Regulation of Consumer Credit Activities Purpose 1 The purpose of this paper is: i) to provide the Board with an update on discussions with the Financial Conduct Authority (FCA) and the Treasury (HMT) with regard to the regulation of SRA-authorised firms carrying on consumer credit activities (paragraphs 8-13); ii) to provide the Board with a high level summary of the main issues arising from the consultation exercise (paragraphs 14-22); and iii) to ask the Board to decide on next steps (paragraphs 23-46). Recommendations 2 The Board is asked to: a) note and endorse the work with HMT on reducing the scope of consumer credit regulation; b) note the current position with the FCA; and c) task the executive with securing option 4 or 3 (in that order of preference) and, only if FCA will not agree an extension, to agree option 2. The Board is asked to continue to rule out option 1. If you have any questions about this paper please contact: Crispin Passmore, Executive Director, crispin.passmore@sra.org.uk, 0121 329 6687 Page 1 of 12
Background Regulation of Consumer Credit Activities 3 The Board will recall that on 1 April 2014, responsibility for the regulation of consumer credit activities transferred from the Office of Fair Trading (OFT) to the FCA. Consumer credit activities which were licensable under the Consumer Credit Act 1974 (CCA) became regulated activities under the Financial Services and Markets Act 2000 (FSMA). 4 Many legal services providers undertake some form of consumer credit activity and, before 1 April 2014, SRA-authorised firms were able to do so under an OFT group licence, held by the Law Society and managed by the SRA. The group licence enabled firms to undertake consumer credit activities, including consumer credit, credit brokerage, debt adjusting and debt counselling, debt collecting, debt administration and provision of credit information services, without being individually licensed. 5 HMT and the FCA decided that these group licence arrangements would cease and from 1 April 2014 firms carrying on regulated consumer credit activities were required to: be authorised by the FCA with the appropriate permission; have been granted interim permission by the FCA; be exempt under Part 20 of FSMA; or cease to carry on consumer credit activities. 6 Section 19 of FSMA prohibits a person from carrying on a regulated activity without authorisation by the FCA, unless they are an exempt person. Part 20 of FSMA provides an exemption in respect of members of a Designated Professional Body (DPB), such as the SRA (by virtue of being the independent regulatory arm of the Law Society). These firms are referred to as exempt professional firms (EPFs). As a DPB, the SRA is required to have rules that govern the carrying on of regulated activities; these are the SRA Financial Services (Scope) Rules 2001 (the Scope Rules) and the SRA Financial Services (Conduct of Business) Rules 2001 (the COB Rules). The purpose of these rules is to set out the scope of the regulated financial activities which may be undertaken by EPFs. 7 In January 2014, in order to allow SRA-authorised firms to benefit from the Part 20 exemption in relation to consumer credit activities, the Board made rules which set out that during the transitional period (originally from April 2014 to 1 October 2014 but subsequently extended to 1 April 2015), firms would have to comply with the provisions and guidance set out in Rule 1.3R of the transitional provisions in the FCA s consumer credit sourcebook (CONC). These transitional rules were approved by the FCA and the Legal Services Board. The purpose of the transitional period was to consider the Page 2 of 12
FCA's expectations and the regulatory arrangements that would need to be in place, from 1 April 2015, to allow SRA-authorised firms to continue to rely on Part 20 for the purposes of consumer credit. Discussions with the FCA and HMT 8 There are ongoing discussions with the FCA to understand what the FCA would expect of the SRA as a DPB. The FCA had given a clear indication that it expected the SRA to have rules with the "equivalence of content and effect" of CONC. We have interpreted this to mean (and FCA confirmed) that all or substantial parts of CONC would need to be incorporated into the SRA's Handbook. As a result we would be responsible for implementing rules over which we have no control and would need to support these rules with appropriate oversight. The FCA pointed out that SRA-authorised firms will have already been subject to many of the requirements of CONC which draws heavily on the CCA and earlier OFT guidance. However, in our view, the Part 20 regime cannot be compared with the OFT s group licence as that did not require regulatory bodies to make separate rules in relation to the carrying on of consumer credit activities. It is also worth nothing that there is no requirement in FSMA for the DPB rules to be 'equivalent' and that is reflected in the way that the rest of the DPB regime operates. 9 As a result of the FCA's position, which they confirmed to us in September, in October 2014 we consulted on a proposal that the Part 20 regime should not be available to firms in respect of consumer credit activity. That consultation has helped us intensify and focus discussions. 10 Most recently, discussions with the FCA have helped focus on what is required of the SRA as a DPB and clarified our options. There has been some discussion about how we might demonstrate equivalence through alternatives to detailed rules which support the SRA's objective to regulate in a proportionate way and the protection of consumers. The FCA has now made clear that it does not expect a different level of oversight from us to that which operated under the Group Licence and acknowledges that SRAauthorised firms undertaking consumer credit activity represent a relatively low-risk. We are unlikely to get further clarity from FCA until we set out our proposed regulatory arrangements. 11 Separately, representations have been made to HMT to seek an extension of the exclusions (from the need to be separately authorised) within the FSMA (Regulated Activities) Order which cover consumer credit activities carried on by a solicitor acting in the course of contentious business - the 'contentious business exclusion'. Exclusions exist in relation to various consumer credit activities including debt collecting, where the regulated activity is carried on by a solicitor (within the meaning of the Solicitors Act 1974) acting in the course of contentious business (as defined in section 87(1) of that Act). These exclusions appear, on the face of them, to be available only where proceedings have been issued and do not cover pre-issue work. We have Page 3 of 12
suggested widening the exclusions to include activities that take place during pre-issue work and for the exclusions to be available to firms irrespective of whether proceedings are commenced. As a result, these activities would continue to be regulated by the SRA. This approach would avoid the need for dual regulation but without any reduction in consumer protection. 12 HMT has also been asked to consider increasing to 12 the number of instalments over which fees may be paid, before such an arrangement is deemed to be a regulated credit agreement. We do not have any details of the number of firms regulated by the SRA that would enter into such agreements with their clients but we believe that it is fairly common and, in our view, it is often in the interests of consumers to allow such arrangements. 13 If these two proposals are accepted by HMT, it may reduce the number of firms that need to rely on Part 20 in relation to consumer credit activities. Responses to the consultation 14 As noted above, in October we published a consultation proposing that SRAauthorised firms which carry on regulated consumer credit activities should seek authorisation directly from the FCA, rather than being able to rely on the Part 20 exemption. The consultation closed on 15 December 2014 and more than 100 responses were received, including responses from firms, individual practitioners, local law societies, consumer bodies, the Ombudsman and other DPBs (the Law Society of Scotland and the Royal Institution of Chartered Surveyors). 15 The vast majority of respondents disagreed with the suggestion that firms carrying on any regulated consumer credit activity should be required to seek authorisation from the FCA and not be able to rely on the Part 20 exemption. 16 Respondents expressed some strong views about the timing and impact of the proposed changes. Many suggested that there would be insufficient time for firms to decide whether to apply for authorisation from the FCA and that, in any event, a transitional period would be required by those firms who did not wish to apply, in order to bring current arrangements to a close. It was also pointed out that the FCA can take up to 6 months to decide whether to authorise a firm. 17 It was suggested that the impact of the proposal was likely to be more significant than envisaged with some respondents, including the Law Society, saying that the number of firms likely to be affected by the proposal was significantly greater that that suggested by the SRA. Others said that very few firms would seek authorisation from the FCA and would therefore have to cease consumer credit activity, which would be to the detriment of consumers and vulnerable consumers in particular. Page 4 of 12
18 Some respondents indicated that a requirement for authorisation by the FCA would be disproportionate because, in most cases, legal services firms represented a very low risk and there was no evidence of detriment arising from the existing arrangements. 19 Not all respondents disagreed with the proposal. The Legal Services Consumer Panel and the Money Advice Trust said that it was not necessary for the SRA to replicate the FCA's regulatory requirements and that this would lead to the SRA incurring unnecessary expense in developing expertise to ensure compliance with another regulator's arrangements. The Consumer Panel considered that the FCA was better placed to regulate all carrying on consumer credit activities as the 'specialist regulator' and that consumers would be better protected as a result. It noted the FCA's ability to impose significantly higher financial penalties than the SRA, suggesting that this would deter poor practice and reduce consumer detriment. 20 The Legal Ombudsman said that it was important for lawyers to make their position clear to potential customers before a service is provided, so that customers understand their rights, who the relevant regulator is, and where to obtain redress if they have a complaint about the service provided. The Ombudsman stated that further consideration should be given to reducing the impact of any consumer detriment as a consequence of the proposed changes. 21 What has become increasingly clear is that many of the activities covered under Part 20 are not separate professional services (in the way that say accountancy or insolvency work might be) but are integral to the delivery of legal services. 22 Regardless of the outcome of the consultation exercise and our discussions with the FCA and HMT, there are SRA-authorised firms that will have already sought interim permission from the FCA and will be going through the necessary authorisation process. Options for action 23 Since the publication of the consultation, as set out above, we have had further discussions with the FCA. We await a decision from HMT about the contentious business exclusion and the issue relating to payment by instalments. 24 Looking ahead there appear to be four options for action, these are: to incorporate CONC into the SRA's regulatory arrangements as originally envisaged by the FCA; to withdraw from the DPB regime for the purposes of consumer credit as proposed in the consultation; Page 5 of 12
to continue discussions with the FCA and request an extension of the transitional provisions to end on 31 October 2015. We understand that the FCA is unlikely to agree to an extension unless we commit to a direction of travel which reflects the FCA's expectations of the SRA as a DPB; or to seek an extension of the transitional provisions beyond 31 October 2015 (for up to 18 months) to allow a longer period for alternative approaches to be discussed and any final decision to be communicated and implemented. These options are considered in further detail below. Option 1: to incorporate CONC into the SRA's regulatory arrangements, as originally expected by the FCA 25 Fully incorporating CONC, or substantial parts of it, will mean that most firms will not need to be regulated by the FCA and, we assume, will therefore continue to undertake consumer credit activity under SRA authorisation. 26 If we incorporate CONC, or substantial parts of it, this would result in an identical set of provisions applying to firms that are authorised by the FCA and to exempt professional firms (EPFs) carrying on activities under Part 20 but in the case of EPFs these provisions will be supervised and enforced by the SRA. We believe that CONC is unnecessarily prescriptive and burdensome for SRA-authorised firms and understand that the FCA agrees that the provisions could be simplified. In many circumstances the consumer credit activities carried out by EPFs in this situation will be low risk and integral to the provision of legal services (such as offering clients the facility to pay professional fees by instalments): this could result in firms ceasing to offer consumer credit services to clients where it is considered that the regulatory requirements and cost of compliance outweigh any benefit to the client. 27 Incorporating CONC, or substantial parts of it, is likely to have an impact on the way in which the SRA regulates firms. In particular, we will need to ensure that we have the skills, expertise and capacity to regulate consumer credit activity by following the FCA's approach. Such a detailed rules-based approach appears to be inconsistent with our strategy and regulatory reform programme, in which we have committed to remove unnecessary regulation and reduce the burden of regulation on SRA-authorised firms. In our view this approach is inconsistent with the FCA position that we do not need to increase our supervisory activity: more detailed and prescriptive rules will need a greater supervisory, investigative and enforcement focus. 28 This option does preserve the existing border between SRA general regulation of firms relying on Part 20 and those regulated by the FCA as dual regulated firms. As noted by the Legal Ombudsman, if we continued as a Page 6 of 12
DPB, the impact on consumers would be limited as confusion in dealing with two separate regulators and complaints systems would be reduced because fewer firms would require dual regulation. 29 This option has been and continues to be untenable for the SRA. Option 2: to withdraw from the DPB regime for the purposes of consumer credit, as proposed in the consultation 30 The most obvious initial impact of this option is that most firms will need to be authorised by the FCA if they continue carrying on consumer credit activities and will therefore incur the costs of being regulated by the FCA. For those firms needing only limited permission, our understanding is that the FCA s fees are not large. The FCA charges an initial fee for authorisation, and annual fees thereafter. Firms regulated by the FCA must also pay towards the cost of the Financial Ombudsman Service. The size of these fees is determined by the income that the firm derives from the activities to be regulated. 31 This option has an advantage of simplicity for firms because it would be clear that any firm carrying on consumer credit activities would require FCA authorisation. However, it could also result in increased confusion for consumers in dealing with different regulators and ombudsmen for different elements of the legal services they are buying. 32 Compliance with FCA regulations is likely to result in additional costs for firms. Compliance officers, in particular, will need to adapt to new regulatory arrangements. The extent to which the FCA will supervise SRA-authorised firms seeking limited permission as part of its regulatory activities is not at this stage known. We must, however, acknowledge that there is an additional regulatory burden inherent in the involvement of a second regulator. An additional impact of this proposal is that firms that become authorised by the FCA to carry on consumer credit activities will no longer be able to benefit from the Part 20 regime in relation to any other regulated financial activities, for example, insurance mediation activities. This is because a firm cannot be both authorised by the FCA and be an EPF at the same time. 33 The impact of not being able to continue as an EPF will result in the firm having to consider its business model and whether it wishes to be regulated by the FCA for all its regulated financial activities. Personal injury firms, for example, often arrange for clients to have the benefit of after the event insurance (ATE) as part of the retainer. If this option were adopted then it would require firms to ensure that they had the appropriate authorisation to ensure the continuation of services to all their clients. Firms would need to ensure that their client care information was updated to reflect the fact that that they were authorised and regulated by the FCA for certain activities and that different client protection arrangements would apply. Page 7 of 12
34 Respondents to our consultation suggested that most firms would choose not to be authorised by the FCA and would therefore cease undertaking consumer credit activity, causing consumer detriment. Where firms cease carrying on consumer credit activities, consumers may find themselves in a situation where they cannot access services or rely on SRA-authorised firms as they may have done under the OFT's group licence regime. While we do not know the scale of impact, this is a significant risk with our withdrawal and central to our recommendation. 35 However, consumer representatives suggested that this option would deliver greater consumer protection through the FCA s robust regulatory regime (as compared to the resources available to the OFT) and will lead to consumer benefits in this area and the better treatment of people in debt. Money Advice Trust commented that it would be beneficial for clients of solicitors to come under the FCA's regulatory regime for debt advice, and debt collection in particular. It was also noted that adherence to one clear set of rules that covered all firms who engaged in consumer credit activities would result in the SRA not having to replicate the same, and less confusion for consumers trying to establish which regulatory regime applied. Option 3: to continue discussions with the FCA and request an extension of the transitional provisions until 31 October 2015 36 As set out above, we have continued our discussions with FCA regarding its expectations of us as a DPB and what our regulatory arrangements might look like if we were to continue to regulate consumer credit activities as a DPB. Despite comments made in the legal press about possible flexibility, the FCA had not communicated any flexibility to us and we understood that the expectation was that we must incorporate CONC or have equivalent rules and that a principles based approach would not be acceptable. 37 However, recent discussions have helped us to consider other options, for example, how the SRA might be able to demonstrate compliance or equivalence through alternatives to detailed rules. The FCA has indicated that if we were to continue as a DPB for the purposes of consumer credit then they would continue monitoring our arrangements as they have done to date in respect of regulated financial services provided by EPFs. There seems to be some common agreement that SRA-authorised firms undertaking consumer credit activities are likely to be considered as low risk and that much of their consumer credit work is likely to be an integral part of legal services offered to consumers. Continuing as a DPB for the purposes of consumer credit activities may therefore allow continued access to services and delivery of quality advice to consumers. 38 These discussions have provided a basis for continued engagement about how we can continue to regulate this area of work and the extension will provide scope for further engagement with the FCA, HMT, SRA-authorised firms and consumer bodies that have engaged with us previously or as part of Page 8 of 12
the consultation exercise. This will involve exploring all alternatives to the incorporation of CONC and whether any guidance can be prepared by the FCA that will help firms understand key risks associated with consumer credit activities. 39 We have not previously been required to replicate the FCA s sourcebooks in relation to other (non consumer credit) regulated activities in either the Scope or COB Rules. This position should, in our view, continue to apply in respect of the regulation of consumer credit activities carried on by EPFs. 40 Our representations to the FCA and HMT have focused on ensuring that if we are to continue as a DPB for consumer credit activities, any rules we make need to be targeted and proportionate. We have committed to ensuring that our regulation does not impose unnecessary burdens on SRA-authorised firms, especially small firms which may be involved in limited consumer credit activities to a small number of clients. We would use the extended transitional period to engage in further discussions with HMT and the FCA. Any final decision will depend on any changes that are made to secondary legislation and reaching agreement with the FCA as to whether alternative approaches are acceptable for the purposes of regulating consumer credit activities as a DPB. Our rules for regulating the provision of regulated activities by EPFs must be approved by the FCA (under section 332(5)). It would be very difficult for the SRA to commit to a position until it obtained a clear understanding from the FCA of the approach it will take to the approval of our rules. 41 It should be noted that during the extended transitional period SRA-authorised firms will need to continue to comply with the transitional rules as set out in the Scope Rules - this means complying with guidance and regulations specified by the FCA in CONC and a breach of such provisions will amount to a breach of the SRA's Scope Rules. The SRA will continue to be responsible for supervision and enforcement of the Scope Rules and any enforcement action will be in accordance with the SRA's enforcement strategy. 42 Irrespective of any positive response from HMT, if an agreement cannot be reached with the FCA it is possible that we will have to continue with Option 2 and withdraw from continuing as a DPB for consumer credit activities. Our discussions with the FCA will also, therefore, need to factor in the potential for 11,000 firms needing to be authorised by the FCA, what information will be required from SRA-authorised firms as part of the authorisation process and subsequently and what information will be given to consumers to ensure adequacy of services. A detailed communications strategy will need to be implemented to ensure that SRA-authorised firms and other key stakeholders are informed of decisions and any support or advice that may be available. 43 If this option is preferred by the Board, depending on discussions with the FCA, we will look to present formal proposals for changes to our regulatory Page 9 of 12
arrangements, our response to the recent consultation and any further consultation required to deliver an agreed option with the FCA in April 2015. Option 4: to continue discussions with the FCA and request an extension of the transitional provisions beyond 31 October 2015 44 The arguments for this option are the same as under Option 3 but an extension beyond 31 October 2015 would allow for detailed discussions with the FCA to continue and longer engagement with key stakeholders as we explore alternative arrangements that might apply to the regulation of consumer credit activities, and also for any proposals to be agreed and implemented. An extension of, for instance, 18 months would allow us to develop our approach should we continue to regulate consumer credit activities as a DPB, implement the changes to the SRA Handbook, and ensure that all affected firms have sufficient time to comply with any new requirements. 45 There is a risk that the SRA's reputation could be damaged if Option 3 did not allow sufficient time for firms to prepare for any new regulations coming into effect in October 2015 or, where necessary, to be authorised by the FCA. There are risks to extending the transitional arrangements as they do have many of the same issues as option 1. 46 As set out under Option 3, if agreement cannot be reached with the FCA then the SRA may subsequently decide to proceed with its decision to withdraw from regulating consumer credit activities as a DPB. Next steps 47 If the Board agrees to the recommendation and the FCA agrees to an extension, we will set out in detail the proposed arrangements, mapped across to the FCA's rules, in preparation for seeking formal approval from the FCA. We expect to do this by April 2015. 48 As soon as we have clarity between the options we will develop a detailed communications plan to ensure that firms understand our direction of travel, possible outcomes and how they can best prepare. Resource implications 49 Option 3 and 4 are unlikely to have any resource implications as it amounts to continuing with the current arrangements until October 2015 or beyond. Consumer impact 50 Any extension to the transitional provisions means the status quo will be maintained and there is unlikely to be any negative impact on consumers. Page 10 of 12
SRA-authorised firms will be able to continue providing consumer credit services provided they can demonstrate reliance on Part 20 and comply with the Scope Rules. However, some respondents to our consultation suggested that withdrawing from the existing arrangements would have a positive impact on consumers in that consumer credit activities will be regulated by a 'specialist regulator' and one set of regulatory arrangements supervised and enforced by the FCA will apply. Equality and diversity considerations 51 No issues have been identified. We will continue to assess the equality impact of the changes and discuss any concerns to the FCA so that appropriate steps can be taken to ensure SRA-authorised firms and consumers are not negatively impacted by the change in regulation. Page 11 of 12
Supporting information Links to the Strategic Plan 52 The proposal is linked to Strategic Objective One: Reform our regulation to enable growth and innovation in the market and to strike the right balance between reducing regulatory burdens and ensuring consumer protection. 53 Developing an appropriate model for the regulation of consumer credit activities carried on by SRA-authorised firms, relying on Part 20, supports our commitment to reforming our regulatory regime to reduce unnecessary burdens on authorised bodies. How the issues support the principles of better regulation 54 It is hoped that continued discussions with the FCA and HMT will help develop a proportionate and targeted approach to the regulation of firms carrying on consumer credit. The design of any regulatory model will need to ensure an efficient and effective use of SRA resource. What engagement approach has been used to inform the work and what further communication and engagement is needed 55 We are engaging with the FCA and HMT and will continue to engage with SRA-authorised firms, consumer bodies and the Law Society to ensure that all views are considered. The SRA's guidance for firms will be updated should we receive positive news from HMT with regards to the review of the exclusion for contentious business and the scope of payment of professional fees by instalments. 56 Depending on the decision of the Board, a communication plan will be prepared with a view to ensuring the SRA-authorised firms are fully informed through webinars and news releases for example. We will also continue to share relevant information or guidance received from the FCA through the SRA website and other media portals. Author Crispin Passmore, Executive Director Contact Details crispin.passmore@sra.org.uk 0121 329 6687 Date 9 January 2015 Page 12 of 12