As the European economy plays a terrifying game of bailout bingo, the European Union continues to do what it does best – churn out new rules.
Since the crash, European directives on capital requirements, consumer protection in the mortgage market and credit rating agencies have all been proposed. Brussels is positively hyperactive with financial regulation, covering huge swathes of the industry across 27 member states.
The upshot is that never before has the Financial Services Authority and UK government kept such a close eye on Brussels’ decision-making. Prime Minister David Cameron has taken a personal interest in protecting London from a financial transaction tax originating on the continent.
For mortgages, the scope and ambition of regulation is vast, with proposals on everything from repossessions and buy-to-let to contract flexibility.
The mortgage directive has had a troubled passage through European institutions after first being touted in 2005. The initial aim was to harmonise European mortgage markets and encourage competition through cross-border lending. When the crash hit, the focus shifted towards more consumer protection laws mimicking much of the FSA’s Mortgage Market Review.
To become law, the directive must gain the approval of all three EU institutions of the European Commission, Council of Ministers and European Parliament. In the latter it has been held up by MEPs’ failure to agree in the powerful European Economic and Monetary Affairs committee (ECON).
But after delaying a vote five times in six months, the parliament finally approved its proposals for the directive this month. The process is not complete, however, and the three bodies will now enter into a discussion, expected to start in September, of the final rules. Publication of the parliamentary proposal is a significant step for the passage of the directive and gives greater clarity to the UK mortgage market about what Brussels may send its way.
The cumbersome process is exacerbated by the problems of regulating every mortgage borrower from Inverness to Bucharest and harmonising the vast array of legal systems, housing and lending markets, cultures and languages.
Regulating such varied markets together can create unintended consequences for the UK and cause safe products to be banned.
At the heart of negotiations is British MEP Vicky Ford, shadow rapporteur on ECON.
“The most wor rying aspect is the Jack-in-the-box effect,” she says. “Every time we try to tinker with the language in one area, it ends up causing a whole host of other sensible and useful mortgage products to breach the rules.
“This is why I don’t believe we need a whole piece of EU regulation. We could have dealt with these issues with a few lines in an existing directive and few amendments to banking legislation.”
Ford’s Jack-in-the-box analogy is based on the physical similarity between the action of the toy and the process MEPs have to go through to suppress some of the rules.
But the origins of the toy also fit well. One theory of where the Jack-in-the-box originates is a tale of a 13th century English prelate who cast the devil into a boot to protect a Buckinghamshire village.
This may explain why in French, a Jack-in-the-box is called a diable en boîte or boxed devil.
“It is mad to try to centralise regulation,” says Dominik Lipnicki, director of Your Mortgage Decisions.
“The markets across Europe are very different. Lenders that want to protect themselves in areas where house prices are falling will be far different from those in a booming market.
“If anything, we would argue that even in Eng – land, the North should be treated differently to the South, rather than adopting a one-size-fits-all approach. European regulation is the last thing we need.”
The arguments for harmonisation and cross-border lending have also come under fire.
“The worst scenario would be regulation in the UK that protects no one and the only reason we have it is to protect consumers in Greece, Portugal or Germany,” says Lipnicki. “These countries have different problems. It’s bureaucracy for bureaucracy’s sake, rather than anything that will help the housing market.”
Ray Boulger, senior technical manager at John Charcol, agrees that while some countries may benefit from EU rules, the UK already has strong regulation.
“Every EU country has different mortgage products, different regulation and needs different approaches – it shows that harmonisation does not work,” he says.
Trade bodies believe the directive is the brainchild of EU commissioners pushing for further integration and union for purely theoretical reasons.
Richard Farr, director of Telos Solutions, says there are more pressing issues for the EU to consider than trying to encourage cross-border sales.
“In the UK, we have international banks that may be mildly interested in cross-border lending,” he says. “For UK-specific banks it could be a growth area but they have much bigger problems to sort out than trying to sell mortgages to the French, such as dealing with capital requirements and the Independent Commission on Banking. However, it could provide an opportunity for banks to sell abroad.
“For building societies, I can’t see Nationwide becoming Europewide and smaller building societies are not going to be interested in it. There is no appetite for cross-border lending here.”
He says it could work in other European markets, such as Germany, where there are more than 2,500 regional building societies compared to around 50 in the UK. Some German societies may be keen on lending in, say, Austria but they do not need a European directive to allow them to do so.
Farr highlights the success of Santander lending in the UK over the past few years as an example of a European bank seamlessly moving to the UK. “Santander has done well moving cross-border anyway without these rules, so it’s just a theoretical dream of EU commissioners,” he says. “I can see it slightly increasing competition but there is zero demand for it and there are much larger issues to concentrate on politically.”
The problem of regulating such diverse markets is apparent in the detail and Ford gives an example of how the Jack-in-the-box approach is affecting the UK.
Last week, Mortgage Strategy revealed that mortgage products linked to savings accounts not used solely to repay the mortgage would be banned under the proposals. It would affect Lloyds Banking Group’s Lend a Hand scheme and potentially other schemes offering parental guarantees through savings accounts.
National Counties Building Society, Bath Building Society and Aldermore all have parental guarantee products that could potentially be caught up in the regulation.
However, offset mortgages have been given a specific exemption from the bundled products because they are treated as one product. The European parliament accepted that although offset contains two separate products, when you put them together they are one single offering. It would cease to exist if they were not tied together and this is taken into account in the partial ban.
Ford reckons the changes would damage the first-time buyer market by removing options available to aspiring home owners. The case illustrates clearly how solving a problem in one country can create an entirely new one in another. The rule change on bundled products was proposed by a Belgian MEP to prevent some of the sharper practices in his country.
“He wanted a plan on tied products so consumers were not forced to buy insurance with a mortgage,” says Ford.
“I understand his reasoning but the language about savings accounts was concerning for the UK.
“One reason why I voted against it is that the language as it stands would end up banning some savings-linked mortgages.” Ford says her top priority is to get the proposal changed. She views the parliamentary report as the first stage in a battle as the EU enters into trialogue discussions.
“I will now be working with some of the larger UK mortgage lenders to explain how many people need these existing savingslinked mortgages,” she says.
“It is a matter of constantly having to explain the differences with the UK mortgage market.”
But the continental lender trade body, the European Mortgage Federation, is close to the process and believes the ban is likely to pass because it has the support of the parliament and the commission.
Boulger says it is an example of the stupidity of European regulation and argues that Belgian authorities should solve Belgian problems.
“It doesn’t need the EU to create a rule that will potentially hurt 26 other member states just because of a problem in Belgium,” he says. “The more you look at it, the more stupid it is because it seems the local Lend a Hand scheme will not be caught as it works on the basis of a local authority guarantee.”
Boulger says he is aware of one lender which is working on a similar scheme to Lend a Hand and is concerned that the EU rules could deter it from launching.
Offset was nearly caught by the EU scatter-gun and the buy-to-let sector can breathe a similar sigh of relief after it too dodged the regulation bullet in the directive.
Among EU countries, the UK is unique in treating buy-to-let as a separate arrangement to an owner-occupier residential property loan. This meant that when the EU made its proposals it covered all loans secured against property, including buy-to-let and bridging. It had the effect of regulating the sectors in the UK when they are currently not wholly regulated areas.
The UK government, regulator, MEPs and most of the mortgage industry lobbied hard against the proposals and won a key victory last week when the UK won an exemption.
David Lawrenson, owner of LettingFocus.com, says the rules would have made it more difficult for landlords to access finance. “All the indications over the past six months are that it would not be included and it hasn’t been,” he says. “It was a real worry when it was proposed and the industry could hardly believe it.
“I don’t think there is any talk of other restrictions coming from elsewhere on buy-to-let mortgages, although landlords are seeing a whole host of regulation from central and local government, which is increasing the cost of being in business.”
The changes would have hit 4.5 million individuals living in private rented accommodation, with the buy-to-let lending market set to reach £15bn this year.
Ford says the UK’s fight to exempt buy-to-let was one of the main reasons for months of delays. “It is good news that bridging and buy-to-let loans have been taken out of the directive,” she says.
“The impact it would have had in the UK private rented sector would have been chaotic and could have shut down the market.”
The shake-up caused by buy-to-let could have been replicated in other areas of the market, such as SVRs.
An original clause proposed that all SVRs should be linked to a published index such as base rate. However, Ford proposed a successful amendment to prevent the clause from being interpreted in this way.
“We changed the wording from ‘the index’ to ‘any index’,” she says. “It was as tiny as that and we worked on it with the FSA. “If you are linked to a publicised rate then you must show it, but you don’t need to if you’re not linked to a publicised rate. It was an important change.”
Variable rates were clearly in the sights of the parliament and even though the UK solved one problem, the Jack-in-the-box popped up again over disclosure of APR.
Under the final ECON report, lenders are compelled to provide consumers with the highest and lowest interest rates from the past 20 years. The idea is to alert consumers to the possibility that their mortgage payments could increase, using past performance to illustrate what could happen.
But Ford argues that showing such detail could prove extremely confusing to borrowers and does not provide a realistic projection of what rates will be.
“Looking at mortgage rates now, would hiking back to 15% really be realistic?” she says. “We believe the pre-contractual disclosure should show different scenarios, rather than past performance and the strong feeling from the FSA is that this could be confusing.”
Pre-contractual disclosure has been another contentious area and the Key Facts Illustration has long been in the crosshairs of EU regulators. Europe has proposed replacing the KFI with a European Standardised Information Sheet as used by most other member states already.
The UK argues that the KFI is more extensive than the ESIS and any changes would cause unnecessary cost to lenders. After intense lobbying, the ECON report gave the UK five years’ grace before it must use the ESIS instead of the KFI. It is believed the UK was close to gaining a full exemption but had to settle for the delay.
The UK argues that the KFI is more extensive than the ESIS and any changes would cause unnecessary cost to lenders
The Council of Mortgage Lenders welcomed the delay to implementing the KFI but the Building Societies Association expressed disappointment that it could be scrapped.
Paul Broadhead, head of mortgage policy at the BSA, says the regulation has not yet been finalised, but he warned of extra costs to lenders.
“We are disappointed that in the longer term the KFI looks as though it will be replaced by the ESIS, which gives consumers less information and will cost lenders a substantial sum to implement,” he says.
Another significant change to the UK market from the ECON report is the introduction of a 14-day cooling off period, although it has been watered down since the first ECON draft report. The parliamentary proposals say that if the buyer draws down the loan during the period then the 14-day reflection would effectively end. “There would not be uncertainty for the bank after they thought they had lent the money, only for it to come back to them,” says Ford. “It could be expensive for banks or building societies to manage that risk.”
CHOICE ON ADVICE
Another risk for lenders is EU action over advised mortgages that has been touted throughout directive negotiations with radical ideas being floated. The EU proposed making advice compulsory before the FSA did so in its final MMR paper in December last year.
Initially, it went even further by appearing to compel all advisers, even those in-branch, to provide whole-of-market advice. This would mean branch advisers would have to offer their rivals’ products. Martin van der Heijden, head of lending at HSBC, said this would lead to its branches becoming mini-brokerages.
“It was completely ridiculous to think lenders should have to advise on their rivals’ products, so it was taken out – which was positive,” says Jennifer Johnson, senior legal adviser at the EMF. She says providing advice carries a higher liability risk for lenders and any mandatory rules would see prices rise for consumers. “Some borrowers don’t even need advice so you are interfering in consumer choice,” she says.
“It also has implications for distribution channels, with certain lenders unable to handle it.”
But Johnson says proposals for a ban on non-advised sales are still on the table and could be included in the final directive.
Currently, the rule changes have had a mixed reception but there are signs of relief from the mortgage industry that the EU has not gone further in its legislation.
“The early implications were worrying because the ECON rapporteur made it clear last September that he was going to throw the whole thing open,” says Johnson.
“Fortunately, we had some strong shadow rapporteurs, who followed it really closely and, in our view, brought it back to where it should be.”
The EMF believes the overwhelming majority of the mortgage industry’s biggest concerns were addressed and that it is in a strong position moving on to the next stage.
The next stage is trialogue negotiations between the three main bodies of commission, parliament and council.
It is believed these will take place in September but much depends on the priorities of the rotating presidency of the European Council, which lies with Cyprus from June. With the country currently in the middle of a banking crisis it is not likely to be top of their agenda.
The trialogue negotiations will involve high politics and tradeoffs and there may still be some shocks in the pipeline as the EU builds a finalised consensus.
However, the publication of the parliamentary report is a major step and it is not anticipated that there will be any huge swings in policy during negotiations.
“In 80% of the cases, we can see where it is going to fall and there will be a debate over the rest,” says Johnson. “However, there is still potential for some big debates in the trialogue discussions.”
The Council of Mortgage Lenders has expressed concern about the late submission of proposals and vows to continue looking at the directive as it enters trialogue.
“Some provisions have been included which only emerged at a late stage of negotiations but which may not have had their full implications considered,” a spokeswoman says.
DRAMA IN A CRISIS
The detail involved is mind-boggling and the over-arching purpose of the rule changes can often be forgotten.
The original plan to harmonise EU mortgage markets was blown off-course by the financial crisis and consumer protection rules have begun to creep into the directive to deal with some irresponsible lending practices.
In the heat of the crisis there are more pressing issues to deal with and some have questioned whether this is the right direction to take. Last December, British MEP Sharon Bowles said the directive felt like moving deckchairs on the Titanic as the eurozone plunged into chaos.
“It is totally irrelevant and the bigger issue is that unless the euro sorts itself out in a controlled manner then we risk lending drying up to a worse degree than in 2008,” says Lipnicki. “It would be a disaster and this is far more important to those who work in the EU, as well as the public.”
The list of just the most recent economic crises in Europe includes a €100bn Spanish banking bailout, the aftermath of Greek elections and Cyprus issuing a bailout warning.
Future upheavals could include a Greek exit from the euro or the creation of a continental banking union.
The unending crisis leaves peripheral issues such as mortgage regulation feeling like nothing more than a distraction.
And yet the directive moves forward and into its next stage with implementation expected by around 2015.
It is far from finalised, however, and the Jack-in-the-box directive may have a few surprises in store yet.
GUIDE TO EUROPEAN PROPOSALS
- Buy-to-let – Set to avoid European regulation as well as bridging loans after being included alongside all residential properties.
- Reasons for rejection – A likely compromise would see lenders providing borrowers with the main reasons for rejection from a
mortgage deal. Some argue borrowers should have all reasons for being turned down; others say just the main reasons or none at all.
- Product suitability – Lenders are required to assess whether products are suitable for borrowers. Lending trade bodies argued that this was similar to advice and it was removed from the parliament text.
- Early Repayment Charges – A statutory cap on early repayment charges will be up for negotiation in trialogue discussions. Lenders want to keep it within the contract.
- Bundled mortgages – A ban on bundled mortgage products has wide support and is likely to succeed but offset mortgages are specifically exempt.
- 14-day cooling-off period – All borrowers have the right to 14 days’ reflection after agreeing a mortgage but the period ends earlier if any funds are drawn from the agreed loan.
- Arrears and repossessions – Included in parliamentary proposals last year, these were a major concern for lenders but have now been watered down so they are minimal.
- Property valuation – Included in parliamentary proposals last year but watered down to the extent that they are now minimal.
- Advice – Mandatory advice is part of the negotiations but the proposal for compulsory whole-of-market advice and in-branch ’mini-brokerages’ appears to have been dropped.
- SVRs – A compulsion to link SVRs to published indices was avoided through a change by a British MEP. SVRs linked to rates need to publish but those that aren’t linked do not.