commissions. Regardless of regulation, though, insurers – and others paying commissions and incentives – need to find a way to link their payments to good customer outcomes (and to penalise poor outcomes).

Related to this, there is a need to better oversee intermediaries to ensure good customer outcomes. The lack of oversight and responsibility for sales, advice, and customer outcomes was a particular issue identified in the life insurer report. FMA considers product providers are ultimately responsible for good customer outcomes, even when products are sold by intermediaries.

Product design and legacy products

Finally, we see implications for product design. Focusing on good customer outcomes means ensuring new products offer value, and are designed with a clear target market and outcome in mind. In our experience financial service providers are normally pretty good at this, but there’s always more that can be done. Some examples include better product training, measuring longer-term product outcomes, and considering the position of potentially vulnerable customers.

Legacy products are more difficult. These are products that are no longer offered to new customers, but still held by existing customers. As the market moves on, legacy products’ features and fees can fail to keep up. In one recent example which received media attention, Fisher Funds’ FuturePlan (a legacy product sold by Tower until 2005) charged fees of more than 8% on part of the investment. We see a need for providers to systematically review legacy products, and make changes where they can and should.

Get in touch!

Partner, Nick Summerfield has extensive experience in culture and conduct issues, and he and the financial services team are actively supporting clients across the sector on these issues. If you have any questions, or need assistance in your business, please get in touch.