On 12 April 2024, the Financial Conduct Authority (FCA) wrote a Dear CEO letter to motor finance firms to remind them that they must always maintain adequate financial resources. This letter reminds firms that the ‘threshold conditions’ and assessment of adequate financial resources are critical components of the FCA’s supervisory work. These aim to reduce the likelihood of market disruption, increase the chances firms can put things right when they go wrong, and minimise harm – to consumers and the integrity of the UK financial systems – if they fail and exit the market.
What’s the background to this?
As the FCA’s ongoing review of historical motor finance commission arrangements continues, they have observed firms taking different approaches to account for the potential impact on their financial resources of potential redress liabilities. The letter intends to remind firms of their obligations under the regulatory regime to maintain adequate financial resources.
So, what are the requirements?
Every firm authorised under the Financial Services and Markets Act 2000 must meet the FCA’s Threshold Conditions and Principles for Businesses. In accordance with COND 2.4, firms must have appropriate resources, both financial and non-financial, and they must be appropriate to the regulated activities they undertake. The purpose is for firms to have adequate financial and human capital resources to discharge their regulatory obligations, which includes covering potential redress liabilities.
Given the FCA’s ongoing review of historical motor finance commission arrangements and the likely significant impact of consumer complaints, it’s clear from the Dear CEO letter that the FCA expect firms to undertake an immediate assessment of their financial resources commensurate to the risk of harm from these complaints. The assessment should:
- be forward-looking, proportionate to the nature, scale and complexity of a firm’s business model,
- consider the risks and potential liabilities the firm is exposed to (including any potential redress liabilities), and
- consider the impact of other members of the firm’s group on the adequacy of its resources.
Alongside this assessment, the FCA also expect firms to ensure the accuracy of their financial statements and regulatory reporting and make adequate disclosures to the FCA in accordance with Principle 11 if:
- They are unlikely to have adequate financial resources in the foreseeable future, and before they take action that could materially impact capital positions or other decisions that could result in serious customer detriment, and
- The firm is involved in litigation relating to motor finance commissions that are subject to or likely to be subject to appeal to the High Court or Court of Appeal;
The FCA has also been clear that firms should continue to deal with discretionary commission arrangement complaints and subject access requests appropriately.
What should firms be considering?
Based on our experience working with firms across the motor finance sector, it’s clear that the FCA expects a firm’s assessment to be proportionate to the nature, scale, and complexity of its activities.
However, all firms should assess the risks inherent in their business model and the potential harm that can be caused, as well as explain how to close the business in an orderly way.
How do you assess whether you have adequate “capital” resources?
The assessment of adequate capital resources is based on how much capital is needed, which is then compared to how much capital is available. The FCA expects firms to have an amount of capital equal to or higher than its assessment of what is necessary. This includes the type and quality of capital and its ability to be used in a going concern or wind-down situation.
The FCA expect firms to have adequate capital to ensure they are able to incur losses and remain solvent or fail in an orderly way. This includes capital required for:
Compensation and redress schemes
Compensation and redress schemes are required to compensate consumers for losses due to a firm’s misconduct.
Enforcement and fines
Due to statutory investigations or enforcement actions by the FCA, which might result in fines.
Direct and indirect litigation costs
Firms may be required to compensate consumers or other firms seeking redress through legal action.
‘Skin in the game’
Adequate capital may be required to ensure firms can function in an orderly way and that their incentives align with the best interests of their clients or the wider financial markets.
What have we observed in other firms?
- An increase in general complaints to motor finance lenders – going beyond a DCA claim.
- Increase in complaints from consumers who ‘don’t believe’ the lender’s view as to whether they were ‘in or out’ of a DCA arrangement – causing friction and additional administration.
- An increase in DSARs from claimant law firms (SRA-regulated) – FCA-regulated claims firms remain quiet.
- Significant MSE & Debt Camel-driven’ information requests’.
- Increase in inbound telephony calls and emails to the Complaints and Customer Service functions.
- FOS adjudicators are reaching uphold decisions based on precedent Ombudsman DCA decisions, but firms are not accepting these and choosing to escalate the decisions to Ombudsman – there is very little Ombudsman activity to report across the board.
What should firms be doing now?
- Analyse your back book and determine whether a discretionary commission model applied.
- Define commission cohorts (DCA – yes, no, live, closed, vulnerable, in arrears, past DCA raised complaints etc.).
- Define your standalone target operating model to handle a reactive and proactive redress scheme.
- Identify and appoint a programme lead.
- Identify and engage a technology provider to handle and control’ mass claims’ if required.
- Right size your existing Complaints & DSAR teams to handle increased complaints and minimise delays, 56+ and FOS escalations.
- Document and simplify the investigatory process, assuming that DCA claims will be upheld—lean on automation and CRM integration.
- Continue to log and investigate DCA-raised complaints to a point (i.e., in or out, including potential redress calculation).
- Define remediation calculations for DCA ‘IN’ claims.
- Deploy management controls to ensure additional complaint points (affordability, GAP, Vehicle Quality, etc.) not related to DCA claims are logged and investigated.
- Identify the key process risks, tollgates and QA checkpoints.
- Agree on the core make-up of the anticipated letter templates and wider internal (Customer-facing colleagues) and external (FOS, Website, Socials, CMCs) communication strategies.
- Develop productivity, pipeline, quality, costs, and outcomes MI to track progress for ExCo and Board members.
- Create and deploy a bespoke root cause analysis framework to constantly learn from consumer and frontline feedback while undertaking reactive activity.
How Square 4 is currently supporting the Motor Finance sector:
- Defining the end-to-end target operating model and implementation of a standalone operating model.
- Performing a time and motion exercise against the core process surrounding DCA, affordability complaints and DSAR requests.
- Identifying key improvements, including system development opportunities, including introducing DSAR, complaints and remediation technology.
- Resource and scenario-based forecasting for critical roles, including trainers, DSAR administrators, complaint handlers, administrators, telephony agents, FOS officers, outcome testers and programme managers.
- Providing resources to process DSARs and information requests, providing telephony support, and working on end-to-end complaints.
- Providing resources to determine whether a consumer was issued finance in or out of a DCA arrangement.
- Designing redress calculator tools aligned with the FOS Ombudsman decisions as a guide.
- Defining and running financial provisioning models to encompass resources, redress, court costs, and FOS escalated costs.
- Shaping the proactive engagement strategy with Claimant Law Firms raising DSARs.
Get in Touch!
Should you wish to discuss the contents of this letter or how Square 4 Partners can help in more detail, please contact us at hello@square4.com, or the team directly below.
Darren Fisher – Dfisher@square4.com
Tom Jeffery – Tjeffery@square4.com
