The final report from the Hayne royal commission into misconduct in financial services is out, and it recommends an end to trail commissions to mortgage brokers, a ban on hawking of superannuation, and tightening of the remits of the regulators.
While mortgage brokers are furious and the recommendations, if followed through in full, will see significant changes in Australia’s financial services sector, there’s no industry-shattering recommendation that will upend the current order.
Commissioner Kenneth Hayne is careful to say in his introduction that “the primary responsibility for misconduct in the financial services industry lies with the entities concerned and those who managed and controlled those entities: their boards and senior management. Nothing that is said in this Report should be understood as diminishing that responsibility. Everything that is said in this Report is to be understood in the light of that one undeniable fact: it is those who engaged in misconduct who are responsible for what they did and for the consequences that followed.”
Some of the commission’s consequences for major institutions is yet to be determined: there have been 24 referrals to regulators for further investigation, which could result in civil or criminal cases, for a range of institutions including including all the major banks except Westpac.
In terms of the concern that the commission could propose sweeping new rules for assessing people for loans and further add to the tight credit conditions that are affecting the housing market, there are no sweeping proposals for new rules. Hayne notes that the banks are already making changes in this area.
The report’s recommendations look set to be disruptive to Australia’s mortgage broking industry at least to some extent. It recommends the phasing out of commissions to mortgage brokers, saying there should be a “steady but deliberate movement towards changing the existing remuneration arrangements for brokers, so that the borrower, not the lender, should pay the mortgage broker a fee for acting in connection with home lending.”
He said changes in “brokers’ remuneration should be made over a period of two or three years,” with trailing commissions to go over the first 12 to 18 months, and other commissions to brokers being phased out over the next 12 to 18 months.
“Lest there be any doubt about it, my intention would be that the fee payable to a broker in respect of advising about, procuring or negotiating loans after that date would be payable by the borrower, and, if the lender agrees, could be paid out of the principal sum advanced to the borrower under the loan agreement,” Hayne says. “How the fee is fixed is best left to the market to determine. It could be a fixed amount, a stepped fee, a value-based fee or some combination.”
However, of the 76 recommendations in the report, this full phasing out of commissions is one that Federal Treasurer Josh Frydenberg is not accepting in full, warning that it could harm competition in the sector, although it does plan to ban trail commissions for new loans in 2020. This of course does not rule out a Labor government implementing the banning of commissions in full.
The big credit tightening question
One of the major questions ahead of the report’s release was whether the commission would recommend severe new rules that could further complicate the already tight credit environment, which analysts and the RBA have noted is having an impact on the broader economy.
Hayne actively makes a recommendation that there be no change to the National Consumer Credit Protection Act 2009, which rules that banks cannot lend to people without checking on their circumstances.
The problem with this was that until a few years ago, banks relied to a large degree on a statistical model called the Household Expenditure Measure, or HEM for short, which takes into account income, location, family and other circumstances, and then benchmarks lenders when estimating their living expenses. This has obvious flaws because it won’t capture risks for borrowers in their individual circumstances, but Hayne noted in his report that the CEOs of both the Commonwealth and ANZ Banks had given evidence that they were moving away from using HEM to assess loans, particularly with the greater use of data on people’s actual spending behaviour especially when they are existing customers of the banks.
Hayne writes that by “improving processes for inquiries and verification, banks’ reliance upon the HEM or other benchmarks is likely to reduce. This is unsurprising, but important. It is important because it underscores the point that while the HEM can have some utility when assessing serviceability – that is to say, in assessing whether a particular consumer is likely to experience substantial hardship as a result of meeting their obligation to repay a line of credit – the measure should not, and cannot, be used as a substitute for inquiries or verification.”
He adds: “I consider that the steps that I have referred to above – steps taken by banks to strengthen their home lending practices and to reduce their reliance on the HEM – are being taken with a view to improving compliance with the responsible lending provisions of the NCCP Act. If this results in a ‘tightening’ of credit, it is the consequence of complying with the law as it has stood since the NCCP Act came into operation.”
Hayne goes on to cite submissions from Treasury that “suggest that the housing market has the capacity to absorb some adjustment in the application of lending standards necessary to meet the requirements of existing [responsible lending obligations] without imposing unwarranted risks to macroeconomic outcomes”.
Taking into account the changes banks are making on assessing borrowers, his conclusion is that the current law, if enforced properly, is sufficient.
Among its key recommendations are clarifying the missions of the prudential regulator APRA, and the corporate regulator ASIC, to ensure they have clear accountability for policing misconduct in financial institutions. While there is no major structural shakeup, Hayne does recommend a new oversight body that will guard the guardians, which will be independent of government and established by legislation.
“The current framework is heavily focused on governance and financial accountability. None of the existing processes requires regular and systematic review of how well either regulator discharges its statutory functions or exercises its statutory powers,” the report finds.
“Given the importance and size of ASIC’s remit, I have come to the view that a permanent oversight body is now required. Similarly, the significance of APRA’s work to the strength of Australia’s financial system and the interconnectedness of its work with that of ASIC – which will be significantly amplified if the recommendations I have made are implemented – mean
that it too should be subject to more consistent and rigorous assessment,” Hayne says.
The report recommends a complete ban on the “hawking” of superannuation products and says changes should be made to the superannuation system so that a person can only have one default fund. “A person should have only one default account. To that end, machinery should be developed for ‘stapling’ a person to a single default account,” the report says.
There are no firm recommendations on front-line pay for banking staff except that the structure of pay be reviewed annually. One of the big questions over the report was whether Hayne would recommend the banning of bonus incentives for bank staff, but he stopped far short of that. The report refers with approval to a pilot study at ANZ that looked at bonus payments based on branch performance rather than that of individual branch staff.
“There are evident advantages, and no obvious disadvantages, in moving to this type of model,” Hayne says. “And there may be advantages, and no disadvantages, in moving to other models, such as models that increase the amount of fixed remuneration paid to staff and decrease variable remuneration, or that remove variable remuneration altogether. The point is that this work should continue. Entities must challenge assumptions about how they can and should encourage certain behaviours and discourage others. In the end, good management, at all levels, is the best and most effective way to obtain the best results.”
His recommendation in the end was: “All financial services entities should review at least once each year the design and implementation of their remuneration systems for front line staff to ensure that the design and implementation of those systems focus on not only on what staff do, but also how they do it.”
Tackling fees-for-no-service — one of the shocking revelations of the commission’s work — is a key recommendation that is likely to affect how a large chunk of Australia’s financial services professionals are paid.
Ongoing fees will need to be renewed annually by the client, and that clients will get in writing “the services that the client will be entitled to receive and the total of the fees that are to be charged, and that there be no payment of fees without the client’s express written authority at the point of renewing an ongoing agreement.