Governance of mortgage brokers

Background

The ASIC Review of Mortgage Broker Remuneration was released in March 2017. Submissions regarding its findings and recommendations are due this week. This comprehensive review revealed much about the operation of the mortgage market and documented a number of worrisome features.

The mortgage market

Approved Deposit-taking Institutions (ADIs) – banks, building societies and credit unions – pay mortgage brokers a commission to procure and retain business. As commission is only payable for success, the ADIs have shifted from the fixed costs of bank branches and staff to a variable cost structure which has low risk in times of lower sales.

The structure and operation of the mortgage market is very similar to that of the financial advice market prior to the introduction of the Future of Financial Advice (FoFA) reforms.

Individual brokers generally act as representatives of aggregators that hold the necessary credit licence and are responsible for their representatives. The aggregators operate much like a dealer group licensee and provide access to a set of lenders via a panel and also provide systems (platforms) to support the activities of their representatives and to monitor and ensure compliance by those brokers. The major ADI lenders own or have significant shareholdings in many of the bigger aggregators.

Up-front and trail commissions are paid to the aggregators as well as volume bonuses and soft dollar benefits. The aggregators pass a proportion of this remuneration onto the representatives.

Remuneration structures

Unsurprisingly, the issues identified in respect of the remuneration structures of the mortgage market, especially commissions, are strikingly similar to those previously identified with respect to the provision of financial and life insurance advice. These include:

• The levels of commission.
• The payment of trail commissions, in some instances for many years, when no service is being provided by the broker to the consumer.
• Conflicted remuneration in the form of volume and other bonuses.
• Conflicted remuneration in the form of soft dollar payments.
• The capacity of conflicted remuneration to influence product recommendations including the type and size of loan and the choice of lender.

A particularly worrisome issue identified was the capacity of the commission system to bias broker recommendations towards bigger loans and also towards interest only loans – which allow customers to borrow more for the same monthly repayment. This is a bias towards higher risk for the consumer and the banking system.

The system also appears to provide a bias towards specific lenders with evidence provided that lender-controlled aggregators favour that lender.

Commission is paid by lenders to procure and retain business which acts to put the consumer’s interests behind those of the lender. This conflict is an intrinsic feature of the commission mode. It is difficult to see how paying trail commissions without any requirement or need for ongoing service can be in the best interests of consumers.

ASIC has made three proposals for the reform of remuneration structures including improving the commission model, and moving away from volume bonuses and soft dollar payments. Unfortunately, these proposals do not contain any firm recommendations. They simply defer to the Australian Bankers Association review into remuneration structures currently underway. We believe that this is insufficient and that ASIC should have articulated firm principles that it expects to be implemented. In our view the principles and provisions established by the Future of Financial Advice reforms in respect of remuneration, and especially conflicted remuneration, should be the benchmark upon which ASIC should be insisting.

Financial advice

In our opinion, the review has avoided a significant issue and that is the form and quality of advice provided to borrowers. Mortgages are almost always associated with the acquisition of a long-term asset – either directly by purchasing a residential or business property, or indirectly by using collateral in a property to invest in other assets. In conjunction with their collateral asset, mortgages are equivalent to other long term investments and require equivalent advice especially in relation to long term risks. Mortgages are not simple consumer credit products.

We do not consider that brokers can act in the best interests of consumers if mortgages are assessed and advised similarly to consumer credit products with a focus on short term income and expenditure. This is particularly the case given the Review’s finding that brokers and lenders did not make sufficient enquiries into consumers’ expenses.

The lack of formal ‘Know Your Client’ obligations that properly recognise the long-term nature of mortgages is a deficiency that should be remedied. Mortgages are long term financial commitments that impact on all other long term financial plans and need to be recognised as such. Advice regarding the type, structure and term of a mortgage needs to recognise these other long-term financial commitments and aspirations. This is especially the case where the mortgage is used to provide gearing for further investment. To do otherwise would be a failure to serve clients’ best interests.

We believe that consumers’ interests would be best served by reclassifying mortgages as Financial Products in terms of the Corporations Act. This would immediately and definitively address the issues related to the levels of remuneration and the conflicts of remuneration. It would also address the quality of advice, the qualifications of brokers, the oversight and disclosure regime, and the need to act in consumers’ best interests. It would also recognise mortgages for what they are, long-term financial instruments, and not simply consumer credit.

We would also consider outlawing commissions as they create a poor alignment of interests. Mortgage Brokers would be able to charge an establishment fee which could be charged at the time of the transaction. Trail commissions make no sense for consumers – imagine what consumers would think if the real estate agent selling a home received a trail commission on the transaction.

Remuneration would then be transparent and unconflicted and advice would be focused where it should be – on the best long term outcomes for consumers.