Since 2009, credit licensees and their representatives have grappled with responsible lending obligations. Following the passage of legislation in response to recommendations of the Royal Commission, mortgage brokers will now also be required to comply with a statutory duty to act in the best interests of consumers.
ASIC announced in May this year that it would defer the commencement date of these reforms until 1 January 2021. However, considering the challenges that faced the financial advice industry as it came to grips with similar reforms, credit licensees and their representatives are likely to need all the preparation time they can get.
Each mortgage broker (whether a credit licensee or a credit representative) will need to understand the new obligations that will apply when they provide credit assistance to consumers. Credit licensees must also separately take steps to ensure their representatives comply with this area of the credit legislation.
The new, new best interests duty
The concept of a best interests duty isn't unfamiliar to the financial services industry. Financial advisers have been subject to a statutory best interests duty since the Future of Financial Advice reforms in 2013. Separate duties to act in the best interests of investors or consumers also apply in other areas of the financial services landscape. However, until recently, there has been no such statutory duty applicable to credit licensees.
The new obligations include not only a best interests duty, but also a duty for mortgage brokers to prioritise the interests of clients over their own.
As already discussed, the new best interests obligations will apply to mortgage brokers. The national credit legislation defines the term 'mortgage broker' to mean a credit licensee or credit representative in the business of providing credit assistance in relation to credit contracts:
- offered by more than one credit provider; and
- that are secured by mortgages over residential property.
The term 'mortgage broker' does not include a credit licensee or representative that performs the obligations or exercises the rights of a credit provider in relation to the majority of those credit contracts.
In practical terms, this means the reforms will not apply to loans officers employed by banks or other lenders, and may not apply to other parties such as mortgage managers (where they step into the shoes of a lender).
Responsible lending: consistent but not sufficient
The national responsible lending regime was intended to encourage prudent lending and set standards of conduct for the industry. So, what are the differences between this new best interests duty and the existing responsible lending obligations? As summarised in ASIC's new Regulatory Guide 273 (RG 273) , responsible lending steps are complementary to, but distinct from, the obligation to act in a client's best interests. As such, complying with the responsible lending laws will not be sufficient to comply with the new best interests obligations. Overall, the reforms impose a higher standard of obligation than the responsible lending obligations.
Mortgage brokers had previously been required to demonstrate that a proposed loan contract was "not unsuitable" for a consumer, taking into account the consumer's objectives and their financial situation. The new best interests duty goes further, by requiring a broker to demonstrate, in a positive sense, that applying for the credit contract would be in the client's best interests. Borrowing from ASIC's guidance on the best interests duty that applies to financial advisers, it is reasonable to ask whether this means that the consumer should be left in a "better off" position as a result of the mortgage broker's recommendations. ASIC's Regulatory Guide on the new obligations does not make any specific reference to the consumer being "better off".
ASIC instead states that in making an assessment as to what is in the consumer's best interests, brokers should prioritise cost or affordability considerations, in addition to other loan features that have a realistic possibility of offering the consumer good value or a "net benefit" relative to other options.
Not surprisingly, RG 273 states that a broker's consideration of the individual circumstances of the consumer and their needs, goals and financial situation is particularly relevant to complying with the obligations. ASIC's guidance highlights that the risk of non-compliance is substantially increased if a broker's processes typically lead to a 'one size fits all' outcome for consumers. As such, it will be critical for brokers to understand what each consumer is trying to achieve, and what product features they value.
The new best interests duty also goes further than the responsible lending regime taking into account ASIC's expectation that mortgage brokers will research and compare a range of credit products. Again, looking at the parallel universe of financial advice, the need to conduct a reasonable investigation into relevant financial products has, in practice, been one of the stickier points of the safe harbour steps set out in section 961B of the Corporations Act. There is no such safe harbour for the best interests duty that now applies to mortgage brokers. As such, it will be up to credit licensees and their representatives to satisfy themselves that they have done everything necessary to comply. We suggest that this should include comparing the licensee's panel of lending products against those in the broader market.
ASIC's guidance also discusses the need for brokers to prioritise the interests of a consumer in the case of a conflict (a new obligation in addition to the ongoing requirement that credit licensees have adequate arrangements in place to ensure clients are not disadvantaged by any conflict that may arise in relation to the credit activities of the licensee or its representatives).
ASIC points out that the conflicts priority rule means that a broker must not recommend a product or service that would entitle the broker (or other relevant parties) to receive higher remuneration unless doing so would also be in the client's best interests. Similarly to its approach in the world of financial advice, ASIC suggests that a broker consider what another broker in the same position but without a conflict of interest would do. One could alternatively ask what Commissioner Hayne would do.
3 things you can do now to get ready
Here are just some of the steps we think licensees will need to take in readiness for the new obligations:
- Reviewing the policies and guidance relied upon by the licensee, and provided to representatives, to ensure these adequately take account of the new obligations. Some of our tips on this:
- We suggest mapping out each of the new obligations and building processes to ensure compliance with each of them, rather than trying to comply with the new obligations by tweaking your responsible lending policies. It may be that the two can be merged after you have done the initial ground work to identify the practical steps required to comply with the new obligations.
- We also suggest including a simplified decision tree for brokers to follow in potentially tricky situations. For example, what should brokers do if they cannot act in the consumer's best interests in providing them with credit assistance? (Answer: decline to provide the credit assistance.) In our experience, financial advisers have benefited from this type of resource in navigating comparable obligations under the Corporations Act.
- Be clear about record keeping requirements. Financial advisers subject to the Corporations Act best interests duty have found out the hard way that if they can't prove that they acted in a client's best interests, ASIC will take the position that they did not.
- Ensuring your monitoring and supervision framework includes relevant checklists for compliance with the new obligations. You may wish to refer to ASIC's guidance, which sets out a list of factors that may need to be considered in an assessment as to whether a particular recommendation was in the client's best interests.
- Reviewing your panel of lenders to ensure the licensee or its representatives will be able to present consumers with loan options that are in their best interests. ASIC's guidance suggests that it expects brokers to have an awareness of the products and features that are available in the broader market, and periodically compare them to their own panel. If you identify any need to make changes, this could take some time.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.