CML Annual Conference
2 December 2003
John Tiner
Regulation, regulation, more regulation

1. I am very pleased to be here today to give one of the keynote addresses. With mortgage regulation now only 11 months away, CML members are rapidly becoming one of the FSA’s most important constituencies, and this conference gives me a timely opportunity to set out how we are preparing, and how we expect you to prepare, for the new regime. It must be said that, when I agreed to give this address, I didn’t know that I would be spending the morning in front of the Treasury Select Committee answering questions about endowment mortgages and sharing the witness box with Walter Merricks! Which was fairly strenuous work.

2. The title “Regulation, Regulation and more Regulation…..and Complaints” is particularly relevant for two reasons. First, because, you now have certainty about the rules for statutory mortgage regulation, starting in October next year. But whilst I expect a period of relative stability in the regulation of mortgage business to follow, it is possible that policymakers in Brussels have other ideas, as they turn their attention from the wholesale markets to the retail markets. My view is that, especially with the advent of a new regime, we must give firms, their customers and our own staff, time to settle into it. Secondly, I can't share a platform today with Walter Merricks without some reference to complaints handling, and the important role of the Ombudsman service in complementing our supervision of firms. However, I intend to devote most of this speech to regulatory change, and touch briefly on complaints at the end.

3. There has, of course, been a lot of change in the past three years, and the next big step is mortgages and general insurance. I sometimes find it difficult to believe that the legislation to create the FSA only completed its passage through Parliament in 2000, and came into effect just 2 years ago. You will, I hope, have experienced some positive impact from the process of transforming a collection of 11 predecessor bodies into today’s single regulator. Many of you will now have one point of contact in the FSA who knows and understands your business and can deal with all aspects of your regulatory relationship. We too, value that relationship, since we know that the most effective form of regulation is pre-emptive – rather than trying to pick up the pieces when things have gone wrong.

4. But looking forward rather than backwards, it would certainly be impossible for me to make a speech to an audience such as this, without covering in some detail mortgage and general insurance sales regulation. Mortgages are, after all, your “raison d’être” and this is a market where you will understand the implications of regulation more than most.

5. The end-October 2004 start date for mortgage regulation has been known for some time, and we have recently issued the final text of the rules that will apply from then – rules on which you have had the opportunity to comment as part of an extensive consultation process. Whilst there are some aspects of the new regime that are still to be finalised, notably the exact format of the new returns that we will require you to complete, there is more than enough certainty for you now to be fairly advanced with your plans for turning the prospect of mortgage regulation into reality. So if you haven’t yet planned how you are going to get your business into shape in time for the start of regulation, you are leaving it very late!

6. In terms of practicalities, we have published on our website the authorisation application form for firms who will be regulated for the first time – although the applications themselves will not be accepted until mid-January 2004. Alternatively, if your firm is already authorised, you will need to apply for a "variation of permission", and we will shortly be giving details of the process by which you will be able to apply for those additional "permissions". We are aiming to make the process as streamlined as possible, particularly for firms that are already authorised for other activities like taking deposits, and to keep information requirements to the minimum.

7. If you are not yet authorised and have not registered for an application pack – take action now. You can register online on the FSA website – www.fsa.gov.uk. We would urge you to apply as soon as possible once we start accepting applications next year – we are anticipating many thousands of applications, and the timescale for processing them is very short.

8. The application form, whether for a new authorisation or a variation of permission, will include a Declaration. You will need to sign the Declaration to say your firm will comply, with the Financial Services and Markets Act and the FSA Handbook from the date you are authorised. This means that, when you apply, you must be certain that you have put in place a robust project management process that will be capable of delivering the required internal controls, information systems and staff training by the time regulation starts on 31 October. Given the importance of this to your businesses, senior management needs to be significantly involved in the preparation.

9. I am sure that most of you are already well prepared for statutory regulation of mortgages, having had the benefit of voluntary regulation under the auspices of the “Mortgage Code”. However, what I want to focus on this afternoon is not the detail of the new mortgage regime, but the fact that it is designed to provide consumers with the necessary information on which to base their own purchasing decisions.

10. To set the scene first, when we look at the current mortgage market, we see a number of developing risks to our objectives. For a start, we have continuing concerns about the level of consumer borrowing. This was a theme of our Financial Risk Outlook published last January. Since then household borrowing has grown rapidly - up a record 14% in the year to September to the equivalent of around £55,000 for the average household with debt outstanding. We said in January, and it remains our view now, that household borrowing clearly cannot continue to grow at its current pace without severe consequences for at least some borrowers – and increased credit risks for lenders.

11. Indeed the Financial Risk Outlook reported that, despite the benign economic climate of historically low interest rates and record levels of employment, some 20% of households were already finding it difficult to service their debts. Since then there has been mounting evidence that there is a vulnerable subset of households who are struggling. Notably Citizens Advice reported that 20% of people who have credit, use it to cover everyday household bills, a quarter of them struggle from time to time to keep up payments, and a further tenth have more serious financial problems. And the Credit Services Association, representing the debt collection industry, has estimated that there is £60bn of debt arrears outstanding. Meantime personal bankruptcies have continued to rise, surging to a new 10-year high in the third quarter, (a trend which is likely to be accentuated by the introduction of the new Enterprise Act early next year).

12. The FSA's remit in respect of consumer debt, is limited. As you know we will be regulating 1st charge mortgages from next October. As a prudential regulator we need to be clear that lenders are acting responsibly and prudently in assessing the credit risk inherent both in their products and in their customers who are borrowing, so that they expect to be able to obtain repayment – especially if they have retail depositors providing their funding. And, of course, we need to be satisfied that firm's are adequately identifying, managing and providing for loans which fail to meet their repayment terms and that they hold capital sufficient to cover the risk of their business.

13. Our other responsibility in respect of debt, relates to our statutory objective to promote public understanding of the financial system, although we are by no means the only players here, as the Bank of England and Office of Fair Trading have critical roles which extend well beyond consumer education. For example, we want to help borrowers better understand the risks and costs associated with borrowing. While it may appear affordable, given the 48-year low in interest rates, borrowers may be underestimating the real costs of debt, such as the full capital cost and variations in repayments over the lifetime of the loan. We want borrowers to think through how they would cope with a rise in interest rates or a fall in income. To this end, we have worked with the CML, to publish a factsheet ‘You can afford your mortgage now, but what if…?’, which highlights those very risks.

14. This brings me to the key issue that I want to focus on this afternoon: how regulation can help achieve a balance between the rights and duties of product providers, such as yourselves, to develop new and innovative products that meet individual financial needs, and the rights and duties of the purchasers of those products to understand how the product they have bought actually meets their needs in a way that offers good value for money.

15. There have been problems achieving this balance in the past. And with the benefit of hindsight, it seems to me that there are usually three key common factors: first, the products themselves are relatively complex; secondly, the sales pitch to consumers is relatively aggressive; and thirdly, the consumers who purchase these products are largely unable to understand the details or risks involved. Any one of these elements on its own might be manageable, but the combination of all three creates difficulties.

16. So, what does this mean for the current mortgage market? Well, there is no doubt that the complexity of the products offered has, if anything, increased over the past few years. Indeed, I have heard the technique of increasing product complexity described as “confusion marketing” – the theory being that the more variations there are, and the more complicated the product attributes, the more difficult it becomes for buyers to compare rival alternatives, and the greater the imbalance of knowledge and understanding between the seller and the buyer. In short, confused customers are more susceptible to a heavy sales pitch. The mortgage market can be confusing, with around 8,000 different products available at any one time, each offering a slightly different variation of the “bells and whistles” of interest rates, fees, incentives, lock-ins, bundled products and loyalty rewards. No wonder borrowers have tended to gravitate to intermediaries offering advice or guidance on what to buy . The market is certainly very competitive, but how many borrowers actually understand the value of the product features they have been sold?

17. So, when we set about developing our rules for mortgage regulation, one objective was to reduce the “confusion” by setting some specific rules on disclosure. In particular, we think that the requirement for firms to issue consumers with a “key facts illustration” in a standard format will not only allow consumers to compare products themselves, but will reduce the likelihood of future mis-selling by allowing them to come to informed decisions about the product that will suit them best.

18. It is certainly not our intention to reduce competition in the market – we have to have regard to “the desirability of facilitating innovation” and “the need to minimise adverse effects on competition” of our regime . But we are of the view that it is the simple, well-designed mortgage products that will look most attractive when presented in a Key Facts Illustration, and we make no apology for encouraging competition through transparency of pricing and other terms.

19. And what about the selling regime for mortgages? We have been publicly critical of firms that flout our “clear, fair and not misleading” test as it applies to the advertising of investment products. From next October, that same “clear, fair and not misleading” test applies to mortgage promotions. Indeed, we have gone further in our new mortgage rules by setting specific requirements for fair comparisons of products. They will require mortgage adverts to be balanced. So, where an advert highlights a particularly attractive feature, such as a low interest rate, the disadvantages such as an early repayment charge, must also be set out in the main body of the text. Our aim is to do away with the small print and formulaic explanations that currently feature in promotions, to ensure that all the relevant facts are presented clearly and succinctly.

20. This will involve quite a significant change in your approach to mortgage advertising, and it is important that you, as senior management, understand the implications for your product design and new product approval process. Once again, our expectation is that the simplest products will lend themselves best to the new promotion regime, although that is not to rule out clear promotion of more complex ones. As we have said before on occasions such as this, the FSA expects senior managers to take responsibility for the product design and marketing process, and not just see this as a task to be delegated to the marketing or compliance department - because how a firm treats its customers should lie at the heart of its strategy and not be the responsibility of just one team or one part of the process.

21. And what about the third difficult element? Even allowing for the lengths to which we have gone to embed simplicity and clarity in the mortgage sales process, I know there are concerns, which we share, about the capacity of consumers to understand the information provided well enough to make an appropriate decision for their needs. So, I want to emphasise here that it is not, and never has been, the FSA’s intention to insulate consumers from the consequences of their own decisions - indeed, the legislation specifically requires us to “have regard to the general principle that consumers should take responsibility for their decisions” . However, given that our remit extends to public awareness, I recently established a “Financial Capability Steering Group” to develop a national strategy to provide consumers with the education, information and generic advice needed to make their financial decisions with confidence. This of course has long-term objectives, but I hope that mortgage lenders will be able to play a full part in this initiative.

22. I would now like to turn to two current issues.

23. First, one of the key rules of our new mortgage regime requires mortgage lenders to take account of the ability of a borrower to repay any loan advanced. And the key facts illustration highlights explicitly the real cost of the deal – both now and when any introductory rate or fixed rate interest period comes to an end. This emphasis on affordability and the costs is designed to protect both the borrower and the lender, though clearly it needs fair dealing on both sides to work effectively. It is a criminal offence for an individual to lie about their income or for an institution to encourage their customers to lie. Clearly, there is an inherent higher risk with self-certified loans which means that lenders need to have robust controls in place to ensure that the features of the product are not abused by either the borrower or the seller. We are taking a close look at self certified mortgages to make an assessment of how widespread abuses may be. We will then determine what, if any, further action we need to take.

24. Let me take another topical example - what we have termed “lifetime mortgages” (to distinguish them from loans that “release equity” for current consumption or even debt consolidation). These types of loan clearly carry additional inherent risk for both the lender and the borrower, and we have already responded to that in part by adding some extra requirements in our rule book governing how they should be sold, and the information that should be provided. We know they are risky, because we have the historical background of the late 1980s and early 1990s to inform us, but we also know that the products have been generally improved since then – not least under the auspices of SHIP and the safety net provided by ‘no-negative equity’ guarantees. To help improve public understanding of these products we will shortly be publishing a consumer fact sheet that will set out all the factors that we think should be taken into account by those considering a lifetime mortgage or a home reversion scheme. The government's consultation on whether reversions should also be subject to FSA regulation closes on 13th February and we look forward to a timely decision.

25. We recognise that lifetime mortgages have a very useful role to play in the correct circumstances - especially given that individuals appear to be looking more and more to their home as their pension fund. And I know that many of you here, along with the CML itself, are only too aware of the risks of these products.

26. However, our view, is that this is a growing market, and the number of lenders, and particularly intermediaries, selling lifetime mortgages is increasing. Given the inherent risk of lifetime mortgages, the controls around the marketing and sales processes are particularly important, especially because the target client base is potentially vulnerable. We have seen some relatively poor financial promotions in this area, and there is clearly potential for mis-selling. Therefore a review of these controls could be one of our early priorities once the new regulatory regime comes into force, and lenders and intermediaries may therefore want to pay particular attention to our rules in this area as they prepare for regulation. And I want to make clear that, if we do find that a badly designed lifetime mortgage product has been sold inappropriately to unsuitable consumers by a sales force that has been incentivised on volume targets, we will be looking to take regulatory action against the firm and its senior management.

27. So far, I have managed to talk almost exclusively about mortgage regulation, but I wouldn’t want you to think that the FSA is ignoring general insurance mediation – which, as you know, becomes a regulated activity from 14 January 2005. We are running the authorisation processes for the two activities in parallel, and we know that there will be a lot of overlap in terms of firms affected – including, of course, you as mortgage lenders. Indeed, we understand that some of you are so keen on regulation that you want to adopt the general insurance intermediation rules early, at the same time as the mortgage rules, and I know we are looking at ways to remove any barriers to you doing so.

28. The general insurance regime has, of course, a completely different genesis to mortgage regulation, since it arises from a European Directive rather than from a direct decision by the UK Government. And, as I mentioned earlier, there is plenty more European legislation in the pipeline to keep you and me occupied over the next few years. Time prevents me from reviewing the implication of this legislation in detail this afternoon, but if you are not yet aware of the Distance Marketing Directive, the Unfair Commercial Practices Directive, the introduction of International Accounting Standards and the new Basel Accord (to be implemented through a Risk-based Capital Directive), you should be. And all these are in addition to any UK legislative changes, such to the Consumer Credit Act, and to the FSA’s own development of an integrated prudential sourcebook that will include new rules for liquidity.

29. So, going back to the title of my address, I can assure you we are well aware of the costs to business of regulation, regulation, regulation and the challenges you face in the years ahead. We at the FSA will be aiming to help firms through the period, and we will certainly be looking to try and find ways of minimising the bunching problems caused by implementation of European Directives. But there is only so much “peak lopping” (to borrow Callum McCarthy’s phrase) that can be done, and you will need to gear yourselves up early to ensure that you have the right resources to meet the implementation timetables.

30. Which brings me finally to complaints. I know that these tend to be seen as evidence of failure by firms to deliver on their service promises to customers. And, it has to be said that we look carefully at complaints volumes, since they tell us quite a lot about the quality of service provided by individual firms, whilst the aggregate figures highlight particular product types that have been causing problems. But my challenge to you this afternoon is to view each complaint as an opportunity to improve service, rather than a necessary consequence of being in business. It has long been an article of faith in the best businesses that a customer whose complaint is dealt with well becomes a more loyal customer, and that the information from complaints can be harnessed to drive process improvements. You may have noticed that most of the speeches I and my colleagues from the FSA have given in the past few months have focussed particularly on the need for the senior management of firms to embed "treating customers fairly" ever more deeply in the operatings of their firms. It seems to me that that complaints handling should be at the heart of that process, and I therefore look forward with interest to what Walter [Merricks] and John [Goodfellow] have to say on the subject.

Thank you for your attention.

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