Commerce Commission finds mortgage advisors face a conflict of interest because they are incentivised to recommend a lender who pays them the best commissions, even if that lender is not the best fit for the borrower

Every time an independent body looks at the role of supplier-paid commissions and remuneration for financial advice, they conclude the system is irrevocably broken and needs serious reform.

The problem they all find is that the built-in conflict of interest damages customers and allows distortions that favour brokers, advisers, and product suppliers. 

For all the 'disclosures' meant to protect customers, none actually do.

The basic conflict is that advisors are required to work for and in the best interests of their client. But in fact they get paid by product suppliers which becomes the dominant influence. The tensions can never properly get resolved. And won't be until advisors are paid by those they work for.

Just after the Global Financial Crisis, a serious issue of distorted relationships in the Australian life insurance industry reared its ugly head. It was a running sore that built and built for years. Finally the industry there decided to 'act' and appointed actuary John Trowbridge to chair an industry working group to recommend reforms in the life insurance industry.

His 2015 report found that life insurance brokers were so conflicted, they urgently needed to give up supplier-paid commissions and inducements because perverse outcomes were hitting customers hard. The industry acted on a set of his overall recommendations, but not the core conflict-of-interest one, the one that would have actually made a difference.

Because the Trowbridge Report was an industry report, and not an official one, the insurance broking lobby worked to stop its industry bodies from adopting the remuneration part.

But the problem didn't go away.

And the Hayne Royal Commission in Australia made essentially the same recommendations as regards financial advice remuneration in 2019.

This time, with the help of the friendly Morrison Federal Government, a more concerted effort by the financial advice community used the same but enhanced playbook to block any reform of supplier-paid remuneration. This was a major achievement because you will recall banks couldn't avoid major remuneration reform. Banks had to abandon all compensation plans that breached the conduct & culture failures in their system; no more sales targets, commission compensation, volume bonuses, etc.

But brokers and advisors avoided those restrictions.

The Australian Productivity Commission then looked at the mess in 2019, and came up with the same reform solutions. But the Australian Treasury's Quality of Advice Review decided not to act, after dragging the Hayne and Productivity Commission evidence all the way to 2023.

In Australia, all this has embedded a perverse set of incentives. Banks can't offer volume-based remuneration schemes, but brokers can. Brokers and the related mortgage aggregator networks became even more powerful, full of the sorts of conflicts that those many reviews identified and tried to clean up.

[We should also note that the Australian Competition & Consumer Commission (ACCC) gets its antitrust decisions overturned by Canberra 'experts' after lobbying and appeals. It is hard getting the right thing done].

All of this 'reform' activity has been followed by New Zealand authorities. But our institutions have been even less effective.

The Financial Markets Authority (FMA) and Reserve Bank dug into bank conduct & culture here. They found odour but misidentified it as only coming from the banks. They left the financial advice industry alone, and only requiring them to 'disclose'. Still in place is the essential conflict. (*)

The latest independent review comes from our Commerce Commission - and it will not surprise you to learn they too found significant problems with the advice and broker industry as they relate to home loans. The conflicts are embedded and serious.

Some of their recent conclusions are devastating.

To be fair, the Commerce Commission report is still in its 'draft' stage, out for consultation. Their final report is due mid-August. But it will be no surprise if our Government dodges proper reform. Somehow doing anything meaningful or lasting that would benefit consumers doesn't seem on their agenda (but you never know).

However, as you read this you can be sure the various industry groups will be marshalling their collective influence to make sure decision makers in Wellington come up with "the right approach" mirroring what has already been decided in Canberra. After all, the FMA has looked at this issue before, and turned a blind eye. The FMA will be influential again on how these things are decided from the ComCom Report.

Here are extracts from the ComCom Report that relate to the role of mortgage brokers in the personal banking sector. (You should read the original report for the full context of these points. Start at page 107).

4.126
These results suggest that mortgage advisors can help to put more pressure on lenders than customers can without an advisor. However, they could also be driven by selection bias, at least in part. This is because a customer who has a reasonable willingness or appetite to change their provider may be more likely to seek out a mortgage advisor, while a customer with a strong preference for approaching their existing provider is less likely to seek out an advisor.

Mortgage advisors are not getting lower interest rates for their customers (on average)

4.138
We heard from many of the providers that their pricing frameworks means that the same customer would generally obtain the same deal, irrespective of whether they came directly to the bank or via an advisor. 
4.139
ANZ Australia touched on this point in its submission to the Australian Productivity Commission review: … we would suggest that a competitive market would deliver convergence of the rates. If one channel delivered better rates through better negotiating power or market insight, it would be reasonable to expect the other channel to drop its rates in response.
4.140
We heard from mortgage aggregators that one of the main ways that mortgage advisors help their customers is by increasing the customer’s awareness of different lenders and advising them about which lender is best suited to serve their particular needs.343 In this way, their service may still result in the customer getting a better deal than they would have if they hadn’t worked with a mortgage advisor (because they approached different lenders than the customer would have done in the absence of the advice).
4.141
However, use of any intermediary means that there is potential for conduct that serves the best interests of that intermediary, rather than or in addition to the best interests of the customer.

Commission arrangements tend to align the incentives of advisors with providers, not with customers

Mortgage advisors receive commission income from lenders

4.142
Mortgage advisors receive commission income paid by the lender. The structure of these commissions can be grouped into the following categories:
4.142.1
up-front commissions calculated as a proportion of the loan principal (paid by the lender when the loan is taken out); and
4.142.2
trail commissions calculated as a proportion of the loan principal (paid by the lender each month while the loan is active).
4.143
Although mortgage advisors are remunerated based on commissions calculated on loan principal, the size of the loan is not closely related to the effort or the quality of the service provided by the advisor. The commission payment tends to reflect the value that the loan represents to the lender, rather than the effort involved.
4.144
The levels of commissions vary between lenders, but not within lenders (that is, each lender offers the same commission structure to each aggregator group).
4.145
Some lenders only offer up-front commissions, while others offer a combination of up-front and trail commissions.
4.146
Although it is not immediately obvious whether a particular advisor would prefer an up-front commission (alone) or a combination of up-front and trail commissions, it is easy to observe that ANZ, ASB and TSB’s commission structure would be preferable from the perspective of an advisor to that of SBS or Co-op, while Westpac and Sovereign’s would be preferable to Kiwibank and BNZ’s.
4.147
Mortgage advisors may face a conflict of interest with their clients because they are incentivised to recommend a lender that pays them the best commissions, even if that lender is not the best fit for the borrower. This includes potential conflicts of interest in relation to:
4.147.1 
lender choice – whereby the advisor has an incentive to favour lenders that pay preferential commissions; and
4.147.2
loan size – an advisor may favour borrowers taking out higher loans (and have less incentive to serve customers who may not have large borrowing needs, such as lower income borrowers or older borrowers), and may have the incentive to maximise the amount that consumer borrows.
4.148
Because commission payments are made by lenders, not borrowers, it is more difficult to determine for whom an advisor acts – the lender or the borrower.
4.149
Separately, because commission payments are made by lenders to advisors, the immediate sting of the payment is not felt by the borrower. Nevertheless, these costs will ultimately affect interest rates and fees paid by all customers in the market.
4.150
Two immediate consequences of this disconnect are:
4.150.1
customers cannot realistically weigh up whether the expected benefits of using an advisor makes doing so worthwhile (ie, whether the benefit of a better home loan offer obtained through an advisor exceeds the commission payment that the advisor receives in exchange); and
4.150.2
because would-be borrowers are likely to view an advisor’s service as ‘free’, there are very limited incentives for customers to negotiate over fees or shop around for an advisor.

Trail commissions

4.151
Trail commissions are regular payments calculated as a proportion of the loan principal and paid by the lender to the advisor (via the relevant aggregator) each month while the loan is active.
4.152
We heard from lenders that trail commissions are designed to operate as a deterrent for engaging in ‘churn’, whereby mortgage advisors might otherwise arbitrarily seek to refinance their customers from one lender to another to maximise up-front commissions.
4.153
We also heard that trail commissions remunerate advisors for providing ongoing services to their clients, such as re-fixing and re-structuring over the life of the home loan. However, we are not aware of any formal commitment that such services be performed.
4.154
More generally, it seems that trail commissions serve to align the advisor’s interests with that of the lender, rather than of the borrower, by reducing the likelihood that an advisor will recommend refinancing to another bank (even if doing so is in the best interests of the borrower).

And there is more. Here are some other sections you may wish to explore ...

Arrangements and practices relating to advisors that may be inhibiting competition
4.160 etc.

Existing regulatory settings do not go far enough to ensure advisors are acting in the best interests of customers
4.164 etc

and 

Disclosure may not be effective.

Chapter 10 is where the Draft Recommendations are, and they include;

14. The FMA should produce guidance and monitor mortgage advisors’ compliance with their duties under the Financial Markets Conduct Act.

Missing from this analysis is how mortgage brokers are paid. Sales commissions, volume targets, incentives that don't put the customer first may all have gone from the banking industry, but they are still all there in the mortgage broking industry, creating the distortions that come with them and have already been found to be toxic.

Outlawing the fundamental conflict of interest behind these distortions would be a good first step. There is already a working model; the Netherlands did that and now uses a fee-for-service style where financial advisers work for their clients, and are banned from taking commissions or inducements from product or service suppliers.

Now that two of every three mortgages are written by mortgage brokers here (page 107, s:4.123), it is high time this area is cleaned up.

Over to you, FMA.

(*) The FMA is currently setting "expectations when financial institutions distribute products and services through intermediaries", and has issued this Guidance Note. Essentially they are trying to beseech the industry to act fairly and in the interests of its clients. But the essential conflict of interest remains in place, a core temptation for everyone operating in the sector. Those temptations will never go away when adviser incomes (and their boats, batches and BMWs) rely on them.