General obstacles to cross-border activity

Difficulties stemming from differences in language and culture affect many cross-border business activities. In the mortgage sector, additional obstacles include low margins, consumer preferences, transaction costs, and national property, and consumer protection legislation and enforcement of this legislation. A deterrent effect of low margins on entry will concern policymakers only if these low margins result from government subsidies.

Consumers of financial services often favour incumbents over newcomers.

Consumers are often reluctant, albeit to a deceasing degree, to switch providers and prefer an integrated service. Such behaviour also explains the continued importance of branch-based distribution, with resulting difficulties for foreign providers. Moreover, consumers tend to focus on headline prices, at the expense of new products that try to compete on other consumer options, such as risk mitigation.

In addition to these general considerations, several legal and regulatory barriers impede cross-border entry into mortgage markets.

48 In the covered bond market alone, there are currently in Europe over 70 issuers (EMF estimate), a figure that is likely to rise in the short term.

49 National regulation assumes that the current classes of bond issuers from all EU countries offer a narrow risk transformation and pool conceptually unrelated risks (such as commercial and residential loans). Risk transfer is underdeveloped, with few issuers transferring mortgage credit risk to investors. The major exception is the German public agency KfW, with its Europe-wide Provide programme). However, it is not clear that it is appropriate for the German government to effectively guarantee mortgage assets through KfW.

Transaction costs in buying and selling houses are further barriers to entry.

Taxes on house purchases and registration costs, all else equal, will lead to a lower transaction rate. In turn this will diminish the opportunity for borrowers to seek out new providers and hence for new competitors to establish themselves in the market.⁵⁰

Transactions costs incurred for establishing or altering mortgage agreements, for example in switching lenders in the event of prepayment, are significant barriers to both domestic competition and cross-border entry.⁵¹ Notary fees, legal fees and registration taxes are the most significant components of such costs, which average around 3% of the loan amount in the EU.⁵² Box 2 overleaf discusses how accessory mortgages (security instruments that are directly tied to the loan contract) create barriers to establishing or altering mortgage agreements.

European property legislation exhibits many idiosyncrasies. Profound differences continue to exist in national frameworks for valuation and registration of collateral. Different standards, or no standards at all may apply, which make it difficult for outsiders unfamiliar with the market to assess the risk of a loan accurately. In response, FGR 27 recommends high mandatory valuation standards, FGR 35 recommends further funding for the EULIS initiative,⁵³ and FGR 37 advocates the creation of a better interface between registers and lenders in the form of a permanent Mortgage Register Representative.

50 Stamp duties, for instance, range between a minimum of 1% in the UK and 12.5% in Belgium. There are also some special cases of zero-rated transactions in the UK.

51 Moreover, a reduction of those costs is likely to contribute to price transparency (i.e., less of a price distortion would arise in cases where third-party costs are not be included in lenders’ price information) and thus amplify the benefits from better information mentioned above.

52 See Lambert (2003).

53 EULIS (the European Land Information System, www.eulis.org) was a joint initiative to pool the resources of national registers from Austria, Finland, England and Wales, Scotland, the Netherlands, Lithuania, Norway and Sweden to make them accessible online on a cross-border basis. This initiative is now over and its funding stream has ended. The EULIS project was successfully finished on schedule in June 2004. The project partners have decided to continue their co-operation and are aiming to set up a live operational service in 2005.

Box 2

Accessory mortgages, legal transactions costs and the Eurohypotec proposal The legal tradition in some European countries of accessory mortgages, i.e. security instruments that are directly tied to the loan contract, is increasingly viewed as incompatible with the financing requirements of mortgage finance of today. The main issue is that altering mortgages, in contrast to changing loan contracts, triggers high legal transactions costs such as registration, notary and legal fees. A second issue is that existing mortgage lenders can block under certain circumstances the use of the collateral for a different lender or purpose.

These issues matter in a large number of circumstances. To give just a few examples:

- A borrower may want to prepay and refinance with the same or another lender. She/he would both incur transactions costs for a new mortgage and may have potential difficulties to release the existing mortgage from the old lender.

- A borrower may want to use the same mortgage to fund both the building and investment phase of a project. While assigning the first registered mortgage is an option in many systems, doing so is not perfectly secure for the investment phase lender.

- A lender and a borrower may want to agree on changing the loan amounts or the financial conditions over time - examples are adjustable mortgages, flexible mortgages and home equity loans – raising legal questions in case of accessory mortgages.

Special securitisation legislation is necessary to help lenders to assign loans or servicing rights to new investors in a cost-efficient way. Such problems would not exist if the loan contract were not tied to the mortgage. Lenders may also wish to create cross-border portfolios (and perhaps securitise them), which is technically almost impossible given the different values of the national accessory mortgage instruments.

In Europe three different approaches currently address these and other cases:

1) Gradual remedy of the negative consequences of accessoriness, e.g. by creating overriding legislation. These initiatives usually address only selected issues of high political priority for the domestic banking system.

2) A reduction of legal transactions costs, which, given the large actual differences should carry large savings potentials for several countries. However, given the need inter alia to invest in new land register systems and overcome the opposition of stakeholders benefiting from high transactions costs, such as notaries, this route seems rather theoretic.

3) Introduction of an alternative concept that limits or eliminates the accessoriness and creates a

’clean’ legal architecture with respect to the above mentioned and other cases. This is the thrust of the Eurohypotec proposal (Drewicz-Tulodziecka 2005). The Eurohypotec is based on the land charge concept. This fiduciary instrument in the hand of the borrower is linked to the loan contract only through a security agreement. Loan contracts thus can be changed without affecting the validity of the security, which eliminates transactions costs beyond the initial registration.

Clearly, the replacement and even the gradual reform of a basic property law concept such as accessory mortgages raises problems of compatibility with several other types of law.

Moreover, according to the EU Treaty, the Member States retain control of much of the affected law, which makes a European initiative difficult. The proponents of the Eurohypotec proposal thus mainly interpret it as an optional add-on to the existing national security concepts, which must be tailored to fit the national legal system. Because of this dual nature it might initially be focused on assisting cross-border trade.