A key recommendation in the Final Report of the Banking Royal Commission was that the payment of commission to mortgage brokers by financiers should be progressively phased out and replaced by a fee for service model where the consumer pays the mortgage broker.
If this proposal is implemented, there will be a range of legal issues that will need to be considered and addressed before any legislated changes are made. In some cases, for example, the broker fee proposals may solve one potential conflict of interest situation, but potentially raise another. By proposing that some of the high level recommendations for change be overseen by a Treasury-led committee, there has been a recognition on the part of the Commissioner that the recommended reform will require close attention to the detail, if the implementation of the changes is to avoid creating new and different issues.
Who acts for whom
A current concern with mortgage broking arrangements is that the broker is paid for its activity by the financier, and only when and after there is a successful finance application. The consumer, however, will consider that the broker is acting for them. Thus, the potential for a conflict of interest. In consequence, the Commissioner has recommended that the law should be amended to provide that, when acting in connection with home lending, mortgage brokers must act in the best interests of the intending borrower, and that the obligation to do so should be a civil penalty provision.
The Commissioner has also recommended that, in the future, it should be the consumer that pays for the services of the broker and that commission payments from financiers should be variously curtailed, for example, by banning new trailing commissions. The intent is that the consumer will be able to better engage the broker to get the best deal for the consumer in circumstances where the selection of the financier is untainted by the commissions offered by the financier. The overall objective is to place the broker in a situation where its duty is clearly to the consumer alone.
While the objective is clear, there will be some difficulties to consider and overcome in any implementation. Currently a mortgage broker needs to have its own credit licence, or to be an authorised credit representative of the particular financier who's product it is recommending. In situations where the mortgage broker is a credit representative of the financier, the broker is required (under the current law) to act on behalf the financier when performing the 'credit activity' of "suggesting that the consumer apply for a particular credit contract with a particular credit provider". Against this legislated obligation, however, under the new paradigm proposed in the Final Report, the mortgage broker that is a credit representative will be separately required to act on behalf of the credit provider and in the best interests of the consumer when recommending a loan with a particular financier. This will more clearly place the broker in a potential conflict of interest situation. The most obvious solution, will be for the credit representative to cease being a credit representative of financiers and to obtain its own credit licence, so that it can represent only the consumer. That solution, however, will place a significant cost and administrative burden on the broker that it does not currently have.
Additional mortgage broker licensing
Separately, the Commissioner has proposed that, after a sufficient period of transition, mortgage brokers should be subject to and regulated by the law that applies to entities providing financial product advice to retail clients. If implemented, this will potentially impose a separate licensing regime on the mortgage brokers, or at least a separate set of licensing requirements if the current Australian credit licensing regime is expanded.
If separately licensed as financial advisors, mortgage brokers will become subject to a new range of legal requirements, ranging from the need to meet prescribed educational standards, to the provision of statements of advice. No doubt there will be further consideration of the extent to which it is appropriate to fully replicate the laws that currently apply to financial advisors. There is a case for treating mortgage broking as a relatively simple one product business that may not need precisely the same regulatory approach as that applied for general financial advice.
Maintaining competition between brokers and financiers in origination
To the extent that the proposed shift in the funding source for the broker's remuneration may have the potential to threaten the future achievement of better deals for consumers that may be generated by mortgage brokers, the Final Report has suggest that one solution may be to require the financiers to charge an additional fee that is a substitute to the new broker fee (Substitute Fee), in circumstances where the consumer comes directly to the financier. It is envisaged that this will be a new fee that is not currently charged and be one that does not exceed the cost incurred by the financier when originating a loan without the assistance of a broker.
This proposal is not readily achievable, however, under the existing laws. Most financiers already charge an establishment fee and that fee is permitted to cover the reasonable costs of the lender in considering and determining the application for credit and in the initial cost of providing the credit. As a consequence the establishment fee will usually cover some or all of the cost of customer acquisition.
As a consequence, there will usually be no scope for the financier to charge an additional fee in relation to the direct origination of the loan, unless the financier incurs separate and additional origination costs which are not currently included in the establishment fee. For this impediment is to be removed, there will likely need to be the grant of a new right to charge fees that are separate from the establishment fee and that do not need to relate to the costs and changes currently recovered through the establishment fee. Separately, it is hard to see how the minimum and maximum Substitute Fee that is proposed could be correctly set and mandated by the legislation or the regulator. The competitive incentive on the financier will be to impose no new Substitute Fee (where the costs of customer acquisition are already largely covered by the establishment fee). This will likely mean that a minimum fee will need to be prescribed and enforced as a mandated charge. However, the mandating of a new and additional cost for a consumer that goes directly to the financier does not seem to be justifiable against the overall context. If the broker is delivering an additional service of finding and identifying the right loan and lender, its fee for doing this is a fee for a service that the financier does not provide. Why then should there be a new mandatory fee from the financier that is set by reference to a service that it does not provide?
No doubt, in recognition of such issues, that the Commissioner has recommended that the required steps for creating a level playing field is something that ought to be considered by a Treasury-led working group.
Authors: Phil Trinca, Partner and Geena Davies, Lawyer.
