Preparing for review and redress programmes in Motor Finance: Lessons learned from Australia

Overview

The Financial Conduct Authority’s  (FCA) current focus on discretionary commission arrangements (DCA) has understandably created significant interest and uncertainty in the UK motor finance industry.

The FCA’s recent announcement (30 July 2024) of the extension to the pause on complaints through to December 2025 (with proposed next steps being announced in May 2025) has only added to this, but has also provided some insights into the FCA’s current thinking and the challenges both they and impacted firms have faced so far. 

Following the FCA’s ban on DCAs in 2021, a flood of complaints about the use of DCAs by motor dealers were referred to the Financial Ombudsmen Service (FOS), who upheld two lead complaints in January 2024. This led to the FCA deciding to step in, with the aim of taking control of the compensation exercise and avoiding the undesirable outcomes that were experienced with payment protection  insurance (PPI) mis-selling several years ago.

The FCA put an immediate pause on the complaints process and appointed a single “skilled person” under section 166 (s166) of the Financial Services and Markets Act (FSMA) to collect information about the sales processes in relation to a range of firms. The FCA required sufficient information to design a compensation scheme under section 404 (s404) FSMA and/or to launch a test case to obtain a legal determination on key issues in relation to DCAs.

Two parallel issues have caused the FCA to push the date for announcing next steps back from September 2024 to May 2025. First, due to the scale, complexity and age of  information to be collected by the skilled person (going back up to 17 years), this process is taking much longer than initially hoped. Second, the FCA recognises the importance of waiting for the outcome of the judicial review of the FOS lead case determination, as sought by Clydesdale Financial Services (a subsidiary of Barclays Bank). The initial permission stage of the application is due to be heard in the autumn, and if it is successful we anticipate that the substantive hearing will be in 2025.  The outcome of the judicial review could have a significant impact on the compensation exercise.

While the extension announcement leaves firms unclear as to the compensation they will ultimately be required to pay, the FCA did highlight that a consumer redress scheme “is more likely than when we started our review”, without elaborating further.

The FCA will be walking a tightrope in designing a compensation scheme on the back of the skilled person review. It will be keen to see that adequate compensation is paid to consumers (sufficient to deter them from referring complaints to the FOS) while seeking not to bankrupt motor dealerships or the motor finance industry more broadly. Compensation schemes under s404 FSMA have 
the benefit of constraining the FOS to apply the same principles in determining compensation on complaints referred to it. And yet s404 FSMA schemes are limited to requiring compensation to be paid where there is a legal right to receive compensation that has been caused by a breach of applicable binding FCA rules. This is significantly more limited than the FOS’s jurisdiction in determining compensation based on what is fair and reasonable in the circumstances. Furthermore, there will be a balance to be struck between putting in place a scheme that is simple, efficient and less expensive to operate (so that compensation can be calculated and paid out quickly) against a scheme that takes into account the circumstances of individual customers, which would calculate fairer levels of compensation but at greater cost of implementation and at significantly less speed.

The delay and uncertainty in the approach to be taken by the FCA has left UK firms in an unenviable position of preparing for the unknown. However, many firms will find that Australia can provide some insight on how this might play out. The Australian Securities and Investments Commission’s (ASIC) review of the motor finance industry received limited attention in UK publications. 

Ashurst’s prominence in both the UK and Australia, combined with our team’s experience working with clients to respond to ASIC requirements, has allowed us to observe many similarities between the two regulatory interventions. 

Can the issues identified in the Australian market provide insight to UK firms about the direction the FCA may take, and what does this mean for how best to prepare?

Australian motor finance industry

Will the UK follow suit?

ASIC has been active in motor finance enforcement activity since 2016, following the identification of a regulatory loophole that allowed dealerships to provide lending without a credit licence.

This sparked a wave of regulatory scrutiny across the industry, including on the use of ‘flex commissions’ (the equivalent of DCAs). UK firms seeking guidance on what regulatory concerns and outcomes may arise, as well as how firms respond to challenges posed, should consider how the issues have evolved in Australia.

Timeline of ASIC Activity: 2016 onwards

Revenue drivers, regulatory response

Australia's industry-wide review was as a consequence of non-compliance with responsible lending laws, leading to customer hardship. 

ASIC’s regulatory interventions required the review of  broader vehicle loan sales practices, including but not limited to the use of DCAs. This differs from the current UK scope. ASIC recognised that DCAs were only one factor in determining the dealers' revenue from a car sale. The FOS lead case decisions have also come under scrutiny for unbundling DCAs from the other financial levers available to dealers when determining the economics of a car sale. This is one of the issues raised in the pending judicial review.

Some UK industry bodies are requesting a more holistic review of the sales process to be considered in the FCA's review of motor finance practices rather than considering DCAs in isolation. The FCA stated that they are considering "how DCAs affected the cost of credit for people borrowing money to buy a vehicle". This indicates the likelihood that the other levers available to dealers could be incorporated into the review process and any redress calculation. 

Motor finance firms in Australia were required to consider each of the following potential revenue streams for each customer's purchase:

• Car price
• Trade-in values
• Flex commissions (DCAs)
• Financing costs
• Add-on insurance

In determining whether redress was due, compliance with responsible lending obligations were considered, alongside whether the dealerships had acted honestly, efficiently and fairly, and whether the consumer had received a good value outcome during the sales process. ASIC’s focus on customer outcomes bears striking similarities to the UK’s Consumer Duty regime. The FCA’s interest in the add-on Guaranteed Asset Protection (GAP) insurance further increases the parallels between the UK and Australian regulators’ interventions in the motor finance industry.

The inclusion of other revenue drivers alongside the impact of DCAs has the potential to reduce redress due to each customer. However, it would complicate the review process and the calculation of redress in individual cases. This level of ambiguity leaves UK firms uncertain how to prepare effectively in advance of any regulatory announcement.

Preparing for review and redress programmes

Lessons learned from Australia

Australian firms were required to undertake their own proactive review, redress, and remediation programmes, overseen by independent consultants. Requirements were not prescriptive but had to follow ASIC’s core principles of remediation design.

When considering sale compliance and subsequent redress, firms were faced with a series of operational challenges that required attention and incorporation into the programme. In our team’s experience of designing, operating and overseeing firms’ regulatory responses to the ASIC motor finance review, the most effective programmes successfully considered and managed the following critical areas: 

Data availability 

Identifying critical structured and unstructured datasets was key to an efficient review. The completeness and quality concerns of older datasets is exacerbated when the finance provider has a broad broker/ dealer network. The FCA review goes back to 2007, which exceeds standard data retention periods. Archives may have to be obtained and cleansed, and legacy system access considered. Where data is irrecoverable, customer-beneficial assumptions were used and agreed to allow progress.

Triaging and cohort identification

The most cost-effective review programmes underwent an initial triage process, to understand the customer base and the types of issues likely to be encountered, such as customer vulnerability. This ensured the programme was responsive to the review population and issues could be agreed with regulators to meet expectations, before a wholesale review was undertaken. Efficiencies could 
be achieved by identifying customer cohorts for similar remediation and redress measures.

Minimise subjectivity

The necessary assessment of multiple sales levers in dealer business models meant counterfactual information required consideration. Remediation plans needed to be designed to ensure that issues were addressed consistently and repeatably, with robust quality controls to ensure correct application.

Use beneficial assumptions

The cost of designing and developing a remediation programme needed to be considered alongside the likely cost of redress due. Utilising scenario modelling and applying beneficial assumptions to customer cohorts identified at the outset helped Australian firms to agree an approach that was risk-based and cost-effective. For example, some entities provided maximum redress where vulnerability factors were identified to minimise customer distress and firm reputational damage. From a UK perspective, Consumer Duty compliance should be a critical consideration for firms when applying assumptions.

Consider ‘tail-risk’

The time taken to conduct review programmes and compound interest due on redress had significant financial impact in Australia. There was often first mover advantage, as redress interest costs were reduced and cases closed before further regulatory requirements were announced. Clear customer communication strategies and in some instances, ex-gratia payments were also key in ensuring 
swift resolution and overall cost reduction.

What priority actions should UK firms take before the FCA announcement? 

UK firms are in a difficult position, as there is mounting pressure to prepare their response and provision for the associated costs, whilst there is still no clear legal or regulatory direction.

Lessons from Australia suggest that the following three steps should be undertaken in advance of the FCA making its determination on the back of the skilled person review and the outcome of the judicial review:

• Identify, cleanse and prepare your critical datasets, including recovering archived and legacy data. The FCA noted the fragmented nature of information between lenders and brokers, and the difficulty of recovery, in their 30 July 2024 announcement. Where data gaps are identified, consider what prudent assumptions you may need to make to address critical missing information.
• Understand your customer base, considering review cohorts - particularly any high-risk and vulnerable customers - to assess segmentation for a more efficient review process. Defining and identifying customer vulnerability to proactively assess remedial options should be a priority. 
• Develop a response plan – explore different scenarios, consider cost structures, and identify a prioritised plan of action across each scenario to inform senior leadership and assess any resource requirements early. Delivering good customer outcomes will have to be at the fore of any response plan, to meet Consumer Duty regulatory expectations.

In our experience, having this information ready will enable firms to respond quickly and provision accurately once the FCA has announced its preferred approach to the compensation exercise.

Authors: Phillip Hardy, Partner; Nathan Willmott, Partner; Matthew Warsfold, Partner; Chandni Dave, Executive