Implementation of the Consumer Duty for Lenders in the Consumer Finance Sector

The introduction of the Consumer Duty is the biggest regulatory shift in financial services in recent years, with a very tight timescale for implementation set out in the FCA's policy statement of 28 July 2022 (PS 22/9).

We have scrutinised each of the FCA's consultations leading up to its final rules and engaged with clients on the key issues, advising them on their implementation plans and how to put plans in place. Drawing on this experience, we have set out in this article guidance on implementing the Consumer Duty for lenders in the consumer finance sector.Lenders should note that the FCA has been clear that there is no 'one size fits all' approach and that implementation plans should be tailored to each firm. Therefore, we recommend firms receive advice on their specific implementation plans and needs.

What is the consumer duty?

Understanding the structure of the Consumer Duty is crucial to then being able to implement it properly. The Consumer Duty has the following structure:

The principle

The Consumer Duty amends the FCA's existing Principles for Business (PRIN) introducing a new Principle 12, the Consumer Principle, which is intended to set higher standards for firms than the existing Principles. This is shown at the top of the triangle. In particular, when Principal 12 applies, the existing Principle 6 (treating customers fairly) and Principle 7 (clear, fair and not misleading communications) are disapplied. Principle 12 is outcome-focused - so your implementation plan should be as well. The new Consumer Duty requires a more proactive approach. The FCA has provided some comfort that the Consumer Duty is not a duty of care, is not a fiduciary duty and does not require firms to provide advice where they would not otherwise do so.

The cross-cutting rules

Underpinning the new principle are three cross-cutting rules.

• Acting in good faith

The FCA has provided examples where a firm would not be acting in good faith. Lenders will particularly want to consider:

• • Taking into account retail customers' interests - ensuring the product is suitable for the target customer (e.g. in the context of mortgage lending, bridging finance may not be suitable for retail customers that need longer-term finance).

• • Not exploiting retail customers' behavioural biases (e.g. some retail customers may have a bias towards taking out credit when it is more prominently displayed than other options).

• • Not taking advantage of a retail customer or their circumstances (e.g. a borrower in financial difficulty, who is also likely to be a vulnerable customer).

• • Not carrying out the same activity to a higher standard or more quickly when it benefits the firm than when it benefits the retail customer (e.g. in particular when providing customer support).
• Avoid causing foreseeable harm

A firm must avoid causing foreseeable harm to retail customers, whether by act or omission, and whether in a firm's direct relationship with the retail customer or through its role in the distribution chain even where another firm in that chain also contributes to the harm.

This cross-cutting rule was amended from “avoiding foreseeable harm” to “avoid causing foreseeable harm” to underline that firms are not required prevent harm where a properly informed retail customer has made the decision to proceed (e.g. in the context of investments, the risk of underperformance or losses unless such risks were risks the customer was only exposed to because the investment was unsuitable for them). One of the FCA's regulatory principles is that customers are responsible for their own decisions.

Whether harm is foreseeable will depend on whether a prudent firm acting reasonably would be able to predict or expect the ultimately harmful result of the firm's act or omission. The Consumer Duty is “underpinned by the concept of reasonableness” so firms are only responsible for addressing the risk of harm that is reasonably foreseeable at the time. Where harm was not foreseeable at the outset of an arrangement but becomes apparent later, firms must take steps to take appropriate action at that stage to mitigate the risk of harm, whether actual or foreseeable.

• Enable and support retail customers to achieve their financial objectives

The implementation of this cross-cutting rule will depend on the type of finance being offered and the target customer base identified by the lender.

The four outcomes

As set out above, the Consumer Duty focuses on outcomes. The four outcomes should therefore be central to firms' implementation at every stage.

Implementation timeline

Firms should focus on the implementation timeline to ensure implementation is feasible within the regulatory timescales.

Implementation for lenders

Implementation should focus on the four outcomes identified above but lenders should be careful to ensure the entire product and customer journey is considered. The key issues are as follows:

• Products and services

Lenders will first need to identify which of their lending products are affected by the Consumer Duty. Lenders will also need to check if they distribute any other products that are affected by the Consumer Duty (such as insurance) or if they design or manufacture products targeted at retail customers that are then provided by third parties.

Once these products have been identified, lenders should identify the customers that these products are targeted at. As product manufacturers, lenders are required to specify the target market for their products “at a sufficiently granular level, taking into account the characteristics, risk profile, complexity and nature of the product”.

Once the products and target customers have been identified, lenders should map the customer journey from start to finish thinking about what outcomes there could be for customers and when they can occur during the customer journey. When mapping the customer journey, lenders should identify all other parties in its distribution chain (including brokers, debt management firms etc.) and gather information and data from them to support the implementation. It is worth lenders identifying the points in their customer journey map where they have the potential ability to influence the customer the most, as these points should be a focus for implementation of the Consumer Duty.

One key thing for lenders to consider is their finance documentation. Particularly for regulated credit agreements, whilst much of the form and content is prescribed by regulation, lenders will need to ensure all documentation presents information in a way that can not only be readily understood by retail customers but also gives the right information at the right time to enable customers to make good decisions. The guidance in PRIN 2A provides some clarity on this point, suggesting that firms can demonstrate acting in good faith to support their customers' understanding by “presenting information in an even-handed way that properly explains the benefits and risks”. Where communications and documentation are not subject to prescriptive rules, lenders will need to consider whether it is appropriate for the target customer. At the point of sale, lenders may wish to focus on how their finance agreements are laid out, what supporting documents are provided (also being very wary of information overload) and how this fits into the customer journey as a whole (i.e. what other conversations and documents does the customer receive at different stages). After the point of sale, lenders may wish to focus on the clarity of their communications and, in particular, ensuring they have robust processes that produce good outcomes when customers miss repayments or are in default.

• Price and value

The consumer finance sector has been the subject of numerous interventions by the FCA for specific products and the FCA has already highlighted a number of unfair business practices, so many firms should already have documented analysis of the price and value of their products. However, a full review of pricing models and value assessment is recommended - including focussing on any cancellation, late payment and refinancing fees. This will likely place further pressure on high-cost credit lenders to justify that, once costs are factored in, their products provide the customer with fair value.

Price and value assessments should be supported by customer research and data collected on retail customers and should be scrutinised at board level.

Price and value assessments will require careful consideration of the fundamental way firms make money from retail customers. However, the value assessment is wider than just financial considerations. For example, the non-financial costs customers may incur include the firms' use of customer data. If customer data is used to develop and sell new products and services, the firm should consider the value of this and factor it into the fair value assessment.

• Consumer understanding

This outcome focuses on the whole consumer journey, and so goes beyond the existing Principle 7 (clear, fair and not misleading communications). This outcome will be particularly important in the consumer credit and regulated mortgage sectors, where there can be significant information asymmetries and behavioral biases.

The prescriptive nature of some consumer finance documents (such as the ESIS for regulated mortgages or the requirements of the Consumer Credit Act 1974 for regulated credit agreements) means firms have little flexibility in adapting them. This is where firms need to pay attention to the FCA's guidance on 'layering' information. This is presenting information in a logical order with key information up front and signposting more detailed information that can be accessed later on.

Another aspect for lenders is whether there is a framework for establishing the correct balance between making finance easy to access and ensuring customers understand the available products. The FCA advocates building in friction into a sales process to prevent customers taking out a product without the proper understanding.Finally, communications should be tested for consumer understanding. At Freeths, our Terms of Business have been given the Crystal Mark by the Plain English campaign, which is part of our work to test the clarity of our communications. This could be a useful starting point for lenders, but data on consumer understanding should also be collected.

• Consumer support

Lenders should identify all channels of communication and support customers might access and consider how each of these channels will meet the new standards.

The FCA has stated that firms need to “deliver support through appropriate channels that enable firms to respond flexibility to their customers' needs”. This will include identifying any current 'friction points' that could benefit the firm to the detriment of the consumer (e.g. a long telephone hold time or other actions that discourage a customer from making a complaint). The FCA describe these as 'sludge practices', which are “an excessive friction that hinders consumers from making decisions in their interests, by taking advantage of their behavioural biases”.

However, lenders should also be considering building friction into processes where this could benefit a retail customer - for example adding verification steps that help protect their customers from scams.

• Testing and training 

Lenders will need to have a good knowledge of the whole customer journey so they can assess whether they are providing good outcomes in the context of the whole customer experience. This will require an understanding of the role of and collaboration with other firms and third parties that have an impact on the customer journey. The first thing to do is to review what sources of data are available in order to monitor and test consumer outcomes and whether a firm is complying with the Consumer Duty. Once these sources of data have been collected, lenders can decide how they will monitor management information. As information is likely required from the other parties in the distribution chain, data sharing arrangements should be reviewed and updated.

For lenders, we would expect the implementation of end-to-end outcome testing. Although lenders could be tempted to complete a review for a specific time period (e.g. reviewing customer outcomes over the course of one year), this could be flawed as customers' lending journeys could regularly last significant longer (particularly in the regulated mortgage sector). End-to-end testing should include testing of the entire customer journey, including: marketing; advice and arrangement of the loan; affordability assessments; any customer contact during the life of the loan (such as servicing the loan); recovery of the loan, debt collection and/or management; arrears; and end of the contract or sale of the debt. Although we appreciate this will incur significant time and resources, we consider this is key to identifying any gaps that may be missed by other testing and monitoring.

The results of all testing and monitoring should be collected and root cause analysis carried out to identify and mitigate any gaps in the customer journey.

Lenders should set out in detail staff training on the Consumer Duty to ensure it is fully understood across the business and to ensure consumers and the delivery of good outcomes for consumers are at the heart of everything employees do.

Specific issues for the fintech lenders

Advancement in technology now means that borrowers can search for, review and enter into finance arrangements online with minimal human input. Technology has been integrated most noticeability in the soon-to-be-regulated Buy-Now-Pay-Later (BNPL) sector (see here for more information on regulation of the BNPL sector).Particularly for consumer credit, this means that finance arrangements can be entered into within minutes with an entirely online sales process. This does, however, rely almost entirely on electronic systems and algorithms being employed to arrange the finance and assess affordability, which is typically based on the responses given to 'stock' questions.Whilst on the face of it this approach is efficient and convenient for both lenders and borrowers, the lack of any human involvement from the lender may mean that certain customers are not entering into loans that produce good outcomes. Affordability assessments and treatment of vulnerable customers will be a particular concern for FinTech lenders. The questions which algorithms use could allow room for confusion or misinterpretation. If the customer had been speaking with the lender or a broker directly, clarification may have been easily obtained. With online purchasing however, these potential uncertainties become more problematic.Where finance is offered both online and in person, lenders will need to ensure consistency of service standards. One solution to this may be a standard procedure of ensuring a telephone call is made to every customer who purchased finance online within 24 hours of them doing so, in which the lender can offer to discuss the finance and check its appropriateness. However, this would require larger human resources than a lot of FinTech lenders may have and be counterproductive for the savings FinTech lenders are seeking from being wholly online.

Considering the cost-of-living crisis when implementing the duty

The FCA sent a 'Dear CEO' letter on 16 June 2022 to over 3,500 firms, including lenders, brokers and, interestingly, BNPL providers (interesting as, currently, these firms are not regulated by the FCA). Overlapping with the Consumer Duty, the focus of this letter was on fees and charges (i.e. price and value), communications and customer support. The cost-of-living crisis has intensified the focus on consumer outcomes, as more consumers may be in financial difficulty (becoming vulnerable customers) and it may be more difficult to achieve good outcomes for consumers. The FCA expects more demand for credit, but with borrowers potentially being in a weaker position in respect of affordability.Lenders therefore need to be robust at the point of providing credit, in particular in respect of affordability assessments, but also show forbearance and be flexible at the point of repayment - taking into account potential future circumstances of the borrower as well as those that persist at the time of repayment.Firms should include the cost-of-living crisis in their implementation of the Consumer Duty and expect of the FCA's scrutiny to intensify in the current circumstances.

Immediate steps for lenders

Lenders should already be well under way with their implementation plans, which should be completed and ready for sharing with the FCA by 31 October 2022. Lenders should also be preparing for providing information on the target market and customer to brokers by 30 April 2023. The FCA has stated that it expects firms to make use of the whole implementation period and to be able to demonstrate the progress of this when asked. We recommend you take the following steps immediately, if you have not already done so:

• Undertake training to ensure all senior management are aware of the significance of the new Consumer Duty and their role and obligations in terms of ensuring compliance with the new standards.
• Engage early with brokers, debt management firms and other firms in your distribution chain and obtain any information, such as information from brokers on distribution.
• Complete your implementation plan.
• Ensure your implementation plan is supported by evidence (such as board papers and minutes) to show you have scrutinised and challenged the plan to ensure it is deliverable and sufficiently robust to meet the new standards.
• Take ownership of the implementation plan at a board level, ensuring each step is implemented on time and the plan is continually updated.
• Start thinking about the annual assessment of compliance with the Consumer Duty early.

How can our financial services team help?

Our team would be very happy to advise on and assist you with your next steps. Our Financial Services Regulation team can assist you with all aspects of preparing your implementation plan and putting this into practice in your business. We regularly advise on complying with regulatory obligations and implementing and adapting to regulatory change. Our Financial Services Regulation team has extensive experience in the consumer finance sector (some of our experience can be viewed here) and has experience assisting firms to prepare for the Consumer Duty. Our expert team is able to assist you with considering how the Consumer Duty regime will impact your firm and what changes and reviews will be needed so as to ensure that you can be confident in your ability to evidence immediate compliance once the new rules take effect.

For further information, do not hesitate to contact Adam Edwards or Daniel Meyer for a confidential, no-obligation discussion to review what support we can give you.