Oral evidence: SME Lending, HC 204Tuesday 10 June 2014

Oral evidence, 10 June 2014.

Witnesses

Professor Mark Watson-Gandy, Thirteen Old Square Chambers, Frances Coulson, Managing & Client Services Partner, Moon Beever Solicitors, and Martin Morrin, Chair, Asset-Based Finance Association and Managing Director at RBS Invoice Finance, gave evidence.

Chair

Thank you very much for coming in. Perhaps I will begin with a nice, straightforward question and just go through the three of you. Why do we need an asset-based finance market, Mr Morrin?

Martin Morrin

I think we need an asset-based finance market because of its specialist skills. If you look specifically at the nature of invoice finance, be that factoring or invoice discounting, I guess our specialist skills are borne out of working really closely with businesses, understanding those businesses, understanding the fundamentals of the nature of the business that they are in, the contracts that underpin their invoices and their sales and our ability to then fund those invoices, which can be up to as much as 90% to 95% of an invoice. Generally, if you look at other forms of lending where it is typically secured lending, they will look at the assets on the balance sheet. If you take sales or invoices as an example, that would probably be closer to 50%, 60% or perhaps in some situations a 70% advance. The additional funding that we generate is often really important to businesses.

Professor Watson-Gandy

I think the answer is this. It is always healthy to build alternatives into a market, especially one involving a particular niche. It is also important to look after asset-based lending because it addresses the particular needs of business in terms of cash flow. One of the problems that companies have is trying to address the issue of cash flow when you are trying—

Chair

If they try to use short-term overdraft facilities, they are often taken to the cleaners by the major banks, aren’t they?

Professor Watson-Gandy

Indeed.

Chair

You are offering an alternative. Is that the reason that asset-based finance is—

Professor Watson-Gandy

I am not in asset-based finance.

Chair

You are not in the market, but is this the reason that the market has some vibrancy or some scope?

Professor Watson-Gandy

Well, the reason the market has particular vibrancy at the moment is because it has come in as an alternative to secured finance based on fixed charges.

Chair

In a market that has been dysfunctional?

Professor Watson-Gandy

Yes.

Chair

Okay. Frances Coulson?

Frances Coulson

Yes, I agree that asset-based lending is very important, particularly for the SME sector. Small businesses quite often will not have a large fixed asset base and they live on cash flow. They are also quite often the subject of slower payment, perhaps, by customers, so I think it is an important area. My concern would be that people understand what the options are, that things are explained to them in plain English, and that they understand what the downsides might be if anything goes wrong.

Chair

We might go into those in a moment.

Steve Baker

Is a willingness to pay the fees associated with invoice financing a sign that a company is getting itself into trouble?

Frances Coulson

No. I don’t think necessarily that it is a sign that it is getting into trouble. As I say, if you do not have a large fixed asset base, then your options are a little bit low. Also, the problem that you see for SMEs—as was said by the previous witnesses—is the speed of decision-making. A small overdraft, which they may need for a short period of time to ease cash flow, can take a very long time for the larger banks to get it approved and to get in place and they do not have time.

Steve Baker

You do not think there is a connection between being willing to use invoice financing and a firm getting to the point where it is going to go insolvent?

Frances Coulson

I do not think it is a corollary. It can happen but I do not think it is a natural corollary.

Steve Baker

Could I ask the other panellists, what would you say accounts for businesses’ wariness when they find a supplier is using invoice finance?

Martin Morrin

I think there are two aspects to that. If you look at factoring, which is a product that is provided, which is a credit management service as well as a funding service, then the buyers of that client, that supplier, their attitude can vary. It depends in part how effective the credit control function may have been in that SME business. If it was not something that was structured and effective, then the professional approach of a factoring company to bring more rigour around asking for payment on time does not always receive a warm welcome. Therefore, I guess you can have a negative comment associated with that service as opposed to something that is positive. At the end of the day, nobody is asking those buyers to pay any sooner or any more than what is due and on time. In my experience in looking across the members of the Asset-Based Finance Association, there are far more businesses who come to invoice finance to grow their business, not to save their business, if I can put it like that. I think it is also important that we look at situations where a business for whatever reason has got into difficulty—it may be struggling to achieve a form of finance, perhaps even its preferred form of finance—and invoice finance, the factoring of invoice discounting, may be the best solution for them. Quite often what you find is that those businesses who use invoice finance, their experience and their outlook afterwards is much more positive and they become advocates of the product as opposed to detractors.

Steve Baker

I understand the Financial Times has said that some SMEs are penalised as potential bad risks. Is that accurate?

Martin Morrin

I do not know precisely what is meant by “penalised”. If you go back to the principles of what we do, the fundamental starting point is that, before any member of the ABFA provides a facility to a client, they start by visiting that business. Generally they will conduct what we call a survey. That will be independent of the person who conducted the first visit. That will go through an assessment of: what are the needs, can the actual supplier meet those needs and, therefore, how we take that forward? They will have an offer letter that will set out the terms and conditions. They will generally stay in place. In the experience of the ABFA, if there are any penalties it generally comes into where there are breaches of the contract as opposed to normal functionality of the contract.

Professor Watson-Gandy

There is also the factor that you have changed the lending package, that you have ring-fenced part of the security that was available.

Steve Baker

Okay, thank you. Is there something that needs to be done to change perceptions of factoring specifically?

Martin Morrin

There are things that need to be done to change the perceptions of factoring because I think factoring has a less than good reputation—if I can put it like that—and in many situations undeservedly so. As an industry, it is up to the ABFA to work with its members to promote the product. In that promotion, we need to use a simplified language. We also need to distinguish between what is factoring, what is invoice discounting and what is asset-based lending. We also need to work with a wider stakeholder group, particularly when I look at the professional community, when I look at accountants and I look at the teachings that are rooted in some of those areas. They are probably more relevant to what was happening 20 to 25 years ago than they are today.

Steve Baker

Is technology a factor in how things have changed?

Martin Morrin

I think technology is aiding the provision of service. Most of the ABFA members—if not all of them—will have an online capability, but I would say the most recent developments come in the translation of invoices and the transmission of data between the factor and its client. More recently, we have seen the development of the online platforms, which I think is a good step forward. That will create choice and it will also create competition.

Steve Baker

Mr Morrin, can I ask you specifically about allegations of poor practice? In the past, asset-based lending brokers have been accused of poor practice; for example, targeting struggling firms—which is what I was indicating earlier—with the intention of profiting from their collapse. What proportion of asset-based lending is done through a broker and what responsibility do asset-based lenders have when they are choosing a broker?

Martin Morrin

I do not have the precise details of what proportion of business is done through brokers, because that is not data that the ABFA yet gather but it may be data that we will gather in the future. When you look at brokers, they also provide a service in bringing more parties to the table in terms of creating competition. If there are specific cases where brokers target businesses that are not going to be in a position to trade out of their particular predicament and if that is very obvious, then no member of the ABFA or, indeed, anybody should be targeting those businesses or benefiting from their misfortune. That is why the ABFA has set out very clear guidance in its code in relation to this. We do have a challenge that the ABFA has to deal with. As a trade association, we are bound by the Competition Act and, therefore, how prescriptive we can be. The structure for guiding members, in terms of what specific business they can do, is not an area that we can at this point in time deal with, but it is something that is on the agenda of the Professional Standards Council for the second half of this year to look at that specific area. We have taken some advice on what the ABFA can do in terms of providing guidance and setting some rules.

Steve Baker

Could I ask you, do you think brokers ought to be among your members?

Martin Morrin

We don’t have brokers as members but we do—

Professor Watson-Gandy

There is an association that deals with finance brokers.

Steve Baker

If a business is out there and it is having difficulty with brokers—and therefore I should think lenders have a problem in there as well—where should they be going for help? If a business in my constituency has a problem with its invoice financing and a broker is involved, where would you suggest they go?

Martin Morrin

It depends. Perhaps two places. I think that can be brought to the attention of the ABFA, depending on whether that broker is part of an association. If it is part of the National Association of Commercial Finance Brokers, it should bring it to that body as well. The ABFA is working closely with the National Association of Commercial Finance Brokers, because it is in both of our interests to make sure that we get the standards right.

Steve Baker

What more specifically do you expect to do in order to deal with these problems with brokers?

Martin Morrin

If the problem rests with the member of the ABFA then, as I said, we have set up a new code. There is a complaints system and an independent ombudsman that will deal with those complaints. The Professional Standards Council will look at all of the evidence that is available in relation to members, when they look at the annual review of that membership. If there is evidence to suggest that a member is not meeting the standards that have been set out in the code by the ABFA, then the Professional Standards Council can fine or expel that member of the ABFA.

Steve Baker

Thank you very much.

Chair

Do you want to say something?

Professor Watson-Gandy

No, that is fine.

Chair

Go ahead. If you want to say something, say it, if you do not—

Professor Watson-Gandy

Well, the problem is pitched very much in terms of it being a problem in respect of the brokers involved. When a business is failing it is going to be fairly desperate to try to raise finance from any source it can. As regards asset-based lending, there is a perception issue because what will happen is a business will try to raise finance; it can get perhaps 80% of the value of the asset that is being financed. But that begs in itself a question. The question it begs is: what is that being secured on? As you know, when you buy a car and it rolls off the forecourt, by the time it has rolled off the forecourt you have lost 20% of the value, and by the time my children have had their grubby fingers over it the percentage of the value has diminished accordingly. It is even more so with businesses because you are looking at an asset that perhaps is going to have environmental issues when it is sold, there is going to be a cost to have it removed. You are looking at pennies in the pound in terms of when the asset is eventually sold. Now, the businessman perceives that his lending is secured on the value of that asset. If the value of that asset only ends up being worth pennies in the pound what is the real security being given? My friend on my right’s members don’t do it from the goodness of their heart. The answer is that they will seek alternative security in terms of personal guarantees.

Steve Baker

The answer you have just given, I can see how that would apply to a fixed asset but surely when we are talking about invoices in particular, the pennies in the pound argument is probably less appropriate?

Professor Watson-Gandy

No, that area has—

Chair

Briefly, if you can. Sorry, do go ahead but if you can be brief we would be very grateful because other colleagues want to come in.

Professor Watson-Gandy

The reality is this, if you are looking in terms of the real security, the underlying security being the personal guarantee, how is it going to be enforced? It is going to be enforced either by bankruptcy, which these days has more of a policy taint towards it or what you do is you enforce it by seeking a charge. Ultimately, if all the security you are getting is something equivalent to a mortgage over somebody’s house, first, it is not what they thought they were signing up to and, second, there are cheaper ways of raising money by getting a mortgage over your home than going down this route.

Chair

Did you want to add something, Frances Coulson?

Frances Coulson

Yes. Just to say that I agree with Professor Watson-Gandy that, when businesses are in distress they are seeking funds from anywhere, they can be quite desperate but that is probably when they need protection. While the new ABFA code and so forth is welcome, of course, people can be asset base lenders without being members of ABFA and without being subject to any penalties for not following the code. I think there needs to be included a delineation for borrowers as to what is a safe place to go, a safe haven where they will get plain English and so forth. You do see some very poor behaviour in some companies at that distressed end of the market, where SMEs are pushed out of banking into invoice discounting and then into—

Chair

As the case is before this Committee.

Frances Coulson

Yes, and then into perhaps the smaller end of the market and then very rapidly into insolvency. I think that is where they need some protection. A SME at the smaller end of the SME market is slightly akin to a consumer in terms of sometimes sophisticated borrowing.

Chair

Is there a specific proposal that can address this for asset-based finance? You do not need to have one but if you have one—

Frances Coulson

The proposals have brought about a regulation, so whether that is self-regulation so that you have to be licensed and self-regulated or whether it is actual governmental regulation are the two options. Self-regulation works perfectly well as long as you have to be part of the club. If you don’t have to be part of the club then it isn’t effective.

Chair

Although a customer will know that if you are not part of the self-regulation that they are more at risk.

Frances Coulson

As I say, at the distressed end of the market, if somebody is coming to them and positively selling them a product—a bit like payday lending and that sort of thing—you get pressure selling and they are desperate. It is time critical and they cannot get quick decisions out of banks, or they are being pushed into invoice discounting and so they need protection.

Chair

On a related point, Mr Morrin, I think I understood you to say—tell me if I have summarised it incorrectly—that competition legislation is getting in the way of intelligent self-regulation? So what are we going to do about that?

Martin Morrin

The ABFA, because it is bound by the Competition Act, cannot be prescriptive in terms of telling its members what it can do in terms of things like pricing, termination, in terms of, “You shouldn’t take on this business because it is in this particular state”. That is what I meant by—

Chair

Is this established case law or just concern by lawyers expressed on the basis of what is current statute?

Martin Morrin

It is current statute and there is no case law that governs all that.

Chair

What we could do with here is some guidance perhaps from the competition authorities?

Martin Morrin

Yes.

Chair

Perhaps you would like to set down what you think that guidance might consist of and get it to the Committee?

Martin Morrin

I will do.

Mr Love

Can I turn to one of the issues that you just touched upon, termination, and ask you: what does your organisation do to ensure that your clients understand the termination fees that they will be subject to when they sign an agreement?

Martin Morrin

The code of conduct and guidance sets out requirements on the members to have plain and simple contracts, and that all of the terms are clear to them in terms of not just the day-to-day terms but also in terms of conditions in relation to default and termination.

Mr Love

Many in the insolvency industry are suggesting that there is a strong market for asset-based lenders to come along and pay off bank debts shortly before the company becomes formally insolvent. This allows the high street bank to evade responsibility for the insolvency but allows the asset-based lender to charge a termination fee. Do you recognise that particular marketplace and what are you doing to deal with this type of abuse?

Martin Morrin

I don’t recognise that marketplace but that is not the first time that those concerns have been raised. Each time they are raised the ABFA have asked the people raising them to please provide them with examples and specifics of the cases and we will look at them, because it not something that should be happening.

Mr Love

Again, the insolvency industry have suggested that in 2012 one in five administrations, where an asset-based lender was a creditor, occurred less than six months after the company used this form of lending. Does that not suggest there is a very active market in this area?

Martin Morrin

It comes back to the point I made earlier around if you look at the different options that a business has when it gets into difficulty, and in some situations those businesses may not have any choice and will choose a factoring product or an invoice finance product. In those situations, the factoring invoice discounter still has obligations in relation to the code of conduct and the standards that they set and deliver, and also the transparency of all of that. But it is unfortunate in some of those situations that, with the best will in the world, those businesses may have done the best to survive but it may not have been possible. In some situations that may have been obvious at the outset or it may not have been.

Mr Love

There is some suggestion that for some asset-based lenders their business model is dependent on this type of activity. Among your membership do you sense that that is the case, that some of them are actively seeking insolvency situations because there will be fees that they can charge that will allow them to continue to make profits?

Martin Morrin

I don’t sense that and I don’t see that, but again I come back to the point I made earlier in terms of: if it is happening it is not something that happens with the blessing of the ABFA or that the ABFA would ever condone that type of behaviour. Where there are examples of that, we do want to see those examples so that we can take that into account when we sit down and do an annual review of the membership, and fit and proper persons will be part and parcel of what we feature in that annual review as we do for each member towards the end of this year.

Mr Love

Professor Watson-Gandy, do you have a view about this? Is this an abuse, if not a scandal, that we should be worried about?

Professor Watson-Gandy

I am not sure whether the conclusion is a correct one, however I think there is a problem. Where I see one of the problems arising relates to termination payments. If you breach the terms of your invoice factoring you trigger a termination payment. That can have a massive impact in terms of the liability of a customer. In terms of an insolvency, I have seen it swallowing up perhaps 50% of the available—

Mr Love

Should we allow termination fees in insolvency? They were originally brought in for other changes that terminated the agreement and have been extended to insolvency. That seems to be where the problem is and where the abuse is occurring. Would it be easy simply to say, “You cannot have termination fees in an insolvency”?

Professor Watson-Gandy

In terms of an insolvency, the termination fee causes an imbalance and an injustice towards the other unsecured creditors, because it effectively deprives an asset class over and above the actual liability to the invoice discounter. Mr Morrin has stressed that he has a code for members, I am not sure if you have seen it. It is two and a half pages long and one and a half pages are interpretation.

Martin Morrin

I think you need to look at the guidance.

Professor Watson-Gandy

Yes, in the guidance it deals with termination fees. One thing that is quite interesting about it is some rules are mandatory and some rules are not. The one area of rules that are not mandatory relate to telling clients about the termination fees, which are under commitment 3.1.

Martin Morrin

If I can just respond to that, on the basis that this comes back to my earlier point around what the ABFA was allowed to do under the Competition Act in relation to being prescriptive. Subsequent to the guidance being produced, the ABFA has taken independent legal advice and—back to the Chairman’s point earlier—we should engage and will engage with the OFT, in terms of getting to that point about how prescriptive we can be. I do want to assure the Committee that this was an area that received a lot of debate. It is of concern, and we want to make sure that the standards that are set are fair and that they are transparent. Some of the cases that have been described are not something that we want to see and not something that we want our members to be able to do. It is not going to enhance the reputation of the ABFA, or indeed it is not going to further the cause of alternative finance.

Mr Love

You seem to be almost recommending statutory regulation here to replace self-regulation, since you seem to suggest that you are limited in what you can do because of the Competition Act. Ms Coulson, you were critical of self-regulation before, what do you think we need to do in terms of termination charges?

Frances Coulson

I am not critical of self-regulation, per se, as long as everybody comes under the umbrella and that there are some teeth to the enforcement. An industry can understand itself and its terms of reference very well, and for example insolvency has an oversight in terms of the insolvency service. In terms of termination fees when it comes to insolvency there has been this abuse, the termination fees are large. On the one hand, you obviously have to balance high-risk lending and a normal contractual loss that a lender is going to suffer if there is a default. That is perfectly reasonable, and sometimes that is misunderstood by directors. As long as that is a reasonable compensation and it is triggered by a material default. At the worst end of this sort of abuse in an insolvency situation—and bear in mind that I am generally seeing cases post administration into liquidation so it is a CSI type situation, it is forensic—where there has been lending of the type you describe, so it has been a substitution, the directors thought it was a white knight, but it was just asset stripping in that case. That was not an ABFA member and it was a large termination fee. The default was something that was in the discretion of the lender, and in fact when the default was triggered the lender was not owed any money at all but it took a £300,000 termination fee. That is at the extreme end of an abuse, and I think insolvency legislation—

Mr Love

How widespread is this abuse? You are giving us an example of something that is very extreme certainly—

Frances Coulson

Very extreme, yes.

Mr Love

But the information we are getting from the insolvency industry is this practice—abuse, whatever you want to call it—is much more widespread than has been admitted.

Frances Coulson

I think it is fair to say that there has been some improvement over the last few years. I think the code helps. It is difficult because we were dealing with a deep recession and an unusual situation, and I think that has made what is the norm very difficult in all sorts of areas of insolvency. But there is abuse. There isn’t a report somewhere that will give me the numbers as to how many cases this happens in. I will obviously see the abuse cases and that is the sort of work that I do. It has been prevalent enough for it to be a topic of discussion, and for me and my competitors and my clients to see a number of cases. Obviously lots of constituents complain to MPs about this sort of thing, but I think it has to be balanced by the fact that it is distressed lending. Insolvency has a good look back generally. The insolvency legislation, once there is an insolvency, can look back at things that have happened before insolvency. So if you had an administration, for example, where it is very useful—

Mr Love

Let me ask you about a situation where distressed lending is applicable and the company is under some pressure. Would it not be sensible to provide statutory backing to the advice that is given to those people at the time? Surely the shortcoming here is that there is no statutory protection for the advice given by an asset-based company, people can be misled—that is probably too strong a word—and they can agree to something that is not in their interest because that has been suggested to them, and there is no recourse for them subsequently to challenge the advice that they were given.

Frances Coulson

I am in favour of all advice, investment or borrowing, being regulated, whether that is self-regulation or not. So long as everybody, as I say, is under the umbrella. But when you are in a distressed situation it is a commercial decision. The courts recognise, for instance, insolvency practitioners have to take quite urgent commercial decisions and directors are desperate for finance. You want to rescue your business, you want to rescue jobs. I think you have had a submission from Stephen Hunt from Griffins about this subject, but if there is a look back and you could, with the benefit of some hindsight, say that was not fair to the creditors—the problem with termination charges often happens with that last minute lending, within the last six months. There is then a termination and the creditors bear that termination fee. If the business is sold in administration, or whatever, it does not bear the termination fee. Those jobs are saved but the creditors in the old company do bear that termination fee and of course creditors quite often involve—

Chair

Andy has one last question.

Mr Love

Just to ask Mr Morrin, obviously this has been a subject of discussion. R3 suggested to us in some of the submissions a number of ways that they could deal with termination fees, capping them, excluding them. Is there any change that your association is supportive of in terms of the way that termination fees are charged?

Martin Morrin

Yes. In terms of the ABFA, we are very happy to engage with all the key stakeholders to work out where the right balance should be found in this. I would come back to my earlier point—and I do not want to give the wrong impression in terms of the UK Competition Act, and we will take advice on that—that whatever the ABFA does it will have to stay upright within the existing law and the framework that is there. But to find the right balance—and the code in relation to this is prescriptive—I haven’t seen any evidence through the complaints process or the ombudsman service that points to this specific area in the last 12 months, but we will see how that goes over the next. We are very happy to sit down, to engage with stakeholders to look at this area and say, “What is the right outcome for all parties concerned, not least the businesses who are receiving finance?”

Chair

Frances Coulson, was the 300K abuse case something that—

Frances Coulson

It is a current case so I cannot really say. It is just an example of a set of facts.

Chair

Is the firm involved subject to the code?

Frances Coulson

No.

Chair

So they are outside the umbrella as you described it?

Frances Coulson

Yes, that is partially my point.

Chair

Okay, we have taken that point on board.

Mr Newmark

We have heard a lot of conversation about the sense that desperate people come and do this and everything else. This is the sort of finance that has been going on for years and years and years. This whole problem came to my attention about a year ago. I have to say I have seen a catalogue of abuse within the system, with abuse of termination fees, with an unhealthy symbiotic relationship with insolvency practitioners and those doing the lending. You are saying it is as though desperate businesses somehow come in, find the termination clause is triggered and it is the end of the world. But many of the businesses I have spoken to are perfectly healthy businesses but somehow, the way the wording is, they are deliberately triggered. Something in the termination clause triggers this so that the fees, instead of being £40,000, end up being £400,000. A business that is supposed to be a good, healthy robust business has become rife with abuse. That is going to be the direction of travel of my questioning now, just so you know where I am coming from. The former ABFA CEO, Kate Sharp, characterised complaint handling within the industry as “a David and Goliath situation”. Martin, would you agree with that or not?

Martin Morrin

No, I wouldn’t agree with it now, on the basis that we have a code that is set up, there is a complaints system and process and there is an independent ombudsman at the end of it. I suspect that what Kate may have been talking about at the time referred to pre that complaint system being in place and an independent ombudsman plus a Professional Standards Council.

Mr Newmark

Last year ABFA put in place the Professional Standards Council and independent ombudsman service, which you have just talked about. Why did ABFA decide that more self-regulation was necessary?

Martin Morrin

The decision that was taken was deliberate and open-minded. We looked at the wider financial services sector in terms of what best practice looked like. One of the things that was of concern all along was that if somebody had a complaint about an ABFA member—and particularly if you look at the smaller size of the SME market—in the event that that could not be resolved satisfactorily between the member and the client, they had nowhere to go. We did not feel that was fair and just, and we felt it was—

Mr Newmark

What triggered this? Did the industry wake up one morning and say, “Gee, we need to have a little bit more self-regulation” or was there an increased pattern of abuse that said, “Hey, we need to do a little more about this, otherwise we are going to be regulated if we don’t self-regulate”?

Martin Morrin

No, it wasn’t that. What triggered it was just part of an overall strategy of the ABFA in terms of: how do we get our message out to a wider audience? How do we give people confidence that, if you are dealing with ABFA members, you can be assured of transparency, you can be assured of a clear standard of service that are articulated and that there is a framework in the event that is not provided?

Professor Watson-Gandy

I may not seem to be the most likely ally for Mr Morrin but in the 20 or so years I have been at the bar—and I have spent a lot of my time either fighting for or more often against invoice discounters—one of the things that I have seen is a gradual and quite positive step being taken in the industry. It used to be perceived very much as the wild west of finance, and you have seen an increasing professionalisation of the industry over the last 20 years.

Mr Newmark

But is that because there has been increasing abuse, because it was the wild west, or increasing evidence of that or not?

Professor Watson-Gandy

I think it is more because traditional forms of finance for various reasons became less attractive, you have seen bigger players enter into the market and in those circumstances the industry itself is trying to provide parity.

Mr Newmark

We are going to get to some of those bigger players in a minute. The Financial Times reported that ABFA’s membership covers 65% to 70% of all asset-based lenders. How effective can a self-regulatory regime be with 35% of players still in the wild west?

Martin Morrin

ABFA’s assessment of the market is that its members cover about 95% of it.

Mr Newmark

So the Financial Times is wrong?

Martin Morrin

I am not sure on what basis they calculated that, but based on the volume of throughput that ABFA has, in terms of what it knows it members does versus those who are not members, that was its latest estimate.

Mr Newmark

Mark, do you think the code and independent ombudsman provides sufficient protection and recourse for small businesses?

Professor Watson-Gandy

No.

Mr Newmark

Why do you say that?

Professor Watson-Gandy

Number one it is a light touch regime but, bearing in mind that it is in essence club rules, you are not going to have a situation where—

Mr Newmark

Do you think members should be expelled? Do you think, for example, if there are insufficient sanctions, if there is not enough protection, how robust should the protection be?

Professor Watson-Gandy

There are two problems. First, if you impose your sanction and expel your member what is going to happen? It does not stop you doing business, you are just not a member of the club anymore.

Mr Newmark

You said it is a light touch regime. I was listening to what you were saying, if you are saying it is a light touch regime perhaps it needs a little bit more teeth so that if you behave badly the ultimate sanction is expulsion.

Professor Watson-Gandy

The other problem is this: if it is a harder regime you are going to have people saying, “I’m not going to join the club because I am going to have to comply with rules that my competitors don’t”.

Mr Newmark

We bring regulation in from the outside then?

Professor Watson-Gandy

Yes. Why I don’t think it provides adequate protection is because so far there are still areas that the rules do not cover but, more importantly, it is in terms of remedy. What is the maximum award that can be obtained for a small medium-sized enterprise? At the worst case scenario, if you go all the way to the ombudsman you can get a maximum return of £10,000.

Mr Newmark

Given the amount of rack renting that you are getting from these players, because some of them are making up to £300,000, if I am willing to risk £300,000 for some paltry fine of, say, £25,000 you would figure why not go for it? Yes, okay, so it is a problem. Now, Frances, do you think the system has insufficient sanctions?

Frances Coulson

I do. As I said before, if you do not have to be licensed then you can just choose not to be a member. If you are a member and you are sanctioned then if you are expelled you can carry on business. The difficulty is that it is self-funding as well. That is the problem. Does it have enough weight? If one of its larger members did breach the code, would it be willing to expel it because it has to pay a fee to join? So I think a licensing system, a regulatory system, even if the industry itself was the regulator, at least being compulsory would help.

Mr Newmark

In its written evidence to this Committee, the Professional Standards Council said that 44 complaints had been logged since establishing the industry complaints process in July last year. The industry serves 43,000 clients; 44 complaints. Why are so few clients using the complaints process, Martin?

Martin Morrin

We have to put the 44 complaints into context and those are the numbers that have been reported to ABFA. They will not cover those complaints that have been dealt with by the member themselves but each member is obliged to have their own internal complaints process. They are obliged also to maintain a log of all complaints and the ABFA, through the Professional Standards Council, can and probably will ask for a copy of that log when they come to look at the annual review so that they can get an overall picture of what is happening with complaints for that member and for the industry as a whole.

Mr Newmark

As Chair of ABFA have you personally reviewed any complaints from clients of asset-based financiers?

Martin Morrin

I haven’t because that is the responsibility of the Professional Standards Council, and one of the things that we have been at pains to point out is the independence of the Professional Standards Council. There are staff at the ABFA that deal with clients who have complaints in the first place, who guide and advise them. If they can be resolved through dealing with the member they will but in the event that—

Mr Newmark

But don’t you think that, as Chairman, you should be at least reviewing, at least seeing, what is going on with some of these complaints or not or are you removed from it?

Martin Morrin

In my day job I am also the MD for RBS Invoice Finance and I am a competitor of these people and, therefore, I think it would be inappropriate for me to be the person reviewing my competitors’ complaints when there is a Professional Standards Council that are equally as capable of doing that.

Mr Newmark

Do you think then you should be Chair of this organisation if that is the case, that you do not have access to what your business is supposed to be about as a self-regulator?

Martin Morrin

In terms of the complaints process, the standards piece of it has been passed primarily to the Professional Standards Council. That is not to say that either I as the Chair or any of the executive of the ABFA do not take this area seriously. We do and we do want to see the standards improve but we also want to see recognition of the really good work that many, many people do. Back to your point about the 40-odd complaints—and there will be more within the members—if you look at the levels of satisfaction of the clients that have been surveyed by the ABFA it is quite high and it is very encouraging.

Mr Newmark

I am just curious, do you think there should be some sense of backdating to allow customers who have been abused two or three years to say, “Hey, this happened to me two or three years ago, can you please look into this”? Does that happen? Is that allowed to happen under your current rules or not?

Martin Morrin

In terms of the current compliance process that deals with the new code, which took effect in July 2013, any complaints prior to that would be dealt with in relation to the old code. As you would probably appreciate, it is quite difficult to bring in new rules and make them retrospective. I am not aware that that happens in a statutory environment, let alone a self-regulatory one.

Mr Newmark

Frances, I have a quick question for you. What I am looking for is a better understanding perhaps of the nature of complaints that you come across, and I want to look the case of Bibby. In 2012 Bibby was found to have incentivised some brokers to identify struggling firms in order to profit from their subsequent collapse. Bibby said these were rare exceptions. I am just curious, how widespread do you think that sort of behaviour is in the industry? I appreciate you do the backend of what goes on there. By the way, I have seen other cases—and I don’t want to just focus on Bibby so they don’t feel like I’m picking on them—Ashley, Pulse, Close Brothers, Lloyds. I have seen examples of poor behaviour from all of those organisations and I am curious what your assessment is of what has been going on.

Frances Coulson

As I say, I think at the distressed end of the market. I don’t have direct overview of any of those individuals because I will see cases coming in at the end and then we have to get documentation and look back at what has gone on, if we can get documentation. But certainly if there is a referral, I think the difficulty is a company in distress takes advice, the directors personally don’t take advice. When a company is insolvent the directors owe a duty to creditors not to themselves or anyone else, but often the company and the directors do not take independent advice. There may not be complaints because if there is a problem the directors themselves may be liable. So if they have signed themselves up for a large termination fee and it is their fault, the creditors may look to them for that. So it just makes their position worse. You certainly do see those sorts of referrals and I do not know what the commission end is because we don’t necessarily get the paperwork for the brokers. I think it is very important that that is transparent and borrowers understand who is getting fees when. Before it had to be paid for, you were obliged to be told about commission if you were getting financial investment advice.

Mr Newmark

Martin, why was the independent ombudsman compensation award limited to £25,000?

Martin Morrin

That is a good question and it is an area we spend a lot of time debating in terms of what was the right level. Rather than hold up the launch of the code, we agreed to set it at a level where smaller members, in effect, could afford to sign up to the new code with the complaints system and have that compensation award at the end of it. The ABFA are well aware that for the bigger members it is not currently set at an appropriate level and that is a task for the Professional Standards Council in year two, which starts in July of this year, to sit down and look at where that is set and what is appropriate.

Mr Newmark

Frances, do you think it is too late?

Frances Coulson

I would have to say the cases I have seen are at the tail end so I think they will not be helped by that. Two things that could help significantly, for example, might be to make the termination fee not a part of the security, so that the primary lending was secured but not the termination fee. Also in an insolvency situation—which is obviously my field—if there had to be a liquidation following an administration, so whether that was the official receiver looking at a case or another insolvency practitioner looking at a case, there would be a look back. You would have an administrator rescuing a business, which is in the moment, they are trying to do the best to recover a business, help a business, perhaps get refinancing before an insolvency process. Let them do that in the moment but look back at it later. So a liquidation exit out of an administration would also help the perception of administration.

Mr Newmark

Basically we are all in agreement. There is an asymmetry or risk award at the moment that needs to be adjusted, right? Okay. Just a parting shot, Chairman, because I appreciate that time is ticking on. I have to say if ABFA and its members do not clean up their act—and I appreciate 99% of what is going on is good stuff but 1% is poisoning the well at the moment—certainly I, through the Chairman, am going to be calling for much tougher regulation from the outside, from the Bank of England or somebody, because you guys have to deal with the incredible bad practices that are hurting very small businesses that are not desperate for finance but are being triggered into some form of insolvency with huge termination fees, which I think are destroying some perfectly healthy businesses. They are not all healthy, but certainly in a number of examples I have seen that has been the case.

Chair

I am going to bring Steve Baker in again for a rejoinder in a moment, but I just want to follow up on the points made by Brooks Newmark. Mr Morrin, do you not think there is merit in trying to think of ways of reorganising your corporate governance so that the chairman, the lead figure in the organisation, can take up individual cases?

Martin Morrin

Yes. That is a good suggestion.

Chair

I do not want you to answer it in full now, it is unreasonable, but basically you are not saying it is bad idea?

Martin Morrin

No.

Chair

Does anybody else disagree?

Frances Coulson

No, subject to everybody having to be regulated by the Chair.

Chair

Mr Morrin, do you think that it might be a good idea if you find ways of taking every conceivable step to ensure that SMEs know, through the Federation of Small Businesses, through other organisations, that they should only go with people who are in the code?

Martin Morrin

Yes, I do.

Chair

What have you done so far in that area?

Martin Morrin

We have engaged with the Federation of Small Businesses and also the Chambers of Commerce in relation to the code. One of the pieces of work that we have to do is to make sure that people are much more aware of the code, of the standards, and indeed what they ABFA expects of its members. Mr Newmark’s point about 99% are probably good and doing a really good job, in my experience that is the case.

Chair

I think you made that point earlier. Am I right in thinking the discrepancy between the FT figure and your figures is that the FT figure is on the number of lenders, whereas the figures you were giving were on the volumes?

Martin Morrin

Yes, that may be so.

Chair

In which case, that suggests that there are a very large number of small lenders out there where the abuse might lie. Is that an assumption that is worth following up?

Martin Morrin

I am not aware that there is a very large number, but I will take a note of the names that have been mentioned earlier. I think the point that was made earlier by Frances, in terms of how do you get everybody into the same church—if I can use that expression—if self-regulation is going to work, and that is, in effect, the piece of work that has to be done next in terms of: how do we achieve that? Because we are conscious of the fact that not everybody is a member of the ABFA.

Chair

One way of getting people into the umbrella might be to do some publicity about the abuses that have taken place that have been brought to your attention, where the abuse has been from outside the umbrella.

Frances Coulson

Some of the smaller members, as I understand it, say they can’t afford to join ABFA because they are very small. I do not know what the joining fee is.

Chair

Crikey, that had not crossed my mind. What is your joining fee, Mr Morrin?

Martin Morrin

The joining fee starts at a few thousand pounds. I don’t think it will be the fee, per se, it is probably the criteria that is set in terms of balance sheet strength and so on.

Chair

Still that sounds like a hurdle.

Martin Morrin

It is a hurdle and that is why there is work underway as we speak to review the position.

Chair

The industry has a common interest here, so there may be some merit in larger players offering some initial cross-subsidy.

Martin Morrin

We are looking at the membership right now in terms of how—

Chair

Can you think of a good reason why you shouldn’t be expelling people who behave badly?

Martin Morrin

I can’t think of a good reason why we shouldn’t expel people who behave badly, provided there is evidence—

Chair

When was the last one you expelled?

Martin Morrin

We haven’t.

Chair

So I think there is quite a lot of movement needed here, isn’t there? Otherwise it is going to be another one of these cases where self-regulation hasn’t worked, and our experience with regulation is highly mixed. We do not want to reach for the heavy weaponry unless we have a lot of evidence that self-regulation won’t work. But a lot more has to be done, do you agree with that, Mr Morrin?

Martin Morrin

I agree that more needs to be done just based on what we hear. But what I would ask, and particularly from members of the Committee, where you have individual experience and where you have individual evidence of cases then the ABFA, along with either myself or the Chair of the Professional Standards Council, will be very happy to sit down and go through the specific cases.

Chair

All right. It sounds as if you can’t as things stand, but we have already looked at that issue because you say that there may be a competitor involved.

Martin Morrin

Yes, but assuming we can overcome that specific issue.

Chair

It sounds as if there needs to be some corporate governance reform. Some quite fundamental further reform seems to be needed.

Steve Baker

Ms Coulson, earlier on you painted quite a vivid picture of a journey of decay and you compared the situation to payday lenders. I am looking forward to the transcript so I can read it again. Also, Professor Watson-Gandy, I was thinking about your written evidence where you said the regulation was Leviathan in its volume and strikingly patchy in the protection it affords. Between the two of you I get this picture of a situation where at the bottom end, at the distressed end, the moral operators come in and end up ruining the market that might otherwise function. Just to cut all this down to the quick, do you think that there should be a legal duty of care on the lenders?

Frances Coulson

It is a commercial enterprise, isn’t it? I think it would be helpful if, at the very least, there had to be some form of legal advice for the directors. They do not have a bargaining position, they can’t amend the terms of the contract and so forth so they have nowhere to go as far as that is concerned. They at least need some form of independent advice so that they understand what they are in for if it goes wrong.

Steve Baker

I heard you make a point I have heard elsewhere, which is at the lower end of the smaller businesses they are akin to consumers. Do you think there is a case to be made that at the smaller end of the scale of SMEs they should be compared to consumers and perhaps have additional rights, like a lender’s duty of care?

Frances Coulson

Yes, there is something to be said for that. We are a nation of shopkeepers, it is said, so there is a lot of small business, and they do not necessarily have the access to professional services or whatever, or the time perhaps to take the advice, but they perhaps need to be forced to do it.

Professor Watson-Gandy

I am an emphatic yes for that suggestion.

Steve Baker

At the small end?

Frances Coulson

Yes.

Professor Watson-Gandy

Certainly at the small end. The practical example is this: I may be running a fairly successful business, in terms of whether I am growing beets or selling sofas or whatever and I know my area of the market very well. I understand the issues but when I come to raising funding and somebody tries to sell me a—

Steve Baker

Interest rate swap.

Professor Watson-Gandy

Precisely. I am in no better position than Joe Public.

Chair

We are opening up much wider questions here. Thank you. Is there anything that any of you came particularly wanting to say and you do not feel you have had an opportunity to unburden yourself about?

Frances Coulson

No, insolvency practitioners are in a very good place to give proper advice and, from my point of view—from the insolvency end—it is the look back and the liquidation exit, so that there is some check to what is going on in the live part of the rescue process.

Chair

You have heard the concerns of the Committee and one or two of you are going to come back with more material. We are very grateful indeed to all three of you for coming to give evidence this morning—now this afternoon by three minutes. Thank you very much indeed. Oral evidence: SME Lending, HC 204 2