Who Do You Work For?
In 2019, we received the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. This report represented a significant turning point for banks and financial institutions across the country, as a spotlight was shone on shonky practices that didn’t have customers’ best interests at heart.
Throughout 2019, stories have continued to be published around bad practices in the financial sector, with regulators now coming down hard on any wrongdoing. Whilst this has largely focussed on retail banking practices, there are stories of caution for businesses seeking investment as well.
The Role Of The Broker Is Broken
One of the main targets of the Royal Commission’s wrath was the broker industry. Brokers are supposed to be the trusted advisors of borrowers, helping them navigate the various lenders available and find the best deal that meets their financial requirements.
Commissioner Hayne’s point was simple – these brokers were not acting in their clients’ best interests. He attributed the cause to a highly opaque incentive structure, whereby the borrower would not have to pay anything directly and the lender would pay the broker a commission (both upfront and trailing) that was linked to the placement of loans.
This incentive structure created the illusion that borrowers were receiving a free service. The broker would say, “If I don’t deliver you a better price and a successful loan, you don’t need to pay anything.” For borrowers, this seemed like a risk-free option. What did they have to lose?
It turns out, they were losing out on receiving advice based on their financial requirements.
For brokers to be able to claim they were providing a free option, all fees and charges were built into and hidden within the loan agreement. This removed all the friction with the customer. The industry grew exponentially to more than 200,000 people off the back of this practice and represented over 50 per cent of residential loans written.
Under this type of agreement, there is no client for the broker. Their own self-interest was the ultimate driving force and to achieve their own financial success all they needed to do was keep a series of stakeholders happy. It now seems obvious what the outcomes of these incentives were:
- Brokers were incentivised to place loans where they get paid the highest commission, not necessarily the loan which was best for the client. In fact, the borrower won’t even see the cheaper options with lower commissions.
- Brokers were incentivised to push loans. If brokers do not get paid unless loans get written, they will of course never advise to exit an investment or simply do nothing.
This doesn’t bode well for the customer and chances are, the deal they are getting is not the right one for them.
A Widespread Issue Impacting Business Funding Opportunities
If you think this type of behaviour is only reserved for dodgy retail brokers or “mum and dad” investors, you’d be wrong. These financial incentives are built into the very fabric of the financial system and are even embedded in more sophisticated lenders.
Advisors to mid-market companies very regularly receive payments from investors or lenders as opposed to (or as well as) the client themselves. The mid-market business borrowers become a stakeholder that is very much transient. The real long term customer is the investor, the one that pays the regular commissions that are built into fee arrangements.
This flawed system means mid-market borrowers are receiving the same treatment as retail customers – an offer based on commission rather than on their financial requirements.
At Neu Capital, we recognised this flaw within the system right from our inception. The Neu in Neu Capital stands for Neutral. That means we are neutral with respect to our investors. We do not receive any payment from any investors. The fees we agree with the client are the only fees that we receive. Ultimately, this means we will always be aligned with you in getting the best option – not the best commission for us.
Our fees are a mix of fixed and success-based, meaning we will never blindly push a client towards a deal that does not make sense or will not bring success. This means that sometimes, the best outcome for our clients is to walk away. Some may need to identify a different deal, one that is structured towards their bespoke needs. Whilst others need a partner as well as an investor, meaning the deal is more than just money.
This is how financial capital is supposed to work. Hayne has gone a long way in shining a spotlight on these practices but they will still exist, particularly in the world of private investment. If we’ve learnt anything from the Royal Commission this year, it is that financial products must be in the best interest of the customer. We just need to make sure the industry as a whole recognises this and structures incentives accordingly. This is what we have done at Neu Capital to help our clients and investors secure win-win scenarios where both parties meet their objectives.
To find out how Neu Capital can secure the best funding opportunity for your business, or even to know whether funding is right for you, contact us today.