Those advisers working in the residential mortgage market may be looking wistfully at the commercial sector’s freedom from statutory legislation. But while commercial lending may not fall under the remit of the Financial Services Authority (FSA), the sector is governed by an effective self-regulatory regime.
The Mortgage Code and the Mortgage Code Compliance Board (MCCB) are only concerned with residential mortgages, and while the Council of Mortgage Lenders (CML) has many members with a commercial lending arm, it too does not concern itself in this area.
Bernard Clarke, communications manager of the CML, says: ‘We are concerned with residential lending and focus on the consumer market. Commercial mortgages are essentially business transactions between one party and another and I do not see the need to have representative bodies involved. When mortgages are consumer focused there is more interest in setting a policy framework that gives guarantees to clients.’
The FSA does not concern itself with the commercial sector either. Rob McIvor, press officer for the FSA, says: ‘It is not within our brief to cover commercial lending, the focus of FSA regulation is concerned with first charge residential mortgages.’ He adds that he is unaware of any future plans to regulate the commercial sector.
Of course the fact there is no significant statutory legislation driving the structure of commercial lending does not mean there are no controls in the market. However, with no umbrella regulation the issues are different for lenders and intermediaries.
The commercial mortgage market encompasses any commercial deal, from a one bedroom flat bought as buy-to-let investment to a multi-million pound development.
According to Tony Armstrong, director of communications at Northern Rock, commercial lending can be complex and as result full-blown regulation would be difficult to implement.
He says: ‘Commercial lending is a broad subject. This is a market that operates within its own sphere because of the technical nature of some of the deals undertaken. Normal residential mortgages only concern a few parties, but the parties involved in commercial transactions can encompass regional development companies, grants, State aid, enterprise funding and specialist lawyers or accountants.’
Keeping lenders in tow
Any commercial lender would almost certainly be signed up to one of the industry’s self-regulating bodies and be bound by a code of practice. These include the British Bankers Association’s Banking Code and the Financial Leasing Association’s code of practice. These often include provision for some sort of arbitration for any disputes. Many lenders are signed up to the Financial Ombudsman Service, which protects clients with small businesses. A small business is defined by the service as having a turnover of less than £1m a year. However, membership of one or more of these organisations, although common, is not compulsory.
One area of legislation which heavily affects commercial lenders is money laundering regulations. In this case it is the flow of money that is being regulated, rather than the mortgage itself. The structure of commercial mortgages can often make money laundering compliance difficult, for example, a deal with a company will involve a check on all directors in respect of money laundering legislation, if there is a trust involved then this extends to the trustees and beneficiaries. Alternatively, if it is an offshore company the legislation still concerns all directors of the company and even its parent company.
Peter Townsend is director of UK regions with Specialist Property Finance, the commercial lending arm of the Bank of Scotland.
He says: ‘The money laundering regulations require you to ‘know your customer’ and because a commercial mortgage may have a complicated structure of companies around it, the lenders are compelled to ensure they know all the parties and can identify them. Money laundering compliance is more stringent and complicated than it would be for a residential mortgage sold to an individual.’
Another legal aspect lenders must keep an eye on is the interest of wives in matrimonial homes that are used to secure business lending. Townsend says: ‘Where the spouse is involved there is a great amount of case law ensuring the spouse has totally independent legal advice. Regulation sitting around commercial lending is more case law driven than regulatory driven.’
There is, however, an area of overlap with the FSA. CP98, now abandoned but soon to be resurrected in a different guise, outlined certain situations where the FSA believed it should be involved in commercial deals. This included certain types of commercial mortgages where there was an element of residential use such as a shop with a flat above.
Another example would be any situation where a first charge was taken out on a residential property, although this is not a common occurrence in the commercial lending field.
Paul Thompson, director of commercial lending intermediaries Acorn Commercial Finance, explains: ‘If a deal involves a commercial loan with a house as security on the loan, then it is a commercial deal and not a residential deal as far as the lender is concerned. However, if we are raising money on somebody’s house in order to put into a commercial deal, that is a domestic mortgage, and we would use a domestic mortgage broker.’
It is probably reasonable to assume the new FSA regulatory regime for residential mortgages will include this area of overlap, as it was not one of the contentious issues in the old CP98.
Acorn is not signed up to the Mortgage Code. Thompson says: ‘We were looking at this at the end of last year and thinking of signing up to the Mortgage Code, but we do not deal with residential mortgages. We stick to the National Association of Commercial Finance Brokers (NACFB) code because it protects us as well as our clients, but there are brokers who do not.’
The company was previously regulated through the Mortgage Code for the occasional case that came their way, but now passes out any residential cases.
The NACFB is, in many ways, the commercial broker’s equivalent of the MCCB, and hopes that as in the residential mortgage market with the Mortgage Code, lenders will only deal with their members. Its belief is that establishing measurable standards of professional practice in commercial funding is vital to the integrity and future well-being of the industry.
A call for action
Keith Heron, chief executive of the NACFB, says: ‘We feel there should be some form of regulation and that our code should form a basis of that regulation ‘ a voluntary code.’
He feels this is especially applicable for the buy-to-let end of the market. The organisation has a complaints and disciplinary procedure, and acts as a lobbying body making representations to ministers and Members of Parliament. It has also introduced a qualification, an Institute of Financial Services Diploma in Commercial Finance.
Heron says: ‘We introduced the diploma a year ago. We wanted to show the market there could be more professionalism and a raising of standards.’
To sum up, the commercial lending market has no regulation other than voluntary codes of practice. Individuals, or small businesses, that are in dispute with lenders may have recourse to the Financial Ombudsman Service, or some other form of arbitration, which would encompass most of the buy-to-let market. This would only apply to the lenders, not the brokers. Intermediaries have only one organisation offering self regulation, the NACFB, which offers an arbitration service. So what are the feelings for any future regulation?
From a lender’s perspective, Townsend says: ‘In the mid to large business community I do not see any demand for regulation because the bigger the business the greater the control of the terms and conditions it will sign up to. The consumer needs protection as an individual against a large organisation and the same goes for the small business. However, sizeable businesses have status to command an equal position with the lender, which is why regulation has perhaps not developed in our industry as it has elsewhere.’
Thompson, as a broker, agrees, but would like to see more self regulation. He says: ‘I would prefer regulation to remain voluntary because statutory regulation is such a big hammer to crack a small nut. What would be an advantage is if banks would not deal with brokers who were not NACFB members in the same way as the Mortgage Code works. It is a complex industry to regulate; we have deals from £20,000 to £20m, but as a broker we are fairly well protected. We are the introducer of a client to a lender so as long as we are upfront and explain the deal and fees then we cannot go far wrong if we stick to the NACFB code.’
Paul Robertson is a staff writer
The FSA may tackle mortgages that are part residential, part commercial.
Lenders usually sign up to voluntary regulators such as the Banking Code.
Members of the National Association of Commercial Finance Brokers follow its code of practice.