CML news & views

One of the key issues the Financial Services Authority (FSA) will consider as part of the current mortgage market review is its scope as a prudential and conduct of business regulator. Should it be extended further? And, in particular, should secured second charges and buy-to-let loans be regulated by the FSA alongside first charge mortgages?

For the last decade, we have argued that it would benefit both lenders and consumers for all secured lending to be regulated by the FSA. Currently, however, the Office of Far Trading regulates second charge lending as part of its broader remit to oversee consumer credit. 

But when a loan is secured against a consumer’s home, we believe there should be a similar standard of protection overseen by a single regulator. And with a mortgage and personal loan facility often being sold together – at least until the onset of the credit crunch – it makes sense to have complementary sales processes and regulatory rules. 

This has not happened so far because a move from the consumer credit regime to conduct of business rules would need careful planning and implementation to avoid confusion and undue costs for regulators, firms and consumers alike. There have been higher regulatory priorities in the last few years.

Time for a change?

Now, however, with the second charge market largely dormant and moves towards convergence in regulation across Europe, the time is right for change. What we need, though, is an assurance from the FSA that it could take on additional responsibility for consumer credit firms in a proportionate, effective and cost-effective way. In principle, this extension of the FSA’s scope would be a positive outcome for consumers from the current review.

The FSA appears sympathetic to the argument, and the Treasury has been consulting as part of its financial services reform agenda. The basic argument is that consumer protection for consumers would be improved – and borrowers would be less likely to over-stretch themselves irresponsibly – if the FSA regulated both first and second charge lending.

Buy-to-let lending

If the FSA’s scope should be extended to include second charge lending, is there a case for widening it further still? The argument for regulating buy-to-let mortgages – available in a market which has traditionally been the haunt of the professional landlord but is now one in which consumers have increasingly invested – is less clear. 

Our starting point is the same question we have posed about making changes to the regulation of personal, secured loans: where is the consumer detriment, and how is it best addressed? In our view, the answer to that question must be properly understood before the FSA proposes change. 

It is a question on which the views of our members vary considerably so, in advance of the FSA discussion paper, it is worth rehearsing some of the arguments here.

Investors – or consumers?

A case for regulating buy-to-let is difficult to sustain simply because it is lending to consumers secured on residential property. Buy-to-let is different from the mainstream mortgage market because it is a commercial transaction with an investment dimension. 

It is not clear therefore that regulation designed to protect consumers as borrowers is appropriate. Unlike a borrower with a residential mortgage, the landlord is not at risk of losing his own home, and many operate as businesses so should not attract protection afforded to consumers simply because of the nature of the product.

Nonetheless, the call for buy-to-let lending to be regulated has gained pace in the last two years, as arrears and possessions in the sector have begun to rise. However, our data shows that for 10 of the last 11 years payment problems have been on a smaller scale in the buy-to-let sector than in the mainstream mortgage market. And data for the second quarter of this year shows an improvement again in buy-to-let relative to the residential sector.

Consumer detriment? 

Was the blip in our arrears figures a sign of some form of consumer detriment requiring a regulatory response? Or was it merely a reflection of one of the risks of a commercial enterprise – namely, that not all property to let will attract a tenant but the mortgage will still have to be paid? Another question is the extent to which the recent figures may have been inflated by fraud by borrowers, rather than poor lending by firms from which consumers need to be protected.

In any case – as we argue in our submission to the FSA – it is too simplistic to argue that, in an economic downturn, rising arrears and possessions necessarily equate with consumer detriment justifying a regulatory intervention.

Essentially, there are two decisions that a buy-to-let borrower makes: to invest in residential property and to take out a loan in order to do so. So, what we need to consider is not only whether there has been consumer detriment, but how it may have arisen. If it exists, is it rooted in the decision to invest in property, or in some feature of the mortgage or the way it was sold to the borrower? 

Although in practice it is not always easy to disentangle these strands, a buy-to-let borrower in difficulty may simply have made a bad decision, investing in the wrong property at the wrong time – for example, a city centre flat off plan. Alternatively, he may have managed his investment badly following the original decision to buy. Or, if he has a grievance with the buying decision, it will not be with a lender, but a developer, a property investment club or some other professional involved in the transaction. 

In all these cases, it is possible to argue that the focus be on seeking to avoid potential detriment by regulating the transaction as an investment, not through regulating the mortgage sales process.

Choices for tenants

We must not forget that only a small number of buy-to-let borrowers are in arrears, in any case – despite the challenging economic conditions. More than 97% of landlords have no problem in making their payments; most are managing their properties well; and the vast majority of buy-to-let mortgages have been prudently advanced and perform well. So, is this a market showing detriment – real or potential - requiring an intervention by the FSA?

Let us not also forget that the unregulated buy-to-let market has already delivered a wide range of benefits, and not just for successful landlords. At a time when entering home-ownership has become more challenging, buy-to-let has improved the choice of housing for tenants in the private rented sector in a way that would not otherwise have been possible.

Renting is now a viable and attractive choice for all types of property in all price ranges, and buy-to-let has allowed smaller landlords into the market alongside larger ones, encouraging competition on price and quality.

Overall, therefore, the extent to which there is consumer detriment justifying regulatory intervention is not clear. We will therefore look at what the FSA says in its forthcoming discussion paper and consult with members before responding more fully to its proposals. 

The current detriment: a shortage of funding

At this point, however, what is clear is that, just as in other parts of the mortgage market, there is a shortage of funding and a restricted choice for landlords looking to transact in the market as house prices have stabilized. This is the current detriment that needs to be addressed, if the benefits of a more vibrant and diverse private rental sector are not to be threatened.

Regulation to protect consumers who might want to invest in residential property in the future is an important issue but not the only challenge the FSA faces.

The FSA is going through a period of significant change as a result of measures already announced and under consultation. So, choosing the right timetable for moving to a new, widened scope needs careful thought. We do not want the FSA to be hampered in its primary goal of introducing more effective supervision of the rules and firms it has already in place.