Read our previous article providing an overview of the required risk analysis when implementing the Consumer Duty in your organisation.
A lender is, in summary, expected to take proactive steps to ensure a high level of protection for regulated borrowers, designed to offset ingrained disadvantages such as their weak bargaining position, behavioural biases, lack of financial experience and lack of information (and, of course, the fundamental issue of vulnerability). In other words, it isn't just a question of whether the borrower can repay, or even can afford to do so; now there are a range of other potential disadvantages which risk creating some form of detriment for customers, and which need to be looked at from a customer point of view.
The extent to which such disadvantages apply to a given set of credit transactions will be context specific. As such, early detailed analysis of a lender's existing/intended target market will be crucial. The Consumer Duty not only applies collectively to a generic identified target market, but also to groups within the target market and even, as circumstances require, to individual customers. Not all customers will be equal, and the application of the Consumer Duty will vary according to factors such as their:
- identity – for example, whether they are an 'unsophisticated borrower', a high net worth individual, or perhaps a businessperson;
- financial circumstances – for example, whether they would rate as prime, sub-prime or somewhere in the middle; and
- position within the 'customer journey' – for example, whether they are the target of an intended campaign, an existing customer or perhaps in default.
Other factors may apply for a given lender, but once the relevant target market has been identified and segmented, it becomes possible to look at potential outcomes. The FCA may label the process as requiring the delivery of good outcomes, but in in terms of risk analysis this inevitably means identifying the potential for bad customer outcomes which need to be avoided.
It is, though, crucial to bear in mind that the four outcomes highlighted by the FCA are not the only items for consideration; they are only the four key items that the FCA have chosen to focus on. As part of the implementation process, all foreseeable outcomes will need to be considered if a firm is going to be able to say that it is complying with the Consumer Duty. That said, the four key items provide a useful focus for any implementation project.
Taking each outcome in turn:
1. Products and services – is the credit product right for the target market?
There are arguably few credit related products that are inherently bad; some, but not many. More often than not, any problems that arise are the result of a mismatch between customer and product. This mismatch may be fundamental; is the product right for a given segment of the target market? Alternatively, the mismatch may be perceived; are the intended customers able to understand the way in which the product is intended to work for them?
Some products are inherently more difficult to match to a target market. A loan agreement is pretty basic, but asset finance can be more complex; motor vehicle PCP, for example, has both extensive terms to protect the lender's interest in the asset and an optional balloon payment structure. The diversity of payment terms applicable to some credit/store cards, including BNPL, can be confusing.
Wider issues such as Affordability or Vulnerability may be part of the problem; should a given customer have access to a particular product, or to credit generally? Alternatively, are the terms right; terms that may well be reasonable for some customers and/or in a given context may be far from acceptable in other circumstances.
Product delivery is also relevant. These sorts of issues are hard enough to deal with when the lender and customer are dealing face to face; harder when the arrangements are made at a distance; harder still when they are made (as so many CCA arrangements are made) through an intermediary.
2. Price and Value – is the cost of credit fair?
In practice, it is impossible to disentangle the FCA's Product Outcome from the issue of Fair Value. How much does the borrower have to pay for the credit they receive? Is that fair, taking into account the benefits received?
Overheads, cost of funds and a reasonable return on capital are obvious factors for the lender, though how much profit is reasonable may vary according to whether you are the lender or the borrower. However, the Price and Value Outcome does require the issue to be looked at from the borrower's point of view, not just the lender's. 'Rate for risk' is clearly a potential issue, but appears to be acceptable provided that it can be justified according to reasonable objective criteria.
More troublesome in a CCA context has to be the issue of commission in an intermediated market (whether disclosed or not). Often there is no direct correlation between commission paid by a lender and rate charged, but either way how can it be demonstrated that a given commission arrangement represents 'fair value' for the distribution of the relevant product?
This problem is amplified for any asset based transaction, when the pricing of the asset itself can be affected by arrangements for the payment of commission to the supplier, or by discounted purchasing structures which effectively (albeit legally) mask the cost of finance.
3. Consumer Understanding – do they need more explanation?
Again, affordability is a key issue; does the customer properly appreciate the financial burden they are taking on; can they make the required 'informed choice'? It hardly needs to be said that misguided customer expectations are all too often the cause of bad outcomes (ie complaints) that could have been avoided had the customer properly understood the terms, or even the basic operation of a finance agreement.
A lack of understanding can appear to be a customer issue, but it may really demonstrate a failure by the lender to fully explain matters which it believes to be obvious. The level of Consumer Understanding is likely to vary between target markets and/or different segments of a given market. Individual customer groups may be inherently vulnerable. The arcane wording of most CCA information warnings is far from helpful.
Even those elements of financing which are particularly difficult to explain, such as the way in which interest is spread unequally over the life of a fixed sum loan with pre-calculated charges, may need to be addressed. The repayment structure of such agreements is probably an academic point in itself, but the potential implications for early settlement need to be understood by borrowers who may not intend to run the agreement full term.
Consumer Understanding is, of course, an issue that can keep coming back to fore throughout the life of an agreement. It isn't just about the generic information provided to the customer in advance. Lifetime issues, such as the options available to a vehicle HP customer with financial problems, or proximity to the end of a BNPL interest free period, need careful handling to ensure that a bad outcome is avoided. In this context, individual vulnerability will be more relevant.
4. Consumer Support – are they able to access help as/when needed?
The previous paragraph also illustrates a key issue for Consumer Support; how to help minimise the effect of financial problems arising during the agreement lifetime. Time was, inability to pay was just a question of 'bad debt'; the inevitable result of credit risk. Now the concept of Forbearance is the flip side of Creditworthiness. That is by no means a bad thing, but the FCA has over the last few years made it clear that the dynamic between the interests of lender and customer in these circumstances has to be different, particularly if the customer is adversely impacted by events beyond their control.
The three questions underpinning good Consumer Support consistently identified by the FCA are:
- can the customer easily access information and/or help;
- does the firm understand the customer's needs; and
- does the firm actually take steps to address those needs?
The last point allows for different ways to comply. If the firm can reasonably resolve the issue, it should do so; if not, it should at least explain properly why it cannot help. Either way, the response should meet the test of 'how would I feel in the customer's shoes?'.
This can all have considerable financial implications for lenders, in two ways: the level and/or timing of recovery from customers is an obvious cost to any lender, but more than that the cost of adequately resourcing the back end of the business so as to provide the necessary support to customers (both defaulting and non-defaulting) can be considerable. However, the FCA have made it clear that inadequately resourcing Consumer Support will not be acceptable under the Consumer Duty.
How can we help?
We are uniquely well placed with our combination of lawyers and regulatory consultants and can help with any or all of your Consumer Duty needs. . For example, in relation to the Products and Services Outcome, credit firms would likely benefit from talking to our investment and insurance market specialists who have been dealing with product governance rules since the introduction of MiFID II and IDD respectively.
Whether you want ad hoc support in respect of specific issues, an independent third party review of plans and progress, or for us to work closely with your internal teams to manage and implement the Consumer Duty, DWF's team is able to help.
If you would like to discuss Consumer Duty and the impact it may have on your firm, please contact: Richard Humphreys, Head of Consumer Credit, Regulatory, Andrew Jacobs Head of Regulatory Consulting or Robbie Constance Head of Financial Services Regulatory.