Preparing for CP25/27: What lenders must do now
The Financial Conduct Authority’s Consultation Paper CP25/27 proposes an industry-wide redress scheme for UK motor finance customers who may have been unfairly charged due to inadequate disclosure of commission arrangements between lenders and brokers.
Covering agreements from 6 April 2007 to 1 November 2024, the scheme targets practices such as Discretionary Commission Arrangements (DCAs) and high or exclusive commissions that may have breached FCA principles.
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It is expected that the compensation scheme will have the following accounting implications for lenders:
Redress provisioning
As a result of the Supreme Court rulings and the Financial Conduct Authority (FCA’s) consultation paper on DCAs, there is greater clarity for affected lenders on their position. The FCA’s paper lays outs a suggested redress methodology.
Under UK GAAP FRS 102 Section, provisions should be accounted for if the following conditions are met:
- The entity has an obligation at the reporting date as a result of a past event – Given that the redress is as a result of agreements issued in past between 2007 and 2024 this condition is satisfied.
- It is probable (ie more likely than not) that the entity will be required to transfer economic benefit in settlement; Given thatinadequate disclosure of commission arrangements represents a regulatory breach that has been confirmed by the courts for which the remedy is redress this condition is satisfied.
- The amount of the obligation can be estimated reliably – Given thatthe FCA has proposed a redress methodology which may change but gives affected lenders a reliable estimate of the redress which they will pay this condition is satisfied.
The FCA’s proposals reduce uncertainty and will allow firm to make meaningful provisions for redress.
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By GlobalDataAffected firms will currently be in one of the following positions:
- No redress provision
- A contingent liability disclosed
- A redress provision already recognised
Lenders who currently do not have a provision in place, should assess customers impacted and use the proposed redress methodology to calculate a provision. Lenders who already have a provision in place, should reassess their provisions. Under FRS 102 Section 21, the initial measurement should be the best estimate that an entity would rationally pay at the reporting date.
Going concern, KPIs and covenants
The inclusion of a redress provision in the accounts may have an impact on the going concern status of the affected lenders. The inclusion of a new provision or an increased provision will reduce the profit for the current period, and the future payments of redress will impact future cash flows. Lenders should factor these impacts into their future cash flow forecasts and consider whether this affects management’s conclusions in relation to going concern.
Furthermore, lenders should consider the impact on any covenants and KPIs. This redress scheme will reduce net cash flows, net assets and profit which could be benchmarks for loan covenants.
Accounts disclosures
The following disclosures should be included in the accounts in relation to the redress provision:
- A reconciliation of carrying value of the provision at the beginning of the period and the end of the period, including any additions and amounts charged.
- A description of the nature of the obligation, expected outflows and resulting payments.
- Detail of the uncertainties about the amount or timing of the outflows.
Practical steps lenders should take now to prepare, in line with FCA expectations:
Affected firms face a number of challenges in relation to the proposed redress scheme. These include the 2007 starting point for redress and the potential difficulty of accessing historic data, and the 2026 start date for redress payments to consumers.
The application of the FCA redress scheme has four stages:
Stage 1 – Identification of the potential redress population
Firms are required to undertake pre-scheme checks to see if loan agreements are included or excluded from the scheme. Firms should contact consumers to explain whether their case can be assessed under the scheme and what actions they should take, within three months of the scheme starting for consumers who have complained, and within six months for consumers who have not complained.
Stage 2 – Assessment whether the potential population is in scope for redress
Firms should then assess whether they are liable to pay redress. A firm should presume there was an unfair relationship, and the consumer suffered loss, where there was failure to disclose one of the defined relevant arrangements unless they have evidence which rebuts this. The FCA estimates that it should take three months for firms to complete this stage.
Stage 3 – Calculation of redress
Firms must calculate redress depending on the relevant arrangement present. This could be either:
- Refund of commission remedy
- Hybrid remedy – both commission and APR
- APR compensation remedy
Stage 3 should be completed at the same time as Stage 2.
Stage 4 – Final determination and redress payment
Firms must send redress determination to consumers and pay redress where necessary within one month.
A delivery forecast is required six weeks after the FCA’s final rules are published. This includes a cash flow forecast. This would be difficult to prepare without early consideration of the 4 stages noted above.
Start preparing
The FCA proposed redress scheme provides greater certainty to lenders that would allow them either recognise a provision for redress or to adjust existing provisions.
Given the potentially significant numbers of consumers who could be affected and the FCA’s challenging timelines for implementing the redress scheme, firms should start preparing now. Significant modification to the FCA’s proposed scheme, is unlikely and we would not expect a High Court judge to contradict a regulator with a comprehensive understanding of the market.
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