When the Supreme Court rejected HM Treasury’s (HMT) bid to intervene in the motor finance appeal in February, many saw that as bad news for the finance industry.
It’s reported that the letter called for any remedy to avoid windfalls for consumers, and for any redress to be considered on a case-by-case basis.
A Treasury spokesperson was reported to have said:
“We want to see a fair and proportionate judgement that ensures compensation to consumers that is proportionate to the losses they have suffered, and allows the motor finance sector to continue playing its role in supporting millions of motorists to own vehicles.”
But did HMT ever expect its application to interene to be accepted? Based on how such interventions work, and the history of interventions by Government, it seems quite unlikely. Instead, perhaps HMT was thinking several steps ahead:
HMT appears to be assuming that the Supreme Court will broadly agree with the Court of Appeal, which ruled in favour of the Financial Ombudsman Service in a judicial review of three linked motor finance commission cases. While the cases are each quite complicated, and it does appear that some points were missed by the Court of Appeal, Judicial Reviews cases against regulators are extremely difficult to win. (Of course, all those in the finance industry still hope for something more helpful from the Supreme Court verdict...)
HMT appears then to be attempting to ensure that the Supreme Court's verdict makes clear the limitations of the appeal it will have considered. While many law firms have noted that the Court of Appeal judgement must be considered in the context of the particular ‘fact patterns’ of the three cases, some other commentators continue to make sweeping statements about the implications of the case.
Once the legal situation is clarified by the Supreme Court, it will fall to the FCA to either design a banket redress programme or to provide guidance to firms on how to implement their own redress arrangements. HMT's position seems to direct the FCA to the latter option, without the appearance of interfering directly with the FCA's independence.
Although the FCA operates independently of Government, it is still accountable to Parliament for meeting its statutory objectives. These include protecting consumers, protecting and enhancing the integrity of the UK financial system, and promoting effective competition. The Chancellor has essentially put the FCA on notice that a blanket redress programme could be seen as incompatible with the statutory objectives.
So what could FCA guidance for providing compensation look like?
Fair and reasonable redress, the FCA tells us, means putting the customer back in the position they would have been in had the regulatory failings not occurred, including any consequential loss.
Although the FCA cannot to impose higher requirements on firms retrospectively (FCA Handbook CONRED 1.3.15) this does not appear to be limited to the FCA handbook rules. So the FCA guidance seems likely to cover both the handbook rules and any other legal requirements at the time, as the Supreme Court judgement might confirm.
The consequential loss part of this is simple. If a customer has suffered a financial loss, there’s established rules, which can be broadly simplified to say that interest should be paid at 8% per year on the amount lost.
But what is the amount lost? That’s far more complicated and needs to be considered as a series of tests on a case-by-case basis. Each case will fall into one of three groups:
Group 1: No regulatory or legal failure
The dealer made the commission disclosure required by FCA rules at the time, i.e. existence of commission. With remarkable foresight, as it wasn't part of the FCA rules, the dealer went further and disclosed the actual amount of commission and how it was calculated (if the Supreme Court confirms this should have been done). The commission involved was fixed by the lender.
No financial loss for the consumer, so no redress due.
Group 2: Regulatory or legal failure but no financial loss
The dealer failed to make the commission disclosure required by FCA rules at the time, i.e. existence of commission to the customer and/or The dealer failed to disclose the actual amount of commission and how it was calculated (if the Supreme Court confirms this should have been done)
The rate paid by the consumer was competitive with any other options that would have been available to the customer, had they chosen not to use the dealer finance.
No financial loss to the consumer, so no redress due.
Group 3: Regulatory or legal failure with financial loss
The dealer failed to make the commission disclosure required by FCA rules at the time, i.e. existence of commission to the customer
and/or
The dealer failed to disclose the actual amount of commission and how it was calculated (if the Supreme Court confirms this should have been done)
The rate paid by the consumer was not competitive with any other options that would have been available to the customer, had they chosen not to use the dealer finance.
Redress would then be due, and there are two potential methods for calculating the amount, both equally valid in theory, but presenting different challenges for collecting evidence to support the calculations:
Cost of finance approach: The difference between the rate agreed to and a competitive alternative rate that was likely to have been available in the market. That might be either for a secured car finance loan or an unsecured loan, from a direct lender or through a broker.
Cost of finance and the linked transaction approach: The difference between the total cost of buying the car using the dealer finance, compared to the cost of buying the car without dealer finance.
How to calculate the relevant benchmarks?
Lenders will need to carefully develop their approaches to calculating redress on a case by case basis. They will need data on (at least):
The interest rate paid by the customer and any fees
The customer's credit history and status
The vehicle
Rates for loans that would have been available from other sources and any fees
If using the linked transaction approach, car prices that would have been available through dealerships not offering finance
Some of this data will clearly be specific to individual lenders and dealers, but rates from other sources could be prepared and independently verified at industry-level (I am happy to discuss this further).
Using relevant benchmark data could be key to keeping redress proportionate to any losses, as alternatives available would often have had a similar cost. Although direct lenders may not pay dealer commissions, they have other customer acquisition costs, and higher losses where loans are unsecured.
For those outside of the motor finance sector, it may be useful to consider the need for similar data. In small business finance, for example, in seems unlikely that alternatives to broker-introduced finance would have been any lower cost in most cases.
FCA redress arrangements are unlikely to mark the end of this problem. Claims management companies will still push for wider compensation for their clients, arguing that redress that resolves financial loss is insufficient. Class actions, including the one still sitting on the sidelines at the Competition Appeals Tribunal, will similarly test whether the FCA's redress requirements go far enough. A market review by the Competition and Markets Authority, looking in depth at the interaction between car sales and car finance (something that goes beyond the FCA's remit) seems the only solution to end the uncertainty for good (see my earlier articles).
For now it's time to prepare the data that's likely to be needed for case-by-case redress that avoids unnecessary windfalls to customers, and in doing so protects both the industry and future users of its services.
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