What practical issues are holding back green consumer finance in the UK?

Green finance faces a range of challenges arising from the existing consumer credit regulatory framework in the UK.

Personal nature of loans

Agreements for credit are between lender and borrower, creating a tension when financing green home improvements, where the property benefits directly. The homeowner sees indirect benefit in the form of reduced energy bills and potentially increased value, but this may not correlate to the amount borrowed or the monthly repayments over the short to medium term.

Borrowers may be concerned about moving house before receiving the full benefit of improvements or continuing to pay off the cost after moving. Homeowners may, therefore, be less likely to undertake "green" home improvements, particularly if they do not expect to stay in a property long term.

The industry is considering models that could "attach" the financing to the property, as more homeowners might improve their homes if the cost becomes a levy attached to the property, rather than a direct cost to the borrower.

Consumer Credit Act 1974

The Consumer Credit Act 1974 (CCA) provides robust protections for borrowers, which can make lending for newer environmentally-friendly products risky for lenders under certain types of credit agreements, in particular a type of agreement categorised as a 'borrower-lender-supplier' (BLS) agreement.

Section 56

Under section 56 CCA, a lender is effectively responsible for pre-contractual representations made by a credit broker or supplier to a customer about the financing or goods, because the credit broker or supplier is deemed to be acting as the lender's agent, as well as in their own capacity.

This poses a risk for lenders, since the customer is entitled to cancel the agreement, treat it as repudiated (that is, that the lender will not perform the contract) and recover damages from the lender in respect of contractual statements or misrepresentations made by the broker or supplier.

In the context of new-to-market green technology, representations could relate, for example, to quality, performance or fitness for a particular purpose. However, by its nature, the performance and longevity of new technology may not be known.

Practically, lenders may not be able to put in place sufficient controls or oversight of the sales process to ensure all statements made about the technology are accurate, particularly if conversations happen via telephone or digital channels. Moreover, the lender may not have sufficient knowledge of the technology to oversee this.

Section 75

From a borrower's perspective, section 75 is an even more powerful protection than section 56.

Section 75 applies where there is a certain type of BLS agreement for credit (not hire). The analysis is not always straightforward, but common examples of in-scope agreements include arrangements to finance vehicles provided by a third-party supplier, and credit cards.

If a credit agreement is a qualifying BLS agreement and the goods being financed have a cash price of between £100 and £30,000, the lender will automatically be jointly and severally liable with the supplier for any claim the borrower has against the supplier for breach of contract or misrepresentation.

Lender liability is not limited to the amount of credit and continues after the credit agreement has ended. In an extreme example, a lender could end up being liable for faulty installation of goods in breach of contract by a supplier, which leads to a fire destroying the customer's home. This protection, therefore, acts like an "insurance policy" for consumers where goods do not perform as expected or are not installed properly.

While the lender has a statutory indemnity from the supplier for any loss it suffers from a section 75 claim, it cannot force the borrower to claim against the supplier. Most borrowers prefer to claim against the party who can resolve the issue fastest and has the deepest pockets, typically the lender.

Section 140A

Under section 140A, a customer can apply to court for a declaration that their relationship with the lender is unfair. If a court determines that an unfair relationship has arisen in relation to a credit agreement, it can make an order under section 140B, including requiring the lender to repay any sum paid by the borrower, reducing the amount payable, and/or amending the agreement.

Provided lenders act in good faith and comply with legal and regulatory obligations, successful claims are uncommon.

However, there is always a risk that a relationship is deemed unfair due to something said or done by a credit broker or supplier on behalf of the lender. Moreover, these claims can be burdensome for lenders in terms of time and cost, not least because the burden of proof is on the lender to rebut the claim.

Voluntary termination

Voluntary termination rights apply in the context of hire purchase (and conditional sale) agreements, a sub-species of credit.

Customers who buy goods on hire purchase can terminate the agreement voluntarily at any time before the final payment is due, provided they pay any cost of installing the goods plus half the total amount payable under the agreement and return the goods to the lender. This means the customer can walk away from the agreement and hand the goods back to the lender, leaving them with an asset to sell.

As ancillaries such as batteries and charging points are necessary for an electric vehicle (EV), it makes sense to offer financing for the EV and ancillaries together, so customers pay a single monthly price. However, voluntary termination rights create a barrier to this. Given the differing values and "shelf lives" of EVs and ancillaries, it is difficult for finance providers to bundle the finance without exposing themselves to financial risk in terms of voluntary termination.

While offering green finance via regulated hire agreements (which do not carry voluntary termination rights) may be an alternative, there are still complexities. For example, the form and content requirements are strict and out-of-date, complicating online sign-up. Problems can arise where customers wish to upgrade kit on hire due to modifying agreement requirements potentially being triggered, which creates enforceability risk for lenders.

These issues make catering for innovative, flexible green finance products challenging, particularly in the EV market, until CCA reform takes effect.

Secured lending

In addition to unsecured finance, secured lending products described as "green mortgages" are available. These typically offer a discounted borrowing rate to customers who already have an energy-efficient home, so do not solve the issue of financing green home improvements in the first place.

It is also possible to finance green products using a regular mortgage over a borrower's home, whether by obtaining a second charge mortgage or increasing an existing mortgage. However, this option may not be available and/or attractive to borrowers.

For savvy borrowers, getting a new mortgage may be less attractive by its nature as a secured loan; moreover, a mortgage does not attract the same customer protections as an unsecured loan.

While mortgage-free homeowners may be asset rich, they may not want additional secured borrowing particularly in retirement, and might in any event fail creditworthiness and affordability assessments.

Osborne Clarke comment

The challenges faced by the emerging green finance market, which can create tricky issues for lenders to navigate, often arise from the way in which existing consumer credit rules apply to these new products.

While lenders have options in terms of structuring their products which may help mitigate some of these issues, it is likely that more systemic solutions will be needed to allow this sector to reach its full potential. As we consider in the next and final instalment of this series, some of these solutions may flow from the long-term CCA reform project, and some may be more driven by the industry itself.

This Insight is the second in a three-part series looking at the UK green finance market from a financial services perspective. The first part looked at the definition of green finance, why it's needed, and what are the challenges. In the final instalment, we explore potential solutions and where the government might be going next to encourage green finance.

If you would like to discuss any of the issues raised in this series, please contact one of our experts below.