Our last article in this series on the proposed new regulation of the Consumer Credit sector looked at the Principles for Businesses which the FCA will require every authorised firm to adhere to and the key areas of change which the introduction of these high level requirements will bring. We now cast our eyes over the approach that the FCA intends to bring to supervision of firms under the new regime, which is much more pro-active than the current situation under the OFT where regulatory scrutiny is focused more on the application for consumer credit licences at the outset, with no on-going supervision of firms after they have been licensed.
Before looking at the details of the proposed approach to supervision, it is worth bearing in mind the guiding principles that the Government has laid down in respect of the transfer of consumer credit regulation to the FCA. These are:
- to secure an appropriate degree of protection for consumers; and
- that the regulatory regime be proportionate to the types of firms and risks posed by them.
To this end, the FCA proposes to apply each of its supervisory activities to all firms, but with varying degrees of intensity depending on the levels of risk posed by a firm and the credit activities it carries out. Clearly those activities thought most likely to cause consumer harm will be afforded the highest degree of regulatory attention and resources.
The FCA proposes that it will categorise each firm to determine the level of supervision that it receives. The criteria used to categorise are expected to include the size of the firm, number of customers and risk to consumers posed by the firm’s activities.
Fixed and flexible portfolio firms
It is envisaged that the largest firms with substantial numbers of retail customers, such as some banks, will be classed as ‘fixed portfolio’ with a nominated supervisor. The majority of consumer credit firms, however, are expected to be classed as ‘flexible portfolio’ and supervised by a team of sector specialists and not a nominated supervisor, which is how smaller firms have always been supervised by the FSA.
The FCA’s supervision model is based on three ‘pillars’:
- Firm Systematic Framework
- Event-driven work
- Issues and product supervision
The Firm Systematic Framework (“FSF”) is designed to assess a firm’s conduct risk and whether the interests of customers and market integrity are at the heart of how the firm is run. Key points of the FSF for larger firms will be:
- Business model and strategy analysis, looking for future risks and building on the business model Threshold Condition check carried out at authorisation stage.
- Assessment of how the firm embeds fair treatment of customers and ensures market integrity in the way it conducts its business. This assessment will be four- pronged, looking at:
- How effectively a firm identifies, manages and reduces conduct risks;
- whether a firm’s products and services meet customer needs;
- the systems and controls relating to the sales or transaction process; and
- how effectively a firm ensures that its customers are treated fairly after the point of sale or transaction, including complaints handling.
- Deciding what actions are required by the firm to address issues identified.
- Communicating with the firm to report the findings of the assessment and required actions.
The principle of proportionality will mean that the intensity of regulatory scrutiny will be less for smaller firms and lower risk activities. For firms authorised with limited permission, the FSF will take into account the different Threshold Conditions and limited permission firms will not therefore be subjected to business model and strategy analysis. Smaller firms can expect direct interaction with the FCA at least every four years.
Event-driven work refers to the regulatory response to information received by the FCA which may indicate that a situation in a firm has arisen which poses a heightened risk to consumers, or where consumers have experienced loss and quick action is needed to prevent the situation from worsening. The information might come from the firm itself through the reporting regime, or from an external source such as a whistleblower, or inferred from a sharp increase in complaints etc.
Issues and products
Whereas the event-driven work described above refers to regulatory action directed at specific firms, issues and product work relates to emerging issues and product reviews which apply to the whole sector of the market. The FCA proposes to use a range of data and intelligence obtained from firms, consumers and trade bodies to identify the most significant risks and prioritise their activity accordingly. Where sector risks are identified, firms can expect an intrusive regulatory approach including actions such as specialist supervisors investigating files, call recordings and conducting mystery shopping exercises to ascertain root causes of issues as well as their effects. In addition to the regulator’s other enforcement options, it is anticipated that the issues and product work could also drive the making of new rules or guidance as may be necessary.
The FCA proposes to supervise consumer credit advertising in line with the original FSA supervision of financial promotions. The CCA requirements relating to advertising (e.g. section 44 of the CCA which governs the form and content of consumer credit adverts) will be repealed. The FCA proposes to replicate these in its financial promotions regime.
Advertisements will be pro-actively monitored across all media-types for compliance with the relevant rules and thematic work will be carried out focussing on particular products or risks identified.
Unfair terms in consumer contracts
The FCA will have powers under the Unfair Terms in Consumer Contracts Regulations 1999 (“UTCCR”) to challenge unfair terms and require assurances from firms that unfair terms will not be used and where necessary apply for injunctions to ensure this.
The FCA approach to regulatory reporting
In line with the requirements imposed on firms originally regulated by the FSA, the FCA proposes to extend this regime to include firms carrying on consumer credit activities. This will involve firms reporting key financial information to enable the FCA to assess the financial size and health of firms and inform its supervisory activities so that it can prioritise its resources to the issues of most significance.
The FCA is considering which information will be required in particular from firms in the consumer credit sector and is likely to include key measures of their activities, such as turnover, transaction information and complaints information. Lenders are also likely to be required to provide information on the value of their loan book and default ratios.
The FCA’s objectives in their approach to reporting include developing a better understanding of the consumer credit sector and mitigating risks posed to consumers. The FCA has indicated that the principle of proportionality will apply to reporting requirements and take account of the activities undertaken and size of the firm. Firms authorised under limited permission will have a reduced reporting requirement.
- As with the rest of the proposed regulatory regime, the FCA intends to apply a proportionate approach to its supervisory activities taking into account the size, activities carried out and level of risk posed by firms in the consumer credit sector.
- Firms will be categorised by the FCA in order to determine the most appropriate style of supervision.
- The supervisory model is based on the three pillars of Firm Systematic Framework, Event-driven work and Issues and Product supervision.
- Consumer credit advertising will be supervised in line with the original FSA supervision of financial promotions.
- The FCA will have powers to challenge unfair contract terms under the UTCCR.
- Reporting requirements will be introduced obliging firms to provide key financial and transactional information to the FCA so that it can build up an accurate picture of the consumer credit market and apportion supervisory resources where most needed to mitigate risks to consumers.
In our final article in our series on the road to FCA regulation, we look at the proposals for enforcement, which will represent a considerable change to the current OFT regime as the FCA will have significantly greater powers than the OFT in this regard. If you have strong views on any aspect of the regime so far the government is asking for comments on the proposed regime. The consultation period will end on 1st May 2013.