Financial services firms urged to improve ethical frameworks

Acting CEO Meegan George said that the findings presented in the interim report are in line with the Governance Institute’s most recent Ethics Index, adding that financial services providers should examine the ethical frameworks (which is different to a code of ethics or conduct) underpinning their future governance models.

“The loss of trust in the banking sector is illustrated by the 2018 Governance Institute Ethics Index — it was the lowest-scoring sector and dropped from -3 to -15 — and is reinforced by the 2018 Deloitte Trust Index, which shows that only 20 per cent of people believe that banks are generally ethical,” Ms George said.

Noting that “conduct is the manifestation of culture”, the acting CEO suggested that an “ethical framework should sit at the heart of a company’s governance structure to serve as a common and authoritative point of reference for all decision makers and give shape to culture”.

The institute suggested in its response that company boards have a role to play in “setting the ‘tone from the top’ and modelling that tone as well as monitoring culture”. This is similar to what the Finance Sector Union claimed in July that one of the prerequisites to improving bank culture is “buy-in” from management.

“Boards must consider how to avoid setting policies, building systems or establishing practices that might drive conduct that is at odds with the declared ethical framework, particularly in the area of remuneration and incentives,” Ms George said.

Once an ethical framework is established and adopted by the company’s board of directors, all aspects of the company should be assessed to ensure that they are aligned with the components of the framework, according to the Governance Institute.

More disclosure won’t help address misconduct

The results of the 2018 Ethics Index indicate that the more a CEO is paid, the more unethical Australians think it is, with 77 per cent expressing their belief that it is unethical for a CEO to be paid $3 million per annum (around 50 times the average Australian’s annual salary).

However, members of the institute believe that increasing disclosure around remuneration is unlikely to assist in addressing financial sector misconduct, with the Governance Institute noting that it has been advocating for simplifying legislative reporting requirements, rather than adding more complexity.

The institute also acknowledged the royal commission’s finding that remuneration and reward practices below executive level can lead to misconduct.

“Incentives and rewards play a powerful role in influencing the values and conduct of individuals, and hence culture, and may have unintended consequences. Research indicates that individuals will seek to do those things that are rewarded, often to the exclusion of activities that are not rewarded,” it said in its response to the royal commission’s interim report.

“This can create cases of folly where the types of behaviour rewarded are those which the organisation is trying to discourage, while the desired behaviour is not rewarded at all.”

Further, changes to frontline staff remuneration will not necessarily be effective in encouraging responsible conduct if their managers are “rewarded by reference to sales or revenue and profit”.

There is the additional problem of the influence of proxy advisers and institutional investors in driving financial metrics for remuneration, the Governance Institute noted.

As such, its members expressed that they would like to see a “wide-ranging conversation on the clarity of the role of the board versus management”.

“Addressing the matters raised by the [royal commission interim report] will require boards and management to work together differently in the future,” the institute stated.

No new regulation proposed

While the institute encourages better enforcement of existing legislation, particularly by the Australian Securities and Investments Commission (ASIC), it noted that it is not proposing the introduction of new laws as reforms are currently underway, in line with the findings of Commissioner Kenneth Hayne.

“Any new individual element of the regulatory landscape needs to be evaluated for its impact on the regulatory ‘whole’ or ‘sum of the parts’,” the Governance Institute stated in its response to the royal commission’s interim report.

“The greatly increased amount of corporate law and governance legislation introduced in recent years has led to significant complexity as well as unintended consequences.”

[Related: A question of ethics]