The Perils of Consumer Credit Reform
Posted: Monday 7 May 2012
The Government’s plans for the reform of the Consumer Credit Act (“CCA”) are probably now far enough advanced that it is worth raising awareness of the problems lying ahead for finance companies providing credit to consumers – “consumers” in the wide sense used in the CCA, which includes sole traders and partnerships with three partners or fewer. The reform will also affect intermediaries of all kinds, including motor dealers and brokers and anyone who helps set up consumer credit deals. It is strange to consider that as this reform goes ahead, such businesses may long for the good old days of the CCA even if it does not feel that we are living in those good old days just now. Some of this proposed reform is very worrying in that it has potential to damage the UK economy as a whole, unless you believe what the Government and the FSA think amounts to reassurance.
The intentions behind this note are twofold: first, to galvanise as much lobbying from as many different sources as possible; secondly, to give a flavour of what is coming. So far, banks, consumer groups and representative bodies such as the FLA and BBA are fully engaged in the process. But the voices of smaller businesses, vital to the consumer credit market, may not be heard though they need to be. The Government is engaged in what it calls a population survey with which it hopes to reach such smaller businesses but, in practice, this may be wishful thinking, as smaller businesses are unlikely to have compliance personnel with time to respond to such surveys. It would also be useful if motor manufacturers could become engaged as, clearly, the lessening of the availability of hire purchase credit for consumers buying cars is likely to have a material adverse effect on their business.
When the Coalition Government came to power it viewed the FSA as a Gordon Brown initiative and wanted to get rid of both it and the OFT. It has thus come up with proposals to merge those two bodies together into a new body – the FCA (Financial Conduct Authority) – but the FCA will be structured and behave much like the FSA. It will issue a Rulebook (which manages generally to be even harder to interpret, far less find, than legislation) and guidance. There may be expensive bureaucracy, extensive form-filling and toothsome enforcement. The great majority of current CCA licence holders (and there are over 80,000 of them) have no experience of such a regime and, in most cases, little manpower with which to deal with it. The FCA think they have an answer to that in its so-called “appointed representative” regime (see below) but, in my view, that has little chance of success.
Proposals
There is to be a new Financial Services and Markets Act (“FSMA”), which is currently making its way through Parliament. Statutory Instruments will then be put through under FSMA transferring regulation from the OFT to the FCA. Under the present timetable the Government will consult on the detailed content of those Statutory Instruments early in 2013.
Both the Government (the Treasury) and the FCA describe the process as creating a proportionate FCA regime. They intend that, where possible, standards of conduct currently in the CCA, its Statutory Instruments and OFT Guidance will be recast as FCA Rules and Guidance where possible. They also want to discuss how self regulation and industry codes might play a part in an FCA regime. This raises the spectre of, for example, the FLA Business Lending Code becoming something of general application whether a business is a member of the FLA or not.
As part of this process the Government will identify what provisions of the CCA should be retained in their current statutory form as opposed to those which can be recast as FCA Rules. The licensing regime under the CCA will be abolished and replaced with authorisation provisions in FCA Rules.
The FCA will set standards that a firm will have to meet to be authorised to carry out consumer credit activity. This may include for the first time prudential requirements such as minimum capital and/or professional indemnity insurance. They say that they expect to implement an “appointed representatives” regime similar to that which is currently used in relation to the selling of investment and insurance products. For example, this could mean that a motor dealer would be an appointed representative of a finance company which finance company would then be responsible for ensuring the motor dealer’s adherence to the regime – see below.
Reassurances
Although they appear already to have decided that the FCA will authorise consumer credit companies and that there is to be a Rulebook so far as possible covering as many issues as can be slotted within it, they stress their cognisance of consumer credit being different from the sale of investment products and insurance and that they need to design something which is proportionate. As previously mentioned, there is to be a population survey which they hope will include smaller businesses though the reality may not match that, and there is to be an impact assessment helping to determine what regulatory approach is appropriate taking account of the risks to consumers and the costs to industry. They are aiming to complete the implementation of the new regime in 2014. Recognising, however, that they may be unable to deal with 80,000 licence-holders within that timeframe, they state that they may not have sufficient time to put everything in place for that timescale, in which case the introduction of the new regime will be phased, though no one knows how. This is reminiscent of the German newspapers’ April Fool when the UK joined the then European Community to the effect that to show solidarity with their new UK friends Germany was transferring over to driving on the left but introducing the law in phases starting with trucks and buses.
Problems
1. The nature of the FCA
The CCA and its statutory instruments may be one of the most complicated pieces of legislation ever devised. It leads to the production for every single advance of credit of huge amounts of paper which supposedly are there to ensure that the consumer has a simple explanation of what he is letting himself in for. But, in practice, as we all know, overkill means the consumer ignores the information, whilst its production is intensely burdensome for the finance company. Nevertheless, at least it is legislation and, therefore, open to legal interpretation according to what the statutory words actually say. The problem with FCA (and, hitherto, FSA) regulation is that instead of legislation, we have a Rulebook. Always assuming you can find the appropriate text (and the FSA website is notoriously impenetrable) you cannot be assured that the rules and their accompanying guidance mean what they say; it is all a matter of the spirit of what was intended. That may be fine when the regulated provider is selling investment products or insurance; it is a far less comfortable source of uncertainty when what you are doing is lending your own money on terms which you hope will mean you get it repaid under a legal obligation of the debtor to do so. Uncertainty may lead to providers leaving the market and may also, of course, mean that those who stay in increase their interest rates to cover the cost of the uncertainty.
2. The nature of the consumer credit market
As already mentioned, there are some 80,000 CCA licence holders currently regulated by the OFT. Some are banks or subsidiaries of banks; many are SMEs and of those some are sole traders or small partnerships. In the 2010 review of consumer credit, the Government through BIS demonstrated that it was familiar with the operations of the large clearing banks and bank lending to consumers. However, it also demonstrated that it was far less familiar with the activities of the finance companies engaged in the asset finance market, and it made many mistakes in implementing reform as it related to hire purchase. Hire purchase and consumer credit more generally are the life blood of the motor industry in this country and also of the asset finance market place for replacing industrial equipment in what has been called “rusting Britain”. There is a real danger that the continued lack of understanding of these market places in Governmental circles will lead to unworkable reform of the CCA with the consequence that finance companies now seek to re-model new business strategies whereby they abandon the business of financing consumers (in the wide sense of the CCA) with consequent problems for the motor industry and industrial suppliers. In a recent statement the Government commented that the focus of the consumer credit market was distressed finance for vulnerable customers. That is simply wrong. Consumer credit is how Mr and Mrs UK and their family fund their lives: get their credit card for the shopping or to book their holiday; afford the new suite; buy the new car.
3. Minimum capital
Many smaller intermediaries are lightly capitalised. Their business is such that they have no need of it. Some finance companies are lightly capitalised too, as, in effect, they act as a conduit between the larger finance company and the end user. They don’t have a need for capital: they lend money and get it repaid and take a turn on it. Their function is to reach parts of the market which the big battalions would not reach themselves or, in some cases, which they do not wish to reach themselves as they do not wish to deal directly with consumers – perhaps because of the existing problems with the CCA, far less this new regime of increased uncertainty.
It would be nice to think that the Government’s impact assessment would lead them to conclude that minimum capital requirements are unnecessary but the tendency for heavy-handed regulation gives little cause for optimism.
4. Appointed representatives
The Government and the FSA are very keen on this methodology because they see that it works in the sale of investment products and insurance. It is the only way one assumes they think that the FCA can have the manpower to deal with the 80,000 plus licensees. In other words, they want to authorise only a few major players and leave it to the major players to act as overseers of the smaller players.
But, we are dealing with a completely different economic background. Why should a big finance company take responsibility for a number of smaller finance companies at the risk of not being able to get its money back? Motor dealers will currently have arrangements with funders and with each consumer customer use a matrix to determine which of its funders is offering the best deal that month for the relevant vehicle and category of customer. Will a major bank or finance company have any interest in taking responsibility for FCA compliance by a motor dealer with which it has a relationship? Even if it is willing, presumably it has no interest in helping that motor dealer with any other funder, so alternative lines of credit would dry up. Are the thousands who can neither find a big friend to support them nor afford to get authorised themselves simply to exit the market? This is potentially a huge threat to the motor industry and the high street. The OFT has coped perfectly well with the current arrangements for 25 years; lobbying needs to take place now to try to ensure that this appointed representative regime is dropped. Its sole purpose is to make the FCA’s administration task easier.
5. Gold-plating
The most recent round of regulation under the CCA in 2010 followed directly from the EU Consumer Credit Directive. The present Government has stated that it wishes to cease the gold-plating of EU Directives as they are implemented in the UK. Nevertheless, the 2010 re-regulation of consumer credit implementing that Directive shows much gold-plating. The new legislation has nothing to do with the EU but suggests even more gold-plating of that Directive than we already have. Moreover, in many regards, the EU Directive is what is called a “maximum harmonisation” directive. That is to say, that while countries have some freedom in how they implement parts of the Directive, they may not implement those parts more strictly than what the Directive itself provides. There is some prospect, therefore, of a UK court striking down parts of the FCA Rulebook on finding that it goes beyond the maximum harmonisation requirements.
6. Judicial review
One of the defects of the UK constitution is that it has no properly developed system of administrative law and administrative courts – unlike other countries in western Europe. Over the last 30 years judges have themselves developed a system of judicial review by which governmental and quasi-governmental institutions can be brought to account for their bad decisions. Judicial review, however, is confined to the high courts and is extremely expensive. While clearing banks can afford judicial review proceedings, SMEs cannot. While there is an appeals tribunal under FSMA, that will not extend to the FCA’s application of its Rulebook, nor say to ill-advised “product intervention” – this being the proposed power to intervene to prevent the selling of products of which it disapproves. If this regime is put in place, there is a crying need for some form of administrative tribunal to which appeals can be made in a judicial manner against perceived bad decisions of the administrator.
7. Consumer hire
Hire and lease agreements with consumers are governed by the CCA. This has always been anomalous and hire agreements have not been affected by recent EU Directives nor by recent changes to the CCA. There has been no mention of these at all in the consultations to date. If, as I suggest, the Government has some difficulty understanding the asset finance market, it and the FCA may feel even less confident of the workings of the consumer hire market. What do either of them know of contract hire and contract purchase? We shall have to wait and see what is proposed here.
8. The FCA looks very London-centric – just like the FSA
In the consultation they are looking to local Trading Standards departments to help with enforcement but there appears to be no suggestion that they will use such bodies to help with the front end process. This will no doubt add significantly to the cost of the new form of regulation. It is reasonable to assume that the bill for being authorised by the FCA will be many times the cost of licensing through the OFT and, potentially, a very significant burden for small businesses – another cause of exits from the market.
Conclusions
Clearly, it is early days and it is always possible that the Government and the FCA together will actually come up with a proportionate regime for consumer credit oversight. However, even if they do – and history suggests they will not – a Rulebook regime is an uncomfortable bed-fellow in relation to the lending of your own money. The current legislation may be imperfect – and it certainly is, in spades – but at least it is legislation.
Some finance companies are already considering whether in light of this regulatory reform they wish to continue dealing with consumers or whether they can re-model their businesses so that they will only lend to non-consumers (as that phrase is construed in the CCA). Motor dealers, of course, have no option – consumers buy their cars and want finance for them, but the availability of that finance may be more restricted depending on how this reform is implemented. There is potential here for a substantial diminution of the availability of credit to consumers with a consequent serious knock-on effect on the overall UK economy. What remains available may be more expensive. The Government is consulting with a stakeholder forum on which are represented consumer groups and finance industry representative groups. The consultation is intended to be completed ahead of the required Statutory Instruments being laid in 2013. It is, therefore, important that all who might be affected now consider their position and whether they themselves are prepared to lobby, whether through their local MP or otherwise, on this matter. It would be particularly helpful if a new sector, hitherto not involved in lobbying on finance matters, were to become involved – I am thinking about motor manufacturers, manufacturers of industrial equipment and, indeed, any other suppliers who rely upon hire purchase or lease finance for a significant part of their sales. Lobbying is unlikely to prevent a transfer to the FCA; that is a purely political decision. But it may help keep more regulation on a statutory rather than a Rulebook basis, it may prevent more gold-plating of the Consumer Credit Directive; it may divert them from an appointed representatives regime; it’s worth a try.
If you would like to discuss this further please contact Bruce Wood on 0131 247 1026.
