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Systemic Issues - Update

Systemic Issues & Serious Misconduct - Update


This is a summary of the systemic issues that we identified during the March quarter of 2011 and reported to ASIC.

This summary does not include details of the outcome or resolution of the systemic issues as they may not yet be resolved and, in any event, outcomes or resolutions to systemic issues are formulated on a case by case basis.

Our systemic issues process is outlined in the December 2010 Circular ( To learn more about our process you can now access Systemic Issues online training on the FOS website click the following link:

The new Systemic Issues online learning module aims to familiarise learners with the FOS approach to Systemic Issues Management. The Systemic Issues Management Process is used by FOS for handling the identification and resolution of Systemic Issues as required by its obligations to the Australian Securities and Investments Commission.

By completing this online training, participants should be able to:

  • provide an overview of Systemic Issues and their impacts
  • explain the purpose of the Systemic Issues Management Process
  • understand how the FOS Systemic Issues Management Process can help businesses with their risk management framework

CPD points are available upon completion.

Proximate disclosure of break cost on switch

FOS considered several disputes related to a financial services provider’s (FSP’s) process and notification of early repayment fees when a customer switches investment loans from a variable rate to a fixed rate. The issues reviewed as potentially systemic related to whether the FSP had:

  • appropriate processes in place to ensure that customers with variable rate home or investment loans were provided proximate disclosure of break cost provisions when switching their loan to a fixed rate, and
  • provided misleading information in the documentation given to customers about their liability to pay break costs if they chose to exit their fixed rate home loans before the term had expired.

It appeared from information provided by the FSP during the course of the investigation that it had revised its documentation in an attempt to improve disclosure. However, FOS remained concerned that the amended wording did not provide a sufficiently clear warning to customers of their future liability to pay a break cost.


Delay in switch causing loss

A number of disputes involving one FSP illustrated that, even though the FSP provided a break cost quote to its customers that was valid for seven days, it was unable to process requests to switch loans to a variable rate during that time frame. As a result, customers could lose money,  particularly if they made the switch when interest rates were falling.

The FSP said that it had introduced improvements to its loan switching process in March 2010, resulting in reduced processing times.  Nevertheless, it did acknowledge that it had not always been able to process switch requests from customers within the seven days that the break cost quote remained valid and that there may have been a class of customers affected by this issue. 

Error in credit listings

A number of disputes received at FOS illustrated that the FSP may have listed a credit default against its customer even though a demand for payment was made after the listing was made. The FSP explained that problems arose when it used a third party to assist with debt collection.  It also provided a copy of its policies and procedures for notifying account holders of a default and warning them of a possible listing.  It confirmed that its policy is to report defaults in accordance with applicable laws and regulations. Nevertheless, it acknowledged that it had received 12 other similar complaints about the actions of its third party agent in 2010. It appeared, therefore, that there were customers other than those who complained to FOS that had been affected by this issue.

Calculation of break cost

FOS considered a substantial number of disputes involving one FSP that illustrated that the break cost charged by the FSP may have been unreasonable. In each of the disputes, following review by FOS’s Banking Adviser and comparison with the FOS method for calculating break costs, we found the break cost charged to be unreasonable.

The issues reviewed as possibly systemic included the FSP’s method for calculating break costs and the contractual disclosure of the calculation method in its fixed rate contracts.

Following an independent review of its calculation method, the FSP acknowledged that it had identified a cash flow error in its method. It agreed to identify customers affected by the error and to recalculate their break costs and reimburse them if they were charged too much.

Reasonableness of break cost methodology

Following receipt of a number of disputes involving one FSP, FOS identified a potentially systemic issue relating to the FSP’s break cost calculation method prior to 1 October 2010. The method included a credit spread at either end of the calculation of the break cost.

In its response to FOS, the FSP acknowledged that, while on average its hedging was adversely affected by credit spreads, the magnitude of the spread was variable and it was unable to make an accurate assessment of its costs in that regard. It had nevertheless agreed to formulate a new break costs method that excluded credit spreads from 1 October 2010. Even though FOS was pleased with the FSP’s decision to revise its break cost method from 1 October 2010, its view was that the FSP should be identifying all affected customers from 1 September 2008 and reimbursing them with the differential (if any) between the break cost charged to them by the FSP and the break cost that would have been charged if the FSP used the new method for calculating break costs, including interest on the reimbursement.


Disclosure of lump sum repayments

FOS considered a dispute regarding the FSP’s apparent practice of calculating a break cost following lump sum repayments to the loan on the anniversary of the loan’s commencement, in some cases up to a year after the break cost event  occurred.  The issues being reviewed as potentially systemic were whether the FSP provided adequate information disclosure in its loan contracts about how it accounts for lump sum repayments and whether its method for calculating a break cost liability in these circumstances represents a fair and reasonable estimate of its loss.

In particular, FOS was concerned that calculating and charging the break cost fee on the anniversary date of the loan may result in a calculation that is not a fair and reasonable estimate of loss.  This would be of particular concern in a falling interest rate environment because the break fee payable at the time of the prepayment (when the loss is crystallised) would be less than on the subsequent anniversary. 

The FSP agreed to review its break cost calculations data for the period 1 September 2008 to date:

  • To establish how many, if any, customers made lump sum repayments to their fixed rate home loans that resulted in a break cost calculation being performed on the anniversary date of the loan; and
  • To determine whether break cost fees paid by these customers were higher than if the calculation had been made on the date the lump sum repayment was made.