There’s a lesson that South African companies keep having to relearn the hard way: European regulators play by different rules. And they play for keeps. FirstRand – one of South Africa’s finest financial institutions, and a company that has spent years carefully building a presence in the UK consumer finance market – has just been handed a bill so large that it has decided to walk away entirely.
Not because the business was failing. Not because the strategy was wrong. But because the cost of operating under the UK Financial Conduct Authority’s new motor finance redress scheme has made the entire venture economically unsustainable.
What the FCA scheme is
A bit of background first.
For years, UK motor finance lenders used a system called Discretionary Commission Arrangements, or DCAs. This allowed car dealerships – acting as brokers – to quietly adjust the interest rate on a customer’s finance deal to increase their own commission.
The customer wasn’t told. The regulator eventually decided this was unfair, banned DCAs in 2021, and has now introduced an industry-wide redress scheme to compensate customers who were charged more than they should have been.
On paper, that sounds reasonable. Undisclosed commissions that cost customers money should be remedied. The principle is sound.
The problem is the execution, and the scale.
The FCA’s final scheme, published on March 30 this year, covers motor finance agreements going all the way back to April 2007. An estimated 12.1 million agreements are now eligible for compensation, with average payouts expected to be around £829 per agreement. The total bill to the UK motor finance industry is projected at £7.5 billion in redress alone, rising to over £9 billion once implementation costs are included.
For FirstRand, operating through its MotoNovo motor finance business in the UK, this scheme was catastrophic.
The numbers that don’t add up
Here is the calculation that should stop every investor in their tracks.
Over a decade of motor finance lending in the UK, FirstRand’s business generated profits of £275 million. The total provision it now needs to raise to meet the FCA’s redress scheme requirements: £750 million. An additional £510 million was added after the final scheme was published – nearly triple the original estimate.
In rand terms, that additional provision alone is R11.9 billion. The total provision stands at R17.7 billion.
The provision is almost three times the profits the business generated over ten years. There’s no commercial logic in which those numbers make sense for shareholders. You can’t run a business for a decade, earn £275 million, and then write a cheque for £750 million on the way out.
And it gets more specific: a considerably larger portion than expected of that new provision relates to business written after 2021 – after the FCA had already introduced regulatory changes. FirstRand is being asked to pay for conduct that occurred under the new rules.
FirstRand’s specific objections
FirstRand has been exceptionally clear that it considers the scheme structurally flawed, not merely unfortunate. Three issues in particular stand out.
First, the UK Supreme Court ruled in the Johnson case that unfairness must be assessed on a case-by-case basis, weighing multiple factors. The FCA has taken a broader interpretation, treating the mere non-disclosure of certain commission types as automatically unfair — pulling in a far larger number of FirstRand’s contracts than the Supreme Court judgment would suggest.
Second, the FCA’s redress calculation uses a “hybrid” formula that is not based on actual customer losses. In some cases, the effective rate of compensation means the lender would be paying out more than the customer was ever charged — in other words, the redress calculation produces outcomes where the original lending rate doesn’t even cover operational costs, bad debts, and the cost of funds.
Third, the FCA introduced a minimum floor of 3% on compensatory interest, replacing a previous proposal of Bank of England base rate plus 1%. Given that the scheme looks back seventeen years, this single change has a material and compounding impact on total cost.
FirstRand has reserved its legal rights. But it also knows that litigation against a regulator in a foreign jurisdiction, over a scheme already confirmed by the courts, is expensive, uncertain, and ultimately a distraction from running a bank.
The decision: sell Aldermore, exit the UK
Having run the numbers – and rerun them – FirstRand has made the only rational call available to it.
The group will sell its Aldermore Bank business in an orderly ownership transition. Aldermore, its broader UK banking operation, is described as resilient and well-run. The decision to exit is not about Aldermore’s quality. It’s about the regulatory environment in which it operates.
As FirstRand stated plainly: the UK as a consumer finance jurisdiction will not deliver the returns the group requires.
The impact on the company’s earnings won’t be trivial.
Full-year normalised earnings, net of the motor provision, are now expected to contract between 4% and 9%.
Return on Equity (ROE) will be at or just below the bottom of the target range. The dividend remains protected. FirstRand has committed to paying based on earnings before the provision impact, but this is still a painful and highly visible hit.
The lesson for SA investors
This is not the first time a South African company has walked away from Europe bruised and wiser. The combination of slow economic growth, complex regulation, and retrospective legal frameworks creates an environment that is difficult to price correctly at the time of entry.
Regulatory risk – the risk that the rules change, or are applied in unexpected ways, years after the fact – is notoriously hard to model.
FirstRand did everything right: it engaged with the FCA’s consultative process, provided input, flagged its concerns, and ran a compliant business. It still ended up with a bill nearly three times what the business earned.
The lesson isn’t that South African companies shouldn’t expand internationally. It’s that the regulatory capital required to operate in jurisdictions like the UK needs to be factored in far more conservatively, because when European regulators decide to act, they act at scale.
For JSE investors in FirstRand, the short-term earnings pain is real but manageable.
The longer-term picture?
A cleaner, more focused group without the drag of UK regulatory uncertainty may ultimately prove to be the right outcome.
Not a subscriber to Money Morning?
You can get free daily recommendations like these with Money Morning eletter. Just sign up here.
