Motor finance: lessons in redress from HCSTC sector

In January 2024, the Financial Conduct Authority (FCA) launched a review of historical motor finance discretionary commission arrangements across several firms in the sector to establish whether there has been ‘widespread misconduct’. This follows a steep rise in consumer complaints to the Financial Ombudsman Service (FOS) about motor finance, which were up 144% year on year for Q2 2023/24. The FCA aims to communicate a decision on next steps by the end of September 2024.

Complaints relate to discretionary commission arrangements (DCAs) – banned by the FCA in January 2021 – where brokers were incentivised to arrange finance at higher interest rates than the market standard in return for greater levels of commission, to the detriment of consumers. However, following recent FOS decisions (see decision DRN-4188284 and decision DRN-4326581), the FCA believes that consumers may have a valid claim for compensation about loans made before the ban was in place as many consumers were never informed how the commission model worked, which firms were required to do. (Read more on the FCA's intervention.)

It's been estimated that loans sold with DCAs constituted three-quarters of motor finance lending between 2007 and 2020, and therefore the FCA expect a significant escalation of consumer compensation claims. Should ‘widespread misconduct’ be established by the FCA, the regulator could instigate an industry-wide consumer redress scheme under section 404 of the Financial Services and Markets Act. While there's much speculation, analysts have estimated the cost to the motor finance industry of compensating consumers via redress payments could be anywhere between £6 billion and £16 billion, plus any fines which may be issued by the regulator.

Regardless of the outcome of the FCA's review, motor finance firms will likely receive increased complaints due to the media attention. The FCA has introduced a pause on the statutory response timeline (until 25 September 2024), but it would be prudent for firms to consider the likely future impact of increased complaints to their business now and start preparing. 

Comparison to the high-cost short-term credit sector

Motor finance firms can draw useful comparisons with the high-cost short-term credit (HCSTC) sector. The HCSTC sector experienced similar challenges around increased levels of historical complaints when the FCA conducted a systemic review to call out unaffordable lending practices. As a result of a steep rise in redress complaints, intensified by the involvement of claims management companies, several firms exited the market or undertook a formal restructuring procedure to deal with redress liabilities. 

We've acted as administrators for a number of these consumer credit firms – including Wonga, CashEuroNet (trading as QuickQuid, Pounds to Pocket and On Stride), MMP Financial (Trading as My Money and Swift Sterling), BrightHouse and S.D.Taylor (trading as Loans at Home). We've also advised on restructuring options, including schemes of arrangement, supporting with the development of large-scale remediation exercises, as well as contingency planning and administration appointments to others in the consumer credit market. Consequently, we have some pertinent observations for the motor finance sector right now.

Focus on financial and operational resilience

For firms in the motor finance sector, focusing on financial and operational resilience is key. The FCA expects that if, or when, firms face a disruptive event, and management can't evidence appropriate recovery or contingency planning to rectify this in a timely way, then the firm as well as senior managers may be held accountable.  

We recommend motor finance lenders conduct a detailed scenario analysis, with cash flow and liquidity modelling to enable management to understand what the business can withstand, both financially and operationally. The process of determining impact tolerances – and then scenario testing to understand if the firm can remain within these tolerances – provides greater visibility of areas of potential stress or vulnerability.

Forecasting likely financial performance in a range of severe but plausible scenarios is also key to assessing a firm’s adequate capital and liquidity resources. It also provides greater clarity on triggers that may lead to underperformance, such as a sudden increase in compensation levels or operational costs related to assessing redress complaints. This is especially important right now.

Revisit your wind-down plan

Given the overlap in data sets and modelling requirements, an increased focus on operational and financial resilience also benefits a firm’s wind-down planning.

Motor finance firms should re-assess their wind-down plans to consider how they may be affected by historical DCAs, including how a remediation exercise and associated liabilities may impact the financial performance of the business.

A robust and deliverable wind-down plan can act as a tool to build stakeholder confidence at a time of uncertainty and ensure that all risks have been appropriately considered. It can also assist management and advisers in developing contingency plans in a more efficient and cost-effective manner.

Practical advice when considering a remediation exercise

In the event your business needs to undertake a remediation exercise, consider these key elements below. This is by no means exhaustive, but gives some indication as to how complex and expansive a remediation exercise can be:

Governance and oversight

• Have you considered a governance framework to aid decision making and co-ordinate a successful remediation exercise?
• What will your MI reporting suite look like and how timely will it be?
• Has a detailed project workplan been developed, identifying tasks, key milestones, roles and responsibilities?
• What elements of the process are expected to be outsourced to a third party and what arrangements are in place to ensure appropriate oversight?

Population identification

• Have you taken suitable steps to identify the population impacted and its various cohorts? 
• Have you undertaken any historical debt sales which may have included impacted consumers? Are there any obligations in the sale and purchase agreement, such as clawback provisions, that need to be considered?
• Are you aware of any gaps in your data (eg, anonymised data), dependency on legacy systems or need to access cold data which may impact identifying the population or review process?

Review methodology

• Does your review methodology cover all scenarios and relevant products?
• Have you identified internal data points, developed review templates and a robust communication plan, including customer data gathering forms and scripts for customer service representatives?
• How will you deal with appeals, contentious cases or anomalies?

Quality assurance

• What quality assurance has been undertaken to verify steps taken to identify the population, assess a complaint and calculate redress to ensure customers are receiving the right outcome?
• Will you be undertaking a pilot phase? Over what time period? What is the sample size? What metrics will be used to measure success?

Funding, resourcing and training

• Reflecting on the projected population, complaint volumes and uphold rate (including appeals), have you performed detailed scenario analysis to identify the financial impact, taking into consideration the operational costs, redress compensation and loan adjustments, as well as collections across your existing portfolio?
• Have you established how the remediation exercise will be funded while ensuring the business has sufficient liquidity to continue as a going concern?
• Have you considered alternative restructuring options if funding the cost of remediation at par is problematic?
• Have you identified headcount requirements across the functions and prepared a resourcing plan?
• Who will train the review team and customer service representatives? What will the training consist of?

Communication and complaints handling

• Have you developed an extensive suite of customer communications across various mediums (SMS, email, letter, website, call scripts), including FAQs and redress assessment letters communicating the outcome of a customer's complaint?

Receiving adequate support throughout a remediation exercise can help minimise disruption across the business and deliver a successful, cost-effective campaign. 

Restructuring procedures to address financial difficulties

A number of firms in the consumer credit sector have used formal restructuring procedures, such as a scheme of arrangement to deal with financial difficulties driven by an increase in redress liabilities. These court-sanctioned restructuring tools can allow a firm to crystallise historical redress liabilities and reach a compromise or arrangement with their creditors which may provide a better outcome than any likely alternative.

The outcomes of various consumer credit firms which have had formal restructuring procedures sanctioned by the court have set precedents for the sector. The judgements in each case are informative for how any motor finance firm should approach the use of schemes in the future, including any challenges that may be raised.

Although a costly process, a scheme of arrangement or restructuring plan can provide finality for firms in respect of their historical redress liabilities and allow a firm to continue to trade which can, compared to an insolvency, improve consumer outcomes. Once there is certainty around dealing with such liabilities, future debt or equity raises become much more attractive to potential investors.

Ultimately, if a business is unable to raise sufficient funds or reach a compromise to deal with any historical redress liabilities, contingency planning should be undertaken and a formal insolvency process may be appropriate. This is something that should be considered early to ensure the best possible outcome for all stakeholders, including redress creditors. 

Camilla Fawkner