The cost of compliance

In this issue of TMM, we look at regulation through the eyes of mortgage advisers - starting with the bottom line. For one adviser, complying with all the new legislation costs almost $100,000 a year.

BY ERIC FRYKBERG

How much does it cost a business to comply with all regulatory changes?

TMM wanted hard information, so we asked an independent financial adviser to open the books - to show us exactly how much he was compelled to pay given successive waves of state regulation.

The answer? Regulatory compliance was adding just under $100,000 a year to his operating costs.

The exact total was $99,687.61, including GST.

This was an actual figure, taken from actual accounts, and so was commercially sensitive. As a result, TMM has undertaken to anonymise the data and to withhold even the geographical location of the company in order to safeguard its privacy.

Broken down, the largest cost was $67,500 a year for a fulltime office manager to deal with compliance.

FAP (Financial Advice Provider) expenses cost $3680 annually, separate from formal FAP application fees.

Engaging a business mentor/board member to handle compliance issues cost a further $8970, and a biannual audit cost $7590 a year.

Extra costs were added for various items such as indemnity insurance.

The proprietor of the firm says regulation has dramatically increased overheads.

New regulations continually impose fresh costs on the lending industry, but do not offer any obvious suggestions in terms of where to look for the money to pay the bills.

“We can't make up for this cost,” he says. “We get paid what we get paid.

“This is a hot topic for us: how do we entwine fees for services with the commission that we are paid already. It’s a hot potato.”

What to do, Minister?

This conundrum faced by small businesses was put to the new Minister of Commerce and Consumer Affairs, Duncan Webb.

“There is space to look carefully at what the law says,” said Webb.

“There may be, and there certainly was… a tendency to take a belt and braces approach, which goes further than the legislation, regulations and guidance require.”

Webb insisted he wanted to have a diverse lending industry, not one dominated by a few big players.

“I want to see a sector which can be innovative and nimble, and deliver good products at the best and lowest cost to consumers.

“But, at the same time, we have seen situations historically where there haven't been good lending practices, and so it is absolutely the Government's role to make sure that we have improved those practices.”

Beyond suggesting advisers examine the fine print of a state regulation carefully before proceeding, and avoid any overreach, Webb did not offer any significant solutions to the problem of broker costs - and continued to insist the matrix of state rules was positive for New Zealand as a whole.

Flying blind

In response, the adviser with the $100,000 bill says if the industry is taking compliance too far, it is doing so only for safety’s sake: no one knows how much compliance is needed, so it is prudent to do too much, not too little.

In response, Webb offered no real solutions beyond saying that small firms needed to be very careful about the costs and obligations they took on.

For smaller operators, he suggested the problem might stem from taking their compliance obligations further than required.

“Everybody is flying blind until the Financial Markets Authority (FMA) starts putting a line in the sand in terms of taking people to court,” says the adviser.

“The Minister himself doesn't know. He doesn't know the consequences of these new regulations.

“So we are being overprotective, because we don't know what all this is going to lead to.”

Webb will end up getting the opposite of what he wanted, the adviser adds, because the costs of compliance will drive small operators into the arms of aggregator groups, thereby reducing the number of independent players.

“Exactly the thing that he didn't want [will have] happened.

“You’ve got a whole lot of independent advisers operating under an aggregator's FAP.

“They lose a portion of their autonomy because they are having to adhere to the third party, the FAP and the aggregator.”

A burden of many parts

Broken down, the compliance burden has many sub-sections.

One is the steady implementation of the Financial Services Legislation Amendment Act (FSLAA), which set up the FAP regime.

Another is the Financial Markets (Conduct of Institutions) Amendment Act (CoFI), the impact of which is described elsewhere in this issue.

Then there is the old bugbear, the Credit Contracts and Consumer Finance Act (CCCFA), which continues to cause irritation despite Government efforts to lessen its sting.

Flap over FAP

The steady progression toward full FAP licensing has riled some advisers.

Despite years to get ready for the new regime, which started this month, most dealer groups report they had advisers who had not completed their Level Five qualifications as the deadline loomed.

The new licensing regime was designed to put all financial advisers on a level footing, and to ensure advice was available to New Zealanders.

Super City mortgages owner and adviser Marchy Pang says the need for full licensing will cause some advisers to move on.

He cites a colleague with 25 years in the business under his belt, who will choose the final FAP deadline as the right moment to quit.

But Pang says not all cases are like this.

Other advisers will leave the industry because they fall short of the standard required by the new rules, bringing more work opportunities for those who are left.

The FAP regime will also improve standards in the industry, he says, so all up it has some merit.

“The good guys will stay, there will be more quality [among advisers], and eventually there will be benefits for the client.”

Full licensing requires high-level compliance in many areas, such as having dependable cyber security.

But none of this is a surprise.

Many large companies in the mortgage business saw what was coming when the whole process began with legislation in 2019, so they got in early.

Squirrel is one such firm.

Squirrel managers recognised that satisfying the new rules for full licensing was an essential part of doing business, so they just went ahead and did it. The company met the full licensing requirements long ago.

Even so, it’s one thing to grit your teeth view, there are three lines of defence: you operationalise compliance and risk management... and then you need to have a second layer, which is compliance oversight... and then the third line of defence is assurance and governance.”

Bell says his company mustered strength well ahead of time to deal with this new era.

“We have been well ahead of the curve in terms of requirements; 99% of our team have completed their Level Five qualification,” he says.

“There are a couple of stragglers still finishing some stuff off. But we got our full licence at the beginning of last year, and got an evolved compliance and risk division [up and running].”

Bell says while Squirrel has enough resources to complete all the obligations imposed on them by regulators, some smaller firms will have been battling to keep up - not only to acquire the appropriate certification, but to actually implement the demands put on them.

He says smaller businesses will need to rely more than ever on larger organisations such as aggregator groups.

Dealer group responsibility

New Zealand Financial Services Group (NZFSG) central and southern regional manager Shaun Fafeita says the dealer group has a lot of responsibility in dealing with regulations because of its broad membership.

“We have to make sure that everyone under our licence adheres to our policies, so we promote these and educate people wherever we can.

“Whether by email or webinars, we have to get our message across.

“Because come full licensing, there are no ifs and buts: you’ve got to comply.” and comply with the rules, but quite another to say it was easy.

Squirrel chief customer officer Dan Bell says the FAP process was no small thing; the new regulations have dramatically increased the amount of work his team had to do in the office.

“Of course it does, 100%. It is certainly increasing the cost of doing business, that’s for sure.

“And those costs need to be absorbed somewhere.”

For Bell, the changes signal a whole new level of oversight of the industry.

“The expectation is that the Financial Markets Authority (FMA) is going to start more actively supervising the sector, so at some stage they’re going to come knocking at the door [to do an inspection].

“From a risk management point of

Fafeita says NZFSG has to look both upwards and downwards: upwards towards the expectations of the FMA, downwards to the authorised bodies for whom it gets a licence, but who still need watching over.

“And we have to look sideways as well, because, as a dealer group, we’ve also got obligations towards our lender and insurance partners; we are responsible to them as well in terms of meeting their obligations.

“Technically, they’ve got their own licence, so they can row their own boat. But we are still responsible as a head group, because the banks have traditionally signed their adviser off under a head group, to give advice on their particular products.”

Unlike some in the industry, Fafeita is not too fired up about the waves of regulatory change, despite the extra responsibility and a significant amount of hard slog.

“Yes, it has been hard work, but we know what the end result will be.

“It’s going to bring a more professional industry.”

Sore heads from the CCCFA

For Maurice Mehlhopt, the new regulations cause endless headaches.

Like many of his colleagues, his particular bugbear is the Credit Contracts and Consumer Finance Act (CCCFA).

“It just drives my customers mad,” he says.

“The amount of detail they have to fill out [when taking a loan] is unbelievable.”

Mehlhopt specialises in reverse mortgages for older people, often well into their 70s.

These are people who have seen their life savings or superannuation lump sum steadily depleted by the need to top up the state pension every fortnight.

They decide to dip into the equity of their home to give them a financial buffer later in life, to make it less necessary to count every penny.

But Mehlhopt says the CCCFA makes it both complicated and highly irritating to use a reverse mortgage as the solution.

He says when applying for a loan, customers are asked to give large amounts of fine detail about their income and expenses - and are then subjected to further demands as to whether they really need the money at all.

Their response is, “That’s my business”, Mehlhopt says.

“They say, 'If I want to get a reverse mortgage and go have a bloody holiday when I’ve got a couple of million dollars’ worth of assets, what's wrong with that'?”

Mehlhopt is emphatic that the banks which offer reverse mortgages are not responsible for this mess.

He says they behave well towards their would-be clients and are forever apologising for asking intrusive questions, saying they are legally required to do so.

He blames the law itself, calling it “just bloody stupid.”

“It’s got to the stage where some of my clients are saying, 'Maurice, it doesn't matter, I am over it, if that’s what it takes, I will do without it for a while.’”

Amendments not enough

Marchy Pang is another mortgage professional with a strong dislike for the CCCFA.

In its early days, the new legislation made life very difficult, by prying into people's smallest daily costs.

“We had the clients asking, 'Can I have the coffee?', or 'Can I have the subscriptions [to a magazine or TV service]?'

“Throughout the year we have had some adjustments [to the law] come into

CCCFA:

effect, but it is still not enough.”

The new CCCFA rules were applied from December 2021, and caused such an outcry that a reform process began within two months.

A lot of the objections came from lenders and advisers having to account for every cup of coffee, without them having the flexibility to assess a person's overall dependability.

Limited reforms were initiated part way through last year. These eliminated the need for minor daily outgoings to exclude discretionary expenses from lenders' calculations, and ease their need to make conservative assumptions about the ability of would-be borrowers to service their debts.

It would also make debt consolidation or debt refinancing more manageable.

Some groups believe the changes will still not go far enough. They accuse the Government of fiddling around the edges, leaving a substantive problem unaffected.

The National Party has pledged to roll back the CCCFA changes if elected in October.

Pang agrees the CCCFA problem is not yet fixed, though he thinks the changes so far have made the lending business easier to manage.

“Banks are making reasonable adjustments... the need to look at expenses has been slowly relaxed, which is good news.

“We don't have to do a line-by-line examination of how many flat whites the clients have had.” be counted if robust data on a person's creditworthiness was available from elsewhere.

The same reform also ended the need to add savings and investments to a person's expenses, by recognising that these payments were fundamentally different from consumption.

After this reform was implemented, a second tranche of changes got underway. These have been proposed, consulted on, and will be finalised this month.

The potential changes would further

In summary, Pang says the CCCFA is better - but that there’s room for improvement.

Mehlhopt, however, is less charitable.

“If I’m working with a client on the phone taking information, when I send that information in, even though I was AFA-registered, they say, 'Maurice, you’ve altered the application forms, you have to sign it, and date every change you’ve made on that form'.

“You can understand it. The banks want to cover their own butts... but the amount of detail you have to give is just so frustrating.” ✚