“There’s a BEAR in there” – The new financial services regime in Australia

I never thought I would be quoting Humphrey B Bear’s theme song as part of a financial services paper but the staff in the federal government have been quite inventive with the acronym for a change to the regulatory regime that potentially has far reaching consequences.  The Banking Executive’s Accountability Regime – Will it be a teddy BEAR – which gives comfort that appropriate prudent decisions will be made? Or a grizzly BEAR – where there is a major impact on governance, management decisions and potentially stifles innovation?

Due to the perception that executives have not been bought to account following a number of banking sector scandals, the government has announced a significant extension to APRA’s powers relating to senior banking executives.  These powers include:

1. A requirement to advise APRA of all senior executive appointments prior to the appointment being made.
2. Enhanced powers to remove and disqualify senior executives and directors.
3. Enhanced conduct standards for senior executives and the ability to apply potentially significant civil penalties to banks that do not follow these standards.
4. Enhanced powers for APRA to review and adjust remuneration policies, including that a minimum proportion of remuneration must be deferred for up to 4 years.

Currently this is to apply to banking only – however, I believe that it will only be a matter of time before it applies across the entire financial services sector in Australia.  Many of the scandals in Australia have related to the insurance and financial planning subsidiaries of the major banks – it would seem odd that if you are an executive of an insurance subsidiary of a bank you would be subject to this regime but if you are an executive in a stand-alone insurer you are not.

The proposed Banking Executive Accountability Regime (BEAR) very much reflects the Approved Persons/Senior Manager regime that currently exists in the United Kingdom. Having just returned to Australia from senior executive positions in the UK I would like to give my personal views from my experience under such a regime.

In the past few years, UK regulators have been placed under significant pressure to ensure that individual executives are qualified to do their roles and are held to account.  They have ramped up their approval process and their oversight of individuals.  In many instances the UK regulator requests full details of the recruitment process (including the full short list of candidates and the rationale for selecting the preferred candidate), interview notes and copies of any psychological tests. The regulators’ criteria are not merely around “fit and proper” but more ambiguous qualities which include gravitas, resilience, cultural fit and so forth – all of which are a matter of judgement and can be affected by unconscious bias.  For a senior role in the UK I was interviewed for almost 4 hours by 11 staff sourced from the regulators. 

What are the potential consequences of this?

• It is becoming increasingly difficult to inject new blood into financial services in the UK as many good senior executives from other sectors recoil at the involvement of the regulators in the recruitment process.
• A significant industry has developed around coaching senior executives to “get through” the approval process
• A refusal by the regulator can be the end of an executive’s career – good and talented people may find that they do not fit in with the regulator’s views around what is needed.
• This process is no guarantee that “bad apples” will not get through (see case study).
• In some specialist areas the regulators’ requirements are creating a severe shortage of people who can carry out specific roles.
• There is a danger that talented senior executives could be excluded from the financial services industry based on perceptions rather than concrete evidence.

In spite of the potential adverse consequences approval of senior executives is a very popular policy.  I still recall mentioning how exhausting the process was at a garden party in our local square and the neighbours all said  “so it should be!” Once in place this sort of regime will be hard to reverse as a result of public perception.

On an on-going basis in the UK the regulators often felt like a phantom member of the executive team or the board.  In many instances the regulator appeared to be an active part of the politics and decision making of a firm.  The regulators often requested draft board papers for review – which in my view is not appropriate. This is classic “moral hazard” – who is to blame if something goes wrong?  Has the regulator become such an intimate part of decisions that they are also to blame for poor outcomes?  Given the implied threat of sanctions has the regulator constrained executives so much that they are unable to make sensible risk based decisions?  Does such a regime stifle innovation?

In spite of an intrusive approval and oversight regime the UK has not been immune from serious financial scandals.  In response to the proposed regime APRA’s Chairman, Wayne Byers stated:

“Most importantly, we do not consider that the measures announced in the budget will fundamentally change APRA’s supervisory philosophy,” he said, adding “their very presence will help us encourage and promote prudent behaviour to begin with”.

This is encouraging, however, given the likely popularity of such a measure amongst the general public, APRA will be expected to use these powers.  It will only take one major scandal to place pressure on APRA to act more forcefully.   

This case study in relation to the Chairman of the Co-Operative Bank in the UK is a case in point. The public will often have expectations beyond the regulators’ powers of investigation.  In the case study cited where the Chairman had drug abuse issues many people were asking – why didn’t the regulator know?  The tabloids were also having a field day – the court of public opinion was placing significant pressure on the regulators.

The regulator also needs to be careful in how this sort of regime is introduced; casual comments by the regulator about executives will have a greater significance than ordinarily, and that could have an adverse impact on people’s careers.  A robust approval process will need to be established so that it is seen to be fair and reasonable and not just based on perceptions.  Additional resources will need to be allocated to implementing and maintaining this sort of regime.      

Given APRA’s current statements bringing the BEAR into the Australian regulatory regime appears to be a relatively benign teddy bear to provide comfort that prudent decisions will be made. However, over time it is likely to bring a fundamental change to regulatory philosophy and may turn out to be a grizzly bear within Australian financial services.

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