If you are planning to originate residential mortgage loans, it is important to be clear on the regulatory and compliance requirements involved so that you can make sure you have the necessary arrangements in place. From a UK perspective, the regulated activities include lending, administering, advising on and arranging regulated mortgage contracts. The regulations are strictly enforced, and non-compliance may result in criminal sanctions. In addition, investors will place close attention to past and future compliance when assessing whether to participate in a portfolio of residential mortgage loans.
This article provides a very brief overview of the regulations having effect in the UK, and also sets out some essential practical points for the originators of mortgage loans.
The regulatory regime
Under the UK Financial Services and Markets Act 2000 (FSMA), the independent regulator, the Financial Conduct Authority (FCA), has the authority to put in place, supervise and enforce rules relating to the regulated activities of lending, administering, advising on and arranging regulated mortgage contracts. The rules provide that those activities can only be carried out by persons with the appropriate permissions. An originator of residential mortgage loans would be likely to undertake a regulated activity during the life of the borrower’s loan, unless an FCA authorised firm is engaged to act on the originator’s behalf.
A regulated mortgage contract is defined as being a contract under which:
- a person (the “lender”) provides credit to an individual or to trustees (the “borrower”); and
- the obligation of the borrower to repay is secured by a first legal mortgage on land (other than timeshare accommodation) in the United Kingdom, at least 40% of which is used, or is intended to be used, as or in connection with a dwelling by the borrower or (in the case of credit provided to trustees) by an individual who is a beneficiary of the trust, or by a related person.
“Related person” is defined as meaning the borrower’s “spouse, parent, brother, sister, child, grandparent or grandchild” or “a person (whether or not of the opposite sex) whose relationship with the borrower has the characteristics of the relationship between husband and wife.”
Under Section 19 of the FSMA, no person may carry on a regulated activity without permission. Any person who does so will be guilty of an offence and may be liable to imprisonment for a term of up to two years, or a fine, or both. Further, any agreement made by a person carrying on a regulated activity without permission is unenforceable against the other party. In order to carry on a regulated activity, a person must make a successful application to the FCA for the requisite permissions.
The Mortgage Conduct of Business (MCOB) must be complied with by lenders and providers, administrators, arrangers and advisers who carry out regulated mortgage contract activity, and stipulates rules which govern the relationship between a borrower, any intermediary and the lender. The rules contained in the MCOB include:
- restrictions on financial promotions and advertising;
- providing consumers with intelligible information;
- the provision of pre-contractual information in a prescribed format;
- affordability assessments;
- clear communication of information throughout the life of a loan; and
- policies applicable to arrears management.
The FCA has recently introduced a number of significant changes to its rules on regulated mortgage contracts, known as the Mortgage Market Review (MMR). These rules focus on responsible lending practices, ensuring all mortgage products are offered on an advised basis unless the customer is a mortgage professional, a high net worth mortgage customer or a business borrower, and confirms that lenders are fully responsible for assessing whether the customer can afford the loan offered.
Following on from the MMR, the European Union Mortgage Credit Directive (MCD) requirements are to be implemented by member states by 21 March 2016. The MCD aims to harmonise the regulatory requirements that EU member states are required to meet in order to protect consumers taking out loans relating to residential property. The implementation of the MCD is to be achieved by building on the existing UK regulatory regime and as it applies to all mortgage lending to consumers, it will have the most significant impact on the regulation of second charge mortgage lending which is currently outside the scope of existing UK regulation on mortgages. It is worth noting here that the UK government wishes to exclude buy-to-let mortgages where the borrower is acting as a business from the wider mortgage regime post implementation of the MCD.
Regulation of second charge mortgages
Second charge mortgages (also called second charge loans) are loans secured on property that is already acting as security for a first charge residential mortgage.
On 1 April 2014, responsibility for the regulation of second charge lending transferred from the OFT to the FCA. Until the MCD is implemented, second charge mortgages are regulated within the FCA’s consumer credit regime. After this date, the FCA will regulate second charge mortgages within its wider mortgage regime which will mean that the activities of lending, administering, advising on and arranging second charge loans will be regulated activities. Those activities will require the same permissions as a first charge lender and will be subject to the rules of MCOB and the MMR as amended as a result of the MCD. Pending the implementation of the new rules that will apply as a result of the implementation of the MCD, firms which take second charges as security should have registered for interim permission under the consumer credit regime, and new entrants to the second charge market (without a Consumer Credit Act licence and an interim permission) must apply for a full consumer credit permission.
Important practical points to note for originators of mortgage loans:
1. If direct authorisation by the FCA through obtaining the requisite permissions is not a realistic option for your firm, certain third party servicers are authorised and well placed with trained personnel and infrastructure to deal with borrowers throughout the life of a loan. Some of those third party servicers can undertake due diligence on a portfolio on an originator’s behalf prior to acquisition, originate new loans and provide further advances under their existing permissions as they realise the need for a ‘cradle to grave’ service offering for their originator clients. Engaging a third party servicer can therefore reduce the barriers to entry to this market.
2. Due diligence is the key to profitability, and this is true whether the loan is secured by way of first or second charge. Any historic non-compliance on the part of a lender can directly impact the value of the loan portfolio.
3. This market is highly regulated and the FCA has warned that it will enforce all rules to impose fines, ensure firms redress their customers and, if appropriate, impose criminal sanctions. It should go without saying that careful preparation is critical for any project involving regulated loans.