Motor finance – the end of the beginning

It’s hard to exaggerate the potential significance of the FCA’s decision to use its s166 powers to investigate discretionary commission arrangements in the motor finance market.

By Martin Lewis’s estimate, if (as widely expected) this work results in a remediation programme, then the top end of compensation could reach PPI scale (c.£40bn/$50.3bn). Given this, I’m focusing this month on what shape a major remediation program might take and what the implications might be for the FCA as a whole.

First though, we should give the FCA credit for its recent webinar, explaining what it’s doing and taking live questions. It was timely, and consequently there were inevitable unknowns, and a healthy reminder of what openness and transparency looks like.

I took from it that the regulator has already set up a dedicated department to manage the investigation. If so, it should help clarify internal accountability and enable what is likely to be a significant programme of work to proceed more quickly and decisively than if it was part of a larger division with other, broader priorities. Both have been problems in the past.

How we got there and other questions

As with much in regulation, it is worth reflecting on the timeline so far:

• 2014 – the FCA took on responsibility for motor finance;
• 2017 – announces an “exploratory piece of work” in its Business Plan;
• 2019 – Final findings published, showing conflicts of interest over use of commission models and high incidence of non compliance with existing rules;
• 2021 – After a moratorium due to Covid, the FCA bans discretionary commission models, with a commitment to review in 2023/24;
• 2024 – Following high numbers of complaints to FOS and two Ombudsman findings in favour of the complainants, the FCA announces a s166 review.

There are questions here. Not least, given the size of the potential problem and the three-year gap before the original “exploratory” work, should the FCA have prioritised this sooner?

It also seems likely that the scope of the regulator’s review, which the FCA is understandably trying to keep tight, will be challenged legally. At some point, Government may ask for an independent report.

For better or worse, all this will inevitably be at the back of FCA minds as this moves forward.

Interest rate hedging and PPI

Mixed lessons from the past is with how the FCA dealt with the mis-selling of interest rate hedging products (IHRP), but it is also worth looking at PPI – not least given the potential scale of compensation, and at pension mis-selling, which the FSA inherited when it was first formed in 1998. Each includes major trade-offs, and each had a major long-term impact on the regulator’s culture and operation.

IHRP

This is maybe the most obvious comparison, given the s166 approach so far adopted, and those interested in the detail should look at the subsequent Swift Review. Here, I’ll concentrate on the most relevant lessons for the motor finance investigation; largely, they pose more questions than they answer.

Mis-selling was identified after a series of small sample file reviews showed 80-90% of each had major flaws. Wanting to be “fleet of foot”, the FCA moved quickly to commission separate s166 reviews for each major product provider. These reported reasonably quickly and those deemed eligible were compensated (to the tune of £2.2bn/$2.8bn), but the reviews were carried out by different skilled persons and each review was tailored to the circumstances found in the specific firm, resulting in some inconsistency between them.

Particularly relevant to motor finance, Swift criticised the “clear shortfalls in processes, governance and record keeping … and a lack of transparency“. The FCA will have improved in these areas, but if it follows a similar approach, effectively using s166 to outsource the work to professional services firms, it will inevitably be complicated.

And if the resulting compensation is anywhere near the PPI level – nearly 20x IHRP – that would be a huge headache.

Payment Protection Insurance (PPI)

If IHRP is the best comparison in terms of what we currently know of the FCA’s approach, PPI might be the best regarding not only scale but also the type of product and mis-selling.

This approach involved consumers having to complain to the firm and then, if that was rejected, appeal to the Financial Ombudsman Service (FOS). But there were several downsides.

• Individual cases were labour intensive and often seemed to take ages, encouraging consumers to got to claims management companies (CMCs), who did the leg work then took 20%+ of any resulting award.
• Certainly in the early years, the Ombudsman was upholding consumers’ appeals in well over 50% of cases.
• PPI put an enormous burden on the Ombudsman, distorting its business model and squeezing much of its other work.
• The whole process took over a decade, and the scope of the programme went through several iterations.

The FCA would want to avoid repeating these, but PPI was essentially another version of outsourcing – to firms and the FOS – so adopting this approach again would leave the key levers largely outside its control.

The PPI remediation project, established in 2011, was originally due to last a year only, and little of its eventual trajectory was planned or foreseen. Often, letting it run its course was the least worst option.

Pension mis-selling

The mis-selling had largely occurred in the early 1990s, the new FSA was landed with the clear-up task, and decided to do the job itself. In 1998/99 the Pension Review (pp18-19), which warranted its own division in the new regulator, cost some £15.8m ($19.9m) against a total budget of £168.3m ($212.1m).

Compared with the other two case studies, this had some positives. It gave the regulator much greater control than either of the outsourcing models, and probably led to greater consistency. The process was long but nowhere near as lengthy as PPI, and because it wasn’t dependent on complaints, there would have been no real scope for CMCs.

However, there were also significant downsides. The FSA had to recruit and train several hundred new staff, and for years it worried about whether it could absorb them effectively in its workforce (eventually it did). The Pensions Review also took up huge amounts of senior management bandwidth to the point where it effectively deterred the FSA from taking the same approach again.

A rocky road

Much of the coverage of the motor finance review has so far focused on the scale of the likely mis-selling – it is important not to pre-judge but the signs are pointing that way and the FCA would not be using its s166 powers at this stage if it did not believe there was a sizable problem.

However, this is really only the end of the beginning for this saga. Whatever approach the FCA decides on will have long-term implications and significant downsides. Both will need to be skilfully managed and their impact minimized where possible.

When the FCA decides on its next steps, in Q3, after what will inevitably be a high -level review of 10 major providers, it will have some big decisions to make.