Making the promises made in the Banking Code more meaningful
Notably, the Commissioner is not recommending amendments to the National Consumer Credit Protection Act (the Credit Act). Instead, he focuses on ensuring compliance with the existing requirements and strengthening the enforceability of industry codes.
New models for mortgage origination
The recommendations impacting distribution models for mortgage and retail credit products represents one of the biggest source of disruption to the sector. Retail intermediaries will be required to comply with the Credit Act. The mortgage broking industry will be subject to new professional standards, lose its trail commissions, and potentially move to a ‘user pays model’ for commissions (subject to the findings of a review to be conducted by the Council of Financial Regulators and the ACCC in 2022).
These recommendations will fundamentally reshape the distribution model for consumer credit products. Removing trail commissions eliminates annuities for the broking industry and may in turn reduce the ‘stickiness’ of mortgages, with brokers no longer incentivised by a flow of income on the back book. The extension of the Credit Act, the treatment of mortgage brokers as financial advisors, and potential recourse against bad apples in the industry will all converge to dampen the volume of intermediate market participants.
The recommendations concerning mortgage brokers, who account for more than half of all residential loans settled, will fundamentally alter the industry. The Commissioner is steering the market towards a user pays model, with customers paying for a broker’s services. Moving to a fee for service model will change the future relationship between lender, broker and aggregators, with big questions over the future effectiveness of the current broker model.
Intermediated auto lending
Removing the point-of-sale exemption will dampen the demand for household goods financed by credit at the point-of-sale.
Enforceable industry codes
Together with other market participants, banks will be subject to mandatory financial services industry codes. The ABA and ASIC will make the provisions that govern the terms of the contract made or to be made between the bank and the customer or guarantor designated as “enforceable code provisions”. Significantly, ASIC will gain powers to approve codes of conduct, with contraventions of enforceable provisions to constitute a breach of the law.
Extension of Banking Executive Accountability Regime (BEAR)
This change, to cover ‘all steps of design, delivery and maintenance of all products offered to customers” will require institutions to rethink the way that product governance and lifecycle models work in the industry. Some institutions are in the early stages of identifying a single point of accountability, but many have not commenced this work. Given responsibilities are often distributed across multiple divisions and functions, implementing a clear accountability statement across the end-to-end product lifecycle will be challenging.
This recommendation is strengthened by the Government’s announcement that it will be expanding the scope of the upcoming product design and distribution obligations to all financial services products – including credit. This will encourage the development of financial products designed to meet the needs of specific target consumers and put in place distribution controls to prevent them being sold to people from whom they are not appropriate.
Financial institutions can prepare for these obligations by critically examining their product suite and strengthening their product governance framework.
Key issues will be:
- How the ‘target market’ of a product is identified and monitored over time
- The level and quality of oversight and interaction with distributors
- How complaints and other data are incorporated into the product review process.
Re-thinking compliance and regulatory engagement
In the post-Commission era, institutions will be required to rapidly identify and report on their compliance obligations.
They will need to be able to:
- Identify who is accountable for each obligation
- Identify the controls in place to ensure that obligations are being met
- Report on deficiencies in the control environment
- Demonstrate meaningful progress in remediation of those deficiencies.
To achieve these objectives, compliance functions will require ongoing funding and support from senior management and the board.
Once [the proposed] changes have taken effect, it may be possible to ask again whether the financial advice industry has truly changed from an industry dedicated to the sale of financial products to a profession concerned with the provision of financial advice.
The Commissioner’s recommendations, while expected, bring significant disruption to and accelerate necessary changes to business models, specifically:
- Removing grandfathered conflicted remuneration
- The suggestion that life insurance commissions be reduced to zero
- Requiring annual consent to fees.
With the potential to gain first mover advantage, organisations must immediately focus on the viability of a fee for service model. Although much of this work is already underway, timelines have been accelerated.
New distribution models required
Shifting to a yearly ‘opt in’ advice model and removing carve outs, exceptions and grandfathering provisions will challenge the economics of advice businesses.
In the short term, anti-hawking requirements may narrow the focus of advice practices, potentially encouraging the growth of niche advice businesses.
Longer term, the recommendations may lead to industry convergence given diminishing commissions and comparable professional standards. The coming Open Banking regulations will also act as a disruptive force in this sector, by making information easily transferrable. This will allow new entrants to quickly understand a customer’s financial position and product needs.
Operating costs will also be increased by the effect of The Commissioner’s recommendations, including for example:
- Higher training requirements
- New reporting obligations and controls
- A significant uplift in internal compliance.
Organisations will need to consider their positioning within this new market dynamic and appropriate fee models that provide perceived value to customers and commercial outcomes. Independent advisers will have significant opportunities to gain market share. These will be businesses that provide truly independent and quality advice – not tied to any product issuer – and that exhibit the professionalism demanded by the reforms and the new regulations.
The changes are likely to accelerate the evolution of robo-advice models and digital delivery to mass customers. There is a real possibility that financial advice splits between robo-advice for the majority of Australians and a face-to-face service only affordable to high net worth individuals.
The 2021 government-endorsed review of the effectiveness of measures to improve advice quality will be an important opportunity to ensure the recommendations have been effective.
Rebuilding trust in financial advice
The sector must re-build trust and demonstrate value, which will take time and effort. To achieve this, the Commissioner is recommending:
- A new disciplinary body to bring financial advisers into line with other professions. Financial institutions should review how they currently monitor and manage their financial advisers. They also need to uplift their training and improve internal procedures for identifying and dealing with misconduct and compliance issues.
- Compulsory training and a new Code of Ethics to be agreed and established across the industry.
- Reporting compliance concerns. When adviser misconduct is detected, organisations will be required to determine the nature and extent of the misconduct and remediate clients promptly. This requirement will be a condition of their licence.
- Reference checking and information-sharing. Organisations will have a responsibility to ensure rigorous recruitment and reference-checking processes for advisers seeking to operate under their licence.