In my last article on the proposed regulatory reform of the Consumer Credit Act (the "CCA") and the change of regulator from the OFT to the FCA, I expressed alarm at the potentially damaging macro-economic effects of the new regime. As HM Treasury and the FCA have now issued somewhat more detailed consultation papers on the new regime and the process of transition to it, we are now in a more informed position to assess how that regime will work and whether or not my fears remain justified. Both consultations are at pains to emphasise that they have listened to the concerns of the consumer credit industry and that, accordingly, their guiding principles are, on the one hand, consumer protection while, on the other, ensuring that the burdens for regulated firms are proportionate. In fairness, the consultations reveal that the FCA has started the process of trying to be proportionate. Unfortunately, in my preliminary view, they are not proportionate enough and that, on full implementation of the new regime, there will still be a probably quite marked tightening of the consumer finance market, as many of the medium-sized finance companies change their business models to avoid consumer finance. Likewise, I believe, that some intermediaries whose main business lies elsewhere will give up their ancillary finance-broking activities. More on that anon. Meanwhile, let's look at what's proposed in the consultations.
The Timetable and Transition
It is proposed that the FCA replaces the OFT as the consumer credit regulator from 1 April 2014 (the "commencement date"). But the FCA appreciates that with upwards of 50,000 licence-holders to process and a completely new type of regulator (for most licence-holders) to deal with, a bedding-in period is required. So, it's proposed that all existing licence-holders will be able to continue in business without obtaining full FCA authorisation provided they apply for an "interim permission". That application will be on-line and is anticipated to be available from sometime this autumn. It appears that the grant of interim permission will be automatic, but the window of opportunity for applying must not be missed.
The Interim Permission
The interim permissions will then be effective from the commencement date until the licence-holder has obtained the necessary authorisation to carry on business from the FCA. It is intended that all must have applied for authorisation by 1 April 2016 and the interim permission will then lapse on authorisation being granted or refused. The FCA will call forward those with interim permission to apply for full authorisation on some sort of priority basis of their devising. For example, it is likely that creditors will have to go through the process earlier than intermediaries - or at least those intermediaries whose main business isn't finance-broking: for example, motor dealers.
It is suggested that an interim permission will cost £150 for sole traders and £350 for everyone else. At present, it is proposed that the dates by which an interim permission has to be obtained and by which it will lapse are absolutely fixed. It seems likely, however, that this rigidity will cause problems - with, for example, a sole trader enduring a period of illness - and that concessions due to extenuating circumstances will have to be introduced.
There are foreseeable problems with the interim permission regime in relation to what happens if a trader needs amendments to its interim permission in the transitional period but, presumably, these too will be sorted in the final legislation. It must, however, be realised that a new entrant to the market during the transitional period will not be able to obtain an interim permission and will need to have full authorisation from the start. Given the likely overload in the FCA dealing with the authorisation of those with existing interim permissions, there are fears for what the timescale will be for a new entrant to acquire a new authorisation during this period - and long time term, too, it will doubtless take much longer to get authorisation than is currently the case with the OFT, irrespective of what a new entrant's commercial pressures might be. It may be a minor point but one can envisage problems with new securitisations of consumer credit agreements here, where the proposed SPV needs consumer credit permissions quickly. Perhaps the FCA may be persuaded for extra cash to introduce a fast-track procedure?
So far, so good. But the real problems with the transition lie elsewhere.
The Timetable for New Rules
The FCA intends that its conduct rules and guidance will take effect from the commencement date. Recognising that for the great majority of interim permission holders FCA-style regulation and the new rules and guidance could otherwise be a shock to the system, it is proposed (i) that for the first six months after the commencement date the FCA will not take formal action in respect of an FCA rule which replicates an existing requirement, if the firm can demonstrate that it has acted in compliance with the CCA and OFT guidance and (ii) during the transitional period, FCA supervision will be what they call "event driven" and "issues based". The six months' period may be extended. There is probably less comfort in this than first appears but, anyway, the real issue lies with the timetable for getting the rules in place by the commencement date. They propose that in autumn 2013 they will consult on draft detailed rules, that the consultation period will end in December, and that final rules may be published in March 2014 for implementation at the start of the new regime on 1 April 2014. In setting out a timetable like this, one wonders if the FCA is unfamiliar with IT systems and the demands on the time of computer programmers. This timetable would, I suggest, strike any reasonable reader as unfair and unrealistic but we'll see where the consultation ends up. Another major issue, given the unfamiliarity of most consumer credit lenders/creditors and brokers with FSA-style regulation, is the huge effort which will have to be put in to training directors and staff on how the FCA operates its principles and rules, the need to keep records of complaints handling, and the new and invasive management information collection and reporting that will have to be prepared for (of which most will currently have no notion), not to mention the very complex process for specialist lawyers to get to grips with the interplay between continuing CCA provisions, new regulations under the Financial Services and Markets Act ("FSMA") and the principles and rules (see below) and then explaining this to the interim permission holders. Prepare for a bumpy ride!
This, I think, is where the macro-economic risks lurk.
The CCA licence regime will be replaced by FCA authorisation under FSMA, with consumer credit now to be a regulated activity under FSMA. Accordingly, those with interim permissions and new entrants will need to apply for FCA authorisation and certain key employees will need to apply to be FSMA authorised persons. (There is, for certain firms, the alternative of becoming simply an appointed representative of an authorised firm, rather like the way ICOB operates in regulated insurance business, but this is likely to be of little use or, at least, only of use to a very small number of firms, even if an authorised firm could be persuaded to take on an appointed representative.) The FCA seeks to demonstrate proportionality in two ways: first, there are to be no minimum capital requirements (except for debt management firms) to qualify for authorisation. This is common sense if there is not to be a massive market impact, though one wonders what it means in practice since a threshold condition of authorisation will, in most cases, mean having "adequate financial resources". Also, they tell us that fee levels will be adapted to the credit sector and will vary according to the activities authorised. Nevertheless, we can expect a substantial rise in costs and, of course, these will be based on London-centric costs. (They also suggest that the fees will be based on the amount of consumer credit business a firm does and it may even be on the net profit attributable to that business. This will cause accounting problems as most lenders, in their accounts, do not split turnover or profit this way.) Secondly, and this is very welcome but probably not welcome enough, there is to be a separate lower threshold authorisation regime for what are categorised as lower risk firms (the so-called "limited permission" firms). At present, these are firms for whom credit provision is secondary to their core (non-financial) activities - for example, motor dealers or dental practices. But, if you are the creditor in your finance agreements, you are higher risk, even if you are small and consumer finance is only part of what you do. There are other "low risk" categories, probably the only one of general interest being consumer hire (- I wonder if we will see a drift from hire purchase to hire business?).
There are changes, too, to the way professional firms, such as solicitors, will be authorised. The current unwieldy split between brokers and other credit intermediaries is likely to disappear.
Limited Permission Threshold Conditions
Looking at the threshold conditions which need satisfied for limited permission firms, it is certainly the case that these should be more manageable for those coming to FSA/FCA-style regulation for the first time, though management information, record keeping and staff training will still need materially upgraded. The main points are that limited permission firms will not need to submit detailed business plans for approval, their required financial resources will be limited, they will have to provide more limited financial information, and they will be able to self-certify factual matters showing that they have appropriate management, staff and controls.
The problem is that those with limited permissions will still have to have at least one individual approved as an authorised person under the FSMA regime, being the one responsible for ensuring that significant business responsibilities in the firm are appropriately divided up among directors and senior managers and those over-seeing systems. For those who have never undergone the form filling and invasive process required by the FSA (including, as it does, a review of that person's own financial soundness), this will likely come as an unwelcome novelty.
And, here's the problem. I mentioned above, motor dealers and dentists as examples of the type of firm to whom the limited permission route can apply. Doubtless, major motor dealers, and by way of another example, major retail stores, can cope with this without difficulty. But, what about small motor dealers; what about the dentist offering an introduction to credit for dental charges; what about the smaller retail businesses? Are they not likely just to give up providing credit introductions? Given the political drive which lies behind all this, one would have thought this was an issue of political interest.
The Problem with the Main Threshold Conditions
Which takes us to the threshold conditions for those who cannot take advantage of the limited permission regime - any consumer credit finance creditor. Let's ignore the banks - they are used to this type of regulation and have large numbers of employees doing nothing other than compliance. But a huge amount of consumer finance, particularly for cars, comes through finance companies, which themselves borrow funds from banks or large finance companies and channel it to their customers in the retail market, those customers being introduced to the finance companies by, say, the motor dealers, the retail stores or the brokers. A finance company with an HP portfolio of many hundreds of millions of pounds may still only have a small staff. Will that finance company be prepared to do what is needed to obtain and keep authorisation and engage extra staff for compliance?
So, what will such finance companies need to do to gain authorisation?
- They need to meet the threshold conditions. These include producing a detailed business plan which the FCA assesses against market norms; demonstrating appropriate financial resources, and the requisite skill and experience of those managing the firm's affairs. The FCA will assess the quality and quantity of the resources, including financial management staff and systems and controls. Then, going forward, detailed management information has to be provided and records of complaints and how complaints were handled.
- Those having "a significant influence function" in the business have all to become authorised persons. This may be all of the Board; it may include senior managers, depending on the size of the business; there will need to be a money laundering reporting officer who will also need to be an authorised person.
Here is where my macro-economic concern lies - and particularly with this second bullet point. Will these finance companies do this? Or will they pull out of consumer finance and suggest to the small businesses they deal with that they should incorporate to continue to have wider access to credit? The jungle drums suggest the latter.
The New Rules
The Only Viable Option?
The Treasury Consultation starts with the reasonable proposition that, until over, say, a five year period, the FCA has had its own time to identify problems in the market, the conduct terms set out in the CCA and OFT Guidance should "continue to form the core of consumer credit regulation". Thus, they conclude the transition to the new regime should not cause undue difficulty. If they stopped there, this would, to a large extent, be true. If they kept the statutory framework in place, together with existing guidance, and simply changed the regulator, then, indeed, most firms could cope and spend the time now devoting their energies to adapting to a new type of regulator - principally, investing in management systems, to be able to produce the type of management information and record keeping the FSA will require and which are not a feature of the current regime. Indeed, given the proposed timescales, this arrangement is probably the only viable option and may yet be what they have to do - if they listen to what, I imagine, will be the consultation responses. But, it is not what they propose.
The Legislative/Regulatory Soup
Rather, they propose that:-
- in part, the CCA should be kept;
- in part, some of the CCA regulations will be re-enacted as new statutory provisions under FSMA;
- but the balance of FCA regulation will be in the FCA's high level principles and FCA rules which replace ("replicate" in HM Treasury's wording) the existing CCA statutory provisions.
We have now seen the first drafts of the statutory amendments but not of the rules - see the timetable above. This is far from being as straightforward for firms to implement as the consulting bodies suggest. And that is so, even if we ignore the legislative and regulatory soup this is all going to lead to. As we all know, finding the law in the CCA and its myriad regulations is hard enough; the new landscape is going to be worse. And, we need to bear in mind that the Consumer Credit Directive, on which much of the current CCA is based, is a "maximum harmonisation" directive and should not be gold-plated by the government. If, for no-one else, this is doubtless all good for the lawyers and we can expect many challenges to future rules based on gold-plating issues.
Identical Rules are not Identical
But the main short term problem is not the soup, it's the fact that the purpose of the rules is to have a regulatory regime which is not interpreted strictly in the way that legislation is, but is interpreted according to its spirit and what the FCA meant by its rules. It does not follow that if a rule is worded identically to a legislative provision then the effect of the two is the same; the legislative provision is definitive of what it means, the rule is not. Existing court decisions on the meaning of a CCA provision will not necessarily be binding as interpretative of the meaning of the identical rule. The majority of consumer credit lenders/creditors have no experience of the FCA's high level principles and conduct rules and will need to reassess their whole business practices and operations, quite apart from identifying the new money-laundering, management information, record keeping systems and staff they will require.
The FCA will also welcome trade associations supplementing the FCA rule book with the codes of those associations. In the new environment, though, such codes may simply be viewed as hostages to fortune, as becoming part of the FCA's off-piste requirements and a form of back door gold-plating of the Consumer Credit Directive. At a guess, I surmise that all these codes will (and, in my view, probably should) disappear so far as they relate to consumer credit.
Finally, a separate issue~: from the commencement date, it is proposed that the advertising regime under the CCA will be replaced by the FCA's financial promotions regime. There are two issues here: the first is that as the advertising rules are set out in the Consumer Credit Directive, it is hard to see what the FCA can do without risking gold-plating of the Directive. Secondly, the lead time for the preparation of advertising brochures and campaigns is such that advertisers will need to be certain, and way in advance of the currently proposed timetable, on what the FCA's requirements are going to be if these rules are to come into force by the commencement date.
There is much more to the two consultations but, for consumer credit lenders, the foregoing are the main points. The consultations appear to be well-intentioned. However, much of the focus is, as it has been for some time, on the banks and pay day lending - the FSA's/ FCA's comfort zone. A huge part of the consumer credit market comes from the simple fact that this is how Mr and Mrs United Kingdom fund their cars and their furniture - markets which, by and large, currently appear to function without much in the way of problem and the availability of credit for which will, in this writer's view at least, lessen as a consequence of the new regime.
There will be substantial costs in the changeover - new documents, new systems, more staff, legal bills. Those who are already FSA/FCA regulated will have less proportionate cost than those who are not and it is, therefore, at the finance company end of consumer credit lending business that these impacts will be greatest. The proposed timescales are probably impossible. We shall wait with great interest to see how it all develops.