A showdown is brewing over Britain’s ‘investability’ problem

This report is from this week’s CNBC’s UK Exchange newsletter. Like what you see? You can subscribe here.

The dispatch

Few things have captured the British public’s imagination more this century than compensation.

The U.K. never used to have a compensation culture, but things began to change when, in June 1995, solicitors were allowed to charge on a “no-win, no-fee” basis for the first time.

The thinking was that, with the courts really only open to the very rich or the very poor (the latter supported by legal aid), it would widen access to justice. Warnings that it would lead to unscrupulous and speculative claims from so-called “ambulance chasers” were ignored.

Sure enough, by 2000, compensation claims had quadrupled from their 1992 level and begun appearing in areas, like stress-related problems against employers, where they were previously unknown.

This was then turbo-charged by widespread adoption of the internet and high-profile advertising campaigns by claims management firms like The Accident Group and Claims Direct. The latter, notorious for its slogan “Where There’s Blame, There’s A Claim,” collapsed after The Sun, the U.K.’s top selling newspaper, highlighted how most compensation payouts were being swallowed by fees. Appropriately, Claims Direct was later sued for compensation by disgruntled former shareholders on a “no-win, no-fee” basis.

But the genie was out of the bottle. Generations of Britons had discovered how easy it was to pursue a compensation claim.

This was highlighted by the scandal around Payment Protection Insurance (PPI) — policies intended to enable borrowers to repay loans in the event of them dying, becoming ill or losing their income.

With generous commissions paid to those selling them, mainly because the insurance was often more profitable to the lender than providing the loan itself, millions of policies were sold — an estimated 16 million between 2005 and 2011 alone. It subsequently emerged many were mis-sold, with some borrowers being wrongly told they had to take out PPI as a condition of being granted a loan and others not even realizing they had been sold a policy.

A tsunami of compensation claims ensued — again with claims management firms taking a chunk of the pay-outs — and the scandal ended up costing the banks an estimated £50 billion ($66.3 billion).

The latest scandal

Which brings us to the latest mis-selling scandal engulfing the sector. The way Britons buy cars has been transformed by a product called the Personal Contract Purchase (PCP). The first was launched as long ago as 1992, by Ford of Britain, but PCPs exploded in popularity when the global financial crisis pushed interest rates to near zero.

With a PCP, the motorist pays the dealer a deposit, followed by monthly loan repayments over a period typically between two to four years. At the end of the contract, the motorist either pays a final sum to buy the car outright, or — more usually — recycles it into a fresh PCP to buy a new car.

The beauty of these products was that the PCP only covered the cost of the car’s depreciation during the life of the contract, not its full value, making the monthly repayments considerably lower than a traditional car loan. They enabled millions of motorists to buy a newer, and better, car than they might otherwise have been able to afford. By 2016, around nine in every 10 new cars in Britain were being bought in this way — the deposits in many cases coming, ironically, from PPI compensation payments.

But it has since emerged that, like PPI, many PCPs were mis-sold. Some cases involved customers being charged an unfairly high commission or buying from a dealer exclusively tied to one lender. But most cases — some 11.4 million — saw salesmen receiving a higher commission if they could persuade the customer to pay a higher rate of interest on the loan than they would otherwise.

At one point, it seemed the scandal could prove a PPI on wheels, particularly after the U.K. Court of Appeal sided with motorists in a judgement in October last year. Estimates of a total compensation pay-out of £44 billion began circulating. Lenders appealed to the Supreme Court and, in January this year, the U.K. Treasury sought permission — unusually — to intervene in the case amid concerns from Finance Minister Rachel Reeves that PPI-sized compensation payments could damage the banking sector’s ability to support the economy.

The Supreme Court refused this request but nonetheless in August found for the industry in two out of three test cases. This has still left the door open to compensation claims and last week the Financial Conduct Authority, the regulator, said redress was due on around 14 million contracts taken out between April 6, 2007, and November 1, 2024. It estimated this would cost the industry a total of £11 billion.

Lenders are now raising their provisions accordingly. Lloyds Banking Group, the U.K.’s biggest domestic lender, on Monday raised its provisions to £1.95 billion from £1.15 billion. Close Brothers on Tuesday nearly doubled its provisions to £300 million, up from £165 million.

But that may not be the end of the matter. The FCA is still finessing how the redress scheme will work and, in its strongly worded stock exchange announcement this week, Lloyds pledged to make “representations” to the regulator. It thinks the FCA approach toward redress may lead to customers being refunded more than their actual losses.

Another affected lender, South Africa’s FirstRand, has warned the payouts implied by the FCA’s methodology are not “proportionate or reasonable.”

The finance arms of the car manufacturers are also unhappy. The Times newspaper reported on Monday that BMW, which faces a hit of £200 million, has sought talks with Reeves.

All this threatens to drive another wedge between the government and one of its regulators. Marcus Bokkerink, the former chairman of the Competition & Markets Authority, was ousted in January — while Reeves was meeting business leaders at the Davos summit — amid concerns he was insufficiently committed to growth.

Charlie Nunn, the Lloyds chief executive, said in December last year that court rulings like the one last October were creating an “investability” problem for the U.K.

If Reeves agrees — and the Treasury’s attempt to try and intervene in the case in January rather suggests she does — it points to a possible showdown with the FCA.

— Ian King

Top TV picks on CNBC

Emily Sawicz, director and industrials senior analyst at RSM UK, discusses the EU’s proposal to lower quotas and hike tariffs on steel imports, saying they’ll have a “significantly bigger impact” than the 25% duty announced by the U.S.

The former Director of Communications and Strategy for the Tony Blair Labour government, mental health campaigner and podcaster Alastair Campbell tells CNBC’s Tania Bryer about the importance of a focus on mental health – and his advice for U.K. PM Keir Starmer as his approval ratings fall.

Simon Bumfrey, head of banking at HSBC Innovation Banking UK, discusses venture capital funding for U.K. companies after the latest data showed firms raised $9 billion in the third quarter alone.

— Holly Ellyatt

Need to know

Bank of England warns of a ‘sharp market correction.” If sentiment around the artificial intelligence trade dips, that, in addition to factors such as heightened geopolitical tensions and fragmented trade, could leave the stock market “particularly exposed,” according to the BOE’s latest meeting minutes.

Britain’s competition regulators designates Google with ‘strategic market status.’ While that label does not find Google guilty of any wrongdoing, it opens the door to the tech firm potentially having to make changes to how its search works in the U.K.

Risk-averse parents are fueling Britain’s ambition crisis, venture capitalists say. The U.K. has a “very different mindset” from the U.S. toward risk and careers, said Harry Stebbings, the founder of 20VC, a firm managing $650 million in funds. It’s a sentiment broadly echoed by other figures.

— Yeo Boon Ping and Holly Ellyatt

Quote of the week

In the markets

London-listed stocks dipped over the past week, with the FTSE 100 losing around 0.3% since last Tuesday. It comes despite the index hitting a record high on Oct. 8, as investors reacted to possible tariffs on steel imported into the European Union.

The British pound fell 0.8% against the U.S. dollar over the course of the week amid the release of U.K. unemployment figures, which were slightly higher than expected by economists in a Reuters poll.

The yield on the benchmark 10-year gilt ticked lower this week, trading around 4.573% on Tuesday, down from 4.727% a week ago, as bond traders respond to potential renewed trade tensions between the U.S. and China.

— Tasmin Lockwood

Coming up

Oct. 16: U.K. GDP data
Oct. 22: U.K. inflation data
Oct. 23: CBI business optimism index