Lessons from Canada

by Melanie Mingas12 Mar 2019

A best interest duty may sound like a good idea, but when Canadian regulators attempted to the same, their project failed at the first hurdle

In the furore over trail, Commissioner Hayne’s vision for a “best interest duty” has quietly taken a backseat.

According to Hayne, recommendation 1.2 is about aligning the law with customer expectations. However, in reality it is a loosely termed yet potentially high-stakes inclusion that could bring many challenges.

The reasoning behind 1.2 was clearly set out. In his report, Hayne said, first and foremost, that the recommendation was based on evidence provided to the Sedgwick Review by CBA, mentioning ASIC’s 2017 review as an additional trigger.

He later went on to assure the reader: “It is not an obligation that should affect the practices of lenders.”

The government’s official response says little other than that it will be acting on the recommendation.

Meanwhile, Labor’s recent pledge to implement “75 of the 76 recommendations” means it is equally uninspired as to how this proconsumer duty should work in reality.

The concern is that such a move would likely result in a measurement criteria either so narrow it is flawed, or so broad it is ineffective.

“A lot of it is going to be an art rather than a science, and they won’t be able to define it,” says Andrew Way, director at Semper Capital. Way, who was a member of the consultative industry group for the NCCP, says such proposals are more about the language than the logistics.

“These things are easy things to say politically, but they are impossible to enforce. They are broad political statements, they are sound bites; they have no practical application because they haven’t explained how they will be measured, accounted for, or made meaningful,” he says.

The Canadian model

In recent weeks much has been written about the ‘Netherlands model’ of broker remuneration and its impact on the Dutch financial system. In this case, there are lessons from overseas too.

“These things are easy things to say politically, but they are impossible to enforce. They are broad political statements, they are sound bites” Andrew Way, director, Semper Capital

In 2016, Canada’s regulatory body, the Canadian Securities Administrators, announced it would introduce a statutory best interest standard following a consultation paper that itself was the product of a four-year investigation to consider how such a requirement would alter the market. From the start, people from across politics, finance and investment were dubious.

While a regulatory best interest standard was supported by the provincial securities regulators in Ontario and New Brunswick, it was opposed by those in British Columbia, and regulators in Quebec, Alberta, Manitoba and Nova Scotia expressed “strong reservations”.

By May 2017, a little over a year after it was first announced, regulators in British Columbia, Quebec, Alberta, Manitoba and Nova Scotia abandoned the project to define what ‘best’ should look like. The following year, Ontario and New Brunswick followed suit – albeit with some reluctance – and Canada dropped its quest to enforce a standard.

However, according to Jesse Vermiglio, partner at Holley Nethercote Commercial and Financial Services Lawyers, ASIC’s previous experience regulating ‘best interest’ as part of the Future of Financial Advice (FOFA) reforms means it won’t necessarily run into the same issues.

“I’m not saying there won’t be teething issues, but it will be easier. The path isn’t new. There are examples about the way in which this will be dealt with,” he says.

“The other thing you need to factor in is it’s the same regulator that is dealing with this for financial planners, so ultimately they are going to think about it in similar terms, obviously taking into account the differences between lending and financial product advice.”

Vermiglio expects ASIC will focus on a client’s best financial interests when interpreting the new duty and largely follow the existing approach for financial planners.

Therefore, in the context of mortgage broking, it will consider best interest to be about the provision of credit assistance.

“It’s really all about the process. If your processes put the client’s interest at the centre of your service, then complying with the new duty should not be difficult. However, mortgage brokers should learn the lessons from FOFA – make sure you have documented procedures which demonstrate your recommendations meet the new duty. Then make sure you follow them,” he says. While such advice is sound, not everybody believes FOFA is directly transferable to broking, nor should it be.

“We tend to default and say mortgage brokers give advice, but they don’t. By law they give credit assistance, and therefore this best interest piece needs to appropriately align itself to our regulations,” says FBAA managing director Peter White.

Should FOFA fail to translate, White says the customer-first duty from the Combined Industry Forum could provide a springboard.

“I can see this being a moving target for quite some time; hopefully not like the Canadian outcome, but I don’t think there will be a quick result. The CIF’s customer-first duty may be the most appropriate first step,” says White.

Despite this clear – and very recent – lesson from an economy that has many parallels with Australia, Hayne’s supporting words for the recommendation read, “the best interests obligation must be enforceable”.

New responsibilities

Currently, Canadian advisers are required to adopt “fiduciary responsibility”. Although located in New South Wales rather than New Brunswick, John Tindall, finance specialist at Accumulus Holdings, works under a business model that takes a similar approach.

His business is structured through a blend of independent ownership and the added obligation to act ‘‘like” a fiduciary.

“Mortgage brokers should learn the lessons from FOFA – make sure you have documented procedures which demonstrate your recommendations meet the new duty” Jesse Vermiglio, Holley Nethercote Commercial and Financial Services Lawyers

“A fiduciary is morally obligated to work in the other party’s interests and may or may not charge a fee for doing so,” Tindall says.

“I have no problems with that statement, but bringing in a best interest threshold can be very tough because it could extend to the point of not charging a fee because it’s in our interest, not the client’s.”

If a suitable definition for ‘best’ was found and agreed upon, the problem would be solved. However, there are many variables to consider in such work, not least whether best can even be measured until a loan has been fully paid down.

One option is to consider the rate a borrower pays for a loan that fits their circumstances; however, such a framework would only be applicable to vanilla loans and customers, as Bianca Patterson, director of Calculated Lending, explains.

“I think it’s imperative that the word ‘best’ is clearly defined,” she says.

“For example, when we deal with clients in complex lending situations, best doesn’t necessarily mean the best rate. It’s often the best lender or the best product. We are trying to achieve something for their long-term goals.”

To illustrate the point, Patterson gives the example of a client who wants to purchase a property to demolish and build three new properties, pending council approval.

If the client is put on the best rate, the loan would most likely not be suitable for the construction phase 12 months down the line.

If the client is placed in a loan that is suitable for both the purchase and construction, they are likely to be paying a rate higher than the market average.

Theoretically, if a broker takes a wrong turn in this process, it could lead to clients retrospectively assessing their loans and exercising their right to question them in court.

“There are possibly some difficulties with that from an insurance perspective,” says Murray Cowan, managing director at Better Mortgage Management.

“A best interest duty could see a spike in PI insurance because perhaps it may be easy for a client to look back and think, ‘This broker didn’t act in my best interests because this rate ended up being better’,” he says.

At the coalface

With brokers’ reputations scathed as a result of the royal commission, the endorsement provided by another layer of regulation is welcomed and provides another dimension to the broker channel’s service proposition.

“I one hundred per cent welcome the change, and I think a lot of other brokers do too,” says Patterson.

“Why not regulate it? Let’s make it our clear point of difference from the bank. If I was a consumer I would choose to work with a broker over a bank because our standards are much higher, and there will be a better outcome.”

On the other hand, many maintain that such a fundamental principle of broking needs no regulatory framework.

“It’s the way every consultant or adviser should operate – in any field, not just the financial sector and mortgage broking,” says Kevin Lee, buyer agent and mentor at Smart Property Adviser.

“I think it all comes down to whether the adviser or consultant cares enough about their client. If I didn’t love what I do and people didn’t appreciate what brokers do, I probably wouldn’t care.

But when the care comes first, everything flows beautifully,” he says. Despite the willingness of the industry to stand by its service proposition, until ‘trailgate’ has been brought to a sensible conclusion, it is likely that the focus on what best interest could and should look like may well be put on hold.

The recommendation still has to be refracted through a federal election and a regulator that it could be said leveraged the royal commission to get a substantial funding boost.

However, as and when the decision-makers meet, it is imperative that attention isn’t diverted by the ongoing trail debate – or another crisis that has yet to arise.

FEE-FOR-SERVICE ‘FAILED’ IN NETHERLANDS

A broker group has said the ‘Netherlands model’ recommended by Commissioner Hayne in the final report from the royal commission has actually been a failure in the Netherlands since it was introduced in 2008. According to a 2017 report entitled Banking in the Netherlands obtained by Loan Market Group, the total number of banks in the Netherlands decreased from 99 in 2007 to just 44 in 2017. Group executive chairman Sam White said, “This just further demonstrates the Netherlands model would be a terrible outcome for Aussies.”

Brilliant research and commentary. It seems to me that Hayne’s recommendations and use of the Dutch model stems from a need to satisfy an ideological viewpoint that, as brokers are paid by lenders, brokers are conflicted. Be damned the logic and consequences, just do it! Wonder how many Dutch banks left the market by 2008 due to the GFC and not the fees issue? That’d be interesting to know.

Broker in the burbs | 20 Feb 2019, 08:26 AM

It seems Hayne’s 30 seconds on Google wasn’t quite enough research for his ludicrous proposal...

Andrew | 13 Feb 2019, 08:51 AM

That is terrific research. I actually enjoyed my morning coffee today reading that. Pity it highlights the true motivation of the recommendation, and that in itself is frightful.

TMAC | 13 Feb 2019, 08:51

AM Self-serving politicians and exorbitantly paid “consultants” like Hayne have no idea of the real world of finance. They clearly have not researched the broker value and benefits provided to everyday consumers confused by the home loan landscape. Politicians don’t care what happens to mortgage brokers because they know they have a big fat taxpayer-funded pension to fall back on when they decide they have exploited the system enough and want to retire at taxpayers’ expense.

Anonymous | 13 Feb 2019, 09:00 AM

Shows how much research was done by the Royal CBA Commission.

Bottom Line | 13 Feb 2019, 09:03 AM

The brokers who think that Hayne and Co. didn’t know these facts are naive. They knew all right – why would Hayne convey any negativity when his agenda was to protect the big four? The banking industry is inherently corrupt.

Tui | 13 Feb 2019, 10:22 AM

LABOR TO OPPOSE CUSTOMER-PAYS MODEL

After two weeks of silence, Labor has softened its approach to Commissioner Hayne’s recommendations. In reports on 21 February, the party backed a 1.1% commission payment. Industry groups are celebrating that both main parties now recognise the importance of mortgage brokers. The MFAA is urging more caution, however, until Labor has made its official response. CEO Mike Felton said, “We feel we should wait for [confirmation]. If their position is aligned to what is being outlined, then we would say it is encouraging.”

This is not a celebration. 1.1% is equivalent to a loan lasting three years on a trail book. That’s a very high run-off rate. The only acceptable and reasonable outcome is to leave the current model as it is. Government has no place interfering with the free market.

Paul Lewis – Lighthouse Financial Services | 22 Feb 2019, 9:12AM

Let’s hope Labor does ignore Hayne and the consumer-pays broker model. As a broker, I believe a flat fee paid by the lender could work, if trail was increased. For example, a commission paid by the lender of $2,500 per loan application. This would be the same regardless of loan size. This then gets rid of the ‘perceived’ conflict of being paid based on loan amount. Clawbacks would be removed. Trail would then remain and be increased to compensate, as there is clearly no conflict with trail and it leads to better consumer outcomes. Trail was increased to 25 points, for example. As a broker trying to build a book and business value, this model would appeal to me very much, to be honest.

Angry Broker | 22 Feb 2019, 09:13 AM

Labor has basically agreed to pay three years’ trail up front – increasing upfront costs to the banks (which we know will be passed on to the clients). It’s basically back to the ’90s. The commission has achieved what? Increased validation costs; reduced number of loans getting approved; opened the door for greedy lawyers to take class action against the banks; created additional costs for aggregators and banks to deal with the fallout; contributed to the current housing market decline.

Another Angry Broker | 22 Feb 2019, 09:52 AM

That’s not a win. It’s just a political move to win votes and get through the next election. The damage to the brokerage firms, aggregators and non-branch lenders is done. The major bank share price is indirect proof. Stay smart and alert, fellow brokers. Justice Hayne had blinkers with big bank logos printed on the inside.

OB | 22 Feb 2019, 10:08 AM