Stephen Johnson, sales and marketing director, Commercial First, discusses the pros and cons for regulation of the commercial mortgage sector
The FSA and the Treasury have both published proposals to regulate the buy-to-let mortgage market. If these proposals are adopted, the distinction between consumers taking out a mortgage to buy their own home and investors taking out a mortgage to finance a buy-to-let business will no longer exist. Any loan secured on residential property (and this includes second charge loans) will be subject to conduct-of-business and prudential regulation by the FSA.
What could this ‘mission creep’ signify for those of us who are involved in the commercial mortgage sector? If landlords involved in the buy-to-let business need the protection of FSA regulation around them, how soon before business owners are deemed to need similar protection if they want to take out a commercial mortgage to buy their business premises? The FSA’s Mortgage Market Review (MMR) makes no reference to the commercial market, but this is certainly an appropriate time to consider the pros and cons of commercial mortgage regulation.
Regarding the ‘cons, on the matter of the distinction between consumers and businesses, home buyers taking out a mortgage on their home are deemed to be unsophisticated and therefore in need of protection. In its introduction, the MMR goes so far to suggest that consumers cannot be trusted to make their own decisions correctly – and need protecting from themselves. On the other hand, by definition a business operator requires acumen to set up and trade a business entity. This is a strong differentiation and demands a level of sophistication above that of a consumer – who needs a proportionately greater degree of protection.
Moving on from the borrower to the products, commercial finance is complicated by the variety of products on offer. Business funding is not limited to mortgage finance. Unsecured facilities, overdrafts, factoring arrangements, asset finance, equity finance, mezzanine finance, leasing, corporate bonds etc, are all additional ways in which business finance can be obtained. If only commercial mortgages are regulated you could see a scenario where other business finance options are promoted/favoured in order to avoid the administrative burden regulation would bring. Conceptually it would also be difficult to stop at commercial mortgages – as the other forms of business finance all involve risk for the borrower and why should a client raising £500,000 secured against vital machinery be less protected than his neighbour raising the same on this shop? So if a move into the commercial finance arena would require all forms to be regulated the FSA would be extremely challenged to standardise an approach across so many different product types. On the face of it the task looks overwhelming.
Focusing on commercial mortgage finance exclusively, the type of transaction in this sector is also significantly more varied and involved than a residential transaction. Commercial mortgages can typically include covenants around business performance and asset performance. They can be complicated with structured repayment terms, independent hedge/swap arrangements, and the borrowing entity and its income is a far cry from two individuals who can provide pay slips. Interpreting the borrower, its asset and liabilities and its revenue/income model can be highly subjective and in this context it is so difficult to see how prescriptive regulation can be applied.
Having reflected on the negatives, it is important to state that regulation could bring some real benefits to the sector. Just as the treasury and FSA cite the existence of fraud as one strong reason to regulate buy-to-let, bad practice also exists within the commercial sector. The recent advance fee fraud debacle is one such set of events that could hasten regulation. In addition, lack of transparency in the terms and conditions of certain facilities could currently disadvantage businesses who have not read the small print.
Some bad practices which FSA regulation has driven out of the residential mortgage market still exist in the commercial sector. For example, linked product sales where an insurance product is presented as a condition of finance or where pressure is applied to switch banking in order to receive a mortgage. This pressure and linking denies the borrower their right to select products/services independently on their merit. More generally, regulation of other markets may drive the unscrupulous operators – lenders and brokers into a non regulated market. Finally, the principles of mortgage regulation would assist the market to develop, and certainly the industry could learn a lot with regard to transparency and presentation of products and literature.
Regulation of the commercial mortgage market may not be on the immediate horizon for the Treasury – and having reviewed the challenges it would present may not be desirable. However if the market does not operate in line with the principles of TCF it is clear that the industry could find itself very much on the FSA’s radar, and with only itself to blame.
