Financial Services Newsletter July/Aug 2017
FCA propose changes for creditworthiness and affordability assessment by consumer credit providers
The FCA have proposed, in CP 17/27 published in July 2017, a number of changes to the existing rules and guidance on assessing creditworthiness, including affordability, required to be followed by consumer credit lenders.
The current creditworthiness assessment regime in CONC is largely principles-based rather than prescriptive. There are some high-level rules, but most of the detail is in supporting guidance which illustrates ways in which firms can comply with these and with FCA’s high-level principles, including treating customers fairly. Most of these provisions were carried across by the FCA from the CCA and OFT guidance.
The FCA’s rules require firms to consider both credit risk to the lender and affordability for the borrower. The FCA are of the view that while lenders have strong commercial incentives to assess credit risk, including the probability of default, the incentives to satisfy themselves on affordability are weaker. They believe, therefore, that there is a particular need for regulatory intervention.
With a few exceptions, the current CONC provisions apply to all regulated credit agreements. However, certain types of agreement, instead of being subject to the creditworthiness rules, are subject to a parallel obligation to assess the potential for the credit commitments to negatively affect the customer’s financial situation. Most of the CONC 5 applies regardless of which specific obligation applies to the particular agreement.
Based on the review feedback, the FCA concluded that the present framework is complex and potentially confusing. Accordingly, they have proposed to apply a uniform set of creditworthiness requirements, as detailed in the new rules and guidance and consequential amendments to the provisions of the Consumer Credit Sourcebook (CONC). The new rules and guidance clarify their expectations and make it easier for firms to comply with the requirements for assessing creditworthiness and affordability on a consistent basis.
The new rules are based on proportionality and, therefore, the greater the actual or potential costs or risks of the credit in a particular case, the more rigorous the assessment by lenders needs to be and the greater the information that is likely to be needed to support it. On the other hand, if the costs and amount of the credit are low, for instance relative to the customer’s financial situation, the firm may need to conduct a less rigorous assessment, and need less information to support it.
The FCA have now proposed more prescriptive requirements for internal systems and controls to be implemented by firms to ensure compliance with the responsible lending rules, which will require firms to:
• Establish, implement and maintain clear and effective policies and procedures to enable the firm to carry out reasonable creditworthiness assessments. Firms must also set out the principal factors they will take into account, set out these policies and procedures in writing and have them approved by the firm’s governing body or other senior personnel
• Assess and periodically review how effective these policies and procedures are and how well the firm is complying with them and with its obligations under CONC 5.2A (or CONC 5.5A in the case of P2P platforms). In light of their review, they must take appropriate measures to address any deficiencies
• Maintain a record of each relevant transaction, which is sufficiently detailed to demonstrate that a creditworthiness assessment was carried out where required and that it was reasonable and in accordance with CONC 5.2A (or 5.5A). This will enable us to monitor the firm’s compliance with its obligations, and
• Establish, implement and maintain robust governance arrangements and internal control mechanisms to ensure the firm’s compliance with the above requirements.
FCA introduce new individual accountability regime for all firms
The Financial Conduct Authority (FCA) have developed a new accountability system that is more focused on senior managers and their individual responsibility. In its first phase, a new Senior Managers and Certification Regime (the ‘SM&CR’) was created and applied, in conjunction with the Prudential Regulation Authority (PRA) to banks, building societies, credit unions and PRA-designated investment firms effective from March 2016.
Now, the FCA has set out their proposals to extend the SM&CR to all regulated firms, in a consultation paper, CP 17/25 published in July 2017. The new regime of individual accountability will replace the ‘Approved Persons’ regime currently applicable to firms (other than banks to whom SM&CR already applies). In parallel, they have also issued another consultation paper, CP 17/26, to harmonise the current senior managers’ regime for insurance firms so as to apply the SM&CR framework across all firms and sectors.
As part of the changes to the accountability regime, The FCA have proposed to apply a baseline of framework to every firm, known as the ‘core regime’. This means that the three main elements of the SM&CR will apply to every firm, a) the Senior Managers Regime, b) Certification Regime and c) Conduct Rules.
Every Senior Manager will also have a ‘Duty of Responsibility’, which means if something goes wrong in an area that they are responsible for, the FCA will consider whether they took ‘reasonable steps’ to prevent this from happening.
Most firms will only need to apply the core requirements of the SM&CR, except for larger firms which will be subject to enhanced requirements, which are similar to those already applied to the banking industry since April 2016. These include:
• Additional Senior Management Functions: There will be additional Senior
Management Functions that will need to be approved by us, such as the Chief
• Additional Prescribed Responsibilities: There will be more Prescribed
Responsibilities that enhanced firms will need to give to their Senior Managers.
Overall Responsibility: Enhanced firms will need to make sure that there is a Senior
Manager with overall responsibility for every area, business activity and management
function of the firm
• Responsibilities Maps: Enhanced firms will need to have a single document that
sets out the firm’s management and governance arrangements
• Handover Procedures: Enhanced firms will need to make sure that a person who
is becoming a Senior Manager has all the information and material that they could
reasonably expect in order to do their job.
The Certification regime covers people who aren’t Senior Managers, but whose jobs mean they can have a big impact on customers, markets or the firm. These roles are defined by the FCA within the proposed rules. These individuals are not required to be pre-approved, but firms will need to check and confirm (‘certify’) that they are suitable to do their job at least once a year. Accordingly, some of the ‘controlled functions’ that require pre-approval under the current ‘Approved Persons’ regime would be covered within the Certification Regime.
The new ‘Conduct Rules’ are baseline rules that will apply to almost every individual who works in financial services. They include things like ‘acting with integrity’ and ‘treating customers fairly’. The Conduct Rules are designed to improve the behaviour of all staff in financial services firms through statutory provisions. Firms are also required to notify the FCA when and what action they’ve taken against a person for breaching a Conduct Rule.
MIFID 2 to apply more widely as FCA publish final rules
The FCA have published final rules in PS 17/14 in July 2917 for transposing the provisions of the Markets in Financial Instruments Directive II (MIFID 2) into UK regulation. MIFID 2 is a package of EU legislation for regulating both retail and wholesale investment business, replacing the current Markets in Financial Instruments Directive (MIFID). The provisions under MIFID 2 will come into effect in all EU member states from 3 January 2018 from which date the new FCA rules will apply. The FCA paper includes a series of new guidance and rules to implement the directive requirements.
MIFID 2 updates the existing MIFID framework and addresses issues in relation to transparency, investor protection and market infrastructure. The new framework for investment firms is designed to strengthen investor protection, mitigate the risks of a disorderly market, reduce systemic risks and increase the efficiency of financial markets. It comprises two key components; the Directive and Regulation, known as MIFID 2 and Markets in Financial Instruments Regulation (MIFIR). MIFID 2 widens both the scope of investment services requiring authorisation and the range of investments falling within the scope of regulation.
In the course of its consultation on the Technical Advice, European Securities and Markets Authority (ESMA) have advised that the regulatory framework under the UCITS Directive and the Alternative Investment Fund Managers (AIFM) Directive have been built on the MIFID framework in many respects, including inducements.
MIFID 2 applies to a wider range of firms who deal in the MIFID instruments and/ or provide investment services, including advisers, distributers, capital raisers and firms arranging investment which had earlier benefited from an exemption for MIFID called the “Article 3” exemption. MIFID 2 effectively removes the FCA’s discretion to allow a lighter regime for such firms. From January 2018, ‘Article 3 firms’ will have rules that are “at least analogous” to in-scope firms under MIFID.
The new rules set out significant enhancements in organisational and conduct requirements including specific provisions for corporate governance in MIFID as well as most non-MIFID investment firms to standards similar to those of the Capital Requirements Directive, which are currently applicable to banks and larger insurance firms. These include new requirements for ‘product governance’, independent compliance, internal audit and risk management.
Lloyds to pay £283m redress to customers in mortgage arrears
Following engagement with the Financial Conduct Authority (FCA), Lloyds Banking Group (Lloyds) has agreed with the regulators that when customers fell into arrears, the bank did not always do enough to understand customers’ circumstances to be confident that their arrears payment plans were affordable and sustainable.
As a result, Lloyds has committed to refund all fees charged to customers for arrears management and broken payment arrangements from 1 January 2009 to January 2016. For those mortgage customers who entered its litigation process during this period, this will include any litigation fees that were applied unfairly.
Lloyds will also offer payments for potential distress and inconvenience, and consequential loss which customers may have experienced as a result of not being able to keep up with unsustainable repayment plans.
Lloyds estimates that approximately 590,000 customers will receive redress payments, totalling around £283 million.
Jonathan Davidson, Executive Director of Supervision- Retail and Authorisations at the FCA, said:
“Ensuring fair treatment of customers, especially those in financial difficulties or who are vulnerable, is a key priority for the FCA. We continue to engage with Lloyds as it works to improve the way it treats customers in arrears.”
The redress scheme will refund the accrued interest on all fees up to the remediation date or, where customers have already paid the fees, the date when the fees were paid. Lloyds will also pay an additional 8% interest for customers deprived of funds.
Lloyds will write to all affected customers to explain the refund they will receive and to prompt them to make a claim for any distress and inconvenience they may have experienced. Lloyds will also advise customers to consider whether they suffered any consequential losses as a result of this issue, such as a direct debit fee charged because of a broken payment plan. Customers do not need to take any action until they are contacted by the bank.
The FCA will continue to engage with Lloyds and the retail lending sector to continue to raise standards and ensure the fair treatment of customers in arrears and financial difficulties.
Changes to Client Money Distribution Rules following review of Special Administration Regime
Following the failure of Lehman Brothers in 2008, the HM Treasury created an insolvency regime for investment firms called the ‘Special Administration Regime’ (SAR). The SAR closely interacts with the FCA’s Client Assets sourcebook (CASS), and in particular the client money distribution rules (CASS 7A), to provide a mechanism under which client assets can be returned to clients in the event of an investment firm failure.
The FCA published a policy paper, PS 17/18, in July 2017 setting out changes to CASS in relation to an investment firm failure and its interaction with the SAR. Collectively, these proposals aim to speed up the distribution of client assets, improve consumer outcomes and reduce the market impact of an investment firm failure.
The changes include allowing a firm, following a primary pooling event, to transfer the client money pool, in whole or in part, to another entity providing certain conditions are met. These conditions would include:
• The transfer does not result in other clients receiving less than they would otherwise receive in a distribution or transfer
• Subject to the SAR Regulations10, the transferor obtains specific client consent to the transfer or have in place a written client agreement which provides that the firm may transfer the client’s client money to another person
• The transferor either obtains a contractual undertaking from the transferee stating that the money transferred will be held as client money in accordance with CASS 7 or is satisfied, after exercising all due skill, care and diligence in its assessment, that the transferee will apply adequate measures to protect the client money following the transfer, and
• Certain client notifications are made in accordance with post-transfer notification rules.
The FCA have also created a new section in the custody rules (CASS 6) setting out rules on the treatment of custody assets post-failure (CASS 6.7). They have also set out that the rules in this chapter would be limited to: (i) communication requirements that must be observed by a firm in the context of a post-failure transfer of custody assets; and (ii) requirements to ensure that clients are given ample opportunity to claim their custody assets post-failure.
New Information requirements for current account services
The FCA have set out their proposals, in CP 17/24 released in July 2017, that seek to promote effective competition by enabling customers to make effective comparisons between providers of personal current accounts (PCAs) and business current accounts (BCAs) based on service, and by incentivising providers to improve service and performance. The CP applies to firms that accept deposits (banks and building societies) and provide payment accounts as defined by the Payment Accounts Regulations, typically PCAs or BCAs that have the features of a payment account.
To achieve the above regulatory objective, the FCA propose to require BCA and PCA providers to publish service information in the following categories:
• Account opening – clear information about the account opening process and information about how long it takes to open an account and gain access to specified services including overdraft funds
• Time taken to replace a lost, stolen or stopped debit card and to organise third party access to a PCA under a power of attorney
• Service availability – identifying how and when various services can be accessed and whether 24-hour help is available for certain matters
• Major incidents – information about the number of major operational and security incidents that firms have reported to the FCA.