Mortgage brokers and stockbrokers appear likely to feel the heat from the government and the regulators, after the financial advice industry had its day in the sun, thanks to the Financial System Inquiry (FSI).
Financial advisers and planners have come under scrutiny following several scandals involving a number of Australia's largest wealth management companies. IOOF Holdings Limited (ASX: IFL), the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) and Macquarie Group Ltd (ASX: MQG) have all felt the heat over that.
Advisers will be required to hold a degree, pass an exam, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year.
In its response to the FSI report, the government has also tasked the Australian Securities and Investments Commission (ASIC) to take on mortgage brokers and their remuneration structure, with the regulator already reviewing stockbrokers' pay structures.
Mortgage brokers and financial planners will be required to disclose who owns them, while commissions for selling life insurance are also under fire. In many cases, brokers and advisers receive between 100% and 130% of the first full year's premium as a commission, and between 10%% and 13% of the premium each year following that.
One of the other issues ASIC is tackling is whether industry commissions encourage clients to trade more than they really need to. According to the FSI, only Australia and the US allow stockbrokers to take a commission on the brokerage fees they earn for writing higher volume. Most other financial centres pay their stockbrokers a salary and a discretionary bonus.
This is an age-old problem – the power of incentives – and it's not limited to the stockbroking industry. Stockbrokers make money from trading, so the more their clients trade, the more revenue they rake in. The more revenue a broker makes for the firm, the more he gets paid – so the carrot is there for brokers to naturally encourage clients to churn stocks.
Stockbrokers Association of Australia boss Andrew Green naturally disagrees, saying that ASIC's market integrity rules manage the risk of churning.
But as Warren Buffett's partner Charlie Munger says, "Never underestimate the power of incentives".
Simply removing the incentive should result in a better outcome for all parties.
Tackling stockbrokers' commissions is likely to pit ASIC head on with investment banks and their brokerage arms – and that's not exactly going to be an easy task to win.
Brokers had secured an exclusion from the Future of Financial Advice laws in 2013, as shares were considered product neutral, meaning advisers had no incentive to push certain stocks.
In most cases that is likely, but in some cases, brokers may be incentivised to push stocks to some clients, above others. For example, one client may wish to sell a large block of stock, which could see brokers push other clients to buy, perhaps unnecessarily, or at the expense of other stocks. But it's a very fine line.
Foolish takeaway
In the health care sector, particularly in the US, a move is underway to link medical practitioners' remuneration with patient outcomes, rather than on a pay-for-service model. In simple terms, it means doctors get paid for the results they achieve for their patients, hopefully reducing wastage and saving billions of dollars.
Maybe Australia needs to adopt a similar model for stockbrokers and mortgage brokers (not to mention financial advisers), where their remuneration structure is linked to the financial outcomes of their clients.
