Owning shares in a Big 4 Bank, including Westpac shares, presents the risk of your stock running afoul of regulators. This happened to Westpac (ASX:WBC) and not for the first time. Last week, it was ordered by the Australian Federal Court to pay a penalty of $1.8 million for its involvement in unconscionable conduct during a massive $12 billion interest rate swap transaction in October 2016.
This transaction, the largest of its kind in the history of the Australian financial market, was related to a consortium comprising AustralianSuper and IFM entities, which aimed to acquire a majority stake in Ausgrid from the New South Wales Government.
To be fair, it is a relatively paltry penalty, compared to the $1bn+ fine it copped in 2020 for breaches of AML/CTF laws. However, it begs the question as to whether or not investors should avoid Westpac shares as a consequence.
Just what happened?
The court found Westpac engaged in unethical conduct while carrying out the interest rate swap transaction. Specifically, Westpac was accused of pre-hedging before the transaction, a practice involving trading to hedge anticipated risks ahead of a potential deal. This pre-hedging behaviour raised significant ethical concerns and exposed the client, and the consortium, to substantial risks.
ASIC Deputy Chair Sarah Court did not mince words in her statement post the ruling, declaring that Westpac’s behaviour was “unconscionable” in this case. The bank’s actions were deemed unfair and unethical, particularly when compared to the practices of several other financial institutions. This verdict underscores the importance of ethical conduct in high-stakes financial transactions.
The court found that Westpac engaged in significant trading of interest rate derivatives before executing the swap transaction. What makes this particularly problematic is that the bank did so without obtaining client consent or providing full disclosure. This lack of transparency had adverse consequences for the consortium, as even a slight increase in the price of the swap transaction resulted in substantial additional costs, amounting to $4.7 million for every basis point increase.
On the day of the swap, Westpac’s derivatives trading desk reaped substantial profits, totalling approximately $20.7 million. In a move that adds another layer of concern, $3.7 million of these profits were allocated as commission to the Sales team. This raises questions about the bank’s priorities and the ethics of such a commission structure.
In light of Westpac’s unethical conduct, the Australian Federal Court is contemplating the imposition of a compliance program on the bank. This program would include an independent review of Westpac’s pre-hedging practices, aiming to ensure that such behaviour does not recur in the future.
Westpac’s Regulatory History
It’s worth noting that this is not the first time Westpac has faced regulatory penalties. The bank has a history of compliance lapses and regulatory fines. Let’s go back to the Royal Commission into Banking and Financial Services. Investors may appear it got off lightly. By mid-2019, none of its executives had been ousted, it wasn’t nudged into selling its wealth business.
At the end of the year, it got hit with a civil lawsuit by AUSTRAC, accusing it of breaching AML/CTF laws a modest 23 million times between 2013 and 2019, covering over $11bn in payments. And then boss Brian Hartzer did fall on his sword. In September 2020, the bank copped a $1.3bn fine.
In late 2021, Westpac was ordered to pay a substantial penalty of AU$113 million (approximately US$82.9 million) due to compliance failures across various divisions of the bank and agreed to pay $80m in remediation to customers who had been wrongly charged fees – including fees charged to dead people, multiple insurance charges for the same property. The bank also charged $12m in illegal commissions and on-sold debts to collectors at rates higher than it was allowed to charge.
In September 2023, ASIC accused Westpac of not adhering to the mandated 21-day response period for customer hardship notices, impacting 229 customers over seven years and worsening their financial difficulties.
In this context, what does the $1.8 million penalty imposed on Westpac mean? Obviously the bank is not going out of business. But it does point to systemic issues within the organization no matter how many times the bank’s PR department may assert to the contrary.
So should I avoid Westpac shares?
In our view, yes. We are not suggesting they are the only ‘Big Bad Wolf’ and the other 3 Big Banks are ‘Goody Two Shoes’. Other Big Banks have copped fines for regulatory breaches in the past – none emerged unscathed from the Royal Commission.
Nonetheless, no other Big 4 Bank has copped as many penalties in recent years as Westpac and points to systemic issues in the organisation that do not appear to have been resolved.
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