How is Brexit likely to affect UK mortgage regulation? Experts say the predicted complexity of withdrawal negotiations means the industry could be in limbo for years
The mortgage market could face a regulatory shake-up when the UK leaves the EU, and experts predict this could take many years.
The most significant EU ruling that affects the sector is the Mortgage Credit Directive, which entered force in March 2016. The rules imposed sweeping changes on the UK regime for second charge mortgages, disclosure documents and foreign currency mortgages.
Mortgage brokers may also be affected by rules governing insurance premiums because, theoretically, the EU’s gender directive could be reversed in a post-Brexit Britain.
The Government has pledged to trigger the Article 50 exit mechanism by the end of March 2017, making a 2019 departure from the EU likely, given the two-year process.
Nature of withdrawal
Experts say much of the impact on the mortgage sector depends on the nature of our withdrawal and whether the UK wishes to retain access to, membership of, or equivalency to the single market.
In theory, membership of the single market requires full compliance with all existing directives and regulations. If the UK were to opt for a passporting system, certain rules requiring a passport would have to apply, which would probably exclude much of the MCD.
Alternatively, there could be a so-called hard Brexit, where the UK has no automatic access to the single market or to an alternative trade agreement. This would provide the most regulatory freedom.
The Financial Conduct Authority says all financial services rules will apply in full until any legislative or regulatory changes are made by the Government. Existing EU regulations apply directly and will have to be reintroduced into UK law in order to apply after Brexit.
Specifically, the regulator has moved to dampen expectations of a rapid dismantling of the MCD, or any thoughts of transitional leeway.
“Very often we have been asked whether firms can ignore all the changes introduced under the MCD, and the answer is: no, you can’t,” FCA mortgage sector manager Lynda Blackwell told the Association of Short Term Lenders conference in April.
“All the changes introduced under the MCD remain unaffected and everything will remain unchanged unless, or until, the Government changes legislation.”
Others say a raft of regulatory change – such as a competition review – is buffeting the mortgage market and will take priority over technical changes to the directive.
But there is hope that more onerous aspects of the MCD that were opposed by the Treasury and the FCA will face eventual extinction.
Your Mortgage Decisions director Dominik Lipnicki says: “If there are any positives from Brexit, it will give us the opportunity to look at our mortgage market and ensure the regulation is suited. Yet I don’t have any more faith in the FCA, Bank of England and British government to do that than I have in the EU.”
The MCD has forced mortgage lenders to implement a series of measures, including a seven-day reflection period and new disclosure requirements. Specifically, lenders must introduce a new form of disclosure document to replace the key facts illustration.
After lobbying, lenders won a five-year grace period before they had to introduce the new European Standardised Information Sheet. Some chose to implement the Esis immediately to stay ahead of the rules, but others opted to wait. Lenders say it is an expensive and cumbersome process and some say they face a dilemma about whether to make the changes at all because the grace period ends in March 2021, by which time the UK will have left the EU.
Building Societies Association head of mortgage policy Paul Broadhead says: “We have a transitional period where some lenders have the Esis and some have the KFI. “It is a difficult decision for the FCA because, if you continue with KFIs, there is a cost for those that have already made changes. And, if you continue with the Esis, there is a cost for those with KFIs.“There is an acceptance that the Esis does nothing better than the KFI and complicates things too. Clearly the KFI is a better document.”
Broadhead says potentially there could be a transitional period during which both the Esis and the KFI were allowed to continue in tandem.
“If I was directing lenders, I would advise them to complete the Esis,” says Telos Solutions chief executive Richard Farr.
“The European conveyor belt crawls and cannot be speeded up. It is terribly slow and the UK is on the path. While the repeal of the Esis may come eventually, it will take time and lenders will have to comply at massive cost and time. It took 40 years to set up and it could take 40 years to get out.”
He adds: “There is no accelerated process for Brexit. You just need to carry on as normal, knowing that things will likely be reversed. There is no alternative.”
Association of Mortgage Intermediaries chief executive Robert Sinclair says financial services rules around Brexit will focus mainly on passporting and whether directives still apply.
“The main issue is on timescales because we have to keep complying with directives until we exit,” he says. “The problem is that the Esis deadline comes into force around the time we exit. I can’t see firms taking it to the brink so it is an issue that is not going to go away.
“Lenders don’t have much choice but to comply at the moment. My sense is that we will stick with the Esis because we have both in the marketplace. There could be some changes in the future but we are pretty stuck in this place and we have to cope.”
A figure at a mortgage lender, who does not wish to be named, says the lender will judge after Brexit whether the Esis should be unwound.
“We have always thought that mortgage markets were national and, although lenders should be able to trade across borders, very few do in practice,” he says.
“Much depends on timing and how embedded the Esis has become by the time we leave. We like disclosure that is suitable for the UK market and protects consumers but, if the Esis has come into effect in a few years’ time, would it be helpful to change it again? There is lots to consider.”
Another disclosure requirement under the MCD is the rule obliging lenders to inform borrowers of their payments in APR form.
Under the MCD, every variable or fixed-rate deal below five years must include an APR that shows how the mortgage could have been affected based on interest rates over the previous five years. The aim is to make consumers better aware of the risks associated with interest rate fluctuations.
The FCA was strongly opposed to the creation of two APRs but was unsuccessful in its lobbying effort in Brussels. Trade bodies and lenders say the requirement will be ripe for change in a post-Brexit mortgage world.
Another contentious area is the MCD’s rules that govern lending in foreign currencies, which sparked a major market shift. The directive defines foreign currency borrowers as those who receive their income in a different currency from that with which they pay their mortgage, or whose mortgage is paid in a different country from that of their residence.
In addition, if borrowers use investments in euros to pay for a UK interest-only mortgage,
for example, this will be classed as a foreign currency mortgage.
The MCD tightened the rules to manage the risk for borrowers. For example, if the currency used to pay a mortgage were to fall sharply, borrowers now could transfer to another currency. Lenders must make borrowers aware if the currency rate falls by more than 20 per cent. In addition, lenders must cap and warn borrowers about any exchange-rate risk to their payments.
The regulations mean banks and building societies that offer foreign currency mortgages are exposed to much greater risk from exchange-rate fluctuations. Many have pulled the plug as a result, such as Bank of Ireland, Lloyds Banking Group, Nationwide and Skipton Building Society.
NatWest Intermediary Solutions, Santander, TSB and Woolwich are among the few that continue to offer foreign currency mortgages.
Sinclair says: “The currency restrictions are definitely something we would like to see disappear but we are stuck with them for now.”
Overseas mortgage specialist Simon Conn works for British borrowers who buy properties outside the UK through foreign lenders. He says after the Brexit vote 5 per cent of his inquiries were to scrap property and mortgage deals and 40 per cent were to put any purchases on hold.
“Holland and Germany have implemented tougher rules on sterling income for their lenders when interpreting the MCD foreign currency rules,” he says. “Many who buy properties in France, Spain, Portugal and Italy rent them out and collect income in euros, which they can use to pay the mortgage.
“There is a lot that could happen in the UK but Britain has not yet put forward a business plan for Brexit. Hopefully, there will be announcements in the coming weeks.”
Perhaps the biggest change provoked by the MCD was the decision to bring second charge mortgage regulation within the first charge regime.
For the first time, all mortgage brokers must inform clients about the potential of second charge deals as an alternative to a remortgage.
Brightstar Mortgages managing director Rob Jupp says the trend was moving towards second charge regulation even before the MCD, the FCA having begun to regulate other areas of consumer credit in April 2012.
“Although the MCD came at an unwelcome time for the FCA because of the resources it demanded, it is now mostly accepted,” says Jupp.
“To have first and second charge mortgages regulated in the same way means it legitimises second charge products. Now that the pain has been taken away, it is probably an unintended positive result of our EU membership. I imagine there will be little or no change after Brexit.”
Sinclair concurs that the FCA was already controlling more consumer credit regulation prior to the MCD.
He says: “The directive may have introduced second charge regulation but we were on that route anyway. Irrespective of the directive, it would have become part of the mortgage rules eventually.”
Another major change emanating from the EU resulted from the December 2012 rules to ban insurance companies from discriminating between men and women when prescribing insurance premiums.
The European Court of Justice decision in 2011 meant women could no longer be charged different rates based solely on their gender.
After leaving the EU the UK may cease to be bound by ECJ decisions, meaning insurance companies once again could discriminate based on gender. Brokers selling general insurance, life insurance or income protection could see premiums and advice procedures change.
In addition, Jupp says the UK could be free to concentrate on areas of regulation with more freedom.“The big issue is non-regulated advice,” he says.
“As long as the resources are available, I expect the FCA and PRA to look at the unregulated sector, including buy-to-let, commercial loans and non-regulated bridging loans, to see if they can be regulated.
“This would see every contract treated as a regulated sale, which could be interesting. When you don’t have to worry about being a member of the EU, it gives you more freedom. Brexit is what it is and we have to get on with it.”
Although trade bodies are keen to dispose of some of the most onerous regulation, there is more concern perhaps about further regulatory upheaval in the sector. There has been a period of frenetic regulatory change and more is to come with a mortgage market competition review and constraints on buy-to-let.
“For some time the industry has been asking for a benign period of regulation in order to innovate,” says Broadhead.
“There are some areas we don’t like but, as these rules are now embedded in UK law, there would be a cost attached to changes. The FCA will have to consult and there will be implementation costs. It is not top of the agenda but some of the stuff that is absolute nonsense will surely disappear eventually.”
Sinclair agrees that regulatory priorities lie elsewhere at the moment and technical changes, even if welcome, will take time to implement.
“EU rules now sit in legislation so it is about how we unwind it and get away from it, which is immensely difficult,” he says.
What type of brexit?
Sinclair continues: “It will depend on whether we have a hard or soft Brexit. In a hard Brexit we will have the capacity to change things but in a soft Brexit we will have to comply with the directives anyway. We all have a wishlist of regulations that could change.”
That wishlist may be fulfilled if the UK gains the freedom to scrap unpopular rules, but the task ahead is both large and complicated.
The mortgage market has a big stake in how Brexit is implemented, including whether the UK retains membership of the single market. Many aspects of the mortgage process will be affected, from foreign currency loans to disclosure. Brokers will be watching closely throughout the negotiations, hopeful that the rules of disengagement will work in the sector’s favour.
UK will scrap any EU mortgage rules it does not want
After formally leaving the EU, we will transfer all regulations into UK law and then sort out and get rid of what we do not like and do not want. That would be most practical.
The issue of passporting and access to the single market looks like it can be solved by awarding the UK regulatory system equivalency status. If we do that in relation to EU rules, it will not be difficult to gain equivalency. Once that regime is in place, we can get to work on what we want to change. There will then be the opportunity to change rules.
Here is an example through my role as chairman of the Enterprise Investment Scheme Association, about which I have been in touch with Chancellor Philip Hammond.
The EU competition commissioner has messed around with our EIS arrangement and the seven-year rule, which has been a pain. EIS investment is a tax-relief structure to boost new firms and is allowed only for companies that have been trading for less than seven years.
Hammond said he understood that, once we had exited the EU, the situation would need to be sorted out, permitting investment in firms more than seven years old without EU constraints on completion rules.
This is one example but there is potentially a raft of rules that can be changed. For anything that affects only the domestic market, we can do what the hell we want because it does not affect equivalency and selling into Europe. We are not going to be selling mortgages or EIS into Europe.
When the EU was conducting its banking reforms in 2013, the UK opted out with its own ringfencing rules under the Vickers Commission. So I am surprised we have to comply with EU mortgage rules when we can do our own thing.
The amount of paperwork involved with financial services these days is a nightmare.
Anything that the Financial Conduct Authority and the Treasury have opposed we can be pretty sure will be gone – the only question is when.
I expect the Government to get to work as soon as we have exited, but there will be a hell of a lot to do.
Lord Howard Flight, Conservative peer and former shadow City minister