Reporting and Governance

There is a great deal of debate about how to facilitate behavioural change within banks. One way could be to have regulators on site, as ASIC is planning to do in Australia following a spate of banking scandals. But is it the right approach? By Lisa Andersson, head of research at Aktis.

Following the spate of headline-grabbing conduct scandals among Australian banks, the authorities there are now planning to place their own staff inside banks in a bid to drive behavioural change: an understandable move, but can it deliver the desired results? 

For the first time, the Australian regulator, the Australian Securities and Investments Commission (ASIC), is planning to embed a number of staff within the big four Australian banks to improve monitoring of their governance and compliance. This highlights a surprising crisis of trust and confidence that has struck the financial sector – given Australia’s reputation as ‘the Lucky Country’ – marking a new era of direct intervention by the regulator.

There is no doubt that significant change is necessary across Australia’s financial services industry, with the recent allegations ranging from mis-selling to bribery and money-laundering. Aktis data demonstrates that none of Australia’s major banks report direct contact between their boards and ASIC in the past year, and this lack of communication reflects a generally poor level of risk management disclosures, particularly around ethics and conduct policies.

There is a perpetual risk that regulators generally get too close to the industries they regulate. While it is clearly important that regulators need staff who understand the complexities of the industry they seek to regulate, the risk of a ‘revolving door’ between the regulator and the industry is clear: regulators with close industry associations risk compromising their objective judgement when faced with former colleagues, or organisations they consider to be prospective employers.

If we consider the regulators’ recent proposals to place staff within regulated entities in this context, this risk of ‘community contagion’ is heightened. This initiative blurs the boundaries between the decision-makers and those who oversee and challenge that decision-making. It is a traditional governance challenge: the role of the non-executive directors is to question and challenge executive decision-making. But they need to be wary of stepping in and making executive decisions themselves, otherwise their independence and objective stance is lost. Similarly, regulators (and indeed public company investors) need to stay outside the boardroom, and challenge board decision-making, rather than become implicated within it.

It is not difficult to understand why ASIC sees the corporate governance challenges at Australian banks as having become so significant that it needs to change the dynamic entirely. ASIC will hope that the presence of regulatory staff on site who are ready to challenge and question with real immediacy will shift cultures and behaviours, making breaches much less likely. However, there will undoubtedly be questions around the involvement of regulators in decision-making, and which decisions should not be privy to external influence, ultimately determining the new internal boundaries which must be set as a consequence.  

Other examples

There have been a number of global cases of regulators crossing boundaries, creating similar challenges to the clarity of the regulator’s role. The UK’s Prudential Regulatory Authority, for example, has insisted on attending the board meetings of some regulated entities, and this model is being adopted or considered elsewhere. However, everyone recognises that this is a process like quantum physics: the mere fact of observation changes the nature of what happens. Typically, this is done at one board meeting per year, and the regulators ask to see the minutes for the other board meetings, to make sure that the non-executive directors are actively holding management to account.

The boundary between the non-executive directors and management may become clearer through this process but the boundary between the non-executives and the regulator becomes more complex. Board meetings also risk becoming more of a performance, with the introduction of a new audience that expects to be played to.

There is also a danger that non-executive directors start to be considered as instruments of the regulator, and less as business advisers and collaborators. The most effective non-executives already tread this fine line of supporting and advancing the business by challenging as well as encouraging the management team. But there is a risk that regulators might make that line much less easy to tread, and in the process make boards less effective in driving business success.

All of these are known risks, but it is vital that all parties acknowledge and have them at the front of their minds when considering the evolving role of the regulator. At the core of governance lies the idea that individuals must be accountable for their decisions. However, in order for them to be accountable, the decisions must be clearly identifiable as their decisions.

Effecting behavioural change among banks is important, particularly following the recent corporate governance scandals in Australia, but the new behaviours must be good ones. While further regulatory intervention is clearly needed, questions remain around whether ASIC’s plan to physically place staff inside these institutions to monitor governance and legal compliance is in fact the best solution. This is a complex issue that has been, and will undoubtedly continue to be, subject to much debate, and it is of the utmost importance that boundaries are clearly defined from the outset, and that the impact of the new behaviours encouraged are carefully considered and understood prior to implementation.