The long-awaited Final Report of the Royal Commission into misconduct in the Banking, Superannuation, and Financial Services Industry was delivered on 4 February 2019.
The Commission has made many recommendations, which are outlined in general terms in our Limelight of 5 February 2019. This edition of Limelight, however, focuses upon the recommendations made in respect to the home loan mortgage industry, being:
- the criteria to be applied concerning the assessment of suitability or non-suitability of loans and the lending criteria which applies;
- the nature of the relationship between borrowers, lenders, and intermediaries such as mortgage brokers and aggregators;
- the duties which should fall upon mortgage brokers when giving advice to borrowers about the type of loan they should obtain; and
- the nature and type of fees and remuneration to be charged by mortgage brokers, financiers and aggregators.
The response of the Government is yet to be known.
Suitability of Loans and Lending Criteria
Commissioner Hayne focussed upon the current criteria set out in the National Consumer Credit Protection Act 2009 (NCCP Act) and its regulations. His view is that the NCCP Act as it stands generally is adequate, but needs to be properly enforced. The Commissioner made clear that there are obligations on credit licensees firstly to verify and assess an application, and secondly to determine whether a contract is not unsuitable for a borrower. These are different obligations and need to be separately considered by a credit licensee.
The Commissioner did not favour moving from a test of ensuring a loan is not unsuitable, to a test of ensuring the loan is suitable. This is because the former is intended to avoid harm to borrowers, whereas the second looks at the benefit to them. He did not consider the focus should be changed in this way.
The Commissioner considered that the application of the Household Expenditure Measure (HEM) has utility in determining that a loan is not unsuitable where information is lacking. The Commissioner said this HEM bench mark should remain, but its use should reduce because better verification and assessment systems should be used. That is, whilst it should be a fall back position, in time it should be used rarely because better information gathering as to a borrower's circumstances should be pursued.
Relationship Between Brokers, Lenders, Aggregators and Borrowers
The Commissioner sought to make clear that a mortgage broker is the agent of the borrower, and not of the lender or an aggregator. By making the nature of this relationship clear, conflict is avoided.
Mortgage brokers and intermediators should be clearly seen to be the agent of the borrower; whereas aggregators are not so clearly pigeonholed and may remain either in the financier's camp or in the borrower's camp.
The Commissioner has made clear that the loan distribution network established by brokers and aggregators is a very useful network and should be maintained.
Duties of a Mortgage Broker
Regulation of Mortgage Brokers
The Commissioner noted that significant fees are paid over the life of a loan to a mortgage broker. Taking out a home loan is a very significant financial transaction for consumers and borrowers. The nature of the transaction entered into should be properly reflected in the nature of the advice being given by the broker.
Consumers rely on advice provided by mortgage brokers in just the same was as they rely on advice provided by financial advisers. Accordingly, mortgage brokers and financial advisors should be treated and regulated in the same way.
The Commissioner has therefore recommended that, after a transition period, mortgage brokers should be subject to and regulated by the laws that apply to entities providing financial product advice to retail clients. This would bring with it a requirement to provide written Statements of Advice and the educational requirements expected of financial advisors.
The report did not provide a specific framework for how this should be achieved. Perhaps the simplest method would be to change the wording of reg 7.1.06(1)(f) of the Corporations Regulations to include mortgages within the definition of a financial product for the purposes of the Corporations Act. However, the flow on effect of this approach would be that mortgage brokers would need to be authorised under an AFSL rather than an ACL. Alternatively, the NCCP Act and Regulations could be amended to mirror relevant provisions in order to enact a similar regulatory scheme.
Best Interest Obligations
The Commissioner placed special emphasis to the duty–interest conflict as it applies to mortgage brokers and conflicted remuneration.
He noted that, across the industry a "good enough" outcome was pursued instead of the "best interests" of the consumer. This is not sufficient. The Commissioner expressed a belief that conflicts of duty and interest can rarely be managed and that carve-outs and exceptions to best interest duties should be removed where possible.
Mortgage brokers have been excluded from the obligations of best interest under the Corporations Act in the past, but the Commissioner is of the view that this should no longer apply. That is, mortgage brokers who are giving advice to borrowers should have a duty to act in the best interests of the borrowers, similar to the duty placed upon financial planners.
The Commissioner indicated that the content of that duty is best expressed as a broad statement of principle, and could be well expressed as a duty 'to act in the best interests of the consumer/ loan applicant in the selection and arranging of loans'.
Because it is a provision of the same kind and quality as the obligations on holders of an AFSL and holders of an ACL – to do all things necessary to ensure that the licensed activities are engaged in 'efficiently, honestly and fairly'– the best interests obligation should be enforceable by civil penalty.
The duty of best interests which would be placed upon a mortgage broker would not fall upon a financier or upon an aggregator.
Investigation and Reporting Obligations
The Commissioner made several recommendations regarding AFS Licensees' investigation and reporting obligations. These apply equally to mortgage brokers in light of his recommendation that they be subject to the same laws and regulations.
The Commissioner recommended that all ACL holders, as a condition of their licence, should be bound by information-sharing and reporting obligations in respect of mortgage brokers authorised under their licence. These requirements should be substantially similar to the Australian Banking Association's 'Financial Advice – Recruitment and Termination Reference Checking and Information Sharing Protocol' which currently applies to financial advisers.
All ACL holders should be required, as a condition of their licence, to report 'serious compliance concerns' about individual mortgage brokers acting under their licence to ASIC on a quarterly basis.
All ACL holders should be required, as a condition of their licence, to take the following steps when they detect that a mortgage broker acting under their licence has engaged in misconduct in respect of advice given to a retail client (whether by giving inappropriate advice or otherwise):
- make whatever inquiries are reasonably necessary to determine the nature and full extent of the broker's misconduct; and
- where there is sufficient information to suggest that a broker has engaged in misconduct, tell affected clients and remediate those clients promptly.
Duties of Mortgage Aggregators and Lenders
The Commissioner also clarified his expectations with regard to investigation and reporting obligations of lenders and aggregators.
When a lender or aggregator detects that a broker has engaged in misconduct in respect of a particular loan, it should always take steps to assess whether the broker may have acted poorly in respect of other loans.
It is necessary for lenders and aggregators discovering misconduct by a broker to make whatever inquiries are reasonably necessary to determine the nature and full extent of the broker's conduct. Where there is sufficient information to suggest that a broker has acted poorly, any customer affected by that misconduct should be told and remediated promptly.
The Commissioner has made clear his view that payment of trail commission and/or up front commission by the financier is inappropriate and should not continue. No benefit is obtained by a borrower for ongoing payment of a commission. It is money for nothing. This is conflicted remuneration, which affects the ability of brokers to provide the best advice to borrowers.
Trail commissions should be phased out for new loans within 18 months to two years; and any upfront commissions phased out within 18 months to two years thereafter.
The Commissioner was of the view that brokers should be paid by borrowers. In his view, this could be achieved by capitalising those fees into the loan amount. This may be around $5,000. This would increase the amount of the loan but he considers that is reasonable.
The Commissioner did identify that this gives a benefit to financiers who can deal with borrowers directly without the intervention of mortgage brokers. He suggested that the financiers might be forced to charge a fee of some sort to ensure competition remains; but he has not clearly articulated how this would work.
As to aggregators, the Commissioner acknowledged aggregators provide a valuable service in linking financiers with brokers and this should be maintained. He said they should be paid by the borrower, the broker or by the financier depending on the service rendered to each one; and the market should determine these fees. There should be no regulation of how that fee could be charged.
The Commissioner recommended that a Treasury-led working group with members from the ACCC and APRA be established to monitor and adjust the new model where necessary as well as to monitor the activities of aggregators under the new model.
The position of the Government is not yet clear but it is likely that most of the recommendations will be implemented.
The implementation of a duty to act in best interests seems reasonable. The transition in fee structures might be problematic and difficult to action; but should in due course provide a more transparent system. The area of concern, not yet clearly articulated, is how to ensure that competition remains in the industry, and that banks do not obtain an unfair advantage.
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