The Value of Finance Brokers and Positive Consumer Outcomes

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1 The Value of Finance Brokers and Positive Consumer Outcomes Date: 8 March Background to this Report 1.1. The finance broking industry has been under the spotlight for a few years now, and in particular since the release of ASIC Report 516 Review of Mortgage Broker Remuneration ( ASIC Rem Review ) in March 2017 and the Sedgwick Report in April In response to these reports, senior members of the industry formed the Combined Industry Forum ( CIF ) to discuss the key findings of the ASIC Rem Review and the Sedgwick Report Membership of the CIF is comprised of industry bodies Mortgage and Finance Association of Australia ( MFAA ) and Finance Brokers Association of Australia ( FBAA ), and various aggregators, lenders and consumer groups. As such, the CIF represents a broad industry membership and stake holding The CIF submitted a report to the Federal Government in November 2017 outlining a series of proposals and timeframes for implementing those proposals that the CIF believes will address the key recommendations made in the ASIC Rem Review and, to a lesser extent, the Sedgwick Report The Australian Government commissioned an independent Productivity Commission to inter alia review competition in Australia s financial system with a view to improving consumer outcomes. The Productivity Commission was to report to the Government, amongst other things, on the nature and degree of competition in the provision of mortgages for households and of credit and financial services for small to medium sized enterprises. The Productivity Commission released a draft report to Government in January Whilst industry in general responded reasonably well to the findings in the ASIC Rem Review, there has been some industry wide objections to aspects of the Sedgwick Report and the draft Productivity Commission Report The CIF has recommended changes to the broker remuneration system to address the issues raised by ASIC in its report and has expressed a commitment to address those issues and to self-regulate The Sedgwick Report has been criticised for making recommendations outside the scope of what it was commissioned to review with regard to broker remuneration. There is also Launch Finance - MANDURAH Phone Fax Unit 1/61 Sutton Street Mandurah WA

2 industry contention that given the Sedgwick Review was commissioned by the Australian Bankers Association ( ABA ), that the report in itself is conflicted The Productivity Commission Report has also been criticised for being poorly researched and not having a complete picture of the extensive services provided by a broker to a consumer when assisting them to apply for, increase or stay in a particular credit contract. 2. Scope of this Report 2.1. The purpose of this report is to highlight some of the shortcomings in the Productivity Commission report and the Sedgwick Review and to offer a more balanced industry accepted view We accept and support the position of the CIF that the industry should work with Government to: Support a co-regulatory approach, and to the extent possible, support industry self-regulation; Have better consumer outcomes at the centre of its approach; Ensure transparency of process for industry participants, government and consumers; Promote competition at all levels of industry; Not aim to change the structure of the industry or unfairly disadvantage any part of the value chain; Promote simple and achievable solutions; Seek solutions that can be applied in all jurisdictions and that take into account the needs of metropolitan, regional and country areas This scope of this report is limited to discussing the value of using a broker in promoting good consumer outcomes and the importance of maintaining a commission-based remuneration structure (including both upfront AND trail commissions). 3. Key Findings from the Industry Reviews 3.1. ASIC Rem Review The ASIC Rem Review acknowledged that Brokers can play an important role in promoting good consumer outcomes and strong competition in the home loan market The ASIC Rem Review also found that in a well-performing market, brokers can help match the needs of the consumer with the right home loan product and lender and improve consumer understanding of home loans and financial literacy. It further stated that having regard to competition, brokers have the potential to play a valuable role in providing a distribution channel for smaller lenders and exert downward pricing on lenders by providing increased market competition One of the key issues identified in the ASIC Rem Review focussed primarily on the manner in which finance brokers are remunerated and in particular the possibility that the current commissions structure could potentially cause a conflict of interest resulting in poor consumer outcomes. Page 2 of 10

3 Other issues identified in the ASIC Rem Review included volume-based commissions, soft dollar benefits, competition in the market being adversely affected by ownership of aggregators by lenders or other key stake holders, governance of the industry and public reporting of key data CIF has sought to adequately address these concerns in its report to Government The Sedgwick Report The Sedgwick Report echoed some of the ASIC Rem Review key issues, in particular with regard to sales volume-based commissions. The report acknowledged that there was not sufficient evidence of significant systematic risks of poor outcomes for customers to support an outright ban on all product-based payments in retail banking. However, went on to say that benchmarks should include a more holistic benchmark including leader development, management skill, culture and governance. This of course relates directly to retail banking staff; however, the report went on to say that banks should adopt the same approach when remunerating brokers The Productivity Commission Report (draft) As part of the scope of the Productivity Commission s investigation into Australia s financial services system, it considered the residential home loan market and the value added (or not) by brokers Specifically, with regard to finance brokers the report raised the following concerns: Home loans originated by finance brokers have only slightly lower interest rates than those originated through proprietary channels The NCCP does not oblige brokers to act in a consumer s best interest, rather they are simply required to recommend a product that is not unsuitable Consumers do not have information about how much brokers are paid by different lenders, meaning they are unable to question when brokers may not be acting in their best interests Brokers commissions are high relative to fees for financial advice (financial advisers are required to act in the client s best interests) Based on consumer surveys, the report noted that consumers identified the following benefits of using a broker: Access to a wider range of loans (though the report overshadowed this with the sentiment that not all brokers are accredited with all lenders) Brokers as a source of advice and expertise Brokers as negotiators The report also considered the benefits to lenders in using brokers: Page 3 of 10

4 Brokers as an alternative distribution channel smaller lenders without a large branch network are able to use the services of brokers to maintain and/or increase their current market share Brokers as a cost saving some lenders assert that using the broker channel is significantly more cost effective than the cost of running a branch, whilst others assert there is little difference. 4. Launch Finance Mandurah Our View 4.1. The Financial Planning Profession The scrutiny that the mortgage broking profession has been under is similar to the scrutiny the financial planning profession underwent following the global financial crisis in Subsequent to that scrutiny, the Future of Financial Advice ( FOFA ) reforms were implemented, and as a result, the financial planning profession underwent significant regulatory reforms. One of which was a requirement to provide advice that is in the best interests of the consumer. This is a highly onerous obligation and one that can be very subjective The legislation regulating the financial planning profession is Chapter 7 of the Corporations Act The Australian Securities and Investments Commission ( ASIC ) is the government body charged with implementing the requirements of Chapter 7 of the Corporations Act and regulating the financial planning profession The legislation regulating the mortgage broking profession is the National Consumer Credit Protection Act 2009 ( NCCP ). This Act is written in very similar language to Chapter 7 of the Corporations Act. ASIC is also the government body appointed to implement the provisions of the NCCP and regulate the mortgage broking industry Given these similarities between the professions, it is unsurprising that the mortgage broking profession has come under similar scrutiny as the financial planning profession. There are however, some key differences that should be highlighted: Subject to the scope of advice requested by a client, a financial planner may handle a client s entire wealth position, including insurances, superannuation, managed investments, debt reduction strategies and estate planning. Ancillary to that, a financial planner may need to consider debt as a means of funding certain recommended strategies, for example borrowing to purchase managed investments A financial planner has to understand a wide scope of different investment products, the costs and the risks associated with those products and whether those products meet the client s stated needs and objectives. Financial products can range in complexity from a Page 4 of 10

5 relatively simple product such as managed investment portfolio to highly complex derivative style products Further to the previous paragraph, a financial planner needs to consider complex areas of law including superannuation law and taxation law. Obviously, the financial planner would not provide professional advice to the client in these areas but needs to have sufficient understanding of these laws to understand how it may impact the recommended financial strategy In circumstances where a financial planner fails to give appropriate advice, dependent upon the complexity and scope of the advice, a client may suffer significant losses which in some cases could be financially catastrophic In contrast, a finance broker deals only with credit. The credit may be a residential mortgage either for owner occupied purposes or investment or it may be for consumer asset finance Whilst there are many different credit products in the market with many difference costs and features, they are all still credit products with a similar aim to facilitate credit to assist the client to achieve their stated goals and objectives The risk profile in providing credit advice to a client is significantly different to the risk profile a financial planner faces when advising a client about their entire wealth portfolio. The risk that an investment may fail entirely, or the risk that the tax effects of a strategy have been misinterpreted are two examples where advice from a financial planner may cause catastrophic loss. Credit advice simply does not have the same risk profile Promoting Good Consumer Outcomes The MFAA recently issued a response to the Productivity Commission s draft report and Launch Finance Mandurah supports that response in its entirety. In particular, we consider the following issues as highlighted by the MFAA in its report to be of key relevance: A broker provides consumers with choice. Bank staff are limited to recommending the products of the particular bank or lender that they are employed by. In contrast, a broker on average will have access to over 20 lenders, through its aggregator, and hundreds of different products A broker provides consumers with personalised and professional service. Broker s also provide consumers with enhanced industry experience and greater relationship continuity. A recent survey conducted by the MFAA of close to 1,000 Page 5 of 10

6 brokers (as referenced in the MFAA Response) found that on average, individual brokers have 11 years experience. This is in stark contrast to bank employees who often have limited experience and staff turnover tends to be quite high, meaning the consumer does not develop an ongoing meaningful relationship with any one staff member at the bank. Brokers provide a different value proposition than the banks, offering greater flexibility to consumers, often working outside of business hours The area of credit is highly regulated and credit products are becoming more and more complex. The MFAA Response re-affirmed ASIC s observation in the ASIC Rem Review by stating that brokers are able to educate and guide their clients through the credit application process, reducing the time and stress associated with applying for credit. Brokers assist their clients to select a credit product that is appropriate for them, having regard to their current financial circumstances and goals Brokers drive competition to the benefit of all consumers, especially those in regional areas where many banks do not have branches. In addition, brokers provide a distribution channel for smaller lenders who do not have the financial capacity to operate a large branch network. Brokers have been able to moderate the dominance of the four major lenders (ANZ, CBA, NAB and Westpac) by making smaller second tier lenders more readily accessible, where clients otherwise would not have had access to them. The MFAA Response identifies that at the end of the March 2017 quarter, the four major banks had a 53% market share in the broker channel but a 73% market share overall (source APRA Quarterly ADI Property Exposures) Consumers are voting with their feet brokers now write 55.7% of all residential mortgages (as at the quarter ending September 2017) with that percentage being closer to 60% in Western Australia. Where a consumer has a more complex situation, for instance self-employed for less than 2 years or perhaps a few issues with their credit history, consumers are seeking the expert assistance of brokers to achieve their credit needs Broker Remuneration The data compiled by ASIC for the ASIC Rem Review did not identify that broker commissions (both upfront and trail) could be linked to systemically driving poor consumer outcomes. ASIC did suggest that the current remuneration model could be improved by moving away from soft dollar benefits, avoiding volume-based incentives and greater disclosure. It did not however, suggest that commissions should be removed altogether The Productivity Commission has suggested that a move to a fee for service would be a more appropriate method of broker remuneration. However, the removal of Page 6 of 10

7 the commission model would have potential consequences unforeseen by the Productivity Commission, as identified in the MFAA Response. These include: Customers who typically cannot afford to pay an upfront fee (first home buyers, for example), could be prevented from securing credit; Customers using the services of a broker would be charged a fee, however those approaching a bank directly, would not. This reduces the broker value proposition and requires brokers to compete with banks on unequal terms; It would hinder competition in the market, as brokers would be a less attractive proposition, thereby making the big four banks once again, more attractive and second tier lenders less accessible; Is unlikely to result in a saving to consumers. Reduced competition, price parity policies between distribution channels and shareholder demands, means that banks are unlikely to pass on the savings from the removal of broker commissions to consumers by reduced interest rates. In contrast, consumers are likely to pay more interest rates remain the same and in circumstances where the consumer uses a broker, they have the additional burden of paying a fee for service The Productivity Commission has also suggested that trail commission creates perverse incentives by rewarding brokers for keeping customers in a loan, thereby discouraging refinancing. This statement fails to take into account the fact that trail is paid on the balance of the loan, which diminishes over time Launch Finance Mandurah echoes the statements made in the MFAA Response that trail commissions support the broker in providing an ongoing service to consumers over the life of the loan. The larger upfront commission reflects the amount of work undertaken to place the consumer in a particular credit product. The smaller trailing commission reflects the work associated with ensuring the loan remains appropriate for the consumer, for example, interest rate reviews, product switches and other ancillary ongoing advice. Removal of trail commission may encourage brokers to recommend client s refinance in circumstances where it is not necessary Trail commission does not restrict or discourage a consumer from refinancing. In circumstances where a consumer does refinance, the trail commission from the old loan is replaced with trail commission from the new loan. The argument put forward by the Productivity Commission that trail commission discourages refinancing is therefore misinformed Payment of trail commissions also encourages brokers to maintain a positive relationship with their clients, to ensure continuity of that income Consumers rely on the ongoing support and advice of their brokers and it is therefore appropriate that brokers should be paid on an ongoing basis. Page 7 of 10

8 The Productivity Commission also suggested that broker commissions are high when compared with other financial services providers and by reference to a UBS report published in 2017, suggested that a broker is paid on average $4,623 commission per loan (upfront and trail combined) compared with $200 to $700 for simple financial advice The MFAA responded to this by performing its own calculations, taking into account the actual amount a broker would receive (net of commissions retained by their aggregator), and calculating trail on the decreasing loan balance over time. The MFAA asserts a broker is paid $3,796 over a four-year term on an average loan amount of $368, It is not clear from the Productivity Commission s report why the work performed on average would be compared to simple financial advice. Additionally, the assertion that simple financial advice would cost between $200 and $700 is not supported by the MoneySmart website to which the report refers The Productivity Commission report notes that broker commission rates are slightly lower than in In 2009, the provisions of the NCCP were enacted, greatly increasing the obligations of brokers. The ongoing scrutiny that the industry has been under means that brokers are being held to an ever-increasing standard. Whilst increasing the standard of the industry is a desirable outcome both from a consumer outcomes perspective, but also for the reputation of the industry as a whole, there has not been a commensurate increase in broker remuneration to reflect the higher workload and obligations The Work We DON T Get Paid For The various industry reviews have focussed on the service brokers provide and how they should be paid for those services. However, a good finance broker does so much more for their clients than simply facilitate credit. Very often, the true intangible value that a finance broker provides to clients is found in the services they provide that they are not paid for At Launch Finance Mandurah, we often meet with clients who are not yet in a position to achieve their financial goals. This may be because they lack the required deposit, or perhaps they have a poor history of paying their bills on time. We will sit with clients and help them develop a budget, depending on their current situation and goals, that is realistic, that they can maintain, and that helps them to begin to show good repayment history and, where relevant, save their deposit This work can be time consuming and it is not work that a finance broker charges for. This work is undertaken with the client s best interests in mind and with a view to helping the client get to a financial position where they can achieve those goals. Note, the Productivity Commission has criticised the industry for not being held to a best interests standard, yet many brokers simply hold themselves to that standard. At this point, we assist the client to source appropriate finance, and once the loan settles, we are Page 8 of 10

9 remunerated via upfront and trail commission. The lead time to get to this point however can be upwards of six months, depending upon the severity of the client s situation. If the client were to seek this advice from a financial planner, they would be charged for it. Furthermore, if a client who needed this type of assistance were to approach a bank directly, they would likely simply have their finance application declined Recently, we assisted a couple who were approaching retirement and were faced with the daunting prospect of losing their home. One of them had been made redundant suddenly, and they very quickly fell behind on their home loan repayments. They were told by the bank that there was nothing they could do to assist. They were referred to Launch Finance Mandurah. We spent hours considering their various options, looking at their budget and trying to find outside of the box solutions. We were able to assist the couple s daughter and her husband to buy the house from them as a favourable purchase. As a result, the couple are able to continue living in their family home and their daughter was able to purchase her first property. The family recently advised that this was an emotionally traumatic time for the couple, and one they may not have survived but for the assistance of their finance broker In another case, a client had existing finance with a non-conforming lender, and due to high interest rates associated with the non-conforming lender, had struggled to make their loan repayments on time, had fallen behind and were facing repossession. We sat with our client and helped them organise their budget, suggested various payment arrangements for outstanding debts and helped them clean up their payment history over the subsequent months. Once they could show a solid repayment history, we were then able to assist them to refinance with a major lender at a much lower interest rate. Whilst we ultimately received commission when they refinanced, there was months of work prior to that to help them get in to a position to be able to do that. Once again, we saved the clients from the harsh reality of losing their home, helped them manage their budget and ultimately save money when they refinanced. 5. Summary 5.1. The Credit Industry is different from the Financial Planning Industry. In response to a review of the credit industry, the CIF was formed, and a considered response submitted to Government. The credit industry is committed to improvement through selfregulation Competition is key to promoting good consumer outcomes. Removing the broker channel would mean the market share of the big four banks would once again dominate, and consumers would struggle to access second tier lenders There is no evidence to support an argument that current broker commission structures systemically promote poor consumer outcomes A move to a fee for service remuneration structure would mean some consumers could not afford to use a broker. Additionally, it would mean that brokers would have to Page 9 of 10

10 compete with banks on an unfair playing field. This would provide the big four with a competitive advantage and could lead to poor consumer outcomes Brokers deserve to be paid for their ongoing support to clients. Trail commission does not prevent or deter brokers from assisting clients to refinance, but simply ensures that brokers are remunerated for the ongoing service they provide. Written by: Steve Milligan and Kirsty Dellow-Pawski Director Operations Manager Launch Finance Pty Ltd Launch Finance Pty Ltd Page 10 of 10