The motor finance sector responds to FCA commission scrutiny

The way in which commission works in the motor finance sector has been highlighted for scrutiny by The Financial Conduct Authority (FCA), following a three year review that began in April 2017.

It has become concerned over the way that commission arrangements in motor finance can lead to consumer harm on a potentially significant scale. This in particularly pertains to the widespread use of commission models that link  broker commission to the customer interest rate and gives brokers the ability to set the interest rate.

This, it says, gives rise to conflicts of interest and creates strong incentives for the broker to charge a higher interest rate.

The FCA estimates that on a typical motor finance agreement of £10,000, higher broker commission under the reducing DiC model model – through which dealers and brokers can sell up from a base rate to earn increasing levels of commission – can result in the customer paying around £1,100 more in interest charges over the four-year term of the agreement.

This means that consumers are overcharged £300m annually according to Jonathan Davidson, the FCA’s executive director of supervision for retail and authorisations.

“We also have concerns that firms may be failing to meet their existing obligations in relation to pre-contract disclosure and explanations, and affordability assessments. This is simply not good enough and we expect firms to review their operations to address our concerns,” he said.

As part of its work the FCA also carried out mystery shopping of firms. It found that where disclosures of commission were given, these were not always complete, clear or easy to understand and as a result customers may not be given enough information to enable informed decisions.

The FCA was also not satisfied that all lenders were complying with the rules on assessing creditworthiness, including affordability.

It reports that “change is needed across the market, to address the potential harm we have identified. We have started work with a view to assessing the options for policy intervention.”

The first phase of the FCA’s review analysed contracts between some of the largest lenders (45% of the motor finance market) and their top dealers over the period 2013 to 2016. Four types of commission structure were used by this sample – increasing difference in charges (increasing DiC), reducing difference in charges (reducing DiC), scaled commission (scaled) and flat fee commission (flat fee).

It found that increasing DiC and reducing DiC commission arrangements can tempt brokers into arranging finance at higher interest rates because their commission goes up with the interest rate charged to the consumer. As the rate is at the broker’s concession, this can be taken advantage of quite easily.

The most recent work conducted by the FCA occurred in March 2018, when it collected data from lenders to assess whether commission arrangements have led to higher finance costs for customers. This, the FCA reported, “involved a sample of around 1,000 motor finance agreements from 20 lenders representing about 60% of the market. These covered January 2017 to July 2018 and represented a range of customers with different credit risk profiles.”

This study found that broker earnings varied widely across the commission models, particularly for increasing DiC, reducing DiC and scaled models. This means that they can “give rise to incentives for the brokers to charge the highest interest rates, given the associated sharp increase in commission levels that can be achieved.”

In response the review, however, the Finance & Leasing Association (FLA) has commented that it used out-of-date information.

Adrian Dally, head of motor finance at the FLA, said: “We welcome the FCA’s recognition of the work done by motor finance lenders to provide training for motor dealers, and the positive impact this has had in meeting customer needs.

“Regarding the FCA’s concerns about commission structures, their survey work is based largely on out-of-date information, and therefore does not reflect the very considerable progress the market has already made in moving away from such structures.

“We look forward to working with the FCA as it modernises its regulations in line with market best practice.”

Other figures in the industry have also added comment, including James Fairclough, CEO at AA Cars: “The FCA report is in line with our own belief that the industry needs to do more to help customers really understand the choices open to them.

“It is key that we simplify car finance for the general public and make it more transparent, so customers can make informed decisions.

“Importantly, what shouldn’t be inferred from this report is that there’s a fundamental issue with the finance products themselves. Instead the issue is how they are sometimes presented to the public.

“The best thing consumers can do before seeking out car finance is arm themselves with as much information as possible.

“There are also online portals that allow customers to carry out ‘soft’ credit checks to see what products they are eligible for without leaving a mark on their credit report, as well as providing a simple breakdown of costs over the course of the term, meaning they aren’t caught out by an surprise fees.”

Sean Kulan, sector lead consumer credit at Huntswood, added: “Today’s findings from the FCA provide a clear call-to-action for lenders to be more transparent in how they communicate with customers, ensuring they are not unwittingly overcharged.

“The widespread use of commission models, allowing brokers discretion to set the customer interest rate and therefore earn higher commission (for example, increasing difference in charges), has been firmly put under the spotlight.”

“In addition to reviewing commission structures, firms should also be reviewing existing obligations in relation to pre-contract disclosure and affordability assessments.”

Dealtrak also responded to the review, calling it uncomfortable reading for many within the automotive industry. Neil Watkiss, head of consumer credit at DealTrak, believes the research will inevitably mark a real positive catalyst for change.

“The report hints towards a consideration of banning unfair commission models and limiting car dealers and finance brokers’ ability to set car finance rates.

“There will undoubtedly be impassioned discussion taking place between lenders, dealers and brokers around the UK.

“The FCA makes it clear that lenders are expected to review their systems and controls in light of the report’s findings. It is extremely likely this will lead to changes in the calculation of finance commission as well as the amount received.

“While many lenders have long-since dispensed with the conventional DiC commission they have instead adopted the reducing DiC model, whereby dealers and brokers can sell down from a standard rate, for reducing levels of commission.

“Significantly though, the FCA believes the reducing DiC model is just as detrimental to customer outcomes as the conventional model.”

However, Watkiss highlights a flaw in the review. “By not following the customer journey all the way through to the final sale, the FCA was unable to fully test all elements of pre-contract disclosure and explanations.

“As a result, lenders are criticised for appearing to be over-reliant upon standard documentation and contractual terms, in addition to not providing enough oversight of their intermediaries.

“The FCA also implies that lenders are more invested in their own credit risk, than assessing the affordability of the loan for the customer, when of course dealers and brokers have a significant role to play when it comes to establishing affordability.”