Treating Customers Fairly and Fairness in Contract Terms
Speech by Katherine Webster, Manager of the Unfair Contracts Team, FSA
at the Council of Mortgage Lenders,
18 July 2007
Good morning and thank you very much Michael for the introduction and the CML's kind invitation to address you all today at this Mortgage Fees update. I have been asked to speak today to give a recap on the FSA's views and position in relation to Mortgage Exit Administration Fees and, more broadly, about how the issue of fairness in contract terms fits into the FSA's Treating Customers Fairly agenda.
I am in fact, and if Michael will forgive me, going to turn the agenda around. I will start by giving some context to a discussion about Treating Customers Fairly and then explain how fair contract terms is a key constituent of TCF. This will then lead us on to the issue of Mortgage Exit Administration Fees. Finally, I will refer to those people at the very heart of your business – consumers.
The FSA's Treating Customers Fairly Initiative
Principles-based regulation
In the past, detailed rules have not always delivered the outcomes they were supposed to achieve. This is because detailed rules cannot cover all circumstances and eventualities. We cannot hope to devise a set of detailed rules to cover all types of business and all types of firm; and we cannot expect detailed rules to be responsive to market innovations and structural changes. A rule-based system will always be trying to catch up with the market, writing yet more detailed rules to address yesterday's problems.
Detailed rules also tend to address processes and not outcomes. This can encourage a narrow approach to compliance with a focus on the letter of the rule and not the spirit.
So our approach is to tackle the root causes. That is why we want to shift the balance more towards high-level requirements and away from detailed rules. And we want to make this shift not only in terms of regulation, but also – and more importantly – in the way that both we, and firms, behave. As such, a principles-based approach challenges both firms and regulator to focus on the outcomes that really matter.
Cultural change and senior management responsibility
Rising to these challenges needs to be driven from the top and flow through each firm's culture to the front line. The primary responsibility for delivering a more principles-based approach rests with each firm's senior management. We expect senior management to focus on the Principles and the outcomes we want them to deliver, and determine how to apply them in practice, in the particular circumstances of their particular firm, consistent with their commercial objectives. This has to be a dynamic approach – as firms and their business models change, so too do the implications of the Principles for the day-to-day behaviour of firms. Firms should have the scope to compete and innovate while meeting our requirements; and the scope to compete by exceeding our minimum requirements.
The TCF initiative
An example of our principles-based approach is our Treating Customers Fairly initiative. TCF is fundamental to our strategy to make retail markets work more effectively and forms a key element in our transition to a principles-based approach to regulation.
The requirement that firms treat their customers fairly is of course set out in the sixth of our Principles For Business, which states that 'A firm must pay due regard to the interests of its customers and treat them fairly.'
Taking a principles-based approach will lead to us working even more closely with stakeholders. We need to have 'grown-up' conversations with firms, trade and consumer associations, public bodies and other stakeholders to reach pragmatic solutions across the industry. On our Mortgage Exit Administration Fees work this is exactly what we did. I'll talk later about how the FSA and CML collaborated to reach a pragmatic solution to this industry-wide issue. For now, I would like to take this opportunity to thank the CML for its broad support – for example, its valuable contribution to the Consultative Group on TCF – in driving forward our overall TCF programme in which contract terms hold a key place.
Fair contract terms – a key constituent of TCF
Unfair contract terms
Our work in the retail market has consistently found that some firms do not treat their customers fairly. The Unfair Contract Terms Team reviews contract terms that are referred to it by consumers and through that work we see many examples of significant deficiencies in firms' standard form consumer contracts. We see this as an example of how the general TCF agenda has failed to take hold in a specific area.
A consumer contract is a document that crystallises the relationship between the firm and the consumer. The fairness of terms in consumer contracts is an important part of Treating Customers Fairly throughout the whole product life cycle. If a contract contains unfair contract terms, it is a black and white example of firms not treating their customers fairly.
Senior management responsibility
As I mentioned before, the primary responsibility for meeting our TCF requirements rests with senior management. And that applies to contract terms too. By that I don't mean that senior management should sit down and draft the contracts! But senior management need to satisfy themselves that the contract terms are fair, and that they have adequate systems and controls in place around them. For example, there should be adequately skilled people drafting the contracts. There should be adequate systems and controls around ensuring terms are applied fairly in practice. There should be adequate systems around checking that contracts comply with any developments in law and regulations. Is anyone checking the FSA's website for the latest undertakings received under the Unfair Terms in Consumer Contracts Regulations and reviewing their firm's contract terms in light of them? Is anyone reviewing the Office of Fair Trading's Consumer Regulation Website for undertakings that may also apply to their firm?
TCF consumer outcomes
The focus of our TCF initiative is that it is outcome focused. We are determined that firms focus on the things that really matter for consumers. Last July we articulated six consumer outcomes, built around the product life-cycle, which explain what we are trying to achieve through the TCF initiative and the behaviours we wish to see exhibited by firms. I have already touched on how culture and senior management fit in with contract terms, but let's have a look at all of the TCF outcomes:
- Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture. TCF is a cultural issue. As such, we expect it to be driven from the top, and from all firms we expect demonstrable commitment from senior management. Putting consumers at the centre of the corporate culture means that rather than simply being about process, TCF should translate into practical outputs in the shape of fair outcomes for consumers.
- Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly. Products and services need to be designed with the intended market in mind. Equally, it is important they are targeted appropriately, to minimise the risks that the marketing might lead consumers to buy products which are unsuitable for them. Contract terms play an important part in this; contracts need to be drafted with the target consumer groups in mind.
- Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale. Clear communication is a key component of a firm's approach to TCF as well as to Principle 7 – paying due regard to the information needs of consumers and communicating information to them in a way which is clear, fair and not misleading. This includes legal obligations in relation to contract terms. For example, there is common law which seeks to protect against particularly onerous clauses being hidden in the body of a contract without attention being drawn to them.
- Where consumers receive advice, the advice is suitable and takes account of their circumstances. Delivering suitable advice – where a firm has chosen to offer it – is a key component of TCF as well as Principle 9: ‘A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgement’. Where consumers have obtained a recommendation, the advice must reflect their needs, priorities and circumstances. In relation to contract terms, firms need to ensure important or onerous contract terms are reflected in the advice given.
- 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 as they have been led to expect. We want firms to be clear about what product or service is being provided and the range of possible results and experience for the consumer. The contract plays an important role in setting out the rights and obligations of both consumer and firm.
- Consumers should not face unreasonable post-sale barriers imposed by firms to change a product, switch provider, or make a complaint. Post-sale barriers can be cultural, contractual or competitive, but ultimately, the consumer must feel confident that they are able to switch providers without incurring excessive penalties. For example, if mortgage exit administration fees are unfairly increased, how can firms satisfy themselves that they are meeting this particular TCF outcome?
Firm risk
The risk to firms of having unfair contract terms does not stop at the FSA, the 'regulatory risk' as you may wish to call it. There are further risks. There is the reputational risk of consumers simply not trusting you and so not wanting to do business with you. Then there is the operational risk of having to spend management time and energy on putting right the wrongs as they emerge, the time spent in redrafting contract terms and repapering consumers. And there are the prudential risks that may arise because you cannot enforce the contract term that has been judged unfair. Regulation 8 of the Unfair Terms in Consumer Contracts Regulations states that an unfair term is not binding on the consumer. For example, if your Mortgage Exit Administration Fee was deemed unfair by a court, it would be struck out of the contract, which would leave you unable to charge any MEAF. That is quite a risk to any firm.
Mortgage Exit Administration Fees
FSA views
It's been over a year and a half since we broached the subject of Mortgage Exit Administration Fees, and some of you may have forgotten why we chose to tackle this rather thorny issue.
Well, we responded to concerns that these MEAFs had been increased unfairly. A mortgage exit administration fee is a fee lenders charge consumers when they exit their mortgage, even if they are not repaying it early. These terms stated that the fee was charged to recover the administration costs incurred by the firm when the mortgage comes to an end, such as the deed release fees and changing the registration at the Land Registry.
We received complaints from consumers that these charges were being increased unfairly, and the increases no longer bore any reflection to the administrative costs they were meant to cover. Our concern was that consumers had made a decision as to what was the best mortgage product for them, given the interest rate, the MEAF and the other charges, only for the MEAF to unexpectedly increase during the lifetime of the mortgage. I must underline here that the FSA does not set prices for the products we regulate. Firms have the freedom to vary the amount they charge for services, such as mortgage administration. However, when a firm varies what it charges, the Unfair Terms in Consumer Contracts Regulations require the firm to act fairly – this may be, for example, by making the variation in line with a valid reason specified in the contract.
We took the view that if a MEAF term is drafted to enable the lender to recover the cost of the administrative services when a customer exits the mortgage, the lender should ensure that the MEAF represents the true costs of the lender's administration services. Also, an increase to a MEAF based on an increase to such costs will only be fair if it is in proportion to the increase in those costs. If a lender cannot show this, then it is possible that any increase to the MEAF on this basis would be in breach of contract.
Resolving this issue individually with each lender would have had significant time and resource implications. It simply would not have been practical or proportionate to address these industry-wide concerns with every single lender.
Statement of Good Practice
Instead, we worked with the CML to reach a practical solution which formed the Statement of Good Practice on MEAFs, published in January of this year. That collaboration, the CML's endorsement of the options in the Statement and the information it has provided on its website for its members has been invaluable in addressing these concerns across the industry. The solution reached in the Statement has the benefit that it stopped the unexpected increases in these fees quickly and without the need for expensive and protracted regulatory intervention. This proportionate and highly risk-based approach is just one example of how the FSA tackles the UK financial market's biggest issues. We are fully aware of our responsibilities to consumers and firms and we seek to operate in a manner that is both inclusive and consultative of firms.
In the Statement, we broke customers down into three categories – past, present and future.
For current customers, we said we would be unlikely to investigate further any lender that reasonably adopted and implemented one of the outcomes which would lead to a MEAF that is equal to or less than the original MEAF by the end of February. We said that those firms who opted to charge a MEAF that was higher than the original MEAF would be required to justify their decision to do so.
We also expect any lender that receives a complaint from a past customer to treat that person in the same way they would treat a current customer in the same situation.
For future customers, the Statement said, broadly, that we expect lenders to review their standard form terms and conditions and the MEAF amounts they charge and, where necessary, to amend them so that they comply with the law and principles set out in the MEAFs Statement. We said we are less likely to take action against a lender that has done this by 31 July 2007.
Firms' responses to the Statement
Current customers (contracts issued before 31 July 2007)
To assess lenders' responses on which option they would adopt for current customers, or at least we can call them 'current' until 31 July, we sought information from all UK regulated residential mortgage lenders.
More than 95% of lenders have chosen to charge current customers a MEAF that is equal to or lower than the original MEAF. This outcome stopped existing consumers being charged for unexpected increases in the MEAFs compared to what was stated in the original terms of the contract and the great majority of existing customers will benefit from no increase to their MEAFs or better. And, as we indicated we would in the Statement, the FSA has asked lenders that have opted to charge current customers more than the original MEAF to justify their decision.
Past customers
While we do not have the power under the Regulations to require lenders to pay compensation to customers, past customers may choose to complain to the lender and to seek compensation. We would expect any lender that receives a complaint from a past customer to treat that customer in the same way they would treat a current customer in the same situation. So for example, if a lender opts to charge its current customers their original MEAF, then if a past customer in the same situation who has paid a higher fee to exit complains, they can expect a refund of the difference between the actual MEAF paid on exit and what was agreed in the original contract. The FSA requires lenders to deal with complaints from customers in connection with MEAFs in line with the relevant rules and guidance set out in the FSA Handbook (where they apply) and with the principles set out in the Statement.
Future customers (contracts issued from 31 July 2007)
As I mentioned earlier, in the Statement we also said we expect lenders to review their fees and their standard form terms and conditions and decide whether they will be amending their MEAF terms and MEAF amounts for future customers in light of the principles contained in the Statement. We said we would be less likely to take action against a lender if it had done this and, if applicable, has applied those amended terms and amounts by 31 July 2007.
It would not be proportionate to ask every UK lender for information on their response to this timeframe. Instead, we are taking a sample of firms based on market size and those firms where we believed there may be the greatest risk of them not complying with the principles contained in the Statement. Firms which fall into the second category include those lenders who missed the end March 2007 deadline for implementing TCF in a substantial part of their business. Our sampling approach adopted here is a good example of our highly risk-based approach and also brings to life the concept of the regulatory dividend associated with the move to principles-based regulation.
We asked these firms to explain to us, ahead of the 31 July timeframe, the outcome of their review of MEAF terms and MEAF amounts and whether they will be amending their MEAF terms and MEAF amounts for future customers, and if so how. More details of our findings in this area will be made available after the 31 July. We do not believe that 31 July is a magic date by which all our concerns with MEAFs will be resolved and we will continue to closely monitor firms' responses to the Statement after this date.
MEAFS and senior management engagement
Let us pause for a moment and consider how this is another example of the need for senior management engagement. Again, the primary responsibility for meeting our TCF requirements rest with senior management. So, how have senior management satisfied themselves that the concerns we have with MEAFs will not happen again? How can they be certain that when they have a contract term which says the firm will levy a fee to recover its administrative costs, that actually, that fee does in fact represent the firm's administrative costs? What systems and controls do they have in place to measure and monitor these costs? And what about variations to those fees, can they be sure that increases to those fees are proportionate to increases to the underlying costs? There are a lot of questions which firms and senior management can ask to help satisfy themselves that they are treating their customers fairly in relation to MEAFs.
As I explained earlier, we do not set prices for the products we regulate. The aim of this work is to address the issue of firms unfairly increasing their MEAFs to the detriment of consumers. Looking forward, consumers should know when they sign up for a mortgage what fee they will pay on exit, or should be given a clear idea of how the fee might be increased fairly. This transparency and fairness will allow consumers to make an informed decision as to what the best mortgage product is for them, taking into consideration the interest rate and all of the mortgage charges.
Consumer considerations
While I am on the subject of consumers making an informed decision, I would like to finish by talking briefly about the challenges consumers face when choosing a mortgage product. Firms should bear in mind the low levels of consumer understanding of financial products, including mortgages. With a variety of interest rates and a range of mortgage fees, the factors consumers need to take into account to ensure they are getting a good deal on their mortgage are getting increasingly complex.
We are working towards improving consumers' financial capability with our moneymadeclear website where there is information about mortgages and also our comparative tables. But it is important that firms also play their part. The development of these increasingly complex products underlines the importance of lenders providing information which is fair, clear and not misleading. For example, firms should ensure that the mortgage fees are explained to consumers at the point of sale.
Conclusion
In conclusion, our work on MEAFs reflects a consistent approach across the FSA – namely that it is proportionate and risk-based. For firms, it provides a real-life example of the FSA's efforts to deliver TCF and effect change in the way firms deal with consumers. Thank you for taking the time to listen to how fairness in contract terms fits into the Treating Customers Fairly agenda and to the FSA's views and position on MEAFs. Looking at the agenda of topics for the day, I can foresee some lively debate! I hope my comments will act as a useful steer in your firms' transition to priciples-based regulation and in particular our views on MEAFs and how we are monitoring responses to the January statement. I look forward to the CML's continued pro-activity and support in this area in the coming months. Thank you.