The proposed directive for the regulation of consumer credit - what changes for the UK?

On 11th September 2002, the European Commission approved a proposal for a new consumer credit directive.

The existing EU directive, 87/102/EEC, has been subject to criticism for some time. First, since it sets out only minimum standards of regulation, Member States are allowed to introduce more stringent requirements if they choose to - this has had the effect of segmenting the Internal Market into national markets and caused discrepancies in consumer protection between Member States. In addition, due to technical advances in the consumer credit field and the increasing sophistication of credit products, the directive is now out of date.

The new directive (in its current form), rather than setting minimum standards, is based upon the principle of maximum harmonisation. It is more prescriptive and explicitly prevents Member States from maintaining or introducing new rules save in relation to the registration of credit and surety agreements and provisions concerning the burden of proof. If it were to be adopted in its current form, and the maximum harmonisation principle upheld, it would mean the rolling back of several consumer protection measures enshrined in the current UK legislation since the UK offers a greater level of protection to consumers than many of its European counterparts.

The New Scope

Article 3 of the draft directive proposes the removal of the exemptions permitted by 87/102/EEC which means the removal of the floor and ceiling limits and extension of the scope to cover all consumer credit products, whatever the amount, type and security. Hire-purchase agreements and overdrafts are now included. While hire-purchase has been included (conditional sale was already within the scope of the directive) the current drafting does not deal with the particular issues which arise in this market and much remains to be done to ensure that the directive reflects the reality of the product it seeks to govern.

In addition to protecting the consumer taking the credit, the draft directive now provides protection for any person providing surety in relation to the credit. In addition, the draft directive will not apply to business lending of any description.

Mortgages

Traditional home loans remain outside the scope but equity release schemes will be subject to regulation. In addition, due to the current drafting, problems may arise in relation to flexible mortgages which have become increasingly popular in the UK over recent years. The draft directive excludes credit agreements where the purpose of the credit is to buy or transform a “private immovable property but the Explanatory Note states that this exemption will not apply if the credit agreement “is to finance, possibly by means of a new drawdown of credit, transactions other than the purchase or transformation of private immovable property. This definition is causing no little concern to the mortgage industry since flexible mortgages which allow payment holidays and/or the drawing down of funds under a previously agreed credit limit will fall within the scope of the draft directive. The effect of this is two-fold. First, lenders could find themselves subject, not only to the FSA regulatory regime, but also the consumer credit regime. Secondly, for lenders whose business has not previously been subject to consumer credit regulation, the cost implication will be considerable - documentation will require substantial amendment and customer-facing staff will need to be retrained to deal with the new requirements.

Improved transparency and cost

The calculation of Annual Percentage Rate (“APR) is to be harmonised to improve comparability. To achieve this, Annex I of the draft directive proposes complete standardisation in respect of rounding-off (the APR is to be rounded to one decimal place) and what is understood by a year (365 days or 366 days for leap years). The method of calculation of fractions of years is retained.

Two new terms are introduced by Article 13:

· “Sums levied by the Creditor (the “SLC) – being the amount the consumer pays to the lender including interest and all the mandatory costs associated with the credit agreement, and

· “Total Lending Rate (“TLR), being the SLC expressed as a percentage

Under Article 6.2(h) and Article 10.2(b), the TLR must be shown in both the pre-contractual information and the credit agreement.

Doorstep Selling Prohibition

Article 5 of the draft directive prohibits all door to door selling of credit products. This is significantly harsher than the earlier Doorstep Selling Directive 85/577/EEC which simply provided a minimum seven day cooling-off period.

Consumer disclosure, duty to provide advice and responsible lending

Under Article 6, during the application process, the consumer will be obliged to disclose all relevant information when requested to do so by the lender. In the UK, most consumers are already required to disclose all relevant information when applying for consumer credit – failure to do so constitutes a breach of the agreement. While the obligation is helpful, it does not appear, at first glance to strengthen the lender’s position in any way.

The quid pro quo is the introduction of the “responsible lending requirement. Under Article 6.3 of the draft directive, lenders, or where applicable, credit intermediaries, will be required to advise each consumer on the most favourable or least expensive product in its range and under Article 9 they must thoroughly assess the consumer’s ability to repay before credit is granted.

Improved data access for lenders and a new central database

A major change for the UK will be a new requirement under Article 8 for Member States to set up a centralised database. The Explanatory Note confirms that the database must hold negative, neutral and reliable data recording late payments, the identification of consumers and guarantors. Access to the database is guaranteed to all creditors. Creditors will be required to consult the database before making a decision to lend and, in addition to assessing the consumer’s payment record, will be expected to make an assessment of the consumer’s current financial position as to whether further credit should be granted. Currently these databases are run by credit reference agencies and if they are selected to run the central database they will be expected to ensure access to the database for all creditors and that the information carried is processed and evaluated in the same way.

The Credit Agreement

In line with the trend towards electronic means of concluding contracts, Article 10.1 provides that credit agreements (and surety agreements) are to be “drawn up on paper or another durable medium. Another requirement under Article 10.1, is that the agreement must contain details as to whether a grievance procedure is available, and if so, how a complaint can be made.

The amount of credit must always be shown and the Explanatory Notes states that once an agreement is entered into, the credit limit may only be changed by novation. This requirement will have a major impact on the credit card industry and for bank’s offering overdrafts since they will no longer be able to offer unilateral increases in the credit facility available.

A further burden is imposed by Article 10.2(c). For agreements where the capital is amortised, e.g. hire-purchase and conditional sale, the agreement will have to contain amortisation tables setting out the payments due, and the periods and conditions relating to the payments. Space is already at a premium on most credit agreements so if this proposal is retained in the final version, some inventive layout will be required.

Right of Withdrawal

Article 11 provides that consumers are to be allowed to withdraw from any consumer credit agreement within 14 days of the agreement being concluded, free of charge and without justification. The consumer will be obliged to pay interest for the period during which the credit was drawn, calculated on the basis of the APR but no other indemnity may be claimed in connection with withdrawal.

Little thought seems to have been given to conditional sale and hire purchase agreements. The draft directive states “No other indemnity may be claimed in connection with the withdrawal. While the current cancellation provisions are rarely invoked in practice, clarification must be sought to ensure that lenders are able to claim for depreciation, wear and tear where new goods supplied under the credit agreement are returned used within 14 days of the date of the agreement.

Unfair Terms

Article 15 contains a “blacklist of terms which should not appear in any credit agreement. Variations in any contractual costs, indemnities or charges, other than the borrowing rate are effectively outlawed which will prevent creditors from raising annual fees. Any attempt to bind a consumer into a series of credit agreements e.g. refinancing the balloon payment on a hire purchase agreement, is included in the list of unfair terms.

Early Repayment

Article 16 reiterates the current UK position insofar as it confirms that the consumer is entitled to terminate a credit agreement and repay the amount owing. The real issue is the provision that any indemnity claimed by the creditor for early repayment must be fair, objective and calculated on the basis of actuarial principles. In addition, in some circumstances, no indemnity may be claimed, for example where the credit agreement has a truly variable interest rate.

The directive ignores the fact that the lender will have incurred set-up costs involved in any credit agreement particularly where an agreement is dealer led.

The DTI recently published its consultation paper on early settlements. While the DTI is keen to move away from the current UK benchmark of the Rule of 78, one of the suggestions is that the Rule of 78 be retained for use in limited circumstances and another is that the lender is compensated for the costs of set up etc. by way of a fixed fee. Clearly, these will not be available as options if Article 16 is adopted in its current version.

While the draft directive deals with early repayment of the credit by the consumer, it fails to address the position when a customer terminates the agreement early. It would therefore appear that if maximum harmonisation principles are applied, consumers will no longer have the right to terminate their agreements early and the “halves rule under the current UK legislation will therefore need to be abandoned.

Lender’s liability for goods and services

Under Article 19.2, lenders will be liable for goods and services where loans are linked to purchases e.g. car loans and where store cards are used to make purchases. Liability in respect of goods and services purchased with non-store credit cards will remain outside the scope of the directive. This would change the UK position since the existing national legislation offers a better level of protection to consumers and would require a change in the current connected lender protection to narrow consumer’s rights in line with the draft directive. Given the difficulties credit card lenders have in relation to goods purchased from outside the UK by credit card, this could be an area where the new directive could work firmly in favour of the card issuers.

Open-end Credit Agreements

Article 22 gives either party the right to terminate open-ended credit agreements on 3 months’ notice. This will be a change for the UK where the requirement is that in most instances a creditor must only give reasonable notice unless there are “valid reasons for termination without notice (in which case a creditor must have notified the customer immediately). In addition to the legislation, this change will need to be reflected in the Banking Code which requires a bank to give 30 days notice before termination unless there are “exceptional circumstances.

Protection of Personal Guarantors

Guarantors are given increased rights under Article 23. When guaranteeing open-ended agreements their liability is limited, in the first instance, to a 3-year period, which may only be extended by specific agreement of the guarantor, when that initial term expires. In addition, lenders will only be able to take action against guarantors if the consumer has failed to comply with a default notice within 3 months. The guarantor also has a right to the same information as the consumer.

Registration

Article 28 states that lenders and credit intermediaries are to be registered and Article 29 sets out the ground rules for the operation of intermediaries. Intermediaries will not require registration if covered by the registration of another registered intermediary or lender but must make it clear at their business premises that the relevant lender or registered intermediary has assumed such responsibility. This is more akin to the FSA “appointed representative regime than the current UK consumer credit regime.

Retrospective Effect

While Article 34.1 proposes that the draft directive does not intend to have retrospective effect for the most part, some changes, particularly as they pertain to open-ended credit agreements and guarantors will applied to agreement entered into before implementation of the directive. "Under Article 32.4 all open-ended agreements and surety agreements which are in effect on the date of UK implementation of the directive will have to be replaced by new agreements within a set period, two years being the current proposed". This provision will particularly affect the credit card industry.

Conclusion

The draft directive is a very different proposition from the existing directive, seeking, as it does to secure maximum harmonisation of the rules applicable to consumer credit throughout Europe. While many of the requirements of the draft directive are already part of the UK consumer credit legislation, there are new provisions which will have a substantial impact on the way the consumer credit industry operates

This is only the initial draft of the directive and therefore much can change during the EU decision making process but clearly, the industry should be aware of the impending change to the legislation which is designed to reflect the realities of the modern consumer credit industry.

To access the draft directive please click http://www.europa.eu.int/eur-lex/en/com/pdf/2002/com2002_0443en01.pdf

For further information please contact Jean Price at [email protected] or on +44(0)20 7367 3353, or contact Mayoor Patel at [email protected] or on +44(0)20 7367 2984.

Date:27-Sep-2002