UK Government Follows Through On BNPL Regulation

The 'new' UK government has followed through with earlier plans to regulate 'Buy Now Pay Later' (BNPL) short term installment credit that had stalled under the previous government. The regulated version will be called 'deferred payment credit' (DPC). The regulations won't bite until mid-2026, but it's good to finally have certainty as to what is regulated (if not the fine detail yet). And merchants, fintech service providers and credit reference agencies can use the 12 month window to figure out ways for consumers to keep track of both their regulated DPC and unregulated BNPL instalment credit. I've already summarised the latest proposals for Keystone here for information purposes, and have added a few thoughts below to consider. If you need advice on the plans, please let me know. 

Given that BNPL agreements directly with a merchant will remain unregulated, there remains an opportunity for third party finance providers (whether FCA-authorised or not) to work with merchants on unregulated BNPL. Structuring the overall offering to remain unregulated will take care, however.

The proliferation of DPC/BNPL arrangements should prove a boon to 'open banking' or 'account information service' providers who can offer consumers visibility of all their obligations, whether directly or via device manufacturers, DPC lenders or even merchants themselves.

There's also a growing credit reference/assessment challenge as more consumers take on more instalment credit, whether regulated or not.

The government is right, in my view, to keep a weather eye on the unregulated BNPL market to see if intervention is required, before acting. Third party lenders who complain about an uneven playing field between should also consider that regulating merchant BNPL could hurt smaller merchants in favour of larger merchants who already possibly have the resources to offer better instalment options, let alone bear the burden of being FCA authorised (not to mention the strain on the FCA itself in taking on every merchant that wishes to offer BNPL/DPC!).

 

UK Consults On BNPL Regulation

Further to my note in June, the UK Treasury is now consulting on the enabling legislation necessary to narrow the exemption for Buy Now Pay Later (BNPL) products, paving the way for greater supervision of the sector by the Financial Conduct Authority. I've included a quick summary of the provisions below. If you need assistance in understanding the potential impact of the proposed regulatory changes, please let me know.

Basically, the scope of consumer credit regulation is being expanded to include BNPL agreements offered by lenders but not by suppliers directly. The government had intended to regulate all BNPL agreements provided by suppliers either online or at a distance, but this was found to disproportionately impact many types of arrangement where there is little, if any, evidence of consumer detriment.

In effect BNPL agreements will be regulated where they are 'borrower-lender-supplier' agreements for  fixed-sum credit (the existing 'running accounts exemption' is not affected) to individuals, small partnerships etc., which are: 

• interest-free; 
• repayable in 12 or fewer instalments within 12 months or less; 
• the credit is provided by a person that is not the provider of goods or services which the credit agreement finances (i.e. third-party lenders); and 
• not specifically exempt under other consumer credit exemptions (plus a new, related exemption). 

There's an 'anti-avoidance' measure to capture agreements where the merchant has an arrangement with the third-party lender to sell the goods to the lender at the point when the agreement is taken out (seeking to turn the lender into a supplier). 

Trade credit and invoicing arrangements will remain exempt, but new specific carve-outs have had to be made to finance insurance contracts/premiums; registered social landlords to their tenants to finance the provision of goods and services; and where the borrowers are employees and which result from an arrangement between their employer and the lender or supplier.

The relevant agreements will qualify as regulated credit agreements within the consumer credit regime under the Regulated Activities Order (RAO). Firms offering those agreements and related regulated activities will need to be authorised and supervised by the FCA, with complaints referable to the Financial Ombudsman Service. 

These agreements will not benefit from lighter regulation that applies to 'small agreements' but will be spared certain pre-contract explanations under the Consumer Credit Act 1974 (CCA) in favour of more proportionate FCA disclosure rules. Consumers are also spared a deluge of information because certain other distance marketing disclosures won't need to be made for these agreements by unauthorised brokers where the information has already been provided by the authorised lender.

Those introducing borrowers to lenders to obtain regulated BNPL agreements will not need to be authorised for credit broking unless conducting that activity in the borrower's home.   

Advertisements and other 'financial promotions' communicated by unauthorised firms for regulated BNPL agreements will need to be pre-approved by an FCA authorised firm (which will not include a firm acting as a payment or e-money institution).

The new regulations won't apply to relevant agreements entered into prior to the changes taking effect; and there are transitional arrangements to enable firms to carry on certain regulated activities in relation to regulated BNPL agreements for a limited time to allow them to get properly authorised, but the duration is a matter for the FCA. It's worth noting, however, that any business that does take advantage of the 'temporary permission regime' must comply with the law and FCA rules applicable to consumer lending (or exercising a lender's rights) and credit broking (if visiting borrowers' homes). That is unlike previous 'grandfathering' type arrangements, where firms could continue as they were until authorised; and potentially problematic, as any unregulated lender offering BNPL today would likely face a very steep climb to operating on a regulated basis.  

It is also left to the FCA to determine how its rules on credit checks, which could prove a thorny issue to the extent we are focusing on borrowers who can't afford the price of fairly low value consumer items. 

But there remains uncertainty over the extent to which the form of agreements and post-contractual notices will be prescribed.

The limits for the application of 'section 75' CCA liability for suppliers will not be altered (£100 to £30,000).

If you need assistance in understanding the potential impact of the proposed regulatory changes, please let me know.

Overdue Reform of the UK Consumer Credit Act

The Treasury is consulting on a long overdue overhaul of the Consumer Credit Act 1974 (CCA) which covers the UK’s £200bn non-mortgage consumer credit industry, including personal loans, credit cards, hire purchase and pawn-broking. I'm waiting on publication of a longer note summarising the detail, and will post a link to that here. You have until 17 March 2023 to respond. Let me know if I can help you in understanding the proposals and likely impact. 

Brexit

As previously mentioned, the current consultation was actually proposed in June, just prior to the European Commission proposal for a new Consumer Credit Directive (CCD2).  Extensive changes were made to the CCA in 2010 to implement CCD1, which had considerable input from the UK. 

Supervision of the CCA transferred from the Office of Fair Trading to the Financial Conduct Authority  in 2014 under the Financial Services and Markets Act 2000 (FSMA). This meant adding consumer credit and hire agreements, and related activities, to the FSMA (Regulated Activities) Order 20012 (RAO); and transferring some CCA regulations to the FCA’s rules. The Treasury now wishes to transfer “the majority” of the CCA to FCA rules, which seem likely to align with CCD2. 

Some aspects that are specific to Scotland and Northern Ireland will be addressed later in the review process.

Scope and Impact

The CCA regulates consumer credit and consumer hire, although the latter has less protection. The government has already announced plans to regulate many Buy-Now Pay-Later (BNPL) products that are currently unregulated. 

Broadly, the activities of entering into regulated credit and hire agreements require FCA authorisation and specific permission when carried on by way of business, as do the activities of exercising the rights of a lender (or owner, for hire purposes) and various ‘ancillary services’ such as credit broking, debt collection, debt counselling, debt adjusting, debt administration, operating an electronic system in relation to lending (peer to peer lending), credit information services. 

Advertising credit and hire products is also regulated, even for unauthorised firms. 

The FCA’s new Consumer Duty does not apply to unregulated or exempt individuals or products in the same way as the CCA regime, but that new duty changes the context in which the CCA protections operate; and makes authorised firms liable for certain activities of unauthorised firms in the product 'distribution chain'.

About 6,000 authorised firms have permission to enter into consumer credit or consumer hire agreements; and 36,000 FCA firms have credit permissions (mainly credit broking). 

I will update this post with a link to the more detailed note shortly.

The Suspicious Timing of The UK Government Review of The Consumer Credit Act

The UK government recently issued a brief press release promising a consultation "by the end of this year" on plans to review the Consumer Credit Act 1974 (CCA). I think you'll agree that the timing and lack of detail is more than a little suspicious.

The release spouts the usual guff about supposed Brexit benefits:

"Leaving the EU has provided additional opportunity for regulatory reform and the government will examine which parts of EU retained legislation can be repealed or replaced to ensure regulation is better suited to the needs of the British people." 

The Economic Secretary also claims that "The Consumer Credit Act has been in place for almost 50 years - and it needs to be reformed to keep pace with the modern world." 

It's a little disingenuous, then, for the press release not mention that the CCA and related regulations were extensively amended in 2010 to implement the EU Consumer Credit Directive of 2008 (CCD1).  

I mean, why pass up an opportunity to blame the EU for legislation you plan to 'reform' all on your own?

It's verging on suspicious that the press release also presents the UK government's review of the CCA as somehow politically independent and part of a more general review of "EU retained legislation" without so much as pointing a finger at the extensive process for reviewing CCD1, which began in 2014 before Brexit was even conceived and culminated in a report in 2020 before Brexit took effect. 

Suspicions are confirmed, however, when the press release makes no mention of the previous week's announcement by the Council of the EU, on 9 June 2022, that it had agreed its approach to a detailed proposal for a new consumer credit directive (CCD2). 

Perhaps the minister is unaware that the UK played a significant role in the development of CCD2? If so, it will come as an enormous surprise when it is revealed that the government has adopted the same approach in its next revision of the CCA, just as it did in 2010. 

But, hey, blue passports!

FCA Guidance on Consumer Credit Lending Authorisation

A key supporting document for applications to the Financial Conduct Authority for authorisation and permission to carry on a regulated activity is the 'regulatory business plan'. 

The requirements for what the plan must cover are usually summarised in various guidance, depending on the type of authorisation or permission being sought, but there's a lot of variation as most advisers have developed their own templates. 

Helpfully, however, the FCA has published a sample regulatory business plan for use by firms seeking authorisation/permission that is also useful for consumer credit lending, with a web page that also contains link to other relevant guidance for prospective lenders.

What is consumer credit lending?

This is a huge topic, but very broadly...

Permissions required for consumer credit lending activity will include entering into regulated credit agreements as the initial lender (under article 60B(1) of The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) and/or buying or exercising the rights under pre-existing regulated credit agreements (under 60B(2)), subject to exemption under article 55 of The Financial Services and Markets Act 2000 (Exemption) Order 2001, for example). That deserves a post of its own.

A similar regime applies to regulated consumer hire agreements (under article 60N of the RAO), while hire purchase and conditional sale agreements are treated as regulated credit agreements.

There are also various related permissions that will likely be required to deal with credit agreements and consumer hire agreements, including credit broking (article 36A, RAO), operating a peer-to-peer lending platform (article 36H), as well as debt adusting (39D), debt counselling (39E), debt collecting (39F) and debt administration (39G). These activities and various exemptions also deserve their own post.

Regulated credit agreements do not generally include "exempt agreements" (based on many exemptions in articles 60C-60K of the RAO that would require yet another post), but carrying out credit broking in relation to exempt agreements is still a regulated activity, and facilitating entry into exempt agreements can also still constitute peer-to-peer lending.

There are also specific exemptions for consumer hire agreements (articles 60O-60R, RAO).

Regulated credit agreements and consumer hire agreements and so on are also subject to the Consumer Credit Act 1974 and related regulations, though some provisions (including those relating to the 'form and content' of agreements) will not apply to "non-commercial agreements" or exempt agreements (though some exemptions require certain declarations in the paperwork). The CCA also deals with pawn receipts, revolving credit (e.g. credit cards), small loans and so on - yet another whole post in itself.

Finally, the FCA's 'Handbook' of rules generally apply to authorised firms who conduct consumer credit/hire activity, as well as specific rules on consumer credit (CONC) which distinguish between different types of consumer credit (e.g. pawnbroking, high cost short term (payday lending) and P2P agreements) for certain purposes.

Please get in touch if any you need advice on any of this.

FCA Clarifies (A Few) Misunderstandings On #ConsumerCredit

The Financial Conduct Authority has attempted to clarify some of the misunderstandings about who needs consumer credit permission and the interpretation of its rules and guidance on assessing creditworthiness and affordability. This is very helpful, but frankly has barely scratched the surface.

Long standing official resistance to shifting the regulation and supervision of consumer credit to the Treasury/FSA meant there was little time to do more than 'drag and drop' the old Consumer Credit licensing regime operated by the Office of Fair Trading into the FCA's world. But a lot less drag and a lot more drop would have saved great deal of time and expense.

Meanwhile, the confusion over permissions required and the 6 to 12 month authorisation time is driving many new entrants to launch into business lending space even where they would prefer to focus on consumers, sole traders and small partnerships.

The Innovation Hub is a great initiative, and a number of clients have taken advantage of this so far, but let's hope there is a solid programme for clearing the regulatory drag that is inhibiting more competition and innovation.

Timetable And Forms For Full Authorisation - #ConsumerCredit #P2PLending

The FCA has published the application 'windows' during which various types of consumer credit and P2P lending firms can apply for full authorisation. 

The dates are in Table on page 9. They vary by type of firm and may also vary by region for some types.

The FCA will write to all firms with interim permission by 1 May 2014 to confirm their application period. You should contact the FCA if you have not heard by 15 May 2014. In the meantime, you should register for an online account with the FCA.

In my experience it takes at least 3 months to prepare an application for authorisation, as there is a lot of information to gather and/or summarise at the same time as running a business. The FCA has published an authorisation application checklist, some sample forms and guidance on the supporting documentation required. Note that if you a P2P lending platform or your are offering high cost short term credit (payday loans) or a credit reference service, you will also need to complete a detailed description of your IT controls, which you can download here. There are a few FAQs here. 

Top tip: make your application for authorisation a proper project and start the process of completing all forms and supporting documents on Day One - especially the application form, regulatory business plan and IT controls forms. Complete the forms in parallel, not one after another, as you may be waiting 3 months before each form is complete. I recommend nominating one person to oversee completion of the application documents and a separate person to gather and provide data.

Please note that the FCA has also published the relevant information sheets that must be sent to a consumer with any notice that they are in arrears or default (under section 86A of the Consumer Credit Act 1974). 

FCA's Final Consumer Credit Rules

The FCA has published its final consumer credit rules, including its response to the feedback it received during the recent consultation process.

In its email alert, the FCA claims not to have significantly altered the rules that it consulted upon other than in relation to high-cost short-term credit, including amending the risk warning for financial promotions and rules on using continuous payment authorities.

However, the scope of peer-to-peer lending has been amended slightly in a new statutory instrument to add conditions necessary for the platform's operations to be within scope. In summary, the platform operator (or another person acting under an arrangement with it or under its direction), must undertake to: 

• receive payments in respect of interest and capital due under the loan contract and to make payments in respect of interest and capital due to lenders; and 

• perform, or undertake to appoint or direct another person to perform, either or both of (a) taking steps to procure the payment of a debt under the loan contract; (b) exercising or enforcing rights under the loan contract on behalf of the lender.

In addition, any activity of a kind specified by article 14 (dealing in investments as principal), 25 (arranging deals in investments), 37 (managing investments) or 53 (advising on investments) are excluded from article 36H (operating an electronic system in relation tolending). 

The FCA also says it has provided new guidance on lending in the course of a business, but this is not immediately apparent, so stay tuned there.

The FCA Handbook will be updated in March to include the consumer credit rules as "CONC".

New OFT Guidance on Consumer Credit Licence Applications

The OFT has published guidance on how it proposes to handle consumer credit applications in the lead up to the handover of its consumer credit responsibilities to the FCA on 1 April 2014. 

Basically, if the OFT can't process your application by 31 March, it will pass it to the FCA to process in accordance with the FCA's requirements. 

If the OFT does grant your licence before 31 March, you will need to apply to the FCA for interim permission to operate until such time as the FCA asks you to go through a full FCA authorisation process (which will be some time before 31 March 2016).

If you plan to apply for consumer credit authorisation on or after 1 April 2014, the FCA has some FAQs here.

Response to FCA Crowdfunding Consultation

I have embedded below my personal response to the UK Financial Conduct Authority's consultation on rules for regulating peer-to-peer lending and crowd-investment platforms, submitted today.

Interested in any thoughts or feedback you may have.

Response to FCA crowdfunding consultation simon deane-johns - final from Simon Deane-Johns

A PSD Passport For P2P Lending?

I was interested to read the overview of European national laws that might apply to various types of peer-to-peer finance ('crowdfunding'), published this week by the European Crowdfunding Network (ECN). It's fair to say that the UK is somewhat more advanced in its decision to specifically regulate, but it's proving fairly easy for other member states to catch up - principally via payment services regulation.

While self-regulation of the peer-to-peer lending in the UK borrowed heavily from the UK's implementation of the Payment Services Directive, no one suggested that a peer-to-peer lending platform was actually a payment service (in my view, it's out of scope, or otherwise exempt in several respects). Whereas, the peer-to-peer foreign exhange platforms, such as Kantox (in the UK) and Currency Fair (in Ireland) did take advantage of the PSD as a regulatory basis for their activities.

The EU passport rights that authorised payment institutions enjoy are obviously important for a foreign exchange platform, but less so for lending - due to the challenges in establishing a cross-border market for consumer credit.

Until now, that is.

Unfortunately, the FCA has been rather heavy-handed in its approach to the regulation of peer-to-peer lending, particularly in terms of financial promotions, client money rules and the red tape deterrent requirement for anyone 'lending [to consumers] in the course of a business' (whatever that means) to hold their own consumer credit authorisation, in addition to the platform. In other words, the FCA ignored pan-European calls for a PSD-like approach and has instead opted to import the activity into its investment regime. The French, on the other hand, are consulting on a PSD-based approach, although they have proposed some ridiculously low limits and appear to restrict the volume to the €3m per month to stay below the threshold for fully authorised payment institution status (where a passport would be available), which need to be lifted if it is genuinely going to enable P2P lending, especially to SMEs. 

The ECN overview reveals that other member states appear to be all over the place on the question of whether platforms fall within the scope of the PSD. Some commentators suggest the payment element of P2P lending is in scope, in which case that aspect should be outsourced, or that the platform operator become registered as a small payment institution or fully authorised as a payment institution (or become appointment as a PSD agent). Others suggest that P2P lending may be in scope but exempt under the commercial agents exemption.

Interestingly, however, the European Commission has proposed a new Payment Services Directive (PSD2), which it would like to finalise by Spring 2014. PSD2 is still somewhat flawed, sure, but even in its current form it would seem more proportionate than what the UK is proposing in relation to P2P lending. Including P2P lending within its scope would also provide the Commission with an opportunity to clarify that, so long as the platform is authorised, lenders (payers) should not also need to be authorised under the Consumer Credit Directive - to enable businesses to lend to consumers and other businesses.

Any port in a storm...

FCA Crowdfunding Consultation

The FCA has today published its crowdfunding consultation, covering both crowd investment in equities and debt securities (which the FCA calls 'investment-based crowdfunding'), as well as the lender side of peer-to-peer lending ('loan-based crowdfunding'). The borrower side of loan-based crowdfunding was covered in the FCA's consumer credit consultation earlier this month. The consultation paper will be of interest not only to platform operators, but also to those looking to raise or contribute funds in a bid to escape bank products, in particular.

The FCA is clearly aware of the general anxiety that any rules it makes should not exclude the 'crowd'. But based on the FCA's summary of its proposals, in my view it has not struck the right balance (called for by the industry last December) for the reasons below. In summary:

• The proposals seem to land quite heavily on peer-to-peer lending (perhaps partly because investment-based platforms are already subject to the investment regime). While in principle the FCA has followed the thrust of the P2PFA's Operating Principles (which was based on payments regulation) the decision to bring simple P2P loans into the investment regime will make it substantially more expensive in time and money to establish a platform. The costs of ongoing compliance will also increase, though largely through the undue complexity of the investment regime, rather than any substantive change in how operational risks are managed. In addition to potentially discouraging entrepreneurs from establishing a platform, the red tape requirement for a lender to be authorised, in addition to the platform, where 'lending in the course of a business' on a platform may discourage business and institutional participation, especially without clarity on where compliance responsibilities lie given that the lender's own operational systems aren't involved at all. There is little proportionality according to the relative risks associated with different types of loan (e.g. unsecured prime, secured, short term high rate and so on). However, there is some good news in that the FCA seems to advocate the introduction of a 'secondary market', where platforms don't already operate one, without apparent restrictions on how these should operate or whether one could participate without first lending into the 'primary market'.

• The proposals for investment-based crowdfunding do at least allow for wider 'retail' participation than the FCA has seemed to support to date. However, people will be asked to certify that they will not invest more than 10% of their 'net investible portfolio' in unlisted shares or unlisted debt securities (excluding their primary residence, pensions and life cover), and they face an 'appropriateness test' if they aren't investing on advice. So it will still be much easier to stick a tenner on a pony, where the house always wins, rather than to back a local business in support of the economy. The risks that the FCA points to in justification for this can all be explained transparently on websites. But who in government will take responsibility for the strange inconsistencies in the way we are allowed to use our money?

Comments are due by 19 December, and it would be best to get involved. The FCA plans to review the overall crowdfunding regime again in 2016, so it could be a long wait before any problems missed will be rectified...

Loan-based crowdfunding

Firms operating loan-based crowdfunding platfroms are to be regulated from 1 April 2014 as ‘operating an electronic system in relation to lending’ (under article 36H of the Regulated Activities Order). The FCA is aware of about 25 firms in this category.

The FCA sees loan-based crowdfunding as "generally of lower risk than that made via investment-based platforms" although it sees the potential for innovation that may bring higher risks, so will keep the sector under review. For the time being, however, the FCA is consulting on:

• minimum prudential requirements that firms must meet in order to ensure their ongoing viability (£20,000 to £50,000 minimum capital and a further 0.3% to 0.1% of volumes on a scale of £50m to £500m);
• the requirement for firms to take reasonable steps to ensure existing loans continue to be managed in the event of platform failure;
• rules that firms must follow when holding client money, to minimise the risk of loss due to fraud, misuse, poor record-keeping and in the event of a firm's failure;
• rules on the resolution of disputes, and
• reporting requirements for firms to the FCA in relation to their financial position, client money holdings, complaints and loans arranged.

It is reassuring that all these issues (other than FCA reporting obligations), have long been addressed by the Peer-to-Peer Finance Association in its Operating Principles. However, those were modelled on payment services regulation (under the Payment Services Regulations 2009), whereas the FCA proposes to apply more or less the full weight of its retail investment regulation on the sector for little real benefit. For instance, the effect of the voluminous client money 'sourcebook' ('CASS') is not terribly different to payment services segregation requirements that would only need to be tweaked slightly). Firms might decide to outsource the handling of client money to other authorised firms, rather than accept the additional red tape that CASS creates (as investment-based platforms tend to do).

Unfortunately, too, the FCA interprets the Consumer Credit Directive to mean that any person or firm lending in the course of business via loan-based crowdfunding platforms will need to be authorised as they are carrying on a regulated activity. That interpretation is inconsistent with the FCA's view that such a person is actually an investor in loans, rather than a lender, but may be driven by the use of the word 'creditor' in the Directive. Moreover, such dual authorisation makes no sense, given that all the operational activities associated with the marketing, creation and servicing of the loans takes place in the platform operator's systems, rather than the lender (even where that lender is, say, a bank). In other words, the lending is being done in the course of the platform operator's business, not any business being run by the lender. Responsibility for compliance in such circumstances is not clear. How is a business lender supposed to comply with consumer credit rules when it is not directly advertising, processing loan applications or servicing the loans? Further, the FCA (like the OFT) declines to give any guidance on what it means to be 'lending in the course of a business', other than to refer to its existing guidance around the 'business test'. Early case law cited in HMRC guidance on this topic, however, requires an assessment of the operational reality which in this case suggests lenders on loan-based crowfunding platforms are not lending in the course of a business operated by them but in the course of a business of the platform operator.

In my view, the FCA's interpretation of the Consumer Credit Directive is another example of UK officials failing to take a purposive approach to interpreting EU law and needlessly creating a rod for our own backs. I doubt very much whether the purpose of the Directive was to ensure dual regulation in the context of loan-based crowdfunding.

Notwithstanding the 'low risk' classification, the FCA plans to treat investments on loan-based crowdfunding platforms largely as it does other designated investments (though there is no guidance on what distinguishes a 'loan' from 'debt securities' in the FCA's view). So rules that apply to firms arranging transactions in designated investments will therefore also apply to firms running loan-based crowdfunding platforms. As a result, such firms will have to comply with two separate FCA rule books - one for borrowers ("CONC"), and one for lenders (now to be called 'investors') ("COBS"), including rules applicable to 'financial promotions'. 

Finally, the FCA seems to advocate the inclusion of a 'secondary market' on loan-based platforms, in the context of a discussion on cancellation rights. The FCA does not explain its view as to whether or how certain exemptions to the right to cancel apply, for instance, where the lender is not acting in a commercial or professional capacity, the main service contract is not a 'distance contract' so the loan can't be a 'secondary contract' for cancellation purposes or the lender makes an irrevocable offer to lend within the cancellation period.

As to the nature of the 'secondary market itself', in its cost benefit analysis, the FCA also points to the fact that most of the main platforms have one and states:

"we estimate a one-off cost of 20 days of web programming to add secondary market functionality to platforms. We assume a cost per day of web programmer time of £200.29 This would mean that adding a secondary market to a platform could create a one-off cost of around £4,000. We also estimate ongoing costs of four hours per day to oversee the functioning of the secondary market. We estimate a cost per hour of £10 for administration work in small to medium firms, so the annual ongoing cost per firm of this option would be £10,000. It appears that, as platforms mature, they prefer to offer a secondary market, so in the long term most platforms are likely to aim to introduce a secondary market."

At last, a little ray of pragmatism, perhaps. But on what functional specification was this estimate based?

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how 'hybrid' loan-based and investment-based crowdfunding platforms should be treated, how a platform might facilitate loans above and below the £25k per loan cap, that some types of loan-based platform are lower risk than others and should receive more proportionate treatment (e.g. secured vs unsecured, or smaller numbers of customers) and confirmation that platforms do not qualify as certain other forms of investment activity (as well as others identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The new rules will take effect from 1 April 2014, but firms with 'interim permission' will have until 1 October 2014 to comply.

Investment-based crowdfunding

A crowd-funding platform needs to be authorised if it carries out the regulated activity of enabling a business to raise money by arranging the sale of unlisted equity or debt securities, or units in an unregulated collective investment scheme. The FCA is aware of about 10 authorised firms and 11 appointed representatives of authorised firms in this sector. However, exemptions may be available. For example if the firm operating the crowdfunding platform is an appointed representative of an authorised person or an Enterprise Scheme they will not need to be directly authorised.  

While the FCA already authorises investment-based platforms under existing investment regulation, the FCA concedes that the current rules don't really fit. The FCA has imposed restrictions on the authorised platforms on a case-by-case basis, which "restrict firms to dealing with professional clients and retail clients who are either sophisticated or high net worth." However, the FCA believes that its new proposals "should mean crowdfunding investment opportunities are available to more retail investors than currently, but with appropriate safeguards to check that investors are able to understand and bear the risks involved." The FCA also intends "to provide adequate consumer protections that do not create too many barriers to entry or significant regulatory burdens for firms." The new rules will take effect from 1 April 2014, but firms will have until 1 October 2014 to comply.

The FCA is proposing to limit the direct offer financial promotion of unlisted shares or debt securities (including websites) by firms to one or more of the following types of client:

• retail clients who are certified or self-certify as sophisticated investors, or
• retail clients who are certified as high net worth investors, or
• retail clients who confirm that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person, or
• retail clients who certify that they will not invest more than 10% of their net investible portfolio in unlisted shares or unlisted debt securities (i.e. excluding their primary residence, pensions and life cover).

Where advice is not provided, firms will need to apply an appropriateness test before selling them promotions for unlisted equity or debt securities.

Where crowdfunding platforms allow investment in units in unregulated collective investment schemes, the existing marketing restrictions will apply. These can only be promoted to certain types of customer, and changes to those restrictions were also recently consulted on and were made here.

Left unanswered are a bunch of awkward issues, such as the distinction between loans and debt securities (now that both seem to be specified investments), how the financial promotion rules actually apply, how 'hybrid' loan-based and investment-based platforms should be treated, and confirmation that platforms do not qualify as certain other forms of investment activity (as well as those identified in Annex 2 of a submission on the Financial Services Bill in June 2012).

The FCA considers investment-based crowdfunding to be high risk, owing to the the high rate of start-up business failures, the possibility of unauthorised advice, professionals picking the best offers, lack of dividends, equity dilution and the lack of a secondary market.

It seems bold to assume that professionals are any better than others at 'picking the best offers'. Research reveals that no one can predict which businesses will be successful. However, these risks can all be explained. What the FCA proposals views don't account for is the ability for people to lose unlimited amounts by betting on the ponies without going through any hoops at all. The FCA states that it has "no evidence to show that the wrong type of investor is investing in unlisted shares or debt securities" but concedes that "it is possible our current regulatory approach is effectively preventing this." Why is someone who bets on the ponies, for example, the 'wrong type' to be investing in a start-up?

From a policy standpoint, if it's ok for somebody to stick a tenner on the next race, when the betting shop is the real winner, then surely, so as long as the risks are clearly explained, the same person should be able to back a small business, where the economy is the winner. 

But who in government will take responsibility for this inconsistency?

Crowdfunding: Brussels Sprouts!

At last, the European Commission has realised that peer-to-peer finance might really be more efficient than banks at getting funding to those who need it. In Brussels, that translates roughly into "let's regulate". So, today the Commission launched a consultation aimed at understanding "crowdfunding: its potential benefits, risks, and the design of an optimal policy framework to untap the potential of this new form of financing."

The consultation paper is here, and responses are due by 31 December. The relevant Commission officials can be reached here. 

If my experience of the Commission's approach to regulating other aspects of e-commerce is anything to go by, it will be a huge challenge to educate officials - particularly for fast-moving entrepreneurs who have little time or resources to spare. 

Yet the risk of awkward, confusing and disproportionate regulation is high, so no one resident in the EEA can afford to be complacent.

So, at the very least, I'd recommend that any UK platforms and/or trade bodies capitalise on the evidence they've submitted to UK officials and Parliamentary committees over the past year or so, including whatever submissions are made in the current round of FCA consultations on peer-to-peer lending and crowd-investment. 

FCA's Consumer Credit Rules

The UK's Financial Conduct Authority (FCA) has published its detailed proposals for regulating consumer credit from 1 April 2014. Specific areas of focus include payday lending (Chapter 6), debt management (Chapters 7 and 9) and peer-to-peer lending (Chapter 8). The detailed rules are in the Appendices.

Peer-to-peer lending (P2P lending) is mentioned in the context of protection for borrowers and the transition arrangements for those who hold a Consumer Credit Licence or wish to take advantage of the interim permission regime. However, a separate consultation paper will cover the new regime for peer-to-peer finance or 'crowdfunding' platforms more generally, including protection for consumers who lend or invest through such platforms. I understand that is likely to be issued around 17 October. 

The consultation period ends on 3 December, and responses may be made online here. The final rules are expected in March 2014. 

The FCA's rules related to borrowing on P2P lending platforms are consistent with the way the consumer borrowing platforms already operate. Which is no surprise, since they have been calling for proportionate regulation for years now, and adopted their own self-regulatory code in July 2011. The key protective rules may be summarised as follows:

• It is proposed that platform operators cannot be an appointed representative of another firm 

• FCA proposes similar provisions in relation to pre-contractual explanations and creditworthiness for P2P lending. 

• introduces the concept of a 'P2P agreement' as a distinct form of regulated agreement

• the platform must provide adequate explanations of the key features of the credit agreement to borrowers (including identifying the key risks) before the agreement is made (see CONC 4.4)

• the platform must assess the creditworthiness of borrowers before granting credit (see CONC 5.5) 

•  rules relating to ‘financial promotions’ (see CONC 3 (where applicable)) 

• the platform must include in the agreement between borrower and lender a right for the borrower to withdraw from the agreement, without giving any reason, by giving verbal or written notice, within 14 days of the agreement being made (see CONC 11.2) 

• peer-to-peer lending platforms should be required to provide notices and information sheets to borrowers in arrears or default, directing them to sources of free and impartial debt advice (see CONC 7.18 to 7.20) 

• equivalent rules should be applied to the peer-to-peer lending platforms that help borrowers get high-cost short-term credit as to those applied to lenders providing such credit (see CONC 6.7.17 to 26 and 7.6.12 to 14) 

• peer-to-peer lending platforms should be required to provide a specific risk-warning to a borrower if the loan is secured against the borrower’s home – see CONC 4.4.5) 

• equivalent rules should be applied to peer-to-peer lending platforms carrying on debt collection (see CONC 7) and credit information services, including credit repair (see CONC 8.10) as to other consumer credit firms carrying on the same activities

• Borrowers with loans not regulated under the CCA (because of one of the exemptions) who borrow from firms currently authorised by the FCA will generally have access to FOS in relation to these loans.

Interestingly, the FCA does not anticipate that requirements with respect to P2P lending will affect mutual societies.

P2P Lending: Need FCA Interim Permission But Don't Offer Consumer Credit?

As mentioned earlier, this is a question on which I've have seen no official guidance on, but I have since followed up. 

In order to operate certain types of peer-to-peer lending platform after 1 April 2014, new regulations will requre you to be either fully authorised by the Financial Conduct Authority, or to have received 'interim permission' that is only available to operators who hold a consumer credit licence issued by the Office of Fair Trading.

But the scope of activity within the FCA regime is broader than the activities currently within scope of the OFT's consumer credit licensing regime. 

Whether your platform is 'in scope' for FCA purposes essentially depends on whether the platform enables loans to which individuals are a party as lenders and/or borrowers (either on their own or as a member of an unincorporated association or a partnerships of two or three). There is an exception in the case of borrowers, where either the lender provides the borrower with credit of more than £25,000 or the loan is entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower.

So, for example, platforms that only enable individuals to lend money to companies would not need a consumer credit licence, but would fall within the FCA's peer-to-peer lending regime.

However, I am reliably informed by the FCA that although the OFT would not normally grant licences to firms that may not necessarily require them, it is aware of the interim permission issue and is prepared to grant consumer credit licences to P2P platform operators who need one for interim permission purposes, provided they otherwise satisfy the licence criteria. Such operators should contact the Head of Credit Licensing at the OFT in advance of submitting the application. The application should cover all the activities the platform will undertake from 1 April 2014, including ‘debt administration’. 

Applying For Interim FCA Consumer Credit Permission?

The Financial Conduct Authority is now open to receiving applications for interim permission to engage in consumer credit activity beyond 1 April 2014. Registrations prior to 30 November 2013 qualify for a 30% discount on the registration fee.

Here's the FCA's step-by-step guide; a timeline, which includes consultation on the regulatory details later this month followed by workshops around the country from October to March. There is also some information on being supervised by the FCA; and a note of the differences in the scope of the OFT and FCA regimes.

Here's the OFT's page on the topic.

There are some specific issues not covered in the material released to date. Most importantly, how do you apply where you will need interim permission, but you don't have a current consumer credit licence and your activities do not fit the OFT's current application form? 

Draft Peer-to-Peer Lending Regulations

The draft regulations enabling the Financial Conduct Authority to regulated peer-to-peer lending have been published for parliamentary approval (see Articles 36H-I). There have been some changes to since the previous version in the March consultation to remove certain issues. The more detailed FCA rules should be out with a further consultation paper in September/October.

Basically, your platform is 'in scope' for FCA purposes if it enables loans to which individuals are a party as lenders and/or borrowers (either on their own or as a member of an unincorporated association or a partnerships of two or three). However, there is an exception in the case of borrowers, where either the lender provides the borrower with credit of more than £25,000 or the loan is entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower. 

Payday Loans: Can Borrowers Have Speed, Convenience And Affordability?

Source: OFT

Problems with payday lending are not new. As with payment protection insurance, campaigners in the US were attempting to address poor practices in this area long before they rose to prominence in the UK - and still are. Regulatory solutions don't seem to make much difference. However, recent research shows that 46% of the UK's online borrowers shop around, versus 28% of those on the high street. This suggests technology may also help ensure compliance with affordability requirements, if only creditors would provide transaction and fees data in machine-readable format.

In its consultation on Payday Lending in the UK, the OFT estimates that the volume of payday loans has grown from £900m to £2.2bn since 2008. It says the top 3 providers account for 57% of all payday loans, but concedes the number of lenders has grown from 96 in 2009 to 190 in 2012. This growth, and the efforts of UK campaigners, sparked the OFT's payday lending compliance review in February 2012. As a result of that review, the OFT is now considering a referral of the industry to the Competition Commission, though it believes the transfer of its own regulatory role to the Financial Conduct Authority in 2014 "is likely to increase regulatory costs and make entry to the payday lending market more difficult."

True, the FCA will have more powers, e.g. to limit the number of roll-overs, cap interest rates and control advertising (see the Treasury and FCA consultation papers on the transfer of consumer credit). But the past decade here and in the US has shown that regulation itself is no panacea. Technology appears to have had a bigger impact, both in terms of access and the ability to shop around, and this suggests that technology represents the best avenue for addressing affordability issues.

It's important to start with the borrower. You can't ignore the fact that 90% of online customers who responded to the OFT survey find it "quick and convenient" to get a short term loan and 81% say it makes it easier to manage when money is tight. Customers expressed their satisfaction in terms of decision speed (36%), convenience (35%) and customer service (27%). While affordability therefore appears to be a secondary consideration for all concerned, that's a bit misleading. Research shows that customers ignore the annualised interest rate and look at the absolute charges. These may make loan cost comparison harder, but makes more sense to someone who believes he's only borrowing for a month - which is the case for 72% of payday loans (see graphic). Assessing affordability is also hard - especially for the borrower, on whom the lender is largely relying to provide the relevant figures.

It is therefore no suprise that the industry advertising generally emphasises 'time to cash'.  But the OFT also found that some lenders seem to skimp on credit and affordability checks in order to deliver that speed. You would think that's a dangerous game for lenders to play when their own money is at risk. But the OFT found that about half lenders' revenue come from the 28% of loans that 'roll-over' at least once before being repaid (see graphic). Instinctively, that looks bad. But if those loans are so valuable to lenders, it seems odd that the OFT found little evidence of competition for them loans that are about to roll-over. Perhaps borrowers think they have no alternative at that point, or perhaps they don't care about the cost. But it's also consistent with the fact that these borrowers - and lenders - find it really hard to assess affordability.

While the OFT will decide in June whether to refer the payday lending 'market' to the Competition Commission, you can see from Annex A to its report that it's struggling to define that market. There's a long list of potentially competing finance products. But there are at least 4 unmentioned 'gorillas in the room'. The 'silverback' is the overall debt scenario facing any borrower considering a payday loan. Another gorilla in this troop is the charge for unapproved overdrafts, about which the OFT is understandably gun-shy after its long-running court battle with the banks. Yet another is the fact that when you use a credit card you have no ready means of knowing what the outstanding balance is, as some transactions may not yet be recorded, and interest and charges may only be added to the bill at the end of the month. That's a common reason that the so-called 'financial excluded' give for not trusting financial services, including cheque books and debit cards. The final gorilla in the troop is the borrower's overall financial situation, including the non-financial implications of failing to pay existing or potential creditors, like kids having no school shoes...

However, like a credit reference search itself, these gorillas are all really data problems that are capable of a technological solution, as I've explained previously. Rather than skimp on affordability checks, lenders should figure out how to enable them to be carried out quickly and conveniently. Small lenders might share the cost of a common underwriting platform, for example. But, more importantly, borrowers need to be armed with an application that very simply presents an option that is affordable, based on the analysis of their own transaction data (including fees) from their existing creditors, and the competing costs of different financing options (including charges for missing a payment). 

This may sound futuristic, but it only requires a commitment on the part of all the typical creditors and financial services providers to make this data available to their customers (or their nominated service provider) in machine-readable format. The analysis can be done by either the customer's or a supplier's computer, with the results accessible either online or physically, via a print-out. 

There are plenty of examples of individual customers' transaction data being made available to them or their nominees in this way already, and the immediate focus of the government's voluntary 'Midata' programme is to persuade the banks, telcos and energy companies to do this for all their customers (rather than only those with internet banking accounts, for example). 

Problems like the affordability issues in the £2.2bn payday lending sector represent a good argument for getting on with it.

Why Our ISAs Don't 'Work'... Yet.

The Treasury consultation on expanding the ISA scheme provides a fresh opportunity to put our savings to work and boost economic growth at the same time.

What's wrong with ISAs?

The “Individual Savings Account” (ISA) rules encourage us to put £11,280 a year into bank cash deposits and a limited list of regulated bonds and shares by making the returns tax-free.

Last year the Treasury estimated that about 45% of UK adults have an ISA, with a total of £400bn split about equally between cash and stocks/shares.

But in 2010 Consumer Focus found that cash-ISAs were only earning an average of 0.41% interest (after initial ‘teaser’ rates expire). They also found that 60 per cent of savers never withdraw money from their account; and 30 per cent see their ISAs as an alternative to a pension. 

Yet the banks don't use this cheap £200bn very wisely. In fact, only £1 in every £10 of the credit they create is allocated to firms who contribute to economic growth (GDP) and 60% of new jobs. In other words, lending to businesses is just not our banks' core activity, even though we also guarantee their liabilities. They earn more by financing consumption and speculation in financial assets. They've even taken £9.5bn under the so-called "Funding for Lending" scheme, and lent even less than before...

So we need the ISA scheme to encourage people to put their ISA money - and the country - back to work.

That means adding alternative asset classes that provide a decent return by financing the real economy, such as those generated on peer-to-peer lending and crowd-investment platforms.

Why hasn't this been done already?

The Treasury has previously resisted calls to do this on two occasions over the past few years. Their defence has been that ISAs are popular, simple to understand, relatively low risk and peer-to-peer platforms are not regulated (see here at para 14 and here at page 13).

But on neither occasion did the Treasury acknowledge the risks posed by the huge concentration of ISA cash in low yield deposits. Or the potential benefits of enabling savers to make some of those funds available to consumers and small businesses at lower cost and far higher returns - especially given that peer-to-peer default rates have proved to be very low.

The regulatory concern also appears to have been misplaced. Banks have clearly demonstrated that regulation affords no guarantee that consumers will be treated fairly. And peer-to-peer platforms, which are already partly regulated by the Office of Fair Trading, have been requesting broader regulation for several years. As a result, the Treasury has begun consulting on plans for more comprehensive regulation by the new Financial Conduct Authority from 2014.

All of that means the latest consultation on adding new assets to the ISA scheme is a golden opportunity to convince the Treasury to let us put our savings to work. 

Let's not miss it.

Consultation on Relocation of Consumer Credit

The consultations on how the regulation of consumer credit will finally transition from the Office of Fair Trading to the Financial Conduct Authority are out. 

The combined Treasury/BIS consultation is here; and the FSA consultation setting out some of the proposals for the FCA regime are here. 

There goes the weekend...