Last Monday, the Financial Services Authority published Consultation Paper 146: The FSA's approach to regulating mortgage sales. From around mid-2004, intermediaries that sell mortgages will need to be authorised by the FSA.
Mortgage supremo Sarah Wilson, director of the FSA's high street firms division, says the regulator wants to make sure that “consumers get clear comparable information on mortgages and that where they get advice they are recommended a suitable mortgage”.
“For many consumers, taking out a mortgage is one of the most significant financial commitments they will make in their lifetime,” she said last week. “We aim to introduce a regime that achieves this goal in a proportionate, cost-effective fashion.”
So what's in the paper? Introductions to any authorised firm, whether independent or otherwise, will be exempt from regulation; mortgage clubs and packagers would not “as the proposed legislation is drafted” “carry on the regulated activity of arranging” and will not, therefore, need to be authorised (broker packagers and correspondent lenders might and will be authorised); the definition of “regulated mortgage contract” will not change and buy-to-let is excluded; section 155 of the Consumer Credit Act is to be “carved out” and the FSA given new powers of protection; nothing in the new regulatory structure will adversely affect lenders' ability to securitise; local authority staff will not be brought within the scope of the FSA regime; the Mortgage Code will cease to exist by 2004; there will be at least 12 months in the run up to regulation for lenders to get systems and procedures in place; the pre-application illustration will remain but in a shorter format than originally envisaged in CP98; the use of credit-reference searches by lender will not be restricted; quick quotes that provide customers with personalised product information that is not in the prescribed format of the PAI will be allowed; new disclosure rules mean that customers may be able to compare UK products with those in the rest of Europe; the FSA has decided not to make rules on the controversial cooling-off period and 'lifetime mortgages' are introduced – the new name for equity release products.
As expected, under the new regime mortgages covered are those that are taken out by “an individual or trustee” and are “a first legal charge on the borrower's property”. In this instance, the FSA says that the property “must be located in the UK and must be at least 40% occupied by the borrower or immediate family”.
As well as mortgages for property purchase, the regime will also cover other products where the security is a first charge over the borrower's residential property – including home improvement loans, debt consolidation loans, lifetime mortgages, bridging loans and secured credit cards.
Despite the FSA coming under fierce criticism for leaving out buy-to-let and second charge loans, one director of a specialist loan company, who asked not to be named, confessed to Mortgage Strategy that “before too long the secured loan and mortgage industries will be policed by Sir Howard Davis and his team”.
“Second charge mortgages have been allowed to stay in the Office of Fair Trading stable for the time being,” he says. “But I believe that once the main priorities are dealt with by the FSA, the regulator will turn its attentions to second charge loans. And this has to be a good thing.”
Without a doubt there is a growing market consensus that intermediaries and lenders alike need clear guidelines for this booming niche market – something the Consumer Credit Act just does not deliver.
So what is covered?
The FSA says that its authorisation requirements relate to the sales process where firms give advice or information. Under the new regime where you give advice, you will need to consider affordability and which mortgage best meets your client's needs and circumstances. Also, where you give information but use filtering questions that narrow down the selection of mortgages, these will need to be scripted and you will have to ensure that sales staff do not stray over the boundary and give advice.
Building on proposals in CP98 last year, the FSA stands firm on pre-application illustrations or PAIs. It says “clear information about the mortgage itself in a prescribed order and layout” will need to be given to your clients so that they can understand the terms of the mortgage and can “compare it with others”.
John Malone, national mortgage manager at Prudential Mortgage Services, says the PAI was always a done deal. “We all expected that,” he says. “If you are a consumer you do need a breadth of information in a prescribed format at a prescribed time to enable you to make the appropriate decision. That is a good thing and an intermediary should use that in a way that will build his file and audit trail and will also reduce queries and any complaints going forward because the consumer can't say they didn't understand that at the time.”
What has come as some surprise, however, is that this consultation is just the first in a series that will cover mortgages and general insurance.
The FSA previously consulted on its approach to the regulation of mortgages in CP98: The draft mortgage sourcebook, including policy statement on CP70 in June 2001, which covered the proposed regime for the statutory regulation for mortgage lending and administering. But now there will be a further three consultation papers issued before the rules are drawn up.
Under the new system Wilson says that firms that will need authorisation will include banks, building societies, specialist lenders and mortgage intermediaries.
But she also says that she would like to see extra protection for consumers buying higher-risk mortgages, such as lifetime mortgages aimed at older consumers. The FSA also wants different requirements for certain types of loan that pose lower risks, such as those for relatively small amounts or having a short term.
CP146 – which runs to 353 pages – sets out the key elements of the FSA's proposals and is the first stage in developing the new regime. The FSA is hoping to finalise mortgage rules in the second half of next year and this should, it says, enable mortgage regulation to begin in mid-2004.
Drawing on past experience the FSA has distinguished between three types of selling process; advised sales -advice on the merits of entering into a particular mortgage; non-advised sales involving filtering questions – where a firm (either a lender or intermediary) uses filtering questions to narrow down the selection of mortgages on which it provides a consumer with information, but does not make a recommendation; and non-advised execution-only sales – where the consumer has decided which mortgage he wants and no filtering questions are used by the firm and no advice is given.
The FSA says the non-advised filtering questioning route gives “firms considerable scope to provide consumers with information on mortgages which is tailored to their needs, without actually giving advice”.
This questioning, it says, can cover both eligibility questions (such as how much the consumer wants to borrow; how much deposit he has; whether he is a first-time buyer; his credit history and so on) as well as information on the consumer's preferences (such as whether he wants a particular type of interest rate) and needs (such as payment flexibility).
The main difference between advice and non-advice is that firms opting to go down the non-advised, filtering questions route must not make any recommendation to the consumer on the merits of taking out a particular mortgage.
A spokesman for the FSA says that “although there is considerable variation between lenders, many have told us that they undertake direct sales on the basis of information rather than advice. The fact that there may be a relatively high proportion of non-advised sales in the mortgage market increases the significance of the potential gap between consumers' everyday understanding of what advice is and the legal definition.”
The FSA also says that the high value of most mortgage transactions means payments often account for a high proportion of household expenditure.
“But compared to the investment market the probability of catastrophic loss (such as a client losing their home) arising from the sales process is less likely in the mortgage market,” says a spokesman. As a result, regulations in the mortgage market are likely to follow a different route to that of investment advice.
“There is less incidence of repossession than there is of investments failing to deliver sufficient income for an intended use,” the spokesman adds.
The FSA has several core objectives for the regulation of the mortgage-selling process under each definition of advice.
For advised sales, the regulator wants consumers to be able to shop around for mortgage advice and understand the importance of doing so. Also, that they should understand the basis on which they are being given advice (i.e., any limitations on the range of mortgages/lenders considered and whether they will be charged any fees) and that they are also advised to take out mortgages that are suitable and good value.
The FSA also wants consumers to understand the features and risks (including the affordability risks) of the mortgages they are recommended and that they can shop around for mortgages on the basis of the advice they receive.
For non-advised sales the FSA wants consumers to be able to understand that the choice of which mortgage to take out is a matter for them to decide. Also, they must understand any limitation on the range of mortgages/lenders they are provided with information on (not applicable to non-advised execution-only sales).
Consumers will also be encouraged to, and be able to, shop around and compare mortgages offered by different lenders in order to get a good value mortgage.
And the regulator wants consumers to have sufficient information on, and understanding of, the features and risks of particular mortgages to be able to select a suitable mortgage.
The FSA also wants to ensure that across all types of mortgage sales, consumers are not subject to excessive fees by firms advising on or arranging mortgages and that they are not subject to high-pressure selling. They also want customers to be able to check that the deal they are offered by the lender matches the mortgage that they applied for and know that over the life of the mortgage they will be kept up-to-date with any changes, from the date of completion to if and when they fall into arrears.
But having identified its objectives, what does the FSA plan to do to ensure they are fulfilled?
The FSA wants to use what it terms “regulatory tools” – the range of actions it can take to address potential consumer detriment. The full range of tools at the FSA's disposal is highlighted in the table opposite.
One of the most interesting areas of CP146 and a significant change in stance from CP98 is the recognition by the FSA that some rules are unnecessary where significant protection is provided by other elements of the rules.
It's a point noted by James Mayne, head of strategic development at Britannic Money.
“One such area that brought a huge sigh of relief from the mortgage-lending industry is the abolition of the proposed “cooling off' provisions,” he says. “Instead the FSA recognises that its ability to apply the financial promotion rules and the principles for businesses rule to firms advising or arranging may offer sufficient protection instead.”
Another area where the FSA proposes removing apparent duplicate regulation is in 'responsible lending'. In CP98 the responsible lending rules required lenders to show that they took account of the customer's ability to repay the loan, keep adequate records and, in absence of any evidence to the contrary, assume that the mortgage payments would be met from the customer's income.
Mayne says that while in CP146 these rules remain, they will only apply for non-advised sales.
But he warns that while it is refreshing that the FSA is again thinking outside of the “regulatory box”, this does however raise some concerns.
“Does this mean that if a customer tells his mortgage adviser that he wants to borrow as much as he can and the adviser finds a product that meets these requirements, the lender that provides the loan need not worry whether they are lending responsibly?” he asks. “That would mean that, as a lender, if you want to offer 5, 6 or even 10 x income you can, provided the customer receives advice.
“But maybe more importantly,” he adds, “does it mean any lender that is currently offering more than generous lending terms won't be able to in the future unless that customer has received advice?” A direct consequence of this, he laments, would be that if advice declines, so too could this type of lending.
Indeed, this theme is carried through to lifetime mortgages where these loans are classified as 'high risk'.
“There are many forms of equity release and some may be more risky than others,” says Mayne. “But I am sure that this classification represents the under developed nature of this market and perceived rather than actual risk. As a consequence of this classification, these products will not be able to be sold without advice.”
John Malone, national mortgage manager at Prudential Mortgage Services, says the sector will attract a more professional level of service.
“If it means that there is a reduced number of intermediaries who transact in that level of business it will actually give a more professional level of standards in that sector,” he says. “It is a specialist subject and specialist lenders see it this way too. They are concerned that people advising on this product are qualified to do so. If it means they have to sit an exam to market and promote that kind of business then it's a step in the right direction.”
Malone suggests solicitors and IFAs who have segregated their business could develop in this market though since they have good relationships with their clients.
“Lenders in the flexible current account environment could go into this market,” he adds. “In the very near future, lenders are likely to introduce a feature that will let homeowners amortise equity.”
However Mayne still believes the development of this market has been severely hampered through CCA restraints on product design.
“If the availability of advice in the market is reduced it will be further hampered by having no one to sell it,” he says. “As the pressures on pensions mount this sector of the market will become more important and a balance needs to be maintained to ensure protection does not end up as prevention.”
Additional reporting and research by Helen McCormick, Ben Stafford and Harriet Williams.
What do you think about the proposals?
Andy Linnett, director, LMS
Finally, the whole debate about mortgage regulation can move on and we are starting to see some clarity around vital issues such as the sales process of advice and execution-only and how the industry needs to interact with the borrower.
As a packager we were interested in and welcomed the clearly defined categories of packager firm highlighted in the recent Treasury announcement. This allows firms to prepare for regulation according to their actual status and means that packagers that provide a service to lenders only are treated as such. They are not swept up under a generic description that clearly bears no resemblance to the reality of how individual packaging firms operate in the industry.
The industry must now digest CP146 and respond accordingly, but at least there appears to be some light at the end of the regulatory tunnel. The industry need not fear regulation because, if it brings renewed consumer confidence and transparency of transaction, it can only be a good thing. The thing the industry was crying out for was clarity of direction from the Treasury and the FSA. It now has this and we can all start to move on.
Frank Eve, managing director, Frank Eve Consulting
At last the cloud of uncertainty is clearing around the proposed regulation of mortgage sales. The release of CP146 this week will eventually bring transparency and accountability to the intermediary mortgage market. Although the document does not, as yet, give the definitive rules, the way in which the CP146 is structured gives the first clues as to how the regulation may work. However, as the cloud is dispersed a new challenge awaits intermediaries and lenders alike as they endeavour to interpret the contents and make their responses known.
The intermediary has to decide whether to take introducer status and thus escape regulation, or to become an appointed representative and, therefore, push the weight of regulatory responsibility onto the lenders. Then there is the issue of independence and polarisation.
What will that mean for commissions and commission disclosure in the new environment? From the lender's viewpoint there are two key decisions: which intermediaries to make appointed representatives and how to control and monitor their activities. For, once the lender takes on an appointed relationship, they will be then be responsible for subsequent actions in terms of regulation and accountability. This is a fundamental change as lenders have, in the past, been completely free of responsibility for the actions of their brokers.
There is no doubt in my mind that the FSA's approach outlined in this document will have far-reaching effects and will change the intermediary mortgage market beyond recognition.
Luke March, chief executive, Mortgage Code Compliance Board
We welcome the publication by the Treasury of the Regulated Activities Order – the legislation that will 'frame' the future statutory regulation of the mortgage market – and also the FSA's CP146 on its high-level approach to implementing regulation and “near-final” rules on information disclosure requirements.
The Mortgage Board will be studying the 350-plus pages of the consultation paper in great detail and will respond in due course, and within the consultation response period.
Our initial reactions to CP146 include a welcome to the proposal to implement clear “grandfathering” arrangements for those advisers who have acquired their professional mortgage qualifications under the Mortgage Board's own training and competence requirements. Also, the FSA's strong support for the qualification deadline of December 31 2002 is an endorsement of our key strategy to raise industry standards.
The commitment by the FSA that the future statutory authorisation process will include provision for “due credit” for Mortgage Board-registered firms in “good standing” is also a welcome confirmation. Both these areas indicate that the Mortgage Board's desire for a seamless transition to the new statutory regulatory regime in mid-2004 is realistic and achievable.
However, initial concerns of the Mortgage Board resulting from CP146 include the proposal that the FSA is consulting on a move away from the requirement for full disclosure of fees. Our experience indicates an increased potential for consumer detriment where fees are not fully disclosed.
Ian Balfour, marketing director, Solent Mortgage Services
As with anything involving regulation, the FSA consultation paper is a bit of a doorstop and the size of the document reflects a general concern that I have about regulation as a whole. Overcomplication in regulation and materials will not benefit the customers that need the protection of regulation the most. The area on advice shows that, while the FSA has thought about what constitutes information and what constitutes advice, too many category definitions can make things confusing for the borrower. Regulation has come about, ultimately, to protect the borrower but in trying to make things clearer for them, in terms of where responsibility lies and who they have recompense against, there is a risk of information overload. Take, for example, the pre-application illustration – this, in CP98, did contain a great deal of information. In my opinion it was and is too much. There is plenty of anecdotal evidence that suggests that consumers simply don't want to be overwhelmed by detail – simplicity is the key to keeping them informed. Clear communication is something we have always made an effort with at Solent and it is something that is clearly appreciated by brokers and borrowers alike. I think everyone in the industry needs time to fully digest the document and I'm sure when this has happened the debate and opinion will really begin in earnest. Overall, this is a positive move for both the industry and consumer alike and we look forward to supporting regulation when it arrives.
Gemma Reece, in-house lawyer, SPML
We welcome the publication of CP146 that will help the industry to set out the context within which regulation for mortgage sales will take place post-2004.
As an extensive and detailed document it will require careful consideration and I'm sure the industry will take the opportunity to make plenty of comment ahead of November 11 this year.
After an early glance, two areas are of particular interest. Firstly, the admission by the FSA that changes are to be made to the content of the pre-application illustration (PAI). We think this will be helpful, having gone through the process of creating our own PAI as part of the consultation around CP98. We thought it would ultimately prove unworkable in its previous format and length and are glad to see that further consideration will now be given to this important document so that borrowers, introducers and lenders can hopefully derive best value from it.
It is also clear that due consideration has been given to acknowledging the differing types of sales processes that are widely in use in the mortgage market. The regulation of advice, if it is to be workable and effective, has to reflect the differences between advised sales, non-advised sales using filtering questions and execution only sales. Trying to fit individual customers' requirements under one descriptive umbrella does not mirror what happens and we welcome the clarification in this area.
Peter Beaumont, sales and marketing director, Mortgages PLC
The document reveals that everything is still on target for the implementation of regulation in mid-2004, which is a positive message. There is also some welcome clarity on the definition of advice. The FSA has proposed distinguishing three types of sales processes. To my eyes these three levels seem to be a realistic way forward. Fact finds have been included in the second level of advice – non-advised sales using filtering questions. This means that this is information not advice – a key point of differentiation for those who use mortgage-sourcing systems and currently give information-only.
Another important point regarding financial promotions, and one which definitely needs bottoming out, is who is responsible for marketing material produced by companies that are not authorised by the FSA? It states that a company which is authorised must approve it. Does this mean that we, as lenders, will need to do so for all packagers or brokers who fall into this camp? This will be extremely difficult for lenders to police and we await with interest the draft rules on this subject and hope for a sensible outcome.
The comments on APR are of interest. The FSA seems certain to keep this measure despite admitting that its own research has found that many consumers have little idea what it means and actually pay no attention to it. Given the wealth of information that the pre-application illustration (PAI) will contain, the question has to be posed as to whether or not people will actually read this.
Howard Broadbent, head of Purple 3
After speculation that seems to have been going on for ages, I am pleased that we have now got something that seems to make a lot of sense.
However, CP146 is not the definitive article and still needs a lot of input from the industry if it is to become an effective piece of regulation. As a collective body, the industry has until mid-November to make a constructive contribution to the debate and help formulate the new framework. I hope all of us can deliver the substance that is going to be required. One area that concerns me and will be a bone of contention for other packagers is the lack of recognition of the mortgage packaging industry. Companies like Purple 3, working alongside lender partners, play an integral role in the distribution and processing of mortgage products. Yet the role of the packager continues to be ignored by the FSA. This is a mistake and I will be endeavouring to set the record straight over the next three months.
Gary Forrest, managing director, High Street Home Loans:
I am extremely pleased that intermediaries will, under the FSA's proposals, be required to disclose pre-application illustrations to the consumer. In the future this will eliminate the issue of whether the particular product that has been recommended to a member of the public is pertinent to their short and long-term needs. At the moment, the Mortgage Code enables an introducer to issue an illustration no later than at the pre-completion stage. This enables a significant minority of intermediaries to work around the true spirit of the Code. Under the watchful eye of an external regulator, I am sure that such actions would not be allowed. Another good thing is that any companies setting themselves up just to handle broker referrals will have to provide the illustrations and the advice prior to receipt of the application. At present I am aware of a small number of firms who do not deal with the advice and compliance aspects of the packaging process until an application has been completed. Although the letter of the MCCB rulebook has not been broken, the practice has to be questionable.
Sally Laker, managing director of Mortgage Intelligence
CP146 has outlined a number of issues that brokers need to be aware of – in particular pre-sale procedures. These refer to advising on regulated mortgage contracts; non-advised with filtering questions and non-advised execution only. The FSA is seeking opinion on whether a consumer credit licence will be sufficient for non-regulated mortgages such as buy-to-let and loans of less than £10,000. In my opinion, the majority of brokers would include buy-to-let mortgages as part of their total mortgage business and would, therefore, no doubt apply the same procedures to both. Under the FPO there will be a tightening up of the regulation in financial promotion, with special emphasis on impaired credit, so brokers need to be particularly aware of this when advertising or promoting particular products and services. I feel reassured that the draft guidance appertaining to mortgage wholesalers shows that the FSA has understood the relationship of the wholesaler is with the broker and not the client.
How key figures in the mortgage industry have responded to issues raised in the Financial Services Authority's consultation paper Keith Robinson, managing director, National Guarantee PLC:
I applaud the FSA for producing a document of substance that appears to have some teeth. It's long overdue and will be a significant factor in helping the industry to deliver more consistent, transparent and professional advice to borrowers.
While the paper weighs in at over 300 pages, I am glad that the FSA has not produced a document that covers all bases. I hope this is because the regulator wants to enter into a period of true consultation with the mortgage industry and, at the end of this process, be in a position to deliver regulation that can go on to the statute books that is supported by consumer and industry professional alike. We will certainly be offering our thoughts. The more the industry offers to the FSA, the better regulation should be when it is formally introduced.
We believe regulation will be good for lender and intermediary alike. The companies that we choose to do business with feel the same as us. However, there are a small number of organisations that have been slow in supporting change. It's my belief that any company that shies away from implementing best practice will soon have a stark choice to make: they will have to adapt or die.
Richard Griffiths, managing director, Network Data Limited
In last week's issue, I commented on the fact that there had been no definition of “independent mortgage advisers” in the Treasury statement of August 8. I now find that this subject has been tackled head-on in CP146, with the whole of Chapter 10 being devoted to “independence in the mortgage market”.
This starts off with a detailed background of parallels in the investment market, including polarisation, defined payment system, better than best advice, CP121 – and what all this may mean for the mortgage market. This should give you some idea of the wide-ranging scope of the FSA's deliberations. Chapter 15 is the largest part of CP146; 33 pages entirely devoted to product disclosure, i.e., the pre-application illustration that featured so prominently in CP98. The FSA says that the general principles of product disclosure “remain valid” now that it is regulating advice. No surprise there.
The FSA goes on to say that due to “very strong industry opposition” it has moved to the back of the PAI the reference to the FSA's website and it is reconsidering whether attention should be drawn to its comparative mortgage tables. This should provide a stimulus to all those who should be responding to CP146; proof that the FSA does pay some attention to voices in the industry. The 353 pages gives the impression that the subject of regulating mortgage sales is a deeper hole than we may have expected. It is impossible to do justice to the issues in a short commentary such as this, and no doubt many intermediaries will get sick of hearing and reading about CP146 over the next few months. But wait, by then we will have separate consultation papers on “appointed representative” status, and on general insurance.
Tim Sturley, business development manager, Mortgage Express
With the statutory regulation of mortgage advice details published last week being the successor to the voluntary Mortgage Code – and given that that Code excluded buy-to-let lending – it was no surprise to see that HM Treasury took a similar view and excluded it too.
This is the right decision, unlike owning shares or other types of savings, investing in residential property to let out as an active investment more like running a small business than owning your own home.
The definition of a regulated mortgage in the FSA's proposals is reasonably clear but if it had attempted to widen the definition to embrace buy-to-let this would have been far more difficult. Attempting to accommodate multiple property holdings, HMO's and part commercial properties as examples would surely lead to ambiguities which would benefit no one – least of all the borrowers such rules would be seeking to protect. Suggestions that a differentiation between so-called amateur and professional landlords, based on, say, the number of properties they own, would be