No trail should mean no clawbacks, says brokerage CEO

While the mortgage broking industry has widely condemned any move to abandon trail, in its inquiry into competition in the Australian financial system, the Productivity Commission (PC) recommended in its final report that trail commissions be banned to remove perceived conflicts of interest.  

The PC claimed that clawback period should be “restricted” to between 18 months and two years, but it did not recommend removing trail.

Additionally, in a consultation paper released in August, the NSW government also called for the removal of trail, claiming that it increases consumer costs and provides “little incentive” for “sellers” such as brokers to improve consumer outcomes.

However, Mortgage Choice CEO Susan Mitchell has issued a warning over the potential ramifications for brokers and consumers if clawbacks remain in place under a “single fee” model.  

“If [we] move to a single fee, I think it would be very difficult to have a clawback structure in [place],” Ms Mitchell said.

“That would imply the broker would not be paid at all for the work that they’ve done, and my concern would be that there would be some customers that wouldn’t be serviced because of that.”

Ms Mitchell expressed support for the current remuneration model, stating that it’s a “pure profit-share” arrangement, which helps prevent “distortion” based on “different complexities of loans or size of loans”.

She continued: “I’m afraid if they do move to [a single fee model] with clawbacks, certain customers just won’t get the service that they need if the feeling is that the broker is going to get a clawback. 

“It may have to be introduced with another broker fee as well if there is going to be a clawback.”

Ms Mitchell noted that clawback arrangements have not garnered the same attention from industry inquires like the financial services royal commission, with Commissioner Kenneth Hayne making no reference to potential conflicts of interests linked to clawback arrangements in his interim report.

Further, the managing director of the Finance Brokers Association of Australia (FBAA), Peter White, has previously stated that a broker’s duty of care to a client is “unfairly commercially challenged” by clawback arrangements.

Likewise, Ms Mitchell said: “They [industry inquiries] haven’t really addressed clawbacks, and I know brokers don’t like them because they feel like they’ve honestly done the work, and through no fault of their own, the customer has decided to pay the loan off, probably for reasons that didn’t exist at the time that the loan was done.”

However, Ms Mitchell said that removing clawbacks from the existing arrangements would be difficult, claiming that it’s “embedded” in the current remuneration model.

“The only chance for the clawback to come out would be if we move to a single fee,” the CEO said.

The brokerage CEO also said that if trail was to be removed, upfront commissions should be increased to offset the loss.  

“I would expect it to be larger than the current upfront to recompense for the loss of trail, but we’re [Mortgage Choice] very supportive of the trail model because we believe in the long run that trail is much more consumer-focused. It ensures that the broker does the right thing by the consumer.”

When asked what the rate of upfront commission should be increased to, Ms Mitchell said that it should reflect rates in foreign markets.

“It would need to be over 1 per cent, I think 1.1 to 1.2 per cent,” the CEO said.  

Further, Ms Mitchell encouraged brokers to persevere through the current regulatory phase by continuing to offer value to consumers through the broker proposition.

“It is a fantastic proposition, I firmly believe, especially with what’s going on right now, that the broker share will continue to climb,” Ms Mitchell added.

She concluded: “The remuneration structure may change, and you may need to consider how you offer the service efficiently, but I firmly believe that the broker proposition is what the consumer wants to receive, and I believe that it will get stronger and stronger, and I do believe that brokers are going to win out.” 

While it is unlikely that the government will recommend any changes to broker remuneration before the financial services royal commission releases its final report in February, Treasury has previously suggested that it does not find merit in the argument to remove trail commissions.

Earlier this year, Treasury released a background paper to the financial services royal commission, which outlined the government department's thoughts on several issues and areas of concern that were brought up during the royal commission, including broker remuneration.

Looking at some of the suggested reforms to broker remuneration that have been put forward, Treasury suggested that lender-paid flat fees could provide brokers with an incentive to “service only those customers with straightforward needs, disadvantaging those with more complex needs such as first home buyers”, should the industry belief that a larger loan size correlates with greater complexity and hence effort on the part of the broker be true.

“It would create some other misaligned incentives that would also need to be managed, such as the need to limit the splitting of a loan into multiple loans to generate additional broker fees,” the submission warned.

Looking at the suggestion of removing trail to provide greater incentive to assist customers to refinance was also considered, with Treasury saying that it “would have the potential advantage of removing incentives for brokers to inappropriately recommend larger loans that take longer to pay back”, although it argued that it was “unclear” how significant this incentive is in practice, and that brokers would have greater incentives to assist customers to refinance.

However, it warned that removing trail could also “reduce incentives for brokers to guard against arranging non-performing loans and to not unnecessarily switch consumers to alternative loans that do not provide for a better deal”.

“Refinancing is not a costless exercise, with real costs for both lenders and borrowers,” it said.

[Related: Bank announces new broker commission structure]