Post Royal Commission Governance - Part 1

"Regulators don’t care if your board is collegiate or not"

Guests at the Due Governance Post Royal Commission Breakfast this month heard that governance is now facing a seismic shift in standards.  This shift has the potential to be bigger than the aftermath of the collapse of both HIH and Centro.  What is remarkable, is that 2018’s ructions have had nothing to do with collapses, but instead they have had everything to do with organisations who have managed their core businesses profitably, in particular banking. 

This is not really about a failure of banking though. It is a failure of organisational management. And that is as important to a bank as a charity who needs to keep donors on side.

As some background, it’s worthwhile noting that I personally consider myself to be a capitalist.  By which I mean that the providers of capital need to be properly compensated for risking that capital, just as workers need to be properly compensated for supplying their labour.  I therefore take it personally when companies are run in ways that destroy shareholder value.

So how did we get here?

While trust in most institutions, including the traditional media are at an all-time low, every once in a while, the fourth estate finds mass market gold.  In this case, the 2014 Four Corners documentary about CBA 'Banking Bad' led to a senate inquiry which in turn led to calls for a Royal Commission which eventually arrived in 2018.  While the rest as they say may be history, it’s only just the beginning for those responsible for overseeing the management of their company’s.

Somewhat less newsworthy but potentially of more practical importance were two reports issued by APRA in 2018.  The first, APRA’s Prudential Inquiry into CBA is now compulsory reading for all directors and those advising them.  The second, APRA’s Thematic Review into Governance at a mere eight pages is the most succinct.  In this, it’s clear APRA wants to see boards provide an appropriate review and challenge function, but the regulator clearly was disappointed that a broad spectrum of boards did not go far enough with some of the basics such as board performance evaluations. 

APRA also made no attempt to hide their frustration with organisations that follow the black letter of the law, instead of following its spirit and intent.  In other words, these organisations have focused on what they ‘can’ do rather than what they ‘should’ do.

This ‘Can vs Should’ theme is picked up again by APRA when dealing specifically with CBA and again by Commissioner Hayne in his Royal Commission Interim Report. 

Hayne uses the example of the Sedgwick Review to illustrate a case in point:

“In response to the Sedgwick Review, all the major banks have made changes in remuneration practices. All would say that they now assess staff performance according to a ‘balanced scorecard’. But what does this mean? It will be sufficient to explore that question by reference to ANZ and Westpac. That exploration shows that both [banks] continued… to remunerate employees in ways that emphasised profit” – Interim Report

Talk is cheap.  ANZ and Westpac’s relabelling is reminiscent of AMP’s policies which they termed ‘Customer Centric’ but which on examination by the Royal Commissioned appeared to be anything but.

It’s typically a risky manoeuvre to make predictions, and it borders on insanity to publish them online.  However, if I were to make a prediction about a future direction of regulators I would suggest that they will want to see material changes to governance processes and they wont be easily fooled by labelling. 

We have summarised the findings of APRA and Hayne’s interim report below:

It may appear to be a long list, but APRA have done an excellent job by getting to the heart of CBA’s cultural issues so succinctly.  Hayne’s Interim Report points the blame at what he refers to as ‘Greed’.  Emotive stuff, and if you’re an owner of capital a phrase such as this doesn’t really offer any solutions or alternatives.  So let’s unpack APRA’s and the Royal Commission’s findings a little more.

When we look through the long list of issues, we can find a smaller number of recurring themes that are relevant for both board and management.  These are summarised below:

Boards need to:

  • Demonstrate the ‘tone from the top’
  • Provide better oversight to hold management to account and ‘do the right thing’
  • Redefine inputs to remuneration and reconsider the kind of people recruited

Management need to:

  • Increase candour upwardly
  • Reduce reliance on key people

While some of these issues are aimed at management rather than the board, if HIH and Centro taught us anything it is that it doesn’t really matter if your management is at fault, the buck still stops at the board.

Many find it difficult to interpret the ambiguous phrases that Hayne has used such as ‘community standards and expectations’ and ‘do the right thing’.  I have heard the question a number of times “how can we manage to a set of expectations that aren’t written down and are subject to change overnight”?    The next generation of fiduciaries will need to figure out just how to achieve that. 

Commissioner Hayne provides the following black and white list to help get us started:

I think we can even distil this list down to three points:

  1. Obey the law
  2. Ensure your company is selling something that clients are prepared to pay for
  3. Meet your fiduciary duties

These sound easy enough – so why haven’t they been achieved in practice?

In the next Part of this series, we will unpack the causes of organisational failure before offering some positive ways to respond.

- James Dick

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