Loan Owners – To Regulate or Not To Regulate?

Domestically, moves are afoot to regulate loan owners in order to address perceived consumer protection weaknesses in the existing credit servicing regime. The proposed measures could significantly affect the Irish market for non-performing loans (“NPLs”).  The measures do not appear to be fully compatible with a recent European Commission proposal, which is designed to facilitate sales of NPLs by European banks.

Domestic approach – new Bill to regulate loan owners

The Consumer Protection (Regulation of Credit Servicing Firms)(Amendment) Bill 2018 (“Bill”) was initiated in February 2018 and was the subject of an ECB Opinion, delivered on 5 July 2018.  The Select Committee on Finance, Public Expenditure and Reform, and Taoiseach published an amended Bill on 12 July 2018.

The Bill follows on from the earlier Consumer Protection (Regulation of Credit Servicing Firms) Act 2015 (the “2015 Act”), which sought to ensure that borrowers retained the benefit of the various codes of conduct which apply to loans originated by a regulated financial services provider, following the sale of their loan to a non-regulated lender. This was achieved by requiring non-regulated loan owners to appoint a regulated credit servicer in respect of relevant loans.

Following implementation of the 2015 Act, most NPL sales in Ireland have been implemented by selling the relevant loans to an unregulated special purpose company which is associated with a private equity sponsor and which appoints a regulated credit servicer.  The appointment of a credit servicer ensures that the loans must be serviced in accordance with the Central Bank’s codes of conduct.  However, the 2015 Act permits the overall strategy for the management and administration of a loan portfolio to be made by a non-regulated entity, which can maintain control over key decisions relating to such portfolios. 

The new Bill was prompted by concerns that the 2015 Act does not sufficiently protect consumers following a loan sale and proposes to regulate the owners of loans directly, rather than those servicing the relevant loans.

ECB Opinion on the new Bill

On 8 June 2018, the Chairman of the Select Committee on Finance, Public Expenditure and Reform, and Taoiseach requested the ECB to deliver an Opinion on the original Bill, having regard to the European dimension to NPL resolution strategies. The ECB delivered its Opinion on 5 July 2018.

In its Opinion, the ECB underlined the importance of well-functioning secondary markets and voiced a number of concerns. Among other things, the ECB warned that the Bill must “carefully balance the benefits of creating well-functioning markets against the impetus to protect debtors” and pointed out that the text of the Bill raises issues of legal certainty and could give rise to unintended consequences.

Committee stage amendments to the new Bill

The Select Committee published an amended version of the Bill on 12 July 2018.

Like the original Bill, the amended version provides for the regulation of loan owners. It achieves this through amending the definition of a “credit servicing firm” under the 2015 Act to include:

  • holding the legal title to credit granted under the credit agreement; and
  • managing or administering the credit agreement including by:
    • determining the overall strategy for the management and administration of a portfolio of credit agreements
    • maintaining control over key decisions relating to such portfolios.

Moreover, the amended Bill excludes securitisation special purpose entities from the requirement to be regulated, subject to the fulfilment of certain conditions.  The securitisation carve-out appears to be designed to facilitate traditional bank securitisations, such as Residential Mortgage-Backed Securities (RMBS).

The Select Committee did not adopt the Central Bank's proposal that loan purchasers be required to become authorised as retail credit firms, mainly because of the Commission's proposed Directive establishing a regulatory framework for credit servicers, discussed below. However, it did indicate that further amendments to the Bill are likely to be made at report stage.

European initiative - moves to encourage loan sales

In March 2018, the Commission published a proposed Directive on credit servicers, credit purchasers and the recovery of collateral (see our previous briefing here). The main aim of the Commission’s proposal is to help reduce the stocks of NPLs, including by encouraging the development of an EU wide framework for both purchasers and servicers of NPLs issued by credit institutions.

Among other things, the proposal provides for the authorisation of “credit servicers”.  It also imposes certain obligations on credit purchasers but specifically states that credit purchasers must not be subject to any additional requirements for the purchase of credit agreements other than those set down in the proposal.

In context: Impact on Irish NPL sales

Both the original Bill and the revised Bill appear to sit uncomfortably with the proposed Directive. In particular, it is difficult to reconcile the requirement in the proposed Directive not to impose additional requirements on credit purchasers, with the requirement for the owner of a loan to be regulated which is set out in the Bill.

If the Bill is implemented, it would require existing unregulated purchasers to apply for authorisation.  This may not be an attractive option for some purchasers and could result in relevant purchasers seeking to sell portfolios to entities which can house the portfolios in a regulated structure.  Requiring loan purchasers to hold loans in a directly regulated entity may mean that traditional SPV debt funding structures will need to be reviewed.

It is possible that the Bill would also increase compliance and administrative costs for potential purchasers of NPLs and may deter purchasers who have not already invested in regulated infrastructure in Ireland from competing for the purchase of Irish NPLs.  Increased compliance and administrative costs and a narrower cohort of potential purchasers may result in lower prices being achieved by Irish banks as sellers of NPLs.

An article included in the Central Bank’s Quarterly Bulletin from April 2018 notes that banks may sell distressed loans as one of the several options available to them to address NPLs, and that it is important to have any conduct risk associated with such sales be mitigated by having a clear consumer framework in place.  Noting that resolution strategies determined by unregulated loan owners may be different to those adopted by banks, it indicates that the Central Bank will continue to engage with existing credit servicers to ensure compliance with the Code of Conduct on Mortgage Arrears (“CCMA”) and other regulatory requirements.

While the new Bill would have the effect of making loan owners directly accountable, it is questionable whether the Bill would result in any substantive changes to the resolution strategies being pursued by loan purchasers already active in the Irish market, given that those strategies are already required to take account of the existing regulatory compliance framework applicable to the servicing of the loans under the CCMA and other codes.

More fundamentally, for the reasons set out above, the Bill could undermine one of the key objectives of the proposed Directive, namely the development of a well-functioning secondary market for certain loans by preventing such loans from being purchased by non-regulated entities.

This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.