Uncertainty Weighs on UK Auto Lenders Due to Recent Court Rulings 

January 2025

UK auto lenders are currently grappling with significant issues due to recent rulings in court cases involving customers complaints regarding the lack of adequate information about commission fees when taking out a financing arrangement.  

PPI 2.0? What is happening? 

The Financial Conduct Authority (FCA) has been investigating the car finance sector for potential widespread abuse of Discretionary Commission Arrangements (DCAs), which were banned in 2021. These agreements allowed brokers, often car dealers, to increase interest rates on car finance contracts, in return for higher commissions from lenders. The outcome of the FCA investigation into DCAs is likely to lead to financial compensation for borrowers who took out financing pre 2021 with DCAs in place.  

Since the ban in 2021, there have been further borrower complaints against lenders regarding other types of commission charges. Three specific complaints were upheld by the Court of Appeal (CoA) in October 2024, which ruled that certain commissions paid to car dealers were unlawful. This ruling could expand the scope of the current investigation by the FCA into Auto commission, as the CoA maintained that full explicit disclosure of any commission payments is required. In one of the cases brought to them, the judges found that there was partial disclosure of the commission which was sufficient to claim the commission was not secret. However, fully informed consent of the borrower was not obtained. This is a breach of fiduciary duty and makes the Lender liable and responsible. 

Consequently, financial compensation by lenders could be significantly more than previously anticipated. The CoA ruling is being appealed and will now be seen in the Supreme Court, with further updates expected before the end of April. In the meantime, the FCA has noted the CoA judgement and is looking to the Supreme Court for speedy clarity. They have also extended the deadline for lenders to respond to complaints around DCAs until December.  

Depending on the Supreme Court final ruling, lenders could be liable for significantly higher sums of redress estimated between £17bn and £44bn by market research teams. The scope of the potential redress has been compared to the UK PPI mis-selling refunds seen in the post GFC decade. For reference, refunds paid to customers from PPI claims were over £38.3bn.¹  

Metro Bank and other lenders like Lloyds have already taken significant provisions in their accounts and share prices of publicly listed lenders have suffered given the uncertainty and potential liabilities. Some lenders such as Metro Bank have made a public statement noting they have stepped back from lending in the near term until more clarity is reached. We also note that a potential ruling against lenders by the Supreme Court, could lead to an extrapolation to other types of consumer lending, most likely in the unsecured loan – non mortgage space. 

Notably, HM Treasury is also now involved in the matter, seeking permission in mid January to intervene in the decision making of the Supreme Court. We would expect their preferred outcome would be for consumers to receive appropriate levels of redress but also limit the impact of regulatory uncertainty for lenders and consumer businesses in the UK. 

Should investors in UK Auto ABS be concerned? 

Around the FCA investigation into DCA’s? No – the impact of this investigation and redress on securitisation is limited as there is a negligible amount of collateral outstanding in securitised bonds, originated pre-2021. 

What about the widened scope of consumer redress – should investors be worried?  

We believe ABS investors should be focused on three key areas: 

• Potential for credit losses remains low 

Key structural protections for securitisations include bankruptcy remoteness as well as representations and warranties from the originators which could require repurchase of collateral from structures by the originator if these were breached.  

Originators with weaker balance sheets may be more exposed to risk of bankruptcy if the rulings result in large levels of required redress. This may results in set off claims – borrowers might try to set off their loans against any amounts they owe to a bankrupt originator, which could complicate the collection process. Originators also typically service the securitisation, contacting borrowers if they fall into arrears and collecting payments. If the originator/sponsor does fail, the transactions are structured so that servicing of the collateral pool can be transferred to a third party if necessary and cash flows continue to reach investors, although this may result in delays and/or friction costs.  

The credit enhancements in place for the investment grade part of the capital structure remain strong. Within UK Auto ABS, tranches typically pay down sequentially and quickly, given the fast-paying loans, thus increasing credit enhancement within the structure.  

• Secondary market liquidity reduced while uncertainty remains 

Uncertainty tends to mean lower liquidity and higher costs to sell investments in secondary markets if this is required for any reason. 

We have already seen this in a widening of spreads and a drop off in secondary market activity in UK Auto ABS mezzanine tranches since the CofA ruling.  

• New issuance volumes likely to be lower 

Supply of new issue opportunities in UK Auto ABS may become more limited as the current environment is not attractive for issuers to price transactions. Loan origination volumes have dropped due to business uncertainty for the loan originators. 

We also note the importance of ESG considerations when investing in ABS; the ruling underscores the importance of robust governance and regulatory frameworks in consumer lending and ABS securitisation to protect consumer interests and maintain market integrity. 

In conclusion…what’s next? 

The ultimate outcome of the Supreme Court appeal will be crucial in determining the extent of financial redress and the broader implications for the consumer lending market and we will be watching this closely. 

The Financial Conduct Authority’s (FCA) scrutiny of Discretionary Commission Arrangements (DCAs) and recent Court of Appeal rulings on commission disclosure are likely to have significant financial implications for lenders, with potential liabilities amounting to billions of pounds. 

However, the impact on UK Auto Asset-Backed Securities (ABS) should remain limited, thanks to strong structural protections and credit enhancements, although secondary liquidity is expected to be more challenged until more clarity is reached. While lending activity may slow down in the near term, the robust support mechanisms within ABS structures provide reassurance to investors. 

Disclaimer:

This material has been prepared by Challenger Investment Partners Limited (ABN 29 092 382 842) (Challenger). Challenger is the holder of an Australian financial services licence AFSL 234678 and is regulated under the laws of Australia. 

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