THE VOUCHER SECTOR

Voluntary protection in most cases

11.16 When insolvent retailers are unable to allow redemption of gift vouchers, consumers suffer detriment. It was put to us that all gift vouchers should be backed by trusts. Otherwise, the consumer is simply buying a low-grade debt at face value without either discount or interest.

11.17 We do not agree that all gift cards and vouchers should be regulated. For most retailers, our research suggests that the level of potential detriment is relatively small in comparison with the size of the market, which is now worth £5.4 billion.⁸ As we saw in Chapter 3, in the majority of cases administrators honoured vouchers during a period of trading in administration, in order to preserve consumer goodwill and the commercial value of the brand, encourage consumers to spend in-store, or to avoid negative press coverage. This makes vouchers from well-known retailers, or from retailers who hold stock, relatively low-risk.

11.18 Furthermore, when consumers do lose money, it appears that they typically lose small and affordable amounts. In the case of Zavvi, for example, the average value of vouchers held by consumers was only £8.12.

11.19 We fear that the regulation of all gift vouchers would impose a significant burden on a wide range of businesses, including small and medium enterprises.

Vouchers are not just issued by high street stores. Small firms, from florists to butchers, can and do issue vouchers. These businesses might find administering trust accounts or applying for insurance to be particularly burdensome.

11.20 However, we urge retailers to do more to protect vouchers on a voluntary basis.

As we argue in Chapter 7, the voucher industry will only thrive if consumers have confidence in it, and that confidence could be undermined by one or two major insolvencies. In Chapter 10, we explore ways to make voluntary protection easier.

11.21 Unsurprisingly, consumers appear to have a low awareness of the Electronic Money Regulations 2011, and may have little idea about whether vouchers are protected. We would wish to increase consumer awareness in this area. We think that providers of vouchers should state in the terms and conditions whether or not any protection is in place in the event of insolvency. We ask whether this can be introduced voluntarily or whether it would require regulation.

A case for regulation in higher-risk sectors?

Risk factors

11.22 Four factors increase the risk of detriment to prepaying consumers:

(1) Consumers pay significant sums.

(2) Sums are held for a relatively long period of time.

(3) Consumers find it difficult to obtain redress from their debit or credit card issuer: either because they have paid by other means; or because the payment was made to one intermediary and passed to another; or because the person who bought the voucher is not the holder of it.

(4) The company holding the funds does not predominantly sell other goods and services and will therefore be unlikely to trade in administration.

8 UK Gift Card & Voucher Association, Gift Cards & Vouchers in the UK – Summary 2014, http://www.ukgcva.co.uk/downloads/factsheets/summary_2014.pdf.

11.23 We discuss two scenarios in which these factors are present. The first is savings schemes, typically for Christmas, where consumers pay for vouchers and goods in advance as a form of saving. We think that there is an argument for introducing some form of regulation for these schemes because they are, in essence, savings products.

11.24 The second is the business model where the retailer’s main business is the sale of gift vouchers which can be redeemed with third-party suppliers. We call this the “intermediary model”. Many voucher intermediaries take steps to reduce the risk of insolvency through prudential accounting standards, holding funds in low-risk investments and, generally, not using money supplied by consumers for other purposes. However, where these measures are not in place, the intermediary model poses greater risks. We think there is an argument for the Government taking reserve powers here, to be used if and when there is evidence of demonstrable need.

Savings schemes

11.25 The biggest consumer losses in recent years arose when Farepak collapsed in 2006, owing £38 million to consumers who had been saving for Christmas. The issue caused great public concern – MPs received huge amounts of correspondence on the issue. The savers waited six years for payment and eventually obtained around 50 pence in the pound (though 70% of this came from compensation funds set up to meet hardship, rather than through a distribution from the insolvency).

11.26 Christmas and similar savings schemes are high-risk: funds are typically held for a relatively long time and tend to represent significant amounts for the consumers concerned. Consumers who are saving money expect protection. This is provided to those who are saving with financial institutions. However, Farepak was not subject to regulation because consumers received vouchers rather than cash returns.⁹

11.27 Several Christmas savings schemes continue to exist. Some are voluntarily members of the Christmas Prepayment Association with trust arrangements in place.¹⁰ However, others (particularly supermarkets) have no such arrangements.

While some do take steps to segregate consumers’ money in a separate company account, this would not protect consumers in the event of insolvency.

Given the size of the Farepak insolvency, and the public anger it caused, this is worrying.

9 A comparison might be drawn with “layby” sales in New Zealand, where goods are paid for in instalments and only delivered when payment has been made in full. These have a statutory priority on insolvency. See para 12.6 for further discussion.

10 For a list of members of the Christmas Prepayment Association, see http://www.cpa-advice.co.uk/members.htm.

11.28 In many sectors of the economy, businesses need to rely heavily on consumer prepayments for working capital – but we do not think that Christmas savings schemes are one of them. We disagree with the OFT on this point. Members of the Christmas Prepayment Association already hold prepayments on trust.

Supermarkets, which do need working capital to service other parts of their business, are nevertheless sufficiently large and well financed that their working capital does not need to come from savers’ money. This is illustrated by the fact that some already segregate consumer funds, and the fact that the Co-operative holds the money on trust as discussed in Chapter 10. Supermarkets benefit from Christmas savings schemes because it increases their sales. In our view, non-regulated businesses should not be operating savings schemes to obtain money to finance other operations.

11.29 Where people put their money in savings clubs, or in products which are marketed as savings schemes, they expect their money to be protected. This protection is already in place where consumers save with financial institutions.

However, the schemes we are concerned with take prepayments for products, services or vouchers and do not return cash to consumers in the way that banks and building societies do.

11.30 We do not propose that such savings clubs should be regulated as financial institutions, which would be onerous and disproportionate. However, it is often the most financially vulnerable who choose these alternative forms of “saving”

and we do not think that these types of schemes should be entirely unregulated.

We think that the Farepak case demonstrates a need for Government intervention in the sector.

How would a savings scheme be defined?

11.31 These non-regulated savings schemes may take different forms. They may, as Farepak did, take monetary instalments in return for goods and vouchers provided at the end of the saving period. They may take the form of gift or loyalty cards which can be loaded up over time.

11.32 We think that the main mischief is marketing a scheme as a form of savings mechanism without providing any protection for the money taken. There are many different words which imply that a scheme is suitable for savings. For example, one travel company advertises its gift cards as “a great way to save”

towards a special holiday, while a toy shop markets a “piggy bank” re-loadable gift card for children. Christmas schemes may be described as “helping families budget for Christmas” by paying “small regular amounts throughout the year”.

11.33 We think all these forms of words suggest that the scheme is suitable for use as a savings vehicle. The definition should catch anything marketed or structured in a way that implies it is suitable as a savings scheme.

What form would the regulation take?

11.34 We provisionally propose that firms should be prevented from marketing or structuring a scheme in a way which suggests that it is suitable as a savings vehicle, without protecting the funds in some way. We think that this should constitute a form of misleading action, similar to other misleading actions within the Consumer Protection from Unfair Trading Regulations 2008.

11.35 Clearly, financial institutions already take sufficient steps to safeguard funds. For other schemes, we do not suggest that traders would need to be authorised by the Financial Conduct Authority, or be subject to anything like the same form of regulation. We envisage that the main form of protection would be holding money on trust. We do not think that this would impose great costs on businesses: those which are part of the Christmas Prepayment Association will already have protections in place, and other businesses should be able to segregate such funds easily as they will not generally rely on them for working capital. We also envisage that firms would be allowed to choose alternative protections if they preferred, such as insurance, bonding or the consumer charge discussed in Chapter 10.

11.36 We seek views on this proposal. We are particularly interested in whether our definition is correctly targeted, and in how far the proposal would impose additional costs.

Voucher intermediaries

11.37 There are several different types of voucher intermediary involving different degrees of risk depending on the precise nature of the business model employed.

11.38 In Chapter 7, we discussed the problems in defining electronic money. The Electronic Money Regulations 2011 apply to “open loop” cards which can be redeemed at a range of retailers for a range of goods. Examples include the Love2Shop gift card and travel currency cards. These cards must be backed by ring-fenced funds. However, there is an exception for “limited network” cards, which can be redeemed from a limited category of retailers, or from a wide range of retailers but for a limited category of products. Book tokens, and spa vouchers redeemable at a number of different spa locations, are well-known examples.

While open loop cards are subject to considerable regulation, limited network cards are not.

11.39 Other intermediary models are those which sell vouchers for “experience days”

such as hot air balloon rides, or websites such as Groupon and Wowcher which advertise a wide range of discounted goods and services. In these cases, the consumer is usually directed to a specific provider of the relevant goods or services which is separate from the company which takes payment for the vouchers.

11.40 In all these cases, the funds tend to be held by an intermediary until the voucher is used. Importantly, because they do not hold stock, intermediaries are less likely to trade while in administration, and retailers or other third party suppliers may well stop accepting vouchers which the intermediary had issued. They are also less likely to involve well-known brands which administrators and future purchasers will wish to preserve by accepting vouchers.

11.41 In para 11.22, we identified risk factors. The first is that consumers pay significant sums. Examples where the consumers may pay significant sums to intermediaries are vouchers for experience days or theatre tokens. In these cases the intermediary issues a limited network card or voucher, possibly for

£100 or more, which can be redeemed from a range of suppliers.

11.42 The second is where these vouchers are held for a relatively long time. For example, vouchers may be sold for Christmas or Valentine’s Day and redeemed during the summer, when outdoor experiences are more attractive. This contrasts with distributors who organise “gift card malls”,¹¹ which hold money for only two or three weeks before passing it to the retailer involved.

11.43 The risks of holding significant sums, or holding sums for relatively long periods, would not be sufficient to justify regulatory intervention on their own. Indeed, there are few examples of such intermediary models becoming insolvent and causing loss to consumers. In the only case we have identified, Red Letter Day, loss to consumers was avoided because new purchasers of the business agreed to honour vouchers.¹² However, the business model can pose particular risks, if firms were to take significant funds, owe liabilities for a long time, use funds for other purposes and fail to provide consumers with any form of protection.

11.44 The OFT was right to draw attention to the problems of definition. There are many different business models which constitute intermediaries and we have considered whether some pose greater risks than others.

Lower-risk intermediaries

11.45 If intermediaries were to introduce the protections we outline in Chapter 10, this would improve the outcome for consumers on insolvency. However, this may not be practicable. Intermediaries are unlikely to be able hold 100% of all voucher sales on trust as they have no other income streams to fund the operation and marketing of the business. Additionally, the lack of prepayment insurance products may mean that this is a costly solution for intermediaries whose business model yields very small margins (which may be 1% to 2% of the voucher amount). Finally, a statutory priority or a voluntary priority (by way of consumer charge) may be of little use here as the insolvency of the business will usually mean that the funds have been depleted.¹³ Unlike in the case of high street retailers, there is also less likelihood of there being secured creditors over whom a priority could be asserted.

11.46 While we would welcome the use of trusts (along the lines outlined in Chapter 10 whereby a proportion of the funds could be used for the costs of running the business) and the development of insurance products, we are aware of the difficulties these may pose in practice. We are therefore interested in finding out more about the steps intermediaries take to manage funds they hold in a prudent manner, thereby decreasing the risk of the business becoming insolvent in the first place.

11 These are stands in retail outlets (and online) where consumers may choose from dozens of gift cards for different retailers.

12 See para 7.28.

13 In situations where the insolvent retailer has assets such as stock, leaseholds and other sales revenue, these may be realised for the benefit of creditors. In the case of voucher intermediaries, where the main asset is a reserve of cash, this is less likely.

11.47 Many companies which use the intermediary business model work already take active steps to protect their cash reserves. In particular, they:

(1) have high liquidity and hold cash balances, or low to medium risk investments, in excess of the value of the vouchers they expect to be redeemed;

(2) have rigorous accounting standards and prudent models for calculating breakage;¹⁴

(3) do not have secured lenders as their business model does not require external funding;

(4) do not invest funds in high-risk ventures or use funds for other purposes, and have independent investment committees to ensure this.

11.48 Furthermore, some voucher intermediaries (including National Book Tokens, Theatre Tokens and National Garden Gift Vouchers) are run on a not-for-profit basis and so are not under the same commercial pressures to use funds for other purposes.

11.49 We believe that businesses which reduce the risk of insolvency by handling consumer funds in the manner described above already mitigate the risks inherent in holding voucher proceeds for an extended period of time. We do not wish to impose any additional regulatory burden on these firms, and hope that this kind of behaviour could be further encouraged. We would welcome any voluntary accreditation scheme, led by industry, which allows those who adopt prudent financial behaviour to make this known to consumers.

High-risk intermediaries: a need for regulation?

11.50 However, the situation is different where intermediaries do not adopt the above measures and expose the funds they hold to risk. With a significant amount of funds at their disposal and no immediate obligation to repay it, intermediaries may seek to maximise returns on investments for shareholders, to further expand their business, or to recognise revenue from the sale of gift vouchers as immediate profit.

11.51 The problem is that anyone may start an intermediary business by issuing vouchers for significant sums to be redeemed within a limited network of suppliers many months later. Unlike those who fall within the Electronic Money Regulations 2011, such intermediaries are under no obligation to segregate or account for the funds they receive from consumers. Instead, an intermediary selling such vouchers may use its funds for any purpose, including buying another business, lending the money to another member of the group, or expanding its business through advertising. ¹⁵

14 Breakage is the trade term for the level of vouchers which are never redeemed.

15 There is nothing in law to prohibit intermediaries from using the funds as they see fit.

11.52 This is unsatisfactory. While we hope that all businesses will be able to lower risk by adopting the measures we discuss in paragraph 11.47, we think that there may be a case for requiring intermediaries to protect deposits where high-risk behaviour continues.

11.53 We think that legislation should provide the Government with a reserve power to regulate in this area, if the need arises. This would permit the Government to require high-risk voucher intermediaries to hold money on trust, or to protect prepayments in other ways, for example through insurance or bonding.

11.54 At present, we propose only a reserve power. This would identify risk factors in general terms. Clearly, before using such a power, the Government would need to consult carefully on the details of the definitions and on the impact of the regulation. We would not wish to impose additional costs on well-run businesses and would welcome the emergence of industry standards which reduce the risk of insolvency.

DEPOSITS

11.55 The scale of potential consumer detriment and hardship is greater where consumer prepayments take the form of deposits rather than gift vouchers. As we saw in Chapter 3, the value of a deposit tends to be higher than the value of the average gift voucher. In addition, they are more likely to have been paid by the consumer for their own benefit rather than as a gift. However, options for prepayment protection are particularly limited where retailers legitimately rely on funds received for working capital in order to service the orders on which the

11.55 The scale of potential consumer detriment and hardship is greater where consumer prepayments take the form of deposits rather than gift vouchers. As we saw in Chapter 3, the value of a deposit tends to be higher than the value of the average gift voucher. In addition, they are more likely to have been paid by the consumer for their own benefit rather than as a gift. However, options for prepayment protection are particularly limited where retailers legitimately rely on funds received for working capital in order to service the orders on which the