Speech by David Geale, Director of Retail Banking, delivered at the London Institute of Banking & Finance mortgage conference.
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Speaker: David Geale, Director of Retail Banking
Event: London Institute of Banking & Finance mortgage conference at Congress Centre, London
Delivered: 19 April 2023
Note: this is the speech as drafted and may differ from the delivered version
Highlights
- Green mortgages have a growing role to play in decarbonising the UK’s housing stock by helping borrowers to improve the energy efficiency of their homes.
- This is a systemic issue, and every part of the housing value chain has a role to play – including mortgage lenders and brokers.
- Lenders risk missing their decarbonisation targets if they don’t evolve their support for homeowners to enhance energy efficiency – this is one of several reasons why brokers can expect to see an increase in green mortgage products and innovation.
- Brokers have a key role to play in helping borrowers navigate a complex and nuanced landscape in terms of green home finance.
- There are various Consumer Duty considerations for ESG products centred around suitability, and the more specific a consumer is about their requirements, the more specific a broker will need to be in the advice they give to them.
What are green mortgages?
I am here to talk to you about a topic that is becoming increasingly important in today's mortgage market – green home finance, often known as ‘green mortgages’. Let’s start by exploring what we mean by ‘green mortgages’, as there isn’t a commonly-accepted definition, and regulated returns data do not distinguish between 'green' and 'normal’ mortgages.
What we do know is that the reference to ‘green’ relates to the property the mortgage is taken out on, rather than the mortgage itself. So perhaps ‘green home finance’ is a more accurate term?
But whatever we call it, in essence we are referring to a mortgage which includes an incentive for people to either purchase an energy-efficient property, or improve the energy efficiency of an existing property. The incentives vary, but typically involve a discount to the fixed rate, or cashback payable after completion of the improvement.
Relevance for the FCA
Why is this important for us as the financial regulator? Our primary objectives are to protect consumers, promote market integrity and promote competition in the interests of consumers – and green mortgages are relevant to each of these. In addition, the Chancellor’s remit letter to us in December 2022 stated that we should consider the Government’s net zero ambitions in our regulation. We are implementing our ESG strategy, helping the UK build a world-leading ESG regime within financial services.
So we want to see mortgage lenders delivering on their net zero pledges, and consumers benefitting from homes with enhanced energy efficiency. And brokers have a pivotal role to play in matchmaking those lenders with those consumers. And we, as the regulator, will do what we can to support and encourage the industry in this relatively new, and rapidly evolving space.
Context
What isn’t new is homes in the UK – we have some of the oldest and leakiest housing stock in western Europe[2]. And while 60% of the housing stock is still EPC rated D or below, the potential for improving energy efficiency was emphasised by research which showed that if all feasible energy improvement measures were to be installed in the current stock of dwellings, 98% would be rated A to C, with just 2% in band D or lower[3]. While EPC ratings are not perfect, this undoubtedly highlights the potential for improvement.
But as we know, decarbonising the UK’s housing stock is a systemic issue. It cannot be solved by any single actor alone, and every part of the housing value chain has a role to play.
And while the cost of living crisis had made energy efficiency improvements more cost-effective than before, it still varies significantly depending on the type of improvement made, and the home which is improved. Money Saving Expert estimate that the break-even point for solar panels is between 9 and 19 years, so demand for energy efficiency improvements is still constrained by cost, while supply and skills issues also act as constraints.
Opportunities
But the Climate Change Committee wrote to[4] the Chancellor in November 2022, explaining that ‘over 60% of households can achieve levels of energy efficiency that are compatible with Net Zero for less than £1,100.’ Nine million people across the UK have no savings and another 5 million have less than £100, according to 2022 research from the Money and Pensions Service[5] (MaPS).
So the opportunity is huge – but homeowners need help freeing up the funds to make their homes warmer, and their bills lower.
Green mortgages can help the decarbonisation of residential homes in the UK, which account for around a fifth of the country’s greenhouse gas emissions. And with over 9 million regulated mortgages in the UK[6], the UK mortgage sector can be hugely influential in helping borrowers reduce emissions from their homes, as well as the costs of their energy bills.
We hosted a workshop on green home finance at the end of last year, bringing UK mortgage lenders and brokers together with leading environmental organisations to explore how green mortgages can help accelerate the decarbonisation of our homes.
We discussed how green mortgages are an essential component of lenders’ decarbonisation targets – climate thinktank E3G highlighted that emissions from mortgaged homes are estimated to account for 80% of mortgage lenders’ total emissions. If they don’t provide sufficient encouragement and influence to their borrowers to decarbonise mortgaged homes, they simply won’t hit their net zero targets.
According to the Green Finance Institute, the green mortgage sector has increased from 3 to over 50 products in recent years, although they are not always the most competitive mortgages on the market, even with the incentives factored in. But we’re now seeing lenders’ targets for green lending which significantly outstrip current volumes, so when lenders set out their strategy for achieving those targets, we can expect to see more innovation and expansion in this space.
The Government has also indicated it is considering further action and will report by the end of this year on potential initiatives for all housing tenures. This includes the possibility of legislating for new minimum EPC ratings for homes, creating further drivers for growth in ‘green’ lending.
Risks
However, while there is massive opportunity here, there are also several inherent risks. I’ve already mentioned how significant emissions from mortgaged homes are to lenders’ decarbonisation strategies, and those lenders could face a variety of issues if they fail to hit those targets – reputational or otherwise. If lenders fail to develop credible plans to meet their stated decarbonisation targets, we are likely to take a very dim view – and it could be perceived by the market as yet another example of greenwashing.
As David Postings, CEO of UK Finance, pointed out last month[7] – lending only to newly-built homes which are already energy efficient may ‘green’ an organisation’s balance sheet. However, it will not help achieve the goal of decarbonising the UK’s housing stock.
Lenders adopting a blinkered approach and targeting only to the most efficient properties would have the unintended consequence of making it difficult, or very expensive, to secure a mortgage for properties with lower energy efficiency, even if those properties could be significantly upgraded. It would also penalise those homeowners who are not currently able to make those improvements without help, and may become – or already be – vulnerable.
There is also a separate risk that innovation in products and incentives could run ahead of consumer demand.
Our workshop discussed various ways to mitigate this problem, for instance, making the incentives on offer more readily useful and useable. Many people use every last penny they have to simply buy a home, pay the legal fees, stamp duty, removals, and essential furnishings. It may not be practical or feasible to borrow additional money to fund energy efficiency when they first move in.
It also takes time to adjust to a new home, and several seasons may be needed before you can decide whether a solar panel on the roof is the best option, a ground source heat pump, or loft insulation.
And, to help address this issue, we’re now seeing some green mortgages emerging where the incentives are available at any point in the lifetime of a mortgage, meaning lenders can help borrowers decarbonise their home as and when they are ready – rather than only being available at the point of taking out a mortgage, which may be the least practical or affordable time for many.
Role of brokers
But consumers need help to navigate the landscape. Given the long-standing and trusted relationships mortgage intermediaries have with homebuyers, they have a really important role to play in the decarbonisation of UK homes.
But every property is different in terms of what is feasible and viable, while every borrower has different circumstances, knowledge, and abilities to pay. But we know many brokers are new to the opportunities that green mortgages provide. They’re not energy efficiency experts, and we don’t expect them to become so. There is no ‘one-size-fits-all’ answer for energy efficiency. It’s not as simple as saying ‘this measure costs X amount, and will deliver Y in reductions to your carbon emissions or energy bills’.
And different lenders offer different types of incentive, depending on a huge range of variables. It’s not easy to compare them, especially when some products require a jump in EPC rating, while others need a specific type of energy efficiency improvement to be carried out.
But, as was highlighted in our workshop discussions, retrofitting has a much more significant impact for decarbonising existing homes than purchasing newly-built properties that are likely to be already energy-efficient.
It’s complexity and nuances like this that make tools like the ‘Broker’s Handbook’[8] so interesting, published in February by the Green Finance Institute in collaboration with many of the organisations who are here today. It’s designed to help brokers identify the opportunities and risks, quality assurance standards, and benefits across the housing value chain, as well as the policy landscape for home energy efficiency.
Tools like this should give intermediaries the confidence and ability to provide additional value in their service to their clients - and the handbook is officially accredited as structured CPD by today’s hosts, The London Institute of Banking and Finance (LIBF). Complementary to the handbook is AMI’s www.greenmortgageadvice.uk[9] website, which aims to provide a single source of truth for mortgage professionals on what is, and will remain, a complex area.
So in a few short years, we’ve seen a rapid development in green mortgages which reflects the growing importance they have for borrowers and consumers. Yes, it is very much a systemic issue – but green mortgages can play an increasingly significant role in helping borrowers reduce emissions from their homes, and help lenders hit their decarbonisation targets, and it can be done in a way that avoids rendering some homes unmortgageable, and without leaving borrowers facing insurmountable costs to improve energy efficiency.
And brokers do, and can continue, to play a pivotal role in helping borrowers understand what their options are, and where to turn if they need additional support to improve the energy efficiency of their homes.
What do we want to see happen in green mortgages? We want to see ongoing innovation from lenders, with compelling incentives that will influence consumer decisions as they seek to improve the energy efficiency of their homes. Our Innovation Sandbox can provide support and guidance for eligible firms seeking to innovate in this way.
And we will continue to monitor the sector, making sure that where lenders have set out decarbonisation targets for the homes they provide mortgages for, they have a credible plan to achieve them.
We also want brokers to be empowered to support consumers in making appropriate decisions, tailored to their expressed needs and preferences.
And this is where our Consumer Duty impacts on green home finance. I know the Consumer Duty has been covered earlier in today’s agenda, but it is hugely important for the FCA – as I’m sure you’re all aware.
Consumer Duty considerations for ESG products
While we all want to promote sustainability, we also need to ensure that financial services deliver good outcomes for retail customers. This is where the Consumer Duty is a useful lens though which to view your ESG plans.
Firstly, when making claims that products are ‘ethical’, ‘socially responsible’, or ‘green’, you’ll need to make sure they are genuinely designed and run as such and match up with any claims made in promotions.
If not, it is likely to be a breach of the Duty’s cross-cutting rule on acting in good faith. And this is before you consider if it meets the proposed ‘anti-greenwashing’ rule we’ve recently consulted on adding into the ESG sourcebook. So please think hard about your marketing and avoid hype just to join a green bandwagon.
Where your product genuinely has an ESG element, have you correctly determined your target market? What are the needs of that market, and have you designed the product in a way that meets those needs? If your lending is designed to boost energy efficiency improvements, how do you filter those who may already be living in thermally efficient properties that are unlikely to see much benefit?
How will the product be distributed? Do the benefits it offers depend on partnerships with other firms, such as suppliers of energy efficient products, who may not be regulated financial services firms? If so, how have you satisfied yourself that where they are part of the distribution chain these firms are aligned with your values, in terms of striving for good consumer outcomes?
You should make sure that your relationships with other firms in the distribution chain do not serve your needs over your customers’ needs. For example, we don’t want to see poor customer outcomes driven by commercial arrangements such as commission levels. So, you might need to consider how fee structures might incentivise poor conduct in the distribution chain, or poor customer outcomes.
Next, does your target market understand the product? Does the product have any unusual or complex features that customers need extra help understanding?
Do your customers understand any trade-offs being made? For example, if a mortgage product is designed to help consumers raise money to fund home improvements, do they really understand the initial and potentially long-term ongoing costs involved in a mortgage, and the impact it might have on their financial situation and options in the future. Also, do they understand the benefits of the work the mortgage is funding. It may or may not lead to financial benefits, and if it does, this may take time to come to fruition. So, the customer needs to understand this.
Does the product offer fair value? Value can be thought about in the round – it’s not always about the cheapest price. But we will expect the customer to get a reasonable benefit from the product compared to the price they pay.
Finally, how are you going to support these customers over the life of the product? Will the support meet the needs of your customers – and have you thought about whether the needs of this cohort of customers might differ from others. Remember, that we will expect you to review your customer journeys, and to act where you see things aren’t working as you expected.
This may feel like a lot to take in – and we do appreciate some if it is new territory for you. It’s new territory for most of us, and it’s still evolving. But we are confident that you have the appropriate skills and judgement to continue delivering positive outcomes for consumers.