Learning the regulatory quick-step

Financial services regulators are out of tune with how the auto and asset finance industry operates, and not all public bodies are singing from the same hymn sheet, as recent decisions from the Financial Ombudsman Service (FOS) in the motor finance market have shown. As a result creating a harmonious approach that works for consumers and funders and meets regulatory requirements has become a challenge, AFC conference delegates heard in a session covering the critical regulatory developments so far this year.

Two FOS rulings on lenders’ failures to disclose the existence of discretionary commission payments in finance agreements for car purchases have prompted the Financial Conduct Authority (FCA) to launch a nine-month review, which requires funders to collate and interrogate data going back to 2007.

In addition, Barclays has set in motion a judicial review of the FOS ruling relating to Clydesdale Financial Services – trading as Barclays Partner Finance – with a decision not expected much before the end of the year.

Out of balance

Against this background regulatory expert Wayne Gibbard, partner at law firm Shoosmiths, characterised the auto and asset finance ecosystem as going through a “period of distress, where everything seems out of balance between the different characters and roles. There’s a need to re-characterise and restore more order and balance.”

The principal players are, firstly, the lawmakers in government who provide the legislative steer. Then the regulators, like the FCA, have rule-making powers to create regulations and the court system implements the law. Trade associations have a role in shining a light on niche areas such as the particular characteristics of a market.

However, Gibbard pointed out that FOS, as a public body rather than a regulator, has a different role in providing an “informal resolution” mechanism undertaken via an independent body. Crucially, FOS makes decisions based on what it judges to be “fair and reasonable”.

“That brings a whole different set of challenges. And in some cases people are left wondering how FOS can make judgments that go against some legal rulings and some FCA interpretations. But challenging those decisions is very difficult and requires a judicial review, which is what we are seeing with Barclays,” Gibbard explained.

However, he cautioned that the industry response of “it’s not fair” was not sufficient, given the high bar. The grounds for challenges to FOS rulings must be based on legality (FOS acted outside its powers); irrationality (in some way FOS did not understand the market); or evidence FOS acted outside its authority.

The situation is further complicated by a legal decision relating to a FOS ruling about pensions which went to review and where the court found that FOS interpretations can be counter to what the law would normally apply, effectively giving FOS a lot of flexibility and wide powers to make decisions, making it harder to make claims of irrationality stick.

Data is key

Underpinning such challenges, and the responses to the FCA review, is access to data which demonstrates how consumers were treated and the processes funders followed.

Richard Dewire, chief revenue office with asset finance IT specialists Alfa, pointed out that the industry’s response to Covid, which saw the rapid introduction of forbearance schemes in the wake of an unexpected disruption showed that “the ability to look at data and make rational decisions based on data is where tech can help.” However he cautioned that, given the current uncertainty, “you do need the requirement first.”

Gibbard reinforced the need for lenders to prepare for the outcome – noting that whatever that outcome might be, it is highly likely to involve some form of redress. While the form that takes is not yet clear, it will require data on individuals, in some cases going back over two decades, which is likely to be held on different software platforms. “Getting data sorted is super important,” he noted.

“As an industry we don’t want – and the regulator doesn’t want – a PPI type situation where the claims process goes on over years. What we are looking at is ‘once and done’, so that everyone has the data ready for whatever it is the regulators decide,” Gibbard said.

However, Dewire pointed out that there are particular challenges given the long period of time – up to 15 years ago – that the FCA has in its sights. “The timescale is challenging given that we usually get rid of data from systems once the regulatory need to keep it is gone. So you could be looking at having to scan paper documents and lenders need to prepare for that.”

Gibbard noted that the statute of limitations, which usually requires lenders to hold data for six years from the time the finance deal was signed, may not apply as the regulator may say that the key date is the point at which the consumer became aware they had a claim, which makes the limitation rule irrelevant.

Regulatory creep

These kinds of twists and turns are leading many to feel that the regulatory lines are becoming blurred between unregulated and regulated business, and that the industry is seeing “regulatory creep”.

Gibbard emphasised the importance of having clarity around the perimeters, saying that Consumer Duty principles had proved helpful in this respect, but warned that increased regulation did not guarantee better consumer outcomes as some funders may exit the market rather than take on the additional burden.

There is further regulatory change in prospect, given the planned review of the Consumer Credit Act (CCA) originally passed in 1974. There has been revolutionary change in how goods and services are sold over the fifty years since its inception, and in the asset and auto finance sector there are entirely new models, such as payments based on usage. These are facilitated by telematics systems collecting data on an individual’s movements which could be subject to data protection regulations as well as financial services regulations.

Usage models

Gibbard highlighted how onboarding consumers to subscription services currently is subject to “so much friction” because of CCA rules which mean purchasers have to be taken through many pages of explanation to meet these and Consumer Duty requirements.

“Looking at it more broadly, there are three types of activity: hire, which is a longer term product; credit, which is well understood; and now this usage product. That’s something new and when we start to look at reform of the CCA that’s going to be really critical for how, particularly in the auto or asset space, how we can drive growth going forwards,” Gibbard said.

“There is so much economic benefit that can be driven through data and leveraged through that I think it will become even more important. The use case will continue to explode,” he added.

Telematics is a key element of this, but Dewire cautioned that OEMs can be reluctant to share data from such systems with their captives, largely because they are traditionally risk adverse, and the regulatory requirements lack clarity. There are also questions for lenders looking to use telematic data to price usage models – in some cases that data is not shared with any other funders, which could lead to charges of anti-competitive behaviour.

But as the panellists concluded, change is a constant theme in terms of regulation, and additional regulation always has the capacity to stifle growth. While an advocate in principle of Consumer Duty, Gibbard conceded that it had “very real effects”, including increased overheads, and the duty to look at all aspects of the organisation and focus resources appropriately.

“It’s a complete reformation. There is no doubt that the sector is in distress and is going through a period of unprecedented change in financial services that will take some time to stabilise so that people have a consistent and clear view of the perimeter,” he advised.

Analysis from David Betteley, Asset Finance Connect’s head of content

This was an excellent session that really brought out the root cause of the issue facing asset and auto finance companies and banks. That root cause is uncertainty. Uncertainty leads to a lack of investment that leads to a lack of innovation and therefore a whole host of unintended consequences.

The major uncertainties arise from the lack of a consistent and/or joined up message from the FOS, the FCA and the FLA. This has resulted in Barclays having to pursue a judicial review of an FOS decision, which (depending on the outcome) will be of major benefit or a major setback for the industry. We await the outcome therefore with some trepidation!

Regardless of the outcome of this case, it is important to point out that the cost of complying with the ongoing changes to the legislative landscape for lenders is biting hard into margins.

Moreover, there is the issue of the cost of compliance becoming increasingly less affordable for smaller businesses, resulting in (what is currently a trickle) a number of lenders exiting the regulated credit market. This again leads to unintended consequences; lack of choice, especially for smaller, less credit worthy SMEs and, this in turn, leads to higher prices for everyone else.

Finally, let’s consider the elephant in the room that no-one talks about – the impact on intermediaries, dealers and brokers. It seems extremely likely that the FCA will decide on a level of compensation in respect of DCA. Once this is quantified, lenders may look to dilute the impact of this on their balance sheets by attempting to move some of the burden onto the original introducers of the business. This may well be possible depending upon the contractual arrangement between the parties.

This may be the next battleground following the final FCA decision, which may of course be delayed from September as the FCA awaits the outcome of the Barclays challenge, but make no mistake, a decision to award compensation by the FCA (at some level) looks to be a certainty.

Asset Finance Connect will look into the issues that may impact intermediaries in a forthcoming webinar. More details to follow.