Consumer protection uncertainties highlighted

A recent European Court of Justice (ECJ) ruling on consumer rights in German loan agreements amplifies legal uncertainty regarding information that needs to be included in contracts, Fitch suggests. The implications for Fitch-rated German auto ABS have been limited so far, but the rating agency says it remains important to monitor the impact on borrower behaviour and how far this increases exposure to originator creditworthiness, as well as developments in deal documentation.

Several, sometimes conflicting ECJ and German court rulings have led to legal uncertainty on how auto loan contracts should be drawn up to comply with applicable consumer protection legislation. The ECJ last week found compulsory information to be missing from applicable German loan documentation. At the same time, limitations in arguments used by lenders to counter borrowers’ attempts to revoke contracts were found.

In practice, risks to ABS deals arising from this persistent uncertainty have been limited, with no significant impact on transaction performance or cashflows. If a borrower chooses to revoke the loan, the purchase agreement is also unwound and the vehicle must be returned.

Legal uncertainty also has implications for asset eligibility, as ABS documentation typically states that no loans with active revocation rights can be included in transactions. If revocation rights were shown unambiguously to persist over the life of a loan agreement, originators could have to repurchase entire portfolios for a large sum.

Consequently, some originators have been adapting their documentation in both new and existing transactions in anticipation of this possibility. One way is to narrow the scope of their repurchase obligations; for example, by stating that these would only apply in cases of “successful revocation.”

Angela Sharda