Royal commission – a picture paints a thousand words

There have been lots of headlines and the mortgage broking industry in particular will (possibly) be the hardest hit.

It all started when Justice Kenneth Hayne presented Treasurer Josh Frydenberg with his final report from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, but refused to shake his hand.

There has certainly been a lot said and a lot revealed through the process of the Royal Commission, but the final report was not what the market expected.  As a result the performance of the big four banks (and AMP/IOOF) rebounded strongly, however the mortgage brokers (Mortgage Choice and Australian Finance Group) were hit hard, off -30%.

The final 950+ page report made 76 recommendations, which both the Government and the Opposition have promised to implement in full, with one exception. The government has said they will not implement the recommendation to ban upfront mortgage commissions due to the anti-competitive impact on the mortgage market. For those not so inclined, the AFR published a good summary of the recommendations.

The report is being hailed as a restrained bookend to a year of public flogging and reputation damage

Hayne laid out four key issues that are central to his recommendations:

  1. the connection between conduct and reward
  2. the asymmetry of power and information between financial services entities and their customers
  3. the effect of conflicts between duty and interest
  4. and holding entities to account.

Hayne also recapped the six norms of conduct identified in the Interim Report:

  1. Obey the law
  2. Do not mislead or deceive
  3. Act fairly
  4. Provide services that are fit for purpose
  5. Deliver services with reasonable care and skill and
  6. When acting for another, act in the best interests of the other.

Hayne concluded by suggesting the advice industry is currently in a state of flux, transitioning from an “industry dedicated to the sale of financial products” to a “profession concerned with the provision of financial advice.”

Mortgage broking industry hit hard

The major area of concern is the impact on the mortgage broking industry.  Unfortunately the benefit of a broker is often not quantifiable, but in simple terms without a broker acting as agent, competition will fall and prices will go up.  Mortgage brokers have not only led to reductions in bank’s lending margins but have enabled non-bank lenders to gain market share. Outside of the major banks there are 70 lenders available to borrowers without shopfronts.  This has resulted in more competitively priced mortgages for consumers.

In the detail of the report Kenneth Hayne suggested “I expect that new forms of intermediation will emerge in the home lending market. For example, I expect that comparison and transaction sites of the kind now so familiar in connection with travel and accommodation may become more common.”  I would argue there is a little more involved than just searching for the best rate.

The upside to all this (from what we are hearing) is that the recommendation won’t be accepted and the mortgage broking industry will survive.

Big banks emerge bruised but not broken

The second area of concern is that vertical integration has been left untouched.  This is where a consumer receives advice from the same institution that supplies the product and often the administration service (and insurance).  This is the real financial services “gravy train” which still needs to be addressed. It is not independent or without conflict. Disclosure will help, but the majors will always find a way round the challenge.  I believe vertical integration / robo advice has a place in this industry, but in a different form and with the appropriate disclosures, i.e. you are receiving “cheap” advice, but the real cost is being subsidised by the vertically integrated model (product, insurance, administration, lending, banking etc.).

Criminal charges?

Once Hayne used the word criminal, the playing field changed. However, the final report stopped short of inflicting the worst reputational outcome of referring specific individuals to the DPP to face criminal charges. While criminal charges may still follow, the Commission held back from the easy hit of naming names under the blinding glare of the media spotlight.  This job has been handed to ASIC, so watch this space.

Grandfathered Commissions

The report stated that grandfathered provisions for conflicted remuneration should be repealed as soon as practicable. The Government subsequently announced this would be implemented from 1 January 2021. Grandfathered commissions relate to the Future of Financial Advice Act, legislated in 2013. Banks and their wealth arms have been charging clients commissions linked to financial products.  This is well overdue in our opinion.

Disclosing (lack of) independence

One of the recommendations was to introduce new laws to disclose an adviser’s lack of independence.  At Ocean Advice we are privately owned, non-aligned and we provide real advice that you can trust. We are in a fortunate position of having access to the full market of opportunities.  We will never take on a client where the cost of our services exceed the value of the advice or the saving we are able to pass on to the client if they were to DIY.

A genuine advice gap will be created

The recommendations will continue to create a genuine advice gap in a big market segment.  The very well-off, many of whom already pay for advice out of their bank account will be fine. At the opposite end of the spectrum, members who can be adequately served by intra-fund and robo advice will also be fine (although the true costs of these fees are much higher than most expect).  But what about the masses in the middle?

The devil will be in the detail of the implementation

Concluding remarks

Many have questioned the value of advice (and the industry), but the system is complex and people require help navigating it.  Most Australians require financial advice of some sort to retire effectively, but often don’t realise this. However, the benefits of advice are intangible (they are hard to estimate prospectively) and it is therefore often hard to convince people even when it is in their best interests. Mortgage broking and many financial advice models will be challenged as a result of the Royal Commission, but the industry will rise stronger with greater public trust.

At Ocean Advice we have supported the need for a Royal Commission into the financial services industry for some time and we are in agreement with the majority of the recommendations, although we were hoping for more.  There will be minimal change to our business as we have been operating in line with the recommendations since inception. There is a lot more in the detail and the recommendations still need to be legislated, and passed, by whoever is in government.


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