Royal Commission Final Report – Intermediated Financial Products

On Monday 4 February, Commissioner Hayne released his final report into the Royal Commission into the Misconduct in the Banking, Superannuation and Financial Services Industry. The report listed 76 recommendations aimed at improving fairness and transparency and at removing conflicts of interest across a wide range of financial products and industries.

While the recommendations are wide ranging, a key theme that emerges is the dislocation of the retail channel for various financial products.

Mortgage brokers

A lot of media attention has been gathered by the recommendations aimed at the mortgage broking industry- including the removal of trail commissions, increased compliance and regulation and the more unexpected recommendation that borrowers instead of lenders pay upfront broker fees (with the option of capitalising those fees into the loan).

Hayne’s criticism of the mortgage broking industry was directed to what he described as “fees for no service” including most significantly the trail commissions that brokers receive for a number of years after a loan is utilised. These trail commissions currently represent a significant percentage of the income of most mortgage broking businesses. He also questioned the upfront fees paid to brokers by banks when signing on borrowers – which created potential conflicts of interest. To overcome this conflict, Hayne suggested that mortgage brokers charge borrowers instead of lenders for the upfront fee. To create a level playing field, Hayne also recommends that banks charge borrowers an upfront fee for originating the loan. However, as Hayne recognised in the report [1], even with the level playing field the impact of this recommendation will inevitably mean that the quantum of the upfront fee charged by brokers will have to significantly reduce.

While there is some political reluctance to the adoption of the borrower pays recommendation into legislation, the balance of the recommendations around mortgage broking seem to be supported by both major political parties. It is therefore clear that the future landscape for mortgage broking businesses will be significantly impacted with revenue streams reduced and compliance costs increased. Indeed, the market reaction to the recommendations was clear with a number of listed mortgage brokers experiencing large drops in share value.[2]

Retail dealers

Mortgage brokers are not the only financial intermediary that will be impacted by Hayne’s recommendations – other retail channels for financial products could also face wide-ranging changes if the recommendations are adopted. These include providers of financial products that currently rely on the point of sale exemption to the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) such the providers of financing options for motor vehicles sold at dealerships or for whitegoods and furniture sold at retailers. Because such retail dealers are currently not subject to any credit licensing requirements, they can essentially sell financial products without being subject to any professional conduct standards or responsible lending obligations.

While there are some credit providers that use credit representatives in their network to sell financial products – there is understandable reluctance in doing this across all financial products and retail channels because of the potential for expanded liability and compliance costs. Therefore, a large number of consumer financial businesses currently operate under the point of sale exemption and will as a result have to significantly alter the way they operate if the exemption is removed.

Impact and opportunities

As always, the devil will likely be in the detail of how, if and when the recommendations are adopted into law. It is clear that there are a number of financial services businesses that will need to alter the way they sell their products to consumers through their retail channel. These changes will present challenges for current business models and opportunities for new and existing players to harness technology and innovation to create new business models. For example, Hayne himself notes that there may be more of an opportunity for comparison mortgage sites to play a role in intermediating the distribution of mortgage products. [3] Some of the advisory role of mortgage brokers may be supplemented or replaced with robo advisers who can provide a lower cost advisory service or otherwise creating greater separation of advice, product intermediation and product manufacturing.

There are also likely to be opportunities to create technology workarounds to allow financial products to be sold at retailers direct to consumers without having to rely on retail dealers as the sales channel by integrating with point of sale systems. For smaller ticket consumer products, the prevalence of buy now and pay later products may continue to expand (if they can continue to operate outside of credit licensing requirements).

On the other hand, there will also be a number of businesses that could face significant cuts to existing revenue streams, without a fundamental restructure for the business. Those business with higher leverage will need to consider the structure of their balance sheet in order to attract the capital necessary to reshape their business in response to the regulatory shift in the industry.

[1] Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Final Report, Volume 1, page 77

[2] For example, the share price of Mortgage Choice dropped than 23% and the share price of AFG Home Loans dropped more than 29% the day after the report was released.

[3] Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Final Report, Volume 1, page 80

About the Authors

Hal Lloyd is a Partner at Hamilton Locke and has more than 20 years’ experience in mergers and acquisitions, private equity, capital raising and distressed transactions across a number of industry sectors.

Zina Edwards is a Partner at Hamilton Locke and has extensive experience advising major trading and investment banks, syndicates, funds and public companies in relation to various high profile and complex financial turnarounds, restructurings and special situations.