More Protection for Borrowers

HM Treasury announced on 26 January 2011 that it intends to bring the onward sale of residential mortgage portfolios within the scope of regulation by the Financial Services Authority (“FSA”). The proposals follow a lengthy consultation initiated in November 2009. The Government identified a failure to protect borrowers whose mortgages are sold on to unregulated entities by their lenders. Such borrowers lack the protections afforded by the FSA regime such as the “Treat Customers Fairly” (“TCF”) principles and a borrower’s right of recourse to the Financial Ombudsman Service. According to evidence provided by the FSA, by the second quarter of 2009, unregulated firms had purchased 16,500 regulated mortgage contracts to the tune of about £1.7 billion. The figure has since increased and the signs are that this figure will continue to rise over the next few years as investors identify opportunities to exploit the difficulties currently faced by the traditional originators of residential mortgages.

The Government is proposing to achieve this regulation by expanding the definition of the regulated activity of “administering” a regulated mortgage contract. This will mean that mortgages that have been sold on are caught by the definition and the regulatory protections ordinarily afforded to borrowers will continue to apply post-sale.

HM Treasury intends to publish statutory instruments “later in 2011” but expects the FSA to commence work immediately to implement these proposals.

The Current Problem

Residential mortgage lenders in the UK must be authorised by the FSA and comply with regulations so long as they continue to make such loans. The problems arise when such lenders decide to sell on their mortgage books, ordinarily in order to minimise losses or raise funds or to leave the UK market.

Many of the purchasers of these books are not regulated by the FSA (i.e. hedge funds and private equity firms) and the new owner’s plans may not necessarily place great emphasis on the borrowers’ interests. The FSA’s fear is that they may seek to maximise margins by raising rates and charges and initiating repossessions to liquidate assets. Notwithstanding the FSA’s fears, purchasers of mortgage books instruct Third Party Administrators (“TPAs”) to manage the day-to-day mortgage contracts on their behalf. These TPAs are already regulated by the FSA (as their role falls within the current definition of ‘administering’ mortgages) and they are therefore already required to adhere to TCF principles. However, technically an unregulated purchaser of a mortgage book does not itself have to comply with TCF principles and comply with the FSA’s regulatory regime; it could therefore make decisions, which the original lender could not have made, which have an adverse effect upon the borrower.

Securitisation

As part of its consultation, the Government considered the impact which any change in the regime would have on residential mortgage securitisation. Despite the lack of securitisation transactions closing in recent years, the Government estimates that there is currently approximately £400 billion in outstanding UK residential mortgage securitisation. The FSA’s proposals to amend the definition of “administering” a regulated mortgage contract are intended to avoid the requirement for the special purpose vehicle within a securitisation structure having to become FSA regulated.

Second Charge Regulation

In addition to the proposal to regulate the onward sale of mortgage portfolios, HM Treasury has, as expected, also announced a proposal to transfer the regulation of new and existing second charge residential mortgages to the same regime as first charge mortgages. The Government expects that the proposed Consumer Protection and Markets Authority will take on responsibility for second charge mortgages on the same date that it takes on the FSA’s existing responsibility for first charge mortgage lending. The current proposal is that this will take place on 1 December 2012.

Practical Impact?

It is difficult to see the real practical effect of the Government’s proposals to regulate the onward sale of mortgage portfolios. Although, theoretically, purchasers of mortgage books could ignore TCF principles and fail to adhere to the FSA’s regulatory regime in making decisions affecting borrowers, in practice TPAs are appointed in order to administer the purchased book; the TPA, of course, is bound to comply with existing regulations.

For further information, please contact James Walton or the Partner with whom you usually deal.