Introduction

The mortgage brokers survived the royal commission. I didn’t know they could do that. I didn't know it was possible for an industry to survive that kind of media and political lashing and come out intact.

We now have no consistent approach to managing conflicted advice.

For the next 20 years, conflicted advice is going to occasionally produce really bad media firestorms because the conflict of interest inherent in the model will attract dodgy behaviour.

Unfortunately, banning conflicted advice produces terrible outcomes that no one likes, resulting in various rounds of killing and then resurrecting industries that provide conflicted advice.

The structure of conflicted advice

There’s a product you want to buy. It’s difficult to do a direct comparison because prices are specific to the individual (insurance), or each variant of the product is slightly different (hotels), or the product is complicated (investment funds).

The textbook example is mortgages, where interest rates are dependent on the specific borrower, the specific property and the Loan-To-Value Ratio. In other words, it's hard to give a firm price without some amount of paperwork. Other things like this include (insurances - car, house, health, life, travel, pet; utilities with usage components - electricity or gas supply; financial advice and/or investment options with varying levels of risk/reward)

Industry Genesis

Markets start with vertically integrated incumbents. The main sales channel is direct sales with suppliers (i.e. you apply directly at the bank for a mortgage)

A broker/advisor emerges to help with paperwork. Eventually, the broker builds out a process to apply to multiple providers simultaneously.

Impacts of brokers

Brokers:

• Price Competition: Brokers force providers into price competition with each other. For suppliers, this sharpens the price elasticity of demand with respect to the broker channel. Often companies are forced into offering their best prices to brokers (more on this in a future post)
• Surface quality dimensions: Brokers can sometimes help customers observe non -price quality, e.g. approval times for a mortgage, not just the rate
• Competition from weaker brands: Brokers become the critical sales channel for suppliers with low brand value/consumer awareness. They therefore flatten competition between reputable brands and smaller players.
• Outsourced Sales Function: Brokers start to take over the functions of the sales arm of the suppliers, often becoming the first port of call for complaints or questions

In general, consumers like this deal because they get a better deal than they got before the brokers existed, particularly when considering the limited amount of effort consumers will put into searching for better deals. Note that this is not the same thing as getting the best deal in the market. 

The conflict in conflicted advice

The perennial fear that regulators have is that broker recommendations are driven by commissions (i.e. kickbacks) and are not necessarily in the best interest of consumers.

Brokers charge consumers $0 for this service, which helps it to go down smoothly. Instead, they make money by receiving commissions from the suppliers in the industry on each sale. The conflict of interest between getting paid by one side of the market, and offering services to another side of the market invariably opens them up to accusations of dodgy behaviour.

The royal commission turned up plenty of examples of terrible financial advice, with consumers being steered into totally inappropriate products that were high fee (and presumably high commission).

Attempts at resolution are doomed to failure

Invariably someone, like the commissioner, tries to un-conflict the advice. This is much harder that it looks.

The vast majority consumers are unwilling to pay anything greater than $0 for the service. (I love asking people I encounter in real life who use mortgage brokers if they'd pay for the service, and their answer has been uniformly "No".)

This means that any attempt at removing the commission structure results in most brokers closing shop. The brokers closing shop are usually fairly unsympathetic characters, so people aren't that mad about it. 

However, the smaller players in the upstream industry (think: small banks and credit unions) start to panic as their largest sales channel is being shut down. 

As far as politicians and boffins are concerned, all the indicators for competition in the market for the supplied service start to get worse. Measures of prices also get worse as the most price elastic sales channel for supplying the service starts to disappear. 

Consumers also start to grumble when their paperwork burden starts to mount and the prices they encounter start going up. 

The only winners are the largest suppliers in the original service (think: the big 4 banks, the big 3 energy retailers, the biggest brand name insurers) who have the brand power to fall back on their vertically integrated direct sales channel. And to be honest, no one likes those guys.

Resurrection

The royal commission, which very masterfully generated a public media narrative and the slammed in some hard recommendations is slowly having its recommendations undone.

The mortgage brokers, who were supposed to lose their trailing commissions, somehow survived intact. And boy are they thriving.

The investment advisors got wiped, but they're already coming back:

Banks, insurers and super funds will be allowed to give customers personal financial advice in a major wind back of the tough rules introduced after the scandals revealed at the Hayne royal commission.

A bunch of the investment funds got banned from offering commissions, but even then, it wasn't all of them:

Following a review by Treasury and the securities regulator, Mr Frydenberg will ban conflicted remuneration including "stamping fees" for newly floated listed investment companies (LICs) and listed investment trusts (LITs).
...
Real estate investment trusts, hybrid securities and listed infrastructure investments will not be affected by the changes.

Some historical examples and an assortment of facts

• A large share of online comparison sites are brokers and have the same issues. This is particularly true when the sale is made directly on the online comparison site. This includes comparators for electricity, gas, hotels, flights,
• Small banks, credit unions and non bank lenders rely very heavily on brokers:

The Dutch-owned ING, which entered the Australian market in 1999, wrote between “85 and 90 per cent” of its new mortgages via brokers, according to Australia chief executive Melanie Evans. Ms Evans, who oversees $60.3 billion of home loans, said brokers were “critical to us achieving scale in this market”.

• Allegendly, a big part of the value of electricity and gas comparison websites is actually to operate call centres to actually compete sign ups. Australian consumers generally don't understand their options and prefer to call someone up to confirm that they correctly understand the deal that they're being offered. Once again, this blurs the line between being a price comparator showing various offers and acting as the sales arm of a supplier.