MPs who are considering alternatives to tenancy deposits have been warned of the dangers of a major mis-selling scandal that could emerge months or even years down the line.

Because a number of the new tenancy deposit replacement products are unregulated, tenants who buy them would not be able to complain to the Financial Ombudsman or have access to the Financial Services Compensation Scheme.

Landlords could also face higher risks: if an unregulated scheme fails, they could be left with unprotected tenancies.

The warnings have come from Jon Notley, one of the pioneers in the burgeoning industry.

He is calling for all tenancy deposit replacement products (DRPs) to be regulated by the Financial Conduct Authority.

Notley says that without the protections placed around the selling of regulated products, there is a real chance that customers could be misled – whether deliberately or not.

He says in a letter to members of the Housing, Communities and Local Government Select Committee who are considering the issue: “There are a small number of DRPs [businesses] that have launched fully regulated insurance or insurance-backed products.

“As regulated businesses, they are required to operate under clear rules set out by the FCA. These rules are designed to ensure that customers are treated fairly, that they understand what they are buying, and all with a particular focus on vulnerable customers.

“Regulated businesses also need to show that they are financially sound, and are controlled by FCA-authorised people who carry personal accountability.”

Notley, whose own Zero Deposit product is FCA-regulated, goes on: “I am concerned that there are a number of unregulated DRPs entering the market.

“These entrants will no have the protections in place that the regulated sector provides.

“In one example, launched by a letting agent in 2017, the tenant pays 4% of the monthly rent (plus VAT) every month.

“If the tenant stays in the property for just over two and a half years, they will have paid the equivalent of the full deposit and yet they will have to pay for any damage in full.

“There are other DRPs that – although seemingly offering a very similar product to regulated DRPs – have bypassed the FCA’s regulation.

“As such, they are not bound by the same rules, meaning that the risk of mis-selling increases.”

There are a growing number of products in the tenancy deposit replacement market.

While they differ, they are designed to save tenants the cost of a traditional deposit – which legislation going through Parliament will cap at six weeks’ rent.

Instead of a deposit, tenants would be offered the choice of an insurance product, typically costing a week’s rent. The policy covers the landlord against losses, while the tenant must pay for any damage, reflecting how costs of damage can be deducted from the traditional deposit.

The principal difference between a traditional deposit and a replacement is that with the former, a well-behaved tenant will get the full deposit back, but with a replacement product, the cost is non-refundable.

Notley says in his letter to MPs that the products must be sold carefully, and that tenants must fully understand what they are buying, including the drawbacks.

Notley says that the new DRP market can offer tenants a much needed choice, and provide landlords with protection, but there are risks that should not be ignored.

He warns that underlying problems from unregulated products could build over time, and affect “potentially thousands of tenants and landlords.

“As such it is our firm view that only fully regulated DRPs should be allowed to operate within the residential letting sector.”