What do the new breathing space regulations mean for financial institutions?

As of April, UK households held around £230bn of debt, equating to an average of £8,000 per household – according to the Institute of Fiscal Studies, and that was before the full economic effects of Covid-19 had been applied.  New regulation in the form of the Debt Respite Scheme had been drafted to address this but it came under fire from financial services firms for its lack of clarity. After a consultation period, the latest draft of the legislation, otherwise known as breathing space regulations, was published in July, and if it is passed by Parliament it will come into force in May 2021.

The regulations are designed to give consumers some time to find a suitable solution to their debt problems, something that has probably never been more relevant as the economic effects of Covid-19 take hold.

So, what does the new draft regulation include and what will financial institutions need to consider?

The Debt Respite Scheme aims to offer consumers a moratorium or some breathing space so that they have a respite period where they cannot be pursued by creditors as long as they are seeking professional debt advice or mental health crisis treatment. The moratorium can last 60 days, as long as the consumer has sought professional debt advice whether that’s in person, over the phone or by email, or in the case of mental health grounds, the paused period could last for as long as the crisis treatment. During the breathing space period, creditors must pause all fees, interest charges and enforcement action.

Who will the new regulations affect?

The Draft Respite Scheme can be used for all unsecured debt so any providers of credit, unsecured creditors, debt recovery agents and LPA receivers need to be aware of the regulations. It’s important to note that while secured debts are excluded from the new regulations, capitalised arrears are not. So, a consumer who hits problems with mortgage payments could apply the breathing space rules to their arrears but not ongoing instalments, which they would be obliged to continue making throughout the moratorium.

How are the breathing space regulations initiated?

As mentioned above, consumers must engage with a registered debt advisor or debt advice agency, and if that agent is satisfied, they meet the eligibility criteria, and the debts are qualifying they must initiate the moratorium.  The debt advice agency must provide advice, free of charge, and then evaluate whether a moratorium is the best course of action – it may not be if the debts could be discharged in full, for example, or if another solution such as an IVA or a voluntary arrangement would be more beneficial.

If all these conditions are satisfied and the debt advisor wants to initiate the moratorium, they must notify the Secretary of State and have an entry recorded on the register, which will generate a notification to the relevant creditors. Before day 35 of the moratorium, the adviser will need to review the moratorium and decide whether it should continue or be cancelled.

A mental health crisis moratorium is slightly different in that the individual must be seeking mental health crisis treatment, and a signed statement must be provided by an approved mental health professional. Unlike a debt-based moratorium, if the action is initiated because of mental health crisis, the breathing space period can be extended until 30 days after treatment is finished.

What rules do financial institutions need to observe?

During the breathing space period, it’s important that no enforcement action is taken, and financial institutions need to make sure that any agents acting on their behalf are aware of this. This means not taking any debt collection action, starting legal proceedings or taking any enforcement steps. It also means not applying interest, fees, charges or penalties during the moratorium period.

Industry response and potential issues

This final draft of the Debt Respite Scheme is an amendment of a previous version, which caused general outcry amongst the financial industry. Financial services firms pointed out that the previous version lacked clarity especially with reference to which debts were included and notifications about when consumers entered and exited the scheme. While the final draft has addressed some of these concerns, there are still some areas of ambiguity. Some of these seem to apply specifically to mortgages, for example, there is still a lack of clarity about which categories of borrowers are eligible particularly in terms of buy-to-let mortgages. And although the treatment of capitalised mortgage arrears has been clarified somewhat since the first regulatory draft, some lenders are still questioning whether the term means the same as it does for the purposes of FCA regulation.

There are also some concerns about whether debt advisors will be able to meet demand or adhere to the strict timescales of the regulation especially as they are not allowed to charge a fee for the service. As the legislation stands, there is also no provision for human error – what happens if the Secretary of State is not informed of a moratorium, and creditors do not receive a notification for example? And what provision will be made for those suffering from long-term mental health issues as clearly a moratorium is not a permanent solution.

Despite these issues though, the consensus is that the latest draft of the regulation is much improved on the last one, and it looks likely that it will be approved by Parliament and come into force by 4 May 2021. Given that over nine million people have seen a wage reduction, thanks to furlough, it could be a timely move which benefits both lenders and consumers by reducing defaults so long as it is implemented well.