UK regulation

Review of the Consumer Credit reforms

The Edinburgh Reforms and the future of consumer credit in the UK

Summary

On 9th December, the Chancellor Jeremy Hunt introduced the Edinburgh Reforms, a package of 30 areas of reforms including a much-anticipated and long-awaited consultation on the 1974 Consumer Credit Act (CCA).

The package of reforms, not all affecting the asset and auto finance industries, builds on proposed and existing legislation and aligns with the Future Regulatory Framework in setting out the Treasury’s vision of the future financial services landscape. It is hoped that the Reforms will stimulate lending and growth in the UK, increase competition, and make the UK an international centre for overseas investment for financial services.

These generational reviews and reforms have been enabled because of the UK’s withdrawal from the EU, allowing greater flexibility and opportunity for change.

The financial services sector has faced unprecedented challenges over the last few years and continues to face macroeconomic challenges and customers continue to be pressured by the cost-of-living crisis. Such challenges have been faced against the backdrop of a global pandemic and fundamental regulatory form in the guise of the consumer duty.

At any other time, the sector would fully embrace the reform of the CCA, but for many the prospect of further change (especially after the recent introduction of the Consumer Duty guidelines) may leave them wondering how their already stretched teams will respond.

However, there is no doubt that the reform of the 1974 CCA is long overdue and for many parts of the market it is no longer fit for purpose for the diverse and demanding needs of customers and lenders in today’s market place.

The consultation and reform of the CCA will be a long process due to numerous areas covered in the Act which are clearly outdated against today’s society, economy, and financial services sector and products.

In the video below, Wayne Gibbard, Commercial Clients and Strategy at Shoosmiths provides an insight into the reform of the CCA and some specific areas related to the asset and auto finance industry.

The consultation is broken down into 30 questions, grouped around different categories, which are very wide in their nature and will require some considerable thought in responding to and also for the responses to be assimilated by the government; this is the central issue as to why reform has been difficult to achieve in the past.

The Consultation promises to seek alternatives which are proportionate; aligned (with the implementation of the Future Regulatory Framework); forward-looking; deliverable; and simplified.

In line with recent Consumer Duty guidelines, it seems both desirable and inevitable that there should be changes to the prescriptive nature of many aspects of the CCA (agreements, notices and information) to more customer centric and focused communications.

Another important aspect of the consultation relates to information requirements. Following BREXIT, the UK now has greater freedom to review aspects of the Consumer Credit Directive and reconsider information requirements for the UK market alone, free from harmonisation requirements.

Issues raised relating to the asset and auto finance marketplace include:

1. Lending to small business – there are many nuances relating to this in the CCA, with current CCA rules impairing the operation of lending in this market which is an engine for growth. If the government’s objective is to further stimulate the economy, lending to SMEs and small business has to be central to that ambition. They could possibly remove the £25k cap and provide that all lending for business purposes is unregulated, as occurred during the COVID pandemic. The government have acknowledged that supporting SMEs is critical for the survival and growth of the economy.

2. Innovation and new product development (such as subscription type products) – access to credit and use of technology is increasing and the current CCA rules cannot keep pace with these changes causing friction in the customer journey. On balance and, given the acceleration of product development and technology, having less prescription must be desirable.

3. The transfer of rules to the Financial Conduct Authority (FCA) and their powers – link to Consumer Duty guidelines which set the foundations of what the future state may look like, along with the FCA’s likely approach to oversight and enforcement in respect of the duty. Having both the rigidity of prescription and then the Consumer Duty will cause potential conflicts in the delivery to customers. Some general guides or baseline requirements may reduce some of the risk for lenders, without creating prescription.

Voluntary terminations

It is encouraging to note that the Treasury have specifically set aside consideration of the voluntary termination provisions of s.99 and s100 of the CCA.

With regulation and oversight constantly evolving since the implementation of the CCA in 1974, there are many questions about the applicability of voluntary terminations in the market place today and whether these offer any enhanced protection to vulnerable customers, or whether they are being adopted by consumers who do not really require the protection.

Wayne Gibbard believes that the removal of the right to voluntary termination, but preservation of some form of similar forbearance in CONC for vulnerable customers, may achieve a balance between this as a protection measure and balance for the lenders’ right.

Graham Wheeler, CEO of Advantage Finance sees that the biggest cost to businesses is currently voluntary terminations, which have been abused since the CCA was established. With Consumer Duty guidelines and changing rules, Wheeler strongly believes that “voluntary terminations rights are unworkable” and present a huge cost to lenders.

According to Graham Wheeler, a new set of rules are needed that the industry can work to as the current processes are unwieldy, with many consumers abusing the VT rights.

Commission disclosure

According to Shoosmiths’ Wayne Gibbard, the transfer of the remaining provisions of the CCA to FCA rules shouldn’t have any direct impact on commission itself. Commission disclosure rules are already set in CONC, requiring disclosure where it may affect the impartiality of the broker or where it could reasonably affect the decision of a customer if it were disclosed.

CONC also elaborates about the amount of commission to be paid (being commensurate with the cost of the transaction/activity being undertaken by the broker).

However, at the current time commission is constantly present in the background of the sector, particular in consideration of the customer understanding and price & value outcomes under Consumer Duty.

While commission disclosure may be a topic for further debate, in looking at the FCA’s previous reviews (in 2019 – Motor Finance Review), Consumer Duty and the current CMC activity, Wayne Gibbard sees that there is a compelling case for lenders to consider disclosure to the customer in line with practice in other market areas, such as insurance and mortgages. This is, of course, a big change, but one which the sector and individual lenders should form a view on by April, when they are required to provide information to distributors under Consumer Duty.

While the CCA reforms will be a long-term consultation and process, Advantage Finance’s Graham Wheeler sees commission disclosure reforms as much more imminent.

Regulated and unregulated business

There are many changes currently affecting the marketplace – commission disclosure, consumer duty, CCA reform – but will they bring regulated and unregulated business together? There will be a change, according to Shoosmiths’ Wayne Gibbard, as long as objectives to stimulate the economy are at the forefront of the government’s minds. While there won’t be a blurring of boundaries between regulated and unregulated business, Wayne Gibbard hopes that there will be clearer lines about business lending being excluded.

As highlighted in the video below, Wayne Gibbard is optimistic that the CCA reforms will clarify and simplify.

If we look at these markets in their purest forms, business and consumer, Wayne Gibbard would like to see the CCA keep them separate to allow for the needs of those customer bases to be served accordingly. Whilst there may be overlap across the marketplace, they clearly have different imperatives and require different outcomes. Trying to serve both these markets through one set of rules, on the face of it, doesn’t make sense.

As Wayne Gibbard notes below, we should strive to make the case that innovation will drive the economy and frictionless transactions with SMEs is a real enabler for growth.

Transfer of power to the FCA

The origins of this new consultation stem from the transfer of powers from the Office of Fair Trading to the FCA in 2014, when some provisions of the consumer credit act were transferred to the FCA rules, but this was limited in scope. Since then, there have been several reviews relating to consumer credit, including the Retained Provisions Review in 2019, which noted the complexity in transferring the remaining provisions of the CCA to the FCA.

The transfer of the remaining CCA rules to the FCA must be seen as a positive step for a number of reasons, according to Wayne Gibbard:

  • Opportunity for lenders to have greater flexibility to serve their customers through the channels and information they deem necessary and customers require.
  • FCA principle-based (not rules) approach is a good thing.
  • The FCA have been clear that they want to stop the constant cycle of remediation activity and for cultures to change to support that. This has to be welcomed and we can already see a move towards this through consumer duty and the more collaborative approach.

However, this is a learning period for the asset and auto finance industry, from a lender and FCA perspective, with many years of learning to be done on both sides. Longer term, the consultative and collaborative approach of the FCA has to be better for lenders, consumers and the regulator.

In the future, Wayne Gibbard believes that we will see this transfer of power to the FCA as a positive move, but the journey between now and then will be difficult for all involved as we learn about the FCA’s appetite and sector view going forward.

While Graham Wheeler agrees with Wayne Gibbard’s view, he feels that “any move towards a single source of truth is a good thing for the industry” and that the best thing for the industry is a merger of the new CCA and consumer duty and FCA rule book to a new book of rules.

“Any move towards a single source of truth is a good thing for the industry.”

Graham Wheeler, Advantage Finance

Role of FLA and other trade associations

In light of the increase in principles-based regulation, trade associations and similar bodies have a crucial role to play in setting the tone for a particular sector and providing some market interpretation. Industry guidance from these associations will be able to shine a light on particular market areas, e.g. motor finance, credit card, direct lending or broker introduced, and should give more confidence to lenders operating in these spaces.

Industry guidance is helpful and has a place in the market as the FCA look at these guidelines in their enforcement guidance or through their decision principles to assess the conduct of a firm. As Shoosmiths’ Wayne Gibbard notes, “there is definitely a place for well-crafted guidance.” This allow the niche and unique area of our market place to be explained and contextualised against general rules and guidelines which may be applicable to the financial services market as a whole.

“Having industry guidance is helpful for us to shine a light on the specifics of our marketplace and how we operate in the broader context of financial services.”

Wayne Gibbard, Shoosmiths

As a director of the Finance & Leasing Association (FLA), Advantage Finance’s Graham Wheeler noted that the dialogue between the FLA and the FCA is already underway, with the FLA taking on an advisory role.

Concluding remarks

The consultation of the Edinburgh Reforms is now open and is seeking views from all stakeholders on a number of reforms including the CCA. The consultation closes on 17th March 2023 and it will be interesting to see what points will be raised that will affect the asset finance industry. Following the closure, we enter the realms of uncertainty but can expect to see packages of reform, proposed through further specific consultations and new regulation, being brought forward. However, the new CCA rules will likely take several years to implement.

As the consultation acknowledges, reform is necessary for lenders, intermediaries and consumers and is seen as a key driver for economic stimulation over the coming years.

There remains a lot to consider and reflect upon before responding to the consultation, but this has to be something which the industry embraces. The generational opportunity to update and reform archaic and antiquated regulations and provide flexibility for new product innovation and changes for the future must be welcomed.

Analysis from Wayne Gibbard Commercial Clients and Strategy at Shoosmiths LLP

Whilst we are at the start of the process for reform of the Consumer Credit Act, it is encouraging to see the focus and desire of the sector to embrace this and recognise the value this could bring to customers and their businesses.

Through an engaging discussion, we were able to get a feel for some of the current friction and complexity caused by the interplay of the Consumer Credit Act and other FCA rules, such as CONC.

Right now, the sector is focused on the delivery of Consumer Duty and the assimilation of that into their businesses. This has to be the priority, but it is worth keeping an eye on the progress of the reforms and especially the outputs from the consultation, as this will guide the new pathways to follow. Also, where there are particular pain points, these should be articulated and rationalised to guide the progress of this reform.

There is a long way to go before we see a full reform and this all remains subject to parliamentary time, but nevertheless we are now at the starting line, prepared with the marathon ahead of us!

UK regulation

Challenges arising from the new Consumer Duty

Summary

On July 27, 2022, the Financial Conduct Authority (FCA) introduced a new Consumer Duty to shift the industry’s mindset and culture, focusing on an outcomes-based proactive approach. Achieving ‘good outcomes’ is the primary focus of the new Consumer Duty, moving away from simply treating customers fairly.

The recent Asset Finance Connect Consumer Duty Unconference, moderated by Shoosmiths, brought together a broad range of participants from the lending, sales, compliance and legal communities to reflect on how the asset and auto finance sectors should be addressing and implementing the new Consumer Duty principle and rules.

“The regulators are opening up Pandora’s box.”

Wayne Gibbard, Commercial Clients and Strategy at Shoosmiths called the new Consumer Duty a process of “continuous learning” as it will require firms to constantly review and challenge processes and policy to ensure it is delivering good customer outcomes.

Wayne Gibbard emphasised that “the customer must be at the heart of everything” and there must be a change in culture with Consumer Duty embedded in a company from top to bottom.

All firms need to have completed their implementation plans (deadline was the end of October) along with supporting evidence of discussions and critical challenges to the plan. Companies should currently be conducting their gap analysis, business mapping, identifying key individuals in the company and designing regulatory processes.

Price and value

Under the new Consumer Duty rules, the focus is on the relationship between the price the customer pays to the overall benefits they can reasonably be expected to obtain from a product. The price and value outcome rules seem to be one of the most challenging aspects of the new principle.

In Consumer Duty particular attention must be paid to the key words of the price and value outcome — “assess”, “consider” and “evidence” — when assessing the relationship between price and fair value.

Many participants questioned if the price and value of a product had to be reassessed part way through a contract due to changing market conditions or a changing consumer situation. The FCA has proposed that firms will review the value of a product or service throughout its lifecycle. The frequency of reviews depends on the nature and complexity of the product or service, any indications of customer harm, the distribution strategy, the cycle of product or service review under the product and service outcome rules and other factors. A range of information will be taken into account and firms will need to ensure they have systems in place to collect whatever information they consider is needed.

When assessing value, the FCA noted that companies need to assess that the value the customer is taking from the product is reasonable, but is value different for each customer? For each customer, value may indeed have a different meaning. Companies need to consider whether there is fair value to consumers in respect of all products and services and differential pricing increases the risk that products and services do not represent fair value, particularly where consumer groups include customers in vulnerable circumstances and customers with protected characteristics. In this respect, it is critical to ensure there is a defined market for products and the sales are targeted to them, with value being assessed to ensure this is delivered to these customers.

With many financial sectors seeing a change in product type from product to a service, most notably in the motor finance sector from ownership to usership to membership (or subscription), many participants wondered if the same rules of price and value would apply. Would the customer be looking for different definitions of price and value between delivering a service and an asset? The price and value outcome of the Consumer Duty focuses on the relationship between the price the consumer pays and the overall benefits of a product, whether it be an asset or a service.

Finance products

The Consumer Duty applies to a vast array of regulated financial products from short-term low-risk to long-term high-risk products. All products must be analysed and deconstructed under the Consumer Duty with all rationale and evidence recorded.

The FCA want parity between the way a product is originated (at the front-end) and the way the customer is supported (at the back-end) throughout their journey.

Many participants noted that familiar long-standing simple products, especially those from the motor finance sector, become more complex when adding a Consumer Duty lens. When analysing products, companies should constantly refer back to the cross-cutting rules to see how they apply to each product. Data points must also be reviewed and added to product reviews, and tailored to different groups of customers. This must all be evidenced in the implementation plan.

New products to the auto and asset finance markets such as subscription and pay-per-use models are not specifically mentioned in the Consumer Duty. However, due to the flexible short-term features such as easy to onboard and easy to leave or switch, subscription is seen as a low-risk transitional product.

Other products with long-term commitment, high exit fees and ancillary products are highlighted and scrutinised in more detail by the FCA as they are seen as high risk. The FCA is focused on ‘sludge’ practices which include a number of imbalances and can cause potential harm to the consumer.

It is recommended that customers are contacted throughout long-term contracts, showing that the company have thought about possible changing situations for the customer and potential harm for the customer and how to mitigate it.

One participant noted that a company must now provide limitless information to the customer to cover every and any eventuality. Some problems arise as consumers do not read all of the legally required terms and conditions of an agreement. The information therefore must be streamlined to be understandable for different consumer groups; for the same products you will need different communication going out to different groups of customers.

With the current cost-of-living crisis, people’s circumstances can change quickly as they did during the Covid pandemic. However, the FCA have noted that not all harm is foreseeable especially during such unknown eventualities.

“The FCA have noted that not all harm is foreseeable especially during such unknown eventualities.”

Managing the distribution chain

At this stage in the Consumer Duty journey, companies should be mapping out their distribution chain and identifying any problems or concerns. Consumer Duty responsibility extends to the value chain with certain firms taking a higher level than others, e.g., captives and finance companies.

All companies in the distribution chain must know where all products originate, the components of a product and if all parts of the chain are compliant.

The main problems noted in the value chain include companies who do not have that consumer loyalty and instead purely focus on the commercial side, as well as the presence of unregulated companies who may not bound by Consumer Duty but who still need to provide information to other members of the chain.

Consumer Duty has highlighted that any detrimental activity or non-compliance with Consumer Duty within the chain can be reported by another company in the chain; this is the oversight of other parties in the chain to call out others, but this could generate friction between the parties of the distribution chain.

Many participants noted the extreme complexity of introducing a unique company process for Consumer Duty, with one participant highlighting the “challenging timeline and complexity, with no single prescribed process” within the value chain.

A recurring issue raised in the sessions was that brokers and retailers in the value chain are not receiving product information from lenders/funders/manufacturers regarding their products. They are naturally concerned that such companies might leave this transfer of information until April 2023 when companies will only have a couple of months to implement the information.

Participants found that some lenders have no urgency in providing product information and unregulated lenders won’t provide information at all, and therefore the broker or retailer will have to make a decision whether or not to use that lender going forward.

While the Consumer Duty applies to regulated activities, there was a general consensus among the unconference participants that there should be an aspiration to apply the same standards and approach to both regulated and unregulated business in the value chain, with the same culture across all businesses.

“All companies in the distribution chain must know where all products originate, the components of a product and if all parts of the chain are compliant.”

Communication

In the Consumer Duty guidance, PRIN 2A.5.3R(1) notes that a firm must support retail customer understanding so that its communications:

(a) meet the information needs of retail customers;

(b) are likely to be understood by retail customers; and

(c) equip retail customers to make decisions that are effective, timely and properly informed.

Wayne Gibbard highlighted the importance of the words “support” to enhance the customers’ understanding and “equip” so that the retail customer can make a decision that is effective and timely.

If we focus on the language, companies need to demonstrate that they are “supporting” and “equipping” their customers at a higher level than currently exists to comply with principle 12.

Many questions and issues were raised during the session focusing on communication ranging from commission disclosure to communicating risk.

The first issue when discussing consumer understanding is that it is critical to identify the target market so that the product design, communications, etc., can be built to meet the target markets’ needs. The original concept of the ‘average customer’ was removed by the FCA in the final Consumer Duty paper so it is fundamental for an organisation to know their target market and the characteristics of those specific customers, not a general population. The vulnerable customer was also a key point in the principle with communication to be adapted accordingly so as to prevent harm and mitigate risk.

Communication must be clear and transparent to the customer when detailing the product offering. It is critical to evidence all customer communication and its effectiveness as this will be measured by the FCA.

With regards to risk, many Unconference participants asked at what point should a customer be informed about product risks and should these risks be reinforced throughout the contract? The main point with risk is that if it is not communicated with the customer, then the company has not met their obligation to avoid unforeseeable harm to the customer.

While there can be an enormous amount of information for the customer to digest, they still need to be made aware of certain elements and risks within a product contract e.g., termination process and exit fees, excess mileage fee, and refurbishment charges.

There are a number of steps to analyse to mitigate risk and that involves looking at where the responsibility lies. The lender must equip the intermediary/broker with information within the distribution chain where everybody has an element of responsibility.

However, while Consumer Duty can be followed to the highest standard, there may still be risk as the company cannot totally insulate the customer. The company must highlight the risks and convey to the customer to “equip” them.

Following a change in a customer’s circumstances, the communication to the customer should be adapted to account for the changing customer’s needs. During the lifecycle of a contract, customer communication can change. There needs to be more discussions with the customer so that the company can really understand the customer and their needs and circumstances so that communication can be tailored accordingly.

Commission disclosure

Despite the fact that commission disclosure was not mentioned in the Consumer Duty guidelines, the issue was inevitably raised during the Unconference with many participants asking how a customer will see that earning commission is value for money.

Shoosmiths’ Wayne Gibbard pointed to existing rules on commission, including the Consumer Credit sourcebook (CONC) which provides guidance around what is reasonable for intermediary commission and the FCA review around commission in motor finance sector (in particular), banning certain models of commission payment.

With Consumer Duty, when analysing all elements of distribution and communication, we must ask how commission may influence or change a customer’s decision? One participant noted that commission increases competition because there is a choice.

“We must keep the customer at the heart of everything.”

Looking forward

Wayne Gibbard notes that Consumer Duty is a “challenging implementation”. With implementation plans being completed by the end of October 2022, all companies within a distribution chain must be prepared with supporting evidence available of discussions surrounding the gap analysis and the implementation plans. Any challenges to the plan must also be documented and available for the FCA.

Businesses need to mobilise on the implementation of the Consumer Duty immediately. While there will be challenges ahead, businesses must complete a full and critical review of their products and services, remain focused on the deliverables and ensure engagement with boards, senior managers and the distribution chain, but above all they must “keep the customer at the heart of everything”.

Analysis from Wayne Gibbard Commercial Clients and Strategy at Shoosmiths LLP

It was fascinating to bring together industry experts and commentors to discuss the Consumer Duty. It was clear from the discussions that firms are taking this seriously and are seeking to implement the requirements within their business. It is also evident, however, that there are many challenges for firms to consider and wrestle with throughout the implementation process.

During the discussions it was clear that there are some common challenges already being encountered, particularly as businesses start to undertake their gap analysis and present findings to the boards. These challenges will continue over the coming months and it is important to create a realistic implementation plan and not expect to have all of the answers straight away.

The FCA have noted that there are likely to be many questions and issues raised by different sectors and have promised to provide information updates and “common issues” to assist implementation. Whilst this was widely endorsed by in the discussions, it is also clear that firms will be required to be nimble in their implementation and continuously seek information and critically challenge their plans.

In addition to the work on reviewing existing products and processes, businesses need to be mindful of the future ongoing monitoring and assurance activity and any realignment of business models. The FCA have been clear that they expect businesses to be able to assess their compliance with the requirement and are likely to increase their scrutiny of this after implementation. As such, it is important to consider this and also ensure there is sufficient resource and expertise dedicated to this after implementation. This should form a critical element of the plan.

Whilst there is much work to follow, it is encouraging to see the industry step up to the challenge and critically review existing models and products in light of the Consumer Duty. Most of all, there was general consensus that putting the customer at the heart of the business is the right approach, even if the Consumer Duty implementation is challenging.

UK regulation

Consumer Duty: a seismic change

Summary

On July 27, 2022, the Financial Conduct Authority (FCA) introduced a new Consumer Duty to drive a fundamental shift in industry mindset. The new plans will ensure a higher and more consistent standard of consumer protection for users of financial services and help to stop harm before it happens.

The new Consumer Duty is intended to represent a “paradigm shift” in how the FCA regulates the retail financial markets, part of the move to an outcomes-based approach. Achieving ‘good outcomes’ is the primary focus of the new Consumer Duty, moving away from simply treating customers fairly.

Why do we need a new Consumer Duty?

The FCA is concerned that currently financial services do not always work well for consumers. The new plans will fundamentally shift the mindset of firms. Through its previous interventions, the FCA has seen practices by some firms that cause harm. These include firms presenting information in a way that exploits consumers’ behavioural biases, selling products or services that are not fit for purpose, or providing poor customer support. New rules will tackle the causes of harmful practices and will raise industry standards by putting the emphasis on firms to get products and services right in the first place. There will also be a focus on ‘vulnerable’ consumers.

Sheldon Mills, Executive Director of Consumers and Competition at the FCA said: “The current economic climate means it’s more important than ever that consumers are able to make good financial decisions. The financial services industry needs to give people the support and information they need and put their customers first.”

“Consumer duty will provide a framework, giving enough space to innovate and think about things without just making it a tick box.”

Toby Poston, Director of Corporate Affairs, BVRLA

The new rules will require regulated firms to focus on supporting and empowering their customers to make good financial decisions and to avoid causing foreseeable harm at every stage of the customer relationship. Firms will have to provide consumers with information they can understand, offer products and service that are fit for purpose, and provide helpful customer service.

The Duty will extend to all firms that are involved in the distribution chain — the manufacture, provision, sale and ongoing administration and management of a product or service to the end consumer, even if they do not have a direct relationship with the end customer. All firms that have a material influence over, or determine, the consumer outcomes will be monitored under the new rules of the Duty. Paul Parkinson, CEO and Founder of Synergy Car Leasing believes that the Consumer Duty “causes us to have a look at ourselves, and look at our people and look at our processes.”

This ongoing drive by the FCA to set higher expectations for the standard of care that firms provide to consumers will require many firms to make a significant shift in their culture and behaviour.

Helena Thernstrom, Head of Legal, Asset & Invoice Finance at Natwest concludes that “the consumer duty is kind of heralding and has as an ambition a culture change across the whole of the industry.”

The first consultation paper (CP21/13) was issued in May 2021 with the second consultation paper (CP21/36) following in December 2021 after a period of consultation. The new rules were published on July 27, 2022 with a very challenging expectation for all firms to have a gap analysis completed by October 2022 and delivery of their implementation plan by July 2023 for all ‘open’ product sales and by July 2024 for all ‘closed’ products.

How will the new Consumer Duty be implemented?

The Duty is made up of an overarching Consumer Principle, three cross-cutting rules and four outcomes that support the new Principle which are summarised below:

Principle

With Consumer Duty we have a new FCA principle where a “a firm must act to deliver good outcomes for retail customers”. Many people will be aware that there are currently 11 principles, but this will bring in a 12th principle which will consistently focus on consumer outcomes. When regulators visit firms, they will want to see how the firm is demonstrating that they are complying with this in a similar way that they will expect to see the firm demonstrating how they comply with the other principles and rules that the FCA have implemented.

Principle 12 will place a higher standard of conduct on firms than Principles 6 and 7. Principle 6 is that a firm must pay due regard to the interests of its customers and treat them fairly, while Principle 7 is that a firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading.

Principles 6 and 7 will continue to apply to conduct outside the scope of Consumer Duty e.g., certain SMEs and wholesale business.

There will be a shift to achieving fairer customer outcomes in all areas of the product or service chain. Firms will not be held accountable for overseeing the action of other firms, but should have written agreements establishing mutual responsibilities with, for example, lenders, brokers, dealers, OEMs, captive OEMs.

Cross-cutting rules

The three cross-cutting rules, so called because they cut across every sector, set out how firms should act to deliver good outcomes for consumers. They are not aimed specifically at one particular financial services product or another, but they require firms to:

  1. Act in good faith to retail customers: Firms must conduct honest, fair and open dealings and show consistency.
  2. Avoid causing foreseeable harm to your retail customers: Firms must not cause harm to customers through conduct, products or services, and they must take proactive steps to avoid it. Consumers are not necessarily protected from all negative outcomes.
  3. Enable and support retail customers to pursue their financial objectives: Focuses on the financial objectives of the consumer in relation to the financial product or service and applies throughout the customer journey and lifecycle of the product. Firms should create an environment in which consumers can act in their own interests.

Outcomes

There are four outcomes, which are the four elements that represent the firm-consumer relationship. The expectation from the regulator is for firms to think through and to show that they are demonstrating the cultural changes and the right culture for their businesses when they are demonstrating compliance with the consumer duty. The good outcomes the FCA wants to see relate to four areas:

  1. Consumer understanding – communication
  2. Products and services
  3. Consumer support – customer service and support
  4. Price and value

For each outcome, the firm will need to think about what the meaning is for them and their sector, and what the implications are for the firm in their value chain for each of these rules:

  1. Consumer understanding: Increased requirements to make sure that you are communicating clearly with customers and that your communication provides support and enables the consumer to make informed decisions about financial products and services. The consumer must be given the information they need at the right time and presented in a way they understand. Poor communication includes promoting products and services in a misleading way or presenting customers with incomplete or distorted information. Good communication, on the other hand, is communicating clearly and highlighting key risks and considering consumers’ information needs after the initial point of sale. Communication will be key to promote understanding and help customers avoid foreseeable harm and pursue their financial objectives. Firms must: (i) tailor communication; (ii) ensure information is provided on a timely basis; (iii) look at the communication channel used; (iv) test communications to support understanding; and (v) monitor the impact of communications. The FCA confirms that ‘testing’ will be an important part of the consumer understanding outcome
  2. Products and services: The products and services must be fit for purpose, designed to meet consumers’ needs and targeted at the consumer whose needs they are designed to meet. Examples of insufficient consideration include unreasonable exit fees, insufficient controls, sludge practices that discourage exit. The FCA expects firms to monitor their products and services to remain consistent with the needs of the target market and deliver the expected outcome. They must ensure that future sales meet requirements too.
  3. Consumer support: This outcome goes further than existing rules. The firm must consider the support the customer needs and make sure their customer service meets the needs of the consumer, enabling them to realise benefits and act in their best interests. Firms should make it as easy to leave of switch a product as it is to buy the product or service in the first place. Customers should get what they paid for without unreasonable barriers such as lengthy phone calls to cancel a product or service.
  4. Price and value: This is one of the largest areas in need of review within the consumer credit marketplace. Products and services should be fit for purpose and represent fair value. The firms must assess the price at the design stage and through ongoing monitoring. Firms should introduce a requirement to set prices so that they represent fair value for their target customers. Firms must ensure that the price of their products and services are proportionate to their value. For credit products for consumers with higher credit risk, the APR should still represent fair value. There are already rules on price and value so it is unclear how the existing rules will work alongside the new rules.

“The consumer duty is heralding and has as an ambition a culture change across the whole of the industry.”

Helena Thernstrom, Head of Legal, Asset & Invoice Finance, NatwesT

Impact on the asset finance sector

The new Consumer Duty will have a significant impact on the asset finance industry as it goes beyond the simple good conduct of the company to the good conduct of the industry as a whole. It is going to have a significant effect on financial services where they have long and complex distribution chains, which could potentially involve non-regulated businesses.

Adrian Dally, Director of Motor Finance & Strategy at the Finance & Leasing Association believes that moving toward a high-level principle and outcomes-based regulation will result in a seismic change for the asset finance industry. As Dally highlights, “this is all about a significant culture change. And it’s a significantly different way of looking at things going forward. And that will be seismic.”

Pros and cons

The new Consumer Duty is going straight to the core of what the FCA is seeking to do by ensuring a higher and more consistent standard of consumer protection for users of financial services and help to stop harm before it happens. The Duty puts the financial practitioner in the driving seat about how to achieve good outcomes for their customer. As a result, existing problems caused by outdated guidance and unintended consequences will fade.

The Duty positions good customer outcomes as a differentiator; rather than enforcing uniformity, it encourages the flexible and innovative servicing of customers. In the FCA’s opinion “clarity on our expectations and firms focusing on what their customers need should lead to more flexibility for firms to compete and innovate in the interests of consumers.”

As Helena Thernstrom highlights, the new Consumer Duty can be embraced by many businesses as a way to enhance existing consumer protection as well as increasing competition.

In addition to elevating the support given to consumers by firms, there is also an opportunity with the new Consumer Duty guidelines to claim competitive advantage by being transparent. Transparency and communication will be key going forward with the new Consumer Duty. The more transparent a company can be, the better the outcome for the consumer.

Many asset finance companies have already implemented excellent compliance and customer services in their business, skills that have been “honed during the pandemic and in the aftermath”. Toby Poston, Director of Corporate Affairs at BVRLA points out that many of these skills are seen as a key part in competing with their professional colleagues and the Consumer Duty will simply give businesses a roadmap to carry on trying to compete while giving them a framework in which to excel. As Poston highlights, “it’s giving them enough space to innovate and think about things without just making it tick a box.”

In changing the culture, behaviour and focus of businesses, the new Consumer Duty guidelines will allow each company to be innovative in the way they implement the new rules and principles focusing on an outcome-based process.

“It’s about changing the culture where ultimate responsibility is on you, the firm to deliver that. And the regulator won’t be giving you yes and no answers anymore. Because that hinders innovation, that hinders the focus on the customer, or the ultimate customer whom we exist to serve,” indicates Dally. “We have to get used to a new world where the future regulator won’t be telling you do and don’t. They’ll be there. It’s an outcome-based process. It is uncomfortable, but it unlocks innovation, and customer focus in many ways.”

However, there are many concerning issues relating to the new Consumer Duty including cost, implementation difficulties, monitoring issues, involvement of prominent unregulated businesses, and, at the end of it all, not knowing if the firm is actually compliant.

The new Duty will result in additional work and mounting cost when it is unclear what the impact of the Duty will be on SMEs and consumers of current practice.

Further concerns point to the implementation of the new Duty and whether simply adding the new principle on top of current ‘treating customer fairly’ rules which focus on conduct is likely to create conflicts. It will be harder to implement the new rules than current principles, with difficulties resulting from the need to monitor the effect on customer – are they receiving the intended good outcomes? The new 12th principle can be seen to be lacking in rigour.

A firm needs to consider much more than their own behaviour. Even if a firm behaves well, it can still potentially breach the new Consumer Duty if the outcome for the customer is bad. This is magnified where there are lots of people involved in determining an outcome as you need to consider the behaviour of all companies in the chain and the effect of all of them.

The Consumer Duty has implications for firms in the distribution chain who do not have a direct contractual relationship with a consumer, but who nonetheless are involved in the manufacture or supply of products and services to the consumer and who can determine or materially influence retail customer outcomes. This will require better communication between the regulated captives and the unregulated OEMs, with more data and information flow required between the partners in the chain.

For many firms, asset based or otherwise, the consumer duty may apply to unregulated business where there is a connection to any ancillary service or where the FCAs existing rules capture certain SMEs. It does not apply to any SMEs.

The implementation of the new Consumer Duty will also require a high level of data gathering and management information, with all senior managers being responsible for ensuring that their business complies with the Consumer Duty requirements. Firms will have to consider every step of the customer journey throughout the product lifecycle, including design, communications, and customer service to assess any areas which may give rise to customer harm.

The Duty must be reflected in firms’ strategies, governance, leadership and people policies, and therefore good governance and controls will be required. Internal processes will need to be reviewed and amended, while customer outcomes will need to be tracked and measured. Customer service processes may need to be re-thought, and firms could have to review their complaints handling processes to ensure issues are identified and reported with product changes effected quickly if necessary.

Many firms will simply see the new Consumer Duty as an unnecessary, timely and costly administrative overhead, and any value gained may well be outweighed by the increase in price that finance providers will need to charge to make providing finance profitable given all the extra work. And in spite of all the extra work and cost, firms will still be unsure if they are actually being compliant with the new rules.

A further concern is whether the new rules might not actually have the desired effect – for example, it may make it harder for brokers to charge for the value they add to customers. Customers do not always understand the value of a service and cheaper is not always better.

What should firms be doing now?

Now that the final Consumer Duty guidelines have been published, firms need to ensure that their gap analysis is complete by October 2022. Companies need to look at their business and make sure that their processes are in line with the new rules, and look at the following areas:

  • Assess the customer journey throughout the product lifecycle, including design, communications, and customer service.
  • Project management – look at internal processes and implement a robust set of systems in order to track customer outcomes.
  • Look at customer service systems and communications.
  • Assess product governance – what is the benefit, what is the value of your products and services?

Analysis from Wayne Gibbard Commercial Clients and Strategy at Shoosmiths LLP

As the panel has rightly recognised, the new Consumer Duty is a paradigm shift for firms and also the FCA. It changes everything (that is at least the expectation).

The Consumer Duty is one of the largest and most encompassing pieces of regulatory reform in financial services since the introduction of Financial Services and Markets Act. Emphasising the points made by the panellists, it will require significant focus from senior managers and cultural reform throughout businesses to ensure it is delivered and embedded.

It is irresistible to argue against the overriding objective of the Consumer Duty, enshrined in the new Principle 12, “to deliver good outcomes for retail customers”. The journey for businesses to reach this standard, maintain and evidence it is going to require significant investment however.

As the panel highlighted, businesses need to mobilise on the implementation of the Consumer Duty immediately.

The FCA have recognised that the implementation timetable is going to be challenging for businesses. Following their consultation, the FCA provided for longer implementation dates, in return it expects firms to be focussed and committed to delivery throughout this period however.

To ensure that the Consumer Duty can be delivered and to meet the expectations of the FCA, it is fundamental to have a well drafted and supported project. The project plan and deliverables should be regularly reviewed, scrutinised and challenged – the FCA have indicated that may request evidence of this.

There are four key dates to remember and stay focused on:

  • October 2022 – Implementation plan agreed by Board
  • April 2023 – Manufacturers should share their reviews with distributors to meet July implementation deadline
  • July 2023 – Implementation of Consumer Duty for new and existing products and services
  • July 2024 – Implementation of Consumer Duty for closed products and services

By now, businesses should have identified a senior person (ideally an independent) who will champion the Consumer Duty within their business. This individual is responsible for ensuring the Consumer Duty is regularly discussed and reviewed. The FCA expect all board members and senior managers to be accountable for the delivery however.

In addition to the appointment of a champion, businesses should also have commenced their gap analysis and be working on presentations to their boards and seniors.

It is critical to ensure the effective oversight and governance of the progress of these discussions and be mindful of requests that the FCA may make for copies of these papers and discussions. The FCA expect there to be robust discussions and challenge by businesses.

There will be many challenges ahead as businesses complete a full and critical review of their products and services. It is important to remain focused on the deliverables and ensure engagement with boards and senior managers.

The FCA have promised to provide updates and examples of good practice throughout the implementation period, so whilst plans should be robust, they should also allow for some flexibility and iteration.

Keep the customer at the heart of your business and remain focussed on ensuring “good outcomes” for them – we can all agree and align on this.

UK regulation

Commission disclosure: speaking with one voice

Summary

The asset finance industry is committed to greater transparency, but is divided on the question of whether or not to disclose both the existence and the amount of any commission payments. That was the clear message from Asset Finance Connect’s webcast on the topic, which questioned whether a broader focus on price and value across the finance ecosystem is needed, and ended with a call for closer working between lenders, brokers and trade associations and a thorough examination of the options.

Jo Davis, co-founder of specialist law firm Auxillias, emphasised that the asset finance sector is and will remain committed to commission disclosure.

The webcast, sponsored by LTi Technology Solutions, went on to debate the practicalities of what a move to enhanced disclosure could look like, with an expert panel comprising Mike Randall, board director of the Finance and Leasing Association (FLA) and CEO of Simply Asset Finance, alongside Andy Taylor, sales director of Haydock Finance and a board member of the National Association of Commercial Finance Brokers (NACFB), and David Foster, managing director of broker Anglo Scottish Asset Finance.

There is a need to continue to ensure that at least the existence and the nature of the commission is disclosed and expressly so whether or not the lender or broker is in the regulated or unregulated market, and that needs to be done with clarity and not hidden in the small print. We all need to think about what this would look like in practice, and to co-ordinate between brokers and lenders so it is done properly.

“there is a need to ensure that at least the existence and the nature of commission is disclosed… and that needs to be done with clarity”

Jo Davis, Founder, AuXillias

Driving forces

Observing that the Financial Conduct Authority (FCA) has not changed its position – that while disclosure of the existence and nature of any commission in regulated markets is mandated, it is only if the customer requests to know the amount that a specific figure is required – nonetheless Davis emphasised that asset finance sector participants are invited by their trade associations to start thinking hard about the question of disclosing the commission amount.

In the motor finance sector, the recent Wood case has shone a light on the issues around disclosing the existence and the amount of any commission. The asset finance industry does disclose the existence of the commission because firms are invariably required to disclose the existence of commission amounts pursuant to CONC 4.5, and therefore the FCA’s own rules already preclude Wood from being applicable. In addition, there is a whole list of distinguishing features in the motor and asset finance industry that support that Wood does not apply.

So where are we?

On regulated agreements, which as an industry even on unregulated deals, the asset finance sector takes into account, the FCA has not changed the rules – it is still the case the commission amount is disclosed upon request. In its paper around the change in commission models for the motor industry the FCA stated: “we are not convinced issuing more prescriptive rules and guidance would improve customer outcomes in a way that would justify the costs involved. Increased prescription on what to disclose, how and when, is likely to be counterproductive given the range of products and commission arrangements across the entire consumer credit industry.”

We know that the Financial Ombudsman Service (FOS) has written to a number of dealer groups who have these claims sitting with them. The letters asking for views on these ‘complex’ cases and specifically, their opinion on whether the recent Court of Appeal judgement in Wood v Commercial First Business Finance Limited & Others [2021] EWCA Civ 471 (Wood) was relevant to these types of claims within the motor retail sector. My understanding is that FOS have confirmed that they had suspended the investigation of Commission Disclosure cases submitted by claims management companies (CMCs). The FOS plans to carry out a full review into the whole CMC activity in this area and will then look to provide clarity and parameters on what it will take on as complaints as an output of that Review. This is likely but not definitely going to cover time barring and the prevailing FCA guidelines at the point of inception of any finance agreement. No specific timescale for the review was provided.

Source: Auxillias

However, both regulators and the public are increasingly demanding greater transparency in financial transactions, and in response the asset finance sector should ensure it can demonstrate it is operating in good faith. While every case is different depending on the roles of the lender and broker, against this background, Davis emphasised that both groups need to ensure they can demonstrate the fairness of the terms on offer and the fairness of the customers’ bargaining power. With regulators focusing on duty to the consumer, the price and value outcome becomes a critical consideration, particular in relation to retrospective claims of unfair relationship.

“In the asset finance market we haven’t been required by the regulator to review non-motor commission models (although the industry have ensured that they do not operate models similar to DIC models) that were banned in the motor market in Jan 2021. The asset finance industry have not yet gone through a review on commissions similar to the DiC review in the motor finance market.

But one of the things to address first is pricing in every single market. Are commissions too high, or are they adding value?” Davis pointed out.

Who makes the disclosure?

The FLA has been considering a recommendation that lenders should be the ones to disclosure payments made to brokers, although an immediate concern is that such a disclosure would not differentiate between income paid direct to the broker or intermediary and fee income passed on to other participants, such as the retailer at point of sale.

In view of the need to identify and mitigate any unintended consequences from such a move, the Asset Finance Connect panel agreed that lenders and brokers should work to build a common approach and speak with one voice, or risk seeing regulators impose a regime which may present disadvantages and difficulties for both.

Watch Mike Randall explain why he’s taken on his FLA role to help make this happen:

While Andy Taylor is clear that the gap between the two sides must be bridged:

And David Foster underlines the strength of feeling within the broker community:

Mike Randall pointed out that currently there is no clear definition of what disclosing the amount of commission means or what it would entail for the regulated and the unregulated sectors, suggesting a much wider conversation around potential options needs to happen. He, along with the other panellists, underlined the need for both the FLA and the NACFB to be on the front foot about how any changes will be implemented.

“I want to try to get lenders to understand what this is and agree a way forward, which is also in agreement with the view of the broker community. A high proportion of the lenders in the FLA rely on the broker channel to serve SMEs – there is commonality between the two groups and it’s imperative that we get this right”

“lenders in the FLA rely on the broker channel to serve SMEs – there is commonality between the two groups and it’s imperative that we get this right”

Mike Randall, CEO, Simply

For his part, Foster pointed out that brokers represent the “boots on the ground” for a lot of funders and yet while broker commission may be disclosed in future, a lender’s sales team on permanent salaries would not be required to share details of their bonus arrangements on a particular deal.

This sensitivity is important in the asset finance sector as, unlike the motor finance area where an applicant is able to drive away a vehicle on conclusion of a deal, the outcome of the deal and any commission disclosure, is markedly different.

What are the consequences?

At first glance, disclosing the amount of any commission looks like a move to level the playing field for all participants, but the panel pinpointed a number of potential stumbling blocks, including:

  • customer focus is distracted from other consideration, such as the APR, because of the emphasis given to commission rates
  • brokers and lenders withdraw from regulated business because it is too complicated to comply, reducing choice for consumers
  • while brokers may be prevented from perceived profiteering with high rates, they may also be barred from being competitive with offering lower rates

David Foster explains his concerns about unintended consequences:

While Andy Taylor underlines concerns around reducing funding to SMES

Jo Davis emphasises the need for a holistic view of any deal

and Mike Randall raises the question of what is best for the customer

Coming together

To avoid the creation of a two-speed regulated/unregulated market, and choking off funding to groups such as SMEs, the panel was unanimous that the main industry bodies need to work closely together to explore how why commission disclosure would operate. Both Randall and Taylor pledged to find ways for the trade associations they represent to start to do this, with regular updates on progress.

Mike Randall discusses the case for strengthening the links between funders and brokers:

Andy Taylor calls for a joined up approach between the FLA and NACFB

For her part, Davis underlined the need for action across a broad range of options, to meet the challenges facing the asset finance sector, encompassing not only the voluntary decision on commission disclosure but also price and value considerations. In Davis’s opinion, the commission models, price and value considerations need to be undertaken first.

Analysis from Jo Davis co-founder Auxillias and head of IAFN compliance community

As contributions to the AFC webinar demonstrated, discussing commission disclosure prompts strong debate within the asset finance community. On one hand, there is concern that done badly, it will disrupt the financial stability of the market and reduce competition. On the other, some voices believe that it would create significantly more transparent outcomes for consumers.

The industry is divided on whether or not full disclosure of the amount of commission is something that is necessary when the regulator or case law (with any persuasive authority) does not dictate this to be the case within our sector, coupled with concerns about the operational changes, additional resource, upskilling and training required. And of course we need to remember that both lenders and brokers are still in early discussions on this and as yet no conclusion has been reached.

However, it’s my view – and this was echoed at the conference – that the industry needs take a wider view of the issues and to be reviewing its price and value proposition first. This needs to be done anyway in light of the proposed changes on Consumer Duty by the FCA, and it is potentially a complex process.

In brief, Consumer Duty is much wider than treating customers fairly requirements (TCF), with the regulator seeking an industry-wide shift in the treatment of retail customers. It will not apply directly to the unregulated market, but as the asset finance market has a mix of regulated and unregulated products, firms are likely to be caught and therefore need to consider the FCA proposals as the timescale for implementation currently proposed is tight.

We already know with Consumer Duty, the regulator has put the onus on firms to undertake fair value assessments, and ensure the total price paid by consumers is reasonable in relation to the benefits offered by the product or service.

Price is the most important aspect of any business model, so hence the level of important the FCA places on this. We’ve seen with price interventions in other markets the FCA can make a significant impact.

Price and value outcomes

When considering price and value, a key starting point is to look at where do the profits come from? Which part of the supply chain is generating the most profit? If the business model is built on a long distribution chain like asset and motor finance for example, with cross-subsidies and tangential revenue streams, it is more likely that the model will need a full review as there will likely be risks to address and the model be open to challenge.

Manufacturers and distributors must be able to obtain sufficient detail, in order to undertake a value assessment, or otherwise it will be very difficult to justify the continued sale of the product.

Here are some example questions for manufacturers that might be applicable for the asset finance market:-

  • Could I demonstrate fair value across all customer types – including vulnerable customers who may have a different experience of the product?
  • Does my value assessment hold true for closed book products?
  • Are my senior managers clear they will be accountable for the outcomes of the value assessments?
  • Does the funding represent the economic life of the equipment?

And a couple of examples of questions for distributors:-

  • Do I fully understand the nature of the product, and the benefits and limitations the customer receives at point of sale?
  • Am I able to obtain from the manufacturer sufficient information in order to make a value assessment and can I show that the services I provide add value?
  • Could I demonstrate fair value across all customer types – including vulnerable customers who may have a different experience of the product?

Looking to the future

While one argument against moving to voluntary disclosing the amount of the commissions is that customers typically have little interest in the amount of commission and rarely ask, there are also arguments in favour regarding the voluntary move to the disclose of the amount of commission such as why would anyone be reluctant to reveal the existence of commission, or its value, assuming that it is fair value?

The challenge comes in circumstances where a finance commission is subsidising a less profitable part of the transaction. The overall price paid by the customer may be correct, but income to the seller is distributed badly, and hence the reason why the price review is important.

However, I think price and value will be challenging to resolve at an industry or trade body level, given that those functions need to be very clear that price is not discussed between competitors. That said, a general framework or set of principles could be established.

But to get to a truly circular economy, where assets are routinely used, refurbished, reinvented and recycled, requires a lot of work. Marije is clear that the asset finance industry as a whole, needs to get together to work effectively on this, and to align to manage some of these topics.

Not least of the challenges is the complexity of the reporting required, and that is an area where the sector will want to collaborate to ensure its particular requirements are acknowledged. Working groups are already being contemplated to tackle such reporting issues, and the asset finance industry needs to unite to make its voice heard. Finance providers will want, for example, to be part of the discussion on how to measure and report on their material emissions – the Scope 3 emissions that come from upstream asset manufacture and downstream usage of assets. There is no doubt, however, that the push to make more of the assets available is set to be a guiding principle for years to come. The asset finance industry has a clear role to play, given the wealth of data available on asset usage, maintenance, output and lifecycle.

AFC is ideally placed to help the industry create communities and working groups that can bring together ideas and solution for everyone.