Martin North – Page 1039 – Digital Finance Analytics (DFA) Blog

Enhanced Financal Adviser Register Necessary, But Not Sufficient

The Treasury has released their proposals for an enhanced Financial Adviser Register for consultation. On 17 July 2014, the Government announced that it would establish an enhanced register of financial advisers, and on 24 October 2014, the Government announced details of the register’s content. Whilst the register is sound (we do not know how many advisers are operating in Australia), and the enhancements are appropriate given the issue of trust with respect to financial advice, DFA is of the view there are still significant gaps in relation to remuneration of advisers and potential conflicts. You can read our recent comments. In addition, further consideration needs to be given to how someone would find a suitable adviser. The MoneySmart Government website refers people to the professional associations, advice from friends and you can check the adviser or licensee’s name on ASIC Connect’s Professional Registers. However, currently advisers who are ’employee representatives’ will not appear on the register as their employer holds the AFSL. This is a muddled processes, and leaves consumers in the dark. More fundamental consideration needs to be given to this from a consumer perspective.

Turning to the current Exposure Draft, the Regulation proposes to make a number of amendments to the Corporations Regulation 2014 to:

enable ASIC to establish and maintain a public register of financial advisers; and
for Australian Financial Service licensees to collect and provide information to ASIC concerning financial advisers that operate under their licence.

A Consultation Note has also been developed to invite feedback from stakeholders on the key drafting issues, to ensure that the Regulation will implement the Government’s policy intent. This Consultation Note also includes: information on timing to enable the Register to be implemented by March 2015; and detail on the form lodgement fee increases necessary to fund the register. Submissions can be made to 17th December 2014.

Picking up on the background in the supporting papers, currently, a person who carries on financial services businesses must obtain and maintain an Australian Financial Services Licence (licence) with the Australian Securities and Investments Commission (ASIC). This person is referred to as a financial services licensee (licensee). Among other things, a person carries on a financial service business if they provide financial product advice. Currently, financial advice is classified under two categories. ‘Personal advice’ is financial product advice which takes into account the personal financial circumstances of the client. Any other financial product advice that does not take into account the client’s personal circumstances is termed ‘general advice.’ Individuals may provide financial product advice in a range of circumstances. They may be licensees themselves; or directors or employees of licensees. They may be non-director/non-employee representatives of licensees – these individuals are referred to as ‘authorised representatives’. In certain circumstances, an authorised representative can ‘sub-authorise’ another authorised representative to act on behalf of the licensee.

‘Representative’ is the overarching term used to describe authorised representatives, director representatives and employee representatives (including those that operate under a related body corporate of the licensee) and any other person acting on behalf of the licensee, that provide financial services under a licence. Responsibility for day-to-day supervision of representatives operating under a licence is devolved to licensees. Financial services licensees are not required to provide ASIC with certain information on director or employee representatives that operate under their licence. This may be contrasted with the requirements imposed on a licensee when it authorises a non-employee or non-director representative to act on its behalf. For these authorised representatives, licensees must lodge certain information with ASIC, and then ASIC must maintain a register of these individuals. Consequentially, there is no register that provides information to consumers, the financial advice industry, or ASIC regarding employee and director representatives of licensees. ASIC is currently only required to maintain public registers of licensees and authorised representatives of licensees. These registers provide information on a licensee or authorised representatives’:

registration/licence number;
licensee name/authorised representative name;
address;
start date of registration/licence;
history of previous licensees (for authorised representatives only);
status (whether the licensee/authorised representative is currently authorised); and
details of any conditions or restrictions about the registration.

As ASIC currently maintains registers of licensees and authorised representatives, but not other representatives of licensees, the total number of financial advisers operating in Australia is not known. There is also limited information available about financial advisers who are director or employee representatives. This transparency gap means consumers cannot easily check whether a particular individual is authorised to give them financial advice, or look up other information that would be valuable to them when verifying the credentials and status of an individual adviser. This gap also means that ASIC has limited visibility of the natural persons providing personal advice on more complex products to retail clients, and is restricted in its ability to identify, track and monitor these individuals who move from licensee to licensee as employees or directors. As a result, this limits ASIC’s ability to take action against individual advisers over and above action that relates to the relevant licensee.

The proposed new law will require a register of all individuals who provide personal advice on more complex products to retail clients under a financial services licence will enable consumers to verify that their individual adviser is appropriately authorised to provide advice and find out more information about the adviser before receiving financial advice. A comprehensive register will also assist ASIC to a regulate advisers who move between licensees as well as enabling the financial advice industry to better protect itself from rogue financial advisers. The new register will be limited to those providing personal advice on more complex products to retail clients – focussing on the area where rogue advisers or ‘bad apples’ present the greatest risk to consumers. The new register will build from the existing registers, and also contain information informing consumers of an adviser’s experience, their recent work history, the eventual owner of licensee they work on behalf, as well as information about whether ASIC has banned, disqualified or obtained enforceable undertakings in relation to them. It is intended that the register will, in time, also contain educational qualifications and professional association membership information. This would require further amendments to the Principal Regulations. The benefits of the enhanced public register include:

providing an easily accessible central record of the competency, employment history and misconduct of individual advisers;
assisting ASIC in its compliance activities and ability to respond to problem advisers;
assisting the industry itself to address risk where ‘bad apples’ are concerned; and
providing broad support for industry efforts to improve professionalism of the industry.

Housing Construction Boom Wavers

The ABS published their preliminary construction work done data to September 2014. Overall the seasonally adjusted value of construction work done dropped 2.2 % to $51,146.4m in the September quarter and makes a 5.1% fall this year. Within the data, NT construction rose, helping to trim the damage, but the result was below market expectations. Within the data. new private residential construction fell by 2.0 per cent in the September quarter but is still 9.7 per cent higher for the year. But the big question is, has construction begun to falter, or will growth continue – building approvals data could suggests it has some way to run, but it looks a little more shaky now. The RBA is banking on construction powering on of course to reach escape velocity as the mining investment boom fades.

The seasonally adjusted estimate of total building work done fell 1.0% to $22,435.8m in the September quarter. The trend estimate for engineering work done fell 3.0% in the September quarter.The seasonally adjusted estimate for engineering work done fell 3.2% to $28,710.6m in the September quarter.

The trend estimate for total construction work done fell 1.2% in the September quarter 2014 but the trend estimate for total building work done rose 1.5% in the September quarter. The trend estimate for non-residential building work done rose 0.9%, while residential building work rose 1.8%. The trend estimates are derived by applying a 7-term Henderson moving average to the seasonally adjusted series. The 7-term Henderson average (like all Henderson averages) is symmetric but, as the end of a time series is approached, asymmetric forms of the average are applied. Unlike weights of the standard 7-term Henderson moving average, the weights employed have been tailored to suit the particular characteristics of individual series. So looking at trend data we see new houses more static than other residential development, (units).

This is shown more starkly if we look at percentage distribution. Whilst conversions are relatively static, units and other non-house residential building is showing more momentum.

The original state data shows that more new houses were built in VIC than NSW, with WA and QLD close together.

Turning to other types of residential building, we see that around 70% are locate across NSW and VIC. We see a spike in ACT units in 2011, but this seems to be slowing now. In WA more houses than units are being built.

OECD Warns Again On Housing

The OECD Economic Outlook 2014 Issue 2 has been released in a preliminary version. There are some important warnings which the RBA should heed. Essentially, OECD is highlighting again the risks in the current RBA policy of using low interest rates to drive housing growth in lieu of mining investment. They appear to believe rates should be taken higher and additional prudential measures should be taken.

Output growth is projected to dip to 2.5% in 2015 but recover to 3% in 2016. Declining business investment will be countered by gathering momentum in consumption and exports. Growth at the projected pace will be enough to lower the unemployment rate, although consumer price inflation will remain moderate due to economic slack.

Fiscal policy should continue to aim for a budget surplus by the early 2020s but given economic uncertainties, it should avoid heavy front loading. Short of negative surprises, withdrawal of monetary stimulus should start in the second quarter of 2015. The booming housing market and mortgage lending will require close attention by the authorities. There is room for both fiscal and monetary policy to provide support in the event of unexpected negative economic shocks.

The Australian economy is going through a period of adjustment as activity has to shift from the previously booming resource sector. Cooling commodity prices and declining resource-sector investment have resulted in job and output losses, but a lower exchange rate is lifting employment and exports elsewhere in the economy. House price increases are encouraging construction and consumption, but are also a concern in that a sharp reversal could cut aggregate domestic demand.

The Reserve Bank of Australia’s (RBA’s) policy rate has remained at 2.5% since August 2013, well below historical norms. Though helping economic adjustment, this monetary support has intensified search for returns by investors. This requires close oversight of asset-market developments, particularly rising housing credit, which is now being driven by investors. Further prudential measures on mortgage lending should be considered as a targetted means to cool the market, thereby heading off risks to financial stability.

External risks remain prominent, with recent steep falls in some commodity prices exemplifying the potential for rapit change in resource revenues. Domestically, the momentum in property prices is uncertain and could unwind sharply. When and how quickly non-0mining investment picks up is uncertain, as is the degree to which households will dip further into savings to sustain their consumption.

High LVR Lending More Risky – RBA

The RBA today published a paper on “Mortgage-related Financial Difficulties: Evidence from Australian Micro-level Data.” Although default rates in Australia are lower than in many other countries,

their research paper delved into the different types of mortgage lending, using loan-level pool data provided by MARQ Services and concluded that higher LVR lending, and interest only loans were more risky than average.

Our loan-level analysis suggests that loans with high loan-to-valuation ratios (above 90 per cent) are more likely to enter arrears, while loans that are repaid relatively quickly are less likely to enter arrears. Together, these results reinforce the importance of supervisors carefully monitoring changes in lending standards that affect the loan-to-valuation ratio of loans at origination and rates of principal repayment thereafter. Although interest-only and fixed-rate loans appear less likely to enter arrears, the fact that these loans tend to be repaid relatively slowly (particularly interest-only loans) means that increases in these types of lending can represent an increase in risk. Additionally, low-doc loans appear more likely to enter arrears than other types of loans, even after controlling for whether the borrower was self-employed. This suggests that lenders should maintain sound income documentation and verification policies, and that supervisors should continue to monitor developments in the low-doc lending space.

Borrowers with relatively high mortgage interest rates have a higher probability of entering arrears, even after controlling for the estimated minimum mortgage repayment, which is consistent with riskier borrowers being charged higher interest rates to compensate for their higher risk. We caution, however, that the loan-level results are affected by data limitations, such as a lack of information on borrower income, wealth and labour force status, and a relatively small sample of banks.

Complementary analysis using household-level data suggests that having a high debt-servicing ratio (above 50 per cent) significantly increases the probability of missing a mortgage payment. This highlights the importance of borrowers not overextending themselves by taking out loans of a size that will be difficult to comfortably service. Additionally, it reinforces the importance of lenders maintaining sound debt-serviceability and income-verification policies.
Having previously missed a mortgage payment is also found to be a significant predictor of subsequently missing another mortgage payment. This highlights the heightened risk associated with lending to borrowers with a history of missing payments, and supports the practice of lenders using information on previous debt payment behaviour (such as credit scores) in their credit assessment processes.

Overall, our results reinforce the importance of supervisors carefully monitoring changes in lending standards, as well as the importance of borrowers exercising prudence when taking on mortgage debt.

This is a significant and important contribution to the current debate about how risky the mortgage loan portfolio are. It also chimes with DFA mortgage stress analysis. Today we highlighted the APRA data which showed that both high LVR loans and interest only loans made up a significant element in the current new business mix. This research paper adds further weight to the argument that capital rules needs to be changed to reflect the true risks of mortgage lending.

ADI Residential Property Exposures Up Again

APRA published their quarterly ADI property statistics today to September 2014. ADIs’ total domestic housing loans were $1.3 trillion, an increase of $103.4 billion (9.0 per cent) over the year. There were 5.2 million housing loans outstanding with an average balance of $239,000. The proportion of investment loans moved higher again to 34% of all loans on book. DFA survey data shows a correlation between interest only and investment loans, (thanks to the benefits of negative equity), but APRA does not provide any linked data on this.

Looking at total loan stock, we see a continued rise in interest only mortgages, and loans with offset facilities. Reverse mortgages, low documentation loans and other non-standard mortgages are relatively controlled by comparison.

Turning to the flow data (loans written each month), ADIs with greater than $1 billion of residential term loans approved $85.4 billion of new loans, an increase of $9.1 billion (11.9 per cent) over the year. Of these new loan approvals, $53.5 billion (62.6 per cent) were owner-occupied loans and $31.9 billion (37.4 per cent) were investment loans. Thus we see that overall monthly totals continue to rise, and investment loans are growing faster than owner occupied loans. The 37.4% of investment loans September is understated because the owner-occupied lending data includes refinances, which should be removed from the analysis, to give a true picture of new lending.

Looking in more detail, we see the value of interest only loans rising in recent months, and also a small rise in the number of loans approved outside serviceability. Low documentation loans remain controlled.

Looking at lending by LVR bands we see about 40% of loans being written are above 80% loan to value, and of these around 10% are above 90%. No data is provided on the proportion of loans covered by lender mortgage insurance. This should be.

Brokers are having a field day at the moment, with commissions being increased, and values written rising. The APRA data shows 43.2% of all loans by value were originated via third party channels.

So, the RBA’s plan that the property sector should take up some of the slack left by the evaporating mining sector is still playing out. However, lending for investment property, and interest only lending have higher risks attached, and we think changes to capital rules are still likely to emerge to try and address some of the implicit risks.

Finally, ADIs’ commercial property exposures were $225.5 billion, an increase of $13.5 billion (6.4 per cent) over the year. Commercial property exposures within Australia were $187.4 billion, equivalent to 83.1 per cent of all commercial property exposures.

Digital Banking Gap Is Accelerating

Using the latest data from the DFA channel preferences survey, last published in the report “The Quiet Revolution“, today we chart the top line digital banking scorecard, from the demand side, looking at different household groups, and on the supply side what banks are doing to embrace digital. The rate of change in terms of bank participation in digital, is tracking the rate of adoption of those who are Digital Migrants, and they are moving faster than those households in the Digital Luddite segments. However, it appears that whilst the Australian banking sector is moving towards digital, those who are digitally literate – the Digital Natives – have ever more enhanced desire to do more digitally. Indeed, the digital gap between expectations and delivery is widening. You can read about our digital segmentation here.

The rate of digital migration is closely tracked by the uptake of smart phones and tablets. Digital Natives are the most likely to be using one of these smart devices, and they have a strong desire to manage their entire financial service footprint digitally. This is true whether it is buying a mortgage, making a payment, or checking a transaction. We know from our profitability analysis that Digital Natives are on average more valuable to the industry, tend to be younger, and better educated, and are significantly less likely to enter a bank branch for any purpose. They use social media and online search tools, and trust these information channels more than a typical bank. They also have high expectations in terms of customer service delivery, and personalization. Many banking players are not meeting these expectations.

DFA is of the view that banks need to accelerate their rate of migration to the digital world, and position to respond to the rising number of new entrants which have the potential to disrupt significantly. We recently discussed Apple Pay, PayPal and Ratesetter. Each of these have potentially disruptive impact. As we said recently:

“DFA has just updated the 26,000 strong household survey examining their channel preferences. This report summarises the main findings.

We conclude that the move towards digital channels continues apace, facilitated by new devices including smartphones and tablets, and the rise of “digital natives” – people who are naturally connected.

We outline the findings across each of our household segments, and also introduce our thought experiment, where we tested household’s attitudes to the various existing and emerging brands in the context of digital banking. We found a strong affinity between digital natives and the emerging electronic brands, and a relative swing away from the traditional terrestrial bank players.

These trends create both threat and opportunity. The threat is that traditional channels, especially the branch, become less relevant to digital natives, and becomes the ghetto of older, less connected, less profitable customers. The future lays in the digital channels, where the more profitable and digitally aware already live. Players need to migrate fast, or they will be overtaken by the next generation of digital brands who are looking towards becoming players in financial services. The game is on!”

APRA Extends Basel III Consultation

APRA today extended the consultation period on the changes to Basel III disclosure requirements.

On 18 September 2014, APRA released for consultation a discussion paper and draft amendments to Prudential Standard APS 110 Capital Adequacy and Prudential Standard APS 330 Public Disclosure, which outlined APRA’s proposed implementation of new disclosure requirements for authorised deposit-taking institutions (ADIs).

The disclosures are in relation to:

the leverage ratio;

the liquidity coverage ratio; and

the identification of potential globally systemically important banks.

This consultation package also proposed minor amendments to rectify minor deviations from APRA’s implementation of the Basel Committee’s Basel III framework.

APRA’s intention was that, subject to the outcome of the consultation, these amendments would come into effect from 1 January 2015. A number of matters remain to be addressed before APRA is able to finalise the new standards. Accordingly, given the limited period of time remaining before the scheduled implementation date, APRA is advising affected ADIs that any new requirements will not take effect until 1 April 2015 at the earliest.

UK Banks To Improve Complaints Procedures

The UK FCA has completed an assessment of the complaints processes at 15 major retail financial firms – seven banks, two building societies, three general insurers and three life insurers – using hypothetical customer complaints. According to the results of the research, the firms chosen accounted for 79% of banking complaints, 60% of home finance complaints, 26% of general insurance complaints (excluding PPI), 42% of life insurance complaints and 42% of investment complaints reported to the FCA’s predecessor the Financial Services Authority between July and December 2012.

The review was conducted by a working group made up of the 15 participant firms and five trade bodies. The FCA also sought the views of the Financial Ombudsman Service and consumer groups.

“We asked firms to carry out self-assessments to better understand how complaints are dealt with in practice, as well as providing their documented policies, processes and management information (MI) for our review. We also established, and chaired, a working group of the participant firms and trade bodies to identify and discuss common complaint-handling issues. Our approach provided valuable insight into how firms manage their complaint functions. This allowed us to observe any barriers to effective complaint handling.”

But while the FCA found some improvements have already been made, such as senior management becoming more engaged with complaint handling and firms empowering staff to make the right judgements and to demonstrate empathy, the review also identified areas requiring further improvement. For example:

Firms do not always consider the impact on consumers when designing and implementing processes and procedures.
There are inconsistencies in the amount of redress offered, particularly for distress and inconvenience.
Firms take a narrow approach to determining and fixing the underlying reason for a complaint, which may affect their awareness of wider issues.

The FCA is asking all financial firms, not just those that took part in the review, to consider the findings and to ensure their complaints procedures “have the interests of consumers at their heart”.

The working group also recommended changes to FCA rules on complaint handling, such as ensuring all complaints are reported to the regulator rather than just those that take longer than one working day to resolve. The FCA is now considering these recommendations and will consult on possible policy changes.

Securitisation Update

The ABS published their data on Assets and Liabilities of Securitisers in Australia. At 30 September 2014, total assets of Australian securitisers were $131.7b, up $0.1b (0.1%) on 30 June 2014. This continues the flat trend, despite growth in house prices and lending for property purchase.

During the September quarter 2014, the rise in total assets was due to an increase in other loans (up $0.8b, 5.1%) and cash and deposits (up $0.2b, 4.1%). This was partially offset by decreases in residential mortgage assets (down $0.9b, 0.8%). Residential and non-residential mortgage assets, which accounted for 82.1% of total assets, were $108.1b at 30 September 2014, a decrease of $0.9b (0.8%) during the quarter.

At 30 September 2014, total liabilities of Australian securitisers were $131.7b, up $0.1b (0.1%) on 30 June 2014. The rise in total liabilities was due to the increase in long term asset backed securities issued in Australia (up $1.7b, 1.8%) and loans and placements (up $0.5b, 3.1%). This was partially offset by a decrease in asset backed securities issued overseas (down $1.5b, 12.0%).

At 30 September 2014, asset backed securities issued overseas as a proportion of total liabilities decreased to 8.3%, down 1.1% on the June quarter 2014 percentage of 9.4%. Asset backed securities issued in Australia as a proportion of total liabilities increased to 78.2%, up 1.4% on the June quarter 2014 percentage of 76.8%.

Finally, looking at loans to households and private non-financial corporations, we see the proportion which are residential mortgages falling to 85%.

UK Banks Fined For IT Failures

The Prudential Regulation Authority (PRA) is today fining Royal Bank of Scotland Plc (RBS), National Westminster Bank Plc (Natwest) and Ulster Bank Ltd (Ulster Bank) £14 million for inadequate systems and controls which led to a serious IT incident in 2012. This is the first financial penalty the PRA has imposed since it came into being in April 2013. The Financial Conduct Authority (FCA) has separately fined the banks for the same incident.

In April 2013, the PRA and FCA announced that they would investigate the RBS, Natwest and Ulster Bank IT incident which led to widespread disruption to customers and the financial system. A joint investigation was considered necessary because the incident impacted upon the objectives of both the PRA and the FCA.

The IT incident, which began on 18 June 2012, directly affected at least 6.5 million customers in the United Kingdom, 92% of whom were retail customers. The IT incident had the potential to have an adverse effect on the safety and soundness of RBS, Natwest and Ulster Bank as it impacted upon:

the ability of the banks’ retail customers to access their accounts;
the ability of the banks’ commercial customers to access their internet banking service, preventing them from accessing their accounts or making payments;
customers of other institutions who were unable to receive payments from the banks’ affected customers; and
the ability of the banks to fully participate in clearing. An efficient clearing system is fundamental to the efficient operation of the financial markets.

Disruption to the majority of RBS and Natwest systems lasted until 26 June 2012, and Ulster Bank systems until 10 July 2012. Disruptions to other systems continued into July 2012. The cause of the IT incident was the failure of the banks to have the proper controls in place to identify and manage exposure to the IT risks within their business.

Properly functioning IT risk management systems and controls are an integral part of a firm’s safety and soundness. The PRA considers that the IT incident could have threatened the safety and soundness of the banks and could have, in extremis, had adverse effects on the stability of the financial system in that it interfered with the provision of the banks’ core banking functions, impacted third parties and risked disrupting the clearing system.

Andrew Bailey, Deputy Governor, Prudential Regulation, Bank of England and CEO of the PRA said:

“The severe disruption experienced by RBS, Natwest and Ulster Bank in June and July 2012 revealed a very poor legacy of IT resilience and inadequate management of IT risks. It is crucial that RBS, Natwest and Ulster Bank fix the underlying problems that have been identified to avoid threatening the safety and soundness of the banks.”

The banks agreed to settle at an early stage and were therefore entitled to a 30% discount, without which they would have been fined £20 million.