Less than a year after we implemented the most significant regulatory changes to the market under the Financial Conduct Authority’s Mortgage Market Review (MMR), we are now looking at the changes required by the Brussels version of the review into the mortgage market, which the UK must implement by 21 March 2016. The UK Treasury have stated their desire that implementation of the Mortgage Credit Directive (MCD) should cause as little disruption as possible to the UK mortgage market. This is because the changes made under the MMR were those that FCA decided were relevant to the UK mortgage market to meet its stated objectives.
The MCD has similar consumer protection objectives to the MMR, as well as an aim to enhance internal markets. However the recent Treasury paper indicates that they see no consumer benefit, but implementation costs of around £18m for UK businesses. The new provisions in the MCD are unlikely to provide any additional consumer protections nor will it enhance the EU internal market for mortgages from the perspective of the UK consumer or industry. That is not to say that the MCD does not provide appropriate provisions in its own right for other EU member states, but rather that it does not sufficiently enhance the UK’s position to balance the costs of making the required changes.
Firms, as now, will need to decide what parts of the market they will be advising on. The rule already exists to ensure consumers are made aware that a further advance might be available for those looking to re-mortgage and borrow more. It is entirely logical that it also be applied to second charge mortgages once they come within the scope of the mortgage regime. We anticipate that the FCA will not require that consumers are made aware of the alternative of an unsecured loan.
For simplicity however we consider it best to restrict the disclosure to the fact that a further advance, re-mortgage or a second charge loan might be available, but the adviser should be able to restrict the scope of their service, to one, two or all options.
Replacing the KFI
The Key Features Illustration has been with us since M-day in October 2004. The new rules mean that lenders must move to producing the new European Standardised Information Sheet (ESIS), or produce a KFI with top-up disclosures. Mortgage brokers will not be accountable for the manufacture of the “ESIS” or the “KFI plus” ‘top up’ but we believe that it is important that all brokers understand the options open to lenders so that they can explain different approaches that lenders may adopt. Brokers will need to ensure that they fully explain the content so will need good briefings from lenders.
The lack of a full transitional arrangement for pipeline cases leaves little time for mortgage firms to be ready to implement the ESIS. Some lender firms may have difficulty in meeting the requirements by 21 March 2016. In allowing lenders a six month window to “go early”, Treasury has given some respite, but we doubt that enough will be ready for this be an industry-wide solution.
There could potentially be some consumer confusion when a consumer is comparing an “ESIS” issued by one lender against a “KFI plus” issued by another. However, such instances should be limited and the potential for consumer detriment will be mitigated by the mandatory advice process required under MMR. Any consumer using a good mortgage broker will be able to navigate through any potential confusion.
We anticipate that “advisers” will use a version of the “ESIS” or “KFI plus” to talk through details early in the sales process as they do now and do not anticipate problems with this. The lender will have to issue a final offer referring to an existing or new “ESIS” or “KFI plus” that makes all the detail clear. It might be helpful to make clear that any documents issued prior to the final offer will be illustrative only and it will be dependent on the lender to define the final position.
For an advised sale we see little issue with the intermediary providing an adequate explanation based upon the disclosures made by the lender, the essential features of the product and any ancillary products recommended and the impact on the consumer. In most intermediated sales this will be happening anyway. However the broker is always limited by the amount of information that the lender has provided to them or placed in the public domain.
For execution-only sales, the necessity to provide an adequate explanation should be limited as the consumer taking out the product should have an appropriate understanding before undertaking this route. If those firms operating an execution-only model find that a more extensive process is required to provide an adequate explanation to the consumer, it may be questionable whether their model is reaching the right target market and whether an execution-only sale is in the best interest of those customers.
Advising on lots of different interest Rates
We are concerned that in many cases advisers will have to explain up to 5 different rates to consumers – the actual rate charged; any revert to rate; the APRC relating to the actual loan, a second APRC being the highest rate the loan might have attracted in the previous 20 years; and a stress rate. This will only add to confusion and make the need for advice absolute in order to meet the adequate explanation provisions. AMI considers that these provisions make the ability of firms to undertake execution only business more difficult. However the interest rate disclosure provisions are a mandatory requirement under the directive, so the UK has to implement.
The potential ability to adopt any aspects of the MCD early will mainly be set by the lender community. Our main concern is that, as with MMR, lenders seemed unwilling to apply regulatory change early. The main reason for this appears to be concern over whether such an early adoption creates a competitive disadvantage or whether it in fact causes a drop in activity compared with competitors who have not yet adopted changes. Where lenders did implement MMR early they did not highlight this to the rest of industry. In fact most of those lenders that did go early actively worked to disguise the fact to as near as possible to the MMR implementation date. However for MCD to work effectively there will have to be some early implementation.
Second charge as a distinctive market
One of the matters not dealt with under MMR was the second charge mortgage market. The market has long supported the moving of regulation of the second charge mortgage market from OFT to FCA. This was not a criticism of the previous legislation or policy, but a reflection of the need for more focussed supervision of the market which the FCA could deliver. The remaining question for the second charge market (seconds) was what rule book it would come under at FCA.
The MCD means it would be very difficult to argue anything other than that the second charge mortgage market should be brought under the same rules as the first mortgage market. What is perhaps more important is that the differences applicable to the second charge market are acknowledged and understood by FCA and then applied to its thinking on the implementation of second charge mortgages into its mortgage regime.
Stress Testing Rates
Second charge mortgages do not often carry five year plus fixed rates therefore they will have to stress test the repayments on most of their products. In addition, by the time the consumer comes to taking out a second charge loan the vast majority of consumers would already be well into their first charge mortgage fixed rate period.
Without a stress test requirement being in place across both loans there would be the ability to re-borrow the first mortgage stressed amount via a second charge loan after the first mortgage had completed. We do not consider that FCA should permit such a scenario therefore the MCOB interest rate stress test must apply to all secured borrowing, both the first and any subsequent loans at the time any borrowing is taken..
Professional indemnity insurance
The MCD sets professional indemnity insurance requirements at €460,000 for each individual claim, and €750,000 per year for all claims. This will capture all mortgage broker firms – both first and seconds. AMI will be working with FCA and the insurance market to try to ensure that there are workable solutions for all. We are concerned about the additional costs that this will levy on firms, in particular smaller firms. The inability of firms to self-insure or to use capital off-set could also cause problems for larger firms.
There will be a lot to do in the next 12 months and the industry is now waiting for the FCA to produce the final rules…The certainty that these will provide is what is required to allow proper planning to begin.