Mortgages Conduct of Business Rules Effectiveness Review
Speech by Dan Waters,
Director of Retail Policy Division, FSA
at the CML Annual Conference
5 December 2006
Introduction
Hello everyone, I'm Dan Waters, Director of Retail Policy Division at the FSA. I'd like to thank the CML for inviting me to speak at this Annual Conference and Kate Davies for joining me in this 'double bill' this morning.
I'm going to talk to you today about the effectiveness review of our mortgage conduct of business rules (or MCOB as most of you know it). I’ll be giving a very brief overview of the review itself and a reminder of our conclusions from stage 1, then I'd like to outline our thoughts about where the review goes next.
I also want to take the opportunity of being here today to talk a bit about the implications for mortgage regulation of the FSA's move to more principles-based regulation.
Overview of the effectiveness review and conclusions from stage 1
As you know, we announced the review of the mortgage regime in December 2004, just after mortgage regulation came in. In line with our Better Regulation agenda, we wanted to test whether our rules were delivering the intended outcomes for consumers. The review started in December 2005, and we published our stage 1 report at the end of September this year, reporting progress against the five consumer outcomes we set for the regime. These are:
- firstly, consumers shop around for mortgages;
- secondly, consumers understand whether they are being given advice or information by firms;
- third, consumers better understand the risks and features of the mortgages they take out, including the affordability risks;
- fourth, consumers take out suitable and good value mortgages; and finally
- consumers are treated fairly over the life of the mortgage, including when they go into arrears.
We have planned the review in stages and will be looking at different aspects of the MCOB rules during the course of the review. In stage 1 we focused on the mortgage process up to the point of sale, looking particularly at disclosure and advice. In stage 2 we plan to focus on a few specialist areas and more generally on post sale issues, especially examining the last outcome on treating consumers fairly over the life of the mortgage.
I should point out that these are outcomes we expect the regime to achieve over time, and we will be measuring progress in the future against where we are now. Some of these things – for example, getting consumers to take out suitable products - are obviously dependent to a certain extent on the level of financial capability in the population (which we found, in our recent financial capability baseline survey, was quite low).
Our stage 1 findings led us to conclude that things are moving in the right direction, which is good news. The prime mortgage market remains competitive and we found consumers can generally understand and use our disclosure documents and are shopping around.
However there are still areas of non-compliance which our thematic work has highlighted – most recently in the work on financial promotions in the sub-prime market. The evidence gathered about poor advertising unfortunately seems to be a sign of wider problems in the way some mortgage brokers are managed and controlled. Similarly, although we were pleased with the overall improvement in compliance, we reported in June this year that some firms still had work to do in getting IDDs and KFIs up to scratch, and ensuring these are issued to consumers.
Plans for stage 2
Moving on now to the subject of where we go next with the effectiveness review. In stage 2 we plan to focus on areas where the potential for consumer detriment is higher and for that reason we will be looking at:
- the sub-prime market;
- lifetime mortgages; and
- how lenders treat borrowers in arrears.
We are currently working up a methodology to measure how well our rules are working in these areas; and as with stage 1 we will draw on existing compliance work to get a picture of whether the rules are being followed.
However there is also a second strand to our approach in stage 2, which we mentioned briefly in our stage 1 report, and that is identifying – with the help of our stakeholders – whether there are any areas of MCOB that we could look to simplify or move further towards a more principles-based regime.
Moving to a more principles-based approach
This leads us inevitably into a wider discussion about the FSA's move to a more principles-based approach to regulation. I'm sure you've all heard a lot about this in recent months, and you may be wondering what the implications might be for MCOB? I'd like to spend the remaining time on this issue, and I hope that this will lead to some interesting and stimulating debate later on when we take questions.
Firstly, what do we mean when we talk of moving towards more principles-based regulation? I would sum this up by saying it is a shift of emphasis by the FSA away from looking at the processes carried out by firms, towards the outcomes we seek to achieve, for consumers, firms and markets.
An example of how this might work in practice can be found in the way we are proposing to treat risk warnings for investment business. Currently, COB has detailed rules on the type of warning that needs to be given for different types of product. In our NEWCOB proposals we are proposing a higher level rule, which leaves it up to firms to decide what will be appropriate to the product they are selling.
However, I should say that, although the idea may appeal to some (but not all) firms, there is no prospect of the FSA moving to a regime based exclusively on principles. We will always have a mixture of specific rules and general principles, and we are clear that there are certain areas where we will continue to rely on detailed rules. One such area is where the rules implement EU Directives.
However, we do want to move firms away from a ‘tick-box mentality’ to compliance – something we as regulators have also been accused of – to a world in which firms understand the regulatory outcomes that we are seeking to achieve and work out how to do that in their particular circumstances and business models.
We understand that firms are interested to know how a move to more principles-based regulation will affect things on the ground, as well as in the rulebook, so I’d just like to touch on that. As you may be aware, we have recently revised the ARROW methodology which lies at the heart of our supervision process, and are now operating under the new ARROW II. ARROW has always been a risk-based approach, and under ARROW II we will be placing a greater emphasis on outcomes and allow more scope for supervisors to apply their judgement to a particular situation. We believe that our approach will reward firms who do the right thing because there will be less need for us to intervene in these cases.
Enforcement is an area where firms and others have raised concerns about a principles-based approach. We recognise that predictability is key here – that is to say that a firm must have been able to predict that its actions were in breach of our requirements if we are to take enforcement action against that breach. But we believe that principles and high level rules can deliver this predictability. And I would emphasise that we already can and do take enforcement action on the basis of principles.
Another feature of the principles-based landscape might be a greater regulatory role for industry codes. We have recently published a Discussion Paper exploring how the FSA can recognise those codes and pieces of industry guidance which we think are in line with the outcomes we are seeking. Obviously, the purpose of trade associations is to represent their members’ interests, and it is for them to decide how best to do this, but we feel that there may increasingly be ways in which they can serve their members by helping to spread good practice. I should add that we are not moving to a world where we are in any sense requiring trade associations to take on the role of providing guidance to their members if that is not what they and their members want or think is desirable. This is strictly a decision for each individual trade association and its membership to take.
I’ve talked about what we will be doing under principles-based regulation, but how do we see this affecting firms? I’ve said that we see a principles-based regulatory regime as one in which firms are given greater flexibility over how to achieve the outcomes we require. This means that we will be looking increasingly to senior management to take responsibility in this area, and to deliver significant changes where necessary.
In return for this commitment to delivering our desired outcomes, we think there are significant benefits to firms. A more principles-based approach will allow firms more freedom to innovate when it comes to designing products and services, and greater flexibility may reduce the burden of regulation and allow firms to offer customers better value for money.
Also, firms who demonstrate that they are ‘getting it right’ by themselves will need less attention from us, and so will be rewarded with less regulatory intervention. I think this illustrates that there is a bargain to be struck here between the industry and FSA as regulator. We need to set out clearly the outcomes we want to achieve, and where firms fulfil their part by taking responsibility for delivering those outcomes, we need to give them the flexibility to do so in the way most appropriate to their business.
In terms of MCOB, we are at an early stage in considering how we take forward this more principles-based approach. And we're in no rush to cut down or rewrite the rulebook if there is no convincing argument to do so. We said in our stage 1 report that we don't intend to change our rules at the moment, and this is for three important reasons:
- firstly, the areas we looked at – in particular disclosure – seem to be working effectively at the moment, at least across the prime mortgage market. As I mentioned, we will be doing some further work on the sub-prime market before we take a view on how regulation has affected these consumers;
- secondly, industry feedback has been that there is no appetite for rule changes at the moment. This has been a consistent message in all of our meetings with stakeholders. Our mortgage regime was costly for the industry to implement, so we understand why your don't favour early change; and
- finally on the horizon is an EU White Paper on Mortgages. If the EU decides to introduce a Directive, the implications for the UK's mortgage regime could be far-reaching so we feel it's right to wait and see what the European Commission proposes before taking any final decisions.
However, in the light of the imminent simplification of COB and ICOB, and our commitment to a more principles-based approach to regulation, it would be inconsistent not to at least open the discussion about principles-based regulation to include MCOB. And we believe that the effectiveness review is a good mechanism for identifying areas that might be suitable for simplification.
Where we think things are working, we won't - at the moment – be looking to change them. This seems entirely sensible, and I hope you'll agree – "if it ain't broke don't fix it".
If, however, we find areas where things are not working well, or where it could be argued we have been overly-prescriptive in our rules, leading to less effective outcomes for consumers, then in the second strand of stage 2 we will consider these as potential areas for simplification.
This could mean stripping back some of the rules and guidance in MCOB, and giving firms more freedom to decide how to achieve the outcomes we're looking for – for example in terms of Treating Customers Fairly - rather than us prescribing in detail how they get there.
Turning to a practical example, to get the ball rolling, and before I pass the floor over to Kate:
One area of the rules that cropped up a number of times in our initial discussions with trade bodies was financial promotions. At the moment, the financial promotion rules in MCOB do go into some detail – for example about the content of promotions. One possibility would be to follow the approach of the equivalent NEWCOB chapter which focuses much more on high-level rules and leaves the detailed decisions to firms. We could simplify MCOB 3 in a similar way – and I'd be interested to hear your views on this.
That's just one example, but hopefully you can see there's plenty to be thinking about here.
I understand we're taking questions at the end, so I'll hand over now to Kate – thank you very much for your attention.