The FCA has released the final findings from its Motor Finance Market review. The review started in July 2017 and so may have been impacted by market developments in the meantime but the FCA has expressed a clear intention to intervene. This could include strengthening existing CONC rules on commission arrangements so motor finance lenders and brokers will need to review their existing models and keep an eye on the regulatory road ahead.
Commission structures – a key concern
Some broker commission models provide 'strong incentives' for higher interest rates
The FCA is concerned that commission models allowing broker discretion on interest rates could have the potential for significant customer harm in terms of higher interest charges for borrowers. It thinks the Increasing Difference in Charges (DiC) and Reducing Difference in Charges commission models 'can provide strong incentives for brokers to arrange finance at higher interest rates'.
With DiC models, brokers are paid a fee which is linked to the interest rate paid by the customer. The contract between the lender and broker sets a minimum (for Increasing DiC) or maximum (for Decreasing DiC) interest rate and the commission earned by the broker is a proportion of the difference in interest charges between the actual interest rate and the agreed minimum or maximum interest rate.
Breaking the link between credit risk and interest rate
The FCA believes that DiC and other commission models allowing brokers discretion over the interest rate may also break the link between credit risk and interest rate. The FCA found that under DiC models, there is typically little relationship between a customer interest rate and their credit score.
Not enough lenders are being sufficiently proactive, so regulatory intervention is required
The FCA does not think that all lenders are doing enough to limit risks from their commission models. It is therefore starting work on assessing the options for policy intervention. This could include banning DiC and similar models or limiting broker discretion. It may also consider changes to strengthen existing CONC provisions.
In the meantime, the FCA expects lenders to review their systems and controls in light of its findings and, where necessary, address any identified harm or potential harm.
Pre-contractual disclosure and explanation: mixed results of mystery shopping exercise
A mystery shopping exercise was carried out on motor retailers and other brokers. The sample size was small, and focused in particular on independent retailers offering PCP or other forms of HP.
Industry sector investment in staff training is paying off
The FCA acknowledges that most brokers in its sample (particularly franchised retailers, car supermarkets and online brokers) appeared to make sufficient efforts to find out about customers' change cycles, ownership/usership preferences and budget. It suggests that this may in part be a result of industry sector investment in staff training.
Some brokers channel customers down the PCP finance route
However, other findings relating to the pre-contractual period were not so positive. For example, it was not always clear in sales discussions that there was sufficient balance between the benefits and downsides of the various finance options offered or available to customers. Instead, the lower monthly costs associated with PCP were generally promoted as the most attractive feature when compared with other HP products.
Initial disclosures and explanations are often incomplete and could also sometimes mislead
The limits of the FCA's exercise meant that it couldn't fully test all elements of pre-contract disclosure and explanations. However, disclosures or explanations given during the initial visit to motor retailers were often incomplete and sometimes potentially misleading. This places a question mark over compliance with relevant obligations.
Shortcomings in some broker explanations of PCP agreements
On PCP, only 31% of brokers explained that PCP and HP customers do not own the goods until all sums have been paid, and that goods can be repossessed without a court order in the event of default (unless the customer has paid a third or more of the total amount payable). Only 28% explained the total amount payable, the principal consequences of a failure to make payments, and the effect of withdrawing from the agreement.
Pre-contractual disclosure of commission is sometimes inadequate
Only a few brokers disclosed that a commission may be received for arranging finance. Even bearing in mind that such a disclosure could have been made later in the process (and therefore outside the scope of the FCA's exercise), the FCA queries whether this would be early enough to effectively alert the customer to the potential conflict of interest or to the possibility of negotiating on the finance as well as the vehicle and other price elements. Where disclosures were made, they were often not prominent.
A reminder of FCA requirements on TCF, transparency…
The FCA expects lenders and brokers to review their policies and procedures to ensure customers are treated fairly and with appropriate transparency. Specifically, any required disclosures and explanations should be provided in a clear and easy to understand manner and sufficiently early in the process to enable the customer to make an informed decision.
…and CONC in relation to commission disclosure
On commission disclosure, the FCA expects brokers to ensure that they are complying with CONC and reminds lenders that CONC requires them to take reasonable steps to ensure that persons acting on their behalf comply with CONC. The FCA thinks that where DiC and similar commission arrangements are in place there must be disclosure to comply with CONC 4.5.3R which requires the existence of the arrangement to be disclosed as the arrangement could affect impartiality and have a material impact on the customer's decision.
Lender monitoring of CONC compliance: is the theory really being put into practice?
In principle, the way lenders told the FCA that they monitor CONC compliance by brokers appears 'broadly reasonable'. But the FCA doubts whether and to what extent the controls outlined are implemented in practice.
Checking FCA authorisation of brokers does not fulfil lenders' monitoring obligations
Of particular concern is the finding that some lenders appear to take the view that it is sufficient to check that a broker is FCA-authorised, as it can be assumed that they will be compliant with FCA rules (as the FCA will monitor compliance). The FCA repeats its reminder to lenders that they are required to take reasonable steps to ensure that persons acting on their behalf comply with CONC. It also reminds them that they could be liable in law (under the CCA) for representations made by a broker acting as their agent.
Again, the FCA expects lenders to review their systems and controls, to reduce risk of consumer harm. They should monitor brokers adequately and take reasonable steps to ensure compliance with CONC, where applicable.
Variable compliance with FCA rules on assessing creditworthiness
The FCA is not satisfied that all lenders it surveyed were complying with its rules on assessing creditworthiness, including affordability. It expects firms to have reviewed and, where necessary, amended their policies and procedures in light of the new rules and guidance in this area which came into force on 1 November 2018.
Supervisory monitoring of creditworthiness compliance during 2019
Where it identified significant concerns, the FCA will follow up with individual firms to provide specific feedback. It will also be assessing compliance with the new requirements through its supervisory work during 2019.
With the FCA already starting work on assessing the options for policy intervention on broker commission arrangements, the motor finance sector needs to be on the lookout for more regulatory change.