It is no coincidence that in the same week the Treasurer released exposure draft legislation introducing a best interests duty and restrictions on conflicted remuneration for the mortgage broking industry, ASIC released its Corporate Plan 2019-23 announcing a new surveillance project targeting mortgage broker accountability.
The exposure draft legislation seeks to give effect to two of Commissioner Hayne’s recommendations although his proposed reforms regarding broker remuneration structures have been pared back following significant industry lobbying.
Implementation is ambitiously slated for 1 July 2020, which leaves the industry limited time to properly embed and integrate the necessary operational and behavioural changes to facilitate compliance with the new obligations.
This alert identifies key issues for consideration, informed from our experience assisting the financial advice sector to implement similar changes over the past few years. It is relevant for all mortgage brokers and intermediaries, as well as investors in mortgage broking businesses.
What key changes are proposed?
- Best Interests Duty: Mortgage brokers1 will have to act in the best interests of consumers when providing credit assistance in relation to credit contracts. The explanatory materials clarify that the best interests duty will not only capture credit assistance relating to residential mortgages but also ancillary credit such as credit cards and personal loans that are packaged with mortgages.
The draft legislation does not prescribe what conduct would satisfy the best interests duty. Unlike the equivalent obligation for financial advisers, there is also no ‘safe harbour’ provision which mortgage brokers could rely on to defend claims that they had not acted in a consumer’s best interests.
- Conflicts Priority Rule: Mortgage brokers will have to prioritise consumers’ interests when they know or ought to know that there is a conflict between the consumer’s interests and their own interests or those of a related party. This obligation is almost identical to the conflicts priority rule introduced for financial planners as part of the Future of Financial Advice (FOFA) reforms in 2013.
- Conflicted Remuneration Rules: Mortgage brokers and mortgage intermediaries will be prohibited from accepting ‘conflicted remuneration’ and employers, creditor providers and mortgage intermediaries will be prohibited from giving ‘conflicted remuneration’.
New regulations will prescribe benefits are not ‘conflicted remuneration’ if they meet certain criteria, which include that they are not volume-based benefits (essentially, payments that are dependent on sales volume or total credit metrics) or campaign based benefits (essentially, payments that are partly or wholly only available during a particular campaign period). Additionally, up front commissions will have to be linked to the actual amount drawn down by the consumer instead of the total loan amount.
Certain non-monetary or ‘soft-dollar’ benefits are expressly permitted provided various conditions are satisfied, including infrequent non-monetary benefits with a value of less than $300.
The Treasurer has confirmed that remuneration structures, including trail commissions and up front commissions, will be reviewed by the Council of Financial Regulators and the Australian Competition and Consumer Commission in three years’ time.
- Liability: The new obligations will apply to all licensees and credit representatives that are mortgage brokers. Mortgage intermediaries will also be caught by the conflicted remuneration rules.
Licensees will need to take reasonable steps to ensure that their credit representatives comply with their new obligations and any contravention could attract a civil penalty of up to 5,000 units.
What are the key issues to consider?
- Don’t underestimate the complexity of the best interests duty: Following the FOFA reforms, the financial advice sector has struggled with the practical challenges of implementing the best interests duty framework across adviser networks. In addition to making the necessary policy changes to reflect the new legislative requirements, embedding a consistent understanding of what it means to act in the best interests of the consumer, and how to evidence compliance with the requirements, will be crucial. While the good intent of mortgage brokers is not in question, compliance with the framework will require an end-to-end approach, including designing comprehensive training, tools and templates and audit processes. Cultural levers, including reward structures and the role of leaders in communicating behavioural expectations, will also need to be considered.
- Demonstrating compliance is key: The necessity to maintain and store comprehensive records which demonstrate compliance with new legislative requirements cannot be understated. Enabling mortgage brokers and intermediaries to capture prescribed information through the use of templates and other tools, rather than an over reliance on file notes, will greatly assist. ASIC has been especially critical of the shortcomings across the financial advice sector to demonstrate compliance through inadequate record keeping and this will undoubtedly be a focus of ASIC’s new surveillance project on mortgage broker accountability.
- How will you monitor your representatives: The current supervisory framework for monitoring compliance by representatives (including credit representatives) will need extensive revision to accommodate the new legislative requirements. The systems in place should be capable of aggregating data and findings from internal and external audits to identify potentially systemic breaches across the broker and intermediary network. The frequency and quality of the management information produced, and how it is synthesised to identify potential issues, will also play an important role in licensees demonstrating they have taken reasonable steps to ensure representatives are complying.
- Review your conflicts compliance framework: The new conflict requirements arguably extend a licensee’s general obligations to adequately manage conflicts of interest to ensure consumers are not disadvantaged. Financial advisers cannot comply with their equivalent conflicts priority rule merely by disclosure or by obtaining client consent and we expect ASIC will take a similar approach with mortgage brokers. Existing conflict of interest frameworks and supporting procedures must therefore be thoroughly reviewed and enhanced to facilitate compliance.
- Provide clear guidance on ‘conflicted remuneration’: Disclaimers will not assist a licensee or credit representative to circumvent potential beaches of the conflicted remuneration rules. Mortgage brokers and intermediaries will need clear guidance and training on what is or could be viewed as conflicted remuneration and adequate controls must be implemented. Soft dollar benefits could take a number of forms including hospitality-related benefits, free or subsidised business equipment and marketing assistance and so how these benefits will be properly monitored, recorded and approved must also be considered.
- Due diligence and valuation for investors in mortgage broking businesses: Investors in mortgage broking businesses will need to ensure they consider the potential impact of the legislation on those mortgage broking businesses. Due diligence investigations should include an assessment of how well equipped such businesses are to deal with the potential legislative changes. Further, the financial metrics of such businesses may be materially impacted by the potential legislative changes, which will impact purchase price calculations and mechanisms.
The changes detailed in this alert are likely to be amended before the legislation is finalised. Nevertheless, it is clear that these will be significant changes for the mortgage broking sector. The challenges faced by the financial advice sector in implementing similar reforms indicate that the task ahead should not be underestimated.
Our multi-disciplinary team of regulatory and corporate legal experts, together with our risk and compliance experts, can help you embed measures to achieve sustainable compliance with best interests duty, conflicted remuneration and conflict reforms. Please contact us for further information.