FSA Mortgage Reform Proposals – The Impact

Preface
There are some 11 million active mortgages in the UK with a combined loan value of £1.2 trillion. Data
from the UK Council of Mortgage Lenders (covering 98% of all residential lending in the UK) shows
gross lending in Q3 2009 came in at £39 billion. Lending in September 2009 totalled 12.9bn, a small
(7%) rise on August but still some 25% down on 2008 figures.

Introduction
After its comprehensive analysis of the UK mortgage market, the UK Financial Services Authority (FSA)
published proposals in October 2009 for major reform seeking to provide a more effective and sustainable
environment for all participants. With its intentions to publish feedback from the industry and consumer
groups as early as March 2010, it will be seeking to phase the implementation of its final rules and guidance,
focussed initially on those areas determined to be of high detriment. But it has also not ruled-out further
future change if its reforms have insufficient effect, including the formal capping of loan-to-value/income or
debt-to-income thresholds.

But how will the FSA proposals seek to address and prevent past circumstances and events and what activity
should firms now take in its planning ahead of implementation?

Changes are planned on a number of fronts, including changes to prudential and capital requirements, as well
as various conduct-of-business changes covering both sales regulation and targeted product regulation to
introduce specific measures and controls around identified high-risk products and customer circumstances.

This Wolters Kluwer Financial Services document looks at the detail as well as providing a high-level frame-
work, which covers some of the key provisions and impact-areas for firms to consider as part of their own
analysis and planning for the proposed changes.

Treating Customer Fairly (TCF)

Firstly, the pillar-objective behind the proposed FSA reforms has been the protection of consumers, whereby
business is conducted fairly and where customers are treated fairly too. But the culmination of problems in
the UK mortgage sector has been both market (lender) and consumer led, sparked by both micro and macro
economic conditions. Nevertheless, the FSA has sought to change its regulatory framework to address the
customer detriment and economic distress fuelled by the rapid expansion and explosion of innovative
products and new sources of market and product funding. These brought cheap credit and over liquidity to
the market with increasing levels of risk e.g. equity lending. But it also brought increased exposure in terms of
managing debt-to-income with a weakened focus on the ability-to-pay and an over-reliance on the fall-back
processes such as remortgaging and ultimately repossession. This also saw the emergence of both high-risk
lending strategies and irresponsible lending practices, with the apparently endless boom in property prices,
and the assumptions of both lenders and borrowers for perpetual market growth, making any lessening in
credit standards seemingly reasonable and costless.

At the more macro-level, the collapse in confidence and emerging lending problems of the US sub-prime
market led to rapid contraction of markets globally and helped propagate the inevitable knock-on effect on
property prices. In addition, the growth of transfer-of-risk business through loan sales and credit securitisation
has also helped relax overall lending standards. It moved the traditional model of mortgage funding using saver
deposits to fund lending with the retention of credit risk on the lenders own books, with the emergence of
non-bank lenders into the market using securitisation and other forms of wholesale funding to divest and
diversify the risk, and perhaps equally the vested interests in standards and controls. And so both supply and
demand drivers have helped compound the proliferation and effect of numerous cross-market issues.

So what has the FSA done?

Consequently, the FSA has seen the need to act to address issues and bring about a fundamental change in
the regulation of the UK regulated mortgage market to deliver the right outcomes for the market in respect to
both efficiency and sustainability, and to control any re-emergence of irresponsible practices and growth
sustained before the financial crisis and recession hitting the UK. So what has gone before is now seen as
ineffective in constraining ‘risky’ lending and unaffordable borrowing. This echoes the FSA’s overall changed
approach, following the events of the global financial crisis, to its risk assessment and supervision roles with
the expected adoption of a much more aggressive and proactive approach to monitoring and enforcement
going forward. All senior management should take heed!

The FSA is seeking to put into place a range of standards and measures which will ensure the mortgage market
works better for consumers whilst being sustainable for its participating firms. Essentially, this is driven by the
overarching aim to see firms only lending to people who can evidently afford to repay out of their disposable
income. Some of the more specific and notable measures being proposed include:
■ Making mortgage advisers personally accountable to the FSA by extending its Approved Persons
regime to those who deal with consumers and to advisers/arrangers with responsibility for
compliance oversight
■ Making lenders responsible and accountable for assessing the end-consumers ability-to-pay
■ Introduction of mandatory affordability testing
■ Verification of borrowers income for all mortgage applications
■ Prohibiting high-risk practices and business e.g. self-certification, so called fast-track loan processes
and ‘toxic combination’ products involving characteristics putting borrowers at risk, or restrictions
where borrowers themselves exhibit multiple high-risk characteristics e.g. high debt or poor-credit history
■ Widening scope of FSA powers to cover all lending on property including buy-to-let
■ Setting clear ‘Treating Customers Fairly - TCF’ expectations when dealing with consumers e.g. default
 practices and arrears charging. And of course, the FSA has recently fined GMAC Financial Services
£2.8m (as well as being ordered to make £7.7m in refunds) for precisely such ‘TCF’ failings in regard to
the treatment and charging of customers in arrears.

Enforcement action
2009 too has seen a fairly constant stream of FSA enforcement activity against regulated mortgage brokers
and adviser firms and individuals for failing to conduct themselves with the required level of honesty and
integrity in the advice and administration of mortgage applications. And many of these have been as a direct
result of this themed review work rather than day-to-day risk-based supervision.

Market reaction
But equally, the FSA’s proposals have already prompted market reaction, with the last main intermediary
lender providing self-certificated loans in the UK (Platform) to immediately withdraw from the market having
concluded the FSA’s stance had rendered the market ‘’unfeasible’’.

So what impact will the FSA proposals have

on participant firms?
Well, certainly lenders, brokers and advisers as well as other market participants should all be ensuring they
digest, understand and where appropriate respond to the FSA, with any views concerns or alternative
approaches on the proposals and expected implementation costs, ahead of the end January 2010 deadline.
This should be done either direct or via their respective trade association(s).

Typically, the firm’s Compliance function will have a lead-role in supporting and co-ordinating the internal
communication and overall assessment process. This may be instigated by issuing a concise gap-analysis
summary and draft action plans, engaging with senior-management and relevant operations functions to raise
awareness and begin to identify and determine the issues and priorities for likely implementation within their
organisation. But again, what are these likely to be? For reference, the attached framework table (see page
7) provides an overview of the matters that firms variously engaged in UK regulated mortgage business may
need to now begin to consider and address from both an operational and customer perspective. This covers
the main governance, prudential and conduct-of-business provisions which are raised by the FSA proposals,
and provide a high-level but constructive framework to inform and guide firms on beginning their own impact
work and assessment. It also includes some pointers on possible key implementation and timeline threats
and exposures.

The impact of the proposals will directly affect a range of participant firms and will necessitate input and
engagement, in terms of decision-making and planning, from a broad range of internal functions, and could
possibly include external third-party ‘reliance-on-others’ relationships too such as customer services or IT
outsourcing partners. For example, resultant changes to marketing, sales and administration processes,
procedures and literature will necessitate the potential creation or revision of both front and back-office
customer documentation and communications. And changes to practices, such as application vetting and
authorisation, including processes calculating disposable free income to facilitate the assessment of the
consumers ability to repay, are also likely to warrant amendments to internal procedures and staff/agent
training material. Similarly, the need for senior-management to maintain oversight of both consequent
change activity and new systems and control processes may also generate alterations to interim and ongoing
management information and reporting mechanisms.

Core impact issues and considerations will certainly be the affect on the firms’ strategic policies and
objectives concerning the products and services they offer and the necessary proportionate and effective risk
management, prudential and governance arrangements needed to maintain compliance with under the
eventual new regime. For some firms, this may involve decision-making and re-prioritisation in respect of
amended business plans and risk profiles or tolerances, with capital and liquidity reform seeking to directly
reduce the incentives and ability of lenders to supply limitless credit with relatively few checks. In particular,
with lenders becoming ultimately accountable for the impact and consequences of lending decisions, a more
counter-cyclical capital adequacy framework as well as generally higher levels in both the quantity and quality
of minimal capital is expected to be developed.

Obviously, those impacts affecting core systems and processes with protracted lead-times, such as IT
platforms requiring new data fields and screens to meet amended requirements, will also undoubtedly
become more immediately time-critical in terms of any technical development needs and also related
business-case decisions and approvals involving specification, build, security, testing and release activity.

Firms involved in mortgage lending and financing will need to establish revised arrangements covering many
core processes from application vetting/authorisation arrangements through to prudent customer account
management (including their ongoing risk character/profile) and fair treatment in the handling and charges
applied to arrears situations and arrangements. And those engaged in offering mortgage advice and conducting
brokerage activities will equally have to grapple with the revised processes and demands of lenders, whilst also
evolving their own culture and governance with the extension of the FSA Approved person regime to
advisers/arrangers dealing with customers and/or with responsibility for overseeing compliance. And even
market participants less directly affected by the regulation regime itself, such as estate agents and conveyancing
solicitors, will need to become familiar with revised requirements and practices to facilitate the effective and
efficient working of the market.

Initial thoughts from the industry

But what have been the initial thoughts of those participants actually engaged in the UK regulated mortgage
business, and what areas of concern and assurance does the FSA’s intended approach provide, to address past
problems and maintain a vibrant and sustainable UK market?

In its press release issued on the proposed reforms to the regulated market, Michael Coogan as Director
General of the Council of Mortgage Lenders in the UK (CML.org.uk) welcomed the consultative approach but
there was a need to ensure that regulatory fairness between all parties was achieved in practice. He went
on to comment ‘’We agree with the FSA that regulation in itself cannot resolve the problems of the recent
market. However, we also agree that clearly delineated responsibilities, which remove regulatory ambivalence,
will help lenders, intermediaries and consumers to know where they stand and to accept the consequences of
their actions’’. And in further commenting to Compliance-on-Line, on the impacts of the current FSA
consultation proposals for lenders and intermediaries engaged in the UK market their Communications
Manager, Bernard Clarke, agreed that whilst much of the detail was yet to be finalised or set-in-stone strong
themes such as ‘income verification’ and ‘arrears management’ would benefit from early senior-management
engagement in the process of identifying the obvious and even latent areas of potential exposure, difficulty
and challenge following any eventual implementation. He also emphasised the importance of firms actively
engaging with bodies such as the CML as an effective conduit of the views and concerns of members, adding
‘’pooling responses and views will enable such bodies to put across the strongest and broadly based case of
the interests and key issues involved’’.

Most commentators have speculated that the devil will be in the actual and eventual detail yet to be outlined
by the FSA, for example, specific proposals to toughen-up rules on arrears handling and administration, not
due until January. Of course the key for any new regime must be to ensure the right product is sold to the right
type of borrower and that the risks are properly understood by customers and reflected in both the lending decision
and the pricing of the loan. But whilst accepting there may be a clear case for some intervention the CML has
equally warned of the heightened risk that hasty intervention can deliver the wrong outcomes for consumers.
Whilst there is a clear case for some kind of intervention, it needs to be proportionate. So if income verification
became a requirement for all loans this could have unintended consequences for consumers. And the resulting
restrictions and even unavailability of certain products e.g. self-certificated loans, could especially impact
those types of consumer for which they were primarily designed such as self-employed and contract workers.
Therefore banning them begins to look like a blunt instrument in a competitive, innovative and dynamic market.

The British Bankers Association (bba.org.uk) in its own published response to the FSA paper equally argued for
a firm principle that high-risk borrowers are not cut-out of the market, and whilst the risks must be effectively
shared by all market participants and new regulatory rules must not serve to create unfair obstacles for either
lenders or borrowers. And the reaction of the National Association of Estate Agents (naea.co.uk), whilst
acknowledging that the extreme lending pre-credit crunch was clearly not sensible, equally expressed
concern that if the interpretation and application of new FSA guidelines failed to find the right balance they
could do untold damage to a UK housing market in a fragile state of recovery.

Conclusion
The FSA is clearly determined to forge ahead with fundamental changes in the regulation of the UK mortgage
market, as with other areas e.g. credit cards. In direct response to its broad market analysis work, but also the
market’s adverse and perceived contribution to the affects of the financial-crisis and the ensuing recession
within the UK economy, the changes will have a significant impact on the way mortgage products and services
are developed, offered and maintained in the future. But it remains to be seen if the proposals will sufficiently
address both broader market and consumer behaviours, or if further measures such as formal capping will
follow-on to ultimately deliver the expected goals for market efficiency and sustainability.

The FSA (FSA.gov.uk) has since announced a series of six consultation roadshow events which have already
started across the UK during late November and early December. This will give firms an outline of the FSA’s
current thinking, and provide a platform for debating views and points clarification with regulated firms.

All participant firms in the UK mortgage market, be they lenders or any intermediary engaged in the product/
service process, need to now maximise any opportunities, during the current consultation process, for lobbying,
benchmarking and contributing to any industry direction and influence on the resultant regime outcomes. In
addition, they need to take an early lead in planning the necessary internal change management to ensure
their business strategies, practices and activities continue to deliver a competitive, fair and compliant
business and overall UK market. With the intention to feedback on its initial consultation in the early spring
of next year, firms need to be ready to act on the FSA’s suggested phasing approach to implementation, and
any initial focus on those areas deemed to present the highest detriment. It is hoped that the impact frame-
work covered here will assist the firms most affected in ensuring they can properly consider and organise their
resources to this challenging task.
FSA Reform of UK mortgage market: high-level impact analysis framework
Regulatory Firms Firm-level impacts Consumer impacts and Key implementation issues Key timeline issues
area impacted expectations
SYSC: Advisors - Effective ‘change’ business- - Trust and confidence in selecting - FSA feedback due Spring 2010 -Reply to FSA proposals by end-
Strategy Brokers case management firm to conduct secure and value- - Identify current business gaps January 2010
Policy Lenders - Review business strategy/goals added business - Identify and assess existing -Phased implementation expected
MI/Reporting and risk profile - Availability and access to innovative prohibited/high-risk business -Action required on
Governance - Clear change direction and leadership and competitive products -Effective oversight of progress and existing business following new regime
Leadership - Decision-making and oversight and services changes across the firm -Education across organisation on new
TCF - Proportionality and fit-for- - Maximise opportunities and minimise policy and culture changes
Outsourcing purpose approach risks within tolerances -Availability of resources and skills to
- Determine and amend TCF issues - Effective top-down judgement and achieve deliverables and timelines.
and outcomes action with clear outcomes -Implementing outsourcing SLA service/
- Speed and transparency in delivering - ‘Listen and act’ using relevant performance changes
any organisational changes internal/external advisers
- Address impacts with third
party relationships
Prudential: Lenders - Re-assess credit/liquidity risks - Assurance in firm’s financial/risk - Introduce effective counter-cyclical -Approvals and resourcing of new
Capital Adequacy - Adjust minimum capital requirements capability as chosen product/ capacity to internal assessment capital requirements and funding
service provider
CoB: Lenders - New Product/Marketing/ - New affordability testing process - New data/system requirements -Possible future threshold capping by FSA
Product regulation Sales literature - Removal of prohibited products and processes if industry and consumer behaviour aims
- Revise application practices - Monitoring of changing/ongoing - Lead-times creation, production and not met
- Affordability testing capability risk characteristics distribution of revised documentation - Available time to deliver/
- Address prohibited products - TCF expectations re supply revised documentation
- Higher-risk characteristics default/arrears
- Customer disclosure/notifications - Fairness of charging/
- TCF management of default/arrears pricing practices
- Charging/pricing practices - Expanded regulation t cover 2nd
- Lender responsibility for creation/ mortgages and buy-to-let activity.
sale of product
CoB: Advisors - Suitability of recommendations - New/revised information or data - New data/system requirements -Adequacy of training for customer
Sales regulation Brokers - ToB/T&C changes requirements and processes advisors and arrangers on product/
- Customer documentation - New/revised evidence requirements -Training of new APER’s on service changes
- Customer disclosure/notifications - New/revised disclosure requirements responsibilities/accountabilities
- Expanded APER registration for
front-facing advisers, arrangers and
compliance oversight
Organisation: Advisors - Management engagement -Ability of front-facing functions -Timing and scale of mail-shots to -Plan and scheduling of all
Marketing Brokers and support to manage and deliver customer existing customers on changes key communications
Communications Lenders - Internal communications (awareness expectations -Design, specification and ordering of -Possible customer resistance or lethargy
Training and technical) - New/revised data retention new documentation to change demands e.g. enquiries and
IT/Systems - New/revised customer data needs requirements -Quality of design and testing of complaint levels
Procedures - New/revised staff training changes to systems/processes -Exposure to future latent/legacy risks
HR - New/revised system requirements
- New/revised processes and procedures
- Identify and establish new APER’s
-Update/amend performance
management targets and systems
Risk Management: Advisors - Articulation to senior management -Support senior management in
Change Analysis Brokers - Gap-analysis and action planning progressing and delivering SYSC issues
Controls/monitoring Lenders - New/revised controls -Internal advocacy/education on
Approved Persons - New/revised monitoring changes and regime impacts on firm
FSA Reporting - Expanded APER registrations -Identify and register new APER’s
- New FSA reporting requirements within firm
- Maintain adequacy and effectiveness
of oversight and controls under
new regime