Before the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry sank its teeth into the financial advice industry, it spent two weeks on consumer lending where they inquired into the mortgage broking industry.
The inquiry examined conflicts of interest that can arise when one party (a broker) is acting on behalf of a second party (a borrower) but is paid by a third party (a lender).
Brokers are paid upfront commissions calculated on the initial principal of the loan; and trailing commissions, calculated on the remaining principal and paid each month. Brokers are rewarded more for selling bigger loans, and earn more if loans are paid off over longer terms.
This structure also advantages the lender – so at least lender’s and broker’s interests are aligned. But it potentially disadvantages the client, if it encourages brokers to convince customers to borrow more than they need (or can afford) and encourages them to pay of the loans over longer terms.
However, it is difficult to conclude from complaints data, despite the royal commission’s public hearings and the suggestions of conflicts, that there is widespread dissatisfaction with the actions, conduct and structure of the mortgage broking industry, or even as much dissatisfaction with brokers as with financial planners.
In the 2016-17 financial year the Financial Ombudsman Service (FOS) accepted only nine disputes relating specifically to mortgage brokers. The Credit and Investments Ombudsman (CIO) accepted 96 complaints, for a total of 103.
Contrast that with the FOS data on the financial advice industry, which has more recently been turned over in the royal commission. Over the same period, FOS accepted 524 disputes in relation to financial planners and advisers, and CIO accepted 48, for a total of 572.
A dispute is accepted if a complaint cannot first be resolved by the broker’s or adviser’s internal dispute resolution process, to the satisfaction of the client. And a dispute is only accepted if it falls within the jurisdiction of the external dispute resolution scheme to adjudicate.
There are about 25,400 financial advisers named on the Australian Securities and Investments Commission (ASIC) financial advisers register, and about 16,700 brokers on the ASIC credit representative register.
After weighting each segment for the differences in numbers, CoreData has calculated that financial advisers generate 3.6 times as many complaints as mortgage brokers.
One of these industries has undergone significant legislative reform to remove conflicts of interests – including the removal of commissions, among other things – and the other hasn’t. And the industry that has been “reformed” is the one the continues to produce the greater number of disputes. The Future of Financial Advice (FoFA) reforms came into effect in 2013, notionally to remove conflicts, eliminate commissions and ensure that advisers put consumers’ interests first.
And yet, in the wake of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry there are calls for an overhaul of broking industry regulation to bring it in line with financial advice, specifically around the banning of commissions linked to the size of loans.
A better deal for consumers
Mortgage broking has introduced competition to the home loan market and has reduced prices for customers, as outlined in ASIC Report 516: Review of mortgage broker remuneration.
“From a consumer outcomes perspective, in a well-performing market brokers can help match the needs of the consumer with the right home loan product and lender; navigate the home loan application process, which can be daunting for many consumers; and improve consumer understanding of home loans and financial literacy,” the ASIC report said.
“From a competition perspective, brokers have the potential to play a valuable role in providing a distribution channel for lenders – especially smaller lenders – without their own distribution network (e.g. branches); exert downward pressure on home loan pricing, by forcing lenders to compete more strongly with each other for business.”
And so a dilemma arises: if a system enhances competition and improves consumer outcomes, but simultaneously potentially exposes consumers to conflicts of interest, which should give way?
Is the answer to conflicts to do away with them altogether – for example, remove commissions linked to loan size, and move to flat-fee remuneration – or is it to enhance disclosure, along with a requirement that brokers select a product that is not only “not unsuitable” for the borrower, but actually “suitable”? Or does mortgage broking need its own “FoFA moment”?
Banning commissions totally could damage the broking industry, and thereby undermine competition and place customers in a worse position than they are today.
But whether a perceived or actual conflict of interest is justified or tolerable for the sake of competition is the whole crux of this situation, and the question that the royal commission’s inquiry and the complaints data invites us to consider.