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28/02/2007 - The Future of Mortgage Regulation

The Future of Mortgage Regulation

Regulation of mortgage advisers is relatively new with the Financial Services Authority only regulating firms from October 2004.In some respects it is too early to say who will be the winners between mortgage networks and support service companies. However much can be learned from the experiences seen within the life and investment market which has seen many more years of regulation.

As a starting point it is important to recognise the significant difference between investment and mortgage advisers. Generally investment firms develop a strong, long term, relationship with their clients, whereas the mortgage adviser tends to provide a transactional relationship with his customer. Once the transaction is complete they move on to the next piece of business, often without ever seeing past customers.

Even reference to the person receiving the advice can be different with one being referred to as a “client” and the other a “customer”. The mortgage adviser therefore tends to move from transaction to transaction and customer to customer. There are no indications at this stage to show that this position is changing. There is of course the requirement that the advice provided is compliant. A move to principal based compliance and in particular “treating customers fairly” however could dramatically impact on this relationship. Consider for example a mortgage adviser selling a fixed rate mortgage. Surely there is a requirement to review his customers’ position during the fixed term particularly if interest rates are falling. Additionally at the end of the fixed term period to ensure that an equitable rate is being paid or even to consider a further fixed period loan. This would be a quantum shift away from the existing model which some advisers may find challenging.

Prior to mortgage regulation there was a strong school of thought that the pure mortgage adviser would seek compliance support by using a network. This resulted in many mortgage networks being established all trying to attract mortgage advisers. In reality mortgage advisers virtually ignored the compliance implications of regulations and were not attracted to networks in great numbers. The result is that there are a relatively large number of mortgage networks but with very few members.

Like most business models critical mass is crucial for a network to be viable. We have therefore already seen a number of mortgage networks disappear, others have merged and it must be anticipated that this consolidation will continue. There is also the question of the financial standing of a network. This is vital as advisers increasingly focus on the financial strength of their network. The same position has been seen in the life and investment networks where over the years there has been consolidation and the financially weak have disappeared.

So why did we not see a large number of mortgage advisers flooding into networks? Firstly over the years the FSA have streamlined their registration process quite dramatically and mortgage advisers have been able to take advantage of this simplification.

Secondly the cost of being in a network is not cheap indeed quite the reverse. Charges can range upwards from 10% of a firms turnover. This is an additional financial burden which cannot be passed onto customers. Many life and investment networks were initially able to attract members by providing increased commission rates which meant that the advising firm was no worse off even after paying network fees. The reality is however that even in this scenario it took several years of regulation for the value of compliance support to be recognised. Indeed, the real growth of the IFA network sector did not start until well into the 90s despite regulation commencing in 1988.

If there has been no great influx into mortgage networks have advisers joined support service companies? There is no evidence to suggest that this is the case. Many support service companies have grown from the life and investment market place and their offerings may not appear attractive to mortgage advisers. Suppliers are now aiming to provide a wider service including that required by mortgage advisers. Also some of the mortgage networks are now offering a compliance support service proposition. This being driven out of financial necessity.

If advisers have not flooded into networks or signed up with service support companies what have they done? The simple answer is not a lot! It would appear that the vast majority of mortgage advisers have taken the route of direct authorisation whilst ignoring their very real need for compliance support.

There are two reasons why this has happened. Firstly the costs associated with both options. As mentioned previously a network will charge in excess of 10% of turnover. Support service companies on the other hand charge much less, typically 2.5% however mortgage advisers have still been reluctant to pay for compliance support.

The second reason why networks and support service companies have failed to attract members is that the mortgage adviser market is very fragmented with the market being dominated by the sole trader. There may have been a perception therefore that the numbers of advisers was so large that individual advisers could hide from compliance requirements. This may have had an element of truth in the early days but this is currently not the position with increasing disciplinary action being taken by the FSA against mortgage firms.

So in conclusion who will be the victor in the fight for mortgage advisers? Well the answer lies in the history of the life and investment market.

Twenty years ago IFA’s were reluctant to pay for compliance support and decided to go it alone. Then as regulation started to bite there was a surge towards networks with many IFA’s joining the numerous organisations that sprung up. However as network charges increased and the advisers ability to operate became limited by network restraints they chose to leave networks and join support service companies which both cut the costs and gave them control over their future destiny. So much so that many commentators see the network model as being obsolete. The big difference with the mortgage community therefore is that they will miss out the network option and move from having no support into using support service companies which will ensure they maximise their profitability and maintain full control of their own business.

The overall winner therefore, apart of course from the adviser, will be the professional and financially strong support service companies that deliver cost effective support focussed on helping their client firms to be compliant and successful.

Ken Davy

Chairman

Simply Biz

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28/02/2007 - The Future of Mortgage Regulation