New regulatory impacts on the business finance market
Last year the Financial Conduct Authority (FCA) announced that Small Businesses (SMEs) would be given an additional element of protection through an increase in the scope of the Financial Ombudsman Service (FOS).
From April 1st 2019, approximately 210,000 SMEs will now be able to formally complain to FOS about financial services or products provided to them in the UK, such as:
- Banking and credit
- Payment services
- Secured loans and overdrafts
- Financial advice
- Insurance for commercial purposes such as property or vehicles
The definition of an SME in this context is a business with an annual turnover of less than £6.5m, a balance sheet value below £5m and with less than 50 employees. A further significant inclusion to this SME category are individuals (e.g. Directors) who act as personal guarantors for loans given to business in which they are involved.
Up until now the maximum award from FOS has stood at £150,000 but, partly in recognition of this increase in the scope of their activities, from 1st April 2019 this limit will be raised to £350,000.
Giving financial advice to limited companies and small partnerships has in general terms been an ‘un-regulated’ activity, all be it that many of the providers of such services and products themselves have been regulated (e.g. banks and insurance companies).
A case could be made that it is this inconsistency or ‘blurring’ of the regulatory lines that has been a key driver in bringing into regulatory scope this ‘customer’ group. To illustrate this, simply take 2 small businesses; one a single director limited company and one a sole trader, both with identical financial profiles. Both take advice and take out similar business loan products. Up until now only the sole trader would have protection (through their eligibility to complain to FOS) and the possibility of obtaining financial redress, although the financial impact of, say, a mis-sold product might be the same for both businesses.
The ‘unregulated’ environment surrounding this sector will inevitably lead to the exposure of legacy issues embedded into the businesses of product providers and potentially advisors. Precedents set and lessons learned from the past indicate that, outside regulation, processes become un-structured and inconsistent particularly when a wide range of products and services are involved.
The impact of these changes will, at differing levels, be widespread. For lending institutions and product providers the FCA have stressed the requirement to ensure that their distribution channels should have appropriate controls and monitoring.
For introducers the case for maintaining robust records, in particular, being able to evidence the way in which advice is given and products are sourced and suitable for their client’s circumstances, must be central to their businesses.
Whilst the Regulator has not, through thematic review or otherwise, cited specific areas of remediation within this area of financial services for the time being, this increase in scope alone indicates concerns about the sector and the level of protection available to SMEs.
In an environment of thriving economic conditions and historically low borrowing costs the number of ‘stressed’ business is understandably not high, however, in a period of slowdown or uncertainty this situation can only reverse. The Federation of Small Businesses observe, by stating on their website, that a fifth of SMEs work in construction, a sector susceptible to market volatility.
In stressed situations professional advisers will, often as a first point of call, look at a business’s borrowing with a view to extricating their clients from or refinancing loans, and the new FOS scope will undoubtedly become a tool in this process.
Clearly there are no precedents or standards for redress cases at this stage however past experience points the way in which products and advice can be reviewed. Let’s look at a scenario whereby a small business owner takes on a loan product for the business on the advice of a professional adviser, and in doing so was required to give a personal guarantee (PG) as security.
Things take a turn for the worse business wise and the lender calls in the PG which in turn motivates the borrower to cry foul!
So, might there be a case to answer?
The PG is a legal document and there has been for some time a compliance requirement for people signing PGs to take independent legal advice, part of this process would be for a lawyer to highlight the risks of taking on the guarantee on behalf of their business.
Providing this process was conducted, and the appropriate evidence is available to prove it was (usually client signatures on the original documents), the PG will stand. This ‘legal’ governance over the process however does not cover the financial advice given to the client and it is therefore this element that will be addressed by FOS.
We have referred earlier to the often-unstructured way in which the advice process in this sector has evolved, and this may prove to be the route cause for negligence claims. Many ‘retail’ lending products are covered by sourcing tools such as Tri-Gold or Mortgage Brain however in the commercial sector there are no such aids to researching the market.
The case for our distressed business owner will likely hinge on the adviser’s ability to prove that the loan product that was recommended was indeed the ‘best’ available (not necessarily the cheapest), and that there was no other loan product available in the market that did not require a PG. In cases that there was no option to affect a PG did the adviser discuss the availability of Personal Guarantee Insurance (PGI)?
We see the challenges thrown up by this regulatory shift requiring specialist people resources to identify and mitigate legacy issues within the lending portfolios of institutions, and to implement appropriate monitoring and quality control of new business being introduced to them.
In addition, specialist complaint handlers will be needed as claims management companies begin to see new opportunities opening up in the industry, perhaps attracted to the higher levels of compensation on offer from April this year.