Understanding mortgage regulation

John LunnPartner, Morton Fraser

21 November 2011

Levels of regulation

Three levels of regulation:

• Global

• European

• UK

Global

• Capital

• Liquidity

• Remuneration

• Increases cost – particularly for ‘higher risk’ lending

• UK moving ahead of global standards

Global – mortgage specific

• Financial Stability Board• Set up by the G20 in 2009• Members are regulators, central banks and treasury

departments• Responsible for setting global standards• Develops regulatory cooperation and technical input

for G20

• Mortgage underwriting thematic published March 2011

Global – mortgage specific

• High level framework of principles• Income verification• Free disposable income• Affordability assumptions• Appropriate LTV ratios• Valuation standards• Mortgage insurance• Stress test future payments• Remuneration of staff

• Consultation published late October 2011 • open until 9 December 2011 • finalised framework early 2012

European

• New regulatory structure• Banking (EBA)• Insurance and pensions (EIOPA)• Securities and markets (ESMA)• Systemic risk board (ECB)

• More active regulatory and supervisory role

European – mortgage specific

• Directive on Credit agreements related to residential property (CARRP)

• Aims are to: • Encourage the development of a single

market • Reduce the risks posed by irresponsible

lending and borrowing

What the Directive covers

• Marketing and advertising rules• Standardised pre-contractual information• Enhance standards of mortgage advice• Ensure adequate suitability and creditworthiness

assessments• Enhance regulatory oversight of credit

intermediaries• Enhance regulatory oversight of non-banks

Scope of the Directive

• Covers all credit agreements secured by a mortgage on a residential property except those where they will eventually be repaid from the sale of the property (i.e. equity release loans)

• BTL caught, with the exception of where someone is doing it by way of trade or business

• Will also catch bridging loans, HNW borrowers and credit union lending

Key concerns: pre-contractual info

• The imposition of the European Standardised Information Sheet for Mortgage Credit (ESIS) across Europe

• Does not contain the same information as the KFI • Considerable cost to UK lenders if the ESIS were to

replace the KFI with no obvious benefits to UK consumers

• And will the FSA still require a document for information not contained in the ESIS that it thinks is important?

Key concerns – advertising and disclosure

• Overly prescriptive approach and different from current MCOB requirements

• Information overload for consumers

• Specific example to be included, but so generic that it applies to no one

Key concerns: obligation to deny credit

• “Where the assessment of the consumer’s creditworthiness results in a negative prospect for his ability to repay the credit over the lifetime of the credit agreement, the creditor refuses credit”

• Requirement to tell the consumer the detailed reasons for rejection

• If based on an automated decisioning process the creditor has to explain the logic involved in the automated process

Key concerns – giving advice

• In the Directive advice constitutes a separate service from the granting of credit

• A service can only be marketed as ‘advice’ where the remuneration of the individual providing the service is transparent to the consumer

• How will this work for lenders giving advice? Will you be able to identify a separate cost of advice?

• Also required to consider ‘a sufficiently large number of credit agreements available on the market’ to be able to recommend the most suitable

Other issues

• A requirement to assess the customer’s ‘level of knowledge and experience with credit’ to determine the level of explanation required. How do you assess financial capability?

• Ensuring that advice can be given over the telephone and over the internet as well as face-to-face

• Credit intermediaries authorised in any member state can operate in any other member state

• Wide range of Delegated Acts where the Commission could impose additional requirements and change the Directive without consultation

How the Directive is considered

• In both EU Parliament and EU Council for parallel consideration

• HM Treasury represent the UK in Council• Two key committees considering in Parliament:

• ECON (Economic and Monetary affairs)• IMCO (Internal Markets and Consumer Protection)

ECON Report

• Wide ranging report proposing to introduce a number of new areas:• A range of flexibilities that a consumer would have by

right including portability, overpayments and a right to convert to equity release at the end of term

• A cooling off period of at least 14 days• Compensation for consumers if credit is rejected on

the basis of inaccurate CRA data• A ban on arrears charges if payment difficulties

caused by circumstances outside the borrowers control

• Specific prudential measures for mortgages including LTV and LTI ratios

ECON amendments

• A number of supportive amendments, particularly from UK MEPs

• Particular support for: • Deleting the duty to deny credit• Limiting the information given to consumers denied a

mortgage• Removing Delegated Acts• Concentrating on the Commission’s original proposal

IMCO report

• Much more in line with industry views• Limiting scope to Commission’s original text• Simplifying pre-contractual information and

creditworthiness assessment• Amendments to the advice provisions which

would allow lenders to give advice on own products

• Removal of many of the Delegated Acts

UK mortgage industry lobbying

• Through membership of EMF, and EBIC• Through Treasury and part of Treasury

cross-industry group• cross-industry group of BBA, CML, BSA,

CBI, FLA and IMLA• Direct action by the FSA in Europe using

strong evidence base gathered during MMR analysis

Where are we on the UK issues?

• Getting BTL out of scope (?N)• Limiting pre-contractual information (?Y)• Keeping the KFI instead of the ESIS (?N)• Clarification of adequate explanations (?Y)• Creditworthiness assessment (?Y)• Will lenders still be able to give advice? (?Y)• Proper control of intermediaries from other EU

countries (?Y)• Removal of Delegated Acts (?Y)

Possible timetable for the Directive

• Amendments considered and debated before the end of 2011

• Earliest Plenary vote (when all Parliamentary amendments will be finalised) - February 2012

• Trialogue – Parliament/Council/Commission agreement needs to be achieved after that

• Earliest final version of the Directive Q2 2012 (but subject to slippage!)

• Member States will get two years to implement the Directive

Interaction with the MMR

• Clear overlaps and dependencies

• FSA continues to press ahead with work on the MMR

• What impact will the FSB work have?

• “FSB and European initiatives not intended to be a substitute for national regulation”

Domestic

• New regulatory structure:• Financial Policy Committee

• Macro prudential levers, potentially including LTV/LTI caps

• Prudential Regulation Authority• Financial Conduct Authority

FSA’s Mortgage Market Review

The FSA’s intended outcome• ‘. . . to have a mortgage market that is

sustainable for all participants and to have a flexible market that works better for consumers.’

• ‘. . . the main benefit for consumers from the package of proposals stems from the reduction in costs of arrears and repossessions consumers would otherwise have incurred.’

FSA CP 10/16: Mortgage Market Review

Mortgage market review proposals

• Income verification in all cases• Detailed assessment of income and expenditure• Affordability to be assessed against

• Capital repayment• 25 year term• Maximum age

• Clear responsibility between lender and intermediary?

• Clear distinction between advice, non-advice and execution-only?

Lord Turner, Chairman FSA23 June 2011

“If you knew in advance that mortgage lending to a customer group with specific characteristics had a 15% chance of resulting in arrears and repossessions, is that too high? - when the implication of considering it 'too high' is that we will protect the 15% from the trauma of repossession, but at the expense of restricting the freedom of 85% of that customer group to make a stretching but still ultimately affordable commitment.

That is a question which deserves wide-ranging debate, as best possible to forge a social consensus: it is not a question which a regulator can resolve on the basis of technical analysis alone.

The analysis required to enable an informed debate on this issue needs to be of the highest quality and clearly presented. This means that we will not be publishing our proposal before early Autumn but I trust that when it is forthcoming, it generates the engagement that this important question deserves.”

Future timetable for MMR

• Expecting to see comprehensive paper from FSA shortly with: • Feedback on responsible lending • Consultation on interest only• Transitional issues and other areas• A full indicative cost benefit analysis

• FSA have promised no new rules until 2012• How will this fit with the EU timetable?

Domestic

• Other areas • ICB “Vickers report”• Liquidity rules• BS sourcebook• New intensive and intrusive supervisory

approach• Simplified products and advice• Product intervention