The mortgage market in the EU
Keynote speech by John Tiner, Chief Executive, FSA
European Mortgage Federation conference, Brussels
22 November 2006
Introduction
Thank you for inviting me to speak at this European Mortgage Federation conference today. I am honoured to be here to speak to representatives of the mortgage industry from all over Europe.
The mortgage market in the UK is an important part of the economy, as is the case throughout Europe. In its Green Paper, the Commission stated that at the end of 2004, the value of outstanding residential mortgage loans represented about 40% of EU GDP. But mortgages are not only important for their impact on the economy, they also provide the means for many of our citizens to have a roof over their head. The European Commission is undertaking some important work to examine the opportunities to promote integration of the European mortgage market and a White Paper is expected in May next year. I am delighted to have this opportunity to contribute to this important debate.
In particular, I want to thank the Commission, who I know are represented here today, for the open and consultative way that they have considered this issue. They have done this by using expert groups, regular consultation and the commitment to cost/benefit analysis and rigorous impact assessment on any proposals. I also welcome the Parliament's careful consideration of the issues. The Rapporteur – John Purvis – and his colleagues have adopted a well thought-out response to the Green Paper and have fully explored the role that the market can play in delivering the desired outcomes.
Today I want to take the opportunity to discuss policy-making from a better regulation point of view, looking at the work that the Commission has undertaken into the integration of mortgage markets in Europe, our experience of the UK market and how it has developed, and how we are reviewing the effectiveness of our regulation of the mortgage market in the UK.
Better regulation
In considering the mortgage dossier, the Commission has committed to following a "better regulation" approach. I applaud the Commission for this commitment and for adopting this more rigorous approach to policy making. It is clear that Commissioner McCreevy has a strong personal commitment to the Better Regulation agenda. He made this plain at the Public Hearing on mortgage credit last December when he said: "Any action to be taken must promise clear benefits for all stakeholders, over and above any regulatory burden. In addition, our consideration of potential new initiatives will continue to be underpinned by transparent consultation, cost/benefit analysis and rigorous impact assessments".
I very much welcome this commitment, and want to take this opportunity to outline what I consider to be a "better regulation" approach and to set out the steps which need to be followed before making the case for new regulation.
First, we must ask ourselves whether there is a failure in the particular market which needs to be addressed. The Commission approach at this stage has been to ask – is the internal market functioning well, or is there scope for action by the Commission or others, to make the EU mortgage market more competitive and to increase choice and value for consumers? In effect, is there evidence of a failure in the internal market for mortgage credit which undermines competition and choice, or is the market working well? If there is no market failure there is no need for regulation, as, I believe a well-functioning market is the best way to deliver benefits for business and consumer participants.
The Commission is showing a growing commitment to the use of evidence in driving its policy thinking, as shown by the study of costs and benefits it commissioned from London Economics. The study concludes that full integration of EU markets would see net benefits of Euro 94.6 billion – equal to 0.89% of EU GDP in 2005. These are indeed impressive figures.
To deliver these benefits, the study constructs a hypothetical package of Community integration measures. However, the study does not assess these individually or quantify the costs and benefits of specific proposals. Instead, it draws on the costs of UK mortgage regulation and uses this as the basis for calculating the cost of regulation for each national market. This is despite the fact that the UK regime addresses causes of detriment in the national market rather than any failure in EU market integration.
At the moment, there is not the empirical analysis to show that there is a market failure. If such evidence can be brought forward, the second step in a better regulation approach is to examine if regulatory intervention is the most cost-effective tool to address the problem. Market failures can also be addressed using other mechanisms. Regulation is not the only solution. In fact, a legalistic approach can impose unjustifiable costs and limit innovation and competition. Policy-makers must consider what is the most effective tool to address a particular situation, taking into account the need to secure specific outcomes and recognising the increase in costs to business and their customers.
If you conclude that regulation is necessary, it is vital to outline the options and consider at an early stage the costs and benefits of each measure. If the costs exceed the benefits, it's hard to justify regulating.
Even if the benefits do outweigh the costs and regulation is introduced, that's not the end of the story. Better regulation also means checking that regulation is delivering the expected benefits.
Adoption of more rigorous disciplines around policy-making in Europe will improve the quality of regulation, ensuring that it is more evidence-based, proportionate and attuned to market failure. Adopting a principles-based approach aimed at aligning the interests of the market with the objectives of regulation should also be considered at the EU level as perhaps the most efficient and effective means of securing the target outcomes.
UK's views about mortgage market integration
Increased efficiency and competitiveness have the potential to contribute to the overall growth of the EU economy. However, most commentators, including the Commission and London Economics, accept that integration is unlikely to be delivered by individual consumers shopping across borders. There are many reasons for this – not least Member States' different traditions, culture, language and legal systems. It is much more likely that the benefits of integration will come from lenders entering new markets or national lenders "mimicking" the products of other Member States in their own market.
If this is the case, then European action should first tackle those structural barriers that hinder lenders operating across borders. These are likely to include:
- Exploring improvements in the efficiency of mortgage funding arrangements and liberalising regimes that restrict mortgage lending to particular entities (such as deposit-takers);
- Increasing non-discriminatory cross-border access to consumer credit data, while maintaining key data protection safeguards;
- Developing trusted common valuation standards that can be widely used and understood by valuers and lending institutions;
- Raising confidence in repossession procedures, while maintaining consumer safeguards; and
- Encouraging the development of open access to online land registry information systems - the EULIS project which the Commission has supported.
Alternatives to regulation should be fully explored before any decision is made on EU level legislative interventions. In all of these areas, as the EULIS project demonstrates, progress can be achieved through market-led initiatives.
In the Green Paper it published last year, the Commission raised a number of issues related to consumer protection including information and advice. If it is acknowledged, as the Commission has done, that integration is unlikely to come about from consumers shopping across borders, this prompts a key question: what is the role for consumer protection measures in promoting integration?
In my view, harmonising consumer protection across Member States should not be a focus of the Commission’s work. Introducing changes to consumer protection regimes risks:
- imposing significant costs, which will be reflected in the price all consumers pay for their mortgages; and
- distorting or undermining well-established national consumer protection measures so that they become less well-attuned to the national market. As an example, recent supervision activity has led us to prioritise further work on the quality of advice processes followed by firms. This will look at how firms are assessing affordability, and the approaches adopted when selling interest-only mortgages or lending into retirement. These are UK issues and are best addressed at a national level.
We know from the UK experience of introducing mortgage regulation that the costs of information rules are high. The cost-benefit analysis we carried out before regulation showed that the total one-off compliance cost would be about 200 million Euros and there would be 100 million Euros of on-going costs each year. Of the one-off costs, about a third, roughly 60 million Euros, are a result of information requirements. A similar cost arises from the rules on the sales process, advice standards and the related need for training and competency.
This cost was justified in the UK because the measures we put in place addressed the specific problems in our market. But these measures look very expensive if they aren't key to delivering an integrated market.
As I outlined earlier, we support the Commission’s continuing focus on better regulation. Taking matters forward needs an assessment of the costs and benefits of each individual measure under consideration. This will highlight the proportionality of any action, as well as identifying the approach that will deliver the greatest benefits for the least cost. And, where the case for regulatory intervention is made, I urge the Commission to consider whether a more principled-based approach would achieve the desired outcome.
The UK mortgage market – why allowing the market to operate freely benefits consumers
I asserted before that a market which works well is the best way to deliver benefits to firms and consumers. I want to turn now to some aspects of the current UK mortgage market which I think illustrate that.
It is, of course, the market about which I am best able to speak. But I think it is a particularly interesting one to look at, given that the UK market is often pointed to as a benchmark for product diversity and choice. I make no claim that this is the result of the regulation we introduced in 2004; the UK mortgage market has long been competitive and innovative.
There are many factors that contribute to our market being this way. If the diversity found in the UK market is to be echoed elsewhere it may be instructive to look at these. I would particularly highlight:
- the variety of firms able to be mortgage lenders. Market entry is not restricted to just one category of firm such as deposit-takers;
- the lack of ‘hard’ regulation on pricing or product design. This enables lenders to develop new types of mortgages to reach new markets and better meet the needs of consumers;
- an active intermediary sector, again with the freedom to innovate in the services offered to consumers; and
- the range of available options for mortgage funding.
It is worth, I think, exploring a few of these with you to bring out some of the conclusions we drew about how best to regulate in a way that would not damp down competition and innovation.
There are around 600 mortgage lenders in the UK, from banks and building societies to insurance companies and credit unions. While many of these lenders take deposits, there are a growing number who rely exclusively on wholesale funding. These firms have been particularly active beyond the standard mortgage market - increasing access and choice for sub-prime consumers.
In setting up our regime we wanted to maintain this, which is why the UK does not restrict the categories of businesses able to offer mortgages. This is not to say that regulation shouldn’t recognise differences between types of lenders. For example, regulatory capital is a commonly-used tool to safeguard deposits where these are taken by mortgage lenders. Wholesale-funded lenders do not present the same risk, because they don't take deposits, therefore the need for regulatory capital is less. We don’t favour treating banks and non-banks in an identical way. Though some have suggested that you need to do so to ensure a level playing field, we prefer a regulatory approach that recognises the differences between lenders and particularly the risks they pose to their customers on both sides of the balance sheet. These differences can foster product diversity and innovation. Regulating to remove these differences, where there is no risk-based reason to do so, is helpful neither to consumers or firms.
As I see it, a key characteristic of a fully functioning market is that it delivers a wide range of products for consumers to choose from - what the London Economics study calls 'market completeness'. As the study of costs and benefits makes clear, increasing product diversity in Member States is key to achieving real benefits from a more integrated mortgage market.
Regulatory choices can play an important role in shaping the market and the diversity within it.
To take just one example, let us consider the use of interest rate ceilings or caps. These are sometimes advanced as a policy tool to address a concern about predatory lending. The FSA is emphatically not a price regulator. However, we think that interest rate ceilings or caps can quickly become the standard or going rate in the market. But even leaving these considerations to one side, the simple fact is that an interest rate ceiling or cap will make credit inaccessible for some consumers who may benefit from its availability. This doesn't sit neatly with the Commission's objectives. Far better, we think, to rely on a fully functioning, competitive market where lenders and intermediaries understand their responsibilities and treat consumers fairly, and disclosure helps ensure that consumers understand what they are getting themselves into, and at what cost.
A further example of diversity is the development of the market in finance which complies with sharia law. Though commonly referred to as 'Islamic mortgages' there are actually a few different financing arrangements, some of which are mortgages and some of which are sale and lease agreements. This is currently a very small market in the UK, but it has the potential to become significant. Regulating for this market poses further challenges because the underlying structure of the products may be very different. Requiring an APR, for example is problematic if, under Islamic law, the concept of interest is unacceptable. The regulatory approach has to be sensitive to this diversity if it is not to have a negative impact on competition and deny consumers access to relevant products. As an aside, this also highlights to us the difficulties that might be faced in designing any 'one-size-fits-all' disclosure regime.
Covered bonds – an example of UK’s commitment to integration
You won't be surprised to learn from my earlier remarks that I favour allowing the market to develop an open and liberal approach to funding – and leaving lenders to choose for themselves which method of funding is most efficient for them. UK mortgage lenders have long had a range of funding instruments open to them and the FSA wants to extend that flexibility by putting in place a covered bond regime that complies with EU requirements.
As you know, covered bonds are highly liquid capital markets instruments and are well-established across Europe. They provide a highly effective means of managing both long-term liquidity risk and interest rate risk for investors and issuers. They are an important funding tool for mortgage originators in many European countries, but are relatively new to the UK.
We now want to make this form of funding more accessible for UK lenders by establishing a EU-compliant covered bond regime. We have been working closely with HM Treasury and with industry on developing this regime – we plan a joint consultation in early 2007 with a view to implementing our new regime by the end of next year.
We expect a number of benefits from an EU-compliant covered bond market in the UK: for consumers, it could help to develop a longer-term fixed-rate mortgage market; for UK issuers, it would lead to a reduction in costs; and for investors subject to the CRD, it could mean a preferential regulatory capital treatment.
I hope that these examples of recent developments in the UK market have gone some way to convince you of the benefits of a competitive and innovative market.
Testing that regulation delivers the intended outcomes
My description of better regulation included testing that regulation, once implemented delivers the intended benefits. I want to close by describing the work the FSA has done to test whether our mortgage regulation regime has achieved what we thought it would. We have recently published our first findings from this review. I’ll touch briefly on these although they are, of course, relevant principally to the UK market. The broader point which I want to focus on is the importance of reviewing regulatory effectiveness against the objectives originally set. We see this as fundamental to the commitment to better regulation. Without ongoing monitoring and review we think it is difficult to establish whether any policy intervention is making a real difference in practice. It will be no surprise then that I welcome Commissioner McCreevy’s comments about similarly assessing the effectiveness of existing Directives.
The review we announced in September 2005 aims to look at the impact of the conduct of business rules we introduced for mortgages, focusing particularly on the target outcomes for consumers. But the review also reflects our determination to find ways in which we can improve the effectiveness of our approach and contribute to the better regulation agenda.
Of course, the outcomes that we have been assessing are very different from the Commission’s declared objective for fostering greater integration. Regulation in the UK was set out to address particular national issues and detriment, with the objectives that consumers:
- shop around for mortgages;
- understand whether they are being given advice or information;
- better understand the risks and features of the mortgages they take out;
- that consumers take out suitable and good value mortgages; and
- are treated fairly over the life of the mortgage, including when they go into arrears.
You’ll understand from these objectives that the effectiveness of regulation in the UK, like any EU initiative, needs to be judged over a reasonably long time-frame. It is important to be realistic about the timescales in which regulatory objectives may be achieved… and we think this is especially true where the aim is to influence consumer behaviour. For this reason we have committed to a rolling programme to measure and assess the outcomes of our regime.
I don’t think it is such a stretch to apply the same reasoning when looking at the existing European Code of Conduct for mortgages. The voluntary Code is a positive example of an alternative to regulation. As a voluntary, market-based approach it has the potential of being much more flexible in addressing national market differences and new innovations. There has, of course, been one very early review of the Code, which we know left many in the industry concerned about the methodology. But since then, there has been no further assessment to check if the Code has now become embedded in national markets or the extent to which the required disclosure has empowered consumers. From our perspective, a further assessment would certainly help inform the debate about the contribution disclosure can make to achieving the Commission’s objective of greater integration.
The disputed methodology of the original study of the Code illustrates a wider point relevant to any review. Robust and reliable assessment techniques are important – both to measure effectiveness and to ensure credibility with stakeholders. For us, this has meant using a variety of techniques that allow ‘research triangulation’ – targeting questions from several different angles, through different pieces of research, to try to ensure the validity and robustness of our results. Practically, this means that we have used:
- qualitative consumer research to test consumer understanding and use of mortgage disclosure documents;
- quantitative consumer research to study the actual sales process consumers go through – getting the answers to questions such as do they shop around?, do they read and use the disclosure documents?, do they seek advice?;
- mystery shopping to check if consumers understand whether they’ve been given advice or information - and where advice is given, to ensure that firms gain enough information about the consumer’s needs and circumstances to give appropriate advice; and
- market analysis to see if there are any trends evident in things such as pricing, fees, remortgaging levels etc before and after the onset of regulation.
Using these techniques has enabled us to conclude, at least for those elements of the regime included in the first stage of our effectiveness review, that:
- there is evidence pointing to our rules achieving their intended objective. The prime mortgage market remains competitive, consumers are shopping around and firms, with some exceptions, are broadly compliant;
- the rules are working well enough so that we consider we don't need to make immediate or piecemeal changes. There is certainly no industry appetite for such change; and
- we can use the next stage of the review to focus even further on the better regulation agenda. In particular, we want to actively engage with stakeholders to get their help in identifying areas where we can either simplify or move our requirements further towards a more principles-based regime.
As I expect you will gather from this, reviewing the effectiveness of regulation is neither straightforward nor quick. But this doesn’t mean that such a review should not be undertaken.
Better regulation has to mean more than improving the processes that lead up to legislative intervention. Regulation, once introduced, should be routinely assessed to ensure that it is meeting its original purpose - and to enhance its effectiveness and minimise its burdens.
Conclusion
In conclusion, I believe that we are reaching a particularly interesting point in the development of the EU mortgage market. In this respect, the Commission’s work is very timely. But if we are to reap the further benefits that could follow from greater integration we all have a duty to ensure that we do not upset efficient and fully functioning markets that are delivering benefits for firms, consumers and the wider economy. In this, our watchword(s) should be ‘better regulation’, meaning:
- acting only where there is market failure;
- proceeding on a clear evidence-base - including rigourous cost-benefit analysis; and
- where the case for intervention is made, only using statute where market-led or self-regulatory action is unable to deliver.
Thank you for your time.