Direct line: 0207 066 3100 Local fax: 0207 066 3101 Email: martin.wheatley@fca.org.uk Financial Conduct Authority 25 The North Colonnade Canary Wharf London E14 5HS Andrew Tyrie MP Chairman of the Treasury Committee 7 Millbank House of Commons London SWlP 3JA Tel: +44 (0)20 7066 1000 Fax: +44 (0)20 7066 1099 www.fca.org.uk Our Ref: Your Ref: 20 May 2013 130321! In our phone call of 26 April, and my letter of 30 April, I promised to provide you with a full and detailed response to your letter of 21 March in relation to the recent action taken by Bank of Ireland UK ("the Firm") in respect of a number of its mortgages. We will continue to work closely with the Firm and with consumer groups on this issue, but are now able to provide a full response to your questions. I would like to assure you that the FSA was concerned about this issue from a consumer protection perspective and that the FCA continues to work with the Firm to ensure appropriate consumer outcomes. The facts of the issue are straightforward - the Firm has exercised clauses in a number of its mortgages, which allow them to increase the differential between the base rate and their tracker rate. However, as these mortgages were sold prior to the introduction of statutory mortgage regulation on 31 October 2004, the obligations of the Firm and intermediaries, the ability of the FCA to respond, and the rights of affected customers, are complex. The issue also highlights an important wider debate about the responsibilities of consumers and the responsibilities of lenders and intermediaries. Given these complexities, and given the concern expressed by consumers, Which? and the TSC over this issue, we have set out our comprehensive assessment of the situation below. This letter covers the following: 1) the Firm's obligations and FSA/ FCA response; 2) obligations on intermediaries and FSA/ FCA response; 3) FCA requirements were such mortgages to be sold today; 4) a possible FCA approach to such mortgages in the future; and 5) a detailed response to your outstanding questions. Registered as a Limited Company in England and Wales No. 1920623. Registered office as above.
(1) The Firm's obligations and FSA/FCA response 1 The FSA became responsible for mortgage regulation on 31 October 2004 and FCA rules and principles do not apply to mortgages sold prior to this date. As the Firm's action relates solely to mortgages sold prior to 31 October 2004, FCA rules and principles cannot be applied to these sales. 2 Any attempt to do so would raise questions of retrospective regulation. This raises the question as to what obligations apply to the Firm, the FCA's role in relation to these obligations, and what options are available for consumers. The Firm's obligations can be split as follows: (i) the Unfair Terms in Consumer Contracts Regulations ("UTCCRs"); (ii) the Threshold Condition of suitability; (iii) the general law; and (iv) complaint handling. (i) The UTCCRs The UTCCRs came into force from 1 July 1995, apply to mortgage contracts, and are designed to protect consumers from unfair terms. 3 These are, broadly, terms that create a significant imbalance in the parties' rights and obligations to the detriment of the consumer. The FCA has powers in relation to unfair contract terms under the UTCCRs and we considered the application of the UTCCRs to the differential variation terms relied upon by the Firm. As we explained in our letter to you of 12 March, and as we have subsequently explained to Which? in our meeting of 12 April, we did not identify concerns with the relevant terms which led us to believe that they might be unfair under the UTCCRs. The application of the UTCCRs can be complex and we are required to consider the entirety of the contract and the surrounding circumstances at the time the contract was entered into. However, at a very high level, for clauses of this type we focus on three factors: the provision of notice to the customer, whether the customer can exit without paying any costs or charges for early repayment, and whether the term sets out the reasons for which a variation may be made. In this case the term requires notice to be given and contains a list of reasons for which the variation may be made. We also note that in certain circumstances early repayment charges are waived. However, only a court may ultimately determine whether a term is unfair under the UTCCRs. (ii) Threshold Condition of suitability 4 The Firm's conduct in respect of non-regulated activities, including in respect of mortgages sold prior to 31 October 2004, is potentially relevant to its ability to satisfy the Threshold Condition of suitability. Had the FSA determined that the Firm's conduct was so egregious that it no longer satisfied the Threshold Condition of suitability, the FSA had the power to vary or withdraw the Firm's permission. 1 This section contains confidential information for the purposes of s348 of FSMA. However, the Firm have consented to us disclosing this information. 2 Our rules over complaints handling may, however, apply for these mortgages. See section 3. 3 Although the current UTCCRs came into force on 1 October 1999, they were preceded by very similar regulations that came into force on 1 July 1995. 4 The threshold conditions are the minimum conditions against which an applicant for permission to be an authorised person must be measured. The conditions must also be met on an on-going basis by authorised persons and failure to meet one of the conditions is sufficient grounds for FCA to vary an authorised person's permission or withdraw an authorised person's authorisation altogether. The threshold conditions cover fundamental matters such as adequacy of resources and suitability to be an authorised person.
The mortgage contracts do contain clauses which permit the Firm to increase the differential and, as stated above, we did not believe these differential variation terms were unfair under the UTCCRs. The Firm has assured us that they will only proceed with the increase where it is clear in both the offer document and the contract that they were entitled to do so. The Firm provided customers with advance notice and has allowed affected borrowers to switch to another lender without paying early repayment charges. The Firm has also taken the following actions: prior to the announcement, the Firm manually reviewed contractual documentation and removed approximately 2,000 customers from the affected pool because the Firm could not be 100% confident that their contracts contained the necessary terms and conditions. the Firm has subsequently excluded a further group of customers, approximately 200, from the affected pool following an issue identified from customer complaints. In these cases the Firm could not be certain that the customers had been provided with the mortgage conditions applying at the time they switched to the Tracker product, which contained the valid reasons for the variation, and decided it would therefore not be appropriate to apply the margin increase. the Firm has also agreed that if any evidence comes to light to demonstrate that they had sent communications to a customer that led them to believe that when they bought the product the differential would remain constant for the mortgage term, they would also be taken out of scope. we understand the Firm is due to issue a press statement on 21 May, which will communicate their decision to remove approximately 1,000 further customers from the affected pool as a result of communications it sent to customers after the point of sale (discussed in more detail in section (iv) below). Given this, we do not believe that the Firm's action called into question its ability to continue to meet the Threshold Conditions. {iii)the General Law 5 A range of both high level and detailed rules will apply to the sale of regulated products, made pursuant to the FCA's statutory objective of consumer protection. As the mortgages in question were sold prior to 31 October 2004, they are not regulated, there were no such rules in place and so customers can fall back on the general law. For example, customers could take action in court against the Firm for breach of contract. Successful action could enable customers to recover any loss which they suffered as result of such a breach. We reviewed the relevant contract terms against the Firm's proposals but did not identify any likely breach of contract. Customers who believe they were misled (for example, because of statements in marketing material that they were given) could take action against the Firm, for example, for misrepresentation. However, customers would need to show that they had suffered a loss and that such loss was caused by the misrepresentation. For example, a customer might argue 5 By the "general law" we mean the legislation and case law other than the UTCCRs and FSMA. The principal obligations are under the law of contract and in tort. The FCA is not directly responsible for supervising the Firm's compliance with these obligations. But in view of our responsibility for supervising complaint handling, as explained below, we did review these matters in February 2013.
that if the misrepresentation had not been made they would have taken out a different mortgage under which they would have paid a lower amount of interest. If customers do believe that they were misled, they should complain to the Firm in the first instance. As stated above, the Firm has agreed to only include customers for whom the relevant clauses were included in their mortgage contracts and their mortgage offer documentation. Given this, it may be difficult for large numbers of customers to claim for misrepresentation, although a court would assess this on a case by case basis and much would depend on the sales process followed in the case in question. Given our determination in respect of the UTCCRs, the Threshold Condition on suitability and the general law, and the Firm's assurance that the increase would only apply where the clause was contained in both the mortgage contract and the offer document, we did not object to the Firm's action. We concluded that customers who felt they had cause for complaint should respond by making a complaint against either the Firm or the intermediary that sold the mortgage and, if appropriate, refer the complaint to the FOS. (iv) Complaint Handling All affected customers have the right to complain to the Firm and generally speaking, customers will have the right to refer complaints to the FOS. 6 For mortgages entered into after FSMA came into force (1 November 2001) 7, the Firm is required to deal with such complaints in accordance with the FCA's rules on complaint handling, which include an obligation to assess complaints fairly, consistently and promptly. The FCA supervises the Firm's compliance with these rules and we are discussing with the Firm how they handle complaints. We ensured that the Firm's letter to customers announcing the increase notified them of their right to complain. We also took comfort from the Firm's response to the flexible mortgage issue: The Firm received complaints from approximately 30 flex borrowers relating to a letter issued after each flex transaction - for example an overpayment or drawdown. This letter gave a summary of the interest rate applying and payment and said "from the date of this letter until the end of the mortgage term, the interest rate we will charge will be 1.40% above the BoE Base Rate". This summary did not refer to the fact that the differential could be changed (thus supporting, In the minds of the complainants, the view that it could not). Customers may have subsequently taken action in the light of that communication which could be to their detriment - e.g. increased their level of drawdown. The Firm has therefore agreed to exclude all impacted customers from the scope, regardless of whether they have complained. As stated in section l(ii) above, this has resulted in 1,000 customers being excluded from the scope. 6 Where a customer is not satisfied with the Firm's response to a complaint, they can refer that complaint to the Financial Ombudsman Service (FOS). The FOS would determine such a complaint by reference to what is, in the Ombudsman's opinion, fair and reasonable in all the circumstances taking into account, amongst other factors, relevant law and regulations (which would include the UTCCRs and breaches of the general law as discussed above). 7 For mortgages sold prior to 1 November 2001, the position is more complex. On the basis of the Firm's membership of the former Banking Ombudsman scheme, such complaints will generally be subject to our rules on the handling of complaints (as discussed above) which the FCA supervises. In addition, borrowers may be able to refer their complaints to the FOS. However, in determining such complaints the FOS must take into account what determination might have been expected to be made under the Banking Ombudsman scheme.
(2) Obligations on intermediaries and the FSA/ FCA response We understand that many of the affected mortgage contracts were sold by intermediaries. However, as the sales were made prior to 31 October 2004, they would not have been subject to FCA principles or rules in respect of intermediaries. This raises the question as to what obligations apply to intermediaries: The UTCCRs do not apply as they only relate to the terms of the contracts, not sales practices. Intermediaries would be subject to the general law as discussed above so customers could, for example, take legal action against the intermediary if they believe they had received negligent advice. Where an intermediary is now an authorised person they would also be subject to the Threshold Condition of suitability, as discussed above. We have no evidence to suggest that any intermediaries acted inappropriately in selling these mortgages, so the question of the Threshold Condition of suitability does not apply at present. If we received any such evidence, for example as a result of complaints upheld by the FOS, we would consider any action against intermediaries on a case by case basis. Where customers believe that they were mis-sold a mortgage contract by an intermediary (for example, if they were led to believe that the differential could not be increased for the life of the mortgage), they can make a complaint to the intermediary who sold them the mortgage. 8 In addition, customers may be able to refer their complaints to the FOS. 9 (3) FCA requirements were such mortgages to be sold today Although the mortgages in question are not subject to FCA rules and principles (other than for complaints), it is worth reflecting on the protections that consumers would have received had the mortgages been sold after 31 October 2004. 10 Many of the affected mortgages are buy-to-let mortgages, which would not have been subject to FSA regulation even if sold after 31 October 2004, and which remain unregulated products. However, for regulated mortgage sales, our rules and principles include requirements regarding communication with customers, prescribed disclosure of key product risks and features, and the quality of advice (for advised sales). We have no specific rules that relate to clauses in mortgage contracts which allow lenders to vary the differential between base rate and their tracker rate. However, we require all communications, including the prescribed disclosure, to be clear, fair and not misleading. Similarly, mortgage advice should consider the customer's preference or need for stability in the level of repayments, for example whether to have a fixed or tracker rate mortgage. 8 As these intermediaries were not regulated under FSMA at the time the sales took place, the treatment of complaints against them is complex. However, where the intermediary was at the time a member of the Mortgage Code Arbitration Scheme (we understand that the majority of them were) and is now an authorised person, such complaints will generally be subject to our rules on the handling of complaints (as discussed above) which the FCA supervises. 9 However, such complaints would need to relate to a breach of the Mortgage Code (which applied at the time) and In determining such complaints the FOS must take into account what determination might have been expected to be made under the Mortgage Code Arbitration Scheme. 10 Many of the affected mortgages are buy-to-let mortgages, which would not have been subject to FSA regulation even if sold from 31 October 2004. Two of the five case studies described by Which? in their letter of 28 March are buy-to-let mortgages.
Had FCA rules and principles not been followed, by either the mortgage lender or by intermediaries, we could have taken action in respect of such non-compliance. For example, we may have asked firms to undertake a customer contact and redress exercise, we may have sought an injunction or varied a firm's permission to require them to remedy the noncompliance, or we could have imposed a financial penalty or issued a public censure. Where concerned about their treatment, including if they thought that FSA rules and principles had not been followed, customers could have complained to the firm and, if necessary, the FOS. The FOS would review individual cases and award redress as appropriate. (4) FCA approach It is also worth reflecting on how the FCA will approach issues such as these in future. As we stated in our October 2012 'Journey to the FCA' document, one lesson learnt from previous market failures (e.g. PPI) is that it can be much more effective to intervene early, to pre-empt and prevent widespread harm to consumers from happening in the first place, rather than clear up after the event. For example, our new style of supervision means we will intervene earlier in a product's lifespan and seek to address root causes of problems for consumers. If necessary, we will intervene directly by making product intervention rules to prevent harm to consumers - for example, by restricting the use of specified product features or the promotion of particular product types to some or all consumers. This approach has been endorsed by the Financial Services Act (2012), which gives us a clear mandate to make rules to ban products that pose unacceptable risks to consumers. The Financial Services Act has also given us new powers to ban financial promotions where we consider that a promotion contravenes, or is likely to contravene, our rules on financial promotions. We have not debated the hypothetical question of whether, under the new approach, we would seek to prevent products from being marketed as 'tracker mortgages' if they contained clauses whereby the differential could be increased. We would consider any such products on a case by case basis. However, our general approach, across all markets, is that products aimed at the mass-market should be simple and easy for consumers to understand. I would welcome a wider debate on what lessons could be drawn from this issue in respect of the future FCA approach. (5) Outstanding Questions Was the FSA/ FCA concerned at the action of the Bank ofireland? As stated above, the FSA was concerned by the Firm's proposed action and worked closely with the senior management of the Firm to ensure appropriate customer outcomes. The FCA has continued to engage with the Firm and has met with the FOS and with Which?. What assessment have you made of the impact of the Bank ofireland's decision on the rest of the industry? We are not currently aware of any other mortgage contracts which contain a clause which allows the lender to increase the differential between the base rate and a tracker rate, and do not believe the Firm's decision will have a material impact on the rest of the industry. We review changes or increases to SVRs and other mortgage rates on a case by case basis. How would the FCA act in the event of lenders taking this sort of action in future? See section 4 above
What priority did the conduct arm of the FSA give to this decision by the Bank of Ireland? Was the FSA~ response affected at all by the restructuring in preparation for the formal beginning of the FCA and PRA in April? The conduct arm of the FSA was concerned by any action that had the potential to cause consumer detriment, and responded to this issue as part of its ongoing supervisory work. The FSA involved experts from its supervision, financial promotions, unfair contract terms and legal divisions when considering this issue. The FSA operated under an internal twin peaks model from April 2012 and continued to deliver against its statutory objectives throughout this period. I do not believe that the FSA's response to this issue was affected by preparations for the legal cutover date of 1 April 2013. Did your discussions with the Bank ofireland lead the bank to change its plans? We can confirm that the Firm was fully engaged with the FSA, remains fully engaged with the FCA, and took on board challenges and suggestions made by the FSA and FCA. Did you assure yourself that Bank ofireland customers affected would have had the clauses which were the basis for the recent interest rate increases pointed out to them when they took out their mortgage? These mortgages were sold at least nine years ago, a large number by intermediaries that were unregulated at the time. Our ability to seek this information or take action is therefore very limited. As discussed above, customers concerned have the right to complain to the Firm, to the intermediary that sold the product and, in most cases, to the FOS. You have said that you cannot give an industry wide view of whether such clauses are in other lenders' mortgage agreements. This is because you review changes on a case by case basis. Which other lenders come to you with plans to activate such clauses, and have you taken any steps actively to find out whether other lenders may have the opportunity to act in this way? We are not currently aware that clauses allowing lenders to increase the differential between the base rate and tracker rate feature in any other lender's contracts. Although, the Firm's action has been in the public domain since early March, no other lenders have approached the FSA/ FCA to discuss clauses relating to tracker differential changes. We have not therefore asked other lenders to confirm whether their contracts contain specific clauses of this nature. Will the FCA allow lenders to include such clauses in future? Ifso, do you intend to ensure that, in future, such clauses are specifically explained to customers? See sections 3 and 4 above. What discussions have you had with the prudential regulation arm of the FSA about the Bank ofireland decision? In particular, have prudential requirements overridden conduct considerations in this case? Has the PRA offered a view as to whether it would have prudential concerns if the FOS were to take the view that the Bank ofireland decision was unfair? Is this an example of the sort ofsituation where a PRA veto over the FCA could be exercised in future? The FSA's Conduct Business Unit ("CBU") took the lead role in responding to the conduct implications of the Firm's decision prior to legal cutover, and the FCA has continued to lead on this post cutover. The FSA's CBU and the FCA kept their prudential colleagues informed of developments throughout. Prudential considerations did not override conduct considerations in
any aspect of our decision making process. The question of how this impacts the Firm's prudential position is a question for the PRA but, generally speaking, this would be confidential supervisory information as defined by s348 of FSMA and we believe the disclosure of this kind of information would compromise the ability of the PRA and FCA to supervise effectively in future. The question as to whether the PRA would use the veto in this sort of situation is also a question for the PRA. I hope you find this response helpful. I would be happy to discuss further, either in person or through a phone call, either this specific issue or the more general debate between the balance between customer, lender and intermediary responsibility. Martin Wheatley Chief Executive '