Regulating the private sector

by 11 Sep 2018

Dallett finance broker David Collett examines the implications of trail reforms in NSW

In July, NSW Fair Trading released a consultation paper on trading standards that takes aim at – among other things – trail commissions. While the recommendations extend beyond mortgage broking to cover insurance and IT work, they still raise some serious questions.

NSW Fair Trading plans to eliminate trail commissions without a corresponding increase in upfront commissions. In its own words, it proposes to “amend the Fair Trading Act to prohibit providers of services, products or advice from paying trailer commissions to intermediaries who recommend or refer customers to their business”.

Since when has it been standard practice for an Australian state or federal government to set prices for the private sector, and who will be next? If accountants fall out of favour, should they too fear an across-the-board pay cut of 40% or more? What about the banks? If the government decides that banks aren’t fashionable any more, will they propose a gross revenue cut for them, too?

The proposal to cut trail commissions naively assumes lenders will pass the full saving through to consumers. However, to get the desired effect of reducing interest rates by the trail commission amount, the government would need to legislate that change. That would be akin to setting prices in the private sector. Is this the path we’re going down?

If there’s no guarantee that cutting trail commission to brokers will result in lenders reducing interest rates to consumers by the same amount, why else is the cut being proposed?

There are three reasons, and the logic behind each is equally faulty.

The first concern raised by the department alleges that consumers generally don’t understand how brokers get paid and that trail commission over the life of a product should be disclosed. However, mortgage brokers already disclose the upfront and trail commission percentage, and dollar amount, in the credit proposal disclosure document. Furthermore, lenders also disclose the amount they’re going to pay the broker as a percentage and dollar amount in the loan offer documents.

If there’s no guarantee that cutting trail commission to brokers will result in lenders reducing interest rates to consumers … why else is the cut being proposed?

If some consumers aren’t clear about how brokers get paid, adding an extra few words in the above documents to show the total life trail commission amount as well is going to make little difference to whether consumers understand how brokers get paid. Regarding transparency and fairness, if the trail commission over the life of the product is stated, it should also be done to show the total interest the consumer is going to pay the lender over the life of the product.

The second concern is that not all brokers provide an ongoing service to their clients to justify receiving trail commission. However, because it is in Dallettthe broker’s best interests to stay close to their clients, a more constructive proposal might include a requirement for brokers to offer a free financial health check to existing clients each year, in order to continue receiving trail.

The third concern incorrectly assumes that brokers have little incentive to apply their skills in helping existing customers. Once again, the reality is the complete opposite. Brokers have a direct financial incentive to help their current customers, because it may result in receiving an upfront commission if a different lender has more suitable products. We have all been to professional development days and heard the most successful brokers say that staying close to their existing customer base and providing ongoing value has made a positive difference to their business.

As mortgage brokers, we can feel good about the fact that we arrange more than half of all home loans each year, and that figure is growing. According to the MFAA, more than 90% of customers are happy with their mortgage broker’s performance and more than 70% of mortgage broker business is referred by existing satisfied clients.

If there is an informed conversation about transparency and incentives, then that conversation goes two ways, and as brokers we can ask some questions too.

To start with, do government ministers have a personal financial incentive for increasing the proportion of Australians who have completely paid off their home by retirement age? If not, why not?

If a lender doesn’t have the marketing budget to compete directly with the big four via advertising or branch access but can afford to remunerate brokers at the same level as the big four, should that freedom be restricted? Similarly, should a small lender that relies on brokers to compete against the big four be able to pay the broker over time?

Australia is one of the last markets in the world to pay trailing commissions to mortgage brokers, but no government should attempt to set prices in the private sector.

David Collett
Finance broker