The Future of Insolvency Regulation

The Insolvency Service have recently published a consultation paper proposing significant reform of regulation of the Insolvency Sector. The consultation paper is seeking stakeholder feedback on the detail of proposed reforms, with the future of insolvency regulatory subject to the response to this consultation. The key features of the proposal to reform Insolvency Regulation include:

• Creating a single regulator to sit within the Insolvency Service, replacing the current system that uses multiple Recognised Professional Bodies (RPBs)
• Bringing insolvency firms under the scope of regulation, as the current regime only covers individual Insolvency Practitioners
• Establishing a public register listing all individuals and firms that offer insolvency services
• Establishing a formal system for compensation
• Changes to the current arrangements for Insolvency Practitioners to hold a bond to cover losses caused by fraud or dishonesty

The proposal to reform the regulatory regime of the Insolvency Sector is greatly welcome in the credit union sector. Credit unions have widely experience issues with Insolvency firms in recent years, notably with Individual Voluntary Arrangements (IVAs) and Protected Trust Deeds (PTDs), and often see little action to resolve or rectify these issues. ABCUL have previously called for a different system for regulating the insolvency sector, and so it is a relief to see action to rectify the deeply flawed system of insolvency regulation.

However, the depth of the issues to be overcome also mean that it crucial that reform goes far enough to create a robust and rigorous regulatory regime for the sector. This briefing highlights the consultation proposals that are of interest to the credit union sector and gives a brief overview of ABCUL’s thoughts on the proposals.

As ever, we would keenly welcome member feedback on the Insolvency Sector’s proposals, to inform ABCUL’s response to the consultation of behalf of its membership. Please direct any feedback to the policy team via policy@abcul.org by close of business on Monday 21^st March.

Background to Consultation

In the current regulatory regime for insolvency, regulation only applies at the level of individual Insolvency Practioners, with insolvency firms left unregulated. Though insolvency services is a relatively small industry, it is regulated by four different Recognised Professional Bodies (RPBs). The four RPBs each set rules and regulations for their Insolvency Practioner members. These rules aim to deliver the professional standards for insolvency set by the Joint Insolvency Committee (JIC).

The Insolvency Service works with the four RPBs as an ‘oversight regulator’ for the insolvency sector. However, this regulatory arrangement has become fraught with issues, and the current regulation of insolvency is no longer fit-for-purpose. This has been the experience of ABCUL member credit unions, who have seen little action to rectify the poor practice in the insolvency sector, in particular with Individual Voluntary Arrangements (IVAs) and Protected Trust Deeds (PTDs). These debt solutions are often mis-sold by insolvency firms, that proceed to charge debtors with an extortionate level of fees, whilst seeing little return to the creditor. As the consultation paper highlights, in the current system complaints against misconduct of Insolvency Practioners are handled slowly, with little redress to the creditor or debtor harmed.

As a result, the Government is consulted on undertaking a wide reform of insolvency sector regulation, with the aims to create better outcomes for debtor and creditors involved in insolvency services and improved professional standards in the industry, by introducing a more effective regulatory system.

Proposals for the Future of Insolvency Regulation

Proposed Model for a Single Regulator

The pivotal aspect of the proposed reforms is to introduce a new, single regulator for insolvency to sit within the Insolvency Service, instead of the current systems of the four RPBs. This new regulatory model would apply to England, Scotland and Wales. The new single regulator would hold powers to authorise, regulate and discipline firms.

The Insolvency Service are also consulting on the option of either leaving the current regulatory system as it is, or taking a non-legislative approach to improving the regulation by promoting best practices amongst the RPBs.  However, the Government have expressed that creating a single government regulatory is its preferred option.

The new single regulator would be set up as an arm’s length body which would be independent from other functions of the Insolvency Service. Whilst there is scope within current legislation to be able to transfer regulation of the insolvency sector of the Financial Conduct Authority, the Government have decided it would be most effective for regulation to sit within the Insolvency Service where there is the necessary expertise and focus on the unique features of the insolvency sector.

Proposed Function of a Single Regulator

Th functions in relation to the regulation of Insolvency Practioners and firms, including: monitoring compliance with regulation; setting professional standards for insolvency; investigating complaints; imposing sanctions and other disciplinary measures.

The Government are seeking feedback on its proposed statutory objectives for a single insolvency regulator. The suggested objectives in the consultation for the regulator are to have a system of regulation that:

• Secures fair treatment for those impacted by insolvency and acts impartially and transparently with regard to those regulated
• Encourages a competitive and innovative industry, that acts with integrity, promotes the maximisation and promptness of returns to creditors, protects the public interest and offers high quality services at a fair and reasonable cost
• Supports those regulated in complying with their responsibilities and ensures consistent and effective outcomes

It is proposed that the regulator would work with industry experts to produce the new set of professional standards in the insolvency sector. The consultation also notes a potential for a non-statutory committee to be set up to provide advice to the regulator in developing these standards.

One aspect of the proposals that would stand to make a significant impact to credit unions is the change in how complaints are processes and investigated. In the current system, complaints on Insolvency Practioners are submitted to a central portal, but then delegated to be handled by the relevant RPB. This system has demonstrated to be insufficient, with complaints resolved slowly and often resulting in no corrective action. The Government expresses in the consultation that it hopes a new complaints investigation process sat within the single regulator would be much more efficient, effective and consistent.  Further, the regulator would have powers to take a range of enforcement and disciplinary actions where there has been evidence of misconduct.

A further aspect of the proposals is the ability for the single regulator to delegate some of its regulatory responsibilities to other bodies, including the current RPBs. The suggested functions that would be able to be delegated include handling authorisation applications, routine monitoring of compliance and provision of training for the insolvency sector. Some functions, such as complaint investigation and taking disciplinary action, would not be able to be delegated.

Statutory Regulation of Firms

Another significant aspect of the proposals is to bring firms into scope of insolvency regulation, as opposed to the current regulation that only covers individual insolvency practioners. This proposal is intended to ‘plug a gap’ in the current regulatory system and address the current conflict of interest between individual IPs and firms that employ them. In particular, the regulation of firms has been suggested to take action against ‘volume providers’ of IVAs and PTDs.

It is proposed that there is an ‘additional requirements regime’ put in place for larger insolvency firms that present a greater risk level to the public. In the consultation paper, it is suggested that an additional requirements regime could include:

• A requirement to appoint a senior responsible person to ensure compliance of the firm
• A requirement of the firm to demonstrate its suitability to conduct business, including an appropriate business model
• A requirement to provide confirmation that appropriate controls and governance are in place, to ensure that there are no conflicts of interest between the aims and policies of the firm and the duties and responsibilities of the Insolvency Practitioners they employ
• A process for enhanced monitoring

Public Register for Insolvency Practioners and Firms

Included in the proposal to establish a single regulator is the move to a single system of registration. The Insolvency Service propose to put in place a statutory public register to record authorisation of insolvency firms and individual practioners, instead of the licensing process currently used to authorise Insolvency Practioners. The register would provide a publicly available record of all firms and individuals authorised to offer insolvency services. The register will also indicate whether there has been any disciplinary action or sanction taken against the firm or individual by the insolvency regulator.

A Mechanism for Compensation

The Government proposes that a formal compensation scheme is established with the new single regulator. At present, there are only statutory measures for creditors to recover funds in limited situations, where the Insolvency Practioner has committed fraud or acted with dishonesty. The purpose of introducing a compensation scheme would be to allow a complainant (either a creditor or debtor) to be compensated for any loss or distress caused by an error made by an Insolvency Practioner or firm. The Government is proposing that a compensation scheme is introduced under the new regulator as an alternative to using the Financial Ombudsman Service for complaints.

In the consultation paper, it is asked of stakeholders whether the new regulator should have the power to require insolvency firms or practioners to:

• Pay compensation of up to an amount of £250 where there has been a service failure which has caused undue inconvenience, anxiety or distress to an individual. For example, where a practitioner has failed to address a question from a debtor about the future of the family home, which has caused the debtor and their family excessive anxiety.
• Restore a party or parties to the position they would have been in had a wrongdoing not occurred, which could be non-monetary, but could also include repayment of financial loss to an estate incurred as a result of the action of an Insolvency Practitioner or a firm offering insolvency services.
• Repay or waive fees

There is a caveat to this proposal as another question being consulted on is whether there should be limit to the value of compensation that the regulator could direct firms to pay to complainants. The Government is also consulting on whether compensation should have to be paid by the firm or practitioner at fault, or if a complaint levy fund should be collected across the sector for the regulator to use to compensate complainants directly.

Reform of Bonding Arrangements

Under the current regulations, Insolvency Practioners must have a surety bond in place, which is used to protect insolvent estates from any losses incurred because of the Insolvency Practioner’s fraudulent and dishonest behavior. Following the views gathered in the 2016 Call for Evidence, the Government has acknowledged that current bonding arrangements have not been effective in protecting creditors from financial loss where an Insolvency Practioner has acted with fraud or dishonesty, and propose to reform these arrangements.

However, a change in primary legislation would be needed to carry out the amendments the bonding arrangements that the Government sees as necessary. This can take an extensive period of time to implement, so the Government is looking at taking a number of steps to improve the current bonding arrangements and protection for creditors in cases of fraud and dishonesty in the interim, whilst the shape of more significant reform is development.  The following changes to the minimum statutory requirements of a surety bond are proposed as interim measures:

• To allow creditors to claim funds to cover the costs associated with making the bond claim. This would be to ensure creditors are not making further significant loss from having to make a claim.
• To add a period of run-off cover so that claims can be submitted for a time after the Insolvency Practioner has left office.
• For interest to be accrued on amounts to be paid out under the bond, based on the value of the loss and accrual started on the date the loss was incurred.
• For cover for a general penalty sum (GPS) to apply to all cases handled by an Insolvency Practioner, so there is a ‘safety net’ of surety bond cover in all cases.

It is also proposed in the consultation that transparency of this protection for creditors is improved by requiring Insolvency Practioners to declare the level of cover on an estate as part of any reports provided to the creditor.

ABCUL’s Feedback on the Consultation

ABCUL strongly agree with the Government that significant reform is needed to the structure of insolvency regulation to protect both creditors and debtors. In particular, we are highly supportive of the intention to put in place greater regulatory invention against ‘volume’ providers of IVAs and PTDs. We would therefore welcome the introduction of a single regulator for the insolvency sector and the move to bring insolvency firms within scope of regulation. We would also greatly support the introduction of a compensation scheme, and steps to improve the surety bonding arrangements, as this would put much greater protections in place for credit unions against the malpractice of insolvency firms and practioners.

However, our initial expectation of reform would have been to bring regulation of the insolvency sector under the FCA. We understand the logic behind the keeping regulation of the sector under the Insolvency Service, in terms of the practical reasons of accessing industry expertise and the greater ability to tailor the regulation to the insolvency sector. However, it does not clarify if the insolvency sector will be required to reach the same professional standards as the rest of the financial services industry. The devil will be in the detail of the new standards set for the conduct of insolvency practioners and firms, and we would hope that the relevant principles of FCA regulation will be incorporated into the new standards set for the sector. Nevertheless, the level of measures proposed for redress and compensation to creditors and debtors does indicate that the Government is taking the impact of malpractice of insolvency firms seriously.