Medcraft's mission to change the world

Australian Financial Review Apr 12, 2019 12.00am

Justin O'Brien

Professor Justin O’Brien is co-editor with Thomas Clarke of the University of Technology, Sydney, of The Oxford Handbook of the Corporation, published this month by Oxford University Press, and author of the forthcoming Trust, Accountability and Purpose: The Regulation of Corporate Governance, to be published in June by Cambridge University Press.

EXCLUSIVE  It can be somewhat dangerous for an economist to mine a literary masterpiece to frame one of the contentious political debates facing the planet: the future of globalisation. Unperturbed, in 2018 the director-general of the Organisation for Economic Cooperation and Development (OECD), Angel Gurria, turned to Giuseppe Tomasi di Lampedusa’s The Leopard for the most celebrated political advice uttered in modern European literature.

Set in 1860 as the forces of Garibaldi were preparing for an invasion to unify Italy, di Lampedusa has the eponymous Leopard caution his ambitious, if impetuous nephew, Tancredi: "If we want things to stay as they are, we have to change."

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The OECD's Greg Medcraft explains to the Trust Project's Justin O'Brien how the new norms of investing by the likes of BlackRock and State Street have redefined long term value.

Gurria gave the same advice in advance of the  June 7-8, 2018, ministerial meeting of the OECD, the agenda of which was a "reshaping of the foundations of multilateralism for more responsible effective and inclusive outcomes". While Gurria misattributed the advice to the nephew, the quotation retains its essential emotional resonance. Gurria’s point was that while "the global elite are tempted by Tancredi’s tack [and] make superficial changes to avoid upheaval of the order that works so well for some … The truth is this won’t work. We are beyond the quick fixes to address the discontents of the masses."

The engineer chosen to address these defects is Greg Medcraft, now the director of the Directorate of Financial and Enterprise Affairs at the OECD. The former chair of the Australian Securities and Investments Commissionand its international counterpart, the International Organisation of Securities Commissions, he is one of the most influential opinion-formers in global policy design. "If you want to really build trust in business on the deterrence side it is all about making sure that the law-enforcement agencies are equipped with the right resources, staff but also court systems that do deliver the active outcomes that communities expect," he maintains, a defiant justification of his tenure at ASIC.

He now has carriage over three of the OECD’s most important initiatives: the integrity of tax policy through the Base Erosion and Profit Shifting (BEPS) agenda; attempts to curtail corporate corruption of political processes; and, most significantly, a fundamental recalibration of the OECD Principles of Corporate Governance to embed a social licence to operate, thereby specifying the duties and responsibilities as well as the rights of the corporation.

"My view is that some of these companies are too slow to realise how important the issue of the social licence has become. You may get around the regulators, you can avoid the regulators, you may get penalties and just go ‘well, it’s another business expense’. But I think the world is changing. In some ways I am optimistic because the power of social media is empowering those who can drive real change," he argues in an interview conducted from his office in central Paris.

Medcraft was as unlikely a market conduct regulator as he is now chief negotiator of the necessary compromise to address one of the most existential challenges facing corporations and the markets in which they operate. A former securitisation investment banker with no regulatory experience before he joined ASIC in 2008, he is unapologetic and passionate about the need for change.

He will not discuss his time running ASIC explicitly, but he implies the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry's criticism of that period overlooked certain factors. He stresses, for instance, that capital markets can drive change only if oligopolies are broken through competition. In particular, he is critical of the recommendation made in the banking commission's final report to ban mortgage commissions.

"I think that was a bad recommendation of Hayne," he says. "You have to balance competition with consumer protection. Mortgage brokers have brought a lot of value to competition to Australia. [The commission] should be disclosed by the mortgage broker. My broker got me a better rate than my bank.

"This [decision to ban] is absolute rubbish. It is so anti-competitive. I think the existing disclosure regime works very well," he maintains, welcoming the reintroduction of Net Interest Mortgage (NIM) securitisation vehiclesinto the Australian marketplace.

Medcraft appears perplexed by both Hayne’s lack of attention to wholesale markets and appreciation of the limitations facing a regulator operating in an environment where the legislators were aligned with an all-powerful industry.

The chaotic introduction of the future of financial advice reforms was subject to much negative commentary in the inquiry's hearings but the cause of this was unexplored in the final report. (This was  not the case in an important but overlooked issues paper, by Professor Pamela Hanrahan, which concluded that across the sector "... the result is legislation that is labyrinthine. The definitions that mark out the regulatory perimeter are lengthy and often the rules themselves are highly specific and detailed; these are often made in response to relentless industry pressure on governments and regulators to supply black-letter prescriptive rules and guidelines that allow compliance risk to be managed internally by firms using a check-box approach.")

The nexus between misconduct and institutional culture identified by the banking royal commission was, Hayne ruled, the responsibility of the individual corporations involved, concluding: "Entities and individuals acted in the way they did because they could."

Medcraft agrees. "Unfortunately, it is the case that many companies in the world view breaking the law as an economic decision," he laments. He carefully suggests that to blame regulators for this is as misplaced as an over-reliance on courts in absence of substantive penalties and judicial capacity.

"You have to look at this holistically because it is no use giving the regulator more penalty powers if the courts are not equipped to deliver timely and effective results. And I think sometimes you may get the resources and you may get the penalties but if you spend five to seven years in the courts people forget why you took the case on initially. That doesn’t become deterrence, because everyone has moved on.”

He dismisses the normative framework put forward by Hayne – obey the law; do not mislead or deceive; act fairly; provide services that are fit for purpose; deliver services with reasonable care and skill; and when acting for another act in the interests of the other –  as little more than "the application of common sense". He suggests it needs to be accompanied by substantive structural judicial reform.

"If you want to really build trust in business it is all about making sure that the law-enforcement agencies are equipped with the right resources and staff but also [making sure] court systems deliver the active outcomes that communities expect"’ he maintains.

Medcraft has been disappointed by the lack of structural change in the market. "I think it is very important in Australia. Competition, I think, can be a key to good conduct. In very competitive markets where we have true competition people treat their customers fairly. In countries where there is an oligopoly in the banking system, that is a major cause of poor conduct and unfair treatment of customers."

Brake on innovation and competition

This suggests that the concentration of the banking sector has been a brake on both innovation and competition, and the ongoing failure to address it is problematic.

For Medcraft, Australia has yet again missed the opportunity to lead from the front in the role with the recalibration of the ASX Principles of Corporate Governance. Initially the consultative council suggested that a social licence to operate necessitated more granular reporting, in line with the United Kingdom Companies Act.

It was diluted in its final iteration to a form of corporate reputation management, as part of a rear-guard counter-attack against regulatory interference in the setting and reporting of corporate culture spearheaded by the current AMP chairman and former head of the Financial System Inquiry, David Murray.

Medcraft and Murray have locked horns on culture before. This time the former regulator has a much more expansive bully pulpit and the endorsement not only of the OECD and the Financial Stability Board, but some of the most influential institutional investors on the planet, including BlackRock and State Street. And he is prepared to use these, and the research capacity of the OECD, to back up his assertions. It makes for a more powerful case than stated commitment to change.

"I think from a business perspective, it is pretty hard to argue that irresponsible business conduct is a satisfactory business model. So it is an issue of defining what is responsible business conduct," he says.

"From a narrow perspective, this would be to do no harm in your business, in your supply chain, for example. But then there is a broader definition, which I subscribe to, which is that responsible business conduct is about aligning with the expectations of the community.

"The social licence is far more powerful than government or regulators because if you are regarded as unethical, investors stop investing in your shares or Millennials don’t want to join your company, or others don’t want to buy your products any more and you won’t be in business."

This position is consistent with the agenda put forward by Gurria in the 2018 agenda setting out the dilemma facing the contemporary Tancredi of global finance and its regulation: "The tackling of core concerns is long overdue: rising inequalities of income, wealth and opportunities; the growing disconnect between finance and the real economy; mounting divergence in productivity levels between workers, firms and regions, winner-take-most dynamics in many markets; limited progressivity of our tax systems; corruption and capture of politics and institutions by vested interests; lack of transparency and participation by ordinary citizens in decision-making; the soundness of the education and of the values we transmit to future generations."

High levels of distrust

Since then, the problem has metastasised as the politics of populism sweeps across the liberal order. "We know that today there is a high level of distrust by society in business and government and that many of those issues are the root causes of many aspects of distrust. The rise of populism really is an echo of the fact that the community does not trust," says Medcraft, charged with delivering what the OECD suggests is the most ambitious repositioning of corporate and political purpose since the Marshall Plan, in the aftermath of World War Two.

Medcraft’s job is to turn the palliative diagnosis into transformative cure. The instrument of choice is the negotiation of "a new intergenerational social contract to restore the confidence of citizens in their institutions". It is a job that integrates politics and economics, law and morality, duty and responsibility, and it is the centrepiece of the OECD’s new global agenda for the coming year, a process that will culminate with a debate on rewriting the OECD Principles of Corporate Governance, which, in turn, will influence all global stock exchanges, which must reframe their own to remain in compliance.

Medcraft recalls discussing the alignment of long-term investment and responsible conduct in Sydney a decade ago. The debate has moved on, he says.

“I don’t think we need that debate any longer. Long-term investors like BlackRock and State Street are saying long-term value equate to companies thinking about the risks to the environment, their social and their governance issues.”

Now is the time for corporate boards to recognise what fiduciary duty actually means in an increasingly hostile political environment, says Medcraft.

"If you want to build trust then really, today, it is about your social licence and making sure your business is not too far away from what society expects. Otherwise, basically, you won’t have a business, because you won’t have customers, you won’t have employees, and you probably won’t have investors," he argues.

Stewardship duty

The search for yield cannot be allowed to push risk. Directors have a stewardship duty to protect the corporation, even against the interests of short-term investors. Not only the corporation but the industry and the state of the nation and the globe depend on it.

Strange as it may seem, it will be up to Medcraft, the accidental regulator and Teflon-coated survivor, to negotiate and deliver the contract, armed with a copy of The Leopard, and perhaps Machiavelli’s The Prince for backup.