Challenges arising from regulatory overload

Summary

Compliance and the sheer overload of recent regulation remain a major concern for the asset finance broker-lender channel.

With the recent introduction of new regulatory rules including the Consumer Duty rules and outcomes, regulators are continuing their drive for best practice and good customer experiences, together with a focus on price and value. This is all to the good, however, confusion surrounding the application of Consumer Duty rules to regulated and unregulated business, along with the review of the Consumer Credit Act and the Appointed Representative (AR) Regime by the Financial Conduct Authority (FCA) and the prospect of yet more change, has left many brokers in the asset finance sector wondering how their already stretched teams will be able to respond to the increased burden.

It is to be hoped that the review of the Consumer Credit Act (CCA) 1974 will bring clarity and a greater harmonisation of regulatory rules, while a possible collaboration of brokers, lenders and industry trade associations should result in a standardised process for information packs and broker oversight reviews, in order to ensure that compliance issues are co-ordinated in a common unified manner.

Standardized broker-lender review process

While regulation is having a notable impact on end-user customer outcomes and is helping to reduce risk and fraud in the financial services sector, the broker community is at a crossroads and can see a potential reduction in business due to the increasing oversight review processes and the introduction of more regulation.

All lenders perform their broker oversight slightly differently, depending on their interpretation of the regulation, leaving brokers having to go through a detailed oversight audit process numerous times in line with the number of funders they have on their panel.

Smaller brokers can therefore end up spending more time dealing with funders, broker oversight reviews and audits than they do actually serving their SME customers.

Standardization and consistency in the execution of oversight audit reviews is needed with funders and brokers collectively agreeing the way forward.

As the industry develops an understanding over what the right controls are, it can hopefully reduce the cost of these controls by making them part of commonly agreed background processes that ensure that all the relevant regulations are adhered to.

Technology can also allow a business to build-in processes that can capture adherence to issues like GDPR and Consumer Duty, demonstrating that they have been addressed.

The core DNA of a technology build is the ability to track matters and show that good customer outcomes have been achieved. Automating certain processes and systemizing data and evidence would assist brokers by bringing to the forefront those activities which brokers must evidence, for example, eligibility and affordability.

Appointed Representative Regime

There is a lot of ongoing activity in this space at the current time, with the FCA undertaking a review of the Appointed Representatives Regime (AR).

Initially AR structures were a convenient device to allow groups to share resources without having to have multiple permissions across multiple entities and effectively doubling-up resources.

However, applying the AR regime to the consumer credit market with all its nuances and complexities, different product types and different customers, has caused some problems.

As the use of ARs in financial services has continued to evolve, the FCA in its recent work has seen a wide range of consumer harm across all the sectors where firms have ARs. In particular, the FCA has identified significant shortcomings in principal firms’ (principals) understanding of their regulatory responsibilities for their ARs.

The FCA consulted on changes to protect consumers and address harm across all the sectors where principals and ARs operate. Effective from December 2022, the FCA introduced new rules requiring principals to provide more information on ARs, clarifying and strengthening the responsibilities and expectations of principals.

The new requirements cover three key areas: design and implementation of a robust AR oversight framework; annual gathering and reporting of AR data; and evidencing compliance with the rules in an annual self-assessment report approved by senior management.

The new rules mark a more proactive and, in many ways, more intense supervisory strategy by the FCA when it comes to ARs. The rules will affect not only principals in that they will have more responsibility in terms of overseeing and reporting information about their ARs, but they will also affect ARs themselves who will have to provide their principals with more detailed information on a more regular basis. Increased resources and costs will transfer to ARs for these services, with brokers once again burdened with more regulatory oversight and reviews.

The FCA added that it would undertake targeted supervision of principals and would increase scrutiny of those firms applying for authorization to appoint new ARs.

The FCA’s updated rules for principals making use of ARs introduce new responsibilities and requirements and signal a clear step-change in the intensity of the FCA’s supervision of principals.

Along with these new rules for principals, there was also a mandatory information gathering from the FCA under Section 165 of FISMA looking for drivers of harm and alerting principals that the FCA are looking closely at the size of AR structures: how compliance of a large network 100 ARs is managed; renumeration; and commission, for example.

Outputs of the review are still pending but the AR regime in relation to consumer credit is up for grabs at the moment. The fact that the FCA have initiated such a huge Section 165 across the whole market suggests that they are minded to explore particular areas of harm and may well seek further interventions.

Consumer Duty

With the new Principle 12 (Consumer Duty), the FCA has introduced additional layers of compliance and raised the benchmark for regulated business.

However, many in the asset finance sector feel that Consumer Duty has a few quirks surrounding the application to certain businesses and no uniform definition provided for the ‘retail customer’ term. These issues need to be resolved and clarified, including an urgent clear description of business use as all subsequent queries lead back to it.

The FCA had an ambition of trying to give everybody clarity about their roles in a regulatory structure but applying it to the asset finance marketplace is extremely complex, which is causing problems for both funders and brokers.

As a sector we need to get the focus right and get the data right and present the case to trade associations that we want asset finance businesses to be outside the scope of regulation.

The introduction of information packs from lenders for brokers, as a result of consumer duty rules, is also causing unnecessary work and upheaval for brokers due to a lack of consistency in the various packs that come from different angles. Different lenders have different views of the market, different risk appetites, and different processes.

Within a matter of weeks, brokers have got to assimilate all this differing and inconsistent information from different pockets of the market, in time for the end of July when Consumer Duty will be in place. Also, it is likely that packs will need to be refreshed and updated as and when things become clearer.

Just like the broker oversight review process, there needs to be more co-ordination in the market regarding information packs that must all contain consistent information and instructions. Consistency is also required across the various codes – FCA, FLA code, NACFB code, Lending Standards Board – with baseline information that lenders should be providing to brokers to try to harmonize the process.

Concluding remarks

According to one unconference participant, “compliance has become an industry in itself” with the focus no longer solely on protecting the customer.

Recent regulation overload has resulted in an increased burden for asset finance brokers, with more time being spent on onerous oversight reviews and form-filling rather than on their actual business and serving the customer.

Many brokers, who have always looked after their customers, are thinking about exiting from FCA permissions, as they simply do not have the time or resources to complete all the necessary checks and provide documented evidence of this, whilst also risking fines or censure if not properly completed.

Many in the industry are optimistic that the Edinburgh Reforms, including the review of the 1974 CCA and transfer to FCA powers, will bring an industry-wide definition of ‘individual’ that will exclude business use. The exclusion of business lending from consumer credit will increase liquidity for SMEs and sole traders and will, in turn, reduce the cost of regulation as the FCA do not see as much harm as in the consumer marketplace.

The asset finance sector, which sees relatively few complaints, should of course still follow best practice for unregulated business in the business-to-business marketplace.

The worst outcome from the Edinburgh Reforms would be if it is decided that all small businesses fall within the scope of regulation. In such a disruptive scenario, asset finance trade bodies would need to unite, co-operate and have a combined voice when dealing with the FCA.

Hopefully the review of the Consumer Credit Act will bring some clarity and peace of mind for the asset finance broker-lender channel; but for now, we will have to wait and see.