UK: The Mortgage Market Review -The Final Rules Bring Change …

Last Updated: 13 November 2012
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

Exploring some of the impacts and considerations for firms as a result of mortgage reforms.

The Financial Services Authority's (FSA) long awaited final mortgage rules were published on 25 October 2012. A series of lengthy consultations with the industry led to the FSA making a number of significant changes that have been welcomed by firms operating in the mortgage sector. The FSA, recognising the range of technical issues that firms will need to consider in implementing the rules, has given the industry a longer than normal lead time to do so. Now that the rules have been clarified, firms need to act; business and operating models will need to be reviewed ahead of implementation of the regime on 26 April 2014.

The recently published requirements span the following key areas:

  • the requirements placed on firms to demonstrate responsible lending;
  • changes to the sale of or conversion to, interest only mortgages;
  • the transitional requirements when dealing with customers that could be classed as "mortgage prisoners";
  • the requirements where firms operate an interactive or non-interactive service;1
  • the FSA's approach to forbearance and whether contract variations would be caught under the advice rules;
  • defining high net worth customers and the affordability assessments relating thereto;
  • the role of intermediaries in the affordability assessment;
  • extension to the definition of a payment shortfall for arrears purposes; and
  • risk based prudential requirements for non-bank lenders.

Customers and the FSA expect firms to provide the most appropriate service to meet the customer's individual needs and act in their best interests. The reforms clearly set the foundations for firms to build upon existing business models but there is going to be some significant changes required for some firms to align their business models to the reforms.

Areas of change

Many of the changes covered have been extensively consulted on over the past few years and have remained largely unchanged.

This is no surprise and although firms have been considering the impact of the proposals on their businesses, now is the time to start implementing the final rules. There were however, three significant developments from the initial proposals:

1. Advice

The FSA initially set out to remove non-advised sales from the mortgage cycle. The industry has defended its position that non-advised sales processes have a place and the implementation of such a change would have a direct impact on arrears management practices.

The FSA reconsidered its position and although nonadvised sales are largely banned, some exceptions have been made. Non-interactive sales (e.g. internet) can be concluded on an execution only basis where there is no increase in balance and all available products are provided to the customer and the customer makes a choice. Further, where a variation to a contract occurs, for example, a concessionary conversion to interest only, and there is no increase in balance, this will not require the lender to provide advice. These exceptions are welcome developments for the industry but firms should be mindful of the need to be able to demonstrate compliance with the requirements and ensure adequate management information exists to monitor their sales and arrears management processes (for instance that contract variations do not result in a customer's balance increasing) and to comply with the advice requirements.

2. Transitional arrangements

The affordability check requirements initially proposed could have prevented some customers from switching products or providers and customers becoming "trapped" with their existing lender (referred to as "mortgage prisoners"). The FSA changed the proposed rules as to when a mortgage lender would be required to complete an affordability assessment.

A key component of the revised transitional provisions is that a lender does not have to ensure a repayment strategy exists when an existing customer changes to an alternative interest only product either with their existing or an alternative provider. However, the balance must not increase. This now gives customers possible alternative options that would not have otherwise been available under the FSA's initial proposals. Firms still need to consider when an affordability assessment would be practical in order minimise credit risk to its business.

3. High Net Worth (HNW)

The FSA has defined a high net worth customer as a customer with a minimum net annual income of £300k or minimum net assets of £3m. Further, where a customer does not meet this definition, lending can be granted when a third party guarantees repayments and is defined as high net worth. The industry has been given clear guidance when certain rules will apply to certain customer groups. It has further been recognised that HNW customers are not typically mainstream retail customers and often it is difficult to apply a read-across of the FSA's responsible lending requirements to these types. Some key exceptions have therefore been made for HNW customers in respect of the responsible lending and interactive sales processes:

  • interactive sales can be conducted on an execution only basis;
  • it is not compulsory for vulnerable customers to receive advice; and
  • firms can decide how best to determine a customer's affordability (but are still subject to the overarching responsible lending rule).

What do firms need to do now?

The final rules now give firms enough clarity to start considering appropriate implementation plans and business change requirements to comply with the new regime. Specifically, firms should start thinking about: Interest only Firms should apply a strategic approach to implement the transitional provisions into their overall lending strategies and in particular, whether current policies are appropriate when considering customers repayment strategies for interest only borrowing.

Advice

Firms should consider the impacts of the interactive and non-interactive sales processes on the firm's business model. All firms that do not currently provide advice will now need to obtain the appropriate permissions from the FSA or where these are already held, staff will need to sit an appropriate examination to obtain the necessary qualifications to provide advice. Systems will need adapting so to cater for an advised sale where it does not already do so. Forbearance and arrears management process should be reviewed to ensure current practices would not result in a firm inadvertently giving advice when assisting customers in financial difficulty. In line with the changes, firms should review their current monitoring and audit plans to include significant areas of risk that will need to be captured as part of implementing the rules.

These changes will be costly for some firms and the impact on the firm's revenue streams and margins will need to be considered.

The final rules now give firms enough clarity to start considering appropriate implementation plans and business change requirements to comply with the new regime.

Transitional arrangements

Designing appropriate products to assist customers that are mortgage prisoners, and that are affordable (firms need to fully define what a material change in affordability is so they can determine when an affordability check should be undertaken). Firms will also be required to implement an exceptions policy which clearly sets out the circumstances where the transitional arrangements can be used. Staff will need to undergo training to ensure a consistent approach in applying the transitional arrangements and robust management information is required to demonstrate compliance with the policy and the wider rule changes.

Record keeping

The FSA requires firms to keep its responsible lending decision records for a period no less than that of the term of the mortgage. Firms need to ensure their systems have the capability to store and recreate records throughout the mortgage term.

Business conduct

Intermediary and staff reward, recognition and incentive schemes should be reviewed to ensure they are fit for purpose under the reforms. Furthermore, firms should regularly test the on-going competency of its staff that provides mortgage advice.

Is there more to come?

The FSA has conducted a Thematic Review of interest only mortgages and the results are due to be published in Q1 2013. The review could highlight significant concerns surrounding customers with interest only mortgages that do not have an adequate or appropriate repayment strategy in place to repay their debt at the end of their mortgage term. Changes in the financial services sector and the volatility of house prices could also mean customers are unable to change product or switch provider, effectively rendering the customer trapped.

Where the FSA highlights significant concerns, firms might be required to perform a detailed analysis of their interest only mortgage back-book with a view to ensuring that customers have appropriate options available to them where these might not currently exist.

What happens next?

Firms have until 26 April 2014 to implement the rule changes with the exception of MCOB 11.8.1E which states firms must not treat customers less favourably than others in similar circumstances, when they are unable to switch product or provider. This comes into force immediately.

The FSA will review the impact of its proposals within 5 years of implementation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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