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Costly business

The cost of implementing FSA regulation has been higher than expected for the industry, with compliance being the biggest drain on brokers’ pockets, says Harvey Jones

Brokers spent heavily to make sure their systems and procedures were compliant in the run-up to Mortgage Day, but growing numbers are now spotting a fresh threat to their bottom line.

Less scrupulous clients are discovering that the complaints system is skewed in their favour and against the broker, and are looking to cash in.

Aggrieved clients can complain free of charge but if a claim ends up at the Financial Ombudsman Service, mounting a defence will cost brokers hundreds of pounds even if it is found to be baseless.

Brokers pay a 50 annual levy to the FOS. The first two complaints in any year are handled free but thereafter brokers pay a flat rate 360 case fee. If the Ombudsman finds in the customer’s favour it can award damages of up to 100,000. But there is no cost to the complainant at any stage.

This is not the only cost brokers can incur. There is management time plus the danger that their professional indemnity insurance will shoot up, even if they receive just one or two groundless complaints.

Now brokers claim clients are raising the threat of a complaint in the hope brokers will pay them off with a few hundred pounds rather than spend even more defending themselves.

John Mills, managing director of Westpoint Mortgages, says it received its first complaint this year. He believes this was partly motivated by the regulatory system.

“The customer threatened to complain unless we gave him 500, which is blackmail,” he says. “We said fine, complain, but we aren’t at fault and that was the last we heard of him. Some people have heard about the regulations and are trying it on. It is important the industry stands up for itself.”

Rules are stacked against the broker. “Brokers have to pay Ombudsman costs, even if they are completely innocent. It is not fair,” says Mills. “The more mortgages you do, the more complaints you will have. We have brokers writing business all day long so we are bound to get more complaints. If you get three or four in a year, your PII premiums could shoot up.”

Mills fears the Financial Services Authority has used a big hammer to crack the tiniest of nuts.

“This will force a lot of people out of the industry,” he says. “Some good people are already being edged out, particularly one-man bands.”

Kevin Paterson, sales director at Park Row, fears complaining against brokers could become a cottage indusBtry. “In complaints where there is a grey area, rather than go down the costly and protracted route of trying to argue our case, we might be tempted to settle quickly – and we won’t be unusual in that,” he says.

Park Row has already faced dubious complaints. “Clients have said if we pay them a few hundred pounds they will drop their complaint because they know the Ombudsman is free to them but not to us,” says Paterson.

“The system is wrong. It gives brokers an incentive to pay somebody, say, 200 to go away. Clients are starting to play the game as they did with endowment mis-selling.”

Paterson has raised his fears with the Ombudsman which told him if it sees a client exploiting the system, it will reject the complaint. “This is reassuring but we still don’t get our costs reimbursed,” he says. Ray Boulger, senior technical director at brokers John Charcol, says under the old MCCB rules, the client had to stump up 50 to take a case to arbitration. “That’s a modest sum, but maybe just enough to deter a frivolous application,” he says. “If they can complain at no cost to yourself, people are more likely to file a frivolous or vexatious complaint.”

Brokers have to make a commercial judgment over whether to pay a client , say, 300 to go away. “It’s a fine judgment,” Boulger says. “If clients think you are a soft touch this could backfire. But on a purely commercial basis, paying off the client could make sense.”

Boulger says the Ombudsman should examine its system carefully. “Clients need the opportunity to make a valid complaint, but it isn’t fair that one party has costs and the other doesn’t,” he says.

Peter Gladdy, director of Mortgages Direct, the financial subsidiary of haart estate agents, says brokers should stand up to clients.

“We will not pay out just for the sake of paying out, because the Ombudsman is actually fairer than its predecessor, the MCCB. So far, it has been quite reasonable, and understood the customer isn’t always right.”

Gladdy evaluates each case on its merits. “Every complaint comes before me. If I believe we were wrong, we will pay up,” he says. “If I don’t believe we were wrong, I will tell the customer.”

Gladdy does expect a rise in complaints but puts this down to the growing compensation culture rather than regulation. “There are plenty of ambulance chasers out there. Quite often, I see complaints in which the customer is clearly being told exactly what to say,” he says.

Melanie Bien, associate director at Savills Private Finance, takes a hard line, saying it will never pay off clients purely to avoid the Ombudsman.

“If the client has a case, we will offer them a settlement, but if they don’t, we won’t,” she says.

Brokers who have faith in their systems should stop worrying and get on with it. “If you experience difficulties, you might need to put your house in order. We send a questionnaire to clients after completion to see if any problems are emerging,” Bien says. “By identifying problems early, we can stamp them out before they become bigger issues. We do make mistakes but this helps us catch them early.”

Ian Giles, marketing director at broker Purely Mortgages, says the key to avoiding lengthy and tedious complaints is telephone call recording.

“In a face-to-face, unrecorded selling environment it’s almost impossible to prove mis-selling didn’t take place, so most brokers will pay up rather than jump through the hoops of the complaints procedure,” he says.

More brokers will face dubious complaints when customers realise the burden of proof lies with the broker, not them.

“These are the same customers who have just complained about their endowments and got a few thousand pounds because nobody could prove they knew the risks when they took out their policies,” Giles says.

Purely Mortgages records all calls. “If we have a customer complaint we listen to the call. If it is our mistake, we pay appropriate compensation, no quibble,” says Giles. “If the customer is wrong, we offer to play the tape back to them – but that generally isn’t necessary.”

Simon Tyler, managing director of Chase de Vere Mortgage Management, says some brokers may be tempted to nip the cost of a complaint in the bud “but that’s not the way we do things here”.

Yet in many cases, refunding part of the fee is the right thing to do and can work in your favour. “If you are at fault and deal with dissatisfied customers quickly and fairly, they normally continue doing business with you, so getting into a protracted disagreement never makes any sense,” he says.

Like most brokers who were members of the MCCB prior to statutory regulation, Tyler says Chase de Vere hasn’t changed the way it handles complaints. “Brokers simply have to get their houses in order and ensure the quality of their advice is high enough so their clients don’t need to complain,” he says.

FOS spokesperson Emma Parker says mortgage brokers should not feel unduly singled out and that it’s a principle of the British and Irish Ombudsman Association, and Ombudsman services across the world, that the customer doesn’t pay.

“If we charge a fee, many customers may be reluctant to make a genuine complaint to avoid throwing good money after bad,” she says.

Most brokers should stay within their ration of two free complaints per year. “Only 5% of firms pay a case fee each year and these will mostly be larger firms which receive more complaints because of their size,” Parker says.

The number of complaints has plummeted since regulation. In the 12 months before Mortgage Day, the FOS dealt with 110,000 mortgage cases, mostly endowment mis-selling cases. Since Mortgage Day, that number has fallen to 500.

“This is at the lower end of expectations. We haven’t seen any evidence of a compensation culture emerging,” Parker says.

And even if complaints do make it to the Ombudsman, between 60% and 70% of judgements go in favour of the broker. “We are not consumer champions. We don’t take automatically take the side of clients,” she adds.

FSA spokesman Robin Gordon-Walker says the regulator is not considering changes. “Our research suggests even a small fee can be a big deterrent,” he says. “We understand brokers’ concerns but this is a balancing act and the Ombudsman does have a mechanism for addressing frivolous complaints.”

Bill Warren, compliance director at Complete Mortgage &Loan Services, says there is a simple way of avoiding the Ombudsman.

“All brokers need do is abide by compliant advice and sales procedures, and follow a complaint-handling procedure in an efficient and timely manner,” he says.

There is always a point at which it makes commercial sense to seek a settlement, but don’t set the bar too low.

“Firms that do this are likely to see costs spiral because clients do talk,” he adds. “If you get a reputation for paying out too quickly, clients may take advantage.

Tyler says compliance is the main reason costs have risen since Mortgage Day. “The cost of new staff, training, competence and systems to produce FSA-prescribed documents, have added up to a sizeable bill,” he says. “These are ongoing, and will probably increase if the FSA decides to regulate buy-to-let mortgages, which it almost certainly will at some point.”

Gladdy says systems have been swallowing up most expenditure. “We have completely changed our systems to provide compliant product documentation,” he says. “You can’t rely on sourcing systems any longer. You have to make sure everything is done to the letter and our systems policy controls that for us, for example by stopping brokers producing a KFI before they have done the full fact-find.”

Compliance teams have to audit and double check everything. “We have invested heavily in training and induction,” he says. “Our CEO is constantly griping about the cost but that’s the world we live in now.”

Gladdy can’t put a figure on the total cost. “All I know is it costs a lot more than the MCCB. We spend money on technology, software for training. We took the MCCB seriously, but that was voluntary and this is statutory, so we have to get it right.”

Mark de Ste Croix, head of comp-liance at Mortgage Intelligence, says supervision of advisers will represent the principal ongoing cost of regulation for networks.

“We favour a hands-on approach with people in the field to monitor and support our advisers,” he says. “Others may prefer remote monitoring techniques such as central file checking and enhanced analysis of business. Either way, you face significant costs in human and IT resources.”

Complaints are less of a worry, unless you receive a lot of them. “Paying to prevent them going to the Ombudsman is self-defeating and unnecessary,” de Ste Croix says. “If a complaint is justified, you should provide appropriate redress, which isn’t always monetary, then make sure the problem doesn’t arise again.”

Brokers shouldn’t fear the Ombudsman. “Assuming you are correct to reject the complaint and the Ombudsman agrees, your cost will be nil for the first two complaints and 360 for each subsequent one,” he adds. “Given the number of complaints made so far, I can’t see how this represents a considerable increase in costs.”

Cath Hearnden, director of My Mortgages Direct, says compliance costs may have increased but it depends on what systems brokers had in place before Mortgage Day.

“The biggest cost is the time principals, advisers and administration staff spend on paperwork, plus the cost of paying for a network principal or compliance officer.”

Steve Butler, head of mortgage club m2i, says brokers’ costs have unquestionably gone up under regulation. “Not only the additional FSA fees to obtain authorisation but also annual Periodic Fees, including levies to the Financial Services Compensation Scheme, increased PII premiums, administration or system software and compliance costs. And the cost of the broker’s time.”

The latter includes time spent on administration, compliance and making sure they don’t fall foul of the rules and associated requirements like the Financial Promotions Order when they could be helping more clients move into their dream homes.

Butler says most brokers will do anything in their powers to prevent a complaint to the Ombudsman. “If that means coughing up the valuation fee out of their own pocket or sending flowers it’s a business decision,” he says. “But it isn’t always their fault as problems at the lender may result in a complaint against the broker.”

Brokers must keep things in proportion. “There are thousands of mortgage transactions carried out every month, but you don’t hear of that many complaints, do you?” says Butler.

Brokers look for ways to offset the costs
More than three-quarters of mortgage intermediaries (84%) say business costs have increased since regulation, research from Marlborough Stirling and Trigold reveals.

Around three-quarters of intermediaries claim they are increasing their focus on technology as a result, and a further two-thirds say they are also looking at ways to streamline business processes.

But depolarisation has brought opportunities as well as challenges, with 53% of intermediaries saying they intend to take advantage of the depolarisation rules and start offering mortgage related insurance products from a broader range of suppliers.

Also, more than one in four (27%) of mortgage brokers not currently operating in equity release product areas say they plan to enter this market in the next two years. Commercial property is also being earmarked by intermediaries as an area for strong growth, with 25% of intermediaries not currently operating in this sector intending to do so in the next two years.

“While it is perhaps unsurprising that costs have increased since statutory regulation, it is encouraging to see the country’s intermediary market looking for solutions and ways to maintain its competitive edge,” says Phil Heaton-Jones, head of marketing for Marlborough Stirling.

Transition costs exceeded original estimates
The Council of Mortgage Lenders has reviewed the transition to the regulated environment and argues the costs of regulation have greatly exceeded the original estimate – and that the jury is still out on whether the anticipated benefits have been achieved.

The CML sees the transition from the Mortgage Code to FSA regulation as a success in operational terms. Consumers did not experience disruption, industry systems coped and there appeared to be little impact on business volumes arising from the regulatory changeover.

But there is a more negative picture on costs. With transitional costs weighing in at double the FSA’s expectations, this raises a question about whether the costs of regulation are, in practice, proportionate to the benefits which provides all the more reason for the FSA to scrutinise whether or not the consumer is better off under the new rules, says the CML. “A year after the introduction of mortgage regulation, the rules are still bedding in and it is too early to say whether the costs are outweighed by the benefits,” says Michael Coogan, director-general of the CML.

“Certainly, the FSA’s work to date has shown some compliance patchiness. This could be partly because of the complexity of the rules themselves. The coming year should give a much clearer picture of where the rules are working and where they may need refinement.

“While we urge the FSA to be thorough in its analysis of the regime, we also ask it not to make major changes in the short-term. All changes are costly to implement and they must deliver tangible benefits. We look forward to working with the FSA and the industry as we move to the next phase of the regulated environment.”

Indirect costs are more difficult to assess
Brian Marsh, head of wholesale compliance, Mortgage Express Under the terms of the Financial Services and Markets Act, the FSA must provide cost beneficial regulation. It undertakes and publishes cost benefit analyses for all of the rules and general guidance that are imposed on the financial services industry. These are the measures by which firms can determine whether they are getting value for money for the fees and levies they pay.

The direct, relatively transparent cost of fees paid to the regulator are calculated mainly in proportion to business volumes, and are therefore relatively easy to quantify. But this is only part of the issue. Direct costs are likely to be the smallest element of the burden on firms. Indirect costs that must be taken into account can be more difficult to assess.

In general, indirect costs of regulation are those incurred by carrying out activities required by the regulator that would not have been undertaken in the absence of regulation. Essentially, this will show up as a marked increase in the cost of a firm’s compliance staff, additional management time, systems, training and record keeping to name just a few examples.

Prior to Mortgage Day, the Financial Services Authority made forecasts of how much additional cost it expected soon-to-be-regulated firms to face.

At one early stage, the FSA expected a one-off cost to all authorised lenders of 34m as a result of the additional procedures they would have to adhere to, followed by a further ongoing cost of 8.50 per new mortgage. This figure does not include additional costs borne by intermediaries. Subsequent research carried out with lenders shows these numbers were a substantial underestimate of the real cost.

But establishing the true total cost of regulation to the whole mortgage industry has proved to be anything but an exact science. Estimates ranging from 150m (FSA) and 250m (CML) to 500m (Building Societies Association) were published in the aftermath of M-Day.

Whatever the cost, unfairness is built into the system due to the economies of scale. All firms have had to pay out fixed start up costs to meet the statutory regulations and this has been to the detriment of many smaller outfits. In addition to the higher monetary burden, following a regulated sale process has increased the time spent with each customer, leading to fewer cases being written.

This is bound to impact on profitability and firms will look to recover any shortfall. Something has to give and ultimately it will be the customer who ends up paying through the imposition of higher fees and charges.

Complaints system is biased against brokers
James Cotton, mortgage specialist, London & Country Mortgages Until now, the focus when it comes to regulatory costs has been on how much brokers and lenders spent on making sure they had compliant systems and procedures in place in the run up to Mortgage Day. But what has the industry spent since October 31 last year, under the Financial Services Authority’s regulatory regime?

Some brokers suggest their costs have gone up considerably as they bury customers’ complaints with a financial payout to prevent them going to the Ombudsman. Will this trend continue and will the amounts being paid out continue to rise or can it be stopped?

As far as L&C is concerned, there was little change for us as we voluntarily subscribed to the FOS for mortgage business prior to Mortgage Day. Our procedures and business practices were prepared for FSA standards in advance, which enabled us to make the transition fairly smoothly.

But for many firms the job of implementing and maintaining a formal complaints procedure for the first time is likely to drive up costs.

It is not surprising that some brokers are seeing an increase in the number of payouts made in response to client complaints. The fact that the broker has to pay a fee of 360 for each case referred to the Ombudsman (apart from the first two which are free) means that the merits of complaints often have little to do with the decision to pay out.

Instead it becomes a question of cost. If a complaint arises over a relatively small figure of, say, 100, why pay 360 to the Ombudsman when you can pay the smaller amount to settle the case? Even if a firm feels it would win, there is a disincentive to go to the FOS.

This creates inefficiency in the process and means there is an inherent unfairness towards firms.

So how do we get around this? I agree that the ability to make a complaint should be free to consumers – charging an upfront fee would act as a deterrent and would deprive those who could not afford it of a fair complaints process. But it is also important to have a system that deters people from making spurious complaints.

One solution is for the FOS to pass the cost on to the complainant only if it feels a complaint is frivolous – this would help to reduce the number of spurious complaints being made. But problems are likely to arise when it comes to proving what constitutes a frivolous complaint and then enforcing payment.

Another option is for the FOS to increase the fee payable by brokers for each case, but waive it in cases where the firm is found to have acted correctly. This would create a more efficient system which would not deter customers from complaining but equally would not discriminate against firms who can prove they acted correctly.

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