Small mortgage advisers: Reasons to engage with the FSA
Speech by Mandy Spink, Head of Mortgages & Credit Unions Department, FSA
Manchester AMI Mortgage Expo Speech
16 May 2007
I understand there is likely to be a majority of smaller firms in the audience today, so I will direct most of my comments to this end of the market.
I am also aware that there are many firms at this conference vying for your attention, so I appreciate you taking time out to engage briefly with the FSA.
Engaging with us
After two and a half years of FSA regulation, we would expect small mortgage firms to be in the habit of engaging with our communications. As a minimum, engagement with the FSA means to take on board the findings we publish from our reviews and to consider in the light of these whether you need to make any appropriate changes to the way you run your firm.
Today, I'd like to recap on what our key regulatory topics are and, going forward, what the areas of our focus will be specifically for the mortgage market. On this basis, I am going to start with Principle-based regulation and Treating Customers Fairly, and then move on to sub prime, self certification and affordability.
To save you writing this down, a copy of this speech will be posted on AMI's website. If you'd like to talk about these subjects, or anything else I mention, please visit the FSA stand A - 55.
More principle–based regulation
So, starting with the FSA's move to a more principle-based approach to regulation. Principles are not new – they have always existed along side more prescriptive rules. The difference is we are now looking to rebalance the focus of our approach away from detailed, prescriptive rules and towards high-level principles. I think there are three questions that small firms should have asked by now: What is principle-based regulation? Why do we need it? and, What does it mean for my firm? I'd like to address each of these in turn.
What is principle-based regulation?
To start, what is principle-based regulation? As I've said, it's about regulating with the emphasis on principles and high level rules, rather than prescription around processes. This relies on the FSA setting the outcomes we want to see you achieve and then directing our supervision to assess how they are being achieved. The move towards a more principle-based approach is a direction of travel, not a project to be implemented by a specific date. It’s a strategic direction that we are convinced is necessary to deliver our statutory responsibilities while at the same time keeping pace with the dynamism of the financial services markets and it's about fostering the innovation and competition to keep these markets successful.
Why do we need principle-based regulation?
Why are we doing this? In other words, why do we need principle-based regulation?
First, the past focus on prescriptive standards rather than on the Principles has not actually prevented misconduct, as seen in the widespread mis-selling of personal pensions and more recently mortgage endowments, split capital investment trusts and SCARPS.
Second, we can see that the current volume and complexity of our standards risks creating a barrier to compliance. Firms unable to devote sufficient resources to understanding what is required of them will deliver poorer outcomes for consumers.
Third, we know that overly prescriptive rules divert industry attention towards complying with the letter rather than the spirit of the standard, making it less rather than more likely to achieve its goal.
And finally, a prescriptive approach to achieving desired outcomes prevents firms from finding the most cost effective and innovative approaches available to them – with a detrimental impact on the costs borne by consumers or the extent of choice they face.
So we are taking a more outcomes based approach. To be more specific:
- we are focusing on the outcomes we want to achieve;
- over time we are simplifying our Handbook so that as far as possible (subject to legislative constraints) it contains only Principles and those more detailed rules we think are necessary for delivery of outcomes.
- we are focusing on the responsibility of management to meet the requirements set out in our Principles and other rules; and
- we are giving firms the opportunity to meet those requirements in a more flexible, innovative and competitive manner.
What does it mean for your firm?
And finally, What does it mean for your firm?
The short answer to this is: there will be advantages but also challenges.
The main advantage for small firms is the move away from the mass of detailed rules. This should make is easier for smaller firms who of course do not have extensive legal and compliance departments, to get their hands and heads around our requirements.
Indeed, it may be smaller firms that find it easier to adapt. The business leaders of small firms are often close to their customers and operations on a day to day basis and so have the depth of knowledge and personal experience to make informed decisions about how to meet their regulatory obligations in the beginning.
But we do recognise that this approach to regulation is a challenge.
Our impression from feedback is that the management in many firms support a more principle-based approach but that you would like more detail on what this will mean in practice.
We also understand that a fundamental requirement for the application of a Principle is predictability. In order for consequences to be attached legitimately to the breach of a principle, it must be possible to predict, at the time of the action concerned, whether or not it might put you in breach.
Predictability can of course be improved by guidance. We accept that more principle-based regulation may require a greater readiness by us to issue guidance. And we have also recently consulted on the future role of guidance issued by the industry, such as through Trade Associations. Equally, we have experimented with a range of means of promoting discussion of what the Principles mean in practice – case studies setting out hypothetical situations, reports giving examples of good and poor practice encountered by our supervisors. It is important to stress though that the overall intention is less prescription.
So if the management of a small firm engages actively with and understands the outcomes we are seeking to achieve then it ought to be more straightforward for them to embed regulatory requirements into the every day running of their businesses accordingly. I accept that the "just tell me what to do" response remains alive and well in some small firms, but this is at odds with what we hear from small firms who do want to know the key outcomes we are seeking to achieve, and where to find some helpful illustrations of ways in which this can be done. This is why we are enhancing the role of our Firms Contact Centre and why we have published some fresh material on our website, aimed specifically at smaller firms. I am pleased that both these initiatives have been strongly endorsed by the Smaller Businesses Practitioner Panel.
Treating Customers Fairly
If you have heard of any of the Principles, it is likely to be Principle 6, which reads: "A firm must pay due regard to the interests of its customers and treat them fairly." I'll say more about this.
In line with our rebalancing away from rules and more towards principles, we have for some years focused on "treating customers fairly" as a way of achieving an outcome of firms improving their behaviour towards consumers in the retail market. We set about tackling consumer detriment not by detailed rules, but by challenging firms to satisfy themselves that fair treatment of customers is embedded throughout the firm's day to day operations, and throughout the lifecycle of the product.
In July 2005, we issued a report on our findings, suggesting that firms might be categorised as going through four phases of progress with TCF: those that are simply aware of the initiative; those involved in strategy and planning to address TCF issues, those that had found issues and were implementing changes; and those that were fully embedding TCF into their business.
Last year we reported further progress with TCF. Although firms told us they were making good progress, we continued to see poor behaviours towards customers in the course of our thematic work. So, in order to sustain momentum with TCF and encourage those firms who had failed to engage, we set a deadline for all firms to be at least implementing TCF in a substantial part of their business by the end of March 2007.
In order to assess progress against this deadline for small retail firms, we conducted a major telephone survey (of 659 firms) during the first quarter of 2007. The survey asked firms what they were doing on a range of important TCF issues, including management behaviours, and how these impact, for example, on advice and complaints.
The results came out last week on 8 May. One of the main messages was that we are concerned about the slow progress made by the small retail firms we reviewed. In total, only 41% of the small retail firms we sampled could show that they were implementing TCF in a substantial part of their business. Disappointingly, when the results were cut by sector as well as firm size, only 22% of small mortgage intermediaries met the deadline as compared to 45% for small general insurance and 52% for small financial advisers.
On a more positive note however, I think we all should recognise that the size and structure of smaller firms gives them a real opportunity to make quick progress. So we believe, mortgage firms that act now to convert awareness into action could quickly and easily help make a difference to those headline figures.
To help small firms further, we will expand the range of TCF online tools and have started the rollout of regional workshops. For mortgage advisers, we have set out examples of good and poor practice on our TCF web pages. If you haven't done so already, I would encourage you to log on and look at all of the help available.
Further action by the FSA
So what next for TCF?
All firms who participated in the survey were given direct feedback at the time about their firm's progress. And, in line with our risk-based approach, our primary focus is to target those firms who pose the greatest risk to our objectives such as those where progress was particularly poor or where firms have simply failed to engage with TCF. We aim to visit every firm in this category by the end of June 2007.
We have also provided further information about the main shortfalls identified in their sector to those firms who have engaged with TCF but whose progress was slow or of poor quality. This was to help these firms to consider whether and how these findings may be relevant to their business and whether they should be taking further action. We will be carrying out further work, including follow up visits to 10% of these firms.
For the firms not measured as part of the survey, they can expect even more focus on TCF in their dealings with the FSA. TCF itself will remain a high priority and we have a number of ongoing and planned thematic projects, which in addition to reviewing particular areas, will provide us with a valuable TCF insight into how firms are managed and controlled and whether the management behaviours are right to bring about the right outcomes for consumers.
To ensure rapid engagement, we have also announced a new deadline for all firms to have completed their work on TCF and to be able to demonstrate that they are consistently treating their customers fairly by end of December 2008.
If you need help on TCF, please make the most of the help available on the FSA or AMI web sites. A very good place to start is to pick up a copy of the TCF toolkit – which is a set of useful questions to ask yourself about TCF – from our stand today, number A-55. Our staff would be happy to discuss any questions/issues/concerns you may have.
Forthcoming mortgage related projects
Let me now turn to the future – and focus specifically on planned mortgage sector work by the FSA.
FSA projects are set out in a six monthly Thematic Plan which you can find on our website or ask someone at our stand. The projects most relevant to mortgage advisers for 2007/08 are: sub prime; self certification mortgages and affordability. Repeat projects include a follow-up to the January 2007 mortgage quality of advice findings. We are also working on projects more relevant for lenders such as mortgages into retirement and interest-only. For the rest of this speech, I'd like to focus on the first three projects: sub prime; self certification and affordability. These projects form part of a broader piece of work looking at Debt and Affordability.
Sub prime
I'll start with sub prime. The sub prime sector has seen rapid growth, and is now estimated at 8% or more of total mortgage lending. And the number of lenders active in the sub prime market has grown, with the entrance of new lenders as well as lenders already operating in the prime end of the market.
The FSA is currently looking at sub prime from two different angles: as part of our Mortgage Effectiveness review; and as part of our thematic work. I'd like to clarify what both of these work streams will be looking at.
The Mortgage Effectiveness review was set up to establish whether the FSA’s mortgage conduct of business rules are delivering the intended benefits for consumers. The first part of the review looked at pre-sale disclosures and consumers' understanding of the products they were taking out. In September 2006, this review found that firms were using the Key Facts Illustration (KFI) to help consumers in a number of ways – including: to compare mortgages; to consider the risks of mortgage products; and to decide if a mortgage is right for them.
The second phase of the Mortgage Effectiveness Review will continue to review whether the FSA’s conduct of business rules are delivering the intended benefits for consumers. This time it will focus on areas where the risk of consumer detriment may be higher. For example, it will look at the treatment of customers in arrears. To do this, we have also decided to narrow the focus onto particular segments of the mortgage market such as sub prime and lifetime mortgages.
The firm-facing thematic sub prime project has been looking at policies and practices in the industry. Its main aims are to :
- assess the sales process from start to finish across intermediaries and lenders to discover whether firms are treating their customers fairly. This includes a review of brokers' and lenders' case files to see how their policies are being applied in practice.
- highlight the responsibilities of all firms operating within this sector to ensure they treat their customers fairly.
So the two FSA reviews of sub prime are coming from different angles: the Mortgage Effectiveness Review will look primarily at whether MCOB rules are delivering the intended benefits. The results of this review will be published in the first quarter of 2008. The firm thematic review will look primarily at mortgage firms' policies and processes – these results are due out at the end of June.
The thematic sub prime review findings will be announced as a press release and a summary of our findings – both of which will appear on the mortgage section of the small firms web pages. There is likely to be coverage in the mortgage trade press. It is slightly too early to say what these findings will be. However, at this stage it looks likely that this project will inform detailed work we plan to do in other areas – particularly on self certification and affordability – later on in the year.
Self certification
The self certification project is a follow-up to the work completed in 2005. Then, we visited 39 small mortgage brokers who sold self certification mortgages and provide advice to customers. From those 39 visits we looked in detail at 249 client files. We also conducted around 40 mystery shopping exercises to small intermediary firms active in the self certification market.
Our findings stated:
- It is important not to overstate your customer’s income: this was not a widespread problem, but it was found in a very limited number of cases.
- 36% of firms sampled recorded either no reason, or the reasoning was unclear, why a self certification mortgage was recommended.
- 42% of files reviewed were for employed customers and in 83% of these cases there was either no reason, or it was unclear if there was a reason, why the customer could not verify their income.
- 47% of the files reviewed did not adequately demonstrate the adviser had appropriately assessed affordability.
These results were disappointing. As part of the forthcoming self certification project we will be reviewing whether this situation has improved. Those advising or selling self certification mortgages should have reviewed whether they are complying with our minimum standards and made any necessary improvements.
The results of this project will be announced in September (which is slightly later than indicated on the FSA's six monthly plan) and again, there will be a press release, and web pages in the mortgage section of the FSA web site.
Affordability
I'll now focus briefly on our project which will look at mortgage advisers' assessment of affordability.
In January 2007, the Quality of Mortgage Advice Processes project found that around half of small firms in the sample did not adequately assess affordability. Indeed, much of our supervisory and thematic work to date has pointed to firms' assessment of affordability being a key area of concern in the mortgage market.
We want lenders and advisers to apply the appropriate checks to take into account whether borrowers can afford their mortgage payments; we want consumers to have a better understanding of the risks they may be exposed to when they take on debt; and when advice is offered, we want it to be suitable to the consumer's needs.
So this project will focus on three areas:
- Firstly, whether mortgage advisers are clear on what should be taken into consideration when assessing affordability.
- Secondly, we will look for instances of good and poor practice in the assessment of affordability in order to share these with you so you can benchmark where you are
- And finally, whether firms are meeting their responsibilities in relation to treating their customers fairly regarding affordability.
We are aiming for the publication of a press release and web pages at the end of the year.
Summary
Before I ask if there are any questions, I'll briefly take stock and summarise what I have said this morning. We expect small mortgage firms to be in the habit of engaging with our communications. As a minimum, engagement with the FSA means to take on board the findings we publish from our projects and to consider in the light of these whether you need to make any appropriate changes to the way you run your firm. The results of the recent TCF exercise show that small mortgage firms need to do more to turn awareness into action.
We will be communicating the findings of several FSA projects relevant to mortgage firms throughout 2007: these include sub prime, self certification and affordability. These projects provide an excellent opportunity for small mortgage firms to more fully develop the habit of engaging with us. By doing this, we will be working together to raise standards across the mortgage sector and delivering real outcomes that benefit consumers.