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The Hayne Royal Commission, Final Report

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Kenneth Hayne

If I were a conspiracy theorist I’d suggest that the Royal Commission’s Final Report into Misconduct in the Banking, Superannuation and Financial Services Industry and the associated recommendations as they apply to mortgage brokers were preordained well before any report was published. Perhaps there’s offshore numbered bank accounts that might help us make sense of the report because the industry-destroying recommendations are the fictional works of a man that was likely influenced by big-bank relationships. How else can we explain it?

In the last couple of months we’ve seen borrowers flock to mortgage brokers in every-increasing numbers (over 60%). Anecdotally, these higher numbers are a result of tighter big-bank lending criteria that has led to more borrowers seeking the support of brokers who have a vast product knowledge and lender network required to facilitate a suitable product. What we’re seeing proves the value of brokers beyond any doubt.

To be clear, eliminating brokers from the industry removes easy access to smaller banks, higher-risk, and other second or third-tier lenders. If the broker network can’t support these banks and products the suppliers will be compelled to invest more into marketing meaning that interest rates and fees will increase as a result. The assertion that eliminating broker channels or diminishing industry authority will have a positive effect on competition is simply false. The net result of devaluing broking services means more profits for the banks that will not translate into positive consumer outcomes.

The notion of ‘Best Interest Duty’ repeats itself over and over in the report as it relates to financial practitioners in such a way that it implies the majority of brokers (and financial advisers) are not acting in the best interests of their clients… and nothing is further from the truth. The number of pages dedicated to the concept simply serves to justify the reports flawed outcomes based on the biased and limited evidence presented to the Commission. One of the findings from the Interim Report that supports the discontinuing of volume-based bonuses or trail is “the vastly different customer outcomes between brokers and banks”. Three points were made in the Interim report on page 60 that serves to diminish the value of brokers and support the Final Report’s conclusions; most notable is the point that states “over time, higher leverage means 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”. If this analysis was indeed correct (as we initially believed) we should first evaluate the cause (or facts) before blindly accepting the conclusion. Any statement of magnitude or consequence must to be backed by rationalised data. If our own limited investigation hold truth then brokers will see a higher default rate only because they inherit a far higher percentage of higher risk loans – including those borrowers that previously sough guidance from the big banks. Carl Sagan once said that “extraordinary claims require extraordinary evidence”… and we’re yet to see any real evidence supporting the Commission’s conclusions as they relate to the broking industry.

… a borrower who engages a mortgage broker looks to the broker for advice. The advice the borrower wants is what the broker thinks will be best for the borrower. And, if there is scope for negotiation with the lender, the borrower wants the broker to strike the deal that is best for the borrower. In all these activities, the borrower rightly wants and expects the broker’s undivided loyalty. Yet, as has been noted in the introduction to this Report and will be developed in the chapter about financial advice, all too often advisers have preferred their own interests against the interests over clients, despite having an obligation to pursue the best interests of their clients. The evidence given to the Commission showed how often those retained to give financial advice to a client resolved conflicts between their duty to the client and their interests (or the interests of some related entity) in favour of their own financial interests or those of the entity they represent, and against the interests of the client (Volume 1, page 74).

If Hayne was making determinations based on the evidence presented before the Commission then it’s expected that he would land on flawed conclusions; the Commission’s role, after all, was to investigate misconduct – not happy endings. If you were to investigate global aviation safety on the basis of the experiences in Indonesia then you’ll also find yourself confronted with terrifying yet erroneous results. Any analysis has to be determined based upon a pool of data that reflects a broad and current snapshot of the entire industry – not just the isolated cases of malfeasance. This wasn’t done.

If general industry representatives were permitted to speak at the Commission, or indeed they were better represented by those that did, the numerous claims of misconduct by Hayne could be countered with thousands of arguments that have applied in the case of virtually every lending transaction. Brokers are the last line of defence against banking greed and they are a necessary layer of abstraction required to keep the industry honest. To suggest brokers have the opposite effect is more evidence that Hayne was under the influence of of bias or a ‘higher authority’ when scribbling his work of fiction.

Of the 76 recommendations made by the Commission many are entirely justified. However, those that relate to the brokering industry are objectively flawed. If the mortgage broker recommendations are acted upon as written the broking industry will cease to exist as a mechanism to apply pressure on the banks to keep the mortgage industry competitive.

The Treasury’s was quick to respond with indications that they’ll likely act upon the 76 recommendations made by the report. Those points that are most relevant (from the Government’s response, page 3) are as follows:

  • requiring mortgage brokers to act in the best interests of borrowers;
  • removing conflicts of interest between brokers and consumers by banning trail commissions and other inappropriate forms of lender-paid commissions on new loans from 1 July 2020 with a further review in three years on the implications of removing upfront commissions and moving to a borrower pays remuneration structure;
  • ending the grandfathering of the conflicted remuneration provisions effective from 1 January 2021 and, in addition to the Royal Commission’s recommendation, requiring that any grandfathered conflicted remuneration at this date be rebated to clients;

The broking Best Interests duty is one that has long applied, and the commercial implication of operating in any manner other than in the best interests of the borrower isn’t conducive to a successful or sustainable business. In nearly 15 years of working with brokers I can categorically state that the implied ‘broker-first’ pandemic is patently false and misleading. The Government and big banks are using the wayward behaviour of a tiny percentage of brokers as a human shield against their own incompetence and high-level criminal conduct. Simply put, the report is using brokers and financial advisers as a punching bag to justify handing back profits back to the big banks (their share price skyrocketed the day after the report). Again, if one was to question the findings, one might conclude that while banks didn’t escape their fair of scrutiny, they were likely contributing authors.

While bigger bank support is generally easy to source, smaller banks (particularly those without a branch presence) rely on the broker network to provide and support those highly competitive products. The trail commission is a kind of ‘deferred payment’ for acting as a branch representative and is provided on the basis that brokers will make themselves available for support long after loan is written. If the client should choose to move their mortgage elsewhere the trail ceases to be paid… and in most cases a clawback applies (within a certain timeframe – usually around two years) meaning that the broker will lose their initial commission. This commercial obligation to provide support justifies the trail and provides inward pressure on brokers to provide exceptional ongoing service. This is an area where our brokers excel and achieve industry-leading referral numbers as a result. However, it’s also an area where we consistently identify brokers generally performing poorly.

To suggest, as Hayne did, that trail is “money for nothing” is absurd (volume 1, page 70). The comment echoes the sentiments of Commonwealth Bank CEO Matt Comyn who in November 2018 remarked with a smirk that trail was provided despite brokers providing limited ongoing service to the borrower. “Limited or none?” Commissioner Ken Hayne asked. “Much closer to none,” Comyn replied. “I’ll take that as none.” Comyn’s goals were clear: to decimate the marketplace that is enabling lenders to compete with CBA.

Why should a broker, whose work is complete when the loan is arranged, continue to benefit from the loan for years to come? It cannot be that they are deferred payment of fees earned earlier when the amount paid as trail depends upon the length of the life of the loan. And it cannot be that they are a fee for providing continuing services given there is no obligation for the broker to do so and no evidence of it being done (Volume 1, page 70).

The distorted and subjective assertion that a loan is complete once written is indication in itself that Hayne has no comprehension whatsoever of what it takes to provide a good broking service.

Even though a broker will ultimately save a borrower significant sums of money and arguably provide a more efficient mortgage structure when compared against pedestrian bank staff, it would be unlikely that borrowers would invest in broker services on a user-pays basis because it compromises their borrowing capacity and associated serviceability (banks can absorb or rebate the fee – brokers cannot). Furthermore, given that the proposed up-front fee will likely be included into the loan amount, compound interest ensures that the fee (probably somewhere between $2200 and $5000 by early indications) will add thousands to yearly repayments and commit borrowers into a product longer-term (despite more competitive products or rates becoming available) because any up-front cost associated with moving will likely compromise any short-term gains.

Asking a client that has invested significant resources into saving for a deposit to pay up-front simply doesn’t work. How would you feel if you were asked to pay a car salesperson an up-front commission when buying your next car?

Poor news reporting over the last few days has generally focused on broker fees as if they were something the client wasn’t familiar with. The sentiment was shared on Channel 10’s The Project, ABC’s The Business, and numerous other cringe-worthy and clueless sources. Brokers have always operated on the basis that their services are supplied to the client with commissions paid directly by the lender. The National Consumer Credit Protection Act, 2019 (Section 121 ) legislates the need for brokers to fully disclose all applicable commissions and fees. This legislation is supported by other requirements consistent with that of Credit Licencing and industry governing bodies. This is done so at least once during the course of a relationship and no secret is made of its existence – a broker doesn’t work for free. Despite this very common information, industry news commentators have failed to represent the broking trade in a fair, honest, or accurate manner.

We called Ian Verrender, ABC’s Business Editor, regarding his comments on broker remuneration on Monday night’s “The Business”. The same call was placed to The Project team and a few other organisations with a less-than-satisfactory care factor. The video above provides us with a good indication of how seemingly intelligent people say stupid things. Verrender’s comments regarding the best-interest obligation are simply false.

Industry Response

I’ve long felt that the broking industry was the Titanic heading towards an iceberg. Instead of taking action I’ve sat back and watched as industry associations have sent strongly worded letters to the iceberg.

If they don’t take action, we will.

Conclusion

There are many areas of the report that are objective and sensible. Taking aim at the mortgage industry, however, is out-of-tone with the rest of the report with the conclusions seemingly based on those few cases of worst-practice presented as evidence.

A Royal Commission’s purpose is to simply write a report and make recommendations. That report should then be seen as a subjective overview of the evidence and then used as a tool for formulating more workable legislation. The Government’s swift response on issues such as removal of trail (from the 1st July, 2020) was made without nearly enough industry participation. A fair and reasonable period should always exist for the industry to counter those findings that are objectively flawed and don’t immediately impose commercial or financially compromising consequences on borrowers.

It’s not all doom and gloomyet. The Government’s response to existing remuneration arrangements is that they’ll follow up on the issue of trail “with a further review in three years on the implications of removing upfront commissions and moving to a borrower pays remuneration structure” (page 3). It’s this latter statement that is of most concern to brokers, and should be seen by borrowers in the same way. Current remuneration is adequate – nothing more. Altering existing arrangements simply seeks to destroy the industry and the competition upon which the industry provides.

For now it’s business as usual. The mortgage industry will continue to relentlessly work at connecting borrowers with best financial outcomes.

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