Broker remuneration, legal standards for brokers and aggregators, disclosure requirements and transparency are just some of the topics the Productivity Commission’s draft report into competition in the Australian financial system calls for further review.
The Productivity Commission’s 640-page draft report — which aims to “review competition in Australia’s financial system with a view to improving consumer outcomes, the productivity and international competitiveness of the financial system and economy more broadly, and supporting ongoing financial system innovation, while balancing financial stability objectives” — was released today (7 February).
The Productivity Commission’s (PC) sizeable document, which includes 25 recommendations for consultation, outlines “notable failings” in competitive behaviour evident in markets of home loans and is looking at potentially recommending a swathe of reforms to the mortgage broking sector.
Looking at the broking sector specifically, the commission voiced concerns over:
• the fact that commission payments made by lenders to aggregators and brokers are “high (compared with other financial services and brokers overseas)”;
• a “lack of awareness” by borrowers about how much their broker is being paid and how the payments are structured;
• a “lack of a legal duty of care” by lender-owned aggregators and the brokers operating under them, which it warned could mean “consumers can be left unaware of better deals available to them”;
• the payment of trail commissions, which the PC claims “creates perverse incentives for mortgage brokers by rewarding them for keeping customers in their existing loan”;
• the inclusion of commission clawbacks which “act as a direct disincentive to consumer switching of home loans”; and
• the vertical integration of brokers which “carries the obvious risk that consumers have an illusion of choice rather than genuine choice in the market” and could mean that “consumers are not given the choice of products that are better for them”.
The draft report reads: “Brokers are not a low-cost option, potentially adding 16 basis points in cost to interest rates. However, surprisingly for such a major-cost item, most lenders were unable to provide the information required to evaluate whether brokers are a lower-cost distribution network. Cost data appears to be a black box for this industry.”
While the PC did suggest that “brokers benefit lenders by allowing them to avoid the fixed costs of branches” and are “clearly beneficial for smaller lenders looking to diversify” (calculating that banks would need to open 118 new branches to generate the equivalent market shares), and while “preliminary analysis suggests that brokers do obtain slightly lower interest rates... it is not clear if this is attributable to brokers’ ability to negotiate with lenders or to other factors such as the characteristics of borrowers who use direct channels to source their loan”.
The draft report continues: “The growth in mortgage brokers and other advisers does not appear to have increased price competition. The revolution is now part of the establishment. Non-transparent fees and trailing commissions, and clear conflicts of interest created by ownership, are inherent.”
“There is likely to be merit in removing trail commissions”
It continues: “Tying mortgage broker remuneration to whether customers remain in the same loan creates perverse incentives for mortgage brokers and is an encumbrance on consumer switching. For this reason, there is likely to be merit in removing trail commissions and commission clawbacks from mortgage broker remuneration structures.
“Alternatively, this conflict of interest could be addressed by imposing upon brokers a legal duty to act in the interests of consumers… This could involve extending that duty to require brokers to continue to act in the interests of their clients so long as they continue to receive commission payments from lenders.”
In fact, the draft report suggests that “serious problems exist with the quality and the reliability of information in the finance sector”, saying that “comparison websites, financial advisers and mortgage brokers do not necessarily solve the information problem. Many consumers consider that financial advisers are too expensive, while mortgage brokers are under no obligation to put the customer’s interest first”.
Productivity Commission chair Peter Harris said: “Lender-owned aggregators and the brokers working under them should always have a clear legal duty to their clients’ best interest.
“This is not a fringe concern — around 70 per cent of broker mortgages are written by lender-owned aggregators.”
Calls for rationale on how brokers are paid
The commission, therefore, is calling for more information from stakeholders on the rationale for the current structure of mortgage broker commissions, as it is “considering making a recommendation to the Australian government on the matter of trail commissions and commission clawbacks”.
It is calling for “feedback on the rationale for how mortgage broker commissions are structured”.
This includes the “contractual or other obligations imposed on brokers in connection with: trail commissions; trail commissions that increase over time; and commission clawback”.
The PC is also questioning whether consumers should pay brokers a fee for service.
It asks for answers to the following questions on the matter:
• Should consumers pay mortgage brokers directly through fees for service (rather than brokers receiving commissions from lenders)?
• What is the likely effect on consumers’ use of brokers and on home loan providers’ ability to source home loans through brokers?
• What is the likely effect on brokers’ incentives to recommend loans to consumers?
The commission is also asking for further information on how obligations on lender-owned aggregators to act in clients’ “best interests” could be imposed and whether such obligations could be imposed under the NCCP, or whether “there is a need for a separate regime for mortgage aggregators and brokers”.
The PC said that it would also look further into why home loans originated by mortgage brokers “have only slightly lower interest rates than those originated through direct channels” and would recommend that ASIC require brokers to have “plain English” discussions with consumers before recommending loans. The discussion must include:
• the types of products offered by different lenders (including white label loans and which lender provides the funding for them) and associated loan features
• the role of mortgage brokers in matching borrowers with home loan providers, including how brokers are limited in their ability to help consumers apply for loans from all lenders because not all lenders are on the aggregator’s panel or the broker is not accredited with a particular lender
• how mortgage brokers are paid (including specific information about their payment arrangements)
• any ownership relationships between lenders and the aggregator, and the requirement for brokers to act in consumers’ interest where an ownership relationship exists.
“Specific details regarding the information provided and the way it is presented should be developed through consumer testing to ensure that consumers understand the information, and the effect of these measures should be reviewed after they have been implemented,” the PC’s draft report reads.
Those wishing to provide a written submission to the PC on the matters listed in the draft report are asked to do so “preferably in electronic format” by 20 March 2018 and/or by attending a public hearing.
Public hearings for this inquiry will be held at the Wesley Conference Centre in Pitt Street, Sydney, on 28 February and 1 March 2018, and at the Rattigan Rooms in Collins Street, Melbourne, on 5–6 March 2018.
The final report will be prepared after further submissions have been received and public hearings have been held and will be forwarded to the Australian government by 1 July 2018.
More to come.
[Related: Calls to revise ‘not unsuitable’ standard]