Kenneth Hayne takes aim at big targets, particularly big banks. But his interim report also hits out hard against the regulators responsible for market behaviour –  good and bad.

The Australian Securities and Investments Commission comes in for particularly astringent criticism as the key organisation supposedly in charge of finding examples of misconduct or illegality in financial services, punishing it as required and preventing it recurring.

In the royal commission’s blunt view, ASIC instead has become an institution too reluctant to litigate, too slow to insist on remedial action, too prone to negotiate rather than denounce and punish and too soft in the penalties it imposes.

This adds up to a pretty comprehensive trashing of the record of former chair of ASIC, Greg Medcraft. Medcraft is currently in Australia on holidays but his new role as director of financing and business affairs at the OECD is based in Paris – out of view if not out of mind as the royal commission trawls through the failings it sees in the “cop on the beat”.

During his tenure, however, Medcraft always strongly defended ASIC’s achievements, especially given financial and legal constraints and the ability of the banks to outwait and outspend a regulator.

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New chair James Shipton is more apologetic and promising change at ASIC while Josh Frydenberg described ASIC’s culture as “unacceptable”. Yet Medcraft’s view won’t have softened despite Hayne’s scepticism. In part, this reflects his frustrations with Canberra’s failure to actually enact more recommendations despite repeated announcements of new measures to improve the regulator’s ability to take effective action.

That includes, for example, failure to pass legislation giving ASIC the ability to ban the sale of dodgy financial products – known as “product intervention” – as recommended by David Murray in the financial services inquiry. Nor does ASIC yet have the promised “directions” power to force banks to speed up negotiations and compensation rather than drag it out.

Such resistance will be diluted by the commission’s “naming and shaming” of such behaviour, particularly with banks desperate to improve tattered reputations.

Question of deterrence

Kenneth Hayne says modest punishments have become "a cost of doing business".
Kenneth Hayne says modest punishments have become “a cost of doing business”.

Illustration Simon Letch

Political and legal reality still means the drama of the commission’s hearings – including systemic failures revealed – won’t be neatly or quickly fixed by yet another series of recommendations, no matter how pithily expressed.

The delays in financial entities reporting breaches and lack of punishment for it may have shocked the public. Yet the wording of the legislation  requires breaches to be “significant or likely to become so” with the timetable only starting after a financial institution becomes “aware” of it. That really is a lawyer’s picnic.

 And while ASIC’s funding has been increased – much of it to be paid for by banks according to new “user pays” rules – the budget of a regulator is far less than banks’ deep pockets.

But is that enough of an excuse for ASIC?

In an interview with The Australian Financial Review last year, Medcraft conceded he had initially been less willing to take enforcement action because he believed people would respond to “engagement”. He quickly realised, he said, this was “incorrect” and that “deterrence works”.

But what sort of deterrence?  Litigation inevitably involves high legal costs, protracted delays and uncertain results. Even if successful, penalties awarded are usually only a small percentage of the possible maximum. This means ASIC takes a big risk, especially given the resources of an organisation that the Abbott government’s first budget cut by 20 per cent.

According to the commission’s interim report, such risk is outweighed by ASIC’s need to demonstrate a credible threat of litigation based on having a much longer list than it does of proceeding to court .

The deterrent effect of this greater willingness to litigate, Hayne argues, would also  be a “sharp spur” to alternative negotiations over liability and compensation as well as acting as more of a deterrent to similar bad behaviour from other financial entities.  

“ASIC’s starting point appears to have been: How can this be resolved by agreement? This cannot be the starting point for a conduct regulator,” he writes in his report.

‘This report is written by lawyers for lawyers to ask for more lawyers’

The finishing point, however, is far less clear.

“This report is written by lawyers for lawyers to ask for more lawyers,” says one industry player. “Relying on the judiciary given the law’s complexity and delays is just out of touch.”

One high-profile example of the legal complications for ASIC is currently playing out with Westpac. An imminent federal court announcement will determine penalties against the bank for being found guilty of “unconscionable conduct” in setting a key benchmark interest rate on four occasions between 2010 and 2012. The fine is likely to be limited given Justice Jonathon Beach didn’t accept ASIC’s central case Westpac was guilty of “market manipulation” over the bank bill swap rate. Both sides immediately claimed vindication.

Rather than risk going to court, the other big three banks had previously settled with ASIC for a total of $125 million in fines while only admitting they had “attempted” to engage in unconscionable conduct.

This hardly looks like a clear-cut win for the regulator despite the years of effort and tens of millions of dollars expended in pursuing the issue. And that counts as success!

This helps explain ASIC’s preference for instead negotiating “enforceable undertakings” or other deals even though such arrangements have been discredited in the commission as taking too long and being too lenient on the banks. This too is now being tested. Another judge faced with a $35 million settlement between ASIC and Westpac over breaches of responsible lending has sent it for review.

Modest punishments usually imposed, according to Hayne, have become “a cost of doing business”, well worth the rewards.

True. But there’s plenty of blame to go round. Dealing with the results will require much more than a belatedly more aggressive regulator. 

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