Consumer group Choice came out this week and called for an end to commissions and conflicts. As the US baseball player Yogi Berra once said, it was déjà vu all over again, because while Choice had the mortgage broking industry in its sights on this occasion, its words had a deeply familiar ring to everyone who followed the Future of Financial Advice (FoFA) legislation through its early stages.
“Right now, there is no requirement that a mortgage broker has to act in the interests of the customer by recommending the best or even a good loan,” Choice said.
We’ve heard this tune before.
Choice went on: “We’ve called for urgent action on trail commissions…trail payments are money for jam…the broker makes money for doing nothing, discouraging them from reviewing the quality of a loan long term.”
Isn’t it great when all this stuff is happening to someone else? This is what’s been described as the mortgage broking industry’s own FoFA moment. To those outside the industry, it was inevitable, and it looks like the drive for change in the sector is gathering pace quickly, following the release of a comprehensive report into it by the Australian Securities and Investments Commission (ASIC), published in March. Don’t be surprised to see sections of the broking community mount largely the same defence of the indefensible that parts of the financial planning community did when early iterations of FoFA were formulated.
The reasons for change in mortgage broking are exactly the same as the reasons conflicts were tackled in the financial planning industry the better part of a decade ago. Conflicts are anathema to the fair and ethical treatment of consumers and customers.
Consumers cannot be sure that their broker is acting in their best interests when there are incentives – perhaps hidden, or even just poorly disclosed – for the adviser or broker to act in a particular way. Incentives create conflicts. It is as simple as that.
Compare and contrast
Examining what’s taking place in an industry other than financial planning, albeit a related one (even though they are regulated separately) is illuminating. Mortgage broking differs from financial planning in some respects: a mortgage broker is a one-product-type shop and “advice”, such as it is, is limited to one kind of product (although there may be variations within that product category); and far more people seek out a mortgage each year than seek (and perhaps may ever seek) financial planning advice.
Nevertheless, there are striking similarities as well. A mortgage broker claims to have expertise that exceeds that of the consumer. A mortgage broker will claim to have a wide knowledge of the products available, across a range of suppliers, and the detailed ins and outs of each. And a mortgage broker therefore occupies a position of trust in relation to the consumer. It’s an abuse of that trust for brokers to put their own interests ahead of the customers’.
In a landmark report published in March this year, the Australian Securities and Investments Commission (ASIC) calculated that in 2015 about 54 per cent of all home loans – 520,000 loans – were arranged via broker. Brokers are paid by the institutions whose loan products they sell, and in 2015 they were paid $1.42 billion in upfront commissions on $175 billion of new loans and $984 million in trail commissions on outstanding loan balances of $545 billion.
There are about 15,000 mortgage brokers active in the market, but the details of the market structure – in particular, who owns what – remain slightly muddy. It is known the big banks own broking networks; that’s another parallel with financial planning. This is an issue because as Choice says in its submission to Treasury, NAB-owned mortgage aggregators directed 22 per cent of home loans to NAB-branded or white-labelled loans, even though NAB’s overall home loan market share is 13.2 per cent. CBA has an 80 per cent stake in Aussie Home Loans and received 37.3 per cent of Aussie Home Loans’ mortgage applications, even though CBA’s overall market share is 20.9 per cent.
Even though individual broking businesses may be franchises or owned by their principals – dare we say it, they are ‘independently owned’ – an implication of the ASIC report is that ownership structure alone clearly cannot guarantee there will not be conflicts of interest.
One of the key conflicts of interest that mortgage brokers are believed to be susceptible to is encouraging consumers to take out larger loans than they can easily afford (in extreme cases afford at all) to service. It’s fairly easy to see why that might be the case: if you’re paid a commission based on the size of a loan, there’s an incentive to sell the biggest loan you can. That’s not to say every broker, or even most brokers, will do that, but the incentive exists and with that incentive comes a conflict of interest. It’s in the broker’s financial interest to sell the larger loan and receive more commission, even if it is not in the consumer’s financial interest to take on excessive debt.
If we remove the particulars of this conflict, what we’re talking about, conceptually, is one group of individuals given an incentive to take a particular course of action, irrespective of whether that course is in the best interests of another group of individuals.
And if we substitute asset-based fees as the incentive in that generalisation, and aggregating client assets so that such a fee can be charged as the course of action, then a similar set of conflicts for financial planners is clear.
Why do we keep banging on about asset fees being a conflict? Because aggregating a client’s assets on a platform or in a financial product might not be in their best interests (coincidentally, paying off a mortgage might be a better idea), but because that’s the way the adviser gets paid, that’s a conflict.
FoFA banned asset fees on amounts of money borrowed to invest. Simply, the fee is deemed to be an inappropriate incentive for an adviser to recommend gearing – which is just another way of aggregating client funds.
There can be little doubt that the mortgage broking industry will be better for the elimination of conflicts, just as the financial planning industry is better for the conflicts that have been eliminated in it so far. But financial planning has aspirations to be a profession, and that means taking it to another level. That means getting rid of all conflicts. And that means getting rid of asset fees.
TOPICS: Australian Securities and Investments Commission, CHOICE, conflicts of interest, Future of Financial Advice, mortgage broking