Following a lengthy and detailed Mortgage Market Review (MMR) project, the UK Financial Services Authority (FSA) has now published the Final Rules arising from its review. As you may be aware, the aim of the MMR was to help promote a sustainable and flexible UK mortgage market and clamp down on the risky lending practices and abundance of cheap credit that were thought to have led (at least in part) to the collapse of the mortgage market in 2008 and 2009. To that end, the Final Rules focus on responsible lending, advice, distribution (sales), disclosure, arrears management and the extension of the bank capital adequacy and liquidity requirements to non-bank mortgage lenders. The Final Rules are set out in FSA Policy Statement 12/16 (PS 12/16) along with a summary of feedback received to the earlier MMR Consultation Paper 11/31, which brought together all of the various strands of the MMR under one mega-consultation document. The Final Rules will take effect from 26 April 2014 (with one exception - see further below) and will be contained in the FSA's Mortgages and Home Finance: Conduct of Business Sourcebook (MCOB) and the Prudential Sourcebook for Mortgage and Home Finance Firms, and Insurance Intermediaries (MIPRU). The rules represent both "Conduct of Business" reforms as well as "Prudential" reforms, as follows:
Conduct of Business reforms (amending MCOB)
Responsible lending: the responsible lending rules reflect the Financial Stability Board's Principles for Sound Residential Mortgage Underwriting Practices. There are three key elements of the responsible lending rules:
- Affordability assessments: lenders must verify borrowers' income and must be able to demonstrate using rigorous affordability assessments that the mortgage is affordable taking into account the borrower's net income, and (as a minimum), its committed expenditure and basic household expenditure (effectively banning self-certification and fast-track mortgages).
- Interest rate stress test: lenders must also take account of the impact on mortgage payments of market expectations of future interest rate increases.
- Interest-only rules: lenders must assess affordability on a capital and interest basis (and never on an interest-only basis), unless there is a clearly understood and credible alternative source of capital repayment available.
In addition, lenders must keep responsible lending records for the whole period that the mortgage remains with that lender (and not just for three years, as previously proposed). Further, in order to assist borrowers "trapped" with their existing lender because they do not meet tightened lending criteria (thus preventing them switching), new MCOB Rule 11.8.1E prevents lenders from treating these borrowers less favourably than others (e.g. by offering less favourable interest rates or other terms). This rule took effect immediately after publication of PS 12/16 (from 26 October 2012). Other transitional provisions effectively allow a "switch-off" of the affordability and interest-only restrictions (providing there is no increase in the amount outstanding), such that lenders can take on customers of other banks that wish to change lender.
- Distribution (in other words, sales): the FSA clarifies what it means by "regulated advice" in relation to mortgages and has removed the "non-advised" sales process from the regime. Regulated mortgage advice is "advice on the merits of the customer entering into (or varying the terms of) a particular regulated mortgage contract or contracts." The majority of mortgage sales will now be "advised" sales, particularly interactive sales such as those made face-to-face or over the telephone. Execution-only sales are still allowed, for non-interactive sales such as those carried out over the internet or by post, and these are optional for high net worth customers and business borrowers. The FSA has changed its approach to contract variations to allow them to be completed without advice, provided there is no increase in the amount outstanding under the mortgage. The requirement on intermediaries to assess affordability has been removed (in light of the new affordability requirements placed on lenders). Every mortgage seller must now hold a relevant mortgage qualification and the FSA's Approved Persons regime is extended to all mortgage advisers - save for those providing execution-only administrative contract variations. There is a new, general obligation placed on lenders to act in the customer's best interests.
- Disclosure: the obligation to provide an Initial Disclosure Document (IDD) to the borrower is replaced with a new requirement for lenders to disclose clearly and prominently "key messages" to the borrower. The trigger point at which a "Key Facts Illustration" (KFI) has to be provided has been changed (see MCOB 5.5.1A) to reduce information overload for borrowers.
- Arrears management: the changes to the arrears management rules limit the number of times that fees for missed payments can be charged, widen the arrears charges and forbearance rules to cover all payment shortfalls, clarify the costs which can and cannot be recovered through arrears charges, and prevent lenders from removing concessionary interest rates due to repayment problems.
- Other COB reforms: other areas in which the FSA has rethought its approach include: (i) allowing lenders to make their own decisions about making exceptions to the responsible lending rules provided there is no increase in the amount outstanding (subject to the borrower demonstrating a good repayment history); (ii) instead of providing a complete carve-out from the MMR package for high net worth (HNW) mortgage borrowers and business lending, the FSA has provided a tailored, higher-level approach for both, under which HNW mortgage borrowers earning a minimum annual net income of £300,000 or with minimum net assets of £3 million (note the different definition of HNW as compared with, e.g. the Financial Services and Markets Act 2000) can opt-out of receiving advice, need not receive KFIs, and the lender may undertake a less stringent affordability test for these borrowers based on their circumstances.
Prudential reforms (amending MIPRU)
- Non-bank mortgage lenders: enhanced prudential requirements will apply to non-bank mortgage lenders. These rules set a risk-based capital requirement, increase the amount of capital non-bank lenders must hold against their mortgage lending and require them to set high-level systems and controls to manage liquidity risk. While respondents to the FSA's earlier consultations would have preferred a set of stand-alone prudential rules for non-banks (rather than cross-referencing to the prudential rules for banks set out in BIPRU (the FSA's Prudential Sourcebook for Banks and Investment Firms), the FSA has retained the cross-referencing approach but notes that it will consider whether it can make the non-bank rules more accessible in future.
The MMR Final Rules are stated to be "in line with" the proposal for an EU Directive on Mortgage Credit, which would potentially sweep away all of these changes if the final text differs from these new rules or indeed goes beyond the FSA approach in some areas. The latest position on the Directive is that the European Council released a General Approach document in May 2012 which set out the agreed revised text of the Directive for further discussion and negotiation, however, it has not yet been adopted in final form.
Although it is several hundred pages long, there is no substitute for reading PS 12/16 to get a sense of the overall impact of the MMR Final Rules on current lending practices. However, the changes do not take effect for some 18 months, allowing lenders time to adapt their systems and practices to the new regime. The current MCOB and MIPRU rules will be amended from 26 April 2014 to reflect these MMR Final Rules (see Appendix 1 of PS 12/16 for how the text will change), and will be further updated in due course to reflect the handover of the FSA's regulatory responsibilities to the new Financial Conduct Authority and Prudential Regulation Authority at some point in 2013.