The Bluerock Review FSA CP186 MORTGAGE REGULATION: AN OVERVIEW. MORTGAGES: CONDUCT OF BUSINESS SOURCEBOOK (MCOB) - WHAT'S IT ALL ABOUT? INDEPENDENCE The FSA has adopted the same definition of 'independence' as it used when defining 'CP121/166 Reforming Polarisation: Removing the barriers to choice (January 2003)'. This means that a mortgage advisor who wants to be called independent needs to offer products that are representative of the market as a whole (both in terms of different types of mortgage products and the APR). They also need to offer the consumer the opportunity of paying a fee for the service rather than gaining commission from the sale (therefore reducing the temptation on the advisor to select the most profitable mortgage rather than the best mortgage for the customer). ADVISED OR NON-ADVISED SALE Companies have the choice of providing advisory sales or non-advisory sales. Advisory sales are now subject to a set of requirements and rules to ensure any recommended offering is deemed a 'suitable' mortgage. The FSA has stated that a three stage process will be used. While there is no requirement to give suitability letters, firms will need to keep records for three years enabling them to justify why a recommendation was made. Those companies not offering advice will require their staff to walk through a set of carefu l ly scripted questions. Staff training and monitoring will be required to ensure that staff do not deviate from the scripts nor offer any advice during the conversation. Clearly, lenders have to continue to meet responsible lending rules, therefore if the details of a loan change (repayment amounts, income, etc) then the lender will Also in this issue: Account Aggregation: A Market Update From 31st October 2004, the FSA will regulate mortgage sales. In this article we describe the new controls being placed on mortgage providers and intermediaries and the impact on their business. Stage 1 Stage 2 Stage 3 An assessment of whether a mortgage is, in itself, a suitable product for a consumer (including considering whether it is affordable) An assessment of which mortgage (or mortgages) and which provider (or providers) best meet the consumer's need and circumstances (for example, finding the better value mortgage based on pricing elements most important to the consumer) An assessment of what type or types of mortgage are suitable (for example, looking at which types of interest rate, or additional features, are suitable) Exclusions: Buy to let, second homes and some business mortgages (i.e. loans to limited companies) are excluded from these rules. have to re-check all the base information. WHAT IS THE IMPACT? The impact is significant. Research conducted by National Economic Research Associates (www.nera.com) for the FSA1 estimated that the additional cost per mortgage (based on 2002 data) was £26.26 per annum and a one-off cost of £52. Working on an NPV over 15 years they estimate the total cost to the industry will be £752.4m. Their qualitative findings were summarised as: - market exit: surveyed firms expected some intermediaries to exit the market as a result of the FSA's proposals with regard to conduct of business and authorisation. To the extent that this occurs, both competition and variety will suffer. However, firms expected that those intermediaries exiting the market would be those facing the largest incremental compliance costs, which were believed to be 'low quality' intermediaries. In other words, average quality was expected to improve as a result of market exit. However, quality improvements resulting from firm exit raises the risk of some consumers not being served. - advised sales: firms expected non-advised, filtering question sales to displace some advised sales, as the costs of non-advised, filtering questions were expected to be lower than the cost of advised sales under the FSA's regime. Initial Discussion Document (IDD) Key Facts Illustration (KFI) Offer document & updated KFI KFI Initial Contact with Consumer Before Consumer applies At offer stage Change of mortgage term*, Product switch, further advance, addition or removal of a party. - Set format - Describes services the firm offers the consumer - a.k.a. Pre-application Illustration - Sets out in standard form product information - Highlights any changes since first KFI * Key information will be provided - though for change of mortgage term this does not have to be in the prescribed KFI format Several surveyed firms also identified a risk that customers using the filtering questions sales process may mistakenly believe they have received advice. For those organisations that want to continue to operate in this market there are significant challenges: People: all front line staff will need to be trained in the new regulations - whether advisory or nonadvisory. Compliance costs will increase as well as the burden on local branch management to ensure that staff are correctly adhering to the new rules. Processes: a number of new and enhanced processes are required throughout the lifecycle of a mortgage application. Banks operating across multiple channels have some significant integration work to do (for example, the rules regarding IDD are different depending on whether this is a phone conversation or a face to face). Technology: new systems will be required to support the capturing and subsequent storage of the key facts and reasons behind recommendations. Local branch systems (which are often 'locked down') will need to provide this additional capability including the ability to print IDD and KFI in the prescribed format. Companies will need to determine how they quantify responsible lending - through manual process (i.e. place the burden on the front line staff) or automation through bureau or other data sources. Credit risk, fraud and compliance all have a part to play in the development of these solutions. 1The Proposed Regulation of Mortgage sales. A final report for the Financial Services Authority Dated: 19 May 2003. BACKGROUND Dec 2001 Government announced that the FSA would be responsible for regulating mortgage advice as well as mortgage administration. CP146 'The FSA's approach to regulating mortgage sales' was published in August 2002 including draft rules for financial promotions and the calculation of the Annual Percentage Rate (APR). CP186 'Mortgage regulation: draft conduct of business rules and feedback on CP146' - drafted the rules for regulation for consultation with the industry. The final rules were published in the Mortgages: Conduct of Business Sourcebook in October 2003. Companies can apply to be authorised from January 2004 and must be compliant by 31st October 2004. Unlike the success of its protagonists, the principle of account aggregation - to provide customers with a single consolidated statement of their net worth - has never been in doubt. The problems have involved converting the idea into practice. When the technologies first became available some five or so years ago, the potential was evident and a handful of software organisations aggressively took the message to market. In partnership with early adopters these firms rushed to take their implementations live, but these projects were dogged by legal and security issues, which, ultimately, conspired to compromise the value derived from these services. The reality did not live up to the initial hype and the account aggregation business has been dealing with this stigma ever since. The devaluation of the markets and wider economic concerns only served to jeopardise further the prospects for account aggregation service providers. Part of the problem was that the business case for account aggregation was not clear. It is a 'nice-tohave' but account aggregation has not provided an answer to any of an institution's immediate business problems. Subsequently, it has tended to languish at the lower end of their lists of priorities, particularly in a market where banks were pre-occupied with sustaining margins and driving down operating costs. The response from the vendors has been to improve the user experience, in particular customer servicing, for existing clients, while looking beyond retail banking to alternative prospects, principally the intermediaries and fund distributors in the high net ACCOUNT AGGREGATION: A MARKET UPDATE Luke Jeffs , Wealth Services Technology worth private client investment management space. This is a sizeable and potentially lucrative market. To this end, the providers of these software solutions are working hard to make available complementary products to their core aggregation platforms, such as advisor workstations. Today's account aggregation services are interesting as far as they go, but the real benefit comes when the aggregated data can be used to populate systems, which can be deployed to better manage a customer's investments. There are the mercenary benefits, that is, the bank has the opportunity to acquire more of its customers' assets, and there are the advantages in terms of being able to manage the relationship with the client better. Consequently there will be more implementations where the aggregated data is embedded in specialist and advisory applications. In its simplest form, the account aggregation service becomes a data feed, like any other. IFAs will use the software to provide consolidated net worth statements to their customers. The rationale is that often the intermediaries have accounting systems that are reasonably effective at tracking captive assets, but they don't always have a facility to monitor their client's investments with other firms. Whereas most retail banks aggregate little more than current accounts and credit cards, these advisors will be expected to provide a full service comprising all of their customers' financial commitments. "When the technologies first became available the potential was evident .... but these {early} projects were dogged by legal and security issues, which, ultimately, conspired to compromise the value derived from these services." Luke Jeffs no different to one bank cashing a cheque issued by another bank, but the complexities arise around ensuring that the customers have the necessary privileges to take funds out of one bank account and move it to another. Account aggregation services continue to mature and the benefits are slowly trickling down to the users of these solutions. Inevitably it will continue to be a slow progress, but as the markets recover and budgetary constraints are relaxed, the prospects for account aggregation services can only improve. The medium term opportunities are outside of the vendors' established market involving strategic partnerships with application providers to address more accurately the requirements of wealth managers. The difference between retail banking and wealth management aggregation service providers is breadth of coverage. High net worth clients are less interested in current accounts and credit cards than regular retail banking customers. Therefore the retail banks and wealth managers have very different requirements when it comes to the data. In retail banking it is more of a complimentary tool to aid with marketing and cross-selling, whereas for firms managing high net worth clients, the service is focused on the advisor rather than the end customer and making the advisor more effective. Account aggregation can potentially add a lot more value in the wealth management arena than in the retail banking space. In retail banking a relatively small client community provides commoditised, or at best low margin, services to high numbers of end consumers. In high net worth wealth management a larger community of prospective users offer potentially more profitable services, though there are obviously fewer millionaires around than online bank account holders. Currently customers can see their consolidated accounts, but they can't act on that information without reverting to another facility. The ambition is to deliver aggregation services which enable the user, whether a retail customer or an intermediary, to actively manage their portfolio of investments. Currently account aggregation services are little more than reference sites, so the next challenge is to provide clients with the tools to analyse the data and then, the ability to transact and make decisions based on that data. To enable the client to manage investments in this way, the account aggregators have to provide the facility to transfer funds, something which few of them currently provide. There are some services that do this but these are typically very complicated products. At a simplistic level transferring funds from one bank to another is Luke Jeffs is the editor of Wealth Services Technology. The full version of this article appears in the Q1 issue of WST. For further information call 0207 422 6508.