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Not one, nor two - it's now three separate regulatory initiatives for UK lenders!


Published: 12 April 2011 | Author: Bernard Clarke

Ever since it became clear that the European Commission (EC) would press ahead with plans for a directive on mortgages, we have been working to try to avoid potential conflicts between separate initiatives to reform regulation in the UK and Europe. Now, however, a third regulatory threat is emerging.

At the end of last month – more than two years after the Financial Services Authority (FSA) first unveiled plans for its mortgage market review (MMR) – the EC finally published its own long-delayed proposals for a mortgage credit directive. In response, we warned that pursuing two separate initiatives at the same time was likely to lead to an "unholy confusion of competing draft rules at a national and European level."

But, on 18 March, less than a fortnight before the EC set out its plans, a third regulatory body, the Financial Stability Board (FSB), published a report outlining its own proposals for "residential mortgage underwriting and origination practices."  Its plans are likely to affect all FSB member countries, including the UK, creating further uncertainty for lenders and consumers, as regulators come under justifiable pressure to reconcile three separate initiatives. 

So, how will the FSB's proposals for mortgage reform mesh with the proposed EC directive and the FSA’s MMR? At this stage, the answers are far from clear. 

The Financial Stability Board’s report

The FSB emerged in the aftermath of the financial crisis as a key international body for monitoring and making recommendations about the management of the global financial system. Established after the G20 summit in London in April 2009, it succeeded the Financial Stability Forum (which had been set up in 1999) and exercises considerable influence. The FSB has no legislative powers, but sets global regulatory standards that its members are obliged to adopt.

Membership of the FSB is closely, though not exclusively, correlated with the G20. So, in Europe, the UK, Germany, France and Italy are members of both the FSB and the G20. The Netherlands and Spain are in the FSB, but not the G20.

The FSB's proposals

In its report on member countries, published last month, the FSB concluded that "poorly underwritten" residential mortgages had contributed significantly to the financial upheaval that began in 2007. Like most other commentators in the aftermath of crisis, it identified weak underwriting practices in any single country as a potential source of global contamination through the process of securitisation. 

What happened during the financial crisis therefore highlighted the importance of sound mortgage underwriting in all member countries, the FSB concluded. It argued that lending should be based on three key principles:

  • Supervisory bodies should require lenders to adopt minimum underwriting standards based on an accurate assessment of the borrower’s ability to repay "in a reasonable period of time." These minimum standards should be published and maintained in such a way as to be accessible to all interested parties.
  • Policymakers should ensure that different types of lender, whether regulated or not, uphold underwriting standards. Regulatory oversight should be consistent, with effective enforcement to ensure lending standards are met.
  • National policymakers should make sure there is appropriate public disclosure of mortgage underwriting practices that are upheld across the market.

The FSB acknowledged that, overall, national authorities were making good progress towards its recommendations. It concluded that nearly all FSB countries were regulated, prudentially or by consumer protection bodies or both. But most countries did not yet have adequate public disclosure or monitoring of information about the overall health of lending, it said, including evolving mortgage underwriting practices and market trends.

The FSB report went on to make six recommendations to promote sound residential mortgage underwriting practices globally, helping to ensure continuing financial stability. It said that:

  • supervisors in individual countries should develop a framework for sound mortgage underwriting practices globally that is "as explicit and specific as possible";
  • the FSB should develop an international principles-based framework for sound underwriting practices;
  • regulators should regularly review underwriting standards and adjust them to address the build-up of risk in housing markets or to counteract any lending boom that poses a significant risk to financial stability;
  • the regulatory remit should be extended in national markets to ensure all lending is supervised and regulated to safeguard both borrowers and investors, and to promote financial stability;
  • regulators and supervisors should ensure mortgage insurers, where they are active, are appropriately regulated and robustly capitalised; and
  • authorities should collect and disclose sufficient information to provide a comprehensive view of mortgage lending activity.

Finally, the FSB said it was important for supervisors and regulators "to maintain momentum" in improving lending practices.

The European proposals

Two weeks after the FSB report appeared, the EC belatedly published plans for a directive on credit agreements that had originally been expected last autumn. There were similarities – but also some striking differences – in their proposals.

Like the FSB, the EC said financial stability was a key priority. "The proposal seeks to promote financial stability by ensuring that mortgage credit markets operate in a responsible manner," the EC said.

But there was a major difference between the aspirations of the FSB and what the EC saw as another key priority. "First," the EC said, "(the proposed directive) aims to create an efficient and competitive single market for consumers, creditors and credit intermediaries with a high level of protection by fostering consumer confidence, customer mobility, cross-border activity of creditors and credit intermediaries, and a level playing field."

The CML’s reaction

While we support the aspirations of both the FSB and the EC in promoting financial stability, we do not believe that the EC should regulate to seek to promote a cross-border mortgage market.

National mortgage markets, even within Europe, are highly idiosyncratic and are likely to remain so even if the EC implements a directive. Consumer expectations and demands for familiar types of credit, national systems of property valuation and registration, and differences in funding markets and mechanisms will not be addressed by the EC proposals. It is highly unlikely that a single market will emerge from the European initiative.

Responding to the EC proposals, the CML said:

"We will need to scrutinise the directive thoroughly, as well as the indicative impact analysis published alongside it, before drawing detailed conclusions. Even then, it may be difficult to work out the real impacts given that so many areas of detailed policy will be delegated to the Commission to finalise and are not even included in the directive itself at present.

"What we can already conclude is that, for the UK at least, there is likely to be an unholy confusion of competing draft rules at a national and European level that will keep legal advisers gainfully employed for some time to come. Whether or not the end result will help UK consumers remains to be seen, but seems unlikely given that the FSA is at the more robust end of the European regulatory spectrum already.

"As we seek to work towards a UK response, we will be seeking evidence of the Commission taking a realistic view about how far its objectives will be, or can be, met through the directive. As the largest mortgage market in Europe, the UK stands to bear significant financial and implementation costs, which means that a convincing case for EU-level intervention is needed if the UK is to support it. That case does not appear self-evident at present."

The UK, Europe and the FSB

Reconciling regulatory initiatives in the UK, Europe and across FSB member countries adds a further twist to the tale. It is impossible to say how European and FSB requirements may mesh in practice, but given the strong degree of overlapping membership – six European countries are members of the FSB, alongside the EC, the European Central Bank, the Bank of England, the Treasury and the FSA – it is to be hoped that the Commission’s proposals, as they evolve further, will be consistent with the FSB requirements.

We agree with, and support, the FSB’s focus on financial stability, and hope that the absence of any aspiration by the FSB to promote an international mortgage market will help clarify for the Commission that this is an inappropriate goal for an international regulatory body.

We would like to see the harmonisation of regulatory initiatives from the FSB and the Commission. We need much more detail on any practical measures but, in our view, the promotion of financial stability on an international scale is likely to be most effectively achieved by focusing on macro-prudential requirements, rather than conduct of business rules.

There are some encouraging signs of alignment between the EC and FSB. In a recent statement on responsible lending and borrowing, the EC acknowledged concerns within the G20 about how lending practices had contributed to the financial crisis.  The EC said: "The resulting action plan includes initiatives to make the overall system more resilient through a range of measures to tackle this excessive leverage and promote responsible lending and borrowing."

Measures to build resilience and promote global financial stability should also help reinforce consumer protection. But international regulatory bodies must not forget that consumer protection is already being addressed extensively in individual national markets, including the UK. 

Even though we need much more detail about European and FSB proposals, some areas of potential conflict are already apparent. The Commission appears, for example, to see product disclosure as a means of improving borrowers’ buying decisions while, in the UK, the FSA is now moving away from this approach. 

Similarly, there are potential conflicts between long-established UK mortgage practices and the FSB’s implied support for restrictions on loan periods or proposals to protect investors. The latter may imply regulation of buy-to-let lending, which we oppose.

We believe that it is crucial to achieve as much harmony as possible between national and international regulatory requirements, with a unified approach to the promotion of financial stability and adequate consumer protection. As the largest mortgage market in Europe, the UK will be playing a full and active part in the international debate.