There may be no connection between the fiercely-resisted Block Exemption that comes into force this year and the EC's new consumer credit proposals, but the auto industry could be getting paranoid about the European Commission. Especially, perhaps, after its dawn raids on the offices of Peugeot, whose chairman happens to be the ACEA's current president. Toby Procter looks at the threat posed by the EC's proposal for a new directive to harmonise consumer credit laws.

The EC's proposal for a new directive on consumer credit provision would update a directive of 1998 which left different member states with markedly different consumer finance laws, and markets. If it survives the scrutiny of the EU Parliament and Council of Ministers pretty much as drafted, it will seek to create something more like a single European consumer credit market. But it will impose new costs on lenders and retailers, and car makers and dealers will hate it.

Yet, rather like the early warnings of the EC's intentions for the new Block Exemption Regulation, the consumer credit proposal has been greeted with silence from the uto industry, though in Britain at least, the Finance and Leasing Association has published a critical counter-blast.

Key provisions
The EC thinks better regulation of credit provision will provide major benefits for EU citizens. 50-65% of them currently use consumer credit for vehicle purchase, reckons the EC. Credit constitutes 7% of total EU GDP, and credit volume is growing across the EU at 7% p.a. But few EU citizens are happy with their creditors, apparently. The EC claims, "No less than 70% of consumers are calling for greater European-level harmonisation of the regulations that protect consumers." Well, maybe so; but clearly, in markets where credit is an increasingly necessary vehicle for supporting economic growth - and the risk of default looms larger as economies falter or increasingly debt-laden consumption fails to revive them - credit is ripe for political scrutiny; one provision of the new directive, for example, would establish national databases of defaulting borrowers, specifically to prevent over-lending.

In outline below are the key provisions the EC wants to see enshrined in member states' national legislation. First, to clarify the scope of the directive, it does not apply to mortgages on real estate, nor to leasing. But it does apply to credit agreements concerning the provision of services as well as goods (taking in car service contracts, for example), and its provisions apply to intermediaries as well as to lenders themselves.

  • All member states would need to maintain national databases of defaulting debtors, which would exclude any data irrelevant to credit rating. Creditors would be obliged to refer to these before granting credit. (This would appear to sound a death-knell for the sub-prime finance houses that treat the car primarily as a security for long-term, high-interest lending to high-risk borrowers.)
  • Member states would also be able to maintain central databases of all borrowers, defaulting or otherwise, if they wished to do so.
  • Intermediaries would be barred from collecting fees from both consumer and creditor.
  • For transparency, the cost of credit insurance, even when optional, would have to be clearly identified as a component of a standard definition of clearly-stated APR calculations. Worse, from the salesperson's view, every APR comparison would need to disclose commission payable on the deal. (That's already disclosed in investment deals regulated in Britain by the Financial Services Authority, but seldom if ever are the dealer profits from finance or warranty discussed between car salespeople and their customers.)
  • "Balloon payments" are in the firing line: the EC describes their use (common in car Personal Contract Purchase contracts) as "… a questionable practice, since the final financial burden is likely to prevent consumers from changing the make of car". So there goes a loyalty scheme specifically designed by the car industry to lower the entry price of new car purchase and raise the exit price for deserting the brand.
  • Consumers' rights to early repayment would be enhanced. A two-week 'cooling off' period is introduced as a compulsory element of credit provision - which, to say the least, would make something of a dent in car dealers' ability to close the sale before the customer's ardour cools.
  • Where creditors offer interest-only loans, they would become responsible for making up themselves any shortfall of capital for end-of-term capital repayment due to the non-performance of funds invested.
  • The directive would require both creditors and their intermediaries to be registered with the relevant national regulatory body. In the UK, for example, dealer sales staff handling finance applications would need their own consumer credit licences, no longer being covered by that of the dealership.
  • Such dealer staff would also have a duty to provide advice on credit before signing up customers. This would put them in the same position as pension/life assurance salespeople, and would, one can surmise, require revision of consumer credit licensing criteria in the UK at least, beyond the ambitions of current Government proposals for a tougher regime. To what is currently required to obtain a consumer credit licence in Britain - a record clear of past convictions, and evidence of some very basic understanding of money - could be added requirements to understand customer disclosures of personal financial information; to declare any personal interest; and to explain the relative advantages of different finance options available from different lenders. That would be a tall order for many dealers' sales departments, bring both a serious training requirement and some loss of productivity.
  • Debtors would enjoy the ability to enforce their rights against creditors and intermediaries alike, and such rights would be more extensive than consumers' rights of redress against the suppliers of goods and services under the Sales of Goods Acts recently harmonised following an earlier EC directive.
  • Excluded from these provisions are consumer credit contracts made at below market-rate interest - including therefore the kind of 0% or below-market rate deals that have propped up the US car market since 9/11, and which have also turned captive finance operations into core discount marketing instruments as much as vital profit centres.

Vital dealer profit at risk
Dealers derive something over 10% of their vehicle sales department gross profit from finance and insurance commission. US dealers depend on F&I, inclusive of service contracts (which would also fall under the new proposal in the EU) for over 25% of theirs. F&I income matters, when the gross margin on new vehicle sales is well under 10% overall.

In Britain, the financial services sector legendarily got into serious trouble in the 1990s through its commissioned agents' non-compliance with regulations. In auto finance, a normally high turnover of dealer sales staff is not going to make it any easier for dealers than for financial services firms to swallow the cost of training, compliance monitoring and certification for their staff. The British Government, however, may welcome the new directive, since car retailing and financial services account for the lion's share of consumer complaints.

Irrespective of the EC's new proposals, UK dealers already face increased certification costs, since following an abortive attempt at self-regulation by the insurance industry, the Financial Services Authority (FSA) will impose statutory regulation on the sale of all general insurance products from January 2005. Authorisation will be needed both for businesses and their staff. Failure to comply would result in dealerships losing the right to sell any general insurance products, including warranties, GAP, payment protection and breakdown cover, for example.

Hitting manufacturer captives where it hurts
Captive financial services organisations, even banks, have become must-have subsidiaries for any car maker. Ford, it has often been remarked, might never have made it to 2003 without Ford Credit. Selling money may be more profitable than selling cars, and captive finance houses have extended car makers' influence beyond automotive into the wider banking market. They've also proved vital and flexible tools for shifting excess metal with below-market rate interest rates, thereby relegating independent finance competitors to used car finance only.

If they sold solely below-market rate products, captive finance houses would escape some of the rigours of the proposed new directive - but would have to comply in order to use their facilities for profitable lending.

The UK Finance & Leasing Association says of the proposed directive, "Our view of the present draft is that it is unlikely to facilitate a Single Market in credit for consumers; and that the market it appears to be promoting would set back market development in the UK by at least a decade, against the interests of both consumers and lenders."

It goes on to say, "… a 14 day right of cancellation for credit agreements signed in store will skew the market in favour of credit/store cards and other forms of revolving credit." The figures show that over the last decade credit cards and unsecured personal loans have already made significant inroads into markets formerly dominated by conditional purchase secured on the goods sold.

The FLA statement indicates the scale of the perceived risk to the status quo in auto finance. But if the proposed directive did actually "set back market development by at least a decade", it could actually be transporting automotive finance back to a more comfortable past than it will face in future under the proposed new regime.

Suggested further reading - The global report on automotive retailing - click here.