Posted: 20th December 2018
On the 22nd November 2018, the FCA proposed a price cap on rent-to-own (RTO) products that would see the cost of credit used to purchase such items limited to a maximum of 100% of the cost of the product itself.
If the proposed rules are finalised after consultation with the industry, the price cap will be implemented from the 1st April 2019. In addition to the proposed cap, the FCA will also require RTO firms to benchmark the cost of the products they sell with those of three other retailers - a requirement aimed at minimising inflated pricing.
The price cap proposal comes after intense regulatory scrutiny of the high-cost credit sector during which the FCA sought to better understand the risks that firms in this sector pose to customers. Given that the customer base for RTO firms is largely made up of those with limited access to credit, or who are potentially financially vulnerable, this market has been a priority area of focus for the regulator.
The FCA believes that RTO firms may be charging more than the regular retail price for essential products like household appliances. Inflationary pricing of these goods – combined with the cost of credit to purchase the product in instalments, add-on insurances and warranties – sometimes means that customers end up paying four times more through an RTO provider than they would if they purchased the product outright.
We have to ask at this point, will the price cap work? What can we learn from past attempts at regulating prices and what does this mean for firms within other regulated industries?
FCA, a pricing regulator?
The FCA has long claimed that it is not a pricing regulator since it does not have formal and regular price reviews built into its remit. Despite this, since 2013, the FCA has introduced pricing regulation in three areas:
- High-cost short-term credit (HCSTC) in 2014
- Workplace personal pension schemes in 2015
- Early exit pension charges in 2016.
The regulator insists that pricing intervention was necessary in the above instances to advance its objectives relating to consumer protection and ensuring competition in the market.
Competition within markets, bar a few exceptions, should encourage pricing strategies that are beneficial for consumers. Conversely, where there is a lack of competition, the risk of unfair pricing strategies tends to increase.
Monopoly or an imbalance of market power is, of course, a concern for the FCA. Those companies who are in an unassailable position are those who present the greatest risk of overcharging consumers. In extreme cases, regulation is required to reduce harm. This is often the premise for intervention into pricing, but the question remains: is pricing regulation the right solution?
To examine this, we should look at what has happened following the introduction of the HCSTC price cap and the likely effectiveness of similar actions at mitigating risks to customers. We also need to give wider consideration to the consumer credit sector as a whole.
The HCSTC price cap
The HCSTC price cap was announced in 2014 and its impact has been closely monitored by the FCA ever since. The price cap imposed a set of limits on the fees and charges that can be levied on HCSTC borrowers, including:
- A daily interest cap of 0.8%
- A default fee cap of £15
- A total cost of credit cap of 100% of the principal loan amount
There were a number of factors behind the FCA introducing these caps. In 2014, there were many lenders in the market, but price competition was weak. This was partly due to the fact that consumers were not shopping around or comparing prices. Why? The simplest answer is that doing this is time consuming and offerings weren’t easily comparable at the time. This was likely exacerbated by the fact that HCSTC customers typically needed access to credit urgently. Evidence suggests that consumers who need access to credit immediately are, on the whole, less concerned with the overall cost of a product.
Due to a lack of rigour from many of the HCSTC firms at the time in determining what the customer could afford, many customers then faced excessive late-repayment fees and charges, suffered from unfair collection practices, and found themselves trapped in debt spirals.
The FCA took the view that they had little choice but to intervene in the form of a price cap.
Since implementing the price cap the FCA has issued a Feedback Statement (FS17 / 2) on high-cost credit which includes its findings on the impact of the HCSTC cap. In the paper the FCA state:
“We have found improved outcomes for consumers since setting the cap. Consumers pay less, repay on time more often and are less likely to need help with HCSTC products from debt charities. Debt charities have also indicated that consumers are presenting themselves earlier and with lower debts, suggesting that underlying problems are being addressed sooner.”
This, along with the commitment to review the cap again in three years-time, suggests that the HCSTC price cap is considered successful in the eyes of the regulator. The Feedback Statement also touches, albeit in less detail, on the impact the cap has had on the composition of the market, with a number of firms being forced to cease trading and others currently looking to wind down.
Is there a similar risk that a price cap in RTO will negatively affect competition in the market?
The RTO price cap
The FCA believes that the current RTO market suffers from a lack of competition already. Indeed, the FCA highlights that a little over 90% of RTO agreements are made by just two firms. This is significantly different to the HCSTC market which suffered from overpopulation of the market.
The consumer base for RTO firms do however share similarities with the customer base of the HCSTC sector. Within the consultation paper, the FCA states that
“Only one third of RTO consumers are in work and most have low incomes. They are more likely to live in the most deprived areas of the UK, a quarter say they have missed a bill payment in the last six months and a third have suffered anxiety or stress due to financial difficulties. They are the least creditworthy individuals compared with other users of high cost credit.”
In summary, these customers are often in urgent need of credit to facilitate the purchase of essential goods. This urgency to secure credit creates similar risks to those witnessed in the HCSTC sector, potentially exacerbated by the lack of competition.
The RTO price cap doesn’t just limit the amount RTO firms can charge for credit, it also limits how they price the domestic goods which are being sold. While the cost of the goods themselves is intrinsically linked to how much a customer will pay if they purchase using credit, this is the first time that the FCA has stepped in to regulate the price of a non-financial services product.
The requirement to benchmark the price of the goods against other retailers presents challenges. Firms will need to develop policies and procedures for continually assessing and monitoring the price of their products to ensure they remain compliant. They will also need to develop record keeping systems which evidence the application of these procedures. One challenge which we foresee in the benchmarking exercise, is that many RTO firms sell products which are not available elsewhere, thus complicating the benchmarking process. The benchmarking requirement will certainly place additional administrative burdens on RTO firms.
LIKELY EFFECTIVENESS OF THE PRICE CAP
In the consultation paper, the FCA states “We estimate that our proposed price cap could deliver net consumer benefits of between £19.6m and £22.7m a year.” On the face of it, this appears good news for consumers but as with any price intervention there are potential unforeseen consequences.
There are some immediate implications of the price cap, most obviously being the reduced revenues for firms operating within the market. Where price caps have been implemented previously and resulted in firms generating revenue at lower levels than previously experienced, some firms have exited the market (which further reduces competition). In the RTO sector this could have the impact of fostering monopolies in the market. Others have sought to generate revenue by other means not subject to the cap with the end result being that customers don’t feel the full benefits of a cap.
So, while price caps can provide benefits, they also need to be continuously monitored to ensure that unintended consequences do not occur and cause more harm than good.
WHAT ABOUT OTHER FORMS OF HIGH-COST CREDIT?
The FCA clearly states that the most recently proposed price cap is limited to the RTO sector. However, there are many firms who operate in the high-cost credit sector that do not fit the definition of an RTO firm, but whose business models and target markets are incredibly similar.
The FCA is aware of this and has stated “we have concerns about consumer hire agreements that have similar features and pricing to RTO agreements. We will consider carrying out further work so that we better understand the risks and costs to consumers of these agreements, and will intervene to protect consumers if necessary.” This suggests a possible extension of the price cap to other firm types.
Non-RTO firms should not rest on their laurels. Instead, they should prepare for future rule changes, potentially in the form of price caps or requirements. The read across should not be underestimated.