Posted: 20th December 2016
Extracts taken from Matt Drage’s speech at the FLA’s Annual Motor Finance Conference.
The FCA has clearly had a busy year in relation to consumer credit. The regulator has initiated plenty of specific work in this area, from publishing occasional papers on financial distress, to, in the last few days, the release of a thematic review into early arrears. Key work on remuneration, incentivisation and creditworthiness is also expected to land soon.
So what are the biggest conduct challenges that motor finance firms are currently faced with, and what will 2017 bring? With much change happening currently, how can firms best incorporate the regulatory priorities for 2016/17 into their business strategies?
Motor finance in 2016 - a regulatory review
Predicting financial distress (the FCA’s Occasional Paper 20)
Approximately 2% of individuals holding consumer credit debts were regarded as being in financial distress when objective measures are used, but looking more widely at subjective measures, the proportion of individuals suffering financial distress rises to 17% of those with outstanding consumer credit debts.
Firms seeking to bridge trust gaps with consumers will need to pay particular attention to protecting and providing good outcomes to the 17% of customers in potential difficulty, as it’s clear that the definition of financial distress is already coming under scrutiny.
Indeed, the FCA’s thematic review into early arrears, published on the 13th December, focuses on the customer’s entire journey through an arrears situation; from the point at which a customer is identified as having potential repayment problems through to the debt being paid-off in full.
Staff remuneration and incentives in consumer credit
Supervisory work by the FCA suggests many motor finance firms may be operating high-risk incentive schemes which can often lead to poor consumer outcomes if not managed effectively. The incentives offered to those selling financial products inevitably impacts on behaviours, and so firms should consider:
- Whether their financial incentives are conducive to protecting customers from detriment and delivering good outcomes (as well as being rewards that reflect successful performance)
- How they can ensure incentivisation doesn’t solely focus on profits for the firm – for example, should there be incentives for successfully matching customers to suitable products?
- Whether there is a culture of compliance and consumer protection in the firm that is endorsed from the top and understood at the front line
The FCA will also seek to understand if similar issues around incentives historically identified in the banking space are also present across the motor finance sector.
Early arrears in unsecured lending
In its 2015/16 business plan, the FCA committed to examining the ways in which unsecured consumer credit debts are collected, and the extent to which firms involved in the recovery and collection process are following the FCA’s rules, treating customers fairly and showing appropriate forbearance.
The FCA has now published its thematic review into this area, and the report confirms that the retail financial sector is causing some concern in terms of its delivery of good outcomes and compliance with FCA rules.
Some considerations for motor finance firms given the specific concerns around the retail financial sector include:
- Are customers at the heart your business model - i.e. is there a culture of protecting them against detriment through proactive measures such as outcomes testing and root cause analysis?
- Does your firm monitor the repayment history of customers and take appropriate action where they see signs of actual or possible repayment difficulties? Is the definition of what constitutes a customer in difficulty clear in your firm?
- Does your firm react to the findings of the above with proportionate action, such as altering policies and product terms to ensure they work better for customers or intervening when individual customers appear to be in difficulty?
- Do you keep a record of these types of decisions?
Getting conduct right in this area will likely involve firms ensuring they have considered the above questions. Quite apart from changes firms may be obligated to make, focusing on intervening in individual cases at the earliest appropriate time can have a significant impact on the outcomes provided to customers beginning to experience difficulty.
A look ahead to 2017
As well as the ongoing challenges of embedding the required changes in the areas above, what are motor finance firms, and indeed consumer credit firms generally, likely to experience in 2017 from a regulatory perspective?
Senior Managers and Certification Regime
The treasury announced the Government’s proposal to extend the Senior Managers and Certification Regime (SM&CR) to all sectors of the financial services industry in 2018. This will affect some additional 60,000 firms.
Firms are currently required to submit robust documentation on the scope of the individual responsibilities of their senior managers (which replaces the Approved Persons – APER – regime). Senior managers will need to take reasonable steps to prevent regulatory breaches in their areas of responsibility.
The extended regime in 2018 has yet to be finalised, however we would expect further information from the regulator in early 2017. Early sounding suggests the regime is likely to align closely to the Senior insurance Managers Regime rather than the Senior Managers Regime for banking. This represents a significant ‘step-up’ for firms in this sector, many of which are only just getting accustomed to the rigours of the APER regime.
CONC 1.2.2 states a firm must ensure that its employees and agents take reasonable steps to ensure that other persons acting on a firm’s behalf are compliant. The FCA published a report in which they described the “serious and widespread issues” with how insurance companies manage Appointed Representatives (ARs) earlier this year. The implications for motor finance appear to be significant.
As part of their broker monitoring arrangements, firms should ensure:
- Robust due diligence on third parties before entering into an agreement to sell finance, including, for example, checks on the firm’s regulatory status and knowledge and experience of sales persons and senior management
- They have a robust risk-based broker monitoring plan in place. There have been many examples where firms have had insufficient metrics in place to monitor broker performance around delinquency data, early cancellations, insufficient affordability assessments, undocumented processes and policies, and procedures and complaints data
- Documented contracts are in place that set out financial arrangements, compliance requirements and auditing arrangements, contingency planning and termination / suspension clauses
- Robust knowledge of the firm’s anti-money laundering procedures and an understanding of the firm’s incentives arrangements and fees and charges applied
FCA-regulated firms across the motor finance sector should be able to demonstrate these points in action internally and within their broker arrangements.
Speaking at the FLA’s Brexit conference, Clive Adamson (Former Director of Supervision at the FCA) said:
“I expect the FCA to spend more time looking at non-bank lending, with a particular view on affordability, and the expectation I have is that the car finance market will come under the microscope in the very near future.”
The FCA has already outlined the need to provide and undertake adequate affordability assessments, as there is an ever-increasing focus on conduct risk. These stricter requirements have put increased pressure on financial services providers to assess and continually manage their customers’ long-term affordability.
A typical affordability assessment process will examine the customer’s financial situation (including an assessment of vulnerability), income estimation and verification, the calculation of disposable income to assess ability to repay both today and over the lifetime of the commitment, the setting of affordable limits and an assessment of both indebtedness and risk.
Embrace change and move forward with confidence
As a firm, are you planning for a future consumer credit landscape which looks different to how it appears today? Early preparation and planning are key in a regulatory and wider economic environment which remains variable. Indeed, in the case of some of the major regulatory work happening in consumer credit, firms’ journeys in a number of areas should already be underway.
Despite a lot of change for your firm in the coming year, the need to ensure consumers are at the heart of your business is one constant firms can bank on. If regulatory change is viewed through the consumer protection lens, firms can better understand the aims of the regulator – and, importantly, ensure they incorporate these priorities into their business strategy.