The Financial Conduct Authority (FCA) has issued a Call for Inputs (CfI) to gather information on how competition is functioning in the UK’s mortgage market. The FCA is seeking feedback from lenders, consumers (including SMEs) and other interested parties. It aims to identify potential areas of concern with a view to establishing whether a full market study is required. Responses are due by 18 December 2015.
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Mortgages in scope
The FCA defines the mortgage sector in the CfI as “the range of markets for the provision of loans secured against a property”. This includes regulated activities, such as lifetime mortgages and first charge bridging loans, as well as activities (currently) not regulated by the FCA in the same way but coming in with the introduction of the Mortgage Credit Directive, such as second charge mortgages. It also includes unregulated buy-to-let.
Competition issues that may merit further investigation
The CfI explores issues that could merit further investigation from the demand side, supply side and also looks at market features that could be impacting on competition.
Demand side behaviour
The FCA focuses heavily on the significance of consumers being able to make effective choices in relation to mortgage products and services. If consumers are making effective choices it enables competition to work well, forcing suppliers to compete more effectively. To make effective choices, consumers need to be able to access complete, relevant and accurate information about the range of mortgage products and services available, assess that information, and then act upon it.
The FCA wants to hear about the range of advisers and sources of information considered by consumers, and the extent to which they meet borrowers’ needs. The CfI discusses the effectiveness of the tools consumers use to access information about mortgage products and services, and their limitations. For example price comparison websites and best buy tables allow consumers to access a lot of basic information quickly, reducing search costs. However, borrowers may form premature biases based on these tools, which affect their decision-making later on and may not understand the limitations of such tools, focussing on headline interest rates only, for example, rather than evaluating the product holistically.
The FCA is also interested in the limitations of mortgage advisers (if they only have access to certain products or the products of certain providers) and lenders (who can only advise on their own product range). In addition, the FCA notes in the CfI that advisers may have incentives to recommend particular products, which may not be the most suitable for a particular customer. The FCA is also concerned that customers with non-mainstream needs or in particular customer segments may not be getting access to appropriate information.
The FCA is interested in the factors consumers with different needs consider when selecting mortgage products and how they do this. The CfI recognises that mortgage decisions involve complex variables and circumstances, requiring borrowers to consider their future personal, as well as macroeconomic circumstances. Such difficulties are compounded by complex fee structures and inconsistencies with how different lenders describe their fees and charges making it difficult for consumers to compare products effectively. The FCA also flags the role of behavioural bias in consumer decision-making, for example a fear of being “locked in” to a product, as well as concerns as to the quality and suitability of mortgage advice.
Once consumers have the relevant information, they need to be able to act on it. The FCA considers that choosing a suitable product is not necessarily about getting the cheapest one but the one that is most appropriate in the circumstances. Inertia and the various (actual and perceived) costs of switching to a different supplier may cause consumers not to make effective decisions, particularly when it comes to re-mortgaging - the FCA is particularly interested in the factors consumers consider at this time. The FCA notes that there may be barriers to consumers being able to access the right products stemming from the risk appetite and commercial strategies of lenders. It also concedes that the MMR-strengthened affordability checks have resulted in some consumers no longer having access to as many products or loans, or the same levels of borrowing as they did before.
Supply side behaviour
The CfI poses a number of questions relating to key supply side issues that it considers have the potential to affect competition.
Reactions from firms to consumer characteristics and behaviours
The FCA is seeking information on whether firms design their strategies or products in a way that inhibits competition, for example by reflecting consumer behaviour and biases. An example given in the CfI is where consumers focus on monthly repayments above all else and firms therefore increase the complexity and opacity of fee structures to ensure that their product ranks highly on this measure. Equally they may constrain a consumer with a propensity to switch by imposing expensive early redemption fees.
The FCA is also interested in whether firms in the mortgage segment are able to compete effectively and whether there are firms that are able to exercise market power in all or some of the mortgage market. Questions aim to establish whether there are firms with stronger portfolios of products and customers or a presence in other financial services activities that give them a competitive advantage.
Co-ordination between firms
Equally the CfI seeks to establish whether features of the sector or of sub-sectors facilitate co-ordination between firms. As part of this the CfI calls for insights on how information is gathered about rival firms’ products and prices. In particular the FCA is calling for evidence on instances where significant price changes (either by interest rates or fees) take place concurrently by a number of firms, where there is no obvious corresponding change in costs.
Vertical and horizontal relationships
The CfI refers to the complex nature of relationships in the mortgage sector and identifies a number of areas where these relationships may result in consumer detriment. One such example is where lenders agree with brokers that the broker will favour their products making it harder for rivals to compete. Arrangements whereby lenders agree with brokers that they will not sell their products more cheaply through their own sales channels (so-called ‘most favoured nation clauses’) can also increase prices and harm competition.
The FCA is looking at the business models of brokers, price comparison websites and mortgage sourcing systems and how they interact with others in the mortgage sector. It raises concerns around conflicts of interest and misaligned incentives. Where firms are connected, there may be incentives to act in their own best interests, rather than those of clients.
Specific market features, such as regulatory and structural barriers to competition, will also be considered by the FCA. In particular, the FCA will take this opportunity to review the impact of changes implemented pursuant to the MMR, particularly with regards to how strengthened affordability checks have affected consumers’ ability to obtain particular types of mortgage.
What this means for you
At this stage the FCA has chosen to cast its net wide, presumably with a view to understanding the market as a whole and unearthing any possible competition issues that could be causing consumer harm.
It is important for firms to respond to the CfI so as to shape the FCA’s thinking at an early stage and ensure that it gets an accurate appreciation of the mortgage market. However, it is also important for firms to take stock. The CfI clearly signals that it is interested in anti-competitive practices by firms, whether they result from market power (abuse of a dominant position), some form of information exchange, collusion or anti-competitive agreements between competitors. A market study or Competition and Markets Authority market investigation offers regulators the chance to assess how competition is working in the market as a whole. It is not unknown, however, for competition authorities to launch investigations into individual companies as a result of such market-wide reviews, such as the OFT’s infringement investigation into branded consumer goods that followed the Competition Commission’s market investigation into the groceries sector.
Access to appropriate information and the ability of consumers to ultimately switch providers if they are dissatisfied appears to be a key focus of the CfI. This focus is consistent with the so-called ‘virtuous circle’ between consumers and competition. This theory suggests that markets work well when: (i) on the demand side, consumers are confident and make well-informed, well-reasoned decisions and reward the firms that successfully meet their needs; and (ii) on the supply side, companies compete effectively and vigorously to deliver what consumers want. The failure of either the demand or supply side can render markets ineffective1. Competition policy has traditionally focussed on the supply side, but the recent trend suggests a shift towards addressing demand side issues as well. Switching has emerged as the primary issue in the CMA’s interim report for its Retail Banking Market investigation, for example.
The CfI also suggests that the FCA is interested in how firms distribute their products and services and any anti-competitive practices associated with this. It refers to most favoured nation clauses, for example, which is a hot topic for competition authorities at the moment. There also appear to be concerns about firms taking advantage of the poor skills of, or information available to, consumers as well as conflicts of interest.
Firms therefore have an opportunity to consider whether there are practices within their business that may not be compliant with competition law, and to try to address these ahead of the intrusive and extensive scrutiny that comes with any review of a market by a competition authority.
It is not all bad news. The FCA recognises that elements of regulatory framework could be hampering competition and there is a willingness to look at the so-called ‘mortgage trap’ that some customers face due to the more stringent post-MMR affordability checks. In this sense, any market study might provide an opportunity for firms to make the case for positive reform. It might also be an opportunity for firms to persuade the FCA that certain products should be brought in or outside of the regulatory perimeter, leveling the playing field where it might currently be uneven, although the FCA’s hands may be tied in part by the requirements to implement the Mortgage Credit Directive.