Many will say that enacting the obligation and then seeing how it operates in practice is all that should now be done in connection with intermediated home lending. It will be argued that to do more than this would be needlessly disruptive. In particular, it will be said that it will diminish the competitive benefits that broker intermediation has introduced into the home loan market by allowing more effective competition from the small to medium lenders whose branch networks are not as extensive as those of the four biggest banks. A further point, made by Mr Shayne Elliott, the CEO of ANZ, was that moving to borrowers paying brokers a fee for service may penalise smaller borrowers because, for them, it would be uneconomic to go to a broker.[1]
Three points must be considered.
First, the present system of remunerating mortgage brokers is conflicted remuneration. It can reasonably be expected to influence the broker’s recommendations about choice of lender, amount to be borrowed, and terms on which the amount is borrowed. And the influence is in favour of the party paying the commission – that is, the lender.[2]
Second, as already noted, a borrower who engages a mortgage broker looks to the broker for advice. The advice the borrower wants is what the broker thinks will be best for the borrower. And, if there is scope for negotiation with the lender, the borrower wants the broker to strike the deal that is best for the borrower. In all these activities, the borrower rightly wants and expects the broker’s undivided loyalty. Yet, as has been noted in the introduction to this Report and will be developed in the chapter about financial advice, all too often advisers have preferred their own interests against the interests over clients, despite having an obligation to pursue the best interests of their clients. The evidence given to the Commission showed how often those retained to give financial advice to a client resolved conflicts between their duty to the client and their interests (or the interests of some related entity) in favour of their own financial interests or those of the entity they represent, and against the interests of the client. Advisers facing a conflict between self-interest and duty have too often sought to strike some compromise between the two competing forces rather than, as the law has required, to give priority to the interests of the client or member. That is, a ‘good enough’ outcome has been pursued instead of the best interests of the relevant clients or members. The short answer is: duties do not always overcome human biases, particularly when those biases are subconscious.[3]
All this being so, why would mortgage brokers behave differently? Furthermore, in the face of experience of how the Future of Financial Advice (FoFA) reforms have operated, how can it be said that prescribing a best interests duty by itself will have the desired effect?
Third, it is said that changing to a system where the borrower, not the lender, pays the broker would reduce the number of borrowers using brokers. It is said that abolishing trail commissions would adversely affect the profitability, and thus the viability, of brokerage businesses. In either event, it is said that brokers will go out of business and the competitive pressures that the broker channel introduces into the home lending market will be diminished. In particular, it is said that this will happen because smaller lenders rely on brokers to compete.
There are at least three unspoken premises for these arguments. First, the arguments assume that borrowers do not see, and will not see, enough advantage in using a broker if the remuneration arrangements change in a way that makes the cost of the service apparent, and charge that cost to the borrower. That is, the borrower will not be able to see that the benefit of using a broker outweighs the cost. The Commission was repeatedly told that borrowers like using the services of brokers.[4] At present, in addition to purporting to act for borrowers, brokers are providing a distribution service to lenders and being paid commission by lenders. It would seem to follow that the price paid to brokers reflects the value to the lender of the distribution service provided to the lender rather than the value of the service provided by a broker to the borrower. If borrowers pay a transparent price for the service provided to them then the market will determine that price based on the value of the service to borrowers.
Second, each argument appears to assume that the cost of using the brokerage service cannot be capitalised in the loan and repaid over the life of the loan. The cost that would be capitalised (even if calculated as the amount now paid as upfront commission plus a net present value of the likely income stream from trail commission) would be but a fraction of the amount most borrowers would borrow and would not be an amount likely to affect serviceability requirements or calculations.
Third, the argument assumes that mortgage brokers are contributing significantly to competition in the home loan market. Recent reports raise doubts about this assumption. The Productivity Commission found that while the pro-competitive effects of brokers in the market were significant and obvious in the 1990s, they have since declined.[5] ASIC’s report concluded that brokers have the potential to play a valuable role as a distribution channel for lenders without a branch network and thus exert downward pressure on home loan pricing by forcing lenders to compete more strongly with each other for business.[6] But ASIC found that remuneration and ownership structures can inhibit the consumer and competition benefits that can be achieved by brokers.[7] ASIC also observed that smaller lenders were less able to access or remunerate brokers than larger lenders.[8] Rather than competing on the basis of who is offering the best product at the best price, lenders are competing on the basis of who can offer higher commissions to aggregators and brokers. And the Australian Competition and Consumer Commission (the ACCC)’s inquiry into Residential Mortgage Pricing found that, while some of the seven non-major banks that were considered have a heavy reliance on brokers and aggregators to gain market share,[9] the big four banks focus largely on each other in setting variable interest rates for their main brands and do not appear to have meaningful regard to the pricing decisions of smaller lenders.[10] What is clear from the review is that there are challenges to competition in the home loan market that go beyond distribution.
So long as brokers are seen by borrowers to be acting on their behalf, the problem that present remuneration arrangements are conflicted remains unsolved by the remuneration changes proposed by the CIF.
I therefore recommend steady but deliberate movement towards changing the existing remuneration arrangements for brokers, so that the borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending.
Changes in brokers’ remuneration should be made over a period of two or three years. I would begin with trail commissions. There should come a time within about 12 or 18 months (no greater precision is possible) when lenders are prohibited from paying trail commission to mortgage brokers in respect of new loans. Existing trail commissions would stand unaffected. No doubt, as Mr Robert Johanson, the Chair of Bendigo and Adelaide Bank, emphasised, it would be necessary to distinguish between trail commissions and the revenue–sharing arrangements that Bendigo makes with its community-owned outlets.[11] It is and should remain a matter for the lender to determine whether it shares the revenue it receives from the borrower with another party. But trail commissions are not a share of revenue earned by the lender.
Within a further 12 to 18 month period, lenders should be prohibited from paying any other commissions to mortgage brokers. Lest there be any doubt about it, my intention would be that the fee payable to a broker in respect of advising about, procuring or negotiating loans after that date would be payable by the borrower, and, if the lender agrees, could be paid out of the principal sum advanced to the borrower under the loan agreement. How the fee is fixed is best left to the market to determine. It could be a fixed amount, a stepped fee, a value–based fee or some combination.
When mortgage brokers are no longer paid by lenders, it may well be that lenders dealing directly with borrowers should be required to charge a fee to recover the costs that would be avoided if the loan were to be originated through a broker, but which are incurred if originated directly. This would be in order to prevent lenders competing unfairly with brokers. I explain this fee further below.
As noted above, CBA assumed in its internal deliberations that the fee charged by a broker on an average loan was about $6,600 and would reduce to around $2,310, in line with the market guidance on the price for complex financial advice.[12] (The assumed rate of commission was 0.6 to 0.7% of loan value.) It should not be assumed, however, that the upfront fee will necessarily be regressive and work to the disadvantage of borrowers of smaller amounts. ANZ’s modelling concluded this would happen because if the upfront commission presently paid was paid by the borrower as a flat fee, the cost to the borrower would be higher for any loan less than $419,000 (approximately).[13] This was based on ANZ’s current commission rate of around 0.55% and a hypothetical flat fee of $2,302. But this ignores the fact that brokers currently provide their services in respect of smaller loans for an upfront payment that is, on average, significantly less than $2,302. Based on ANZ’s figures, brokers earned around $550 upfront for a loan of $100,000. In any case, this figure reflects the value of the broker to the lender as distributor. It does not reflect the value of the service to the borrower.
Changes of the kind that I have described above were introduced in the Netherlands in 2013. The mortgage broking industry continued without significant adverse consequences to its own operations, the market generally or individual participants. Mortgage brokers offered different remuneration arrangements including charging an hourly rate for advice and flat fees.[14] Furthermore, to ‘create a level playing field’ between direct and intermediated lending, lenders were required to identify their costs of providing advice and other services to borrowers who did not use a broker and expressly charge a fee to recover those costs from those borrowers.[15]
There is, therefore, readily available experience to be drawn on to move to a mortgage broking system where borrowers who choose to use a broker pay the broker a fee for the service. The result would be that within a period of two to three years brokers would no longer receive conflicted remuneration. No longer would the remuneration arrangements within the industry be such as can reasonably be expected to influence the choice of lender, the amount to be borrowed, or the terms on which the amount is borrowed.
Changes of the kind I propose will give brokers the incentive to give borrowers value for money. In particular, the changes will induce brokers to search out the best deals available. To do that, they will have to look beyond the entities with which they may have become accustomed to dealing. And brokers will also have the incentive to offer, or continue to offer, services that borrowers cannot derive from the direct lending channel and for which borrowers are willing to pay.
I acknowledge that the changes I propose are significant. They are responsive to the current state of the residential mortgage market. But the residential mortgage market is constantly changing and will change further as a result of what I have proposed. It is important that adjustments can be made as the market continues to evolve.
A Treasury-led working group should be established to monitor the changes and make adjustments as necessary. That group should include representatives of the ACCC and APRA. The working group should pay particular attention to:
- the effect of the changes on interest rates;
- the effect of the changes on competition between lenders;
- the effect of the changes on competition between lenders and brokers; and
- developments in the residential mortgage market that mean that the changes that I have proposed should be re-evaluated.
As I have indicated, it may be that to create a level playing field between banks and brokers, banks should be required to charge a fee to direct customers based on the costs that are incurred by the bank when there is no broker. I recognise that suggesting that banks charge an additional fee will be difficult for some to understand. But, if brokers are to charge a fee for their services, then it may be necessary for the purposes of maintaining competition, for banks also to be required to do so when directly originating a loan. The fee should reflect no more than the costs incurred by the bank when originating a loan without the assistance of a broker. If only brokers end up charging a fee, customers may cease to use their services, which would eliminate any potential benefit that brokers can have on competition in the residential mortgage market. Both the fee charged by the broker and the fee charged by the bank should be able to be capitalised into the loan.
Although I have explained what I think may well be necessary in order to create a level playing field, this is a matter that ought to be considered by the Treasury-led working group and should form part of their consideration of the effect of the changes on competition between lenders and brokers.
Assuming that such a fee is required, the Treasury-led working group or the ACCC should be responsible for monitoring the fees set by banks and ensuring that they charge no more than the additional cost to the bank of making a loan to the borrower through its proprietary lending channel rather than through a broker.
I expect that new forms of intermediation will emerge in the home lending market. For example, I expect that comparison and transaction sites of the kind now so familiar in connection with travel and accommodation may become more common. The ACCC’s survey of residential mortgage borrowers found an increase in borrower preferences for online residential mortgage applications, suggesting that online originations may become more important in future.[16] As I have said above, as these changes occur in the market, it will be for the working group to assess whether the new model requires adjustment.
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Recommendation 1.3 – Mortgage broker remuneration The borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending. Changes in brokers’ remuneration should be made over a period of two or three years, by first prohibiting lenders from paying trail commission to mortgage brokers in respect of new loans, then prohibiting lenders from paying other commissions to mortgage brokers. Recommendation 1.4 – Establishment of working group A Treasury-led working group should be established to monitor and, if necessary, adjust the remuneration model referred to in Recommendation 1.3, and any fee that lenders should be required to charge to achieve a level playing field, in response to market changes. |
[1]Transcript, Shayne Elliott, 29 November 2018, 7339–41.
[2]Productivity Commission, Report 89, 29 June 2018, 323.
[3]See Sunita Sah, FSRC Research Paper: Conflicts of Interest and Disclosure, 7 November 2018, 6.
[4]Transcript, Matthew Comyn, 19 November 2018, 6560–1; Exhibit 7.121, Witness statement of Shayne Elliott, 16 November 2018, 24 [147]; MFAA, Interim Report Submission, 5; Loan Market Group, Interim Report Submission, 6–7.
[5]Productivity Commission, Report 89, 29 June 2018, 301.
[6]ASIC, Report 516, 16 March 2017, 9 [22].
[7]ASIC, Report 516, 16 March 2017, 9 [23].
[8]ASIC, Report 516, 16 March 2017, 17 [72].
[9]ACCC, Residential Mortgage Price Inquiry Final Report, November 2018, 10.
[10]ACCC, Residential Mortgage Price Inquiry Interim Report, March 2018, 28. That finding appears undisturbed by the findings in the ACCC’s Final Report: ACCC, Residential Mortgage Price Inquiry Final Report, November 2018, 50.
[11]Transcript, Robert Johanson, 29 November 2018, 7381.
[12]Exhibit 7.15, 12 April 2017, Emails Comyn to Narev, 3 [4.3.1].
[13]Exhibit 7.158, 7 December 2018, Letter from Shayne Elliott to Commissioner Hayne, 1.
[14]ASIC, Report 516, 16 March 2017, 45 [222].
[15]See Background Paper No 30, 25.
[16] ACCC, Residential Mortgage Price Inquiry Final Report, November 2018, 58.