The Edinburgh Reforms - consumer credit reform

On 9 December, the Chancellor of the Exchequer announced The Edinburgh Reforms - a regulatory shake-up designed to “drive growth and competitiveness in the financial services sector”.

On the same day, the Treasury released its first consultation on reforming the Consumer Credit Act 1974, one of the key parts of its Edinburgh Reforms strategy of “Delivering for consumers & businesses”. Speaking to clients across the sector, reform of consumer credit is warmly received, with most of the industry recognising the need for reform. Much of the detail is yet to be finalised, but the 71-page consultation provides insight into the direction of travel. In this article, we have set out what the new regime might look like and what firms in the sector should be doing now to prepare. We also focus on two sectors in particular, green finance and motor finance.

Why is reform needed?

The Consumer Credit Act 1974 (the CCA) is now over 50 years old and, in that time, the consumer credit market has evolved rapidly. It is generally accepted that the CCA is no longer fit for purpose, which has been shown by the industry-wide response in support of reform. Part of this is due to the older style of regulatory approach in the 1970s. Another issue is that regulatory changes over the years has led to a fragmented system of regulation which has become overly complex and split between overlapping legislation and rules in the CCA, subordinate legislation and the FCA Handbook. Some of the key regulatory developments that have led to the patchwork of consumer credit regulation are:One final factor necessitating reform is the integration of technology with lending. With the rapid growth of fintech lenders along with existing lenders in the market adopting new technologies, regulation has struggled to keep up with the pace of change. For example, more than 50% of new credit card agreements are now arranged online and many consumers will keep informed about existing credit products on their smartphones.

Impact of the reforms

The consumer credit sector is by far the largest portfolio of firms the FCA regulates, with around 36,000 consumer credit firms being regulated by the FCA. Due to this, and the impact the sector has on our daily lives, the sector is of critical importance to the public and the UK economy. The reforms sit alongside and will be impacted by other regulatory changes for firms in the consumer credit industry, such as the FCA Consumer Duty, which firms will currently be implementing ready for 31 July 2023. We have drafted separate articles on implementing the consumer duty for lenders and brokers and intermediaries. We expect the Consumer Duty to impact the CCA reform in many areas, including the form and content of documents. There will be a transition period in which the Consumer Duty is in force but CCA reform has not been finalised. During this period, firms will need to comply with the existing CCA requirements, whilst supplementing this with other measures to ensure the Consumer Duty is properly implemented.

Basic Principles

The FCA has set out 5 basic principles for reform:

• Proportionate: A balance should be struck between consumer protection and the added burden on businesses.

• Aligned: Reform will be aligned with other regulatory developments in progress, including the Future Regulatory Framework, the FCA Consumer Duty and diversity and inclusion.

• Forward-looking: A criticism of the old regime is that it is too inflexible, so the new regime will be designed to be more flexible to future changes in how credit is delivered.

• Deliverable: Reform must be deliverable for financial services regulators and the industry.

• Simplified: The regime will be simplified and modernised to resolve these criticisms of the old CCA regime.

Whether the government delivers on these objectives is yet to be determined, but the initial prospects look positive as these themes do run throughout the consultation document.

Buy Now Pay Later (BNPL) Reform

As set out in our previous article, the Woolard Review recommended BNPL reform is prioritised. One unintended consequence of accelerating BNPL regulation is that BNPL lenders are going to be subject to some different regulatory requirements to consumer credit lenders in the period between BNPL becoming regulated and wider CCA reform. BNPL providers may also have to cope with two changes of regulation - one when they are brought within the regulatory perimeter and another when wider CCA reform is implemented.One bizarre anomaly caused by this relates to small agreements as currently some parts of the CCA do not apply to agreements under £50 due to section 17 of the CCA. When BNPL regulation is implemented, it will apply to all agreements, including small agreements. This would result in interest-bearing agreements under £50 not being subject to certain requirements (including form and content requirements and creditworthiness assessments), but interest-free BNPL credit would be subject to these requirements. We anticipate this will be rectified by removing the small agreement provision in section 17 of the CCA so all CCA protections apply to all consumer credit agreements.

Business Lending

The scope of business lending that is caught by the CCA regime is regularly one that is questioned by our clients. Limited companies and limited liability partnerships fall wholly outside of the CCA regime. However, sole traders and some partnerships fall within the scope of the regime unless the lending satisfies an exemption that requires the credit to be for greater than £25,000. This distinction seems somewhat arbitrary (in particular, given that a loan to a private limited company that is secured by a personal guarantee made by a director would fall outside of the regime) and discourages lending to sole traders and partnerships under £25,000. The government is therefore consulting on changes the scope of business lending that is caught by the CCA regime.

Pre-contractual, Contractual and Post-contractual Documentation

One of the main changes will be to the information provided to borrowers. This includes the information required to be included in the credit agreement itself, the explanations and information provided prior to the credit agreement being entered into and the information and notices provided to borrowers after they have entered into the loan (such as default notices).Currently, the CCA has strict form and content requirements for most credit-related documentation, with highly prescriptive wording that must be provided in a particular form at a specific time. This approach means that a consumer will receive the same information about different credit agreements, allowing the customer to easily compare different agreements. Consumers that repeatedly use credit will also become familiar with the documentation. However, the disadvantage of a prescriptive approach is that it doesn't allow for flexibility, so the borrower may be getting information that is not relevant for their agreement or may not be getting the appropriate information at the right time. Further, it is not easy to provide the information in certain forms, such as via an app, as some of the prescribed form documentation is not easy to read on a mobile phone screen. The FCA has favoured a non-prescriptive approach in recent regulation, following its outcomes-focussed approach. As such, we expect to see a more flexible approach to documentation under the reformed regime, with lenders and brokers having the ability to decide the form and content of documents.The government included two examples in the consultation which, although it was keen to point out are for illustrative purposes only, do show how the government is currently intending to implement the reforms. The first example was to introduce a minimum pre-contractual information requirement, which firms can build on when giving pre-contractual information. The second example was replacing the Notice of Sums in Arrears (NOSIA) with a requirement to notify the customer with the necessary information to understand their circumstances when they fall behind on repayments. The common factor is that the onus is shifting from the legislator or regulator determining what information is sufficient to consumer credit firms having to make that decision, with penalties and possible compensation that would follow if a consumer credit firm gets it wrong. This shift in onus, along with the inevitable initial uncertainty of what is appropriate and sufficient, may leave firms more reticent about these particular reforms. The consultation responses here may be similar to some of the early responses to the Consumer Duty, where firms raised the issue of the onus shifting onto firms to determine what the information needs of a customer are, and the inevitable delay in case law precedent and a standard market practice developing.These reforms should be considered in the context of the proposed sanctions for not complying. The current CCA regime makes agreements in non-compliant form automatically unenforceable and certain enforcement action cannot be taken where certain prescribed notices have not been given. However, where the information requirements are less prescribed, it may be more difficult to implement a rule of automatic unenforceability. It will be interesting to see the industry reaction to the suggestion of giving the FCA the power to apply unenforceability as a sanction for breach of the FCA rules in a wider set of circumstances than it currently has the power to do under the Financial Services and Markets Act 2000. However, the suggestion that such sanctions should be proportionate and relative to the consumer harm caused will be welcome for the industry, as this is less draconian than the current regime. Finally, Islamic Finance providers will be reassured to see that the requirements of Islamic Finance providers will be taken into account when the government reforms the information requirements, as currently some Sharia compliant personal loans are being prevented from coming to market due to CCA documentation requirements.

Retaining important consumer protections

The government has highlighted some important CCA protections that it intends to retain in the CCA reforms and has proposed moving others to the FCA Handbook. We do not propose to go through each of these in this article, but two are particularly pertinent.Section 75 CCA liability is one of the key protections that the government wishes to retain but that cannot be moved to the FCA Handbook. This makes certain regulated credit providers jointly and severally liable with suppliers for a misrepresentation of breach of contract in relation to goods and services financed by a credit agreement. The government wishes to reconsider or clarify certain aspects of section 75 CCA liability but is concerned about this impacting the body of case law precedent that is in place for the existing section 75 CCA. How the government will tackle the areas of the CCA that cannot be replicated under the existing FCA regime is not clear, but it is possible the FCA's rule making powers could be increased.Another important protection in the CCA that we regularly advise on is section 140A-C CCA unfairness. The consultation suggests that FOS does not provide the same consumer protection as the unfair relationship provisions (given the FOS compensation cap and the time taken for the FOS process to result in a decision). We consider it is likely some form of unfair relationship provision will be retained.

The impact of the reforms on specific sectors

CCA reform will be tailored around the financial products currently available in the sector but flexible to allow future innovation. The legislation should be designed to facilitate competition and innovation in the sector, whilst protecting consumers. Two sectors will be particularly focused on: green finance and motor finance.

Green Finance

Green and ESG (environmental, social and governance) factors are currently at the forefront of the mind of the government, investors and regulators. A big factor in the green revolution is finance. The government clearly wants to encourage green finance initiatives, such as financing renewable energy solutions, electric vehicles and green home improvements. It is interesting that the consultation document discusses “removing barriers” and enabling new products to be “easily incorporated into the regulatory structure”, which suggests the government is intending to implement this by structuring the regulation of consumer credit in a way that facilitates all new finance initiatives, rather than bringing in specific exclusions or exemptions for green finance initiatives.

Motor Finance

The growth of motor finance means that, after a residential mortgage, motor finance usually represents the second largest debt incurred by consumers. It is therefore not surprising, but is striking, to note the number of references to motor finance in the CCA consultation document. Much like green finance, we expect the government to structure the regulation of consumer credit in a way that facilitates a properly functioning motor finance market, rather than implementing specific regulations for motor finance.Consumer hire is a popular financing option in the motor finance market, with Personal Contract Purchase (PCP) and Personal Contract Hire (PCH) both being popular options. Currently, consumer hire is subject to a lower standard of rights and protections compared to consumer credit. We expect the outcome of the consultation will be to have comparable standards for both consumer hire and consumer credit products.One focus of the consultation was on the use in the motor finance market of the right to voluntary termination for hire purchase and conditional sale agreements (currently contained in sections 99 and 100 of the CCA), which are used in motor finance to move from one agreement to another. The government has highlighted that this was not the original intention of sections 99 and 100 of the CCA, which were designed to help customers in financial difficulty. The consultation states that this use of sections 99 and 100 of the CCA could be impacting prices and rates, so CCA reform may prevent sections 99 and 100 of the CCA from being used to move from one agreement to another and instead restrict its use to situations where the customer is in financial difficulty.We encourage businesses in the motor finance sector in particular to engage with the consultations.

Implementation timeline

As set out above, CCA reform should be approached positively by the industry and consumer credit firms will likely welcome a simplified regime. However, CCA reform will take many years and will include a number of consultations and draft proposals, following which Parliament will need to make legislative change, which will be a long process. It is likely the reforms will go beyond this Parliamentary session and the outcome of the next general election could impact the exact direction of the reforms. However, given the broad support for reform from Parliament, the consumer credit industry and the regulator, it is likely that the reforms will continue in the next Parliament.

How our financial services team can help

We encourage all firms in the consumer credit industry to engage fully with the consultations and to be cognisant of the direction of travel. Our Financial Services Regulation team includes specialist Consumer Finance lawyers,  who are keeping up to date at every stage of the reform of the consumer credit sector. We regularly advise on complying with regulatory obligations and implementing and adapting to regulatory change. Our expert team is able to assist you with considering how the CCA reforms will impact your firm and what changes and reviews will be needed to ensure that you can be confident in your ability to evidence immediate compliance once the new rules take effect. Our team have also supported a number of clients across the consumer finance sector, which has included drafting the full suite of consumer credit documentation and other compliance documentation. For further information, do not hesitate to contact Adam Edwards for a confidential, no-obligation discussion to review what support we can give you.