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Financial Services and Markets Act 2000 (Regulated Activities) (Amendment)(No. 2) Order 2006



The Committee consisted of the following Members:

Chairman: Mr. David Wilshire
Balls, Ed (Economic Secretary to the Treasury)
Breed, Mr. Colin (South-East Cornwall) (LD)
Clark, Greg (Tunbridge Wells) (Con)
Cousins, Jim (Newcastle upon Tyne, Central) (Lab)
Curtis-Thomas, Mrs. Claire (Crosby) (Lab)
Ellman, Mrs. Louise (Liverpool, Riverside) (Lab/Co-op)
Ennis, Jeff (Barnsley, East and Mexborough) (Lab)
Fallon, Mr. Michael (Sevenoaks) (Con)
Goldsworthy, Julia (Falmouth and Camborne) (LD)
Heppell, Mr. John (Vice-Chamberlain of Her Majesty's Household)
Hurd, Mr. Nick (Ruislip-Northwood) (Con)
Johnson, Ms Diana R. (Kingston upon Hull, North) (Lab)
Jones, Helen (Warrington, North) (Lab)
Selous, Andrew (South-West Bedfordshire) (Con)
Villiers, Mrs. Theresa (Chipping Barnet) (Con)
Williams, Mrs. Betty (Conwy) (Lab)
Wyatt, Derek (Sittingbourne and Sheppey) (Lab)
Mark Egan, Committee Clerk
† attended the Committee

First Standing Committee on Delegated Legislation

Monday 23 October 2006

[Mr. David Wilshire in the Chair]

Financial Services and Markets Act 2000 (Regulated Activities) (Amendment)(No. 2) Order 2006

4.30 pm
The Chairman: The Economic Secretary has already asked me about such matters, but, as I always say at the beginning of a sitting when I am in the Chair, members of the Committee may, within reason, take off what clothing they wish.
The Economic Secretary to the Treasury (Ed Balls): I beg to move,
That the Committee has considered the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No. 2) Order 2006. (S.I. 2006, No. 2383)
May I, Mr. Wilshire, start by thanking you for your generous and laissez-faire approach to sartorial elegance? It is a great honour to serve under your chairmanship today and to be in Committee with the hon. Members for Chipping Barnet (Mrs. Villiers) and for South-East Cornwall (Mr. Breed), and the Vice-Chamberlain of Her Majesty's Household, my hon. Friend the hon. Member for Nottingham, East (Mr. Heppell). It almost makes one nostalgic for the Finance Bill, but not quite.
We are to discuss changes that the Government are introducing to ensure that, from April next year, consumers of home reversion plans and ijara home financing arrangements will benefit from protection afforded by Financial Services Authority regulation. In addition to the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No. 2) Order 2006, we have also laid two negative procedure orders before Parliament. The Proceeds of Crime Act 2002 (Business in the Regulated Sector) Order 2006 and the Terrorism Act 2000 (Business in the Regulated Sector) Order 2006 both make consequential changes by aligning the money laundering treatment of arranging or advising on the product that the main order deals with, while at the same time reducing burdens on firms.
Home reversion plans are sold generally to older people. They allow some home owners to realise the value locked up in their homes in order to supplement their income or improve their standard of living. However, buying a home reversion product is a huge financial decision. It can have significant implications for tax, benefits and inheritance. Regulation is designed to help people make informed choices and have access to appropriate mechanisms for redress.
This secondary legislation brings a certain part of the home reversion market within the scope of FSA regulation and, at the same time, it ensures that consumers who wish to access the growing market in sharia-compliant home purchase plans also benefit from the protection of FSA regulation. These changes follow the Regulation of Financial Services (Land Transactions) Act 2005, which was supported widely by the industry and consumer groups and which received Royal Assent last year. They have also received widespread support during the consultation that we have undertaken on the secondary legislation.
I shall set out in some but not too much detail exactly what is meant by the different products. There are two main types of equity release schemes. First, I refer to lifetime mortgages when the consumer takes out a mortgage loan secured on a property, which is then repaid when the property is sold. It is a standard mortgage and is already regulated by the Financial Services Authority under its mortgages regime. Secondly, there are home reversion plans when consumers sell all or part of their home, but retain the right to live there. They are not currently regulated by the FSA, which is why we are introducing the order today.
More widely, sharia-compliant home financing arrangements have been developed to meet the same purpose as a conventional mortgage product while also complying with Islamic principles. Again, there are two main types: first, murabaha mortgages, when an institution buys and resells the home to the consumer, accepting payment of the price over a lengthy period. Those are currently regulated by the FSA. Secondly, I refer to ijara products, which is when an institution combines a sale with renting the unowned share of the property to the consumer. They are not yet regulated by the FSA and will not be until the order comes into effect. Our aim is to remove the current imbalance between lifetime mortgages and home reversion plans on the one hand and between the murabaha mortgages and the lack of regulation of ijara products, on the other, so that all consumers who choose to use mortgage-type or non-interest bearing products will benefit from FSA protection.
At present, home reversion products are not completely without protection. The market is subject to voluntary regulation through safe home income plans, whose members agree to comply with a code of practice and undertake to provide fair, simple and complete presentation of any plan that they offer. They also guarantee that consumers will never owe a lender more than the value of their home—a no-negative equity guarantee. However, if protections fall short of the sort offered by statutory regulation and the FSA’s regime, it would extend FSA protections and ensure a level playing field in the equity release market, removing any artificial regulatory distortions. As I have said, those changes will ensure also a level playing field in the sharia-compliant home financing market, which is already firmly established.
I stress that the order does not specify exactly the form that the regulation of home reversion and home purchase plans will take. That is for the FSA to set out separately in its detailed rules, which it will do in good time to ensure the effectiveness of the order when it comes into force in April of next year.
The order specifies as regulated activities, for the purposes of the Financial Services and MarketsAct 2000, the activities of entering into, administering, arranging and advising on regulated home reversion and regulated home purchase plans. That means that the FSA will be able to require firms undertaking those activities by way of business to be authorised unless they benefit from an exemption.
The order also clarifies the existing provision relating to high net worth, business angel companies and amends the overseas person exception by replacing the reference to a “non-resident” with a reference to a person who is not resident in order to capture corporate trustees resident overseas. The order extends the existing exclusions from regulation for activities such as general advice in newspapers so as to be in line with the treatment of other mortgage-related activities.
Home reversion and purchase plans are defined in detail in article 18, and the activities to be regulated in relation to those products are defined in articles 4,13 and 18. Those differ from the equivalent regulated activities for mortgages in two important respects. First, intermediaries for home reversion providers—lenders—will be regulated as well as those for reversion sellers. Secondly, the acquisition of an existing home reversion by a new provider, including a provider who was the not the original provider, will be regulated. Those differences were consulted on by the Treasury and the FSA and have received support.
During consultation, the order received wide support from industry groups, which have welcomed the Government’s desire to ensure a level regulatory playing field. Indeed, we published a summary of those consultations in September this year and have taken further account of comments on the draft legislation.
As a result of those consultations, in September, we laid three statutory instruments before the House. The main order was required to define exactly which home reversion and purchase activities will need to be regulated. As I have said, the two other orders make changes to the money laundering rules. They are subject to negative resolution procedures and therefore are not being debated today, but they are relevant to the discussion at hand and so I thought that it was worth while bringing them up.
When the order has been approved by the House, the FSA will be able to open its doors to applications from firms carrying out regulated activities, which will give firms the necessary time to prepare. The FSA will also publish its detailed rules and guidance early in November, and as set out in the secondary legislation, those orders will take effect from 6 April 2007.
In general, our approach throughout has been to establish a regulatory regime equivalent to the existing mortgage regime. It is only right that consumers of home reversion plans and ijara home financing arrangements benefit from consumer protections, which are afforded by FSA regulation. I believe that that will strengthen confidence in the market—consumer confidence is an essential base for diverse and competitive markets. I believe that everyone here will support that outcome. I commend the order to the Committee.
4.39 pm
Mrs. Theresa Villiers (Chipping Barnet) (Con): May I join the Economic Secretary in saying how pleased and delighted I am to be serving under your chairmanship, Mr. Wilshire? I do not propose to delay the Committee because there is a political consensus on the need to regulate such products. However, the matter before us is an important one and therefore I shall take a little time to go through some of the issues in contention.
As I have said, the Opposition broadly welcome the delegated legislation on the introduction of regulation for these two types of product. The Opposition think that there is a good case for regulating equity release products, such as home reversion plans, but not because they are inherently suspect—quite the contrary, finding ways for older people to unlock the value tied up in their home will become ever more important with our ageing population. Many people who first bought their council properties in the 1980s are heading towards retirement and this type of scheme is of significant interest to them.
The Council of Mortgage Lenders estimated that pensioners own housing assets worth about £1 trillion in this country and, with dwindling returns on annuities and the pressure of expenses such as council tax, many thousands of older people find themselves asset rich and income poor. It is entirely understandable that many will seek to release some of the equity in their property without the disruption and the cost of moving to a smaller home. Equity release looks as if it may well become even more important in the future, given that many people in their 30s and 40s these days are using the property market as a substitute for more traditional pension planning.
Putting all those factors together, this is potentially a very large market. For the reasons I will set out, it is one that we agree should be subject to regulation. Normally, I am reluctant to accede to new areas of regulation. I tend to be sceptical about whether regulation is needed in a particular context, but I think that there is a good case for it here. Similar products are already regulated by the FSA. The statutory instrument will mean that more or less the whole consumer mortgage market is covered by regulation.
There could be difficulties if consumers had a choice between very similar products, one of which was regulated and one of which was not. They certainly might feel aggrieved if they had access to the Financial Ombudsman Service and the compensation schemes when purchasing one product, whereas if they opted for a similar product, they could not access those options. It could skew the market artificially if we had very similar products that fell on different sides of the regulatory boundary.
Of course, the main reason for intervention in and regulation of the financial services market is based on informational asymmetry. In many cases, the consumer will know less about the product than the salesman and will therefore find it more difficult to make an informed choice without the intervention of regulation. Information asymmetry is probably more serious in this context than in many other financial services contexts. These products look comparatively straightforward to people experienced in financial services matters, but deciding whether one of these products is suitable for a particular person is a complex judgment. Certainly, people contemplating entering into equity release will have to consider difficult issues such as the impact on their entitlement to state benefits and their tax position. To be able to give an appropriate level of advice, salesmen would have to have a degree of knowledge and training that might not occur spontaneously in an unregulated market.
Such arrangements may often be a far more cost-effective way of dealing with the asset-rich, cash-poor situation. Again, specialist and well trained advisers are needed to ensure that customers get the correct advice on this. Something that concerned me when I was researching for this debate was an FSA mystery shopper exercise that found that 77 per cent. of independent financial advisers had not asked their equity release customers whether they had considered those alternative methods.
Another reason why regulation is probably justified in this case is that people contemplating such arrangements tend to be elderly and might be more vulnerable than many other groups to pressure sales techniques. A point strongly made by the Council of Mortgage Lenders in its support for regulation in this area relates to the vulnerability of the target customer market. Equity release is now one of the issues most commonly raised with the Age Concern helpline.
Introducing regulation here could also help to increase consumer confidence. Certainly, the early history of equity release is not an attractive one. People were ripped off, and it seems clear that the SHIP—safe home income plan—organisation has cleaned up the market. However, it seems likely that if home reversion came into the regulatory structure, that could, I hope, increase consumer confidence and enhance and assist the marketing of that type of product. The existence of regulation, however, does not absolve the consumer from needing to make their own informed choice.
Turning to some of the questions that I should like the Economic Secretary to consider, it is important to emphasise that the FSA should work with groups such as Which?, Help the Aged and Citizens Advice, to help to educate people about these products and to ensure that they can make a judgment about them. No matter how much information the regulators require to be provided to customers, it is still important that customers have the ability to make their own judgments.
On timing, I flag up the fact that it has taken some time to get the system up and running. The decision to regulate was taken as long ago as spring 2004, but the regulatory structure will not come into force until 2007. I appreciate that time was needed for proper consultation, but perhaps things could have moved on a little more speedily, given that we knew that there was a problem with the products, certainly since the late 1990s.
Turning to costs, the compliance costs are considerable. There seems to be several different numbers floating around. The Treasury regulatory impact assessment estimates the cost of the one-off start-up to be £8.6 million, and the ongoing costs at £4.4 million. It would be useful to hear what steps the Treasury and the FSA will be taking to minimise the ongoing costs of the regulation.
What distinctions will be drawn between the regulation of lifetime mortgages and the home reversions that we are considering today? Is it proposed to regulate them in a more or less identical way?
I have a series of short questions that, to be fair, are probably more logically directed at the FSA, but as we do not have the opportunity in Parliament to challenge the FSA, it would be useful to hear the Economic Secretary’s thoughts about them. The FSA seems likely to provide that the promotion of home reversion schemes is carried out in a way that is
“balanced ... clear, fair and not misleading”.
It would be interesting to hear his thoughts on how that will impact on the sort of advertisements that were once quite common in our Sunday newspapers and that went along the lines of “Fancy a holiday to New York or a new car? Why not check out equity release?” The marketing of some of those products seems to have encouraged a fairly inappropriate use of equity release. It would be interesting to hear whether the regulation will have an impact on such advertisements. What key product information is likely to be supplied to consumers? It is important that they have information on any impact on their benefits and tax position, their legal position, their possible inability to buy back their home once they have sold it and the restriction of their ability to move house. Consumers should take all those issues into account, so there is a good argument for including them in the information required by regulations to be given to consumers.
Such matters are so complex that it is important that consumers are encouraged to obtain independent legal advice. In particular, they might have to register the leasehold interest that they would retain in the property, and they are simply unlikely to be aware of that unless they have advice from a solicitor. It would be useful to hear what role that will play in the regulatory structure. Similarly, the property valuation is a key factor in determining whether the customer will get a good deal. What arrangements will be made to ensure that the valuation is sufficiently independent?
On the training of those who will be permitted and licensed to sell the products, the Council of Mortgage Lenders has pointed out that the knowledge and skills required to sell equity release products are rather different from those required for standard mortgages. It might not be easy to grandfather in pre-existing qualifications. Will existing advisers need to obtain new qualifications, or will pre-existing qualifications be accepted under the new framework?
It is important to ensure that enforcement is effective. Without effective enforcement, regulatory rules merely provide a lot of hassle for the law-abiding without catching the crooks. In many cases, problems might not manifest themselves until the death of the customer. That could be 10, 15 or even 20 years after the transaction and, for obvious reasons, the key witness will not be around to say what happened. Will any steps be taken to ensure that problems are uncovered promptly so that effective enforcement action can be taken?
I shall mention home reversion plans before I speak about ijara mortgages. Regulation 18 of the order will add a new sub-paragraph, 63B(4)(c)(ii), which defines a related person as
“a person (whether or not of the opposite sex) whose relationship with that person has the characteristics of the relationship between husband and wife”.
That definition seems to have certain ambiguities. It is difficult to predict how that might be interpreted in practice. Are there any other definitions in different legal contexts that might be easier to use than that rather complicated one?
I turn for a few minutes to ijara transactions. As I said during debate on the Finance Bill, the Opposition believe that it is important to bring sharia-compliant products into mainstream financial regulation, and I acknowledge the Chancellor’s valuable work in that area. If an ijara home purchase plan is designed to operate similarly to a standard mortgage, it makes sense to regulate it similarly. As the chairman of the FSA recently pointed out, we need the same level of protection and confidence in Islamically compliant products as in any other. It is important to prevent financial exclusion of the Muslim community and to provide the right conditions for Muslims to plan their financial future in a way that is consistent with their religious principles. It is also important, of course, to securing a competitive position for London in a rapidly growing finance market.
My questions are rather brief. Most financial institutions selling mortgages will never sell an ijara home purchase plan, so it is important to take steps to ensure that the burden of regulation specifically tailored to ijara financing arrangements is focused on those firms that actually sell them and is not expanded to the rest of the mortgage market. Ijara transactions do not cause the same anxiety about consumer vulnerability as equity release, so it is important that the framework for these products has a lighter touch than the framework for the others that we are considering.
For many hundreds of years, our legal system has been building up protection for borrowers in the context of mortgages. In many cases, such protection predates the FSA regulation of mortgages. However, it is important, for example, in relation to the steps that the lenders—the financial institutions—take in the event of default, that the protections that have been built up in relation to the standard mortgage should be available for an ijara mortgage. For example, there should be an obligation, should the property be repossessed, to sell it promptly and make efforts to obtain the best price.
I am grateful for the Chairman’s and the Committee’s patience and I should be interested to hear the Economic Secretary’s response.
4.57 pm
Mr. Colin Breed (South-East Cornwall) (LD): I agree very much with what the hon. Member for Chipping Barnet has said. We also welcome this additional regulation. I suppose that any additional regulation at this time has to be necessary—and this is. It does more than just tidy up the situation; it begins to consider areas about which there has been growing concern.
I have heard about a couple of unsatisfactory cases and there are some growing concerns in the industry about home reversion plans, which were often specifically written to avoid the sort of regulation that is now being advanced. Thereby hangs much of the problem, because this is often a long-term issue and the problems often do not arise until people are a long way down the line.
I assume that all the plans that are currently written will not be caught under the new regulation and that therefore there will be a fairly long period in which current plans, which have already been agreed and written, will not be caught under new regulations. I suspect that, following whatever the FSA brings out, the industry will have to respond and, probably, draw up new sorts of contracts and so on.
I, too, am concerned about the advertising of such plans. There are many examples of misleading advertisements encouraging people to obtain such products that were targeted at a vulnerable part of the community. I hope that the advertising of such products will come under stringent control.
The Economic Secretary said that the FSA will advance its proposals very soon—by the end of November—and it will be interesting to see their scope. We should ensure that those proposals give clear guidance and the sort of consumer protection that I know we and the Government want. However, such protection has to be seen to bite and act accordingly.
I support the view that independent legal advice should be totally independent from those who will be selling, offering, or even advising on, the product. Back in the long-distant past, when I used to lend a little bit of money for one of the major banks, we used to insist on independent legal advice and on an independently witnessed signature on such mortgages. Regretfully, that provision was taken away because it was felt to be discriminatory, particularly to women. We used to insist that women took separate legal advice from their husbands. Removing that condition was a mistake, because it provided people with some way of deciding for themselves whether they wanted to sign a mortgage. Many customers used to ask for an explanation, and I used to tell them that the five or six-page document—which probably now has 20 pages—actually said, “No matter what you do or say, and no matter what the circumstances, if you do not pay us back, we will take your house.” That rather stark advice can sometimes go lacking when people are keen to promote products that have a nice fat commission on the end of them.
The market has existed for a long time, and there are probably far more home reversion plans than we ever realised. Many of them will come to fruition in the next few years. We shall see what happens, but the couple of unsatisfactory cases that I have seen suggest to me that there will be quite a few more.
The market in products that comply with Islamic law is a new one. I, too, pay tribute to the Government for encouraging those products—it is an excellent move. The market is still developing. Issues will arise and there will be unintended consequences, so there should be regular reviews, but bringing those products into a regulatory framework is a good move and my party gives a broad welcome to the measures. We look forward to the FSA’s proposals for implementing the regulations.
5.2 pm
 
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