Implementation of the EU mortgage credit directive. Response by the Council of Mortgage Lenders to the HM Treasury consultation paper

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1 Implementation of the EU mortgage credit directive Response by the Council of Mortgage Lenders to the HM Treasury consultation paper Introduction 1. The CML is the representative trade body for the residential mortgage lender industry that includes banks, building societies and specialist lenders. Our 125 members currently hold around 95% of the assets of the UK mortgage market. In addition to lending for home-ownership, the CML members also lend to support the social housing and private rental markets. 2. We welcome the opportunity to respond to HM Treasury s (HMT) consultation on the legislative amendments needed to implement the Mortgage Credit Directive (MCD), Implementation of the EU mortgage credit directive. We have some general views on the consultation as well as points about some specifics. 3. This response relates only to HMT s consultation on implementing the MCD. However, it makes occasional cross-reference to the FCA consultation paper on implementing the MCD. 4. We are grateful for HMT s open and consultative engagement with the industry on the MCD. We look forward to continuing this as the legislation is developed. General comments 5. From the perspective of both borrowers and lenders, the MCD adds little value to the UK mortgage market. The UK s existing regulatory regime, recently reinforced by the Mortgage Market Review (MMR), is already robust, clear and offers consumers full protection in areas where the MCD now makes extra provisions. No extra protection for consumers is conferred by the MCD. Rather, new processes for delivering existing protections are required, which will be neither visible to nor appreciated by UK borrowers. 6. We consider the UK s general approach to implementing the MCD should be minimalist and only do what is absolutely necessary to meet the obligations of an EU member state. Going further will simply damage a well functioning and well regulated market that already provides good outcomes for consumers. 7. While we broadly agree with HMT s proposed overall approach to implementing the MCD, we have some specific recommendations where HMT should consider particular proposals to ensure the minimum possible change. 8. One major area concerns applications in the pipeline. The absence of a way of dealing with applications that cross the MCD s effective-from date will reduce the time firms have to implement the new rules and would likely cause significant market disruption. We therefore welcome HMT s decision to consider what further steps it can take to smooth the implementation. We will participate enthusiastically in continuing discussions to identify a solution that fully addresses the problem. 9. For buy-to-let (BTL) lending we believe the changes proposed are at best unnecessary. At worst they will lead to a reduction in the functionality of the market where borrowers able to obtain mortgages now will have additional confusing burdens placed upon them. A potential side-effect of this could be a reduction in BTL lending as a borrower s capacity to obtain BTL mortgage finance may be diminished. While we recognise that HM Treasury must deliver a system which complies with the MCD our clear preference would be for HM Treasury not to go beyond the legal minimum so as to minimise any detrimental impacts on the BTL market. address North West Wing Bush House Aldwych London WC2B 4PJ telephone fax website

2 10. We welcome HM Treasury s aim of finalising the measures needed to implement the MCD by March 2015 so industry has sufficient time to comply with the changes. It is vitally important this timetable is met so that industry has as much time as possible to implement the requirements. Transitional period for mortgage applications 11. We welcome HMT s decision to consider whether there are further steps the government could take to smooth the process for cases open but not complete by 21 March We believe there could be substantial disruption to the market if a way of fully dealing with these cases is not found. Our comments in this section apply to all mortgage types in scope of the MCD, including consumer BTL. 12. The MCD does not make specific provisions for cases open but not complete before 21 March 2016, when the MCD s requirements take effect. A case open before this date may therefore have to revert to an earlier stage under the MCD rules if it is not complete before 21 March The implications of this could be substantial. Firms issue mortgage offers that are typically valid for up to six or twelve months. We therefore estimate the number of cases in train but not completed by 21 March 2016 could be in the hundreds of thousands. This figure is especially high because March is part of the annual peak period for UK mortgage activity. 14. This could cause significant customer confusion and frustration and may have financial implications. Customers will be at different stages of the process, with many close to completion. Delaying or slowing the completion could lead to their incurring certain charges or losing completion incentives if their house purchase is upheld. There may be a disproportionate impact on buyers of new build homes. Lenders may give extensions to mortgage offer periods to allow building to complete and there are likely to be more of these transactions in the pipeline towards the end of the financial year when the MCD is implemented. 15. We also note it is not clear to what point in the MCD-regulated process customers would have to revert. Would customers at an advanced stage have to be given a reflection period that they would likely waive anyway, for example? It should be borne in mind, too, that many cases will be in property chains, magnifying the disruption if some chose to accept the reflection period and some chose to waive it. A possible consequence of all this is that firms simply reduce their activity around this time to manage the number of affected cases. 16. One option to mitigate the impact of this is to allow firms to comply with the rules before 21 March We therefore welcome the FCA s proposal to enable the rules from 21 December 2015 but we think this is only a partial solution. Firms already have only a year to make the necessary changes to comply with the directive. Being compliant early would reduce what is already a very challenging timetable for making a substantial number of changes to systems and processes. 17. We welcome HM Treasury s proposal to include in its draft legislation the exception provided by the MCD for loans existing before 21 March The MCD is explicit at article 43 (1) that this is the case. However, this is not included in the FCA s draft Handbook rules. We recommend the FCA matches the legislation by including this in its rules. 18. We would welcome continuing discussions we have had with HMT to-date about this issue to find an approach that fully addresses the problem. This will reduce the likelihood of substantial customer and market disruption that we describe above. 19. We note there was very little overall disruption to the market from implementation of the MMR. A major contributor was having a period from 26 April 2014 for non-advised cases to proceed under the previous rules if there had been no material change in circumstances. Buy-to-let mortgage lending 20. Buy-to-let lending in the UK has always been considered to be a business transaction and therefore has, predominantly, remained outside a conduct regulated system (for consumers) such as the one for residential mortgages.

3 21. The case for introducing further regulation into the BTL sector, as HMT observes in this consultation, has simply not been made. There has been no demonstration of customer detriment, dissatisfaction or distortions within the wider housing market because of BTL transactions. 22. Therefore, it is disappointing that the UK is required to adjust this long-standing approach because of European rules. 23. It is inevitable that some landlords will find the process of obtaining BTL mortgages less straight-forward than before and the range of mortgage products available could become more limited for those landlords. The proposed approach 24. We recognise that HMT is attempting to achieve the least-worst solution in order to comply with the requirements of the MCD. 25. While we would have preferred for HMT to allow the industry to self-regulate through the adoption of its own framework for BTL lending we understand why this is not considered to meet the legal minimum expectations of the European Commission in delivering the MCD. 26. We are wholly supportive of HMT s preference to use the discretionary framework (the framework) option for BTL lending rather than to apply the MCD in full to the BTL market. To apply the MCD in full would have a significant negative impact on BTL as an investment vehicle and severely constrain housing supply within the private rented sector. 27. In designing the framework for consumer BTL lending we support the principles contained within this consultation and that it must not apply to all BTL borrowers, only a cohort, who because of their circumstances are choosing to become a landlord and exhibit the characteristics of a consumer. 28. Because of this principles-based interpretation, and the narrow set of circumstances when a customer is likely to fit the framework and be considered to be a consumer BTL customer, the impact on the BTL market is likely to be minimal. But there is likely to be some exclusion at the margins. 29. It is important to recognise that the UK will, once these changes are applied, move to a three tier regulatory system (non-regulated, MCOB regulated & consumer BTL regulated) for BTL lending which may cause confusion for borrowers and will create complexity and cost for lenders. Market fragmentation 30. In defining consumer BTL as a new transaction type HMT is creating an artificial sub-market and because of the FCA regulatory overlay mortgage lenders will be required to opt in if they wish to offer mortgages to these customers. 31. It is likely that, given the additional cost and complexity, some lenders will choose not to service this part of the market. 32. In order to aid the decision-making process we encourage HMT to ensure the FCA release their consultation in a timely manner so that lenders can better understand the practical requirements of participation and cost as well as making the necessary system and process changes in order to adopt consumer BTL within their business. Borrower declaration 33. As currently worded the legislation provides a large degree of uncertainty around who is a consumer for the purposes of the framework. As the determination is made, largely, on a customer s own circumstances it is important that responsibility for the correct regulatory streaming remains with the customer.

4 34. The use of a declaration form at the point of sale, where responsibility for the decision remains with the customer, is a useful tool and will be helpful for lenders to ensure there is a reduced risk of regulatory cross-over into a system that is not appropriate for them. 35. As customers will be provided with information to enable them to make a determination of their status we believe that such an approach is suitable and would comply with the requirements of the MCD. 36. As currently drafted, the wording states that lenders can assume the declaration by the borrower is correct unless they know or have reasonable cause to suspect the declaration is incorrect. There will be circumstances where this is simple to determine; however, there will be a significant number of cases where the lender will have to presume the information supplied is correct. 37. Our strong preference is for lenders to be able to rely on the information provided unless they are alerted to a change in status before the mortgage has completed. To assume that lenders will verify the customer s declaration feels unnecessary and in our view goes beyond what the MCD requires. 38. In the case of incorrect regulatory streaming where the borrower has inaccurately declared their status, either accidentally or deliberately, the lender should not be held accountable where the borrower was provided with the information necessary to make a decision as is required within the legislation. Definition 39. The definition of a consumer for the purposes of the framework is particularly unclear. While we recognise the efforts of HMT in adopting a definition which allows for some flexibility, it is important to increase the certainty of the definition so that lenders treat borrowers consistently and in a manner which is aligned to regulatory expectations. 40. To be clear, any customer with a pre-existing rental portfolio of one property or more should be excluded from the consumer regime as to not consider them to be persons acting predominantly for business would be counter-intuitive. This point should be made explicit within the legislation. 41. Often the determination of a consumer will have to be made on a case-by-case basis by lenders in conjunction with the borrower s declaration. However, some consistent principles would be needed if for no other reason than to help consumers understand which category they best fit in to. 42. Therefore we propose that the following rules be adopted to make the definition of a consumer clearer for all parties involved in a mortgage transaction: i. All customers who have an existing rental property, with or without a mortgage, should be considered exempt from the consumer regime; ii. iii. All customers who are first time landlords and engaging in a let-to-buy transaction would be included within the consumer regime; All customers who inherit property from a family member and are a first time landlord would be included within the consumer regime. 43. In adopting these principles within the scope of the definition it will give lenders additional certainty that borrowers are being subjected to the correct regulatory system. This is especially important for the larger lenders who cannot, because of volumes, interrogate applications on a caseby-case basis to determine the customer s status.

5 FCA oversight 44. We are pleased that HMT has given the FCA a tightly controlled remit within legislation which does not allow the regulator to create rules. This is an important consideration and will prevent regulatory scope-creep. 45. As we say earlier, lenders need to understand the mechanisms under which they will be required to function in particular when developing systems, processes and reporting in time for implementation in These changes will run concurrently with changes being made in both residential and second-charge lending and HMT needs to be mindful of the burden this will place on lenders. Disclosure, advice and early repayment charges 46. Paragraph 6 (1)(o) of the Schedule in relation to the amendments to the Financial Services and Markets Act 2000 requires lenders to provide an illustration of how the annual charge may change if the interest rate increases by 1%. This is different to the requirements in the MCD for residential lending where the illustration is provided in reference to a rate over a period of 20 years. We do not believe there is a case for doing things differently for consumer BTL and therefore propose that the requirements of the ESIS are aligned for consumer BTL. 47. Paragraph 1 (2) of the Schedule in relation to the amendments to the Financial Services and Markets Act 2000 discusses the provision of advisory services. Our assumption is that this is not in reference to the established understanding of regulated advice as defined by the FCA for residential lending but is instead a generic reference. Regulated advice does not exist for BTL lending. We would like additional clarity to confirm that advice does not have to be provided. 48. Paragraph 16 of the Schedule in relation to the amendments to the Financial Services and Markets Act 2000 sets out the approach that lenders must take in relation to early repayment charges. We note there are a number of similarities to the proposed approach taken by the FCA in relation to residential lending and which are set out in their consultation. As both sets of wording are believed to be compliant with the MCD our preference would be to harmonise the approach between residential and consumer BTL so there is a single, consistent, form of words. Alternatively lenders will need the reassurance that they can rely on either form of words for the purposes of consumer BTL lending. Creditworthiness assessment 49. Paragraph 12 (1) and (2) of the Schedule in relation to the amendments to the Financial Services and Markets Act 2000 sets out the requirements for the assessment of creditworthiness. It states that lenders must take into account rental voids, rental arrears and typical letting costs. 50. Lenders do not, routinely, attribute a value to each of the three items listed above in isolation and instead use an interest cover ratio (ICR) where the income generated in rent must exceed the cost of the mortgage payments. This difference between rent collected and mortgage payment allows for the management costs of the property which includes costs the landlord may be required to bear. 51. Our view is that under the proposed form of words lenders will feel that an ICR could no longer be used and instead lenders would need to take into account these items in isolation. This feels onerous and unnecessarily complex and therefore we would urge the wording to be adjusted in order to allow for ICR calculations to continue. 52. This could be achieved by re-wording paragraph 12 (2)(a) as follows: obtained by the lender from relevant internal or external sources and can include reference to a lenders own modelling. Information from the borrower, and including information provided to the credit intermediary during the credit application process must also be considered.

6 Continuity 53. The MCD uses the term entering into when discussing the completion of a mortgage between a lender and a borrower. For the purposes of consistency, references to executing and concluding should be adjusted within the legislative changes proposed to be more reflective of the wording used in the MCD. Knowledge and competency 54. Given the principle of a light-touch approach for consumer BTL lending, it is unclear why these requirements should be established as they appear to go beyond what is legally required. We believe this is unnecessary and amounts to gold-plating. 55. We note the extended timetable for these proposed requirements and believe that this will be helpful for lenders in delivering the MCD. It is however, unusual, that the requirements for consumer BTL are to be enshrined in legislation unlike the requirements for residential lending which are taken account of in the FCA s rules. It is a blunt tool and any changes required in response to market dynamics would be much slower than for residential lending. 56. As drafted, it is not clear to what extent lenders will be required to ensure their employees possess the expected knowledge and competency and how this will be delivered and assessed. 57. It would be helpful if additional clarity on expectation was provided to ensure consistent interpretation across lenders. Second charge mortgage lending 58. We believe that it is appropriate for subsequent charge mortgages to be regulated upon the same basis as first-charge mortgages to ensure the best outcomes for customers. The current system has led to confusion and inconsistent treatment of borrowers, especially when they suffer payment difficulty. 59. We do not believe there is any merit in creating a new regime for this kind of lending as this will not necessarily result in any customer benefit and will result in the same, disparate approach, which presently exists. 60. It is important that we give proper consideration to the types of lending caught under the proposed regime, particularly on specialist products like equity lending and mortgages with a secured loan (drawdown) facility. 61. There is no explicit reference to first-charge consumer credit act regulated mortgages transferring across to the regime for regulated first charge mortgages. It would appear unusual for these types of loans to remain outside of the FCA s MCOB rulebook when all other types of loans are transferring in. 62. Given the high-level nature of the proposals in this consultation we will provide more substantive feedback on this in the FCA s consultation. Further changes to the scope of FCA mortgage regulation and amendments to the Financial Services and Markets Act HMT proposes to amend article 61 of the RAO so that mortgage contracts are secured by a mortgage on land in the EEA. We note this could make it uncertain to which transactions MCOB applies. This introduces the possible risk of overlapping jurisdictions, with the FCA and the local regulator potentially both regulating the transaction. 64. There also appears to be some inconsistency between the proposed legislation and the FCA s consultation. The FCA s proposed definition of a regulated mortgage contract in its glossary of

7 terms is a mortgage on land in the United Kingdom (page 11). The FCA s proposed PERG changes refer to land in the EEA. There would be substantial uncertainty for firms if the adopted definitions that differ between the RAO and the FCA rules. 65. We believe the current scope of the jurisdiction set by the existing RAO and PERG gives firms clarity about which regulator oversees which territories if they have operations in the UK and the EEA. We would welcome HM Treasury clarifying this territorial application issue. 66. We also note the proposed changes to article 29 regarding exclusions in arranging regulated mortgage contracts. There may be an issue for those, such as developers or estate agents, who provide mortgage product information to a customer but who do not formally advise the customer on the transaction. We would also welcome clarification here. Contact 67. We have prepared this response with our members. Please send comments and questions to Andrew MacLachlan (andrew.maclachlan@cml.org.uk) or Matt Burgum (matt.burgum@cml.org.uk).