One of banking royal commissioner Kenneth Hayne’s key recommendations was for mortgage brokers to act in the best interests of the intending borrower when arranging home loans.
The main reason for this recommendation was to bring the law into line with consumer expectations around the role of mortgage brokers.
“Borrowers look to mortgage brokers for advice…and brokers not only give advice about what they think is best for the borrower, they submit the loan application on the borrower’s behalf and…negotiate the terms of the loan for the borrower.”
Under current law, a mortgage that secures obligations under a credit contract is not a financial product, so when mortgage brokers make a recommendation or state an opinion about a mortgage they are not giving financial product advice or personal advice. This exclusion is important: it means brokers are not bound by the best interests duty imposed under Chapter 7 of the Corporations Act. Such a duty may arise under common law or in equity, although this is dependent on the particular circumstances of each case; but for many in the real world, the cost and uncertainty of running litigation to answer this question is simply too high or plainly out of reach. And which brokers are sufficiently on top of the case law to know when the duty applies?
Customer outcomes under the current law
In his Final Report, Mr Hayne cited a 2017 ASIC report which found that broker loans:
- were “reliably associated with higher leverage”, meaning broker customers “have an increased likelihood of falling into arrears, pay down their loans more slowly and on average pay more interest than customers who dealt directly with the bank”; and
- have “a higher incidence of interest-only repayments, have higher debt-to-income levels, higher loan-to-value ratios, and higher incurred interest costs” compared with loans negotiated directly with the bank.
Mr Hayne found that the two main drivers of these poor customer outcomes were value-based commissions (ie. upfront and trailing commissions) and the fact that lenders pay brokers (rather than borrowers paying).
Value-based commissions are ‘conflicted remuneration’
Mr Hayne found that the upfront and trailing commissions received by brokers are forms of conflicted remuneration, i.e. these commissions “are a form of remuneration that can reasonably be expected to influence the choice of mortgage, the amount to be borrowed, and the terms on which the amount is borrowed”.
Mr Hayne referred to earlier findings by the Productivity Commission when he recognised that commission-based broker remuneration became entrenched in the industry simply as a matter of convention, and has “no credible rationale based on consumer interests”, but actually “work[s] against consumer interests”.
This view does not seem to take into account the consumer interest in not having to pay brokerage fees.
Keep in mind that in December 2017, the industry agreed to remove volume-based commissions, where brokers are rewarded for the number of loans placed with a lender.
Mr Hayne’s recommendations
Mr Hayne made a series of recommendations regarding mortgage brokers:
- Mortgage brokers “must act in the best interests of the intending borrower” in connection with home lending (recommendation 1.2)
- “The borrower, not the lender, should pay the mortgage broker” a fee for acting in connection with home lending (and commissions paid by lenders should be phased out over 2-3 years) (recommendation 1.3)
- A Treasury-led working group be established to monitor, and if necessary, adjust the remuneration model referred to in recommendation 1.3, and “any fee that lenders should be required to charge to achieve a level playing field” between banks and brokers, in response to market changes (recommendation 1.4)
- Mortgage brokers should be subject to and regulated by the law that applies to entities providing “financial product advice to retail clients” (after a transition period) (recommendation 1.5)
On 4 February 2019, Treasurer Josh Frydenberg announced that the government intends to ban trailing commission from July 2020, however the government has not accepted a total ban on upfront commissions paid by lenders – Mr Frydenberg said this could decrease competition and strengthen the banks’ position in the home lending market. The federal opposition has indicated that it will adopt all of Mr Hayne’s recommendations.
In the Final Report, Mr Hayne pre-empted some of the arguments against the abolition of broker commissions, citing a Productivity Commission report which found that while the pro-competitive effects of brokers in the market were significant and obvious in the 1990s, they have since declined. Mr Hayne also noted that the cost of using the brokerage service can be capitalised into the loan and repaid over the life of the loan. Mr Hayne said that banks may be required to charge a fee to customers who deal with the bank directly rather than a broker, in order “to create a level playing field between banks and brokers”. This fee should be “no more than the costs incurred by the bank when originating a loan without the assistance of a broker”.
In our view, this last suggestion will be problematic as banks will naturally use their size and position as originator to absorb costs elsewhere in their product and service offering in order to offer borrowers a cheaper loan process than independent brokers could offer. The Treasury-led working group (and perhaps the ACCC) may have its work cut out in “monitoring” this type of behaviour as the market adapts to these changes.
Hayne’s recommendation creates some dilemmas. Will the standalone mortgage broking industry survive? Are legislated price floors a desirable way to keep the broking industry alive? Will consumers face substantially higher upfront transaction costs when acquiring loans?