Mortgage Regulation: conduct of business rules and other issues

The conduct of business rules for mortgage firms (MCOB) were published in CP186 in May 2003. CP186 taken together with previous consultations (particularly CP146, CP160, CP174 and CP180) means the final picture for mortgage regulation is becoming much clearer. CP186 should be seen as a clear sign for those intermediaries who have yet to prepare for mortgage regulation to examine their business models and decide which route they wish to take - authorisation, appointed representative status or to leave the market.

The consultation period for CP186 closes on 22 August 2003 so it is not too late for lenders and intermediaries to respond. In fact, if there is a particular part of the conduct of business rules that will affect your business, it is in your interests to raise it yourself with the FSA because the FSA will, to a certain extent, take into account the number of responses they have received on a particular point whether that response came from a trade body or a small firm.

Key issues to come out of CP186 are:

• Mortgages will still be divided into standard and high risk, with lifetime mortgage equity release schemes regarded as high risk. A separate, more stringent, regime in MCOB will apply to lifetime mortgages.
• Sales will be divided into advised and non-advised. A third category of non-advised sales using filtering questions has not been adopted instead the same rules will apply to non-advised execution only and non-advised scripted question sales.
• There will be full grandfathering of the MCCB fitness and competence requirements but the FSA will not now insist on a top up examination for advisors selling standard mortgages – firms themselves will be responsible for ensuring advisors are familiar with the new regime.
• The initial disclosure document will be branded with a "Key Facts" logo so there is uniformity with other products and activities regulated by the FSA.
• The Pre-application Illustration will now be known as the Key Facts Illustration.
• There are specific client money rules which the FSA are likely to adopt.
• The responsible lending requirements will apply to all sales – advised sales and non-advised sales.
• The FSA have indicated the transitional rules that will apply during the changeover period for mortgage sales begun before Mortgage Day. Advertisements will have 3 months after Mortgage Day to comply with the rules in MCOB3.

Below is a list of the more controversial points that have arisen during the consultation process. Some of these points have been raised in CP186 but others have existed for some time.

The scope of regulated mortgage activities

One of the aims of mortgage regulation is to increase consumer protection so it is odd that the scope of regulation was not extended to include 2 mortgages, the selling of which, are just as much in need of protection – buy to let mortgages and second charge mortgages. Apart from the limited application of the financial promotion regime in MCOB3, neither buy to let nor second charge mortgages will be regulated by the FSA. The only regulatory regime that may apply to second charge or buy to let mortgages is the Consumer Credit Act which is a far less intrusive system of regulation.

Another regulatory gap is the other equity release product, the home reversion scheme, which will not be within the FSA regulatory regime. Lifetime mortgages, which will be regulated by the FSA, are often sold with home reversion schemes so it would make sense to regulate both products. In fact there have been many calls for the regulatory distinction between the 2 equity release products to be removed. The Treasury have heeded these calls and will be releasing a consultation paper in the Autumn looking at the regulation of home reversion schemes.

Cold calling – unsolicited real time financial promotions

CP186 confirmed the FSA stance in CP146 of completely banning cold calling - or, as they are known in the Financial Promotions Order, "unsolicited real time financial promotions". The FSA see cold calling as the first step in high pressure selling techniques employed by some intermediaries. Cold calling will only be permitted when "…the customer has an established existing customer relationship with the firm and the relationship is such that the customer envisages receiving unsolicited real time qualifying credit promotions". There is no guidance on when a customer could expect to receive cold calls but it is likely that the firm would have to give the customer an explicit warning that it will be making unsolicited calls. The curtailing of cold calling has caused concern amongst intermediaries in the remortgage market which relies heavily on telephone sales. The industry has attempted to argue that the Telephone Preference Service provides enough protection for consumers against cold calling but FSA have rejected these arguments and it seems that the ban on cold calling will remain.

Disclosure of commission

Disclosure of commission is another matter that the FSA consulted on in CP146 and confirmed in CP186. The FSA see disclosure of inducements as part of a firm’s duty to conduct its business with integrity and to treat customers fairly. The draft rules in MCOB 5.6.107R state that all cash and "material" non-cash inducements paid to an intermediary or any third party must be included in the Key Facts Illustration given to a customer. A wide interpretation of "non-cash inducements" may mean that payments made by a lender to a packager for processing applications may have to be disclosed in the Key Facts Illustration. Without further guidance, it not clear if payment for this type of outsourced activity was intended to be included within the definition of "procuration fee".

Independence in the mortgage market

The principles applied by the FSA in coming to a definition of independence in the mortgage market have been taken from the work the FSA have undertaken on reform of the polarisation restrictions in CP166. Mortgage intermediaries may only describe themselves as independent where they intend to provide a whole of market service and offer the customer the opportunity of paying a fee for this service. A firm that advises from the whole of the market merely has to show that it has considered a sufficiently large number of mortgages generally available from the market and that the consideration reflects adequate knowledge of the market. The guidance issued in MCOB 4.3.5G suggests that whole of the market could be achieved by a firm using a panel which includes "…representative firms from the whole market". This may allow a firm with a small panel of lenders to describe itself as independent whereas a firm with a larger panel but excluding, for example, a non-status lender will have to describe itself as tied or multi-tied.

Suitability letters

Under the existing Mortgage Code firms issue suitability letters whenever they make a personal recommendation to a customer. The FSA have re-stated their position in CP146 that suitability letters for mortgages only serve a limited purpose because they detract from other more important disclosure statements in MCOB. Trade bodies and consumer organisations have argued for the retention of suitability letters but the FSA have said that there is nothing to prevent firms from continuing to issue letters – indeed the letter may go some way to helping firms meet the record keeping requirement that a firm should maintain adequate records of the reason why a recommendation was made. It looks increasingly likely, however, that, unlike other FSA regulated firms making a recommendation for an investment product, the FSA will not require suitability letters for a firm making a recommendation for a mortgage.

If you would like to find out more about how FSA's proposals will affect your business, please contact:

Mayoor Patel

CMS Cameron McKenna

+44 (0)20 7367 2984

[email protected]

Jean Price

CMS Cameron McKenna

+44 (0)20 7367 3353
[email protected]