Give SMEs the regulatory protection they deserve

Lord John Sharkey, Liberal Democrat Peer and Ned Beale, Hausfeld Partner, share their thoughts in an article for Thomson Reuters Regulatory Intelligence about the fact that commercial lending to SMEs remains unregulated. SMEs are the lifeblood of the UK economy, comprising the overwhelming majority of businesses by number, and liquidity is the lifeblood of SMEs. 

That is especially so in the post-pandemic economy. As the CBI commented when publishing its April 2022 trade survey figures, poor retail sales reflect how rising prices are affecting households’ spending power, which means that the cost-of-living crisis is going nowhere soon. This squeeze is already affecting SMEs in retail, services and manufacturing. 

It was not surprising that the Insolvency Service announced that business insolvencies had reached a 60-year high in Q1 2022. It is therefore vital - not only for SMEs, but for the entire economy - that businesses have access to finance. They should also be treated fairly and sensitively when loans are refinanced or if they struggle to make repayments.

However, SMEs can take scant comfort from banks’ past conduct. SMEs have borne the brunt of bank misconduct in previous recessions. As the multiple reviews into banking scandals such as Global Restructuring Group and the fraud at HBoS Reading have shown, that misconduct has been most egregious in recovery units such as RBS’ Global Restructuring Group and Lloyds’ Business Support Unit. These bank recovery units are the divisions of banks likely to be particularly active in 2022.

The case for regulation is particularly compelling because SMEs will rarely have the practical ability to enforce legal rights against banks. It would be exceptional for an SME to have the financial resource to take a bank to court. Even if an SME is brave enough to do so, they face a judicial environment which, more often than not, favours the bank. A judge trying a claim arising out of the 2008 recession ruled that a bank executive threatening to have a borrower’s ‘head on a spike’, in the context of forcing a sale of the borrower’s assets to the bank’s own connected company, was merely part of the ‘rough and tumble’ of normal commercial negotiations.

The counterweight to all of this should be the UK’s financial services regulator, the Financial Conduct Authority. However, as the FCA acknowledged in its latest regulatory perimeter report, almost all lending to businesses is unregulated. The FCA also highlighted that the unprecedented nature and take-up of the Bounce Back Loans Scheme, and that these loans are now being collected. However, the FCA’s only actual extensions of the perimeter were to funeral plans and crypto-assets.

This is tinkering at edges, leaving SMEs just as vulnerable as before. The authors believe that legislation can and should be passed which requires the FCA to provide meaningful protection to SMEs as the country faces stagflation or recession.

We propose new legislation which will enact two changes. First, it will ensure commercial lending to SMEs generally and in respect of property is regulated. That will be achieved by amending the FSMA Regulated Activities Order 2001 to remove the exemptions for credit agreements exceeding £25,000 and those relating to the purchase of land for non-residential purposes where the borrower is an SME. This will bring a large segment of lending to SMEs within the scope of the FCA’s protection.

Second, it will enable SMEs to sue lenders for breaches of their regulatory protections by amending the FSMA Rights of Action Regulations 2001 to enable SMEs, as well as individuals, to bring actions for breach of the FCA and PRA rules as ‘private persons’. Many legal claims by bank customers, for example in relation to interest rate swap mis-selling, foundered because banks are not currently liable for breaches of the Financial Services and Markets Act 2000. This change will therefore help business help themselves, via court action.

In each case, the EU’s definition of SME should be adopted, being a business which employs fewer than 250 persons and has either an annual turnover not exceeding £40m or an annual balance sheet total not exceeding £36m.

The authors believe that this legislation will help the entire economy. It will enhance protection and also simplify it, by aligning SME protection with that already enjoyed by individual consumers, as well as with that often promised to business customers by banks’ own policies. Meanwhile, avoiding the scandals that have plagued the banking sector since 2008, and which are still costing banks significant sums in litigation, reviews and compensation, will help every part of the economy.

A bill to this effect, proposed by Lord Sharkey, is entered in the May 2022 House of Lords ballot and will hopefully receive a second reading before or after the summer break, depending on the results of the upcoming draw.

For the original article (subscription only), visit the initial publication site, Thomson Reuters Regulatory Intelligence.