The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has released its Interim Report before they undertake another round of public hearings. It comes in the aftermath of the Competition In The Australian Finance System report published publicly by the Productivity Commission on the 3rd August.
The Government reluctantly sanctioned the $75 million investigation into the banking and financial sectors to identify areas of malfeasance. The interim report provides a teaser of findings without making any conclusive recommendations. However, it's clear that that the damaging report will shift a massive responsibility back onto Government to introduce legislation that will mitigate the predatory practices and fraud that has evidently taken place. Certainly, testimony from banking executives themselves - many that were forced to resign in the aftermath of the hearings - have introduced further mistrust that will invariably drive massive and enforced changes to their culture, management, and conduct, largely thanks to their own testimony.
While the Productivity Commission report took great pleasure in taking aim at mortgage brokers and financial advisers, the interim report, as expected, took a much broader approach and sought to identify the corruption and result-drive fraud perpetrated at the highest levels. Financial practitioners, mortgage brokers, and others, will inherit the wrath of the report simply by association.
We'll look at just some of the criticisms and recommendations that were made as they relate to mortgage brokers.
Change Is Necessary
The report makes mention on page 86 (as it relates to financial planners) that there's widespread rhetoric suggesting "a few bad apples". However, it goes go on to state that "the characterisation serves to contain allegations of misconduct and distance the entity from responsibility. It ignores the root causes of conduct, which often lie with the systems, processes and culture cultivated by an entity". The assertion is that the culture of greed is not only ignored by banks, but they (historically) played a role in supporting and encouraging the wayward conduct. The clear underlying implication that repeats itself over and over throughout the report is that greed-driven unethical conduct in the banking industry is the norm rather than the exception.
The sad truth is that there is widespread fraudulent conduct in the industry and it's only the Australian Securities and Investments Commission's (ASIC) utter failure as a regulator over the past two decades that has allowed the criminality to take place at all levels. It's the Hayne Royal Commission that has potentially proved the final and fatal indictment of ASIC's negligence or, even worse, complicity in allowing the moral decay of the banking industry to unfold. ASIC's failure as a regulator may see regulatory reform significant enough to compromise the continued viability of small broking offices as a profession or, at best, shatter the trust the industry has spent the better part of twenty years building.
The nature of the change as it relates to Mortgage Professionals is summarised in an underlying conclusion on page 54 that says "[m]uch if not all of the conduct identified in the first round of hearings can be traced to entities preferring pursuit of profit to pursuit of any other purpose." This single theme repeats itself with a monotony that should have the mortgage industry prepare for the worst.
For whom does the intermediary act?
The report states that there's no simple legal answer for whom the intermediary (broker) acts, stating that "[a]t a practical level, however, the intermediary is paid only by the lender". While we believe that there's absolutely no question that the vast majority of brokers are acting in the best interests of the customer, the report goes on to ask "whom does the borrower believe that the intermediary is acting?"... and it's this question that is more important than any other, particularly when consumer-facing marketing material promulgated via the MFAA, FBAA, brokers themselves, and others are stating in no uncertain terms that brokers are acting on behalf of the client. As the report correctly states, "in most cases, even if an intending borrower believes or expects the intermediary to be acting in the interests of the borrower, the intermediary owes no general duty to the borrower to seek out the best and most appropriate deal for the borrower."
We've witnessed misconduct numerous times... from the guy that wrote over 80% of all incoming loans to one bank so as to qualify for volume bonuses, to the guy that'd write for one lender over any other due to a volume-based elevated status that'd get the loan approved quicker... and we've seen about everything in between. The underlying truth that no Mortgage Broker is overly anxious to share with their client is that "... the relationship between broker and would-be borrower will either be obscure or a relationship in which the broker owes the borrower no duty larger than not to negotiate an unsuitable loan", and it's this blurry service expectation that provides scope for abuse... and we see it over and over (as had virtually every broker actively working in the industry).
"There may be cases where the intermediary expressly assumes some more specific role with respect to the borrower. This may be the case, for example, if the broker were to agree (or assert) that he or she would act in the borrower's best interests or if the broker were to assert that the loan proposed was the 'best' available. In the first of these cases the broker might be found to have assumed an obligation to act only in the interests of the borrower; in the latter case, the statement made would be measured against the law of misleading and deceptive conduct." - page 58.
It's this extract that potentially implicates every broker with a potential breach of lending practices and conditions imposed by way of an ACL that might, when measured against legislation, amount to fraud. Virtually all marketing material makes mention of the 'best available product' or 'most suitable product' when neither is necessarily true. The only assertion that can be made is that savings might be made using one product over another... yet the means for product comparisons is again subject to the discretion of a broker that might potentially lead a consumer into making a predetermined decision, and this is something that must be addressed.
Even comparison websites for which we highly advocate tend to have limited, often outdated, and usually include incomplete product details. The websites themselves are commercial entities and often impose a bias towards one product over another based on commissions or affiliations with certain lenders, meaning that they cannot be relied upon.
One of the findings made that supports the discontinuing of volume-based bonuses was the vastly different customer outcomes between brokers and banks. The following three points are made on page 60.
- Broker loans were reliably associated with higher leverage, even for customers with an identical estimate of risk;
- Loans written through brokers have a higher incidence of interest-only repayments, have higher debt-to-income levels, higher loan-to-value ratios (LVRs) and higher incurred interest costs compared with loans negotiated directly with the bank; and
- 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.
"ASIC concluded that, even after controlling for differences between those who deal directly with a lender and those who used a broker, consumers going through broker channels obtained loans with higher LVRs (typically between 1% and 4%, depending on the lender) and larger loans in dollar terms. ASIC further concluded that, again controlling for differences, consumers going through broker channels 'obtained significantly more interest-only loans: for all eight lenders reviewed, brokers arranged at least 50% more interest-only loans, and up to four times as many interest-only loans in the case of one lender'."
The statistics point towards inevitable change, more regulation, and more compliance practices for brokers. The evidence cannot be ignored: value-based upfront and trail commissions to third parties contribute to higher-risk lending. The clear conclusion made is that "value- and volume-based remuneration for intermediaries in the home loan industry has been an important contributor to misconduct and conduct falling short of community standards and expectations and poor customer outcomes" - essentially concluding that the mortgage broking industry is having an opposite effect on the industry to which they claim. Coupled with other findings (such as higher interest rates for broker-originated loans), industry reform is inevitable.
The industry 'customer first' policy was introduced in the aftermath of the 2017 ASIC review of mortgage broker remuneration. The Combined Industry Forum (CIF) landed on a number of conclusions, most of which are expected to be implemented by December 2018. The report, largely designed to support the viability of the future of mortgage brokers, is seemingly designed to strip away those perks normally reserved for industry 'top-performers', and limit those areas of remuneration that would most likely illicit opposition from borrowers. More important is that the report took to the banks and sough to moderate those incentives most likely to influence any broker into one product over another... and basic remuneration and trail fit into this category. However, it does little to address the widespread irresponsible lending practices that does take place from a small percentage of brokers. Additionally, the somewhat disingenuous 'customer first' tagline merely shifts an industry expectation inline with existing Government legislation such as the Corporations Act. Shouldn't the customer always come first?
The Hayne Royal Commission made numerous mentions of the difficult-to-define 'poor consumer outcomes'. Is a good consumer outcome determined by product features, price, interest rate, broker support, speed, or something else? Is simple satisfaction enough? For any review to be taken seriously, the report's forthcoming conclusion should address the root of the problems; poor broker training, a broken mentoring program, industry oversight, poor IT support, biased comparison software, and rogue brokers.
The HEM Index
Using the Household Expenditure Measure (HEM) as the default measure of household expenditure assumes, often wrongly, that the household does not spend more on discretionary basics than allowed in HEM and does not spend anything on 'non-basics' (page 28). The index itself lends itself to irresponsible lending because it doesn't consider the discretionary spending that invariably takes place. Limited to only defined expenditure, it is a poor measure of a lender's ability to service a loan, and those institutions that rely on HEM shouldn't constitute verification of expenditure without further research. Living in a digital economy, virtually all expenditure can and should be compared against known spending over the course of a longer time period to assess realistic serviceability.
The application of HEM is one that went unchecked for a number of years; it's only now that lenders are beginning to undertake their own verification, or they're taking steps to apply their own margin to return a more realistic figure. Some brokers we work with have claimed that blanket bans has more than tripled the number of loans that are being rejected on grounds of serviceability - hitting entry level buyers and investors in particular.
The issue of fraudulent payslips, tax returns, and other documentation wasn't criticised by the Commission as it should have been. The assertion made by report, and validated by CBA's submission, is that when a broker submits a loan application to a lender, the broker takes reasonable steps as the 'agent' of the borrower to verify documentation. Those lenders that check documentation do so indiscriminately and only take certain measures to verify selected documents. It outwardly appears that the issue of fraud is muddled up in the transfer of data with no party wanting to take ultimate responsibility.
Does the broker have a responsibility to verify provided data to more accurately assess the HEM score? The report makes mention that since ".. so many home loan applications proceed by the lender assuming that the borrower's living expenses are equal to the HEM measure, not as the borrower declares them to be, can lead only to the conclusion that in many of those cases the broker has not taken any effective steps to inquire into, or verify, the expense information supplied by the borrower." Whenever the HEM index is equal to that of the declared spending, one can only assume that brokers have 'manipulated' figures to meet serviceability criteria. This tail-wagging-the-dog approach (or a broker fiddling with numbers to meet lending criteria) actually becomes a criminal endeavor when a broker engages in further meddling by way of, say, 'training' the borrower into declaring the purpose of a property. For example, it's not uncommon for brokers to have borrowers state that a property might be an investment property when it is in fact intended for residential purposes. As soon as this predatory manipulation of purpose takes place, either party is subject to prosecution, and it's a widespread practice that the report failed to specifically address.
While there's large business-facing documentation that requires compliance in certain areas - such as the National Consumer Credit Protection Act 2009 (Cth) (the NCCP Act) - it's the Crimes Acts (1900) that imposes underlying penalties of up to 10 years imprisonment. While 'responsible lending' is difficult to define, it's easy to enforce or manage internally when the implications are considered. Knowingly altering any document, providing fraudulent numbers, and especially altering the purpose of a loan for financial gain , is subject to the severest of criminal consequences.
AS it relates to Financial Advisers, the reports states that "[t]he investigation and punishment of breaches of law should not be outsourced to private bodies. Licensees and industry bodies should not try to resolve breaches of law by advisers internally, but must notify ASIC or other appropriate authorities." This is an underlying issue with regulatory bodies such as the MFAA and FBAA that often make their own incomplete assessments of violations and then make determinations in a manner that is least likely to draw negative attention upon the industry they represent. I know of at least a few instances where leading industry figures (including at least one that represents the MFAA) that have chosen to ignore serious criminal activity to avoid their own organisation attracting scrutiny. For this reason, it's important that there's a separation of church and state - essentially distancing aggregators and 'governing' bodies... with the latter groups prohibited from making in-house determinations. The report suggests the law is treated with a kind of contempt by industry "as if the laws governing the conduct of financial services entities are some less important form of law". Contraventions of law are not to be treated as no more than bargaining chips to procure agreement to remediate customers. Instead, each intentional breach or otherwise should first be assessed as if it were in fact a criminal matter. If ASIC has a reasonable prospect of proving contravention, the starting point must be that the consequences of contravention should be determined by a court.
Very few infractions are criminally investigated (as they should be) and the obligations of the associations are often focused on those they represent rather than the customers their stakeholders rely upon for honest service. ASIC claims that when they identify breaches of the law, they use their resources and power to ensure that there are meaningful consequences for the perpetrators. That said, ASIC had never instigated a civil penalty proceeding against a financial adviser (or mortgage broker) for a breach of the 'best interests duty'. Since 2008 ASIC had banned 229 advisers, just under half of whom were banned permanently. If best interests duty isn't enforceable, shouldn't it be replaced with something quantifiable and more meaningful? ASIC's industry oversight is simply inadequate.
Flex Car Loans
Over 90% of all car sales are arranged through finance, of which around 39% are financed through a dealership and around 61% are financed from other sources. In almost all cases, the 39% that are succumbing to the convenient charms of their dealership are paying more than they would anywhere else. Borrowers would likely be horrified if they were aware that brokers and car dealers literally set their own commission by way of a sliding scale to set interest. Despite Flex loans coming under attack, it's a practice that dealers rely upon to subsidise any 'discounts' applied to the already overpriced vehicle, and one that brokers often use to quickly inflate profits.
Unless the primary business model relies on car finance, we advocate that our brokers do promote car loans, but we also ask that they provide the minimum interest rate available (or a minimal margin) and use the opportunity a real-world lead magnet for bigger-ticket items, such as home loans. Our referral and relationship building systems work the same with equipment finance as it does with any home loan product.
The conduct identified and criticised in the Hayne report was pointing to a ubiquitous conduct that indicated that the general provision of services provided a financial benefit to the individuals and entities that provided the service. However, the underlying premise of 'broker interest first' isn't necessarily a popular one in the broking community, and the report makes no mention of the majority that operate a consumer-focused business. Certainly, those we work with uphold to the highest standards of their published code of conduct and statement of values, and it's this basic trust that forms the foundations for our referral and partnership programs. The report is somewhat offensive to those areas of the market that are compliant in every respect.
If a 'customer first' policy was genuinely employed and formed the foundation for every broking or financial business, there would be no reason to make significant change. Sadly, it's ASIC's incompetent oversight, poor education and policing by industry bodies, and a wayward banking culture that hasn't suitably addressed or even acknowledged the issues of dishonesty or downright greed that has led us to reform. While the report is mindful of the damage any change might have on the industry, a measured response is forthcoming. The evidence presented to the Commission is highly critical meaning that regulators are obligated to cater for the dishonest factions of the market and recommend legislation that'll affect all industry stakeholders.
Brokers should refer to page 71 of the report and draft their own 'customer first' policy based on the questions asked, and this statement should be disseminated early in a customer relationship. A response to the report might be publicly considered (the final report will require it as part of standard business damage control), and a clear and ongoing tactical response should be made via social media and other web channels to reinforce the overarching, and fundamental, requirements of the Corporations Act 2001 (Cth) (the Corporations Act) and the National Consumer Credit Protection Act 2009 (Cth) (the NCCP Act) in that your business must (and will) do all things necessary to ensure that the financial services are provided 'efficiently, honestly and fairly'. Shying away from the findings will no nothing; addressing them directly will contribute towards the trust that forms the foundation of your business. We will assist all our clients - current and former - with the creation of any material necessary to reinforce their honest business practices.
The report is worth reading in its entirety.