Executive Summary

1. On 7 July 2014, the FCA published its DP, which sets out the regulatory framework and how the FCA applies its Principles for Business in practice when considering the fairness of a change (eg to interest rates, lending criteria, withdrawal of a product or feature etc) to a lender’s regulated mortgage contract (RMC) .http://www.fca.org.uk/static/documents/discussion-papers/dp14-02.pdf. This paper contains the BSA’s views in response to the DP The BSA represents all 44 UK building societies 1.

2. Our key comments are as follows –

• We endorse the FCA’s statement that it has “no plans for new rules, nor changes to existing ones.” The FCA has enough rules to tackle unfair terms and practices. Therefore, in our view the FCA should pursue option 1 ie no further action in terms of rule changes or new rules.
  
  As well as the 1999 Regulations (currently themselves undergoing significant strengthening through the Consumer Rights Bill), the FCA has its TCF Principles and Outcomes and a detailed regulatory Handbook, relevant areas of which (notably MCOBS) have recently undergone major change and face further upheaval because of impending European regulation. There are also the Consumer Protection from Unfair Trading Regulations and other relevant measures.
  
  The BSA believes that this range of mechanisms provides adequate tools for the regulator – indeed, any further new rules risk adding unnecessary complication, which would not help consumers.
   
• Firms face a vast array of systems-intensive changes in other areas, including senior management and conduct rules. The existence of rules per se does not ensure TCF – this is much more likely to be achieved by clear, simple requirements, that are consistently and proportionately enforced, underpinned by a strong ombudsman scheme. While we recognise the need to review rules and principles from time-to-time, the FSA issued a detailed statement on unfair terms as recently as 2012.
  
  The BSA believes that the FCA should continue with its, already active and effective, supervision remit without introducing yet more changes regarding the regulation of contract provisions.
   
• Regarding the Consumer Rights Bill, there is a strong responsibility on the authorities (ie the Government and the FCA) to guard against complexity in application, overlap and double jeopardy in respect of financial services firms.
  
  We also need clear guidance on how this horizontal legislation impacts on vertical mechanisms, such as lenders’ KFIs (and what replaces them under the forthcoming European Mortgage Directive).
  This is not a matter for the DP but will be important once the Bill becomes law.
   
• For lenders, it is necessary to achieve a practicable compromise between two separate matters (both imperatives, neither ‘nice to haves’); ie –
  • on the one hand, the requirements of the Unfair Terms in Consumer Contracts Regulations 1999, the FCA’s Handbook Rules, and the wider obligation to treat customers fairly, and
     
  • on the other hand, the need for mortgage lenders to be run prudently and not to be unduly exposed to the risks arising from an inability to administer the interest rates on a large section of their book.

We strongly welcome the acknowledgement by the FCA that prudential, as well as consumer, considerations are a key part of the overall picture.

• The FCA acknowledges that consumers need to take “some responsibility for protecting their own interests when buying mortgage products”. The BSA produced a paper on consumer responsibility some time ago.

While we recognise that the degree of responsibility is not always straightforward, the official recognition that consumers owe some responsibility is important. The principle of ‘caveat emptor’ has been modified over the years but it is not dead.
 

Overview – Chapter 1, and The Regulatory Framework - chapter 2

3. These chapters do not include questions. Chapter 2 re-iterates the key provisions that the FCA and lenders work with; namely –
 

• the FCA’s Principles for Business, especially 6 (due regard to customers’ interests and TCF) and 7 (due regard to the information needs of clients and communication of clear, fair and not misleading information to them)
   
• the former FSA’s TCF Outcomes, especially No 3 (firms to provide clear information to customers and keep them appropriately informed before, during and after sale) and No 5 (firms to provide customers with products that perform as they led them to expect, and the associated service to be of an acceptable standard and as customers were led to expect)
   
• relevant MCOB Rules, for mortgages sold on or after 31 October 2004
   
• other relevant FCA Handbook provisions eg relevant DISP Rules, and
   
• the Unfair Terms in Consumer Contracts Regulations 1999

4. The BSA believes that the summary set out in the DP accurately represents the key rules and principles relevant to mortgage contract terms, with which firms must naturally comply.

5. The DP does not consider the 1999 Regulations in any detail because the FSA published guidance as recently as 2012 and the Consumer Rights Bill, currently in Parliament, will make changes to the 1999 Regulations.

6. In the circumstances, we believe that the approach in the DP is appropriate and sensible. However, the Consumer Rights Bill is ‘horizontal legislation’, but financial services are also heavily ‘vertically’ regulated by the FCA Handbook and other provisions.

7. Therefore, longer term, there will be a strong responsibility on the authorities (ie the Government and the FCA) to guard against complexity in application, overlap and double jeopardy in respect of financial services firms.  We also need clear guidance on how this horizontal legislation impacts on vertical mechanisms, such as lenders’ KFIs (and what will replace them under the forthcoming European Mortgage Directive).

8. We particularly agree with certain observations that the FCA makes in these chapters,
including –

• the acknowledgement that “for the mortgage market to be sustainable there are valid reasons why firms build flexibility into their mortgage contracts and why they might seek to use that flexibility.”

Of course, we recognise that firms must do so in a regulatory compliant fashion that treats customers fairly.

• that the FCA “would generally expect that an analysis of fairness under the [1999 Regulations] and Principles 6 and 7 would produce broadly the same result”

Whilst there might be certain exceptional circumstances as discussed later in the DP, it is unlikely that the application of the very broad fairness requirements under the 1999 Regulations would leave much scope for further, related unfair conduct open to regulatory capture.

• the fact that the FCA has “no plans for new rules, nor changes to existing ones”.

The FCA has more than enough rules to tackle unfair terms and practices and this is clearly demonstrated by the DP.

A particularly negative feature of UK consumer protection over the years has sometimes been the introduction of ill thought-out, occasionally overlapping laws and rules that were often the product of media or political pressure, or ‘front-running’ or ‘gold-plating’ of EU law, rather than a proper and objective consideration of the issues.

The knee-jerk reaction to any problem has tended to be ‘we need more laws or rules’. Indeed, legislation is increasingly used to deliver ‘messages’, rather than to address mischiefs directly. This whole approach is helpful neither to businesses nor to consumers.

We hope that the Consumer Rights Bill signals a genuine change of direction, and that a move towards enforcing what is already there, rather than installation of window dressing, is also signaled by the DP.
 

Consumer Experiences of the Mortgage Market – chapter 3

9. The diagram on page 17 of the DP (and broadly replicated on page 23) illustrates the FCA’s broad approach in assessing the fairness of a change to a RMC. It is interesting to note that considerations relating to the 1999 Regulations apply only to steps 1 and 2, which are followed by 5 others (relating to MCOB, TCF, FCA Principles etc). As already noted, the BSA’s view
is that overall the DP presents a fair picture of relevant requirements, but there is a responsibility on the regulator to ensure that its own rules and principles are applied consistently with the law (in this context, mainly with the 1999 Regulations).

10. The chapter goes on to ask consumers a number of questions relating to experiences and views regarding changes to mortgage terms, SVRs, fixed-rate mortgage contracts, removal of contract features, and change of mortgage providers. Although aimed at consumers, we provide some brief comments on some of the questions in order to provide fuller context.
 

Question 1: Your experiences

Has your mortgage contract been changed at any time?

What change was made?

Did you think the change was fair or unfair? Please explain why. Think about
how the firm has treated you, how they communicated the change to you, and
if you think they considered your needs or situation.

11. We think it absolutely right for the FCA to seek views from actual consumers and not simply from consumer bodies (in the same way that comments from individual firms sometimes add a different dimension that complements the feedback given by trade bodies).

12. Of course, in the context of the regulation of mortgage terms and related practice, the reference to a consumer itself raises the question: which consumer? Is this a particular, identified consumer; a ‘typical’ or ‘average’ consumer; or an ‘average bystander ‘(what used to be called ‘the man on the Clapham omnibus’)?

13. The issues paper published by the Law Commission in 2012 (Unfair Terms in Consumer Contracts: a new approach) concluded that where the court assessed a term for fairness in relation to a particular consumer - that is to say, where that consumer was alleging unfairness - it had to take into account all the circumstances attending the conclusion of the contract. This would include the individual circumstances of that consumer.

14. But, in relation to general challenges by a regulator (ie the context of the DP) it should consider the typical consumer. This seems to reflect the approach taken, for example, by the courts in OFT v Foxtons Limited [2009] EWHC 1681 (Ch), and in Abbey National plc v Office of Fair Trading [2009] EWCA Civ 116 -

"not only that the typical customer is reasonably well-informed and reasonably observant and circumspect, but also that he or she is taken to read the relevant documents and to seek to understand the contractual terms from that reading" (para 117). 
 

Question 2: Change to a standard variable rate (SVR)

Imagine you have a mortgage contract where the interest rate is the lender’s standard variable rate (SVR).This is a rate set by the lender which can be increased or decreased. The lender should set out the reasons why the interest rate may be changed in the mortgage contract.

What do you think are fair reasons for a lender to increase the SVR?

Is there anything that the lender could do to make sure the increase is fair? For example, does the lender give you notice of the change; do they clearly set out their intention to increase the SVR; do they set out your options if you do not like the change?

15. In considering validity (and, ultimately, fairness) it is appropriate to ask how a typical consumer views a variable rate mortgage product. What are his/her legitimate expectations? Clearly, there would be a recognition that the rate was not fixed. We would suggest that the expectation does not extend to the rate moving exactly in line with any external rate, since that would be a tracker mortgage, which is sold as a separate and distinct product.

16. That would indicate acceptance of a degree of discretion being reserved to the lender in setting the exact rate. There may also be acceptance of other matters, such as the need for the lender to factor in its actual cost of raising funds where necessary to maintain the ability to continue to service the loan. It will be interesting to gauge consumers’ actual views on relevant matters.

Question 3: Change to a fixed-rate contract before the end of the fixed term

Imagine you have a mortgage contract with an interest rate that is fixed for five years.

Would you expect the interest rate to be changed before the end of the five-year period? If so, in what circumstances do you think this could be fair?

17. Again, it will be interesting and important to hear actual consumers’ views. We imagine that they would not expect a fixed rate to be changed unless this possibility, and probable reasons, were communicated prior to completion of the mortgage and in clear terms. Limitations in regulatory KFIs could be an issue here (see below).
 

There are further questions, 4-6, on more detailed topics

Applying the Regulatory Framework in Practice – chapter 4

18. The chapter sets out a non-exhaustive list of specific factors that the FCA considers may be relevant. The factors relate to –

• the contract itself
• expectations about the operation of the product
• communications about the product
• impact of the change.

19. In order to give some practical context, the DP sets out certain fictional case studies with question on each. The FCA acknowledges that consumers need to take “some responsibility for protecting their own interests when buying mortgage products”. While we acknowledge that the degree is not always straightforward, the recognition that consumers owe some responsibility is important.

20. The case studies concern changes to -

• a SVR
   
• a fixed rate of interest during the fixed rate term
   
• features of a mortgage; ie (1) ability to rent out the property, and (2) ability to draw down additional mortgage funds
   
• terms and conditions following another lender taking over the existing lender.
   

As well as questions on the individual case studies, which are essentially the same in each case (see panel below), the DP seeks views more broadly on the factors it views as relevant to fairness of changes to RMCs.

Questions 7-11: Case studies

Do you agree that the factors we have listed are the most relevant in this case study?
 

Do you think any further factors are highly relevant to an assessment of fairness in this case study? Please state these.
 

Do you agree with our view about the likely fairness of the change in this case?
 

How would your view on fairness change with different facts?

Question 12: Do you think these factors are relevant when assessing whether a change to a regulated mortgage contract is fair?

Question 13: Are there any other factors that you consider may be relevant in this context? Please explain and be as specific as you can.

Question 14: What factors do you consider to be the most important? Please explain why and be as specific as you can.

Question 15: Can you think of examples where you believe that the current regulatory framework has not been sufficient to address potential unfairness?  Please explain why you think this is the case.

21. We agree that all of the general factors listed on pages 24 – 25 of the DP could be relevant in a given case, but it would naturally depend on the particular circumstances. The 1999 Regulations, being specifically designed to address fairness of contract terms, must be key and other provisions (eg FCA Principles) should not be applied inconsistently with those Regulations.

22. Not unreasonably given that the DP is published by the FCA, most of the factors referred to relate to consumer interests. While we support this focus, it is imperative that the prudential aspect is not lost.

23. For lenders, it is necessary to achieve a practicable compromise between two separate matters (both are imperatives, neither is a ‘nice to have’) –

• on the one hand, the requirements of the Unfair Terms in Consumer Contracts Regulations 1999, the FCA’s Handbook Rules, and the wider obligation to treat customers fairly, and
   
• on the other hand, the need for mortgage lenders to be run prudently and not to be unduly exposed to the risks arising from an inability to administer the interest rates on a large section of their book.
   

24. Prior to publication of the DP, the FCA stated that –

“the aim of the DP is to open up a discussion about the fairness of changes to mortgage contracts by considering whether the current regulatory framework:

• ensures fairness for consumers by considering (i) fairness under the framework and (ii) whether the framework is sufficient to ensure fair outcomes, 
   
• provides an appropriate degree of certainty to lenders (including to enable them to compete effectively) and
  borrowers, and 
   
• allows the market to operate in a way that is sustainable for all participants.”
   

The BSA agrees with these points and believes that the prudential dimension is integral to the third. It should not be forgotten because it is a crucial part of the bigger picture.

25. We broadly agree with the conclusions in the case studies, but remind the FCA (regarding the case study on a change of terms and conditions following a takeover) that firms are often constrained by merger law and this could be an important factor regarding takeovers, mergers etc.
 

Options – chapter 5
 

26. This chapter speculates on potential regulatory options, which are not necessarily mutually exclusive, ie –

• no further action 
   
• no changes to regulation, but provision of further FCA guidance 
   
• guidance on MCOB or other Handbook provisions – but the FCA acknowledges the significant changes made under the MMR and the advantages of allowing them to ‘bed down’
   
• new rules.

  Questions 16-17: Options

  If this is your preferred option, please explain what you would welcome further guidance on. 

  Question 18:

  Which, if any, of these options would you favour and why?

  Are there any other options that you think we should consider?

  Please state them and explain why.

27. In the BSA’s view, the FCA has more than enough rules to tackle unfair terms and practices. As well as the 1999 Regulations (currently themselves undergoing significant strengthening through the Consumer Rights Bill), the FCA has its TCF Principles and Outcomes and a detailed regulatory Handbook, relevant areas of which - notably MCOBS - have recently undergone major change. There are also the Consumer Protection from Unfair Trading Regulations and other relevant measures.

28. It is very difficult indeed to see what more a regulator could require in order to regulate contract terms effectively. However, we can see no objection to the inclusion of some of the DP’s helpful ‘light touch’ guidance, such as the useful flow charts, being replicated in the feedback statement.

29. The introduction of additional regulatory rules, as well as being entirely superfluous, would risk cutting across the Government’s simplification policy exemplified, for example, by the consolidating nature of the Consumer Rights Bill.

30. We have already noted that, as is indeed illustrated in the DP, the regulator has numerous tools (ie rules, principles and enforcement mechanisms) with which to tackle unfair terms in mortgage and other contracts. These tools are not theoretical – they are regularly applied in practice.

31. For example, the FCA, and before it, the FSA, has been diligent in requiring undertakings from firms where the regulator took the view that terms were unfair. More than 50 such undertakings are listed on the FCA website in the unfair terms library, including 10 specifically relating to mortgage contracts. The FCA also has powers in relation to injunctions,
redress, enforcement etc, which it uses from time-to-time.

32. Furthermore, the Financial Ombudsman Service can, and does, consider the 1999 Regulations and other material regulations, rules and principles where appropriate to do so in respect of relevant complaints.

33. The one slight qualification we have is only indirectly relevant to the DP but we have already mentioned it (see above) – ie guidance, either from the Government, the FCA or jointly, will be needed once the Consumer Rights Bill
becomes law, in order to ensure consistency between the respective ‘horizontal’ and ‘vertical’ provisions.
 

34. In the DP, the FCA states that -

“Based on our experience to date in applying the regulatory framework to regulated mortgage contracts, it is our view that the Principles in particular have provided us with the flexibility we need to appropriately consider the fairness of a change to a regulated mortgage contract. In our view, the current regulatory framework has been sufficient to provide
us with the necessary tools to address actual and potential unfairness.”

For all the reasons stated in this response, we agree with what the FCA says.

35. Therefore, our firm view is that the FCA should pursue option 1; ie no further action in terms of rule changes or new rules.
 

Head of Legal
BSA
23 September 2014
 

1 Building societies have total assets of over £325 billion and, together with their subsidiaries, hold residential mortgages of over £240 billion, 19% of the total outstanding in the UK. They hold nearly £240 billion of retail deposits, accounting for 19% of all such deposits in the UK. Building societies account for about 28% of all cash ISA balances. They employ approximately
39,000 full and part-time staff and operate through approximately 1,600 branches.