Mortgage regulation – background
Last reviewed 02/12/2014: any recent updates in this colour.
- A summary of the background to mortgage regulation
- The Mortgage Code
- The Treasury review of 1998
- Financial Services Authority consultations on the new regime
The Treasury announced in January 2000 that it was going to bring in a statutory regime for regulating mortgages. The initial proposal was that regulation would be confined to mortgage lenders (not mortgage intermediaries) and would not cover mortgage advice. The Financial Services Authority (FSA) was to put in place the detailed regime, and it started consulting on how it proposed to do this. In December 2001, the Treasury announced that it had decided to extend the FSA's regulatory remit, so that mortgage intermediaries and mortgage advice would, after all, come within scope of the new regime. This had the effect of delaying the introduction of the new regime for another two years. The Mortgage Conduct of Business (MCOB) rules finally came into effect on 31 October 2004, signalling the end of the voluntary Mortgage Code, which had been in effect since July 1997 for lenders (and April 1998 for mortgage intermediaries).
With effect from 6 April 2007, the FSA has also been responsible for regulating the sale of home purchase plans (arrangements for home finance which are compliant with Islamic law) and home reversion plans. To reflect this extension to its powers, the FSA has re-named MCOB as the Mortgages and Home Finance: Conduct of Business Sourcebook, though it will still be commonly known as "MCOB".
The Mortgage Code
In 1995 and 1996 we started work on developing a Mortgage Code to complement the Banking Code, which had been introduced in 1994. A General Election was due to be called during 1997 and it was generally expected that the Labour Party would win. We were aware that Labour had expressed an intention to review the way in which mortgages were sold, and believed that the Mortgage Code would send out important signals that the industry was taking steps to regulate itself.
Labour came to power as expected on 1 May 1997 and the Mortgage Code was introduced for lenders on 1 July that year. Almost immediately, discussions began on how to extend the Code to mortgage intermediaries. The Mortgage Code remained in force until 31 October 2004, when it was superseded by the Financial Services Authority's Mortgage Conduct of Business rulebook.
The Treasury review of 1998
In line with its pre-Election Manifesto commitments, the new Government announced that it would review the sale of mortgages and a Treasury review was launched in 1998. We submitted robust evidence defending the lending industry, emphasising the Code's achievements and arguing that statutory intervention in the mortgage market was neither necessary nor justified.
A second Treasury consultation – Regulating Mortgages - followed in 1999. This proposed partial regulation, in the form of statutory authorisation of lenders and a prescribed sales process. The Treasury acknowledged that the mortgage market was highly competitive and that it was relatively easy for consumers to exit uncompetitive or unsuitable products and to re-mortgage elsewhere. It considered that such consumer detriment as existed was caused not by poor advice, but by the fact that the information received from lenders made comparing prices and products very difficult. The quantity and quality of the information given to consumers pre-sale would therefore be prescribed, and the Financial Services Authority (FSA) would be responsible for developing rules to give this effect.
Since it was clear that the Treasury was intent on going down the statutory route, we re-considered our position. We argued that the industry had become familiar with voluntary regulation under the Mortgage Code and that this had brought benefits to consumers because it was proportionate, effective and cost-effective. We believed, however, that if statutory legislation were to be introduced, then there should be just one regulator for secured loans, and that should be the FSA. The Consumer Credit Act (CCA) had not been designed to regulate domestic mortgages and many of its provisions were unwieldy and inconvenient both for consumers and lenders. The decision to legislate offered an opportunity to have a streamlined and unified regime, with all secured lending under one regulator – the FSA.
In January 2000 the Treasury announced the outcome of its consultations. It confirmed the proposals set out in the 1999 consultation. A dual system of regulation – under the new Financial Services and Markets Act 2000 (FSMA) - and the CCA – would therefore continue. Furthermore, the regulatory regime would not include mortgage intermediaries and would focus on pre-sale information, but not advice. It looked as if the Mortgage Code would need to continue in existence to cover these areas – in addition to the dual statutory regime. We were disappointed with this policy decision by the Treasury, and described it as a missed opportunity.
Following lengthy consultations, a Regulated Activities Order was laid in Parliament in February 2001. It was intended to take effect – and thereby bring the FSA's mortgage rules into force – on 31 August 2002.
Financial Services Authority consultations on the new regime
In November 2000 the FSA published Consultation Paper 70 (CP70) setting out its high-level proposals for mortgage regulation. This was followed in June 2001 by CP98, which set out more detailed proposals and included draft rules. Probably the most contentious proposal was that the FSA would make lenders responsible for ensuring that mortgage intermediaries complied with some aspects of the statutory regime. This drew heavy criticism and resistance from lenders and intermediaries, as it was felt the FSA was exceeding the remit given to it by Treasury.
As the industry awaited final rules from the FSA, it was taken by surprise by a Treasury announcement, on 12 December 2001, of a significant policy change. The FSA's remit was to be extended, so that mortgage intermediaries would need to be authorised (or exempt from authorisation, by virtue of being Appointed Representatives of authorised persons). Mortgage advice was also to be brought within scope: in fact, the whole FSA regime would adopt a "cradle to grave" approach, touching on all aspects of consumers’ relationships with lenders and intermediaries throughout the life of their loans.
The reason for the policy change was the Treasury's realisation that, in order to give effect to the recently-adopted European Directive on Insurance Intermediation, it would have to give the FSA power to regulate general insurance intermediaries. Since there was a considerable overlap in terms of intermediaries who sold both mortgage and general insurance products, and the Treasury was aware of the industry support for regulating mortgage intermediaries, it decided to extend the FSA's remit. The immediate impact of this was that the timetable would be set back by about two years: the new target date for mortgage rules to come into effect was 31 October 2004. A two-year implementation period for general insurance rules would begin as soon as the final text of the Intermediation Directive was published. Publication was slightly delayed and finally took place on 15 January 2003. This meant that the general insurance rules did not come into effect until 14 January 2005.
The Treasury started consulting on revisions to the Regulated Activities Order which would define the additional activities to be regulated by the FSA. The activities of "arranging" and "advising on" a regulated mortgage contract joined the existing activities of "lending" and "administering". In all, five Orders were laid on 5 June 2003, as follows:
- The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No 1) Order 2003 (SI 2003 No 1475). This Order amends the Regulated Activities Order made in 2001 (SI 2001 No 544) which provided the definition of “regulated mortgage contract”. The new Order adds the activities of “arranging” and “advising on” a regulated mortgage contract to the list of regulated mortgage activities.
- The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No 2) Order 2003 (SI 2003 No1476). This Order implements in part the European Parliament and Council Directive 2002/92/EC on insurance mediation. It amends the Regulated Activities Order made in 2001 (SI 2001 No 544) by adding insurance mediation activities to the list of regulated activities.
- The Financial Services and Markets Act 2000 (Exemption) (Amendment) (No 2) Order 2003 (SI 2003 No 1675). This Order makes local authorities and certain bodies involved with the provision of social housing exempt from the FSA’s mortgage rules in relation to advising on and arranging regulated mortgage contracts and activities relating to certain insurance contracts.
- The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2003 (SI 2003 No1676). This Order amends the Financial Services and Markets Act 2002 (Financial Promotions) Order 2001 (SI 2001 No 1335)by specifying two new controlled activities and providing a further exemption from the financial promotion restriction in that section.
- The Financial Services and Markets Act 2000 (Misleading Statements and Practices) (Amendment) Order 2003 (SI 2003 No 1474).
The FSA published a further consultation paper - CP 146 - in August 2002. This set out feedback to issues raised in CP 98, many of which were still relevant to the new, extended, regime. It also consulted on the new areas which were to come under the FSA's remit, in particular, its proposals for regulating mortgage advice. Feedback to CP 146, together with draft rules for the new regime, appeared in CP 186, which was published in May 2003.
The final Mortgage Conduct of Business rules (MCOB) were published on 16 October 2003, giving the industry the clear 12 months it had asked for to implement the new regime.
The MCOB regime came into effect on 31 October 2004. It adopts a “cradle to grave” approach throughout the relationship between consumers, intermediaries and lenders:
- It starts with a Financial Promotions regime on advertising.
- It then lays great emphasis on providing consumers with intelligible information, provided in a consistent format, that will enable consumers to shop around, compare different products, and make informed choices.
- Every consumer MUST be given pre-contractual information, in a highly prescribed format - the Key Facts Illustration - before they can apply for a particular loan.
- Lenders are under a duty to lend responsibly: that is, they must be able to show that they have given proper consideration to a prospective borrower’s ability to repay the loan being applied for.
- Information must continue to be given to consumers in prescribed format. At mortgage offer stage, and throughout the life of the loan.
- Consumers who fall into arrears must be given prescribed information, including an official FSA leaflet.
- The Rules set out how firms must deal with arrears and possessions cases.
- Separate rules govern how “lifetime mortgages” are to be promoted and sold. The FSA regards these products as high risk and has specified a separate regime accordingly.
The RAO as amended now prescribes four regulated activities, of lending, administering, advising on and arranging regulated mortgage contracts. A regulated mortgage contract is defined as being a contract under which:
- A person (“the lender”) provides credit to an individual or to trustees (“the borrower”); and
- The obligation of the borrower to repay is secured by a first legal mortgage on land (other than timeshare accommodation) in the United Kingdom, at least 40% of which is used, or is intended to be used, as or in connection with a dwelling by the borrower or (in the case of credit provided to trustees) by an individual who is a beneficiary of the trust, or by a related person.
"Related person” is defined as meaning the borrower’s “spouse, parent, brother, sister, child, grandparent or grandchild” or “a person (whether or not of the opposite sex) whose relationship with the borrower has the characteristics of the relationship between husband and wife.”
Authorisation under the new regime
Under Section 19 of the FSMA, no person may carry on a regulated activity without permission. Any person who does so will be guilty of an offence and may be liable to imprisonment for a term of up to two years, or a fine, or both. Further, any agreement made by a person carrying on a regulated activity without permission is unenforceable against the other party. For more information see the separate web page on authorisation and appointed representatives.
As referred to in the opening summary, the FSA's rules were extended with effect from 6 April 2007 to include home purchase and home reversion plans, neither of which had fitted the original definition of "regulated mortgage activity". The FSA issued a press release explaining the amendments. FSMA had been amended in December 2005 to enable extension of the FSA's powers, and the relevant secondary legislation (SI 2006 No 2383) had received Parliamentary approval in October 2006.
The revised rules now refer collectively to "home finance activity", which is defined in the Glossary in the FSA's Handbook as "any home finance mediation activity, home finance providing activity or administering a home finance transaction". A "home finance providing activity" is, in turn, defined as "any of the regulated activities of -
(a) entering into a regulated mortgage contract
(b) entering into a home purchase plan
(c) entering into a home reversion plan; or
agreeing to carry on a regulated activity in (a) to (c).