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Unravelled: What's ahead for home loans in 2019

20 December 2018

Written by Senior Associate Jack Power

As we, and many others, have written over the course of this year, the Royal Commission will bring (and, in fact, already has brought) monumental changes both in how banks are regulated and to the actual laws that apply to them.

Consumer lending was first out of the blocks for the Commission hearings (starting all the way back in March, which for many will feel like a lifetime ago) and the topic was comprehensively covered in the Commission's interim report released in September (please see our reports).

The role of third party brokers drew particular attention from the Royal Commission, and has been a focus of ASIC from well before the Commission hearings, with the publication of ASIC's REP 516: Review of mortgage broker remuneration in March 2017. This is an industry we expect will be the subject of significant further attention, and possibly regulatory reform, in 2019. In anticipation of this, in recent months the banks have already begun to introduce quite significant changes to their broker streams, including the manner in which broker commissions are disclosed to borrowers and how those commissions will be calculated.

The potential reforms to the regulation of brokers' conduct and remuneration also provide a useful example of the detriment that might be caused to industries and consumers should lawmakers rush through fundamental changes without there first being a more balanced, less heated debate about the important services provided by brokers. We think these debates are to be welcomed, but not rushed.

Brokers – just how important are they?

Brokers play a significant role in the mortgage market, with more than 50 per cent of all home loans being written by brokers. The service they provide borrowers (at least, the service as it is intended to be provided, and is actually provided, in the vast majority of cases) of navigating the various mortgage options among a multitude of lenders is valuable, and greatly assists many consumers when making a long-term, and significant, financial decision. They also offer a range of related benefits for the market, including acting as conduits to smaller lenders that often do not have substantial, independent distribution networks like the big banks do.

As a result, any fundamental shift in brokers' legal obligations and remuneration structure is likely to cause ripples across the entire property market (although 'ripple' is probably underselling it) and so such changes should be considered very carefully by lawmakers. Considering the importance of this topic, it is unsurprising it is one that drew great attention not just during round 1 of hearings and in the Commission's Interim Report, but also during the evidence provided by several of the major banks' CEOs during round 7.

Broker remuneration

At present, brokers normally receive upfront and trail commission from the lender when the broker writes a loan. The customer does not pay the broker anything for their service.

As a result, the structure of brokers' remuneration may resemble (at least, at a superficial level) the 'conflicted remuneration' (that of financial planners, which was the subject of so much criticism by the Royal Commission, as well as ASIC and a multitude of others, for substantially contributing to the quality of advice received by individuals).

As a result, it was perhaps inevitable that broker commissions would also become a focal point of the Commission's criticism and a likely subject of reform.

Conceptually, a transition from the current remuneration structure of lenders paying upfront and trail commissions to brokers, to the payment of, say, a flat fee from the customer is easy to grasp. However, the practical realities are far more complicated and a complete abandonment of that structure is likely to ignore some of the realities of the market.

For example, the commission that brokers receive from different lenders is often very similar, meaning that it might often not be the reason a broker prefers a particular lender (although a particular broker will, all things being equal, likely have a favourite lender for many other reasons, such as ease of application processes, and better service). Second, often banks will be entitled to claw back commissions from brokers where the customer refinances with another lender within a certain period, which should work to limit the desire for brokers to pick a particular lender that might be unsuitable just because the commission might be higher.

A fixed fee approach to remediation is also likely to have its own problems. For example, some have suggested that transferring the burden of paying the fee to the borrower means that those in a better financial position might enjoy access to brokers, whereas those with small mortgages (who, in fact, might be in greater need of the broker's services) might not be able to afford a fee of this sort.

These sorts of unintended consequences, which may impact access to the housing market, must be weighed carefully against the advantages the legislature thinks would be achieved by imposing changes in the structure.

Broker's duties to the customer

The other aspect of a broker's role in the mortgage market that attracted great attention during the Royal Commission this year was the fact that brokers currently do not have an obligation to act in the best interests of their customers (as financial advisers do post FOFA). This was raised largely in the context of the Commission's point that it is often difficult to tell (and certainly customers might be confused) whether the broker acts for the customer or the lender.

While requiring brokers to act in the best interests of their customers certainly sounds like a no brainer (as many will ask, 'Why weren’t they before?'), there are a couple of points worth bearing in mind.

First, brokers do already have duties to customers, such as ensuring that the loan recommended to a customer is 'not unsuitable'. While this obligation could be reframed as a more positive duty, it is worth applying a lawyer's mind (and that is the only one we have) to some of the issues this could create. In particular, we would argue that it is unclear the extent to which the introduction of a best interests duty for advisers in 2013 during the FOFA was responsible for any great improvements in the quality of the financial advice, as legislators had hoped it would, especially when you consider some of the other reforms that were introduced at the same time.

If it is not guaranteed that introducing a best interests duty would lead to material improvements, it is worth considering the regulatory confusion that it might cause. For example, ASIC, in its submissions in response to the Commission's Interim Report, argued that 'the content of this duty should be expressed as a broad statement of principle, such as an obligation "to act in the best interests of the consumer in the selection and arranging of loans" (i.e. it would have a broad application similar to the statutory obligation to act efficiently, honestly and fairly and act as a guiding principle for the conduct of the broker across all their dealings with consumers).' We think such a formulation is unlikely to be a good idea.

We have previously discussed some of the issues with the Royal Commission's approach to the interpretation of 'efficiently, honestly and fairly' in the context of AFSL holder's obligations under s912A (see our Unravelled: Efficiently, honestly and fairly – overarching and fundamental obligations?, especially its vagueness, and, indeed, a similarly worded obligation is already imposed on credit licensees when authorising credit activities (see s47 of the NCCP Act). But, as the Commission hearings have showed, such vaguely worded obligations, without clear boundaries, leave those subject to the law in a state of confusion, and could potentially be relied upon by regulators or courts to retrofit a standard of conduct on an industry.

Furthermore, at a more basic level, it is not reasonable to ask an industry to comply with a duty that has no clear boundaries (to say nothing of the added expense of complying with an obligation that is both vague and pervasive), especially if that is intended to be a provision under which ASIC can seek a civil penalty – although whether that is the case will ultimately depend on the precise legislation that introduces the best interest obligation (as for the current obligations of acting 'efficiently honestly and fairly' under s912A of the Corporations Act and 47 of the NCCP Act, the Draft Treasury Laws Amendment (ASIC Enforcement Bill) 2018 seeks to make both civil penalty provisions).

Perhaps a middle ground will be reached, such as the introduction of a 'safe harbour' provision upon a broker taking certain steps, as exists for financial advisers under s961B(2) of the Corporations Act. But the difficulties certainly highlight the need for careful thought.

Some other areas to watch

Other areas of potential reform to watch in 2019 include amendments (whether formal or informal) to the extent that banks can rely on the Household Expenditure Measure (HEM) Benchmark (and other benchmarks) when evaluating the expenses of potential borrowers. These are often a useful tool for lenders, given a borrower's declared expenses will frequently be inaccurate (more often from human error than any intention to deceive in order to obtain a higher loan).

The use of benchmarks was the subject of significant criticism by the Commission, particularly in its Interim Report. The Commission's solution was to require more detailed declarations, and review of an applicant's various bank statements and other records. Facing such uncertainty, many hoped that the decision of Justice Perram in ASIC's test case against the reliance of one of the major banks on the HEM Benchmark would provide greater guidance.

However, in November His Honour rejected the proposed settlement between ASIC and the bank, on the basis that he was not satisfied reliance on the HEM Benchmark was a breach of the responsible lending requirements.

Another key area to watch will be the performance of AFCA. It took over from FOS in November of this year, and 2019 is likely to be when it will really come into its own. It will be particularly interesting to watch AFCA's response to systemic issues within lending institutions and the manner in which it exercises its right to require lenders to do, or refrain from doing, any act that AFCA considers to be reasonably necessary to achieve one or more stated objectives (see our Unravelled: AFCA's powers and obligations – 'systemic issues).

We look forward to keeping you updated in 2019. Have a relaxing and enjoyable summer break.

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