Consumer credit: preparing for FCA supervision

Overview

On 1 April 2014, consumer credit regulation will move from the Office of Fair Trading (‘OFT’) to the Financial Conduct Authority (‘FCA’). An interim regime will be in place between 1 April 2014 and 1 April 2016.

Where before, a firm needed a consumer credit licence to operate in this sector, under the new regime firms will need:

• full FCA authorisation;
• ‘limited permission’ authorisation (an innovation for lower-risk consumer credit activities – see below);
• to act as an Appointed Representative (for a limited number of activities); or,
• interim permission (during the interim regime only – see below).

Any firm conducting consumer credit activities without one of the above will be committing a criminal offence.

Broadly speaking, the standard of conduct required will be much the same: as the FSA wrote, “firms that already comply with CCA requirements and OFT guidelines will only need to make minimal, if any, changes to their business”. In particular, most regulations under the Consumer Credit Act 1974 (‘CCA’) will be carried over to the new regime; some will be identical, word-for-word.

The enforcement of conduct standards, on the other hand, will become much stricter. What was previously OFT and industry guidance will, in some cases, become enforceable FCA rules. General matters of governance and integrity will fall under FCA high-level rules such as ‘Principles for Businesses’ – which form the basis for most FCA enforcement actions. The process for obtaining authorisation will be given greater rigour. Generally, the FCA will have greater powers to investigate and sanction, and an approach that is more preventative and proactive than the OFT.

Fundamentally, consumer credit regulation is going to be moved onto (a slightly simplified and adapted version of) the same regulatory framework used for most other financial products.

The final details of the new regime have not yet been decided on – at the time of writing this is still at the consultation stage – although the FCA has issued a policy statement on the broad shape of the regime and the high-level rules, along with a consultation on a draft copy of the new consumer credit sourcebook (‘CONC’) (please see above for details)

The regulatory framework for second charge mortgages will not be changed yet, but is intended to be consulted on in May 2014.

The Interim Regime and the Transitional Period

Interim Regime

An interim regime will be in place between 1 April 2014 and 1 April 2016. Anyone holding a valid OFT licence who applies prior to 31 March 2014 will be able to obtain ‘interim permission’¹ from the FCA, which will exempt them from some parts of the new regime, including:

• periodic reporting, including complaints reporting (although the FCA reserves the right to request information from firms as and when required);
• the Approved Persons regulations;
• notifying the FCA about any changes to controllers or key individuals; and
• proactive, preventative regulation by the FCA: firms with interim permission will only be subject to reactive, events-driven regulation by the FCA, as well as sector-based investigations of specific products or issues.

Interim permissions have some limitations attached, e.g. such firms can only approve financial promotions related to the activity for which the permission applies.

After 31 March 2014 it will be too late to join the interim regime, and firms will need to apply for FCA authorisation before they can operate – a much more onerous process, and one which brings a firm under the full FCA consumer credit regime. Similarly, if a firm holding interim permission wishes to add a new activity after 31 March, it will need to apply for authorisation from the FCA.

Firms with interim permission will not be able to act as principal to Appointed Representatives (‘ARs’) for consumer credit activities. Firms that intend to act as an AR for consumer credit activities should obtain interim permission (as explained above) which they will then be able to keep using until their prospective principal is fully authorised for consumer credit activities and is then able to appoint them as an AR.

The interim regime will not last beyond 1 April 2016 at the latest. Firms may apply for authorisation from 1 April 2014, and the FCA will begin to direct firms to apply for authorisation from 1 October 2014, with different deadlines for different categories of firm. These deadlines will be announced in early 2014.

Firms can apply for interim permission now – and should do so “well in advance of 1 April 2014”. This will cost £150 for sole traders and £350 for others, with a 30% discount for firms that register before 30 November. The application process will require “minimal” further information.

It is strongly recommended that firms make sure they hold OFT licences for all the activities they need before applying for interim permission; and that all other details (including trading names) on their OFT licence are up-to-date.

Firms carrying on activity that might fall into the definition of debt adjusting² or debt counselling³ should obtain Category D and E consumer credit licences respectively: after 1 April 2014 it will become a criminal offence to conduct these activities without permission (or equivalent).⁴

Transitional period

In addition to the interim permission regime described above, there will be a six-month transitional period from 1 April 2014 during which the FCA will not take action against any breaches of the new rules where a firm is able to demonstrate that it has complied with the old CCA requirements and OFT guidance.

The Two Tiers

Under the full regime, firms will be divided into two ‘tiers’:

• Full Authorisation / Higher-risk, covering: consumer credit lending (including loans, hire purchase, credit cards, overdrafts and pawnbroking); credit broking (except where secondary to the sale of goods and non-financial services – see below for details – also note that credit intermediation and credit broking will now be combined into one activity);credit reference agencies; debt counselling, debt adjusting, and other credit information services (except where not-for-profit, or when carried on as a secondary activity to lending, broking, or hiring); debt collection and debt administration; “operating an electronic system in relation to lending” (i.e. facilitating peer-to-peer lending), and
• Limited Permission / Lower-risk, covering: interest- and charge-free lending; secondary credit broking (i.e. where this is secondary to the sale of goods and non-financial services – excluding “broking carried on in the consumer’s home on more than an occasional basis”);consumer hire; broking of vehicle leasing;& Green Deal brokers; and debt counselling, debt adjusting and credit information services, where not-for-profit, or when carried on as a secondary activity to lending, broking, or hiring.

Firms with limited permission will generally enjoy lighter-touch regulation, with less reporting, lower ‘threshold conditions’ for authorisation, limited and reactive supervision only, and lower fees. Smaller firms will also face less intensive supervision (see below).

If a firm with limited permission wants to carry out a higher-risk activity, however, then it will then need to apply for full authorisation. Alternatively, the firm might be able to carry out that activity as an AR (see below).

Authorisation

Just as the FCA will replace the OFT, CCA licensing will be replaced by Part 4A authorisation under the Financial Services and Markets Act 2000 (‘FSMA’).

The OFT’s relatively basic ‘fitness’ test will be replaced by a far more stringent set of ‘Threshold Conditions’ (see Appendix I). The requirements differ for fully-authorised and limited permission firms.

Consumer credit firms – even limited permission firms⁶ – will also be subject to the FCA’s ‘Approved Persons’ regime. Under this regime, persons carrying out certain ‘Controlled Functions’ (‘CFs’) must first be vetted and approved by the FCA – the ‘fit and proper test’ – and afterwards will be supervised individually by the regulator, with personal liability for their regulatory failings. This goes well beyond the OFT’s existing requirement to take account of the conduct, skills, knowledge, etc. of a firm’s employees when deciding whether that firm is fit to hold a licence.

See Appendix III for the list of applicable CFs. Unlike other financial services firms, consumer credit firms will not be required to pre-approve front office and customer-facing roles (i.e. the CF 30 ‘Customer Function’ does not apply).

There are additional Approved Persons requirements for debt management firms and debt advice firms.

Alternatives to Authorisation

As an alternative to authorisation, for some activities a firm can opt to become an AR. An AR holds a contract with a fully authorised firm (the ‘Principal’)⁷, whereby the AR can operate under the Principal’s authorisation and the Prinicipal will accept responsibility for the AR. The activities⁸ for which a firm can become an AR are:

• credit broking;
• consumer hire;
• debt adjusting
• debt counselling;
• debt collecting;
• debt administration;
• providing interest- and charge-free credit; and
• providing credit information services.

Credit reference agencies and lenders charging interest and/or fees may not act as ARs.

ARs are an existing part of the FSMA system of financial regulation being extended to consumer credit, but with one innovation: previously, no firm could hold FCA authorisation and act as an AR; now, under the new ‘Two Tier’ system, a firm can hold limited permission authorisation and act as an AR at the same time (e.g. for higher-risk activities that would otherwise require full authorisation, or for non-consumer credit regulated activities such as insurance broking).

During the interim period, firms with limited permission will not be able to act as principals to ARs (see above).

Also exempt from FCA supervision are Designated Professional Bodies also known as Exempt Professional Firms: the Law Society of England and Wales, the Association of Chartered Certified Accountants, and similar bodies. (Please note that group licences have been abolished.)

The Rules

The Government does not believe that the conduct standards enshrined in the current regulatory regime require fundamental reform […] Rather, it is the limitations on how compliance with those standards is enforced that need to be addressed in order to tackle consumer detriment more effectively (para 2.1 (p15), HM Treasury consultation paper ‘A new approach to financial regulation: transferring consumer credit regulation to the Financial Conduct Authority’

The new regime consists of both high-level, cross-sectoral rules (PRIN/GEN/SYSC) and detailed rules and guidance for consumer credit (CONC). Debt management and debt advice firms will have additional prudential requirements. Approved Persons have their own set of rules (APER) which they personally must keep.

High-level rules

These are (often very broad) principles which firms across all sectors are required to adhere to. The high-level rules are extremely important as, in practice, most FCA enforcement activity is for breach of these rules.

Following its March 2013 consultation, the FCA has decided to apply the high-level rules from the following sections of the Handbook:

• ‘Principles for Businesses’ (‘PRIN’): these are listed in full in Appendix II, below. The FCA “expect[s] that well-run firms will be familiar with the concepts found in our principles as similar concepts already exist in the CCA licensing test and the OFT fitness guidance”, with “the exception perhaps of Principles 3 [management and control] and 4 [financial prudence]”.
• ‘General Provisions’ (‘GEN’): this covers the interpretation of the Handbook, status disclosure, the use of regulators’ names and logos, acting in an emergency, and a ban on insuring against the payment of regulatory penalties.
• ‘Senior Management Arrangements, Systems and Controls Handbook’ (‘SYSC’): this expands PRIN Principle 3 (management and control) by describing what the FCA expects to see in practice.

Detailed Rules

In addition to the high-level rules, above, there will be a new section of the FCA Handbook dedicated to consumer credit: the consumer credit sourcebook (‘CONC’). A draft version of this was published for consultation on 3 October 2013.

Most of the conduct-related provisions in the CCA and its secondary legislation will remain in place after 1 April 2014. The provisions that are to be repealed will be “replicated” as FCA rules and guidance without being “substantially changed”; indeed, some will be copied out, word-for-word. These include the CCA provisions on:

• pre-contractual explanations (s.55A CCA);
• assessment of creditworthiness (s.55B CCA);
• current account overdrafts (s.74A-B CCA);
• assignment of creditor’s rights to a third party (s.82A CCA);
• credit intermediaries (s.160A CCA);
• promotions for credit agreements secured on land (Consumer Credit (Advertisements) Regulations 2010); and
• promotions for credit agreements not secured on land (Consumer Credit (Advertisements) Regulations 2004)

The new rules on promotions will be “broadly equivalent to the current CCA advertising rules”; firms will also have to comply with the high-level rule PRIN 7, which requires that communications are “clear, fair and not misleading”.

In addition, some existing OFT guidance will be turned into FCA rules, particularly where the guidance specifies what must be done in every case. This includes parts of:

• ‘Irresponsible Lending Guidance’ on pre-contractual explanations of credit agreements, affordability assessment, post-contractual issues, and dealing with arrears ;
• ‘Credit Brokers and Intermediaries Guidance’;
• ‘Debt Collection Guidance’;
• ‘Debt Management (and credit repair services) Guidance’;
• ‘Second Charge Lending Guidance’;
• Department of Business, Innovation & Skills guidance on the Consumer Credit Advertisement Regulations; and
• some third-party industry codes (e.g. the Debt Management Protocol).

Breaches of rules can be directly enforced by the FCA. So while the breaches of guidance would most likely have been taken into account by the OFT implicitly when deciding whether or not a firm was fit to hold a licence, under the new regime, breaches can be actively enforced and punished. Remaining OFT guidance will be preserved as FCA guidance. The FCA also anticipates that some voluntary industry codes will continue to exist.

Finally, the FCA has proposed various rules specifically for the payday lending (or “high-cost short-term credit”) sector:

• limiting the number of times a loan can be ‘rolled over’ to two;
• limiting the number of unsuccessful attempts to take a payment with a Continuous Payment Authority to two;
• a ban on the use of a Continuous Payment Authority to take part-payment;
• the requirement to submit product sales data for high-cost short-term loans and home-collected credit; and
• adding a special ‘risk warning’ to loan adverts (“Think! Is this loan right for you?”).

Approved Persons

As noted above, all consumer credit firms⁹ will require at least one Approved Person. An Approved Person must continue to meet the FCA’s ‘fit and proper test’ –informing the regulator of any matter that may affect their ongoing fitness and propriety – and comply with the Statements of Principle and Code of Practice for Approved Persons (‘APER’)

An Approved Person may be held personally liable for any breach of APER or failure to meet the fit and proper test.

Other

Some terminology in the rules will change, e.g. the CCA’s “creditor” and “debtor” will become “lender” and “borrower”.

In general there will be no prudential requirements for consumer credit firms over and above the ‘appropriate resources’ Threshold Condition (which, in the case of limited permission firms, simply means being solvent). Debt management companies, however, because they handle client money, will be subject to a capital requirement which will be the higher of £5,000 or 0.25% of relevant debts under management.

In addition, some CCA regulations, mainly those specifying criminal offences, will be retained at least until 2019 (with the long-term plan being that these too should be repealed and replicated as FCA rules).

Supervision and Reporting

The FCA’s supervisory approach to consumer credit will be “phased in” over time; although ultimately it will be “aligned” with that of other financial firms.

In particular, this means three different modes of supervision:

• Firm Systematic Framework (‘FSF’): individual-firm-oriented, proactive, preventative supervision¹⁰, with a focus on fair treatment of customers and market integrity;
• Event-driven work: reactive supervision, driven by events; and
• Issues and product supervision: sector-wide investigations of a particular product or issue (including thematic work).

According to the FCA, limited permission firms will face only “limited reactive response to problems that have already materialised” and “possible limited thematic work”.

The level of supervisory intensity will also vary according to the size of a firm and its number of retail customers, with four different degrees: from the largest (C1) to smallest (C4).

A small number of larger firms (C1 and C2) will be ‘Fixed Portfolio’, and will have a nominated supervisor. The great majority of consumer credit firms (C3 and C4) will be ‘Flexible Portfolio’, and will be assigned to a sector-specific team.

Reporting

The requirement for periodic reporting will come into effect on 1 October 20146. This will be the same fundamental regime as for other FCA regulated firms, and is set out in chapter 16 of the FCA Supervision Handbook (‘SUP 16’).

The frequency of reporting will be either annual or half-yearly, dependent on the size of a firm, and aligned to the firm’s financial year end. Firms that are already regulated by the FCA will not need to duplicate data. Reporting will be done via the FCA’s ‘GABRIEL’ electronic reporting system.

As noted above, after 1 October 2014 firms will need to submit product sales data for high-cost short-term loans and home-collected credit.

Complaints

Firms will have to record every complaint they receive, including how it was resolved, and keep a record of this for three years¹¹. Complaints data will have to be reported to the FCA either annually or half-yearly, depending on the consumer credit activities involved.

Limited permission firms will only have to complete part of the complaints reporting form.

Controllers

Consumer credit firms will also be subject to the FSMA change in control requirements. This means that anyone who wants to acquire or increase control over a firm must obtain prior permission from the regulator if it results in a that person holding more than a certain percentage of shares in a firm (or its parent); more than a certain percentage of voting power in the same; or shares or voting power that result in that person being able to exercise significant influence over the firm.

For firms that only conduct consumer credit activities, the thresholds will be

• 20% for fully authorised firms; and
• 33% for limited permission firms.

Firms will not be required to submit annual controllers or close links reports, unless they already do so.

Enforcement

The FCA will have “significantly greater” enforcement powers than the OFT, being able to use its full ‘toolkit’ of powers and sanctions when regulating the consumer credit sector.

These additional powers include the ability to:

• ban individuals from working in financial services;
• publicly censure firms and individuals;
• seek injunctions and freezing orders;
• impose a consumer redress scheme, and require restitution to customers; and
• bring civil, criminal and disciplinary proceedings.

The FCA will also have enhanced investigatory powers, including the power to apply for search warrants, demand disclosure of documents, and demand that people answer questions put to them by the regulator.

Under the Unfair Terms in Consumer Contracts Regulations 1999 (‘UTCCR’) the FCA will also investigate potentially unfair terms in standard form consumer contracts. Where a firm will not voluntarily give assurance that it will change its terms (where necessary), the FCA has the power to obtain an injunction compelling them to do so.

The “lead enforcer” of the UTCCR will be the Competition & Markets Authority, however, once that body is created (by a merger of the Office of Fair Trading and the Competition Commission). This is currently scheduled for April 2014.

New financial product intervention powers allow the FCA to place restrictions on product features and selling practices, and even ban products outright. In the consumer credit sector, the FCA also has specific powers allowing it to cap the cost of credit and restrict the duration of credit agreements. (The FCA has stated that it does not intend to use either of these powers in the immediate future, however.)

After 1 April 2014 consumer credit will move from the Financial Ombudsman Service’s (‘FOS’) “credit jurisdiction” to its “compulsory jurisdiction”, although it is not anticipated that this will make any practical difference, and consumers will still have access to FOS as before.

Local Authority Trading Standards Services (‘LATSS’) will retain a prosecutorial role, and will work with the FCA in policing the “regulatory perimeter” (e.g. action against illegal loan sharks). There will be a rule against ‘double jeopardy’ stopping both LATSS and the FCA from taking action over the same offence.

Next Steps

This is an ongoing consultation; the deadline for responses to the FCA’s most recent consultation paper (CP13/10) is 3 December 2013.

Firms may be particularly interested in the opportunity to suggest revision of the consumer credit advertising and promotions rules.

As well as the detailed Handbook rules for consumer credit, CP13/10 also suggests in passing a few other, more tentative changes: extending the new ‘risk warning’ requirement for high-cost short-term credit to other (or all) credit products; extending the collection of product sales data (which currently only applies to high-cost short-term credit); and a possible outright ban on cold-calling.

The FCA will publish a Policy Statement in response to CP13/10 in February/March 2014.

There will be further consultations on ‘plain language guidance’ to the new regime, and further consequential changes to the Handbook, in ‘late 2013’.

[1] Firms which are already FSA/FCA authorised for non-credit activities (e.g. insurance services) can obtain an ‘interim variation of permission’ for consumer credit, which has the same effect as an interim permission. Note that authorised firms will still need to apply for this, and it will not be given automatically. ARs for insurance services (etc.) can obtain an interim permission for consumer credit as described in the main text above.

[2] negotiating with a creditor or owner, on behalf of a debtor or hirer, terms for the discharge of a debt due under a consumer credit agreement or consumer hire agreement; taking over, in return for payments by the debtor or hirer, his obligation to discharge a debt under such an agreement; or any similar activity concerned with the liquidation of a debt under such an agreement (s.145(5) CCA).

[3] giving of advice to debtors or hirers about the liquidation of debts due under consumer credit agreements or consumer hire agreements (s.146(5) CCA).

[4] There has been concern that motor dealers who use electronic systems in order to arrange loans would be covered by the new regulated activity of ‘operating an electronic platform in relation to lending’. Firms that want to carry on such activity during the interim period would then need to obtain a Category G (debt administration) consumer credit licences by 31 March 2014. The Finance & Leasing Association (FLA) has said that the intention is that the activity of 'operating an electronic platform...' relates solely to peer-to-peer lending (typically where the lender is a non-corporate body). The FLA are in discussions with HM Treasury over amending the proposed legislation to make this clearer.

[5] This activity has a complicated – and seemingly very broad – definition in Article 36H of the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.2) Order 2013. At the time of writing, the FLA are seeking further clarification from the FCA on the precise scope of this activity.

[6] Although limited permission firms will only need one Approved Person; this person will need to carry out the CF8 ‘Apportionment and oversight function’. Fully authorized firms will need as many Approved Persons as there are Controlled Functions filled (see Appendix III)

[7] Firms with limited permission cannot act as Principals to ARs. An AR can have more than one Principal.

[8] Technically, these are the activities for which an unauthorised firm may act as an AR. The list of activities for which a limited permission firm can act as an AR is yet to be published.

[9] Except for firms with interim permission, which will be exempt from this requirement.

[10] For C1 firms this is by a “firm-by-firm business mode and strategy analysis”; for C2, in “tak[ing] a group of similar firms in the same sector to identify common risks”; for C3, in “look[ing] at a sample of firms businss models across a sector”; and for C4 “a less intensive assessment” still. In CP13/07, the FSA envisioned “specific [FSF] regulatory engagement with smaller firms once every four years”.

[11] Except for firms with interim permission, which will be exempt from this requirement.