Regulation of Financial Services (Land Transactions) Bill
Lord McKenzie of Luton (Government Whip (technically a Lord in Waiting, HM Household); Labour)
My Lords, I beg to move that this Bill be now read a second time. The aim of the Bill is to bring home reversion plans and Ijara financing arrangements into statutory regulation by the FSA. Noble Lords will be aware that the FSA assumed responsibility for the regulation of first charge mortgages secured on a purchaser's primary residence from
Buying a home reversion plan is a huge financial decision involving the most important and sometimes only significant asset of elderly people. It can have significant implications for tax, benefits, inheritance and long-term financial planning, which need to be considered very carefully. Regulation is not designed to discourage people from purchasing these products, but to help them make informed choices, offer valuable consumer protection and ensure that there is a level playing field in the equity release market, most of which already falls within the scope of FSA mortgage regulation. Furthermore, and equally important, these provisions will ensure that Muslim consumers are able to access the growing market in Sharia-compliant home finance products while benefiting from the protections afforded by FSA regulation.
The Bill has been introduced not only to meet the needs of consumers, but also at the behest of industry, which has welcomed the news that legislation is being brought forward to level the regulatory playing field in this area. Noble Lords may find it useful if I take a moment to clarity what home reversion plans actually do. In short they are a form of equity release scheme—financial products that allow homeowners to release the value of their property above any amount owed on a mortgage. In a home reversion plan, homeowners sell all or part of their house at a discounted rate in return for a lump sum and/or income and continue to live in the house rent-free or for a peppercorn rent for life. The amount paid to the homeowner is based on a number of factors, including the value of the property, the proportion of the property sold; life expectancy of the owner(s), long-term interest rates; and expected house-price inflation. However, these are not simple products to understand, hence the need to ensure that potential purchasers receive an appropriate level of advice.
These plans are not currently regulated by the FSA and the Bill paves the way for this to happen. A home reversion plan should be distinguished from lifetime mortgage, another equity release scheme. In a mortgage-based scheme the householder retains ownership of the property, whereas in reversion plans the reversion provider becomes the owner of whatever proportion of the property is sold. For lifetime mortgages, homeowners take out a loan secured on their property, but with the interest on that loan becoming payable when the house is finally sold, typically on death or when the owners move into long-term care. These products are currently regulated by the FSA.
The other products that this legislation is designed to bring within the scope of regulation are Ijara home finance products. As I am sure noble Lords are aware, interest charging loans do not comply with Sharia law. However, Islamic law can accommodate some types of contracts to facilitate house purchase, so alternative products have been developed. There are two main types of Islamic-compliant home finance products in the UK at the moment. The first is Murabaha, where a financial institution purchases the chosen property and then sells it immediately to the individual at a higher price. The higher price is then paid back on a monthly basis over a period of, say, 15 years. The repayment is secured by a first legal charge over the property and therefore these products are already covered by FSA regulation.
The second type of Islamic-compliant product is Ijara, where a financial institution purchases the chosen property and the individual agrees to pay back the exact purchase price either over a period of up to, say, 25 years or at the end of the payment term. Ownership of the property remains with the financial institution until the payment term is up and the individual also pays rent to the financial institution over the payment term. The individual becomes the owner of the property once the purchase price paid by the financial institution is repaid. This is an arrangement not currently covered by FSA regulation.
In addition, I should note at this point that the Bill will allow flexible tenure products to be brought into the scope of regulation if that becomes necessary in the future. By "flexible tenure", I mean an arrangement that would allow a homeowner to increase or decrease their equity stake in the property by transferring interest within the property to and from a financial provider. This allows homeowners to increase their ownership when personal finances are stable and to decrease ownership in the unfortunate event of financial difficulty.
At present, the only providers of these products would in any event be exempted from FSA regulation, as they are registered social landlords or local authorities. However, in response to consultation, we have undertaken to keep the door open for regulation of these products if commercial providers enter this market in future. Any action to introduce regulation in this area would be subject to rigorous cost benefit analysis and would require secondary legislation.
As I indicated, neither home reversion plans, nor Ijara home finance products are currently regulated, because activities relating to these products are not specified as regulated activities pursuant to the Financial Services and Markets Act 2000. The fact that activities relating to reversion plans are not currently specified as regulated activities does not mean that there is not still scope for abuse. Indeed, given that some of these products, by their very nature, are aimed at the elderly, one might argue that some consumers of these products are particularly vulnerable. Not only is there a risk of mis-selling, but at present there is a lack of redress if things go wrong.
I would not wish to paint an unduly worrying picture, however. Consumers of home reversion plans are not completely without protection at the moment. The home reversion market is subject to voluntary regulation through Safe Home Income Plans arrangements. Members of SHIP 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 offer a guarantee that consumers will never owe a lender more than the value of their home—a 'no negative equity guarantee'.
However, these protections fall short of the sort of protections offered by statutory regulation and the FSA's regime. The sort of rules that one would expect to see the FSA apply to home reversion schemes under the powers granted by this Bill would include: rules to ensure that providers must advise of risks as well as benefits when advertising reversion schemes; rules on advice to consumers which would ensure advisers considered implications for tax and benefits, as well as matching the consumer's overall needs and circumstances to product features; and a requirement for firms to issue key product information to consumers in a clear and understandable format. Furthermore, FSA regulation will offer consumers access to the Financial Ombudsman Service in the event that they wish to make a complaint, and it would also provide cover under the Financial Services Compensation Scheme.
Industry has been a keen proponent of regulation for reversion plans precisely in order to remove any consumer confusion and to boost consumer confidence in the equity release market as a whole. The market in home reversion products, though growing at 13 per cent in the first quarter of 2005, remains small at less than 3 per cent of the total value of lending in the equity release market. FSA regulation is seen by many industry participants as a prerequisite of further expansion of this market. By boosting consumer confidence it will ensure that potential demand is realised and by securing the reputational risk of reversion providers it will encourage more players to enter the market.
There is a very similar story to tell in the Islamic home finance market. Here, a nascent market is developing to serve the needs of Muslim house buyers and to avoid distorting this market as it develops and ensure the same level of consumer protections across the board. Islamic home finance providers also welcome the prospect of regulation that this Bill holds out.
Having set out clearly the benefits of extending FSA regulation in the way that this Bill proposes, I should stress that we have arrived at a balanced view of the overall benefit of regulation following extensive consultation. In line with the Government's general commitment to better regulation, we have sought to ensure that the changes proposed by this Bill both are necessary and the costs justified.
A consultation document seeking views about whether home reversion plans should be regulated was published in November 2003. Following points raised by respondents to the initial consultation which demonstrated strong support for the regulation, a further document was published in summer 2004 asking for views on whether Ijara products should be included within the scope of regulation. Again, the vast majority of responses agreed that Ijara products should be regulated
The second consultation exercise also confirmed that flexible-tenure products, which allow people to buy and sell equity shares in their houses, should be brought within the scope of regulation. However, as at present the only providers of these products are currently outside FSA regulation, this will not be taken forward at this stage. The estimate of costs associated with the proposed regulation is set out in the RAA. Obviously, the precise nature of the regime will not be clear until the FSA has consulted on detailed rules and produced a detailed cost benefit analysis.
The Bill is extremely short and simple, with only two clauses. The background to the Bill is that in order for an activity to be FSA regulated, it must be carried on by way of business and specified in an order made under Section 22 of the Financial Services and Markets Act 2000. Schedule 2 to that Act sets out in broad terms the kinds of activities and investments that can be specified in an order made under Section 22. Although it includes loans secured on land for standard mortgages, it does not cover other kinds of finance provided in connection with the acquisition or disposal of land. The Bill amends Schedule 2 of the FSMA to make it clear that financial arrangements in connection with the acquisition or disposal of land can be specified in the order under Section 22 of the Act.
If the House sees fits to support this measure and the Bill is passed, secondary legislation would be brought before the House in the form of an affirmative resolution statutory instrument, which would define precisely the activities that would actually be regulated in future by the FSA. The content of that secondary legislation will be consulted on publicly to ensure that it is properly targeted and effectively focused. The FSA would also need to draw up and consult on the detailed rules that would apply to the activities relating to these products going forward. There is no reason to believe that any future regulation of home reversion plans and Ijara products would be very different from that already in place for lifetime mortgages or other products. However, it is important to note that the FSA is obliged to take account of the particular features of each activity that it regulates and to ensure that the rules it applies are proportionate to the risk posed.
I hope that I have gone some way to convince noble Lords of the considerable merits of the Bill. It will open the door to important consumer protections to be extended to vulnerable and minority consumers, level the playing field in mortgage regulation, ensure that no artificial distortions go forward, bolster consumer confidence in those products and thus help to ensure that the markets continue to develop. The Bill has found strong support among consumer groups and industry alike, was widely supported in the other place, and I hope that it will garner support from all noble Lords today.
Moved, That the Bill be now read a second time.—(Lord McKenzie of Luton.)
Lord Newby (Spokesperson in the Lords, Treasury; Liberal Democrat)
My Lords, we on these Benches welcome the Bill. It is an example of how the remit of the FSA needs to evolve and expand to deal with new financial products as they evolve and expand. At the end of my speech I shall suggest that it might be expanded a little further. The Bill is also a rare example, in my experience, of the felicitous drafting of a mere couple of clauses killing two fairly disparate birds with one stone, and the parliamentary draftsmen are to be congratulated on that.
The Bill covers two different kinds of product, the first of which is home reversion plans. As the Minister has pointed out, as people live longer and, as he has not pointed out but is the case, normal pension provisions are found to be increasingly inadequate, the demand for home reversion plans is bound to grow. In 2004 new plans amounted to £1.2 billion and new lifetime mortgages to £4 billion. Although only one of those two products is being covered today, they are broadly in the same field. Yet household wealth net of mortgages amounts to approximately £2 trillion. Therefore, there is a great deal of scope for the development of this market in the years ahead.
Despite the impressive SHIP scheme, the history of this sector is that there has been cause for concern about mis-selling. One of the reasons is that these products are typically sold to the elderly, who, although they can be extremely astute on financial matters, in some cases, as with the not so elderly, are easily bamboozled by the way in which financial advisers attempt to sell products.
That has been borne out by the mystery shopping that the FSA did in this area when it found that about 60 per cent of the financial advisers whom it contacted failed to explain the risk involved in the products when attempting to sell them.
Secondly, there has been scope for mis-selling as regards the valuation of a property, particularly at times of market volatility. Thirdly, there has been scope for mis-selling as regards the fees that have been charged for valuing properties and legal fees. Therefore, there is a series of good reasons why these plans should be covered by the regulation.
The second area covered by the Bill concerns Islamic home finance products, which is a relatively new market. However, I understand that it is growing extremely rapidly by about 70 per cent per annum. It is estimated that it could be worth some £1.6 billion within the next three or four years. As the noble Lord pointed out, the principal products within that market are the Murabaha product and the Ijara product and, I understand, the splendidly named Diminishing Musharaka product. I am extremely grateful to officials in the Treasury who produced an excellent briefing note. Before that I was completely ignorant of those products. Treasury officials produced a very clear note and briefed me personally, for which I am grateful. At a time when we are all looking for ways to encourage the Muslim community to feel that they have a stake in British society, the ability to gain greater access to housing finance on a basis which complies with their religious beliefs is doubly welcome.
While I welcome the Bill, I have a question and a proposal. My question relates to cost. In another place my honourable friend Vince Cable pointed out that on the Treasury figures the cost per company which becomes regulated under the Bill will be £475,000 in the first instance. That seems to me a very high figure. I have had recent discussions with the FSA about compliance costs. I was impressed by the steps that it is taking to reduce the length of the rule book and reduce compliance costs where it can. It is not always helped by the industry. Sometimes when the FSA goes out to consultation, the industry is not very good at coming forward with specific areas of compliance which it wishes to be rid of. Therefore, the FSA does not necessarily get the positive response that it wishes. However, will the Treasury look again at those figures and satisfy itself absolutely that a compliance regime at that cost is strictly necessary?
My proposal is that the Bill should be extended to cover property investment clubs. Property investment clubs through which investors typically purchase flats off plan—that is, before they are built—now account for up to half of all new flats purchased in the UK. Typically they offer investors the prospect of large capital gains, not least by claiming that they are selling the flats at a discount. There are, however, a number of serious pitfalls for the unwary investor. As with all financial services products, there is no shortage of unwary investors.
First, the so-called "discounts" are often found in reality not to exist. One can imagine that in a property market where prices are falling that could be an increasing problem. Secondly, very large fees are often charged by the clubs for alleged training and advice which is merely passing on information that any investor could obtain by reading the financial pages, or possibly looking up the FSA website. Thirdly, the risks of purchasing the properties are often understated. At present there is no protection against mis-selling in this area. The FSA has recognised that there is a problem and has issued a discussion document in which it suggests that those PICs which do not exercise day-to-day control over the management of a property should be classified as collective investment schemes. Those which exercise such control would remain unregulated. That appears to be an unsatisfactory distinction. It excludes from regulation many PICs which simply should be covered.
The FSA argues that to include all PICs would require primary legislation. However, such legislation—a mere few clauses—could be justifiably and logically added to this Bill and, in doing so, an area of current mis-selling cleaned up. I understand that the Council of Mortgage Lenders would support such a move. I therefore invite the Minister to use this opportunity to agree to amend the Bill accordingly.
Baroness Noakes (Spokespersons In the Lords, Treasury; Conservative)
My Lords, I thank the Minister for introducing this short but significant Bill. We on these Benches support the Bill. We have long been of the view that it was anomalous for the FSA to be able to regulate mortgage-based equity release schemes, but not home reversion plans. While we are generally suspicious of increased regulation, we are content that it is appropriate for home reversions to be subjected to the same regulatory regime as lifetime mortgages.
The lack of regulation of home reversion plans creates an undesirable incentive for providers to sell them. The safe home income plan trade body has mitigated some of the risks of unregulated home income plans, but nobody could seriously argue against the proper regulation of the whole of the equity withdrawal market on a consistent basis.
I do, however, have some issues for the Minister to address. The first is timing. We have been waiting a long time for the Government to act in relation to home reversion plans. The issue is not a new one. The Government's consultation on the regulation of home reversions was eventually published in November 2003, and the Government announced in May 2004 that legislation would be brought forward. But it then took over a year before the Bill we are considering today was introduced into another place. The Bill before us is, of course, not the end of the story, because the Government still need to bring forward secondary legislation under the Financial Services and Markets Act 2000 to define precisely what is to be covered.
The Government finished their consultation on that a year ago but, as I understand it, they have not yet issued a draft of the statutory instrument which will actually give effect to the Bill. Even when this Bill is an Act, and the Government have implemented it by way of statutory instrument, the FSA will then have to draft and consult upon the detailed rules.
This is a simple Bill. If the Government had been so minded, they could have implemented it by now. The only conclusion that can reasonably be drawn is that the Government are rather half-hearted about the issues. Will the Minister explain two things? First, why has it taken so long for the Government to get to where we are today? Secondly—and more importantly, given where we are—how long will it take for the combination of the Government and the FSA to complete the job? In other words, when will home reversions actually be within the FSA's regulatory scope on a fully implemented basis?
I have already said that we are content for the extension of regulations implicit in this Bill. That does not mean that we have no concerns about the additional regulation, particularly the costs—a subject already raised by the noble Lord, Lord Newby. The Explanatory Notes say that the costs associated with ongoing regulation of home reversions will be £5.4 million, and that there will be one-off costs of £11 million. That is not an insignificant amount, especially in the context of the amount spent by the FSA on mortgage and general insurance regulation in the past financial year, which amounted to £27 million. The costs could be even higher than those set out in the regulatory impact assessment once the FSA has drawn up the detailed rules to implement the regulation.
The financial services industry has general concerns about the cost of the FSA and the regulatory burdens that it imposes. The Government rejected in another place an amendment proposed by my honourable friend Mr Mark Field, which would have increased Parliament's scrutiny of the final regulatory impact. The Minister in another place said that the existing processes to hold the FSA to account were sufficient, but we are far from convinced of that, and we have some sympathy with the view of the Prime Minister about the FSA's over-regulation. Are the Government content with the FSA's approach to regulation in general? Will the Treasury take any specific interest in the way that this Bill is implemented in terms of the regulatory burdens imposed? Or will they just ignore the issue once enactment has been got out of the way?
We welcome the regulation of the equity release market, first by putting lifetime mortgages under the FSA and now by including home reversions. The regulation of the equity release market was necessary because of problems that occurred in the past. Indeed, even today consumers are vulnerable if they enter into a home reversion scheme before this Bill is enacted and fully implemented. I have already raised concerns about timing. The Minister will be aware of the instances where home income or shared appreciation mortgage products were sold in the 1980s and 1990s to individuals whose circumstances made those products unsuitable and who were not made aware of the risks. I am sure that he will also be aware of the many cases of genuine hardship that have resulted. We are not only talking about the role of financial advisers and mis-selling in this case; we are talking about some major institutions, including building societies, which actively marketed those products.
I know that the easy answer is that only the regulatory regime then in existence is relevant to those hard cases, and I can see a great temptation for the Government to hide behind that legalistic approach. I believe that the Government are hiding behind that legalistic approach. I have seen one recent letter in which the Economic Secretary said that the Government,
"hope that all lenders will continue to take as generous and sympathetic an approach to residual debt as possible".
Does the Minister agree that that is a weak response? What have the Government specifically done to put pressure on the lenders who are still failing to give relief to the victims of those earlier schemes?
The Minister will know that the power of government goes beyond the power to legislate. They have enormous powers of persuasion or even of coercion. Will the Minister commit the Government to using all their de facto powers to achieve relief for those locked into those early schemes? If he will not do so, will he please explain in detail for the record, and for the benefit of all those who are desperate for the Government to help them, why they take that approach?
I have concentrated in this speech on home reversion schemes. The Minister also explained that the Government intend to use the Bill to bring Ijara mortgages within the scope of the FSA's regulation. I state for the record that on these Benches we welcome that. It makes good common sense that all transactions that are in substance lending should be regulated in the same way. Regulation should not be delineated by artificial legal boundaries.
In that light, I note that the Minister said that the Government do not intend to use the Bill to bring flexible tenure products within the scope of the FSA. The rationale, as I understand it, is that those products are provided only by local authorities or registered social landlords at present. I have two questions for the Minister arising from that. First, what remedies are available in respect of local authority or registered social landlord flexible tenure schemes at present? Are those remedies at least as strong as those available for borrowing regulated by the FSA? I have in mind in particular the role of the financial services ombudsman and the financial services compensation scheme. Is there anything equivalent for flexible tenure arrangements at present, and if not why not?
My second question relates to the issue of timing, which is similar to the question I raised earlier. It has taken a long time to get to where we have on equity withdrawal regulation. What procedures will the Government put in place to ensure that they can act swiftly if any other financial schemes related to people's homes need to be brought explicitly within the regulatory net? For example, if some form of flexible tenure scheme were devised and sold by a commercial company, would the Government act immediately to bring them within the FSA, or would they wait for more financial loss and more human misery to accumulate before acting? I look forward to the Minister's reply to the questions I have put to him and also to the remaining stages of this Bill.
Lord McKenzie of Luton (Government Whip (technically a Lord in Waiting, HM Household); Labour)
My Lords, I thank the noble Baroness, Lady Noakes, and the noble Lord, Lord Newby, for participating in this debate today and for the support which each has given to the Bill. A number of questions have been raised and I will try and deal with those first.
The noble Lord, Lord Newby, referred to the mystery shopping exercise with regard to lifetime mortgages. He was right in identifying that there was not compliance. It underlines the point that having regulation is all very well, but it is important to make sure that that regulation is effective and implemented. The Diminishing Musharaka is a subsect of Ijara and therefore is potentially within the scope of the provisions that we are dealing with.
The noble Lord, Lord Newby, and the noble Baroness, Lady Noakes, both raised the issue of costs of regulation. At this stage these are inevitably an estimate of the proceedings but those estimates were based upon experience in looking at regulation for mortgages. Clearly, in due course, when the FSA has looked at its detailed rules and done its detailed cost and benefit analysis, those costs will change. The noble Baroness suggested that they might increase. Well, they might also decrease and they are the best estimate that is currently available and must be seen in the context of the benefits that will ensue from that regulation. But the Government will keep the issue under review and look forward with interest to what comes out of the FSA in due course.
On the issue of property investment clubs, we understand the concerns that have been raised, as the noble Lord, Lord Newby, identified. He is right to say that the Government have recently put out information about trying to clarify what, in their view, is a collective investment activity and that which is not, and therefore that which is already regulated by the FSA and that which is not. There are concerns and the Government remain to be convinced that for the generality of the buy-to-let market there is the need for regulation. The product is different and by definition we are not dealing with people's primary residences and—depending on the nature of the products—they are not necessarily financial products. They clearly need to be kept under review and I imagine that we will return to this at later stages of the Bill. The Government's response is that they do not currently see the need to regulate in this area.
The noble Baroness, Lady Noakes, talked about timing and asked why has it taken so long and what is the timing going forward? There is inevitably some lead time to the introduction of regulation. If we are going to get it right and if it is going to be based on consultation then that process does take some time—perhaps longer than we would all wish. In terms of moving forward, it is hoped that the secondary legislation and the FSA could be dealt with in a timescale that would mean regulation will commence in the first quarter of 2007—just over a year from now. There are still two further processes to be gone through, each of which involves consultation.
The noble Baroness raised the issue of home income plans and what had happened on them. She is right that it was a sorry tale of a product that was not properly and fully regulated at the time, and vulnerable people have suffered considerable hardship. The position is as in the letter to which she referred; namely, that a lot of lenders—most lenders, fortunately—have offered a package of measures to home-income plan investors in respect of their residual debt. The Government hope that those that have not will move towards taking a similar line.
Baroness Noakes (Spokespersons In the Lords, Treasury; Conservative)
My Lords, I am sorry to press the Minister on this point, but he will understand that there is considerable interest among a small number of people who have nevertheless suffered considerable hardship. Will he say something about what the Government continue to do in discussion with the organisations that sold the products, from which one might hope for some redress?
Lord McKenzie of Luton (Government Whip (technically a Lord in Waiting, HM Household); Labour)
My Lords, the Government are pressing those involved in lending. At the moment, I cannot give the noble Baroness a detailed, point-by-point explanation of what is happening—who is pressing whom and through what forum—but I will be happy to follow up on it and make sure that she has that information. It is impossible always to deal with things retrospectively. There was not proper regulation, which is a market failure and a failure of the process and regulation at that time. Those are the risks into which people entered at that time. Nevertheless, the Government remain sympathetic to those people whose financial circumstances, as a result of mis-selling, are pretty dire. I am sure that we will continue to do what we can within our remit to press people to try to ease the burden. I shall write to the noble Baroness in some detail about what is happening more precisely in that regard.
Flexible tenure products were raised. The amendment to the FSMA will allow for secondary legislation to be brought forward to regulate them in due course. Therefore, if products emerge that require regulation, there is scope for going through only the latter two stages and not primary legislation to have them implemented. Again, the more experience we have on regulation in the area, the shorter we hope the lead time will be to get in any additional regulation under those provisions implemented. It would be the Government's intention to act if it were required.
Parity in respect of those who have provision via local authorities or social landlords was mentioned. The remedy would be the housing ombudsman. The noble Baroness pressed me about the detail of what that might mean in comparison with what would be available to an alternative regime. I shall have to write to set that out, as I do not have the detail on that. I hope that she will accept that as an appropriate follow-up.
I hope that I have dealt with all the points raised. I thank noble Lords again for their support for the measure. We now wish to press ahead and implement it as quickly as we can.
On Question, Bill read a second time, and committed to a Grand Committee.