If you go looking for misconduct in the Banking, Superannuation and Financial Services Industry you never know what you might find.
But even the most sceptical of us have been gobsmacked as to what was underneath the scab.
Driving past the dead bodies and the carnage has a sick, voyeuristic pleasure but seriously – what to do next ?
How do you make sense of it – how do you set the context, how do you frame your thinking ?
Commissioner Hayne’s Final Report – Volume 1 is 496 pages.
Volume 2 (Case Studies) is 455 pages. Volume 3 (Appendices) is 118 pages.
Hayne and his team have covered a lot of ground and moved at a fair clip…getting the job done in about 13 months.
I’ve now read Volume 1 and my conclusion is that this is an impressive effort by an impressive team who bring high legal skill together with good old fashioned clear thinking and I must say, very clear language.
So – how do you approach bringing together all of the issues into a set of recommendations ?
Well, you distil it back to a simple set of principles.
[my comments in parentheses]
Norms of conduct
[Hayne identified six “norms of conduct” :]
- obey the law;
- do not mislead or deceive;
- act fairly;
- provide services that are fit for purpose;
- deliver services with reasonable care and skill; and
- when acting for another, act in the best interests of that other.
“These norms of conduct are fundamental precepts. Each is well-established, widely accepted, and easily understood.”
[Hard to argue with that….etch them in stone.
But then the sharp legal mind speaks to us :]
“The six norms of conduct I have identified are all reflected in existing law. But the reflection is piecemeal. “
[How’s that for a simple but powerful sentence ?
Hayne then described some general rules building upon the norms of conduct.]
“The six norms of conduct I have identified support, and in some cases entail, some general rules:
- the law must be applied and its application enforced;
- industry codes should be approved under statute and breach of key promises made to customers in the codes should be a breach of the statute;
- no financial product should be ‘hawked’ to retail clients;
- intermediaries should act only on behalf of, and in the interests of, the party who pays the intermediary;
- exceptions to the ban on conflicted remuneration should be eliminated;
- culture and governance practices (including remuneration arrangements) both in the industry generally and in individual entities, must focus on non-financial risk, as well as financial risk.
[Which fair, normal person would find issue with any of these general rules ?
Of course if you’d been telemarketing dodgy insurance to unsuspecting customers then the 3rd rule would be problematic….but hey…too bad.]
[Then Hayne finds his voice….]
“The conduct identified and criticised in the Commission’s Interim Report and in this Report has been of a nature and extent that shows that the law has not been obeyed, and has not been enforced effectively.
[hey ASIC & APRA are you awake ? ]
It also points to deficiencies of culture, governance and risk management within entities. Too often, entities have paid too little attention to issues of regulatory, compliance and conduct risks. And the risks of regulatory or other non-compliance and of misconduct are the risks of departure from the first general rule of ‘obey the law’. What consequences follow, and whether this amounts to effective enforcement of the law, bears directly upon the nature and extent of the regulatory, compliance and conduct risks that entities must manage.”
[if the regulators are asleep at the wheel you can get away with anything – if there are limited consequences of behaving badly…..why would executives, boards or shareholders care too much about norms, rules or laws ?]
Intermediaries (e.g. brokers)
“In the Interim Report, I pointed out how difficult it may be to decide for whom intermediaries act and to whom a particular intermediary may owe duties and responsibilities.”
“The point is much more important than a dry point of legal analysis.”
“For whom the intermediary acts determines what duties the intermediary owes and to whom they owe them.”
“The general rule that should apply throughout the financial services industry is that an intermediary who is paid to act as intermediary:
- acts for the person who pays the intermediary;
- owes the person who pays a duty to act only in the interests of that person; and
- ordinarily owes the person who pays a duty to act in the best interests of that person. “
[And this goes to the heart of the dilemma of mortgage broking and some insurance arrangements. How can you said to be truly acting for the customer if your (the broker’s) money comes from the lender or an insurer. How can you be and be seen to be acting in the best interests of the customer ? You are structurally conflicted – particularly (as is often the case) your reward (the commission) is not particularly transparent and may in any case vary from supplier to supplier and increase based on volume. Your reward may be maximised by me buying more insurance or getting a bigger loan. It is by no means clear that the incentive arrangements are encouraging advice & assistance that is in the customer’s best interests.]
[More on mortgage broking later]
Making change carefully and simply
“Treasury and many of the entities that made submissions, urged the need for caution before recommending change.
This is undeniably right. As I said in the Interim Report, adding a new layer of regulation will not assist. It will add to what is already a complex regulatory regime.
No doubt the financial services industry is itself complicated. That may be said to explain why the regulatory regime is as complicated as it is.”
[but again – here’s the killer punch, the brilliant skewering of the industry bullshit]
“But closer attention will show that much of the complication comes from piling exception upon exception, from carving out special rules for special interests.”
[pure, simple, brilliant clarity]
“And, in almost every case, these special rules qualify the application of a more general principle to entities or transactions that are not different in any material way from those to which the general rule is applied.”
[despite the inalienable logic of the general principles, they don’t apply to my special interest group because we have better lobbyists than the next guys and / or we’ve got the ear of the legislator and / or regulator by a combination of financial political donations, baffling them with bullshit dreamt up by our clever, expensive lawyers or schmoozing and power networking.
However we’ve done it…we’ve cleverly made sure so that the normal rules don’t apply to us – and it’s business as usual.]
[Hayne then discusses the reality that simplifying legislation can be complicated and take a very long time – but then he provides a path to actually get this stuff done, whilst pre-emptively skewering much of the standard industry obfuscation.]
“There are two parts of that task that can inform, and I consider should inform, what is done in response to this Report.
First, it is time to start reducing the number and the area of operation of special rules, exceptions and carve outs.
Reducing their number and their area of operation is itself a large step towards simplification.
Not only that, it leaves less room for ‘gaming’ the system by forcing events or transactions into exceptional boxes not intended to contain them.”
[Hayne is calling BS on the standard industry playbook – but – are our legislators up to it ?]
Second, it is time to draw explicit connections in the legislation between the particular rules that are made and the fundamental norms to which those rules give effect. Drawing that connection will have three consequences.
It will explain to the regulated community (and the regulator) why the rule is there and, at the same time, reinforce the importance of the relevant fundamental norm of conduct. Not only that, drawing this explicit connection will put beyond doubt the purpose that the relevant rule is intended to achieve. And, the further consequence will be to highlight the fact that exceptions and carve outs like grandfathered commissions constitute a departure from applying the relevant fundamental norm. Emphasising the fact of departure may assist in reducing both the number and the extent of these qualifications.
[Their exceptions carve-outs are nothing but self-serving BS – do not fall for it under any circumstances]
In their submissions, some entities used the undoubted need for care in recommending change as a basis for saying that there should be no change.
The ‘Caution’ sign was read as if it said ‘Do Not Enter’.
[that last sentence is a beautiful piece of clarity]
An assertion was necessarily implicit in the submissions that sought to maintain some aspect of the present regime unchanged: that doing nothing about those matters would carry less cost than making any change to the rules under consideration. But rarely, if ever, was the submission developed beyond the point of bare assertion.
Rarely, if ever, was there explicit examination of, or comparison between, the costs of doing nothing and the costs and consequences of changing the rules.
[even your BS is lazy]
“The rules that govern grandfathered commissions provide a useful example.
Two grounds have often been given for maintaining the present rules about grandfathered commissions without modification: orderly transition and constitutional infirmity. If the provisions were made to allow orderly transition within the industry, that time has now passed. How much longer is the transition to take? For all the suggestions that it will ‘wither on the vine’, the charging and receipt of grandfathered commissions remained alive and well until some of the larger participants in the industry (especially the banks) sensed the wind of change may be blowing and found it best to bend now by phasing it out rather than have the wind grow to such intensity that it snap off this branch of their activities. “
[1. How stupid do you think we are ?]
[2. A wonderful turn of phrase – this bloke should write a novel or something]
“Whenever change is mooted, someone will suggest that changing the permitted forms of remuneration would lead to constitutional difficulties because it would amount to an acquisition of property otherwise than on just terms.
As I said in the Interim Report, two points must be made.
First, where would be the acquisition? Who would acquire anything? What proprietary benefit or interest would accrue to any person?
[an ok try I suppose – it sounds importantish – but it does look like you’re just making shit up]
Second, if the point is good, it was good at the time when most forms of conflicted remuneration were prohibited. Yet no-one sought then to challenge the validity of the relevant provisions and the Future of Financial Advice (FoFA) ban on conflicted remuneration has now operated for more than five years without challenge.
It is time to ignore the ghostly apparition of constitutional challenge conjured forth by those who, for their own financial advantage, oppose change that will free advice about, or recommendation of, financial products from the influence of the adviser’s personal financial advantage.
[here’s the proof that you’re just making shit up]
A third point is sometimes made in attempting to justify preserving grandfathered commissions. It is said that prohibiting this form of remuneration once and for all will carry with it unintended consequences and the advice industry will be disrupted. Generalised fears of this kind should not be heeded. ‘Disruption’ and similar terms can be used, and in some submissions to the Commission were used, as little more than pejorative synonyms for ‘change’. As the Treasury submissions show, however, it is always necessary to identify the nature and the extent of the consequences that will or may follow from the change under consideration before speaking of the change as ‘disruptive’. Without identifying those consequences, ‘disruption’ has no useful content.
[look over there – it’s disruption – it’s scary and it’s bad – trust us – those consequences (for us) which you don’t intend could cause the sky to fall down on all of us – it’s just too scary !]
If an exception to the rules prohibiting grandfathered commissions is to be preserved, the exception must be closely and cogently justified. Saying only that there may be ‘disruption’ or ‘unintended consequences’ is nothing but a naked appeal to fear of the future.
[that strategy might have worked once upon a time – but you’re going to have to be better than that]
And it seeks to graft some exception onto the body of law intended to give effect to a coherent set of policy objectives without any attempt to identify the competing policy objectives. Creating exceptions that depart from underlying principles has consequences. Those consequences are amply demonstrated by the grandfathering arrangements made in respect of FoFA. ‘Temporary’ or ‘transitional’ carve outs departing from principle too often become (and in this case did become) entrenched. Carve outs and exceptions are too often exploited (and in this case have been exploited) for purposes having nothing to do with the stated purpose of their creation. Creating carve outs and exceptions impedes, and may even prevent (and in this case did prevent) achieving fully the intended policy objectives that inform the body of the law.
[clearly you can’t be trusted…..your self-serving BS is evident for all to see. The only surprise is how you got away with it for so long]
Instead, the law is (and here it was) made more complex; it is (and here it was) made harder not only for regulators to administer but also for the regulated community, and the public more generally, to understand.
[good for the finance industry, good for fancy lawyers, bad for consumers – baffle everyone with BS and hopefully no one notices.]
After establishing this as his context and with the backdrop of the public hearings, submissions and examination of relevant case studies, Hayne then provides 76 recommendations.
Basically he’s dealing with the specific subject matter at hand but always with reference to the “norms of conduct” and general principles.
With “reference to the more particular changes that must be made to protect consumers against misconduct, to provide adequate redress and to address asymmetries of power and information.”
Make no mistake – Hayne has delivered an excellent piece of work that is of huge importance to this country.
What Hayne doesn’t cover
This Royal Commission was all about “misconduct”.
It was not established to review why we have a finance system and if you had a clean sheet of paper – what it would look like.
There are important questions that need to be canvassed :
- Is 4 Big National Banks the optimum structure ? [I’d argue no – we need smaller, regional banks to better serve businesses]
- Should there be limits on the ability of these private banks to create money without limit ? [Yes – they’ve pumped the Australian economy up {house prices} with debt]
- How do we increase competition ?
- Should the Government guarantee their deposits ? [No]
- Have APRA got the capital adequacy settings right ? [massive tilt towards housing at the expense of business]
- What else should be done to increase competition or change the landscape of Australian Banking ?
Mortgage Brokers
Shorten has said that he’ll implement the recommendations in full if he wins power the government have said they’ll “act” on all of the recommendations with the exception of mortgage brokers.
Frydenberg has said : making borrowers pay the fee to brokers not lenders “would basically be a free kick to the banks”. They’ll ban trailing commissions and review the fee issue in 3 years.
Hayne said :
Recommendation 1.2 – Best interests duty
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. The obligation should be a civil penalty provision.
[Is it unreasonable that a mortgage broker act in the best interests of the intending borrower ? I think not.]
Recommendation 1.3 – Mortgage broker remuneration
The borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending. Changes in brokers’ remuneration should be made over a period of two or three years, by first prohibiting lenders from paying trail commission to mortgage brokers in respect of new loans, then prohibiting lenders from paying other commissions to mortgage brokers.
[Hayne remains true to the simple framework he outlined. “when acting for another, act in the best interests of that other.” “ intermediaries should act only on behalf of, and in the interests of, the party who pays the intermediary” “exceptions to the ban on conflicted remuneration should be eliminated”. So – Hayne was always going to land here.
The mortgage broker acts for the intending borrower but the lender pays commission to the mortgage broker. There is a clear conflict with Hayne’s principles – and if he was to remain pure, this is the right answer]
Recommendation 1.4 – Establishment of working group
A Treasury-led working group should 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, in response to market changes.
[I suppose it’s complicated and there’s detail to be worked through]
Recommendation 1.5 – Mortgage brokers as financial advisers
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.
[Clearly it’s a big financial transaction for most people and advice is a component – so why not ? Otherwise would be a carve-out]
Recommendation 1.6 – Misconduct by mortgage brokers
ACL [Australian Credit Licence] holders should: • be bound by information-sharing and reporting obligations in respect of mortgage brokers similar to those referred to in Recommendations 2.7 and 2.8 for financial advisers; and • take the same steps in response to detecting misconduct of a mortgage broker as those referred to in Recommendation 2.9 for financial advisers.
[the Banks can no longer act surprised when brokers originating mortgages on their behalf don’t do the right thing. Ignorance (accidental or intentional) is no longer an excuse]
Hayne is not the only one shining a spotlight on mortgage brokers.
In June 2018 , The Productivity Commission looked into this matter.
Their report can be found here.
Basically they found that competition is weak and that the large financial institutions “have the ability to exercise market power over their competitors and consumers.”
They noted that “there have been past periods of strong price competition, for example when the advent of mortgage brokers upset industry pricing cohesion. “ but “for this situation (extraordinarily high profits) to persist as it has over a decade, channels for the provision of information and advice (including regulator information flow, adviser effort and broker activity) must be failing.”
“In home loan markets, the mortgage brokers who once revitalised price competition and revolutionised product delivery have become part of the banking establishment.
Fees and trail commissions have no evident link to customer best interests.
Conflicts of interest created by ownership are obvious but unaddressed.
Trail commissions should be banned and clawback of commissions from brokers restricted. All brokers, advisers and lender employees who deliver home loans to customers should have a clear legally-backed best interest obligation to their clients. “
“The competition benefits of mortgage brokers have become compromised.
From a relatively small industry in the 1990s, mortgage broking has grown such that just over 50% of all new home loans now originate through a broker. The competitiveness of Australia’s home loan market is now substantially dependent on the decisions of home loan providers, brokers and aggregators (intermediaries between lenders and brokers). The intimidatingly complex and confusing nature of the home loan market, and the absence of a direct cost to consumers from using brokers, are strong motivators for consumers to increasingly choose brokers over direct contact with lenders. “
“Yet the major banks have not only survived the emergence of the broker model, they have leveraged their market positions to, quite literally, make it their own. The major banks source around 40% of their loans through brokers, are represented on the vast majority of broker panels, and account for just over 60% of the total loans that brokers generated. And all the major banks, except ANZ, have an ownership stake in at least one mortgage aggregator.”
“Mortgage brokers are remunerated through commissions, which are paid by lenders. Commissions are determined as a proportion of the loan value and include both upfront payments and trail payments that are paid over the life of the loan. Industry participants have committed to removing bonus commissions (that increase motivation for a broker to maximise loan size beyond a customer’s need), but this has not yet been widely implemented.
Our primary concerns about broker remuneration, from a competition perspective, include that recovery of such payments by lenders (for example, through higher mortgage interest rates across their portfolios) may be imposing additional costs on all home loan borrowers, and that current structures are at times highly likely to motivate brokers (and possibly lenders) to act in ways other than in the consumer’s interests.
Unlike in wealth management (a similar advisory business, involving serious financial cost), mortgage brokers are not presently obliged by law to act in the best interest of the customer. And as we have seen with wealth management, a shift in that law may not be sufficient — CEO or board-level interest in its application is needed. The best place to start is simpler and open remuneration structures aligned as far as practical with customers’ best interests.”
“Despite industry-led initiatives to reform broker remuneration structures, it is apparent that little change is occurring and the principal commission structures continue to create conflicting incentives for brokers. At its simplest, brokers have a strong incentive — regardless of what may be in their customer’s best interest — to give preference in their loan recommendations to lenders that pay higher commissions.
This may be uncommon, but there is no obligation for transparency of the payment to prove it.
Remuneration structures must also motivate at least some brokers to prefer advising new customers (with a new stream of trail commissions and potential referrals), particularly during the clawback period for an existing loan.
Compounding this, many brokers and the Combined Industry Forum (where changes to remuneration structures are being debated by lenders and brokers) agree that brokers prefer to negotiate with a customer’s existing lender before considering refinancing with another lender.
This preference for loyalty is demonstrably often not in a customer’s interest.
And without any ability to withhold payment as an incentive to receive competitive offers, a consumer is actually in a poorer position to receive quality on-going advice as long as trail commission persist.
To the extent that brokers’ business models rely on them maintaining ongoing (if infrequent) interaction with customers, they are likely to provide on-going advice irrespective of commissions. We see no case for paying for something (that is, through trail commissions) that is going to happen anyway.”
“Fixed fees paid by customers rather than commission structures have been proposed, and would eliminate conflicts, but the cost to competition would be high.
Consumers would desert brokers, and smaller lenders (and regional communities with few or no bank branches) would suffer much more than larger lenders, if customers were required to pay for broker advice. But change isrequired — to the role of the lender in being the paymaster — to reduce the scope for damage from conflicted advice.
Thus, while we propose that up-front commissions remain paid by lenders, we consider that going forward, trail commissions must be abolished — as they have already been in other parts of the financial system.
We accept that up-front commissions may rise as a consequence of such action. Broking businesses would need to remain commercially viable. Industry agreement to abolish volume-based commissions (commissions based on the volume of loans written by an aggregator) must be implemented by all lenders without further delay.
The absence of evidence that this is occurring affects industry credibility.”
So – The Productivity Commission and Hayne are on the same page with the potential for conflicts, demonstration of bad behaviour, the need to abolish trailing commissions and for greater transparency.
The key difference is that Hayne says that borrowers should pay the brokers for their service, The Productivity Commission argues against that on the grounds that it would reduce competition – “ the cost to competition would be high. Consumers would desert brokers, and smaller lenders (and regional communities with few or no bank branches) would suffer much more than larger lenders, if customers were required to pay for broker advice.”
Surely there is scope for some hybrid model.
A small fee upfront and a fixed fee – funded somehow out of the loan – ideally, transparently bolted on to the loan. Once the fee for service is agreed between the borrower and the broker has been agreed – if the successful lender offered a higher “commission” , then anything above the agreed fee could be rebated to the borrower.
This is a big change to the arrangements and not all brokers would survive but there is a sustainable model in there.
As to the issues regarding competition…yes – totally agree we need to urgently deal with this and should be next on the “to do list” of whoever is in government.
But first things first. Great job Kenneth Hayne and your team.
Now – let’s see what the politicians and the regulators do.
Comments are closed.