The Times reported that new policies being shaped by the European Union (EU) could mean that Britain’s smaller lenders including building societies and challenger banks may find it too expensive to continue providing fixed-rate mortgages because of the way the hedging instruments / derivatives would be traded.
The European Commission’s (EC) review of the European Market Infrastructure Regulation could affect competition severely with a dramatic reduction in the number of fixed-rate mortgages available unless the new rules are relaxed.
Last year, a staggering 90% of building societies’ gross lending was through fixed-rate mortgages, about the same percentage as the mortgage market as a whole. To hedge these mortgages, an interest rate hedging instrument called an interest rate swap is entered into by the lender. Under the new policies being adopted and implemented by the EC over the next three years, the system of transacting swaps between two counterparties, for example the mortgage lender and a bank, will no longer be allowed. Instead, a central EU counterparty will be established for these transactions. Does it matter? Well yes it might.
Like so many well intentioned regulations the effect might be at best to increase the cost of the transactions or at worst it could mean that smaller lenders are unable to obtain market pricing. Consumers suffer ultimately and at a time when interest rates are expected to rise and fixed rates are therefore more attractive.
Ironically, the initiative is part of a worldwide effort to make the financial system safer and more transparent. I’m all for that, but it has to be fair and considered – not necessarily a one-size-fits-all approach. While larger banks and institutions could meet the increased costs, smaller institutions may have difficulty finding partners prepared to act as their clearers because of the relatively small number of transactions they do.
There is currently some good work being done by the Building Societies Association (BSA), which is encouraging the EC to make an exception for smaller lenders. Jeremy Palmer, head of financial policy at the BSA, said: “Using derivatives to hedge fixed-rate mortgage may sound a bit exotic but it matters for all the people who want to borrow from a building society.” Hear hear I say. He added that he hoped Lord Hill of Oareford, the UK’s EU commissioner could use his influence to ‘make common sense prevail’.
It would seem the US has already exempted smaller lenders from the more burdensome standards. Let’s hope for the sake of a just and competitive mortgage market that the same will be afforded here.
Tony Ward is president and CEO at Clayton Euro Risk
