December 2019


FSRC counter-productive for corporate reform

by Resolve editor Kate Tilley

The financial services royal commission (FSRC) may be counter-productive to driving sustainable reform in Australia’s corporate sector.

That’s a view from Wendy Harris, QC, Senior Vice-President of the Victorian Bar, who spoke at the AILA conference in Hobart on managing non-financial risk in a post-FSRC world.

Ms Harris said “I hope I’m wrong”, but FSRC “wasn’t much of a wake-up call to those outside the FS sector and, perhaps, not even to some within that sector”.

The “fervent atmosphere” in which FSRC played out had contributed to the apathetic response from other sections of the economic community. It diminished the findings’ relevance and recommendations to companies, boards and managers outside FS. “It cultivated the perception [of] bad conduct in ‘some other industry’. And, within the FS sector, I suspect it has made many timorous and nervous about how to effect appropriate change in case they get it wrong.”

Ms Harris said corporate Australia had to proactively examine and improve risk management in their own corners.

It was not just a responsibility for board chairs or CEOs. Underwriters should ask:

• Are your insureds critically examining organisational culture and governance?
• Are they taking a robust top-down, bottom-up approach to identifying and managing non-financial risk?
• Are they taking active steps to close the gap between what they say and what they do?

Ms Harris said lawyers, internal and external, had to drive better risk management and positive cultural change through their advice to clients. “We shouldn’t be afraid to challenge established business models and practices in which many [clients] are likely to be invested.”

FSRC showed that organisations should not just ask whether they can do something, but whether they should do something. “The best governed companies are now actively doing that, and using their conception of organisational culture to frame the answer.”

While FSRC’s “gotcha moments were alive and well in the collective consciousness, the meat of its findings” on its core terms of reference were less so.

Ms Harris’s presentation highlighted:

• risk management – especially non-financial risk – is not confined to the FS sector
• organisational culture is central to managing non-financial risk
• culture is not just a buzzword and, while core responsibility for setting and driving culture rests with the board and senior management, maintaining good culture is an organisation-wide concern
• when organisations don’t appreciate those imperatives, and get them right, the ramifications are felt well beyond the entity.

Ms Harris said under-prioritisation of non-financial risks was a FSRC key theme.

The failure to properly manage non-financial risk was at the heart of many systemic and one-off examples where FS entities had transgressed legal norms and community expectations, and had then failed to mitigate against a repeat by demanding accountability, applying appropriate consequence, and strengthening their risk management architecture.

ASIC’s Corporate Governance Taskforce report on Director and officer oversight of non-financial risk identified that failure was not unique to the FS sector. “Under-appreciation and shallow management of risk is endemic,” she said.

The ‘twin peaks’ of culture and governance received substantial airtime in the FSRC hearings and its interim and final reports.

Ms Harris said culture was “the way, in any given organisation, people go about doing what they do”. It was “a reflection of what an entity sees as its purpose and its values. It should influence, identifiably, the way the organisation executes its functions against its purpose and its vision and strategic objectives.

“It should be reflected in the way everyone goes about their job, and makes the decisions and choices their roles entail, from the mail clerk to the CEO, from the delivery driver to the board chair.”

Ms Harris agreed with Commissioner Hayne’s observation that culture “cannot be prescribed or legislated”. He said while proper governance, a healthy culture and accountability are all desired outcomes for a corporation, “they cannot be imposed by rules that say, ‘You must…’ or ‘You may not…’”. Sustainable cultures needed to arise from, and be implanted in, an organisation’s DNA.

Culture was affected by, but not exclusively limited to, an organisation’s governance.

“Culture is what is ‘lived’ by the organisation – not just what is contained in its external marketing or internal ‘values’ statements. And the deficiencies in the culture of many organisations were starkly exposed by a disconnect embedded within this paradigm: quite simply, there was a difference between what organisations said they did (‘we put customers first’) and what they actually did (prioritising profit over good customer outcomes),” Ms Harris said.

A straw poll at the General Counsel Summit in Sydney last May asked the audience whether their corporations had changed the way they did business in any way since FSRC and only 38% said yes.

Ms Harris said the response was astounding and very troubling. It suggested many across Australia’s corporate landscape “perhaps enjoyed FSRC’s voyeuristic flagellation of the FS industry, but viewed its subject matter and outcomes as remote from their own operations and experience”.

Those underwriting conduct risk, including D&O and liability, should be terrified, she said.

“Remote leadership is poor leadership. There is no hope of embedding good corporate culture unless boards, CEOs and senior executives lead by example, demonstrably embodying the values and purpose of the organisation in what they do.”

What can and should be done?

Ms Harris said the first step was diagnosis and critical self-examination. Organisations – large and small, customer facing or not – should give themselves a culture and governance health check.

“All organisations should ask themselves hard questions, such as: ‘How are we embedding, how are we living, an organisational culture which is compliant and value-driven?” she said.

Employees needed to feel comfortable speaking up when they saw something was not right.

Ms Harris said all organisations should ask themselves: Are we encouraging good outcomes and sound risk management?; Are we encouraging a curious and critical mindset when identifying and assessing risk?

The assessment should examine messages about culture being publicly projected and consider internal messages from leadership and middle management.

“Organisational culture will only justify the name if it has enterprise-wide buy-in. In the words of Commissioner Hayne, managing culture is not a ‘one-off event, but a continuous and ongoing effort that must be integrated into day-to-day business operations’. That is only achievable if organisations first do two things: identify the culture they want to ‘live’, then look hard in the mirror to see where they fall short.”

Ms Harris said the second step was better risk management.

Mitigating risks required building the right organisational culture. It also involved boards (in particular):

• obtaining an appropriately deep understanding of the nature of their company’s business
• being sufficiently informed to interrogate and challenge management on the existence of non-financial risks and the way they are addressed
• responding in a mature, principled fashion when those risks materialise.

ASIC used organisational expert Elizabeth Ardazon, from Kiel Advisory, as a consultant on its risk oversight report. She was reported as saying “boards were grappling with important elements of the management and oversight of non-financial risk … and their oversight was less mature than needed”.

Ms Ardazon identified that bad corporate culture wasn’t just an ethical problem; it was likely to lead to poor financial outcomes because of the likelihood the company would run into costly conduct and compliance risk.

Ms Harris said organisational psychology was increasingly being explored as a tool in the context of leadership, decision-making, risk management and operational performance.

“Thinking outside the square to improve culture and behaviour within organisations with material conduct and compliance risk issues is well overdue.”

Ms Harris agreed with Commissioner Hayne’s observation that cultural change required “more than an exercise in box ticking ... proper application demands intellectual drive, honesty and rigour. It demands thought, work and action informed by what has happened in the past, why it happened and what steps are now proposed to prevent its recurrence. Above all, it demands recognition that the primary responsibility for misconduct […] lies with the entities concerned and those who manage and control them”.

Was a Royal Commission the best way to drive change?

Ms Harris said FSRC fostered a much-needed focus on organisational governance, culture and accountability, a recalibration in the minds of many about what was important, and a reassessment of corporate and individual responsibility. It trained the spotlight on poor management of non-financial risk.

But Ms Harris said it was not the best vehicle for driving reform of organisational culture and risk management.

The human cost of the process was too high and was paid not only by those required to give evidence – who in many cases were those who had been called in to fix identified problems – but by, among others, those who had some involvement (however innocent) in the events examined.

“Many will say that you can’t make an omelette without breaking eggs. Doubtless that is true. But what kind of omelette did we actually make?” Ms Harris asked.

With few exceptions, FSRC uncovered nothing new in terms of misconduct. The case studies it examined focused on misconduct, or conduct falling beneath community expectations, which was identified for it, in advance, by the FS entities themselves, and which [often] had already been the subject of regulatory action, litigation, internal reform or public scrutiny.

“These matters were worthy of examination as a platform for broader-based reform. However, the atmosphere in and around FSRC did not conduce to the sort of mature, reasoned debate I think we actually need to get things right.” Ms Harris said.

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