FirstRand drops Aldermore over “deeply flawed” FCA scheme

FirstRand has tripled its provision for motor finance claims and plans to sell UK lender Aldermore in response to the final details of the Financial Conduct Authority (FCA) redress scheme, which it labelled “disproportionate and unfair”.

The South African-based bank was cited in the Supreme Court case involving Johnston via its ownership of auto lender MotoNovo, and claimed the FCA’s scheme “significantly and inappropriately” diverges from the ruling given at that time

FirstRand said whilst the FCA had made some changes to the scheme in response to issues it had raised during the consultative period, any mitigation had been more than offset by other amendments, which “are problematic in that they result in a financial impact above the group’s expectations”.

It had initially set aside £127.4 million for potential claims, adding £115.1 million to that in September, and has now made an additional £510 million provision, bringing the total to £750 million.

FirstRand stated: “A considerably larger portion than expected of the £510 million raised is for the business written post the FCA’s regulatory changes in 2021. This total provision compares to the £275 million of profits the group extracted from motor finance activities from over a decade of motor lending in the UK.”

Flawed approach

FirstRand outlined what it identified as specific flaws in the final FCA policy, notably:

• The Supreme Court judgment in the Johnson case stated that multiple factors on a case-by-case basis must be taken into account for “unfairness” to be applied. However, the bank argues the FCA is applying a different legal interpretation, listing the non-disclosure of discretionary commission arrangements, a commercial tie or a high commission as unsubstantiated standalone factors which separately result in unfairness. 
• The lender says this results in a much larger number of the groups’ contracts now included in the redress scheme compared to the group’s original estimate which had been mapped against the Supreme Court ruling. 
• The FCA has applied an unsubstantiated hybrid redress calculation in the final scheme, which is not loss based, resulting in instances whereby, once applied, the effective rate charged for lending to customers does not cover operational costs, bad debts and cost of funds.
• Previously the FCA proposed to apply the Bank of England base rate plus 1% per year but has now introduced a minimum floor of 3%. Due to the length of lookback of the scheme, this has a material impact to the expected redress cost for the group.

FirstRand said it was “extremely disappointed with this outcome” to the FCA’s consultation, describing the scheme’s construction as “deeply flawed”. The bank argued the redress approach went against two of the FCA’s original guiding principles, namely principle 2 which “ensures the approach to determining breaches and calculating redress are fair to consumers and lenders” and principle 7 which concerns market integrity.

Aldermore disposal

FirstRand warned that: “Given the provision amount facing MotoNovo in meeting the requirements of the redress scheme, the business will require further recapitalisation from the group’s existing available resources in its UK operations. This may mean financial resources available for allocation to motor finance in the UK will be severely constrained, resulting in capital not being available to fund growth in the MotoNovo business.”

In addition, while the group believes that Aldermore Bank is “a resilient and sustainable business” it maintains that “the UK as a consumer finance jurisdiction will not deliver the returns the group requires”. 

In conclusion, the bank said “the business case for FirstRand to own and operate a UK consumer finance entity, particularly given its disciplined financial resource allocation principles, coupled with the legal and regulatory look-back risk, is not within the group’s risk appetite.  Cognisant of protecting shareholder value and ensuring Aldermore’s future success the group will work with the Aldermore board and respective regulators to facilitate an orderly ownership transition.” 

Despite the challenges of the redress scheme FirstRand said the group’s pre-motor provision normalised earnings guidance remains intact. The group now expects full year normalised earnings post the motor provision to contract between 4% to 9% and the ROE to be at or just below the bottom-end of its stated range.

FirstRand is the first lender to indicate it plans to quit the UK auto finance market over concerns about regulatory uncertainty. This was a key issue highlighted in comments made last year by Charlie Nunn, group CEO of Lloyds Banking Group, when he told a House of Lords financial services regulation committee “If the UK is to be an investable destination, then we need clarity around regulation.”

Giving evidence to a session examining the potential impact of the FCA’s redress proposals, Nunn cautioned: “Having a scheme like this, that would take away more than 20 years of the profitability of [the car finance] sector.

“It’s a really difficult issue for both global companies looking to invest in the UK and, for that matter, my investors looking to invest in financial services. So there’s a deeply important investability issue for the UK, we think, coming out of this.”

Nunn warned that the FCA’s redress proposals were “not proportionate”, citing particular concerns about regulator’s proposal for “an 18-year look back, chasing all the way back to 2007.”

Since then, the FCA’s final proposals have included dividing the scheme into two, with the first part tackling claims for the period 2007 -2014, and the second concerned with agreements made at a later date.

Some commentators have argued that the split is an acknowledgement that there may be legal challenges to the scheme’s rules around the inclusion of older agreements and the terms of compensation. In its regulatory statement, FirstRand noted that the group “reiterates its view that the FCA scheme significantly and inappropriately diverges from the Supreme Court ruling and therefore the group’s legal rights remain reserved.” 

FirstRand’s statement is here.