Article originally published in Mortgage Introducer July 2022 – page 17
KYC. Know your customer. It’s a fundamental for any business hoping to succeed; it’s also a regulatory requirement and critical anti-money laundering and fraud avoidance tool.
Intermediaries, by their very definition, have more than one customer though. First and foremost is the client. Understanding their financial situation, competence and needs to allow you to advise on the most appropriate product or service for them.
But there is another customer sitting in the background, several steps away from the day to day of mortgage advice. The investor.
Of course, not all mortgages are funded through securitisation, but as with a lender’s credit committee reviewing risk appetite based on back book exposure, so the saleability of a securitisation rests on the aggregated risk profile of that book.
Asset quality is one component. Borrower affordability and creditworthiness are others. A third is emerging as vital for mortgage books to meet investor requirements. Climate exposure.
Towards the end of last year the Financial Conduct Authority published two policy statements confirming rules and guidance to promote better climate-related financial disclosures based on the recommendations of the Taskforce on Climate-related financial disclosures (TCFD).
The FCA said: “Better corporate disclosures will help inform market pricing and support business, risk and capital allocation decisions. And improved disclosures to clients and consumers will help them make more informed financial decisions. This, in turn, will strengthen competition in the interests of consumers, protecting them from buying unsuitable products and driving investment towards greener projects and activities.”
The new rules are being rolled out in phases with publicly listed companies among the first required to submit formal TCFD disclosures. From 1 January 2022, larger FCA-regulated asset managers and asset owners – including life insurers and pension providers – have also had to disclose how they take climate-related risks and opportunities into account in managing investments. The rules apply to smaller firms from 2023.
How does this translate for mortgage intermediaries?
Having to abide by these rules is designed to change corporate and commercial behaviour in order to reduce carbon emissions and meet the UK’s legally binding net zero targets.
Changing the rules, means changing what banks can lend against and what third party investors will fund. It’s not just asset managers buying into securitisations, TCFD affects capital market appetite, warehousing funding lines and where publicly listed, bank funding.
The buy-to-let sector is where this is becoming most obvious on the front line, underpinned by incoming regulation requiring minimum energy efficiency thresholds on new and subsequently existing assured shorthold tenancy agreements.
Though government has stated it wants existing residential property, be it privately owned or rented, to be Energy Performance certificate band C or above by 2028, TCFD may accelerate the need for this shift.
Obviously, enforcing EPC minimum band thresholds is possible only when a property is bought and sold under existing regulation – something bound to slow energy efficiency improvements across the UK’s housing market. But regulations can and do change.
We are all aware of how front and centre ESG – environmental, social and governance responsibilities – has become across commercial activity in all sectors. The next stage will be more granular application of this awareness. Turning nice to have into need to have.
Lenders and their intermediaries have a real opportunity here.
There is already a filter which exists by virtue of there being an adviser in the transaction chain. Unsuitable borrowers, those who simply cannot afford to buy and those whose credit record makes them too big a risk for any lender to approve finance for are all filtered out before the application ever begins. The broker’s judgement is part of the value intermediaries offer lenders.
There’s also a filter on the security front, though it’s less restrictive at the moment. All brokers know a flat above a curry house, fish and chip shop or late night drinking establishment is going to limit mortgage options for a prospective borrower. Ditto Japanese knotweed, bamboo, subsidence, etc, etc.
Now, climate-related risk is baked in to criteria for the biggest lenders in the residential mortgage market. It will only become more important – a sort of climate credit rating for a home.
As it stands the EPC is probably the best tool to assess that climate risk, along with mapping of flood plains and areas where ground movement is more frequent.
It seems inevitable that energy efficiency will have an increasing impact on asset values in the future, while properties located in areas with greater exposure to more extreme heat and precipitation are likely to become higher risk for underwriters.
Everyone will be drawn into this and understanding what data is available and how quickly in the process will enable intermediaries to add real value in this regard to their respective clients and lenders. Brokers will be drawn in to aid as the frontline filter when it comes to this evolving criterion. Understanding that early, could prove a real competitive advantage.