Mortgage Advice and Distribution - A Brave New World

The Financial Conduct Authority (“FCA”) implemented its far-reaching reform to the mortgage market through the Mortgage Market Review (“MMR”) on 24 April 2014. The key reforms included:

• Affordability: Making lenders solely responsible for assessing whether a Customer can afford the loan including verification of a Customer’s income;
• Sales Process: Removing the non-advised sales process and implementing an execution only sales process for non-interactive sales;
• Competence: Requiring all mortgage advisers to hold a relevant qualification;
• Interest-only: Continuing the grant of interest-only loans, but only where there is a credible strategy for repaying the capital;
• Disclosure: Replacing the requirement to provide the Initial Disclosure Document with the provision of key messages about a firm’s service; and
• Product Information: Requiring a Key Facts Illustration (“KFI”) to be provided only where a firm recommends a product, where the Customer asks for a KFI or where the Customer indicates the product they want in an execution only sale.

The FCA’s Business Plan 2015/2016 highlighted the FCA’s plan to assess how firms are implementing the post-MMR rules in three initial phases:

• Phase 1: Advice and distribution review (Summer 2015);
• Phase 2: Wider assessment of barriers to competition e.g. ability to switch providers, factors affecting consumers’ ability to access credit and barriers to entry and/or expansion (Autumn 2015 onwards); and
• Phase 3: Market study on those aspects of the mortgage market that are not working for the benefit of consumers (early 2016 onwards).

On 25 June 2015, the FCA completed Phase 1 and published its Thematic Review entitled Embedding the Mortgage Market Review: Advice and Distribution (the “Review”).

The Review covered both lenders and intermediaries and focused on Customers’ experience of receiving advice and the extent to which firms are recommending mortgages which are suitable. The review methodology involved independent consumer research, 11 firm visits, 134 mystery shops and 34 file reviews from five firms.

In summary, the Review found that there was no systemic detriment to Customers and only 3% of cases were deemed unsuitable. However, whilst 59% of mystery shops and files reviewed were deemed suitable, in 38% of cases it was not possible to determine whether the mortgage recommended was suitable. This highlights a gap between the advice given and the ability for a reviewer to discern the analysis for the advice from the documentation. Specifically, the Review highlighted the following key findings:

• Provision of information: Some Firms placed over-reliance on Customers’ initial preferences or asked too few or too narrow questions to objectively assess needs and circumstances. Best practice included Firms that asked sufficient questions and further probed and challenged customers when they expressed conflicting preferences or needs.
• Assessing suitability: The Review found a range of specific circumstances where customers’ needs and circumstances were not fully considered when assessing suitability. These included placing undue weight on Customers’ preferences to minimize payments at the outset, steering Customers’ to a repayment term where the initial payment met their exact budget, early discounting of interest only and products with flexible features and not explaining clearly the impact of adding fees to the loan. Best practice included assessing all aspects of the mortgage in combination and exploring priorities and any necessary trade-offs with the Customer.
• Provision of advice: The Review noted that whilst a highly structured advice process helped provide Firms with a standardized approach and control over recommendations, it provided minimal or no leeway for advisers to apply subjective judgement to take account of individual circumstances. Conversely, advice with little or no structure resulted in inconsistency and a higher risk of unclear or unsuitable recommendations. Best practice involved the use of a structured process whilst allowing sufficient flexibility for advisers to use their judgement in individual circumstances.
• Communicating with Customers: Some communication practices risked disengaging and confusing Customers. Best practice included delivering disclosures piecemeal and/or checking Customer understanding at key stages in the advice process. Overall, firms must ensure they communicate with Customers in a way that is clear, fair and not misleading.
• Culture, governance and oversight: The Review highlighted a focus of senior management on compliance with process rather than assessing the risks of poor Customer outcomes and designing oversight arrangements to mitigate those risks. Best practice included a strong tone from the top to create a culture focused on Customer outcomes, the use of different components of the control environment to undertake root cause analysis and robust management information that identifies post Customer outcomes and conduct risks.

As the FCA continues to focus on whether Firms consistently focus on good customer outcomes, lenders and intermediaries should assess not only whether their business model, systems and processes are compliant with FCA rules but also undertake a gap analysis relative to the findings in the Review.

Kinetic Partners has significant experience in the mortgage market designing and assessing controls and processes to identify and mitigate the risk of poor customer outcomes. We can help your firm:

• Undertake a gap analysis of its processes against both FCA rules and the findings from the Thematic Review;
• Review its sales processes and control functions including risk and compliance to identify potential improvements;
• Implement further training to advisers and support staff on customer outcomes and conduct risks;
• Assess the quality and quantity of file reviews; and
• Enhance its governance and reporting framework to focus on good Customer outcomes.