Over the last few weeks, I’ve been helping asset finance brokers to finalise their implementation of the Financial Conduct Authority’s new Consumer Duty rules. One part of this is setting out how they deliver fair value, which includes matching the customer’s profile to the most suitable lenders to achieve the best possible rate.
A broker’s ability to deliver fair value clearly rests on there being a choice of lenders with different risk appetites, and therefore different interest rates, in the market.
In an online meeting on Friday morning, we ran through the broker's lending panel to find that only a handful were still offering regulated agreements, broadly speaking being finance agreements up to £25,000 with unincorporated businesses and small partnerships.
Midway through our conversation, the broker received an email from one of the remaining firms offering regulated agreements. It said that firm would stop offering regulated loans on 21 July. That’s ten days before the FCA’s Consumer Duty rules take effect, although the lender made no reference to the new regulations.
"We believe that by focusing on writing non-regulated business, we can streamline our offering and deliver a better level of service to our Introducers" the email from the lender said, noting that it would still offer exempt agreements (loans over £25,000 for business purposes).
This shift away from regulated lending has been taking place over time and lenders are taking different approaches:
At one extreme, lenders decide not to lend to any unincorporated businesses (that’s 3.2 million SMEs, 56% of all UK businesses, although the majority of these are microbusinesses that are less likely to have a significant need for asset finance)
Other lenders, like the one making the announcement on Friday, restrict lending to unincorporated businesses to exempt agreements
One or two have decided to offer only regulated hire agreements, not credit
The reason many lenders are reluctant to continue offering regulated business finance loans is that it is expensive and risky to prove compliance with all the FCA handbook rules for credit agreements (hire is also regulated but the rules are more straightforward).
The extra risk isn’t because these firms don’t meet the regulatory standards. They almost certainly do, although the FCA's guidance on how to apply consumer credit rules written for 'real' consumers to business transactions is scant. For example, what precisely does affordability mean in practice for a business?
The risk is more around it being difficult to prove that every step of the customer journey met the requirements. Brokers visit customer’s offices, factories or farms, and the discussion is not filmed or otherwise recorded. While the FCA does not require conversations to be recorded, sadly this is becoming the only robust way of defending against malicious claims. Such claims are rare, and unlikely to be upheld, but claims management firms are always searching for their next targets.
If the very regulation intended to secure fair value has the effect - albeit indirect and unintended - of driving lenders out of the market, as appears to be the case, something clearly isn’t working. But before we decry the small business finance regulatory system, is there a practical solution?
Across all regulated sectors firms increasingly rely on technology to ensure compliance, sometimes termed ‘RegTech’. That can mean that personal service tends to fall by the wayside. But regulated finance deals for under £25,000 are hardly the bread and butter of most asset finance brokers or lenders. They are offered more as a service to enhance existing business relationships and are unlikely to provide a decent return on the time required to set them up.
The new technology enables online finance applications by customers for many other financial services including mortgages and insurance. The best in class are slick and intelligent, I expect employing some AI. Finance professionals will recognise they are designed to meet regulatory requirements, but for the customer they are surprisingly user-friendly (try starting an home insurance application on Comparethemarket, or a mortgage application on Habito).
For asset finance, some applications might be worked through by a customer with the help of a broker. But introducing this sort of technology is more likely to shift the finance application online, alongside the asset being ordered. This would fit the trend towards embedded finance, particularly the frenzy among investors in the fintech world to find opportunities in B2B Buy Now Pay Later (noting many fintech gurus don't seem to spot that B2B BNPL is in essence a tech-driven version of the existing asset finance market).
Where does this leave brokers? It means for the smallest deals their role may be replaced by technology. But few will be upset about that. More positively, it should in future allows them to spend more time signing up and supporting equipment suppliers (earning fees or commission for this work) who can then offer online integrated finance options.
If all of this sounds a bit far-fetched for some customers - at the risk of over-generalising, the agricultural sector does come to mind - it’s not necessarily a one-size fits all solution. There will still be a need for personal face-to-face contact with customers, but on a far more targeted and specialised basis than today.
So it's right to be concerned about the distinct trend towards less choice in the market, and I know many brokers are very worried on behalf of their small business customers. But could FCA consumer credit regulation, including Consumer Duty, eventually work out well for regulated business customers, brokers, and lenders alike?
With the right technology - including elements of RegTech, FinTech and AI - and perhaps some clearer guidance from the FCA to clarify how consumer credit rules should be applied to small businesses, it is all beginning to look possible. Instead of being the Archilles heel of the asset finance market, small-ticket finance could become a focus for innovation and growth in the industry.