by Paul Scott, Director of Consulting at Huntswood

Two regulators, both alike in dignity, in fair London where we lay our scene: from ancient grudge of mis-selling scandals, where retail firms cause retail customers detriment. Shakespeare’s works and retail banking compliance may not often share the same stage, but with the writer’s death and birthday passing, perhaps the financial services could learn from his warnings. Here, we focus on the coming Financial Conduct Authority (FCA) which intends to concentrate its resources on high risk banks and insurers. In so doing, it will break its bond with a broader list of previously relationship managed, lower risk firms.

What does this mean for the small, medium or – in some cases – relatively large firm who has been privy to the bitter sweet relationship with the regulator until now? Is it time to relax and celebrate freedom? Or is there a chance that this freedom will result in a different kind of risk for customers? Will firms choose the route of proactive management of compliance risk, avoiding bad habits which will lead them straight back to the regulator’s arms? Or are the paths of regulated firms and the regulator simply star cross’d, destined to end in tragedy?

It’s not you it’s me

Given the failings of the past, the regulator has promised “a new approach to conduct regulation” with new staff and objectives leading the way. Through the regulator’s reorganisation, if you are no longer relationship managed it is because the FSA deems your firm lower risk; its priority is higher risk firms and its scarce resources are best used in a different way.

In the short term, lower risk firms will no longer have a specific point of contact at the regulator; instead engagement is more likely to follow through thematic and sector reviews. Essentially, you will be left to your own devices, which means that your interpretation of regulatory obligations will require closer scrutiny and more independent validation by trusted and informed experts. In essence, you will self-regulate according to the information you can source.

 “Show me”

If your firm is within scope of the thematic reviews, confident provision of information that you use to run your business should be made available. This is the expectation in the regulator’s “show me” stance; proactive compliance is the name of the game.

Your firm has the opportunity to react in one of two ways: a) relax now and panic when the thematic reviews come along or b) slowly build good management information (MI), documentation and compliance risk management into all product areas now, enabling you to “show” the regulator as and when required. The latter will put you in good stead for a healthy, if arm’s length, relationship with the regulator post break up.

The greater your ability to demonstrate compliance and good customer outcomes, the more regulatory trust you will gain. When questions are asked, your CF10 should be able to confidently answer: “here is our MI, these are the risks and this is our risk mitigation plan. We understand our products, we have responsibly brought them to the market, we can demonstrate real senior management engagement and oversight. We have an effective and sustainable business model and our MI is robust, demonstrating positive customer outcomes.” This good news story may well promote an even more arm’s length relationship as the regulator seeks to devote resources to perceived risks in other firms.

Of course, the other reason the regulator might get in contact is if you use your new found freedom to let standards slide. Crystallised case work will let your firm feel the wrath of the new regulator through intense focus on the reasons you have treated your customers unfairly. Expect intrusive inspections, increased use of section 166 – reports by skilled persons with their unpredictable costs – and product intervention if things are going very wrong. Via MiFID II, the regulator will use its power to ban your products which puts a great deal of research and marketing time at risk of negation.

Tough love

Not only is the regulator going to give you space and require you to hold your own; firms can expect, if they have not already experienced, a hands off approach which is to become wide spread. When asked by a firm to advise how to handle a recent issue, one FSA staff member responded by saying “you get on with it and I’ll tell you afterwards if I don’t like it”. The regulator is not responsible for firms treating customers unfairly, for customer detriment or mis-selling; this can only be down to the firm itself, its senior management and its governance and culture.

In this new world, the regulator is leaving your firm to take responsibility for interpretation of regulation and the action required to implement or remedy faults. Of course, the regulator will do its part by being open and transparent in engagement with the industry, but the firm must use its resources to bring itself up to scratch. As Clive Adamson, Director of Supervision, Conduct Business Unit, has stated, there is a “greater expectation that firms demonstrate they have resolved issues promptly (not FCA devoting resources to monitoring this)”. It is up to you how to go about your business.

Don’t look back

Many firms complain that the regulator does not understand them. Their business is different. The regulator will never comprehend the commercial context in which they function. For those lower risk firms with such feelings, this is an opportunity to lead a self-regulated, trouble free life without the threat of enforcement. As long as firms understand their regulatory obligations towards their customers and seek independent validation of these, they can use this opportunity to quietly shine, getting on with the job in hand.

The increase in horizontal sweeps of the market through thematic reviews will pick up those who would rather make a quick buck from their customers, with problematic business models relying on customer apathy. Poor conduct in retail business will simply mean that they and their senior management will end up back in the arms of the regulator, their mortal enemy. And we know how that ends in Shakespeare’s play.

Epilogue

Romeo and Juliet is not a perfect love story. They met, were pulled apart and though offered the chance to live free lives they opted for each other and a truly tragic end. The will of Parliament is that regulated firms and their regulators are bound together to ensure the fair treatment of the customer; only to this extent are firms’ and regulator’s paths star cross’d. Lower risk firms have the opportunity to proactively uphold the fair treatment of their customers, away from the intervention of the regulator. They can break free from the poor conduct of business which has helped to leave confidence in financial services at an all time low.

Some shall be pardon’d and some punished: for never was a story of more war, than this of the firm and its regulator.

by Paul Scott, Director of Consulting at Huntswood

The double-digit growth rates demonstrated by well-known fast food chains in recent years are a tell-tale sign of the popularity of convenience eating in the UK. The population appears more than happy to buy mass-produced, low-nutrition, appealingly packaged snacks, whose price is frequently higher than home cooking would be. The benefit to the food-buying public is that it does not have to plan, cook or clean up afterwards, but in the long term, a lack of knowledge about how to self-cater and possible dietary deficiencies could result. No one is forcing the public down this path, yet demand increases.

This is not only happening to the UK’s eating habits. The Financial Services Authority (FSA) concluded in its Retail Conduct Risk Outlook 2012 (RCRO) that retail customers have opted for convenience in their finances, too. The packaged account market has grown markedly in the last five years, with the top four banks taking £10 billion in 2009 alone from such revenue streams, and average premiums edging upwards. Banks’ reliance on packaged accounts has led the FSA to posit the theory that the industry is successfully trying to replace losses from sales of payment protection insurance with money from selling packaged accounts. The challenge for the industry is not to repeat the lessons of the past, and to ensure a healthy market for firms and consumers alike.

New recipe

The proposed rules which are set out in CP11/20 will tighten the sales process and seek to make customers more aware of what they are buying. Customer eligibility is to be checked for each policy in the package and shared with the customer; eligibility statements sent to the customer annually; and for advised sales the suitability of each policy is to be established and the customer alerted to any unsuitable features. The FSA’s cost-benefit analysis stated that the one-off cost to the industry will be £21 million, with ongoing costs of £13.5 million annually to maintain the new systems and training. Put in the context of the revenue these products are already generating, this is a marginal cost. As well as providing better protection for consumers, the new measures may also give firms greater assurance.

Force feeding?

The FSA stated in its consultation that “packaged accounts tend to be sold rather than bought”, and the volumes may also indicate a “push” rather than “pull” relationship. This increases the risk of mis-selling.

In the new regulatory world, the Financial Conduct Authority (FCA) will be more forward-looking in its assessment of potential problems, and will intervene earlier and secure redress for consumers if failures do occur. At the most intensive end of the spectrum, the FCA will look at firms’ business models and strategies to see whether they deliver good outcomes for consumers. Given the focus on business models and the increasing importance of packaged accounts to firms’ overall revenues, firms should expect greater challenge about how their sales of packaged accounts are achieved.

A number of Core Tier 1 banks have indicated that this is very much a risk which is front-of-mind, particularly regarding packaged account sales which are made by unmonitored branch staff, i.e., those not selling by script on the phone or online. Without regular monitoring, staff may cross the line from non-advised to advice in the course of conversation with customers.

The risk that non-advised products may be recommended, or an unsuitable product sold by staff, is an important one for firms but it is not new, nor is it specific to packaged accounts. The onus is on the bank to collect and monitor management information to make sure that sales volumes are not being driven in these ways. The solution across all product types may well be to ensure: that there is appropriate training and competence; that customer experience exercises are run to train staff and to have a robust, independently validated sales process with comprehensive documentation. The regulator’s “show me” attitude will make meaningful management information on this issue invaluable.

Going the whole hog

Firms should ask themselves whether the mistakes of payment protection insurance can be avoided. Banks’ in-house compliance departments should be undertaking comprehensive reviews of the risks around this super-sized revenue stream, and this should include an analysis of the business model and strategy; an assessment of the product design and approval process; testing firms’ governance and the adequacy of their management information; and early-stage testing of the sales process and of post-sales handling. Early identification of issues is positive; assurance that there are no issues, even more so.

Firms are already aware that they must expect more challenge when the regulator comes to visit, given the FCA’s intention to probe and assess firms’ business models. The obligation is on firms to demonstrate that they are aware of, and are managing, risks both to themselves and to their customers, and that the revenues which accrue as a result are built on healthy demand from an informed customer base.

It will be essential for firms to able to show the regulator that they have carried out proactive due diligence, and to be able to provide clear evidence of quality product design, governance and sales. This will need to be backed up by a deep understanding of independently-validated management information on complaints, customer experience monitoring and remuneration or reward systems which do not drive unfair customer outcomes. All this will put firms in good stead to avoid packaged accounts becoming the next payment protection insurance.

Proof is in the pudding

In the future, both firms and the FSA will need to gather more information to establish just what it is that drives the packaged accounts industry. Unlike fast food, it will probably not turn out to be an addiction to poorly suited insurance products. The findings of the FSA’s spring 2012 information-gathering exercise are to be welcomed, but in the meantime firms need to be confident in their product offerings and about the routes they use to market. Blind confidence is no good; confidence backed by evidence and detailed testing will ensure that firms do not have to reconsider their dish of the day.

How many emails, texts and phone calls have you received today from Claims Management Companies promising you compensation for dodgy loan insurance cover?  This aggravating blight on our daily lives is reaching a crescendo as claims firms try to cash in on the billions of pounds the banks have already set aside for the missale of Payment Protection Insurance.

The banks and the Financial Ombudsman Service are also being snowed under with complaints harvested from Daytime TV advertising and automated phone calls.  Eighty per cent of PPI claims to the FOS now come from CMCs, whilst the banks tell of spreadsheets with hundreds of names on them, none of whom have ever had PPI.  At least some of the cost of checking out these bogus claims is of course falling on the rest of us as bank customers.

But despite being reviled by the banks, consumer groups and the frustrated recipients of unwanted phone calls, they are not entirely unloved. Most of their clients think they do a good job. When I was chair of the Financial Services Consumer Panel we commissioned the only research done so far on why so many members of the public used claims firms when the Financial Ombudsman had apparently made the complaints process so easy.  Sixty eight per cent of those who had used a CMC, whether successful or not, said they would recommend them to a friend. Consumers made comments such as “Some money is better than no money” and “I’ve no time, they sort it out for you”.

It’s easy to underestimate the capabilities of some complainants.  The FOS says its paperwork is simple but it’s thought about seven million people in the UK are functionally illiterate, meaning they have trouble finding a plumber in Yellow Pages, so even the streamlined FOS documentation, a three page factsheet and a seven page complaint form, can look daunting.

The CMC’s are also spending a huge amount on advertising, reaching people who wouldn’t otherwise know where to start. They can also empathise with the client and reassure them that they have a legitimate grievance, which the FOS can’t do because it must be impartial. Little wonder then that so many people are prepared to part with 25 per cent or more of their compensation for a helping hand.

We must face up to the fact that many people do want this service and it is here to stay, with some CMCs already looking at other issues like the missale of mortgages.  The problem is in the regulation of the companies. The Ministry of Justice has responsibility for them at present but it has been slow to deal with the dramatic increase in irresponsible behaviour through lack of resources.  Even so last year it struck off 734 firms.

Justice Minister, Lord McNally, meeting fellow peers and consumer groups today, has already conceded there may be “a better home” for the regulation of CMCs than the Ministry of Justice.  The FSA could do it but many CMC’s also manage personal injuries claims, so not the FSA’s bag at all.  The Solicitors Regulation Authority is another possibility but it’s a relatively new organisation finding its feet and will it react any quicker to bad practice?

Whoever regulates the sector must be much more responsive.  At present we are all suffering from the appalling behaviour of the worst firms with aggravating phone calls, wasted time and the increased costs to the banks.

The Financial Services Authority (FSA) launched the Retail Distribution Review (RDR) in June 2006 with the specific aim of identifying and addressing the ‘root causes’ of problems that continue to emerge in the sector.

By now, we are probably all aware that RDR will lead to fundamental change for firms engaged in the retail investment market; all firms should have evaluated their business models and be well underway to making the necessary changes to meet the new RDR requirements.

Ultimately, RDR aims to ensure that customers are offered a transparent and fair charging system for the advice they receive, that they are clear about the service given to them and that they obtain advice from highly respected professionals.

RDR applies not only at an organisational, but also at an individual level; it directly affects all Advisers in the retail investment market, regardless of the type of firm they work for (banks, product providers, independent financial advisers, wealth managers, stockbrokers) – but this is well documented. Most Financial Advisers know what they need to do to achieve diploma status in ‘RDR compliance’ and to be able to continue giving advice post 1 January 2013. If they have not already, many advisers are well on their way to achieving the relevant qualification(s).

But what about the thousands of Contractors who work behind the scenes in the industry, those doing complaint handling, past business reviews, file checking and the like? Historically, most of blue-chip companies in the financial sector have required these people to hold the same qualifications as Financial Advisers, such as the Financial Planning Certificate at level 3. It is a reasonable assumption that, in a post-RDR world, these ‘back-office’ people will also be required to hold level 4 qualifications, in line with Financial Advisers.

However, with the current focus being ensuring that frontline staff – i.e. those actually giving advice – meet the deadline, it seems that little thought has been given to ensure that ‘back office’ workers in the financial services sector are also up-skilled. As an outsourcing company with around 2,000 Contractors deployed on client sites throughout the UK, many of whom are currently FPC3 qualified, Huntswood is committed to driving even higher levels of excellence within its contractor base.

In general, Huntswood is known for its work in assisting clients with their strategy and the subsequent alignment of their operating and control environment to ensure it is fit for purpose in a post-RDR world. We are less well known for our work in learning and development; hence, the People Learning and Development (PLD) department within Huntswood was commissioned to design a programme that would not only inform Contractors of the implications of RDR, but also provide support in helping them gain diploma status.

Initially, the PLD team undertook research with Huntswood’s Contractors to find out their views and to assess their ‘appetite’ for study. They also sought to understand the challenges and constraints Contractors face in studying for and sitting professional exams. The outputs of the research led to the Huntswood PLD team putting together a simple, but effective, strategy:

The first stage was to inform. All Associates on Huntswood’s books received a letter highlighting what RDR could mean to them and their future job prospects. They were given an outline of Huntswood’s high-level plans and invited to offer any comments and suggestions they had beyond the original research.

The second stage was to meet Contractors face-to-face. Huntswood followed up the letters with a series of nationwide, on-site ‘roadshows’ outlining what people need to do to become level 4 qualified and the benefits to them of attaining this status. For some people, this will mean passing all six of the Chartered Insurance Institute’s (CII) ‘RO’ exams; others will only need to sit one of two RO papers in order to attain the requisite number of ‘credits‘ needed to complete the qualification. As and when appropriate, Contractors were referred to the CII for advice, or in the case of members, were encouraged to use the Institute’s online ‘gap fill’ tool.

The third, ongoing stage is to provide study support. For many people, studying for financial exams can be daunting; research shows a 50% increase in pass rates for those who take part in revision or study workshops compared to those who go it alone. The CII run a number of revision workshops, but these are at times and locations not suited to all Contractors.

Huntswood’s experience is that many Contractors work at remote locations and at times of day which are not conducive to attending courses. Even when they can be granted ‘day release’, the nature of their contracts means that they will often lose a day’s pay in order to attend a revision workshop. Huntswood’s solution is to provide cost-effective learning opportunities outside of working hours through a variety of channels and using highly qualified individuals to run the workshops.

Huntswood provides two study options:

1. ‘Face-to-face’ revision workshops run at weekends in locations where Contractors actually live and work. These include an opportunity to revise core aspects of the curriculum of the relevant exam programme, practise exam-type questions and clarify their understanding in group discussions and question and answer sessions. These workshops are run according to demand.
2. Utilising state-of-the-art ‘virtual’ classroom technology, Huntswood provides a guided study and revision programme which can be accessed by anyone with a computer and internet/phone connection. Virtual sessions take place over an eight-week period, and are supported by 1:1 telephone mentoring and an individual study plan.

Both options are competitively priced. The aim is to encourage Contractors to raise their level of expertise which not only increases the amount they can earn, but also makes them much more attractive to companies who would rather have an accredited person handling their products and services as opposed to someone who doesn’t hold any qualifications.

The project was launched in January 2012 and the first workshops begin in April 2012 and run throughout this year and next.

Visit our website if you would like to know more about how to increase your chances of passing RDR RO exams, or contact either Phil or Rachel on the details below.

Phil Festa
Director, People Learning and Development
07909975841
pfesta@huntswood.com

Rachel Jannaway
Consultant, People Learning and Development
07786251024
rjannaway@huntswood.com

For more information visit  the People Learning and Development website

The recently published retail conduct risk outlook from the FSA is the first major publication from the regulator with Martin Wheatley’s signature on it.

Wheatley will head the new regulator, the Financial Conduct Authority, in about a year’s time. As the outlook is the FSA’s view of potential dangers up to 18 months ahead, does it give some clues to his thinking?

My interpretation is the FCA will concentrate far more on the retail sales of the banks as it expects the retail distribution review to sort out most of the worries about IFAs.

Wheatley’s foreword to the document gives little away but the accompanying press release is more forthcoming, in which he says: “Consumers rely on financial firms and their products to provide them with vital services – literally the means to run their lives.”

He recognises that, for most of us, the utility aspect of financial services – bank accounts, credit cards and insurance – is the most important. He goes on to say that consumers worry they “aren’t being sold the right products”, and the risk outlook will help firms “understand how to avoid the bear traps of designing products for maximum profit but little benefit to customers”.

This relates to research in the outlook document that says consumers see the banks as employing pushy sales tactics, regardless of a consumer’s situation, with the priority on the sale rather than service.

At the risk outlook launch, Wheatley is reported as saying that free banking is an “outmoded concept” that “doesn’t really work”. He went on to say that if the banks are providing free services, they are being subsidised elsewhere, in part by cross-selling.

The Independent Commission on Banking, chaired by Sir John Vickers, also identified cross-selling of high-margin products to subsidise wider service provision as a problem for the banks.

The argument then goes that this carries a big risk of misselling if incentives to staff encourage them to concentrate on the sale rather than suitability.

Bonuses and commission have also come under the FSA microscope and the regulator has just finished a year-long thematic study into financial incentives paid to direct salesforces, which decided that action is necessary.

The FCA seems to have concluded that the RDR will address past problems with independent advice and that banking is where it must now focus, targeting complex products that have been missold because of inappropriate incentives.

Wheatley’s preference looks like an end to free banking, with bank accounts realistically priced to make the basic business model sustainable and a clampdown on high bonuses paid to staff to sell riskier products.

This will mean less pressure on bank staff to cross-sell and on customers to buy. For IFAs, this may also go some way to redress the imbalances they see in the RDR.

The proposed power to ban the sale of financial products for 12 months could prove to be a powerful tool for the new Financial Conduct Authority. It is hoped product intervention will allow the regulator to halt misselling of an unsuitable product in its tracks.

The theory is that the use of such a power in the past would, for example, have stopped the sale of payment protection insurance before it got out of control.

But the Treasury has insisted that the new regulator publishes and consults on a set of principles governing the circumstances in which it will use the new banning powers – and surely there will need to be a robust appeal process over what could otherwise look like arbitrary decisions about the “safety” of particular products.

Drawing up these principles will not be easy and several aspects of the regime are proving tricky for the FSA/FCA to crack. Staff there are in the process of identifying indicators of potential consumer detriment which might lead the regulator to impose a ban, like the complexity of a particular product.

One of the more controversial indicators is “excess profit”. If the return a firm gets from a product reaches a very high level, the FSA/FCA view is this could indicate consumer detriment.

The regulators acknowledge it is not possible simply to equate high returns with an unfair product and they have not yet worked out how this measure should be defined. The view of excess profit could have very widespread effects.

The Treasury’s latest guidance on the Financial Services Bill says the FCA will not prescribe prices in the manner of some of the utilities’ regulators and in the past the FSA always proclaimed it is not an economic regulator. The FSA/FCA is trying to maintain this stance while intending to take action over what it sees as unjustifiably high prices. In a Radio 4 Moneybox interview, Hector Sants explained the regulator might say a product should be £10 less but not set the price from the outset.

So when do pricing and profits become “unfair” and deserving of intervention? Just because a company is making a big profit on a product does not necessarily mean it is being unfair to customers. Substantial returns could be fair if customers are getting a cracking deal. What is unfair is if high profits are producing losses to clients through misselling or bad product design.

Much more difficult to judge is where high profits are not producing detriment but are not producing much benefit either. Should this be grounds for intervention? Joe Garner, head of HSBC in the UK, says: “One important element of fairness is that there is a balance between the value that the customer and the bank receive over time.”

This will be a tough one for the regulator, excess profits are emotive but the circumstances in which they can be said to be unfair will be very tricky to unravel when at the moment everyone, from politicians to protesters, are still trying to work out just what fairness means.

This is the final instalment of my four MMR blogs summarising my CML mortgage conference speech. Having covered lending into retirement, the higher standards expected and lenders’ relationship with their intermediaries, this final blog is a personal reflection on the MMR and the challenge it presents to the industry.

I certainly did not receive lessons in financial advice at school, at sixth form or at university. In fact, I don’t recall my first employer sitting me down and talking me through the intricacies of a mortgage and what I should be asking the adviser either; and that first employer for me was the FSA! That said, I worked in the industry so I was more financially aware and able to enter into some meaningful dialogue with my broker. But how many customers know the difference between a tracker and a standard variable, between a cap and a collar, or can tell an offset from a payment holiday?

The internet and the financial press do provide the opportunity for customers to become more financially aware. The Money Advice Service is an excellent example of high quality, free information about mortgages. Despite the availability of this information, the industry must acknowledge that customers are often financially unsophisticated and it takes time to educate them. This is the case particularly with products such as mortgages that may be a one-off, not a repeated annual purchase. This point shouldn’t be underestimated; how can we expect customers to do something complex, out of the norm, and get it right first time? Firms process mortgage transactions every day, customers do it once in a life time. Perhaps this is where the real asymmetry comes from.

The point is that there is an imbalance of knowledge between firms and their customers; the sheer nature of the transactions also creates an inherent risk.  Obtaining a mortgage is not like receiving pension advice, it is often associated with the emotion of getting on the property ladder or buying the family home.  It is undoubtedly the case that customers require and rely on the advice of lenders and intermediaries to ensure they get the best possible advice.

With the customer in mind, I think it is fair to say that the mortgage market is on a journey of increasing standards to protect customers. In 1997 when I joined the industry, mortgages weren’t even regulated. The industry survived the first peak of mortgage regulation in 2004, but the MMR is a much greater challenge. My message to the industry is this: start your preparation for the second mountain of regulation. Each firm wants to get over this mountain and come out in the lead, but to do so your training and preparation must start now.

In this third of four blogs on the MMR I will cover the advice process and, especially, how this will affect lenders’ relationships with their intermediaries.

The crucial point here is that, ultimately,  lenders are responsible even where advice is provided by an intermediary. Where this is the case, if you are a lender, how can you truly make sure that the suitability of advice given by intermediaries is up to the necessary standards?

No longer will an arm’s length relationship with your intermediaries be adequate. What is needed is real assurance through proactive due diligence.

To be able to demonstrate the quality of business through intermediaries you’ll need to consider:

• Ongoing monitoring of your retail intermediaries
• Have a system of risk based scoring for your intermediaries
• Be able to provide independent third party assurance

Mortgage advice, or rather the suitability of mortgage advice, and responsible lending are major challenges. They will bring with them a mountain of regulation to climb.

So, what should the industry be doing?

• Start with the FSA’s examples of good practices for advised mortgage sales
• Ensure your mortgage sales process has been updated and refined to reflect the higher standards expected
• Make sure the training and competency of your staff members selling mortgage products are top quality; your staff must know what the increased expectations are and how to include them in their work ethic
• Make sure you carry out the requisite due diligence to ensure your retail intermediaries are upholding the standards required of them
• For the benefit of your customers and to ensure compliance with the regulations, be pro-active about the risks in your back book

In this series of blogs looking at the FSA’s Mortgage Market Review I’ve set out how the proposed changes are likely to impact firms and, in particular, the changing face of advice, lending into retirement and the role of intermediaries.

The MMR is still only a set of proposals; however, the FSA is already moving in this direction, demanding ever higher standards from client firms. It’s very clear where the regulator is going and that firms need to act now to get the processes in place to convince the FSA they are up to the new standards.

In case you missed the last two articles on mortgage lending, click here to see them on our blog.

Originally published by Thomson Reuters GRC. © Thomson Reuters.

Those with legal backgrounds might remember the story set in Paisley which started with a bottle of pop, a scoop of ice cream and a rogue snail. Poor Miss Donoghue was horrified when she slurped her ginger beer and ice cream float to find that a decomposing “gastropod” had housed itself in the bottle at some point in the bottling process.

These unlikely events were the making of the legal case which caused goods manufacturers to be responsible for the products they sold to customers, even if they had been sold through a café, or some other means of distribution. The manufacturer, Mr Stevenson, to his and the industry’s surprise, was found to owe Miss Donoghue a duty of care, making him ultimately responsible for the rather nasty consequences of her mollusc encounter.

It might seem unlikely, however, for snails to find their way into a mortgage product, and in many respects this is true: mortgage regulation does not have such a quaint reason for handing “ultimate responsibility” to mortgage lenders for the suitability of their products. Nevertheless, the outcome of the Mortgage Market Review (MMR) has effectively been such a shift, even if lenders distribute products through intermediaries. Unlike the 1930s drinks industrialists, however, lenders are not shocked by the direction the regulation has taken; although few are aware how to proceed or how quickly they should begin preparations.

The MMR challenge

Mortgages are closely followed on the regulatory radar and the landscape is changing. At a recent Council of Mortgage Lenders (CML) conference, delegates discussed the changing regulatory landscape for mortgages, and in particular, that the higher suitability standards found in COBS are being replicated in MCOB. The truth of the often-stated cliché, i.e., that mortgages are the single, biggest financial commitment most customers make in their lives, combined with the poor practices of the past, have ensured that mortgages have been pushed higher and higher up the regulatory agenda.

Given the close watch which the regulator has been keeping on the mortgage market, higher standards are to be expected across the board. This change would have been a challenge in itself, but M-Day in 2004 saw mortgages become regulated products for the first time and the market dealt well enough with that. Upfront enhancements will be required in relation to suitability processes and, going forward, a more responsible approach to interest-only mortgages. The biggest shift following the proposed rules, however, is in the relationship between lenders and intermediaries, and this is for two main reasons.

First, the buck does not stop with the mortgage intermediary selling the mortgage to the customer. Lenders have the double challenge of meeting higher standards and, crucially, making sure that their retail intermediaries also meet them. The MMR has specifically stated that, in affordability assessments, lenders have “ultimate responsibility”, not the duty of care established in the Donoghue v Stevenson snail case. Therefore, not only does the lender have higher standards to deal with, but it also has the still more challenging task of policing them further afield. Lenders should consider setting higher thresholds for intermediaries’ entry criteria and undertaking frequent testing and audits.

There is a second and interesting background force which makes the weight on lenders’ shoulders that little bit heavier. As the regulator morphs from the Financial Services Authority (FSA) to the Financial Conduct Authority (FCA), supervision of the major market players will increase, but the smaller firms will have to police themselves more and more. Without the regulator’s constant knock at the door, standards in the small firms and intermediaries may slip faster if lenders do not keep a close eye.

Quality at a price

There is much debate among lenders about the role of, and interaction with, intermediaries in the changing mortgage landscape. Some lenders have argued that the role of the intermediary will be reduced and therefore lenders should pay intermediaries less. It is possible, however, that the converse is true: that the expectations on intermediaries are now much greater and therefore lenders should pay more. Quality always comes at a price.

The new regulation certainly advocates a more robust relationship between lenders and intermediaries, ensuring that intermediaries advising on products meet the higher standards expected and provide positive outcomes for customers while safeguarding lenders’ reputations. Recruitment and training standards for intermediaries should be checked, as should sales processes and, of course, the quality of their sales to date. Reviewing the advice process and the quality of advice regularly is essential to ensure that the higher standards required remain uppermost in the minds of intermediary managers and sales advisers.

Suitability assessments for mortgage sales must test and demonstrate affordability in reasonably foreseeable events. They require interrogation of the information supplied by the customer and a high standard of documentation to back up suitability of sales. Lenders will need to have evidence to support the intermediaries’ quality, and to be able to demonstrate this to the regulator. Intermediaries should be doing this anyway, but it will now be in lenders’ interests to check, check and check again.

Due diligence

There are already examples of major players in the market who have had to implement expensive and complex remediation programmes to provide redress for customers in the mortgage markets. The issues are often compounded by a lack of documentation about sales made by intermediaries. Complaints are consequently difficult to investigate because of the lack of comprehensive records. This trend is likely to continue but, this time, with enforcement on the basis of intermediary activity.

The era of arm’s lengths agreements is clearly over; when lenders choose their intermediaries, they are going to have to get their hands dirty. The market should interpret the new standards as a call for proactive due diligence. Engaging seriously with intermediaries’ practices, training and culture is the way to work out whether they will distribute mortgages to the standards that lenders and the regulator require of them. The window of opportunity is now open for lenders and intermediaries to prepare for this new mindset.

Responsibility for the proverbial snail lies with the lender. If that snail, even through the poor work of distribution channels, reaches the customer, the new rules mean that the regulator will knock on the lender’s door first. If, when the MMR’s new responsibilities come into force, a mortgage product contains a proverbial snail, the lender has the responsibility to ensure that what the customer experiences is the finest escargot, not its decomposing counterpart.

I jumped straight into training whilst still recovering from the jet lag. Queensland is 10 hours ahead of the UK and the jet lag certainly causes some funny things to happen: it felt like my heart and lungs could not cope with the demands of my aggressive training regime. I fought to hold my own, despite struggling, until the end of the week which found me relying heavily on double espressos! The Australian national coach congratulated me on being one of the few Europeans to ever fully complete their first week of training out there and we all went out to celebrate.

Paul training in Australian with Olympic champion, Ken Wallace.

After the first week, the jet lag settled down and I was back in my stride enjoying the training. On the second weekend of my stay I flew to Sydney to compete in the New South Wales State Championships on the Sydney 2000 Olympic lake. I had not raced since the World Championships in August and wanted to blow out a few cobwebs. I was still a bit rusty, but managed to do enough to take a few medals- although the nine races in eight hours almost killed me; normally, at larger international regattas, we only compete once or twice in a day!

The following weekend I travelled to the Sunshine Coast to compete in the Queensland State Championships. I was pleased to take a win in the K1 (single kayak) 1000m, just nudging my nose in front Max Benassi, the Italian national champion.

After the competitions, it was back to the Gold Coast for another training block. Training started at 5.30am every morning and the day usually consisted of two 90 minute paddling sessions, 50-100 chin ups, some abdominal work and a 90 minute gym session. This routine kept me pretty busy and I was falling asleep by 8pm most nights. Sundays were a day off and so I used this time to rest, recover and work on my surfing!

It was a great experience to train out there with some of the best athletes in the world in an environment that is tailored for elite sport. The weather was pretty good too!

About Paul
Paul joined Huntswood a year ago and works as a Client Partner promoting all of Huntswood’s service offerings.

Paul is also an Olympic hopeful and in 2011 he, with Huntswood’s support, broke the world record for crossing the English Channel in a kayak in a time of 2 hours 28 minutes (breaking the previous world record by 31 minutes). He prepared for the crossing whilst also undertaking his training with the Olympic team (he beat the current Olympic kayaking champion in a 1-on-1 to represent GB at the 2012 qualifiers) and is now concentrating on qualifying for the K1 1000m which means that he will hopefully represent Team GB at the 2012 Olympics. Read all of Paul’s articles on the Cross Channel Challenge website.

About Huntswood
Founded in 1996 by David Brownlow and Philip Eaton, Huntswood is a professional services organisation helping businesses to manage regulatory challenges while optimising business performance.

Huntswood offers a range of complementary propositions which focus on customer service delivery, consulting, recruitment and learning and development.

Huntswood’s background and reputation within the financial services sector has led to the natural migration and diversification of services offered. As well as financial services, Huntswood also delivers solutions to the telecommunication, healthcare, travel and utilities sectors, in both the public and private sector, as well as regulators and trade associations.

Dedicated facilities in Reading, London and North Lanarkshire also enable Huntswood to provide high quality, fully integrated off-site solutions to their customers.