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.
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.
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.
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.
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
Population identification
Review methodology
Quality assurance
Funding, resourcing and training
Communication and complaints handling
Receiving adequate support throughout a remediation exercise can help minimise disruption across the business and deliver a successful, cost-effective campaign.
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.
