Regulation Committee of the Homes and Communities Agency

Written evidence from the HCA Regulation Committee (HCA 17)

What has the regulation committee been doing since it was set up in 2012? Are there other things it should have been doing? What impact has it had on the social housing sector since its establishment?

1. Since its establishment in April 2012 the Regulation Committee has taken decisive steps to shape the future strategic direction of social housing regulation. We have articulated our main strategic aim as the protection of social housing assets so that tenants and tax payers who have invested in the sector are protected and the sector remains attractive to private investment. We have three core elements to our approach to meeting our strategic goal: strengthening our framework; strengthening our operational approach; and strengthening our capacity.

2. More specifically we have:

a. In June 2012, for the first time, set out the regulator’s comprehensive view on risks in the sector and communicated this to registered providers in our "Sector Risk Profile" document – which has informed our main activities. [1]

b. Published a "Regulating the Standards" document setting out our methodologies for assessing performance so all providers are clear about our expectations. [2]

c. Continued to regulate with a light touch regime for the smallest providers (for examples alms houses and small scale co-operatives), whilst ensuring we have a proportionate and risk based approach to the largest associations, some of which now own up to 90,000 properties.

d. Revised the approach to regulatory judgements on social housing providers, key documents where we make public our regulatory view on providers which are important to creditors and enable boards to hold executives to account. We subsequently published judgements on governance and financial viability for 113 of the c.250 providers for whom such judgments are produced.

e. Overseen from the regulatory perspective the successful resolution by the sector of issues at Cosmopolitan Housing Group, a landlord owning c. 10,000 homes in North West England. This was one of the most complex cases in the history of social housing regulation where there was a possibility of provider insolvency.

f. Overseen other significant case work.

g. Started developing policy in relation to the diversification of the sector and started carrying out substantial stakeholder engagement on proposed future regulatory approaches.

h. Overseen a restructure within the regulation directorate to improve capacity to regulate in a more challenging environment.

i. Provided ongoing advice to government on issues relating to the social housing sector and its regulation.

3. These are the activities that we set out to do in the HCA corporate plan and are in our view a realistic and reasonable interpretation of the remit we have been given by legislation. Despite the challenging operating environment, the Committee has maintained the position that no tenant has lost their home and no investor in the sector (be they the tax payer or private investors) have lost their money as a result of provider failure.

What are the major risks facing Housing Associations and the social housing sector? Are the standards set by the Regulation Committee on governance and financial viability adequate to mitigate those risks? Are the established arrangements providing self-regulation of the sector being adequately supervised and tested? What effect are EU procurement rules having on the financial stability of the sector?

4. We have a responsibility to keep abreast of risks facing the sector and communicate these in a clear way to stakeholders and hold them to account for how they are addressing those risks. We do this through our sector risk profile publication, the publication of other monitoring data and our on-going regulation of providers. The sector is facing risks from a number of sources. How these risks affect different providers and interact with other risks depends on the precise nature and business models of individual social housing providers.

5. The main risks we identify in the sector risk profile document are:

· Asset related risks – In order to finance the development of new social homes in a world of constrained grant, providers are taking on more debt and having to rely on riskier activities such as market sales to cross subsidise social housing development. Taking on such activities places a high premium on effective risk management.

· Liability risks – These risks predominantly relate to the liabilities of providers arising out of their funding arrangements. Private finance providers are under well publicised pressure to conform to Basel 3 regulatory standards on capital and liquidity management. As a result they are looking at ways to increase the interest rates they charge on debt, which given that rents are fixed, could result in less money available for new homes or other services. Additionally, as a result of the current, more constrained, lending environment some providers are turning to more complex forms of financing. Depending on the precise types of financial instruments that providers use they are likely to have to manage a greater range of liability risks than traditionally.

· Income risks –providers need to manage a greater risk of rent arrears as a result of a range of changes to the benefit system. Elements of the welfare reforms affect different types of provider differently so there is an ever greater premium on providers understanding their stock and tenant base and the specific feautres of the local areas in which they operate.

· Cost related risks – as with many businesses providers are exposed to cost related risks e.g. costs of pension funds, build/ maintenance costs etc.

Diversification of activities within the sector, which we discuss below, is in part driven by a response to many of these risks and in particular to enable cross subsidy for development in a lower grant environment.Diversification also brings with it its own specific risks to providers if not managed effectively.

6. The standards set on governance and financial viability are largely outcome focussed and seek to ensure that registered providers meet the criteria of being sufficiently well governed and financially viable.In turn we gain assurance that these standards are being met. In the main we think these standards are the right ones but we have identified that more could be done in the standards framework to clarify our position on the management of diverse activities in order to more clearly articulate that boards must understand their exposures and not put social housing assets at risk.

7. The regulator’s approach to seeking assurance on compliance with the governance and financial viability standard is set out in Regulating the Standards. We obtain our assurance and reach our judgements based on financial and statistical information and importantly the assurance that boards themselves get and the quality of controls and risk management. We carry out a routine suite of activities annually for all providers owning more than 1000 units, in a risk based manner seeking greater assurances from larger, more complex or riskier providers. In a rolling programme publish our judgments on the governance and viability of these providers. Within the context of the current regulatory framework, based on the principles of co-regulation, we believe that this approach allows us to gain adequate assurance on providers’ compliance with the regulatory standards.

Is the Regulation Committee policing the financial regulatory regime adequately to address both the risks of the failure of individual registered providers and systemic failure? Has it the power and resources needed to regulate effectively?

8. The Regulation Committee’s aim is to mitigate risks of failure and manage failure situations to protect social housing assets so far as possible, not to necessarily ensure the survival of every single provider. The regulation of the financial viability element of the governance and financial viability standard is designed to give early warning signals of potential failure. Where providers do get into difficulties our aim is to be prepared to take necessary action to support the resolution of problem cases and in extremis use our powers to do so. We are commissioning a lessons learned exercise from the recent Cosmopolitan case to ensure our approach to managing failures in individual providers is as robust as it can be.

9. Because of the way the sector is funded there is a strong connection in this sector between failure of an individual provider and the success of the sector as a whole for delivering new supply of social housing. This is not a systemic risk in the classic sense but is very important at the sector wide level. Currently providers are able to borrow at preferential rates in part due to the expectation of government support (through regulation) in preventing failure. If a provider were to fail it is likely that this would lead to an increase in the price of debt limiting the capacity of the sector to develop new homes. We manage this risk through our regulation of individual providers and through close on-going liaison with financial institutions.

10. Although not strictly systemic risks, there are a large number of common risks faced by providers to which they are exposed to a greater or lesser degree. These are largely those explained in our sector risk profile, as examples, risks to income from direct payment of benefits to tenants, exposure to higher interest rates, headroom for changes in rental policy etc. As part of our regulatory approach we assess the degree of exposure of providers to sector risks and as part of our ongoing engagement seek to test providers’ understanding of the risks to which they are exposed and their strategies for mitigating such risks.

11. More classic systemic risks arising from the interdependence of providers do exist in the sector, e.g. interdependence on pension scheme liabilities built up through a history of mergers and stock transfers, dependency on e.g. maintenance or building contractors or joint service provision. These systemic risks are important but the interconnectedness between providers is at a much lower order than, for example, in the financial services sector. It is therefore unlikely that a financial failure in one provider will create a domino effect through the sector or the economy as a whole but in line with our comments above may cause loss of confidence in the sector and increase the costs of borrowing. Currently exposure to such risks is examined through our financial regulation of individual providers. Our proposals on recovery planning as set out in our recent discussion document should enhance the sector’s preparedness to deal with systemic risks that exist in their particular networks of dependencies.

12. The regulator’s powers were developed in a benign pre credit crunch environment when there was a strong focus on consumer protection. In theory this gave us a graduated range of powers to regulate the sector. In practice there are now severe limitations on how we can use these powers as a consequence of the financial environment where use of powers could lead to a breach of loan covenants and in turn repricing or repayment of existing debt. Within the detail of our powers there are also some challenging issues. Our experience in planning for a moratorium illustrated that it would be challenging successfully to complete the process within 28 working days.  Much would depend on the willingness and ability of secured creditors to work with the regulator and a lead bidder to reach a simple and fair solution.  It is also essential that the regulator has sufficiently robust data to enable prospective bidders to assess the value of the assets, which really means starting work well before an insolvency event triggers the moratorium process.  One of the issues we face is that Industrial & Provident societies (which constitute a significant proportion of the sector) cannot be put into administration, making resolution of problem cases more difficult than would otherwise be the case. The standards based approach can sometimes make it difficult to deal with novel and more complex types of provider, where regulation by contract or other more bespoke means may be more appropriate.

13. Once the proposed strengthening of regulatory capacity and of the regulatory standards has been achieved then the regulator will be in a materially stronger position to cope with individual risks and systemic failure. Recent work restructuring the regulation directorate has been designed to release capacity to deal with more complex providers within our current regulatory model. Changes to the regulatory framework of the nature set out in our recent discussion document will inevitably mean the regulatory operational model will need to evolve and resources will need to be aligned accordingly. We are considering this alongside the development of policy. The regulator has the powers in the Housing and Regeneration Act to generate its own income for its functions through fees charging. This is an issue that the Regulation Committee keeps under close review.

In April the HCA published a consultation document, "Protecting Social Housing Assets in a More Diverse Sector: a discussion paper on the principles for amending the Regulatory Framework for social housing in England <http://www.homesandcommunities.co.uk/sites/default/files/our-work/130404_regulatory_framework_discussion.pdf> ". Why are changes needed, and are those proposed adequate? Would the proposed changes have any adverse consequences?

14. We set out why we think that changes to the regulatory framework may be necessary at the start of the discussion document. The need for changes flow directly from our analysis of risk in the sector as set out in the Sector Risk Profile that we refer to above. In summary the main reasons for looking at the framework are twofold:

a. There is a long term trend of diversification in the sector and we believe that in the current operating environment the drivers and incentives for providers to diversify activities are greater, particularly in order cross subsidise new supply in an environment of decreasing subsidy;

b. The Housing and Regeneration Act gave providers freedoms on how they organise themselves and allowed new types of provider who operate on a for profit basis to enter the sector.

In line with our statutory objectives, our concern has been to ensure that diversification does not lead to undue risk being put on social housing assets and thereby putting historic investment at risk or make the sector less attractive tofuture investment. In feedback from our recent consultation exercise many in the sector were concerned that methods for dealing with these risks that we set out would act as a constraint on beneficial activities. We are continuing our dialogue with stakeholders to find an appropriate balance between protection of social housing and freedom for providers to carry out a range of beneficial activities. We remain determined to address the risk of recourse to social housing assets from commercial activities.

15. We made proposals in three main areas in the discussion document, these are: (i) "ring fencing" of social housing assets from risks caused by non-social housing activities; (ii) recovery planning (measures that providers can take to be better prepared for and thereby avoid failure situations); and (iii) proposals on capturing public value on disposals out of the sector by for profit providers. We deliberately framed the document as an open discussion with the sector and have sought feedback on alternative proposals and potential consequences. Before the regulatory framework is changed we will conduct a formal consultation as required by statute on the detailed changes.

16. The changes that we have proposed in the recent discussion document describe how similar issues have been addressed in other regulated sectors, including in the financial services sector and make proposals about the applicability to this sector. The biggest balancing act in the discussion document is between ensuring the risks to existing assets are well managed by those providers engaging in diverse activities whilst not stifling a potential source of revenue for new supply. Throughout our engagement on the discussion document and in the responses that we are now analysing a range of alternative suggestions on how we can meet the twin objectives of protecting social housing assets and promoting new supply have been made. We are currently reflecting on the results of this initial phase of engagement and working through alternatives to determine what proposals we ultimately want to put to the sector in our formal consultation to change the regulatory framework.

Are the arrangements in place sufficient to preserve the independence of the Regulation Committee in relation to the HCA and the sector?

17. Within the HCA the statutory separation of functions between the HCA acting as regulator and the rest of the agency is elaborated upon in the protocol between the HCA board and the Regulation Committee, which works in practice. We carry out extensive on-going engagement with key sector stakeholders. The experience of the Regulation Committee has been that its independence is respected within the HCA and by the sector.

Are the standards set by the Regulation Committee relating to consumer regulation adequate and are the monitoring arrangements sufficient?

18. The Localism Act set out a new approach to dealing with consumer issues in social housing. Under this new approach the expectation is that issues are resolved at a local level wherever possible, with the housing ombudsman dealing with complaints that cannot be resolved. The role of the regulator in relation to consumer regulation is limited to: (i) setting standards which to a large part are policed by others; (ii) reaching a judgment and then dealing with the most serious breaches of the standards that have or are likely to lead to serious detriment to tenants on the basis of information received from third parties. We do not proactively monitor compliance with the standards.

19. The vast majority of the content of consumer standards is set out by formal directions from the Secretary of State. Our arrangements for dealing with potential breaches of the consumer standards as notified to us by third parties are as set out in the Regulatory Framework and elaborated up in the Regulating the Standards document. Essentially we operate a triage system where enquiries in relation to consumer standards are assessed and filtered in three stages. In the first year of operation of the new consumer regulation regime we received 421 complaints relating to consumer standards (stage 1). Of these 111 were referred to our Consumer Regulation Panel (stage 2) and 20 investigated in further detail (stage 3). No cases of serious detriment were identified in 2012/13. We are satisfied that the approach to dealing with potential breaches of the consumer standards is consistent with our remit in this area.

June 2013