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A decade later, the royal commission came to the same conclusion that was reached during the GFC about the impact of conflicted remuneration structures on culture and conduct, a senior official at the Banking and Finance Oath has said.
Speaking at the Governance Institute of Australia’s Governance and Risk Management Forum in Sydney on Tuesday (18 June), Dr John Laker, chair of the Banking and Finance Oath, noted that the financial services royal commission, 10 years later, came to the same conclusion that was reached during the global financial crisis – that is, remuneration structures have been “promoting behaviours and outcomes that were inconsistent with sound risk management and the best interests of customers”.
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“The financial and non-financial incentives of an institution must support its core values and culture. Remuneration arrangements signal the behaviours that an institution values and celebrates,” he said.
“Remuneration outcomes are one of the best leaders to reinforce individual accountability, but incentive structures embrace much more than how employees are compensated. They include how employees are recruited and promoted and how wrongdoers are identified and punished. So, remuneration and other incentives both affect and reflect culture.”
Dr Laker continued: “To make the obvious point, incentives that are linked to sales encourage staff to sell products and tell them that a sale is a good outcome. This can create a conflict of interest between the staff member and the customer, as it is not always in the interest of customers to buy products.”
The Banking and Finance Oath chair reflected on how 18th century philosopher and economist Adam Smith’s notion of the invisible hand had failed to guide society to establishing a “moral marketplace”.
“You could say: ‘Isn't the issue of profit what is meant to drive the market economy? Doesn't acting in one’s self-interest ultimately help to maximise society's welfare?’ Certainly, these motivations have been the moral foundation of markets since Adam Smith's Wealth of Nations gave birth to the notion of the invisible hand,” he said.
“So, in the financial services industry around the globe, Smith's invisible hand doesn't seem to have guided us to [an] inherently moral marketplace. Smith himself acknowledged that free markets needed to be based on certain ethical norms. Trust is one. Another that appears to have gone missing in finance was what Smith called sympathy for others, a recognition that each of us has obligations to the wider society.”
Dr Laker added that this is why commissioner Hayne’s reference to greed and the absence of basic standards of honesty in the final royal commission report is “so telling”.
“Financial industry participants who succumb to these failings appeared not [to] have had a clear sense of professional responsibility or appropriate incentives to behave in ways that would have protected the interests of customers and counterbalance any tendency to greed,” the chair said.
He said company boards have a key role to play in ensuring remuneration and other incentive arrangements “promote ethical behaviour and prudent risk-taking”.
“We know that when they're properly designed, incentive structures can play a significant role by providing staff incentives for good conduct and positive customer outcomes,” Dr Laker added.
He pointed out, however, that remuneration standards are “still evolving and far from settled”.
“There's no one-size-fits-all solution,” he said, adding that rewards for strong performance should not just be based financial metrics, but also cultural and behavioural metrics.
Dr Laker believes there needs to be a greater focus on how customer outcomes have been achieved.
“Factors such as conduct, customer outcomes, assessment against an institution’s values, these help to signal to staff the importance that management places on appropriate conduct,” he said.
“The experience globally suggests that it's much easier for institutions to deal with the ‘what’ rather than ‘how’.”
The chair added that one of the challenges globally is how to address the issue of a high performer who is not meeting the firm's cultural expectations.
“Dealing with high performers who display behaviours that are not acceptable actually requires a degree of board and senior leadership courage,” Dr Laker said.
“Now, APRA has been tasked by the royal commission with developing a stronger framework of regulation and supervision of remuneration. So let's watch this space.”
[Related: Commissions to stay but change is 'constant']
