The Mortgage Credit Directive (2014/17/EU) is relevant to firms that offer consumer finance relating to or secured on residential property. Second charge lenders may need to take the new framework into account in the context of their FCA consumer credit application and compliance preparations. First charge firms also need to be aware of the scope of the changes for their business models.
The Financial Conduct Authority ("FCA") has set out the majority of its final rules in PS 15/9. As stated in PS 15/9, the FCA intends to implement the MCD through its existing rules for first charge mortgages wherever possible. The additional rules only apply to mortgages within the scope of MCD, so will not apply to regulated mortgage contracts taken for business purposes or which are otherwise exempt from MCD. This briefing covers some of the points of interest for first charge lenders.
As MCD follows the Mortgage Market Review and changes to consumer credit regulation, the FCA sets relatively contained demands for firms but may have underestimated the extent, and costs, of change - particularly the effect on the commercial viability of niche business lines.
What do firms need to do?
Firms offering lines of consumer finance relating to residential real estate should consider how the new regime applies to their business.
- First charge lenders should assess how they need to amend their practices to comply with the revised rules. Core areas to review include:
- requirements for affordability assessments when a lender:
- takes on a borrower from another lender; or
- makes further advances;
- making binding offers (which may impact decisions in principle or indicative offers); and
- pre-contractual disclosure requirements following the model ESIS.
- requirements for affordability assessments when a lender:
- Firms should consider:
- when to transition to the new approach (see the timetable below);
- how they can make use of the new passporting regime; and
- if passporting into the UK under a UK branch, whether to elect for Financial Services Compensation Scheme top-up cover and disclose this in the European Standard Information Sheet ("ESIS") (see COMP 14.2.1 R).
How are these rules changing
The new FCA rules address a range of measures for implementation that apply to mortgages within the scope of MCD. We have set out some of the points of interest for first charge lenders.
While the affordability requirements introduced by the FCA's Mortgage Market Review ("MMR") remain generally the same, additional responsible lending provisions are set out in changes to MCOB 11.6 and 11.7 and new MCOB 11A. The rules require firms to set out the information the client needs to provide in order for the firm to make an affordability assessment and, importantly, must warn customers that it will not be able to enter into an arrangement when the firm is not able to make the assessment.
There is a departure from the existing transitional provisions (in MCOB 11.7) introduced following MMR. These allowed 'mortgage prisoners' with pre-MMR mortgages to switch lenders (provided there was no extra borrowing) or increase their borrowing in order to carry out essential property repairs, in each case without an affordability assessment. However, the FCA has acknowledged that the MMR transitional provisions are not consistent with MCD. While these will fall away for MCD regulated mortgage contracts, firms will want to understand where customers can still benefit from the provisions in MCOB 11.6.3 R.
- adjust existing processes to fit within the remit of the amended requirements;
- amend documentation to ensure that it sets out what information the customer needs to provide and by when – checking that this is fair, clear and not misleading;
- ensure staff are trained and informed to apply assessment requirements across all relevant product lines and customers, balancing obligations to treat customers fairly;
- be aware of the important additional provisions in MCOB 11A.2, which prohibit firms from cancelling or varying the terms of an arrangement where the affordability assessment has not been accurately completed;
- take care not to embed processes that lead to arbitrary negative lending decisions or de-risking across groups of potential or existing borrowers. Decision processes need sufficient nuance for individual evaluations and should not lead to systemic poor customer outcomes; and
- give thought to the move to any new process and the logistics of training and document changes as the FCA may make further rule changes to reflect European Banking Authority guidelines on the creditworthiness assessment as well as arrears and foreclosure, expected later in 2015.
The creditworthiness assessment will have a particular impact on "mortgage prisoners" (i.e. existing borrowers who are unlikely to be able to arrange similar mortgages if trying to change lenders or products) for whom allowances were made under the rule changes made following the MMR.
While it is a moot point whether industry practice made much use of this point of flexibility, this is an important development: mortgage prisoners number nearly 4 million borrowers and about 40% of homeowners would not pass such an assessment to qualify for a new loan (see BBC News 24 April 2015). The FCA is keen to ensure some avenues remain so firms will need to think how they treat any mortgage prisoner customers they might have. This will be an area that talks to treating customers fairly.
The European Standardised Information Sheet ("ESIS")
This is a prescriptive and standardised product disclosure document. As the ESIS is an area of maximum harmonisation, the FCA must replicate the MCD requirements in its rules. Although there is a level of similarity to the FCA's current Key Facts Illustration ("KFI") requirement, it is sufficiently different to cause firms to overhaul their current approach. However, the FCA has confirmed that the timing of this disclosure shall be kept the same as the KFI in order to minimise disruption into firms' sales processes, including maintaining certain trigger events in MOCB 7.6 that require additional KFI/ESIS disclosures.
- In the transitional period, firms may continue to use the KFI approach but if it does so, it must make top up disclosures (see the MCOB transitional provisions, such as MCOB TP 45-48).
- The ESIS rules are set out in the new MCOB 5A (MCD pre-application disclosure).
- Look for detailed rules particularly in relation to the messages to be given with information on a MCD regulated mortgage contract, the form and content of an ESIS and the timing when it must be provided.
- Follow the FCA model ESIS and its required content (see MCOB 5A Annex 1R and MCOB 5A.5.2 R, as well as amendments to the Perimeter Guidance manual and the additional examples in PS 15/9).
There are other circumstances when an ESIS is required (see MCOB 7.6.18 (2) R for an example.) A firm will need to provide an ESIS where a further advance requires an additional agreement within the scope of MCD. Although the rules slightly change going forward, the FCA may consider that continuing to set out total borrowing, debt and cost details at the firm's discretion (not as part of the ESIS) plays to evidence of a firm treating customers fairly and understanding the information needs of customers (Principles 6 and 7). Firms will of course also keep in mind that any information provided to the customer must still meet requirements to be fair, clear and not misleading.
Where a firm intends to enter into an MCD regulated mortgage contract, it must provide a binding offer set out in an offer document and the offer must be on the basis of the information in the ESIS (see new MCOB 6A.3.1 R). A binding offer must also be made when varying the terms of an MCD regulated mortgage contract. MCOB 6A.3.4 R requires firms to allow customers to have at least seven days as a "reflection period" during which the binding offer must be open for acceptance. The offer document must contain information prescribed in MCOB 6A.3.9 R, as well as the customer's repayment strategy, complaints information, and other required information (e.g. see MCOB 6A.3.17 R, 6A.4 and 6A.5).
Firms are free to continue practices involving draft or indicative offers, where these are non-binding, but must ensure they go on to make an offer which meets the requirements of a binding offer. The use of a binding offer process does not prevent the use of conditions within the offer process (e.g. that a borrower repays other outstanding credit commitments) but it should prevent a firm withdrawing or materially re-writing the loan offer, unless there is a material change of the facts on which the offer was made. Additional clarity is offered in MCOB 6A.3.3 G. Whether firms need to make a change to accommodate this point will very much depend on the current processes in place. Firms must at least review how their model works in substance (not just the name given to each document) to see whether alterations are necessary.
As part of the organisational obligations in MCD, firms are required to adopt and embed (see Article 7 of the MCD) remuneration practices that do not have the cause or effect of encouraging poor conduct within the mortgage industry (see new MOCB 2A.1).
The measures do not necessarily require profound change; many firms will be tackling this as part of compliance with the CRD IV package and these are similar to moves across the financial services industry (e.g. MiFID II). Nevertheless, firms may want to take a lateral glance at emerging FCA guidance on performance management and the MiFID II approach to managing conflicts of interest. This is another area in which firms need to be able to demonstrate they have reviewed and amended their practices.
By avoiding an overly prescriptive route, the FCA rules allows firms to arrive at remuneration, assessment and rewards cultures that do not lead to artificially inflated remuneration levels and ensure that there is continued coalescence between risk and reward. Cutting risk to consumers of financial services meets the regulatory and political agenda and is representative of the intentions of most firms. Firms should play an active role in finding the solution.
Again in keeping with similar moves in other sectors (e.g. packaged bank accounts or general insurance add-ons), firms will not be able to "engage in tying practices" (see new MCOB 2A.2 and Art 12 of MCD) so that firms cannot make the offer of a loan dependent on the customer taking another product. There are limited range of situations when tying is permitted including:
- the product cannot be offered separately from the MCD credit agreement e.g. a secured overdraft;
- requiring a consumer or a close relation to:
- open a payment or savings account to accumulate capital designed for repayment or (broadly speaking) to service the credit;
- invest in a product offering income or capital for repayment for specified purposes linked to the loan; and
- the firm can demonstrate to the FCA that bundling results in a clear consumer benefit.
We anticipate some teething difficulty for firms identifying exactly where the line can be drawn here and firms will need to look at the permitted circumstances closely where they require tied products to be opened.
When do firms need to implement change?
In the UK, firms will have some flexibility in when they move over to MCD compliance and they are presented with a range of dates within which they should comply with the different rules, including:
- firms may elect to make use of transitional provisions to bring some or all of the rules into effect in their business from 21 September 2015 (see for example MCOB TP1.1 – TP 20-44); as part of this firms must decide how to approach "pipeline transactions";
- the FCA expects firms to meet the majority of their rules by 21 March 2016, the date by which Member States should transpose the MCD provisions into national law;
- certain changes to the FCA's Supervision Manual (e.g. in relation to passporting) come into effect on 21 December 2015;
- embed the ESIS by 21 March 2019 (see the MCOB transitional provisions, such as MCOB TP 45-48);
- amendments made to the FCA's Training and Competency sourcebook are subject to transitional provisions effective across a range of dates from 21 March 2017 to 21 March 2019 – the detail should be checked for each firm and rule requirement (see TC TP9); and
- sales data report for second charge mortgages shall be required from 31 March 2017 (see SUP TP1.10 (1)).
The FCA has published a new link setting out FAQs relating to the UK implementation of the MCD.
Firms will also want to consider other areas, for example:
- changes to their levy contribution, (see the Fees (Mortgage Credit Directive) Instrument in Appendix 2 of PS 15/9 (p 283, FCA 2015/21));
- their approach to complaints handling;
- changes to knowledge and competence assessments for staff, which under MCD now extend to staff involved in product design and underwriting (and further rules are expected later in 2015);
- assessing how they make use of exemptions (e.g. high net worth exemptions (e.g. see new MCOB 5.7 or additional wording in MCOB 7.7.1 R will not apply in the same manner going forward);
- changes to way APRC is calculated for MCD mortgages;
- changes to general information provided to customers (e.g. see new MCOB 7A);
- consumer buy-to-let products (a lighter touch FCA registration regime will apply to this relatively niche area – see the follow up to FCA paper CP 15/3, expected June 2015);
- whether to align non-MCD business with MCD contracts (see new MCOB 1.2.16 R); this may be perceived as scope creep but it does allow firms to deploy one set of systems, documents and processes rather than multiple iterations, allowing for costs streamlining, provided any implications from doing so are understood.
If an MCD exempt bridging loan is treated as if it were an MCD regulated mortgage contract assumptions in MCOB 1.2.18 R should be applied to the APRC (annual percentage rate of charge) calculation, which may lead to the APRC being higher than the APR figure to be used for an exempt loan, which may cause the offer to appear uncompetitive or unappealing to customers (compare the APRC formula in MCOB 10A.2 against the existing APR formula in MCOB 10.3).
This provides a snapshot; however, there are a number of other areas to consider (e.g. foreign currency loans, lifetime mortgages, changes to financial promotions and customer communications provisions). Given the range of changes, first charge firms should be pleased that they should not need to apply for a variation of permissions as a result of the MCD implementation. Our first briefing centred on a general introduction and subsequent briefings will focus on second charge lending, buy to let and other key impacts for mortgage lenders.
The adjustments required for the MCD are likely to trigger IT systems changes, documentation revisions and, potentially, organisational or business remodelling. Firms may want to consider the long term viability of marginal product or business lines: the increased costs of compliance may undermine the commerciality of a product. Contrary to the intended effect of the MCD to open up competition, it may well contract the market.