Mortgage regulation - is it working?
Speech by Clive Briault, Managing Director, Retail Markets, FSA
Mortgage Business Expo
15 November 2006
Introduction
After two years of mortgage regulation, we need to ask ourselves an important question: is the mortgage market working for consumers?
I want to address this question in two parts. The first relates to the disclosure of information to consumers, and the second to whether mortgage advisers are treating their customers fairly.
This is a good moment to ask whether mortgage regulation is working and to address any shortfalls.
We are seeing record levels of lending almost every month. Approximately 60% of mortgages are advised on by mortgages brokers. So this is a large and vibrant market with new products being launched all the time. This is good news for the industry and consumers alike.
Mortgage advisers have had a relatively benign economic climate in which to adapt to mortgage regulation. More recently, however, consumer debt has continued to increase, and interest rates have gone up. Although interest rates remain relatively low compared to previous decades, they are now at their highest level for five years. A significant number of consumers could experience financial problems because of their high level of borrowing.
So the pressure is starting to increase on the processes for giving mortgage advice, and this is already revealing some worrying cracks. My message today is that the regulatory regime is in place to cope with this pressure and to protect consumers, but this requires all mortgage advisers to ensure that they are delivering the right information and a good quality of advice to consumers.
Disclosure and the Mortgage Effectiveness Review
When we introduced the new regulatory regime for mortgages two years ago, our primary objective was to provide additional protection to consumers while maintaining an innovative market place with access to a wide range of products, providers, and delivery and advice channels. The main focus of our regulation of mortgage lending was for consumers to be given clear information about their mortgage before sale, so that they could make comparisons between lenders, shop around and make informed decisions based on an understanding of the risks and features of the mortgages they took out. The main focus of the advice regime was for firms to have good selling practices in place so that consumers received good quality and suitable advice.
We announced in September last year a review of the mortgage regime, to measure whether the regime was delivering the intended benefits to consumers. The first stage of the effectiveness review was completed recently. It relied primarily on consumer research to assess whether the rules on pre-sale disclosure and on firms' advice and selling standards were delivering the intended benefits for consumers.
The headline result is that 77% of consumers are actively shopping around for mortgages by gathering information from more than one firm before making a final decision. We are seeing similar results from other sources. For example, the number of visitors to our online comparative tables increased by over 130% between 2003 and 2006, after a successful consumer campaign – Mortgages Laid Bare - which was launched in October 2005.
It is also encouraging to see that consumers find Key Facts Illustrations useful and are using them in several ways. For instance, they can compare mortgages available in the market, consider the risks and features of different types of mortgage, and perhaps most importantly, use the information to help them decide if a mortgage is right for them. Our research showed that 52% of consumers used the Key Facts Illustration as a prompt to ask questions to clarify their understanding. We are pleased to see that while price is still one of the key drivers in deciding what mortgage to have, many consumers are taking a much wider consideration of the features of their mortgages. It is also interesting to note that the length of interviews with advisers is not discouraging consumers from shopping around.
Our research also shows that consumers find the Initial Disclosure Document - which is the key document to explain to customers the service being provided and how the adviser will be remunerated - a useful and accessible document. The results from our mystery shopping exercise showed a positive link between disclosure and consumers knowing the type of service they received – in particular, whether they had received advice or information.
So disclosure is a key element in consumer protection. There is evidence that where consumers are given clear and relevant information, they can shop around and make informed decisions. And consumers who shop around and understand the risks and other features of their mortgage will be more likely to take out a suitable and good value mortgage.
These results confirm that in the areas we looked at, the mortgage regime is working effectively where firms comply with our disclosure requirements. Equally, however, we continue to see cases where disclosure documents are not in line with the format and content required. Some are too long or too legalistic. Some contain material errors on fees and charges. Some do not contain all the required information.
Through our thematic work earlier this year we found that more than half of Initial Disclosure Documents contained five or more errors. Although individually the errors were not major, taken together they can undermine the purpose of the documents. This is a concern, particularly as we have reviewed this area before and published all the information firms need on our website, including a Build Your Own disclosure document which makes it even easier for firms to deliver simple, clear and accurate information to consumers. We are now looking into this area for a third time. If mortgage firms have not made the right improvements in these areas, we will take appropriate action.
The second stage of the Effectiveness Review will take place next year. This will focus on parts of the mortgage market where we believe there is likely to be consumer detriment, including lifetime mortgages and the sub-prime market.
More Principles-Based Regulation and Treating Customers Fairly
The disclosure aspects of the mortgage regime are only part of the story. We also need to ask whether mortgage advisers are following the obligations under our Principles to treat their customers fairly and to provide suitable advice.
Our eleven Principles for Businesses have been in place since 2001 and provide the backbone of our regulatory regime. They impose overarching requirements on all firms, and they focus on outcomes rather than on detailed processes or procedures.
In practice, the Principles will always need to be supplemented by more detailed rules and guidance, not least to implement EU legislation and because in some areas detailed rules and guidance are the best way of achieving a desired outcome. But our intention is to move decisively to more principles-based regulation. This is because we believe that this is the best way of making a real difference to consumers. We believe that there are four key elements to the "delivery mechanism" here.
First, we are continuing to emphasise the responsibility of senior management of firms to deliver a significant change in the way that their firms treat their customers.
Second, a more principles-based approach provides firms with greater flexibility to determine for themselves how best to run their business, and to decide for themselves how to deliver fair treatment to their customers in a way which is consistent with their commercial objectives. That is why, for example, we are consulting on a new Conduct of Business rulebook for investment business that is half the length and written much more clearly than the current version.
Third, providing flexibility rather than prescribing detailed processes should enable firms to compete and innovate more effectively in product design, in the quality of customer service, and in providing value for money.
Fourth, this delivery mechanism can be reinforced by the FSA in various ways, including through our work on financial capability and disclosure; our supervision of firms in a more principles-based way; and, where necessary, our taking enforcement action against firms and their senior management when they fall below the standards we would expect of them.
Our work on Treating Customers Fairly is an example of how more principles based regulation will work. In our most recent update, published in July, we set out six consumer outcomes that we want our Treating Customers Fairly initiative to achieve, namely:
- Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture;
- Products and services marketed and sold in the retail market are designed to meet the needs of identified groups of consumers and are targeted accordingly;
- Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale;
- Where consumers receive advice, the advice is suitable and takes account of their circumstances;
- Consumers are provided with products that perform as firms have led them to expect, and the associated service is both of an acceptable standard and also as they have been led to expect; and
- Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
We expect all firms to have reached at least the 'implementing' stage of their Treating Customers Fairly work in a substantial part of their businesses by the end of March 2007.
Some firms may find a more principles-based approach challenging. Their senior management will need to understand the Principles for Businesses, to consider how to translate this into their business, and to ensure that this is firmly embedded across their business practices. This could require a change in the firm's approach or culture.
We recognise here the particular challenges our Treating Customers Fairly initiative and our move towards more principles-based regulation pose to smaller firms, which do not have dedicated compliance resources. This is why we produced the Self Assessment tool for smaller firms – a simple to use A4 sheet. We have also published on our website a number of statements of good practice (and some indications of less good practice) and case studies, including some relating specifically to mortgage business; and we are offering training courses, roadshows and surgeries specifically designed with smaller firms in mind.
So if you have not yet done this, a good place to start is the self assessment tool. This contains several key questions designed to prompt smaller firms on some of the areas on which they should focus on order to be satisfied that they are treating their customers fairly.
There are many firms out there giving good quality advice and treating their customers fairly. Consumers are right to have confidence in the mortgage advice industry. We see examples of good practice in mortgage firms every day.
- We have seen sub-prime advisers and lenders diarising future meetings with clients so that they can review their circumstances on the basis that the customers would have had time to 'repair' their credit position and could possibly then be looking at non sub-prime products which would be cheaper for them.
- We also see some mortgage brokers taking first time buyers through the whole home buying process and working with them to understand the total costs (solicitors, removals etc) rather than merely the cost of the product they are recommending.
We need those firms that do not treat their customers fairly to act now to improve so that they do not damage the good reputation of the industry for all.
Quality of advice processes
We looked at the quality of advice processes in investment advisory firms earlier this year, and now we are looking at the quality of advice processes in mortgage firms. We aim to announce the results of this work at the beginning of next year. Early analysis of the results is worrying – particularly on the processes relating to affordability, lending into retirement, interest-only mortgages, and training and competence.
We are continuing to monitor the provision of good quality advice within the mortgage sector to set a baseline against which future improvements can be made and measured. This will remain a priority for us next year.
Affordability
We are particularly concerned about what the quality of advice processes work tells us about the approach to affordability in mortgage firms.
It is too early in the project to confirm numbers, but it is becoming clear that affordability is not being adequately discussed and assessed in an unacceptable number of firms. Indeed, in a worrying number of cases, affordability is not being discussed with customers at all. Some advisers believe this is the sole responsibility of the lender. Let me be clear about this. Both the adviser and the lender have responsibilities to ensure the mortgage is affordable; neither party can delegate responsibility to the other party.
I would like to remind you of our position on income multiples and how these relate to the assessment of affordability. We believe that gross income on its own is a poor guide to affordability. After all, two individuals with the same level of income could have very different lifestyles and other financial commitments, meaning that a mortgage affordable for one could be unaffordable for the other.
We generally focus on three key aspects to assessing affordability:
- First, to look at net income – that is, income after tax coming into the household and taking off costs such as borrowing, maintenance, dependant relatives and similar regular calls on available income.
- Second, whether the borrower can afford the payments – not just at the start of the mortgage but also when rates change, such as after an early discount period.
- And third, whether the borrower can repay, or has a plan to be able to pay, the capital amount.
Affordability also means checking the potential impact of possible future increases in interest rates. And where a mortgage extends into retirement affordability means taking account of a customer's likely income and expenditure in retirement. We have found too many cases where no such assessments have been undertaken and discussed with the customer. This is simply not acceptable.
Interest Only Mortgages
The work we are doing on the quality of advice processes in the mortgage market also includes some analysis of interest-only mortgages.
During 2005, 24 per cent of all new mortgages were on an interest-only basis. In more than three-quarters of these cases, accounting for 19 per cent of all mortgages, it was not clear from our thematic work whether a repayment vehicle was in place. This seems a high proportion to us. So we are investigating, through interviews with 750 consumers who have recently taken out an interest-only mortgage, whether advised and non-advised customers understand the risks of an interest-only mortgage. We want to know whether they make informed decisions when choosing this method over a repayment mortgage.
We will publish the results of these two projects – on the quality of advice processes in firms in the New Year, and on interest-only mortgages before the end of this year.
Conclusion
So, is mortgage regulation working for consumers?
We believe that the regulatory regime is working, but our thematic work shows pockets of mortgage advisers who have not yet put in place the disclosure and advice processes needed to deliver real benefits for their customers.
These advisers need to make a real difference for their consumers by treating them fairly so they are assured of getting a fair deal in the mortgage market. We will then have a healthy and sustainable mortgage market for the future.