Making change

The debate about the best way to remunerate mortgage brokers for providing advice is as old as the profession itself.

Periodically, the debate gathers momentum in response to initiatives such as the Retail Distribution Review or concerns about consumer protection, but to date, there has been little change to the model that has endured since the beginning: payment by procuration fees.

It is easy to understand why. Consumers do not have to part with their hard-earned cash and as far as they are concerned the advice they receive is free. The great strength of this system is that it gives as many people as possible access to professional financial advice, and the advice they are provided with is underpinned by a rigorous regulatory regime that provides a high degree of consumer protection and demands all financial advisers treat their customers fairly.

Necessary concern?

For the past couple of decades many thousands of brokers have been able to generate a decent living through procuration fees and many millions of borrowers have been helped to find the most competitive mortgage deal for their needs. So why the continued concern about the commission-based system?

The answer is that some within the various interested parties - consumer groups, lenders, regulators and brokers - believe the system does not work in their best interests.

Consumer groups have continually argued that any commission-based system will result in consumers being mis-sold products. They say that reports such as the Competition Commission's recent investigation into the sale of payment protection insurance are proof positive that greed induced by commission payments stimulates all the wrong sales instincts and that consumers' interests are pushed down the priority list below that of revenue generation.

In order to counter concerns such as these, the regulator has developed a regime which is designed to ensure that brokers treat customers fairly, and that consumer needs are made priority number one. Regrettably, however, lenders and intermediary firms continue to be reprimanded, fined and shut down by the regulator for inappropriate selling practices. Some industry experts say the only way to overcome such problems is for the commission system to be abandoned and replaced by one in which brokers charge their clients fees. That way, they argue, there is no temptation to provide inappropriate advice.

Lenders have a different concern, which has been put into sharp focus by the credit crunch: profitability. When the market was booming lenders were willing to pay generous commissions in order to attract greater market share. This trend was very evident in the sub-prime sector, where fees payable to packagers and brokers ran to 2% or 3% of the value of the loan, rather than fees typically of a third to a half of one per cent, which are being paid on prime applications.

However, increasing market share is no longer the priority and lenders do not need to pay big proc fees in order to buy business. The focus is now firmly on keeping a tight control over business volumes and loan quality, which puts downward pressure on proc fee payments.

Possible solutions

Which brings us to the concerns being expressed by brokers. Most brokers are seeing their income being eroded, not only because of falling sales volumes, but also because of less generous proc fee payments.

The demise of the sub-prime sector has hit some firms hard, particularly packagers, but even those brokers who are focused on the prime market are starting to struggle to make ends meet. There is only so much firms can do to cut costs before they eventually go out of business. If sales are simply not generating sufficient revenue, the business model clearly needs to be changed.

But how should the system be changed for the best? Many argue that brokers need to start charging their clients fees, which not only reduces their dependence on procuration fees but also clearly positions them as being wholly independent and agents of borrowers rather than product providers.

This argument is fine, if clients are willing to pay broker fees. But there is a concern that the consumers who most need independent and professional financial advice will be the least willing to pay for it, and that only wealthier clients will be willing to pay fees.

Consumers have also become used to the idea of advice at point of sale being free and if they have to start paying for it, many may decide to simply cut out the middleman and deal with product providers direct. With more and more online comparison sites and a wealth of information being provided by TV programmes, newspapers and specialist magazines, many consumers are feeling more confident about 'doing it themselves'.

A wholesale shift to charging fees could, therefore, be the death knell of independent financial advice. The counter argument, of course, is that in the investment sector, brokers have been charging fees and are still in business.

It is also argued that consumers are happy to pay accountants, lawyers and other professionals for their services, so why not financial advisers?

Indeed, a shift to a fee charging regime could result in a shift in the general public's perception of financial advisers which, at the moment, is not always favourable. Some say that such a change would rid the industry of its cowboys, who have been tarnishing the reputation of the financial advisers for far too long.

And to add another layer of complexity to the debate, some say that a dual system would work in which brokers both receive commissions from product providers as well as charging their clients fees. This is not a new concept; many brokers have been doing this for some time.

It has also been argued that the procuration fee model should evolve with greater emphasis being placed on trail commission, which will not only discourage churning but also more directly link the brokers' reward to the profit being generated by the lender. Lenders point to some of the short-term fixed rate deals being marketed in the past, which generated no profit during the fixed rate term and borrowers were then simply churned onto other deals with other lenders thereafter, meaning that the numbers simply did not stack up for lenders.

So, will the age-old debate about proc fees ever be resolved? To date it has not and the proc fee system has not actually changed very much at all, since the emergence of the intermediary mortgage sector in the mid-eighties.

I suspect that if a significant change is going to happen, it will require a catalyst such as legislation to make it happen. It will be interesting to see what else comes out of Retail Distribution Review.

In the meantime, although an increasing number of brokers may opt to charge fees, I suspect that the proc fee system will be around for some time to come. n

Paul Field is divisional director (residential lending) West Brom for Intermediaries