On 17 May 2018, the FCA published for consultation its proposed new guidance on `Fairness of variation terms in financial services consumer contracts under the Consumer Rights Act 2015'. The closing date for this consultation is 7 September 2018. Although the consultation specifically focusses on the fairness of variation provisions, the FCA talks about the requirement for firms to make sure that the terms of consumer contracts in general are fair and drafted in plain language. The FCA explains that: "The senior managers' regime specifies principles of accountability. In line with these, we expect firms to allocate appropriately responsibility for ensuring that consumer contracts are fair and transparent under unfair terms law to an appropriate individual in a suitable role at the firm." The senior managers' regime came into force on 7 March 2016 for deposit-taking firms, and is due to come into force for dualregulated insurers from December 2018. The FCA's expectation is that commencement of the regime for solo-regulated firms will take place in mid-to-late 2019. The actual commencement dates will be announced and set by Treasury in due course. What is clear is that the FCA expects that resource is devoted within firms to review consumer contract terms and products to ensure there is compliance with the unfair contracts rules now contained in the Consumer Rights Act 2015 (CRA).
What does the FCA say is good practice for regulated firms?
The FCA sets out 16 examples of what it considers is good practice for firms . These include the following: Frequent reviews of all consumer contracts for fairness and transparency, Assessing contracts as part of regular product reviews throughout the product lifecycle to ensure a firm can
demonstrate it is treating customers fairly, Reviewing contracts after having received complaints, cancellations or evidence that terms may be u nfair, Reviewing undertakings obtained by the FCA / CMA about terms in consumer contracts , and Improving staff training to ensure staff meet the standards set out in product literature. It is clear from this that the FCA expects firms to be proactive and for there to be regular reviews. With the SMR in force, the accountable individuals within a firm will need to ensure that this culture is embedded within the firm.
What does the FCA say is poor practice?
On the other hand, the FCA sets out these 5 examples of what it considers to be bad practice for firms: Internally-focused reviews of consumer contracts of what looks fair without consideration of external legal or
regulatory information, Being passive and relying on external publications through monthly emails, Reviewing external publications and updates only during the annual review of consumer contracts, Not assessing contracts for fairness frequently resulting in contracts containing out -of-date material, and Relying on external compliance firms without checking or questioning their work. Firms will need to assess whether their existing practices fall within these poor practices and , if so, make appropriate changes.
Factors to determine if a contract variation term is unfair or not
The FCA sets out 11 factors that it is says it will take into account in determining whether or not a variation term is unfair or not. This list is as follows: Has the firm included the variation term to achieve a legitimate objective? Are the reasons to justify amending a contact term no wider than is reasonably necessary to achieve a legitimate
objective? The variation term permits a change to the contract. Is the extent of that change no wider than is reasonably
necessary to achieve a legitimate purpose? Are the reasons justifying amendment objective or not? Is it possible to verify whether or not the reasons justifying amendment have arisen or not? Does the variation term allow for variations:
both in favour of the consumer and in favour of the firm (e.g. price decreases as well as increases), or only in the consumer's favour? Are the reasons for variation clearly expressed? Will a consumer understand at the time the contract is concluded the consequences that a change to the terms might have for him or her in the future? In relation to price variation: does the contract set out the method for varying the price? will a consumer understand the economic consequences of the variation term? What, if any, notice of the variation does the contract require the firm to give the consumer? Does the contract give the consumer a right to terminate the contract before or shortly after any variation takes effect? To what extent could that right be freely exercised in practice? Does the variation term strike a fair balance between the legitimate interests of the firm and the legitimate interests of the consumer?
Reasons given by firms for variation
The FCA gives its view on these 5 reasons used by firms to justify contract changes changes in technology or systems, regulatory requirements, legislative changes or court/FOS decisions, changes to cost of funding, to enable a firm to remain competitive, and any other valid reason Helpfully the FCA says the first 3 reasons are generally likely to be valid. However, the FCA explains that the fourth reason is unlikely to be valid. Similarly, for contracts of determinate duration, such as a 3 year loan, the FCA says that the fifth catch all reason is 'unlikely to be valid,' but for open ended contracts such as a bank current account, there may be more flexibility.
Mortgage lending and SVRs
From an industry perspective, there has been concern about the standards of fairness to apply when setting a standard variable rate in line with the CRA. The FCA makes a couple of helpful comments on this point in the Guidance Consultation. It explains that:
"In relation to certain variable interest rates, such as SVR rates, the main influence on the level of a firm's variable rate is the firm's cost of funding, which takes account of many factors specific to that firm. In 2007-08 the financial crisis both reduced available sources of funding for firms and increased the cost of it. Whilst a departure from historic patterns may be discernible since the financial crisis between, for example, SVR rates and reference rates such as the Bank of England base rate, this is not a reliable measure of the existence of harm."
The FCA goes on to explain that harm is more appropriately assessed by considering the relationship between the variable rate charged to consumers and the drivers behind setting that rate. Helpful ly, the FCA concludes that the, "evidence of our day-to-day unfair terms casework to date suggests that in general firms' adaptation to the changing costs of their funding over time has not led to widespread harm to consumers."
Helpful comments from the FCA
The FCA make a number of helpful concessions:
It says its day-to-day case does not suggest that variation terms have generally been used in a manner likely to cause widespread harm to consumers,
It is not proposing to conduct a proactive review to assess the fairness of variation terms entered into before the finalised guidance comes into force.
Influence of decisions from the CJEU
This draft guidance is influenced from a number of recent decisions from the Court of Justice of the EU. It has had to rule on a number of cases (with a number still pending for hearing or decision) on the scope of the umbrella 1993 Unfair Contract Terms Directive which underpins the CRA. This remains a fluid area and firms will need to take advice and be ready to resp ond by making contract changes in response to CJEU judgments. For example, the Grand Chamber on 15 May 2018 heard 2 cases from Spain in which it will have to rule on whether a standard consumer mortgage contract which permitted a lender to accelerate the full outstanding balance when a customer fell into arrears was an unfair contract term or not.
Complaints to firms
The FCA reminds firms of the need to comply with the provisions of the DISP section in its Handbook , especially DISP 1 where a firm receives complaints about consumer contract terms. The FCA recommends that firms review contracts after they have received complaints that terms may be unfair. The FCA says firms should use management information on complaints about unfair terms to identify potentially unfair contract terms and then to make appropriate changes. It points out that it is a regulator under the CRA and, therefore, has the power to consider complaints and challenge firms on unfair contract terms. The FCA stresses that where a contract term fails the CRA fairness test, it will not be binding on a consumer.
Once the consultation has closed, the FCA will digest the responses. We then expect to see a feed back statement in the autumn, with the final version of the guidance issued before the end of 2018. Although there may be some adjustments to the detail, a s much of this is a restatement of earlier guidance, it is unlikely that the final version will look substantially different. On this basis, firms should start to plan now for compliance reviews and update of product terms and conditions on the basis of this draft guidance.
Breakfast briefing seminar
The Financial Regulation team will be giving a breakfast briefing on this . This will cover:
The draft FCA guidance in full,
Case law from the CJEU on unfair contract terms,
What firms need to do to remain compliant.
You will be able to ask questions. Timings for this session will be circulated shortly.
The documents below were issued on 17 May 2018. Guidance Consultation GC18/2
AMANDA HULME Partner Head of Financial Regulation Mobile 07921 404515 Tel 020 7880 5853 [email protected]
ROSANNA BRYANT Partner - Financial Regulation Mobile 07738 679349 Tel 0113 209 2048 [email protected]
SOPHIE COCHRANE Associate - Financial Regulation Mobile 07912 395667 Tel 020 7160 3939 [email protected]
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