Capital treatment of trail commission for authorised deposit-taking institutions using Standardised Approach to Credit Risk
This letter clarifies APRA’s approach to the capital treatment of trail commissions for ADIs using the Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112). The aim is to ensure consistency in the capital treatment of trail commissions across ADIs, regardless of the accounting approach adopted.
ADIs enter into agreements with intermediaries or brokers that provide those parties with a commission for the sourcing of new mortgages (or similar products) on behalf of the ADI. These may take the form of one-off upfront payments and/or ongoing “trail” commissions.
These trail commissions are typically structured to be payable by an ADI only as long as the associated loan remains funded by the ADI regardless of whether this is securitised or on-sold. The obligation to pay the trail commission ends when the loan is refinanced or repaid by the borrower or the loan defaults.
APRA has observed two approaches to the accounting of trail commissions both aligned to Australian Accounting Standards. APRA does not stipulate a preferred accounting approach but notes that it is subject to agreement between the ADI and its auditor. The prudential capital treatment implications of each accounting approach are set out below.
| Accounting approach | Capital treatment |
|---|---|
| Approach 1 | |
| The expense reduces net interest income on a cash basis each time commission is paid. | This will not impact regulatory capital as trail commissions are not reflected on the balance sheet and there is no deduction under Prudential Standard APS 111 Capital Adequacy: Measurement of Capital (APS 111) and there are no changes to loan balances that are risk weighted in accordance with APS 112. Capital is reduced as and when costs are expensed and paid. |
| Approach 2 | |
| The present value of expected future trail commissions is recognised as a liability with a corresponding matching increase in the book value of the loan asset, which is progressively unwound through profit and loss over the expected life of the loan. | This has the potential to increase regulatory capital requirements to the extent that the increased book value of the loan asset is then risk weighted in accordance with APS 112. APRA is aware that some ADIs are netting (also known as on-balance sheet netting) the trail commission asset and liability, which would avoid this increase. |
Under Approach 2, APRA will allow ADIs to net the trail commission asset with its corresponding liability when determining credit risk-weighted assets under APS 112 but only if the ADI meets the specific conditions set out below. When these specific conditions are not satisfied, the ADI must apply the risk weight prescribed in APS 112 applicable to the associated loan inclusive of the trail commission asset.
Specific conditions for netting of trail commissions assets and liabilities
APRA will allow ADIs to net the trail commission asset with its corresponding liability (recorded as a separate trail commission liability) under APS 112 subject to the following conditions being met:
- the trail commission asset must only reflect expected future trail commissions payable;
- the trail commission asset must be extinguished upon loan default, refinancing (or under any other conditions or events specified in the contract); and
- the trail commission asset cannot be less than the corresponding liability, and no net positive impact on Common Equity Tier 1 Capital occurs.
The specific conditions relating to the netting of trail commission assets and liabilities for ADIs using Approach 2 must be supported by robust governance and risk controls and must also adhere to existing requirements, including the annual Risk Management Declaration1 and the auditor’s ongoing reporting obligations2, to ensure continued compliance with prudential standards.
Under the ADI capital framework, netting is permissible only under a limited set of circumstances. This is a narrow scope and targeted approach that applies to trail commissions only. The current practices regarding partial write-off and netting, as outlined in APS 112 remain unchanged. Netting trail commission assets and liabilities affects the calculation of regulatory capital ratios, which must always comply with the requirements in Prudential Standard APS 110 Capital Adequacy (paragraph 25).
Next steps
APRA will look to refine the relevant prudential standards as part of its minor updates to the prudential framework next year. ADIs are also encouraged to share this letter with their appointed auditor. Should you have any questions relating to the application of these requirements, please contact your responsible supervisor.
Yours sincerely
Therese McCarthy Hockey
APRA Board Member
Footnotes
1Refer Prudential Standard CPS 220 Risk Management (paragraph 49).
2Refer Prudential Standard APS 310 Audit and Related Matters (subparagraph 36(d)(i)).