FSA Regulation
Duncan Young

April 2007

On 6 April 2007 the FSA took over the regulation of home reversion plans, which includes everything from initial advising to investing. For the first time, providers had to be authorised and new rules for advisers were put in place. The industry has welcomed the introduction and, to date, all seems to have proceeded very well.

The impact of regulation is broadly twofold. We have seen changes both in the way that advisers do business and the way they can become qualified to do business.

First and foremost the new regulation extends the protection afforded by the Financial Ombudsman Service and the Financial Services Compensation Scheme to customers who entered into regulated home reversion plans after 6th April this year. The old Safe Home Income Plan Compensation Scheme is effectively replaced. Alongside this, equity release providers have had to put in FSA approved complaint procedures. So, as the FSA has stated, the regulation of home reversion plans “will result in increased consumer protection so these products will be on a level playing field with lifetime mortgages.”

This move can only be seen as positive. It is also helpful that the FSA has tried to minimise changes to its handbook so that the rules for both lifetime mortgages and home reversion plans are broadly similar.

The main areas of the handbook to be concerned with are the conduct of business and Prudential Standards. The FSA has drafted a new Mortgages and Home Finance: Conduct of Business sourcebook – which I am sure we will all learn to either love or hate! The Prudential Standards really apply to product providers and refer to regulatory capital, professional indemnity insurance and other matters of a similar nature.

One area which does not really jump out of all this, but which nonetheless is worth highlighting, is the fact that the FSA has created an equity release market with two tiers with not all investors in home reversion plans being regulated.

When the FSA conducted its initial research into the home reversion market it found there were large corporate product providers who are members of SHIP and who by and large have a significant presence in the equity release market. There was also a group of smaller investors who had no public persona but who had bought home reversion plans off brokers on a one off basis.

The FSA did not want to curtail these activities completely as some of these investors have particular niche investment criteria, for example being prepared to buy ex- council house stock or properties built on flood plains. So a rule has been instituted that if the investor does not invest “by way of business” many of the regulations do not apply to the investor but fall on the adviser.

For example there is a requirement that a valuer has to be independent of the product provider. With regulated providers this responsibility is borne by the provider but if the provider is unregulated the onus is on the adviser. This is not helped by the fact that the definition “by way of business” is somewhat vague and many people assume that if the investor buys less than five home reversion plans a year then they will not have to be authorised.

It is clear, therefore, that one impact of the new rules will be that advisers will need to know their product providers status with the FSA in a way that has not been so important before.

As with the lack of definition on “by way of business” advisers also have to interpret the FSA’s training and competency rules to fit in with the way that they want to conduct their business. But in essence as soon as the grandfathering rules, introduced by the FSA, run out advisers who want to cover the entire equity release market will have to demonstrate a good overall knowledge of the market and have passed an exam. These rules mean that if advisers have been authorised to advise on Lifetime Mortgages by 5 April 2007 they will be able to advise on all forms of equity release, including home reversions, but after 5th April 2009 advisers will need to have passed an appropriate qualification in order to advise on the full range of equity release products.

The Financial Services Skills Council (FSSC) has created a list of suitable exams to achieve this end result which can be found at www.fssc.org.uk. Making up part of the list is the new Certificate in Equity Release from the Chartered Insurance Institute. It was introduced and designed specifically to help advisers meet the new regulatory requirements for lifetime mortgages and home reversions. The CII also fast-tracked the development of a home reversion top-up unit for holders of its CF7 exam.

However, the FSA grandfathering rules have been superseded in part by a decision by SHIP that SHIP members will only accept home reversion applications from 6 April 2008 where the adviser has passed the necessary exams. This follows the principle that lifetime mortgage qualifications are essential from August this year.

So that has been the change – what is the likely impact? Overall, I would say that the qualifications are a start rather than an end in themselves partly because the exams are fairly basic and also because they will need to be augmented by further training and experience, presumably delivered by product providers.

I have read many comments on this and there is a strong difference of opinion. I have to admit to being in the evolutionary rather than the revolutionary camp. The revolutionaries see a quick return to home reversion plans having a significant market presence, but I believe that there are two issues at play neither of which will be settled at speed.

The first issue is a practical one - a lack of knowledge and confidence in the adviser community over the technical side of a home reversion and the right way to sell it. Advisers understand mortgages. A charge document or advance criteria are grist to the mill. A reversion either traditionally involves a sale and leaseback or in a more modern context an option over a trust – all very different.

To take an example of a lifetime mortgage, if the customer wants to prepay there will be a penalty charge, which could be draconian, and a mortgage exit fee and that is all. With a reversion, prepayment might not be possible at all and could involve protracted negotiation or be very simple with no penalty fee. In other words there is no standard formula. It will take more that the passing of a multi choice exam to give many advisers the confidence they need to deal with the technical side of home reversions.

This technical side, however, can be assisted greatly by product provider education and responsive operations desks. A more intractable question is the right way to sell a home reversion plan within the FSA guidelines.

If an adviser sells the technical position, ie “do you want to sell your property?”, then the number of new home reversion plans sold will be limited. If however the benefits of a home reversion plan are explained first, which can include issues such as the amount of money raised and the certainty of an inheritance, then sales will be higher. But it will take time for brokers to prepare and have confidence in their sales techniques.

Once these two issues are resolved, and this will take time, the success of home reversion plans will be dependent on the merits of the product. Home reversion plans have strong advantages over lifetime mortgages but they also raise concerns about cost due to house price inflation and life expectancy. If house price inflation is low then a home reversion plan that is analysed financially is a good deal for the customer. Also, if the customer lives longer than the mortality tables suggest then a home reversion plan is again financially sound. This is not always the case however, and so both sides of the argument must be put forward.

I believe that home reversion plans will gradually take a larger percentage of the total equity release market, with lifetime product providers having to battle for a smaller market share. This is a negative way of looking at matters and it is worth debating whether the regulation of home reversion plans will augment the equity release market as a whole. The benefit will not come from the regulation per se and its benefits of FOC and FSCS, but instead from something else.

All participants in the equity release industry know the impact of adverse publicity. There have been many issues that have needed airing and resolving, but alongside that there have also been scare stories and malign positions taken which bear no relationship to the facts. This will not stop simply because of regulation but regulation will remove one plank of criticism – namely that the whole market was not regulated.

I do believe, however, that it is incumbent upon the FSA and home reversion product providers to reinforce the new position in the media and with the public. 6th April saw a flurry of short factual articles in the consumer press all of which I am sure have been forgotten, if ever absorbed. The message needs to be transmitted loud and clear. Lifetime mortgage providers would be welcome to join in as it would help the equity release market as a whole.

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