OFT to FCA: two years of FCA regulation of the consumer credit industry

On 1 April 2014, the FCA took over the regulation of the consumer credit industry from the Office of Fair Trading (OFT), to much anticipation and no doubt a degree of trepidation from the industry. Shortly before, in October 2013, the FCA set out its stall by stating "our message to any company that harms their customers – the clock is ticking". The regulator, seemingly in no doubt about the scale of the task facing it, stated in its 2015 business plan that its regulation of consumer credit has "fundamentally changed" its own structure, not least due to the additional number of staff needed to cope with regulating such a large and diverse industry.

With the Bank of England's chief economist, Andy Haldane, saying in November 2015 that consumer credit was expanding at "a rate of knots", we take a look back over two years of FCA regulation of the industry to see whether the new regulatory regime will be a credit to the regulator and what we might expect in the coming year.

Changes to the regime?

It would be fair to say that the OFT was not the most "hands on" of regulators, so the approach of the FCA must have represented a dramatic sea change for the industry, as must the introduction of the consumer credit sourcebook (commonly referred to as CONC), with new rules on governance and fair treatment of customers, along with new capital requirements. That said, many of the rules governing the consumer credit regime remain the same in the retained provisions of the Consumer Credit Act, so the main challenge for the industry will be embedding the FCA's customerfocused approach into their businesses.

The authorisation regime under the FCA is much more onerous than under that under the OFT. Firms must meet (to name a few) stricter organisational, capital and conduct of business requirements than previously, with increased thresholds and accountability for senior management. Given this, it is perhaps surprising that the FCA states on its website that it now regulates more than 50,000 consumer credit firms, around the same number of those with OFT permissions that the Office of National Statistics said were active in the consumer credit market in 2013. How many of these will be granted full authorisation by the FCA remains to be seen but it represents a massive increase in the number of firms under the FCA's remit (which was previously around 27,000).

The FCA began assessing authorisation applications from those existing consumer credit firms that registered for interim permission in October 2014 and by now all firms wanting to apply for permanent authorisation will have submitted their applications, the deadline being the end of March 2016. The FCA expects to have assessed all applications by March 2017, by which time we will have a better idea of the number of active consumer credit firms and the key regulatory challenges they face.

High Cost Short Term Credit (HCSTC)

Even before the FCA took over from the OFT, the Government and the FCA had signalled their dislike of HCSTC, or "payday lenders" and it was always going to be first on the hit list. Somewhat surprisingly, given the level of publicity surrounding it, payday lending makes up a small percentage of the entire consumer credit market. The FCA estimates that of the 50,000 credit firms that come under its widened remit, 200 were payday lenders, yet it is through its approach to this segment of the industry that the FCA has set out its stall.

Only three months after taking over, by July 2014, the FCA had imposed new rules on HCSTC providers in relation to rollovers, continuous payment authorities (CPAs) and risk warnings to address areas where they perceived a high risk of potential customer detriment. In addition to which, price caps on the total amount of interest and fees which could be charged were introduced from 2 January 2015.

The FCA notes that much of this industry was simply not ready for regulation. Substantial systematic and cultural changes were, and still are, required; from changing senior management and retraining staff to putting in place systems to improve monitoring, compliance and risk.

Undoubtedly, not all those currently operating as payday lenders will make it through the FCA authorisation process and the FCA expects to see a number of lenders withdraw from this market in the face of increased regulatory burdens. For those that do tough it out, the road ahead looks rough and we can expect further developments and more public announcements of redress for past mistakes. Indeed, the FCA has suggested that HCSTC firms should consider "whether they need to take steps to provide redress to customers affected by any past unfair treatment", and that now may be the time for any customers who feel they have been unfairly treated to seek redress.

Debt management

In the press release accompanying the thematic review into the quality of advice in the debt management sector, published in June 2015, Linda Woodall, acting director of Retail Supervision at the FCA, said "debt management firms play a critical role in the consumer credit market, but far too many are not meeting the standards we expect and we will be looking for significant improvement".

Firms operating in this sector were warned in a press release in September in 2014 about the regulator's concerns, the FCA having previously noted that "some of the examples of consumer treatment we've seen are incredibly poor", with firms being told to "raise their game", but it appears that little progress had been made by the time of the thematic review.

Of concern to the regulator during the thematic review was the fact that their rules were largely based on the OFT's former Debt Management Guidance, and so represented rules that firms should already be complying with, rather than establishing any new standards or expectations.

The FCA's findings demonstrated that the general standard of advice provided by fee-charging debt management firms was of an unacceptably low standard. The advice provided by free-to-customer debt management firms was generally of a higher standard, but there was still scope for material improvement. The review also uncovered failures and inaccuracies in the information provided by advisers eager to sign people up to a debt management plan with their firm. One fee-charging firm misleadingly told a customer that the free sector was "owned by the banks" and that the customer should only use the free sector if "they were prepared to do all the work themselves".

The FCA has made it clear that it considers debt managed to be one of the highest risk consumer credit activities, and is undertaking a broader assessment, on a firm-by-firm basis, as to whether each individual firm meets the standards for authorisation. One debt management firm with 16,000 customers has already been refused authorisation and so it would not be at all surprising if we see a fall in the number of such firms operating and see more customer redress initiatives in this area.

Enforcement action

While technically not enforcement action, having not gone through the formal FCA enforcement process and, at least in part, relating to conduct prior to the FCA's regulation, a number of consumer credit firms have entered into voluntary redress exercises to compensate customers for a variety of failings, including inadequate affordability checks, inappropriate lending criteria and poor debt collection practices.

For example, on 26 October 2015, payday lender Dollar Financial UK (Dollar) agreed to provide £15.4m redress to over 147,000 customers. This followed the appointment in July 2014 of a skilled person to review Dollar's lending decisions, including whether customers were being treated fairly and were only lent sums that they could afford to repay. The review concluded that many customers had been lent more than they could afford to pay back, as well as identifying issues with debt collection practices and systems errors. Dollar agreed to make changes to its lending criteria and provide redress to all affected customers.

In respect of a different consumer credit sector, on 24 March 2016, the FCA announced that the credit card provider NewDay would be refunding over £4m to over 180,000 customers following disclosures made to it following a review by NewDay of its business in preparation for new FCA regime for credit. NewDay had looked at the fairness of its charging model and had identified that, in a small number of circumstances, default fees and other charges triggered additional charges in a way they considered unfair. In addition, delays in posting transactions also

meant some customers incurred additional charges NewDay felt were unfair. NewDay has changed these practices and voluntarily agreed to refund customers. This is an excellent example of a firm's Principle 11 obligation (to deal with the regulator in an open and honest manner) in practice.

What next?

Credit broking

Tucked away in its recent consultation paper (CP15/6), in the context of inviting comments on the forms of remuneration for credit brokers, the FCA made the following statement:

"We would also be interested in views on whether, and to what extent, the CONC requirements in this area should be aligned to those in other sourcebooks, in particular on mortgages (MCOB) and insurance (ICOBS)."

Does this signal the intention of the FCA to regulate brokers in all financial services sectors in the same way and hold them all to the same standards? If so, this would represent another major shift for credit brokers after the FCA's use of its emergency powers in December 2014 to introduce new rules (which have now been confirmed as permanent).

Credit cards

The FCA launched its market study into the credit card market, one of the largest markets it regulates, on 25 November 2014, the FCA, somewhat proudly, stating that it is the largest consumer survey it has ever undertaken involving the analysis of several gigabytes of customer data.

The study's aim was to explore the following three main areas:

1. How easy it is for consumers to shop around and find a card that best meets their needs. This includes looking at product complexity, the transparency and fairness of terms and behavioural drivers, and the extent to which consumers drive effective competition through shopping around and switching.
2. How firms recover their costs across different cardholder groups and the impact of this on the market.
3. The extent of unaffordable credit card debt; in particular, whether some consumers are over-borrowing/under-repaying on their balances and whether firms have incentives to provide unaffordable lending that works against the best interests of consumers.

The interim report was published on 3 November 2015 on which comments were to be submitted by 8 January 2016, with a final report to follow this spring.

The interim report concludes that competition is working fairly well for consumers but there is concern about the scale of potentially problematic debt for consumers who are just above default levels, and the incentives for firms to manage this. The FCA also wants to see better information for those shopping around.

The FCA found that around 6.9 per cent of cardholders (about 2m people) are in arrears or have defaulted. They estimate a further 2m people have persistent levels of debt that some may be struggling to repay, and that a further 1.6m people are repeatedly making minimum payments on their credit card debt.

The FCA's interim findings show:

• Firms compete strongly for custom on some features, offer a range of products to meet consumers' needs, and there have been new entrants in the market in recent years.
• Consumers shop around, switch and value the flexibility offered by credit cards.
• The FCA found that firms were not targeting particular groups of consumers to cross-subsidise other groups.
• Consumers in default are extremely unprofitable and firms are active in contacting consumers who miss payments, triggering forbearance at this point. However, consumers with persistent levels of debt or who make minimum payments are profitable; firms therefore have fewer incentives to help these customers.

The FCA has identified a range of potential remedies to make the market work better for consumers.

In relation to shopping around and switching, this includes:

• measures to help consumers find the best deal include enabling better access by consumers to their transaction data, boosting the role of comparison sites; and
• ensuring consumers can search the market without damaging their credit score, and prompting consumers when they are nearing the end of a promotional period.

To reduce problematic credit card debt, this includes:

• measures to give consumers more control over credit limits and utilisation;
• measures to encourage consumers to pay off debt quicker when they can afford to; and
• firms doing more to identify earlier those consumers who may be struggling to repay and take action to help them manage their repayments.

It is likely therefore that following the publication of the final report, we will see consultations on rule changes to introduce measures to relation to some, if not all, of these potential remedies.

Consultations

The FCA has stated, both in its business plan and in its policy statement setting out final rules and guidance on rule changes, that the following are its consumer credit priorities for 2015/2016:

• Changes arising from the Competition and Markets Authority's payday lending investigation. A consultation in relation to this was published in October 2015, with responses due by 28 January 2016. This is likely to result in changes to the way in which HCSTC can be presented on price comparison websites and a further investigation into the credit broking market.
• Responsible lending standards for consumer credit to promote effectiveness in delivering adequate assessments of creditworthiness, including affordability.
• Whether to introduce repeat borrowing rules or guidelines in the HCSTC market.
• Whether to ban or restrict cold calling or direct marketing, especially for HCSTC and debt management services.
• About providing or facilitating the use of quotation searches across all credit sectors.
• Further work on credit broking and guarantor lending with a view to potentially consulting on new rules and guidance in 2016.

Additionally, the FCA announced in its business plan its intention to carry out the following two thematic reviews which are currently underway, the reports on both of which are expected in Q2 of this year:

• the collection of unsecured debts – looking at the ways in which consumer credit debts are collected and the extent to which firms involved in the recovery and collection of debts are following FCA rules; and
• staff remuneration and incentives in consumer credit firms – to assess how firms are managing the risk that their reward arrangements could encourage potentially undesirable behaviours that might lead to poor outcomes for consumers.

A Call for Input on the review of retained provisions of the Consumer Credit Act was also published by the FCA on 18 February.

It is uncertain what rule and policy changes will come out of all of these pieces of work, but what is certain is that, in a sector where there has previously been very little regulatory verbiage, firms need to keep on top of all of the output, contribute to consultations where relevant and implement changes accordingly.

Enforcement action?

It is unlikely that at this early stage we will see any formal enforcement action from the FCA, not least because they are still in the process of authorising all firms with interim permission, a task which will take them until the spring of 2017. However, Dollar and NewDay-style redress exercises would seem likely if the FCA (or a firm itself) spots other conduct which it takes issue with, seemingly no matter how historic. Anyone, firms and individuals alike, who carries on a consumer credit activity should therefore take steps to review and understand the risks of any past practices on their current and future business, and engage at an early stage with the FCA to provide any necessary redress.

One area where we may see enforcement action is the area of financial promotions. The FCA reviewed over 1,500 consumer credit promotions between April and August 2014 and expressed its disappointment at its findings in two press releases The FCA stated in those press releases that between April and August 2014 it had opened 227 cases in relation to non-compliant promotions. The consumer credit industry faces tough challenges regarding financial promotions as it uses social media, such as Twitter and banner advertising, perhaps more than some other financial services providers, and with the limited characters available, conveying all of the required information presents a difficult task. This situation is compounded by the Consumer Rights Act 2015 (CRA). Under section 50(1) of the CRA, anything said or written to the consumer that is taken into account by the consumer when purchasing a service (including credit services), or making a decision about the service, is to be treated as a term of the contract. Statements made in promotional material and oral statements made by sales staff could now form terms of a credit agreement. Section 50 also applies to things said or written by the creditor or "on behalf of" the creditor, raising the possibility of third party brokers and sales agents making unapproved statements that will contractually bind the creditor.

On 22 March 2016, the FCA announced that it had entered into an agreement with Dunraven Finance Ltd, trading under the name Buy as You View, to redress £939,000 to more than 59,000 customers for historic unfair treatment and affordability assessments. In response to this, an independent "skilled person" was appointed in October 2015 to review and monitor the firm's plans to address the concerns raised. It would seem that the use of a skilled person to oversee and implement changes to business practices, along with the use of s166 reviews in general, will be a key FCA tool in the short term for dealing with failings in the consumer credit industry. This allows firms a bedding in period to review their businesses and make changes, but under the watchful eye of someone who will report back to the regulator on progress, or lack thereof.

Change in focus

The FCA likens its focus since taking over consumer credit regulation to having being on "products", with its focus for the coming year being on industry-wide issues such as credit broking, cold calling and quotation services. It is likely therefore that affordability, competition, the treatment of people in financial difficulty and how to ensure consumers make informed choices will be key general areas for the regulator in 2016.

The FCA also notes that the main risk it has identified from its two years of regulation is a market-wide one, being affordability, and it is likely that this will be its focus for the foreseeable future. Concerns over growing levels of debt, particularly among the young, lead the regulator to the conclusion that poor affordability assessments by firms may be pushing up levels of unaffordable debt. A priority therefore for firms should be to review their business models alongside their affordability assessments and consider whether they lead to positive consumer outcomes. Lessons should be learned from Dollar's and NewDay's voluntary agreements with the FCA. Given the FCA's stance on payday lenders, it is entirely possible that, where firms have been making what the regulator considers to be inappropriate affordability assessments, firms will find themselves in the position of having to write off lending and/or exercising considerable forbearance.

Peer-to-peer lending has also received some regulatory attention, with the recent handbook changes in relation to the segregation of client money on loan-based crowdfunding platforms, the Innovative Finance ISA, and the regulated activity of advising on peer-to-peer agreements. The regulator will be keeping a close eye on this sector and monitoring for any poor consumer outcomes.

Conclusion

It is clear that the FCA considers the consumer credit industry in dire need of more stringent regulation and a closer eye on their activities. In comparison, the OFT's approach was quite lax and the new regime has caused a stir and major change in the industry. The past two years have seen the FCA crack down and introduce tough new regulation. It looks like, in the coming year, the FCA will continue its focus on improving the standards of consumer credit which may result in a number of providers exiting the market and will present a significant amount of hard work for those that remain.