There have been a number of smoke signals in the last few months around the increase of consumer debt in the UK and a focus on those firms providing consumer credit across the credit spectrum but particularly in the "sub-prime" or "near-prime" space.
Since the credit crunch, a number of consumer credit businesses have stepped in to fill a gap in the lending market. They give sub-prime or near-prime borrowers, who may find it difficult to obtain credit from traditional sources, with high-cost, short-term credit - instant access to funds.
The availability of this type of credit (often at the click of a button and with very little human interaction), combined with attractive returns, has led to a surge of new participants into the marketplace - both new borrowers and new lenders. While this has created greater choice and availability, it has caused the UK regulators to keep a close eye on the sector to ensure the lending practices remain fair.
This article presents a snapshot of the insolvency regime around consumer credit in the UK and the particular challenges for insolvency practitioners appointed to restructure a consumer credit business.
Financial Conduct Authority
Since 1 April 2014, the FCA has been responsible for regulating consumer finance in the UK. The FCA’s criteria for authorization are more stringent than those of the previous regime under the Office of Fair Trading, but the FCA did introduce two categories of authorization to distinguish between higher and lower risk activities:
- Limited permission applies to less risky activities (such as consumer credit lending where the main business is selling goods and there is no interest or charges)
- Full permission applies to higher risk activities (such as personal loans, credit card lending, overdrafts, hire purchase and debt collecting)
Since the introduction of the FCA consumer credit regime in 2014, firms have had to adjust to a more complex set of rules and principle-based regulation under The Financial Services and Markets Act 2000 (FSMA), The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and the FCA Handbook. In addition, the FCA has taken specific action in sectors where it considers that customers have not been adequately protected. Many of these changes (such as the introduction of an interest cap on providers of high-cost, short-term credit) have had a direct effect on the profitability and/or viability of consumer finance firms.
There is also now precedent for the FCA effectively ordering financial redress for wronged customers, which could have a significant impact on consumer finance firms. In addition, to redress some of the recent press around certain companies in the sector focusing on alleged lending practices, which could result in a significant fines being levied by the FCA if the allegations prove to be true.
Prudential Regulation Authority
The PRA's general responsibilities in this context are first to promote the safety and soundness of the firms it regulates (mainly credit institutions and insurers), and second to facilitate effective competition. The PRA recently expressed a number of concerns in lending practices in consumer credit in the UK as part of its statement on consumer credit on 4 July 2017. It cites particular concerns over a combination of continued growth, lower pricing, falling average risk weights and some increased lending into higher risk segments in credit markets.
Further concern is raised over the adequacy of management information and delayed recognition of credit losses. As a result, the PRA is requiring firms to provide evidence as to how they are addressing these concerns, specifically on credit scoring, stress-testing and prior consideration of a borrower’s
Automotive finance, which has been the subject of significant press coverage recently, is seen as a particular risk by the PRA and the FCA (particularly PCP products − personal contract plans) which finance over 90 percent of sales in the new car marketplace).
Insolvency Regime and FCA Consent
There is no distinct insolvency regime for consumer finance businesses although (i) there are some additional duties on officeholders appointed over consumer finance businesses and (ii) the FCA does have some limited involvement and powers in relation to FCA authorized businesses under Part XXIV of FSMA. The most significant rights and duties are that the FCA must provide consent before directors can file a notice of intention to appoint administrators or apply for an administration order. The FCA prescribes a form for use for the purposes of the request for consent which includes the nominated insolvency practitioner providing:
- Confirmation that it has the required professional qualification and experience to accept the appointment
- Commentary on their experience and expertise, including whether people with the relevant financial services experience will provide the necessary assistance
- Indication of the purpose of the administration and express satisfaction that this purpose is reasonably likely to be achieved
The powers of the FCA in relation to insolvency processes of authorized firms are set out under Part XXIV FSMA and include allowing the FCA to:
- Apply for an administration order or present a winding-up petition in relation to an authorized person, who is an appointed representative or is carrying on a regulated activity in contravention of the general prohibition
- Challenge in court any decision or implementation in relation to a company voluntary arrangement
- Apply for an order under Section 423 Insolvency Act 1986 (transactions defrauding creditors
- Participate in insolvency proceedings, attend creditor meetings and receive creditor reports of an authorized person
- Receive reports from office holders if they think a regulated activity is being carried on in contravention of the prohibition
- Provide consent before directors can file a notice of intention to appoint administrators or apply for an administration order
Every IP has a duty to report to the FCA if the relevant authorized persons act in a way that breaches the conditions of their permissions or carries out a credit-related regulated activity without the necessary permission.
(A) Special permissions
IPs must either seek direct authorization from the FCA under the FSMA regime if they wish to provide the full spectrum of advice services, or alternatively, operate within the boundaries of a more limited statutory exclusion which is afforded to them. The exclusion for IPs operates such that where IPs are giving advice as an officeholder (i.e. acting as an IP in respect of a formal appointment under the Insolvency Act) or in the context of their pre-appointment obligations, and are doing so in reasonable contemplation of acting in a formal capacity, they and their firms may provide debt counselling, debt adjusting and credit information services outside of the FCA regime1. Their recognized professional body2 will regulate the activities they conduct within this exclusion, and the advice they give is not considered to be activity regulated under the FSMA (provided they act within the parameters of the exclusion afforded to them).
These measures avoid duplication in regulation and assist the many IPs who exclusively engage in insolvency appointments. However, IPs who wish to offer broader advice services or offer non-statutory solutions themselves (including informal negotiations on behalf of consumers) will be conducting regulated consumer credit activities which require direct FCA authorization. It also raises questions around upon whom an IP can reasonably rely in terms of the advice or other work conducted by others prior to the insolvency appointment.
(B) Potential pitfalls
Regulated credit agreements
The definition of a regulated credit agreement is set out by way of statutory order and is "an agreement by which a lender provides, (i) credit of any amount to an individual or a relevant recipient of credit, and (ii) where the agreement is not exempt". The category of exemptions is beyond the scope of this article but in practice the definition of regulated credit agreement is extremely wide and might conceivably extend to negotiating an extension to a repayment date or other financial accommodation in favour of the borrower which might not naturally feel like the provision of credit.
Similarly, in respect of collection under regulated consumer credit agreements, there are a number of formalities to follow particularly in respect of notices to be provided to the borrower before action to collect can be taken. The types of notices and timing of notice will depend on the type of agreement but non-compliance with these rules can result in the agreement becoming unenforceable during the period of non-compliance which might have the effect, for example, that the borrower has no liability to pay interest and charges during that period of non-compliance and thereby have a real material adverse impact on the value of the assets flowing into the insolvent estate.
Collection of Debts
IPs are specifically excluded from the requirement to be authorised for 'debt collecting', however significant issues can arise around collection activity which mean that it is prudent not to assume that the IP (or their agent) can simply collect debts due to the insolvent company without detailed reference to the underlying consumer credit regime. It is very easy for an IP to be in breach of the detailed rules set out in the Consumer Credit Sourcebook (CONC) if the IP is not aware of its obligations thereunder. Under certain circumstances, failure to observe the rules set out in CONC may give grounds for the borrower to argue there is an "unfair relationship" within the meaning of Section 140A of the Consumer Credit Act 1974 under which the entire terms of the credit agreement can be reopened notwithstanding the offending action or omission may appear relatively minor by itself.
Owing to the interest UK regulators are showing in the consumer credit marketplace and the record levels of consumer credit in the UK market (against the backdrop of wage stagnation and the prospect of increasing interest rates), it seems highly likely that financially distressed situations will arise in this sub-sector. An understanding of the likely challenges and pitfalls when faced with a distressed consumer credit business and how to manage the interests of the FCA will be imperative when trying to find the right restructuring solutions for the business and all stakeholders involved.
Paragraph 52 of the Schedule to the Financial Services and Markets Act 2000 (Exemption) Order 2001, as amended by The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.2) Order 2013 and Article 3(1) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, as amended by The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2014.
Recognized bodies which authorize and regulate insolvency practitioners as set out in the Insolvency Act 1986.
CONC is ancillary to the Consumer Credit Act 1974 and details obligations in respect of regulated credit activities.