self-employed

Speech by Lesley Titcomb, Director of Small Firms and Contact Centre, FSA
Mortgage Business Expo
11 November 2009

Good morning, it is a pleasure to be back at Mortgage Business Expo.  I would like to thank the Association of Mortgage Intermediaries (AMI) for inviting me to speak and for hosting this session and I’d also like to thank them for their help so far on our Mortgage Market Review.  We want this review to have a positive impact on the future of the UK mortgage market, so AMI’s help, and your engagement, are important and gratefully received.

You will be pleased to hear that I’m not going to stand here and summarise all 118 pages of the Discussion Paper – instead I would like to speak about the proposals that will have the most impact on intermediaries.  I don’t get to speak to mortgage intermediary audiences as often as I’d like to, so I will also cover some other topical subjects away from the review if I have time.

This is also a good opportunity for me to dispel some of the myths that are out there about our proposals.  Does anyone really think that we really want to stop self-employed people – over three million people – from ever getting a mortgage again?   And do we really want to make all lenders ask their customers how much they spend on cigarettes and alcohol?  The answer to both of course is No, but you could be fooled into believing otherwise by some of the comments we’ve seen so far.

Some have also questioned whether a review is even necessary.  I’m tempted to suggest they should take their heads out of the sand.  We know that the mortgage market has worked well for many over the years, but the financial crisis has brought it near the top of the pile of big issues the FSA has to deal with.  Our existing rules did not do enough to prevent irresponsible lending and borrowing or to secure the fair treatment of borrowers, so we’ve had to look at why that is and in our paper we’ve set out proposals to make improvements.  We have taken a holistic approach – this is not just about reforms to the Mortgage Conduct of Business Source Book – we have looked at the prudential framework and how we can use the gateway to regulation, as well as how we ourselves monitor and enforce.

Others wonder whether the FSA really understands the mortgage market.  I would say that we do and that our proposals are evidence-based and built upon thorough analysis of what went wrong and why.  It would have been easier for the FSA – given the support in the press and in Parliament for tough action – to make wholesale changes that could have left the market unrecognisable.  We could have done that, but the evidence and analysis showed us that we didn’t need to.  We believe that the proposals that we have put forward offer us a good opportunity to build a more sustainable market and one that works better for consumers without having to do things like cap LTV and LTI limits.

Others suggest that the market has already corrected itself.  Well, it’s true – the market may be more cautious now, but we know that once the economy picks up, once funding and confidence return, current cautiousness will be forgotten.  We must not forget the lessons of the past. The reforms we are putting in place will ensure that when confidence returns the market will operate better, to the benefit of all participants.

Before I cover some of our proposals in detail I should put our review in context. We must accept that regulation alone is unable to resolve the problems in the UK mortgage market.  Regulation cannot reverse the impact of the downturn, regulation cannot provide funding for banks, and regulation can only go so far in ensuring that the unsustainable and destabilising boom in the property market is not repeated in the next upswing.

But what regulation can do is put in place the right incentives and framework to ensure more responsible lending and borrowing and the fair treatment of customers. Our focus is therefore on proposing regulation that works for the future, not on addressing all the current issues in the market. But there are some current practices, notably in the area of arrears and repossessions, which we do need to address and we propose to do so urgently, of which more later.

LTV/LTI caps

The Turner Review raised the prospect of product regulation, and it’s worth considering what this encompasses.  It’s perhaps most helpful to think of it as a spectrum – at one end a full-blown ban or pre-approval of every product prior to launch – at the other, more generic restrictions placed on product design.  In the Mortgage Market Review, we haven’t gone as far as some thought we might.  For example, and as I just mentioned, we have not – for now at least – included any proposals to cap LTV or LTI ratios.  Our analysis suggests that the case for imposing such ratios on consumer protection grounds is not clearly proven and that this would not necessarily be an effective tool for reducing default rates.

But we are assessing whether we should ban the sale of products which exhibit certain toxic risk combinations. These characteristics include high LTV and LTI; low income levels; high levels of debt; being credit impaired; or borrowing for the purpose of debt consolidation. The case for a focused use of this form of product regulation is, in our view, clearer.

Income verification

In the paper we say there is a clear and non-controversial case for product regulation in the shape of requiring income verification. It has certainly proved one of our most controversial proposals so far – but I think that controversy (which, I might add, is largely among industry members) is because of a lack of understanding of what we’re actually saying.

Firstly, I should explain why we’re looking at this.  At the height of the market in 2007, 45% of all mortgages were advanced on a non-income verified basis, either as self-certified or what became known as ‘fast-track’ mortgages.  Expanding beyond its original market, self-certification in particular has allowed many borrowers to inflate their incomes and subsequently take out unaffordable loans.  Arrears rates for these loans tend to be higher than those for standard mortgages.

In our view, the best way to deter lenders from accepting, and individuals from applying for, a mortgage based on an inflated income figure or on a non-existent source of income is to require income verification in every case.

Some have suggested that this means a self-employed person or a contract worker would not be able to get a mortgage and that we’re blocking access to the market.  This is way off the mark.  We can think of no reason why the self-employed or a contract worker would not be able to verify their income.  As we say in the paper, an income flow that is ‘non-regular’ is not equivalent to, nor does it imply, one that is ‘non-verifiable’.

People counter this by saying that lenders require self-employed workers to show three years’ worth of accounts.  Well, this is something that we have never mandated anywhere – it is a market practice among some lenders. We plan to work with the industry to agree what good practice looks like and therefore what are the appropriate forms of income verification.

We do not want to introduce anything that is unworkable or that prevents people who can genuinely afford one and who can demonstrate that their stated income is genuine from getting a mortgage.  But what I should be clear on is that the days of accepting a business card or some headed paper as proof of self employment and therefore income will be over.

Affordability

In our view, a key problem in the industry has been either the lack of proper affordability assessments or poor practice in this area. We are therefore proposing to tighten our responsible lending standards and spread the existing good practice on affordability.

We propose making the lender ultimately responsible in every sale for verifying affordability. This means a proper assessment of whether the customer can afford the mortgage, verifying statements around income and considering the plausibility of other information provided.

Many who are not familiar with how the UK mortgage market has evolved over recent years would expect this to be done anyway – because why would you lend money to someone without checking whether they could afford to repay it?  They would be amazed at the evidence we have – in some cases showing that the customer’s mortgage repayments actually exceeded their monthly household income.  These types of loan were sold in the market boom – they won’t be able to be sold in the future.

There is naturally a question about whether we will need intermediaries to also do an assessment of affordability.  Well, we believe that as the intermediary needs to properly ascertain the suitability of a mortgage, and as you obviously cannot do this without first assessing a borrower’s affordability, you will need to continue to do a preliminary assessment of affordability as part of this, with the lender making a final assessment.

We need to work out exactly what this will look like in practice and we are in the process of setting up an industry working group to discuss and help decide what an affordability assessment should look like for both intermediaries and lenders.

We have already heard some lenders say they believe their fast-track processes can help us achieve the outcomes we want.  We are not convinced that current processes – where income verification is sought but only sample of cases actually scrutinised – can provide a proper assessment of income and affordability – as it will always leave the vast majority with no income verification and no proper affordability check.  We believe the onus is on the industry here to prove that exceptions to our proposals could work, and remain firm in our belief about the importance of proper assessments of income and affordability.

Intermediaries are obviously a key part of any change and will continue to be important players in the UK market.  We are one of the few countries in the world where intermediaries play such a strong role in providing mortgages, something that is driven by the value that intermediaries can add for consumers in a market like ours which has had so much product diversity – and we see that strong role continuing.

Approved persons

We have found widespread support for the idea of extending the approved persons regime to those individuals in customer facing functions in mortgage intermediation.  We are proposing to extend the regime so that individual mortgage advisers – in intermediary and other firms – will need to be assessed as honest and competent by us and be individually registered with us, and we intend to move forward on this proposal quickly.

There will be costs to this but we believe they will be outweighed by the many benefits.  And I am pleased to see the consensus on this shows that many agree with us that this is the right thing to do and important way for us to drive up standards and create a better and more sustainable industry in the long term.

The enforcement actions we’ve taken against mortgage intermediaries (70 banned over the last three years) demonstrate that there is a small percentage of people out there that can tarnish the good reputation of your industry.  In the future the approved persons changes will help us prevent such individuals becoming advisers in the first place; it will help us keep track of them and  prevent them moving through the industry, and will enable us to take tougher action against them and hold them to account for their actions.

Charging

And we are determined – as we have shown in our recent fine of GMAC-RFC – that we will crack down on unfair charges in the mortgage market.  One of GMAC’s failings was on the charges it placed on borrowers in arrears.  We will be looking further at charging practices in the industry to get a better understanding of charging and pricing structures to enable us to indentify and challenge unfair and excessive practices.  Initially this will be on arrears charges before looking at wider levels of lender product charges and lender charging models.
We also propose to collect data that will allow us to identify firms earning large commissions in addition to charging customers large fees.

We are assessing the case for banning certain specific charges.   And this is one area that many people have missed so far, and that I would like to draw your attention to.  We are looking at whether we should ban the practice of lender charges (such as set up fees) and intermediary fees being rolled up into the loan and then paid off by the customer as part of their regular mortgage payments.  Doing this could help to focus the customer’s attention on what they are actually paying – because they are unlikely to focus on it currently as these charges almost disappear into the overall cost of the loan.  This marks a substantial change in our approach to date, as we have so far been reluctant to be a price regulator, but we think it is something that is worth looking at further.

In the meantime, we intend to press ahead with specifically outlawing some of the worst practices in arrears charging, such as making an administration charge when a borrower is adhering to a repayment plan.

Non-advised sales

Our Mortgage Market Review analysis shows that consumers do not understand the distinction between advised and non-advised sales.  This has caused us to look closely at the differing standards we set for each.

Non-advised sales offer less protection as there are no checks to ensure the consumer can afford the product choice and no checks to ensure the products presented to the consumer are appropriate.

So this is something we believe we have to address in some way.  We could move to a fully advised market – but where would that leave the knowledgeable consumer happy to buy with information only, and would the costs to the industry justify this move?

Instead we propose to retain non-advised sales but introduce a standardised affordability and appropriateness check across all sales. Firms will no longer be able to provide the consumer with information on a range of mortgages without first assessing whether a mortgage is actually appropriate or affordable for that consumer.

We are also looking at ways to ensure sales standards for advised sales meet the needs of the market and appropriately protect consumers.  Should we toughen up the suitability standards?  No decisions have been made on this and we welcome the industry’s feedback.

Retail Distribution Review

Finally, we assessed whether there is a case for applying to the mortgage market some of the recommendations of the RDR applying to the investment market.

Intermediaries will be relieved to know that we will continue to let them choose how they charge for their services and are not proposing to introduce ‘adviser charging’.   We haven’t seen the same issues in the mortgage market that we did in the investment market, and which warranted change there.

Yet we do see merit in aligning with the RDR on ‘scope-of-service’ labels. We have a diagram of the different services in our paper and it clearly shows the complexity of the current labels for intermediaries.  We propose to replace the existing ‘whole of market’, ‘independent’, and ‘single’ labels, with the much simpler and readily understandable ‘independent’ (whole of market) and ‘restricted’ (limited panel) advice only.  For similar reasons we propose to replace non-advised with ‘information-only’.  For firms and consumers this will mean the labelling of services for both mortgages and investments will be better aligned.

In the investment market, the RDR is also proposing to introduce higher qualification requirements for investment advisers.  We have seen no evidence that a lack of training and competence is a significant issue in the mortgage market so we do not propose to make the same changes for mortgage intermediaries.  Of course this is partly because mortgage products are inherently less complex than those in the investment market.  We are however looking at the possibility of reviewing the existing mortgage syllabus to ensure that the exams remain ‘fit for purpose’.

Disclosure

We also propose changes to disclosure.

To put our changes into context here we need to look at the behaviour of consumers – and it is clear that irresponsible borrowing has been just as much a part of the problem in the mortgage market as irresponsible lending.  A significant minority of consumers have made decisions which were imprudent.

Our policy approach to date has been underpinned by a view that consumers will act rationally to protect their own interests. And disclosure has been the cornerstone of that approach, in the belief that it enables consumers to shop around and compare the risks and costs associated with products and helps them make informed choices.

We now believe that this assumption is wrong.  The evidence shows that many consumers do not use disclosure as intended. We therefore need to change our approach, recognise the behavioural biases of consumers, and be more interventionist to help protect consumers from themselves.  And these changes are a combination of some of the product and sales regulation changes I have already mentioned, together with proposals to update our disclosure regime.

We propose to remove the requirement for the initial disclosure document (IDD) and whilst we will remain prescriptive about the key messages consumers must be made aware of, we will allow firms to set out them out in their own format, perhaps in their terms of business letter.  We think we should keep the key features illustration (KFI) but also have firms explain key points to customers orally.

We have also recognised that suitability letters may have a role to play in improving outcomes – intermediaries will have better records of the advice given on file which may help improve the quality of the advice given.

Prudential reform

So there is clearly a lot in our paper that will impact intermediaries – but the focus of our proposals for constraining irresponsible lending is on lenders. It is lenders that design, develop and sell the products that can cause risk and harm to consumers and the market. The proposals in our paper will combine with measures already going on to improve lenders’ capital and liquidity – and to improve the overall stability and sustainability of the lending market. They will address the general problem of the rapid expansion and sudden withdrawal of credit and will give banks and other lenders a stronger financial backing, make them assess risk more realistically and smooth out the peaks and troughs of the lending market.

High-risk lenders

We are looking at some specific proposals to temper the level of risk being taken by high-risk lenders.  Although some banks and building societies did engage in high risk lending, greater risks were taken by the subsidiaries of the banks and building societies and the group of lenders that came to represent a significant part of the market, who we call the ‘non-banks’, as they didn’t have branches or depositors.

Our extensive research showed that non-banks advanced a significant share of their mortgages at a high LTV; on a non-income verified basis (generally self certified); to credit impaired borrowers; and for the purpose of debt consolidation.   And the significantly higher arrears rates for these lenders (between 30% and 60% of all of their borrowers are in arrears) shows that these combined risk characteristics to have proven to be ‘toxic’.

We are therefore assessing, in the overall context of our proposals for prudential reform, the case for further regulation of non-banks, including changes to capital requirements; the vetting or banning of business models; and looking at lessons we can learn from other countries’ approaches to regulating these types of firms.

What we eventually do will be proportionate here.  We have no problem with new lenders, like these firms, entering the UK market.  But what we will ensure is that they have sustainable business models and they add value to our market in the longer term and do not expose customers to unacceptable levels of risk.

I mentioned arrears just now – as I’ve said, the review also looks at firming up our rules on arrears charges and banning some of the charges we think are unfair.  We plan to issue a Consultation Paper in January setting out our proposals for change.

In the paper we also set out the case for extending FSA regulation to consumers taking out second and subsequent charge mortgages as well as mortgages for buy-to-let purposes, but it is for government to decide whether to make these changes.

One area where we still have some thinking to do is on whether we need to limit the amount of equity borrowers can withdraw from their homes – one startling statistic is that by 2007, remortgaging to withdraw equity had replaced home purchase as the main reason to take out a mortgage.

So that is a quick canter through some of our proposals.  I will be interested to hear what you think, and take any questions afterwards.  And I should also give a plug to our consultation roadshows – these begin later this month and we still have space at some of the venues.  You can find out about them by looking at the events section on our website.

And now briefly on to some other points.

The ‘new’ FSA and small firms

The review has coincided with the emergence over the past year of a different FSA to the one that existed before the financial crisis. It is undoubtedly a more intrusive and interventionist FSA than before.

Larger firms are finding the approach of the FSA quite different – we’re taking a closer look at their businesses, checking their staff holding senior positions and stress testing their business models to make sure they still maintain the standards we expect.

But we are getting more focused with smaller firms too. We’re well on track with our assessment programme for small firms, which is now becoming part of our normal approach to supervision. And we are making sure that once firms are assessed we keep in contact with them through our new regional education programme so that we can be certain our smaller firms are continuing to treat their customers fairly.

And we’re getting smarter in the way we regulate small firms. Our new risk-profiling tool enables us target the highest risk of the smaller firms – allowing us to focus our resources on those firms that pose the biggest danger to consumers or which impact significantly on the FSA’s other objectives. In the past our choices of which firms we reviewed, for example through our thematic projects, were based upon the business they were in or the product they were selling. Now we can take a more holistic approach and we can look at firms’ riskiness based upon a wider range of factors.

For example, looking at financial risks we have so many data sources now that we are much better at spotting actual or potential financial stress. If you send us something and we spot a problem we can be on the phone to you very quickly.

So the FSA is now more intrusive, more focused, and more proactive. Many firms we speak to about this are pleased – because we will be tackling the bad guys.

Good firms have nothing to fear from the new more interventionist FSA, but if there are firms that clearly do not have the interest of their customers at heart we will find them and we will take tough action. You may have seen that we have already concluded two enforcement cases so far as a result of our small-firm assessment work and there will be more to come.

We are prepared to take action against firms, whatever their size.  If firms do not treat their customers fairly, then we do not think they should be operating in the market.

But I want to emphasise that what this does not mean is that we are out to get small firms. We are taking a tougher approach with larger firms too – and I can point to a number of examples to support this.  But I would note in passing that I have been working in regulation for the past 18 years.  During that time, there has been a constant cry that the regulator is out to kill off small firms – and yet small firms are very much still with us.   I don’t want to belittle the challenges that small firms face, whether it is from the current recession, or from the overall burden of regulation imposed by the combination of the FSA, the taxman, employment law, health and safety and so on.  I marvel at the resilience shown by these small firms and I applaud it.  I want to emphasise to you today, the FSA wants to see a thriving small firm community, but we also want to see one where standards are high, and I’m sure you do too

An example of where there continues to be clear need for action is on mortgage fraud and tackling this remains firmly on our agenda here.  We continue to both ban and fine brokers – and continue to work with lenders to identify and act against fraudulent brokers and to help lenders enhance their systems and controls to prevent fraud.  So the depressing routine of fraud enforcement cases will continue while we crack down on these rogue individuals.

You may have noticed that in September a mortgage intermediary was convicted in court for failing to notify us that he had taken a controlling interest in a firm, but also for making false statements to us.  We specifically require regulated firms and individuals to meet our principle of being open and honest with us.  We’ll be taking action against firms that lie to us or try to hide things that we need to know about to supervise effectively and protect consumers.

Last year at Mortgage Business Expo I warned firms against trying to become ‘phoenix firms’ – firms that cancel and then try and re-appear with the same people behind them, and often the same premises and customers, but without the liabilities they have left behind for others to pick up.  Our recent consultation paper on payment protection insurance brought the prospect of firms having to reassess past payment protection insurance (PPI) complaints they have rejected and some think this could mean more firms try and become phoenix firms to leave these behind.

I should warn them that we are alive to that threat.  We are watching certain firms very closely and we are determined to remain one step ahead of potential phoenix firms and take strong action against firms and individuals that try this.

I spoke earlier about the limitations on the FSA, in terms of our ability to put everything right in the mortgage market.  I know that at the top of most intermediaries’ list at the moment are issues with lenders, such as the lack of choice available with only six lenders of scale left, products being withdrawn at short notice and, most importantly, dual pricing.

These are all a symptom of the current market conditions.  We cannot intervene to turn these market conditions around – as I said earlier, we cannot return funding to the market, create more lenders, or ask them to favour one form of distribution over another.

Dual pricing is clearly a problem for intermediaries at the moment, but as Robert pointed out recently in his Mortgage Strategy blog, we can understand why lenders are favouring their own branches in such difficult market conditions, just as we can understand that this makes your job even tougher.  They are not obliged to lend through intermediaries.  And how they choose to price and distribute their products is up to them.

I realise this makes life difficult for you, especially when combined with lower levels of activity anyway.  But these commercial decisions are not something that the FSA can intervene to stop.  However, we do expect lenders to be sensible and act with integrity.  Where an intermediary product is of such poor value compared to direct product from the same lender, we question why lenders would continue to market that product.

And there are some signs that conditions could be improving for intermediaries with a few lenders recently launching exclusive products for intermediaries.

Before I finish I’d like to mention one other thing.  One area where we have seen anecdotal evidence of business growth and poor practice is where FSA-authorised firms are introducing their customers to claims management companies.

I would just like to say that if a claims management company approaches your firm, be careful.  We have seen firms failing to consider their data protection obligations when referring customers without the appropriate consent, others failing to perform any due diligence on the claims manager they refer to, asking no questions about success rates, the average length of time to complete on a claim and refund policies where fees are taken up front.

In one case we have seen an intermediary referring customer for claims where evidence was held on file indicating the claim was unlikely to be successful from outset.  While we recognise there are good claims managers out there, as with any sector there are poor firms and we expect you to act with integrity and to make the fair treatment of your customers central to what you do.

I hope that you have found my pointers on current issues and current FSA thinking useful and you have a better insight into our mortgage market review and the other work we have on with small firms.  I realise that the financial crisis has already had a big impact on your businesses, and that further change led by the FSA is probably not going to be at the top of your wish list.  But we believe that our proposals, combined with our new approach to supervision, will help bring about a better mortgage market for all, intermediaries included.