As one of the fastest growing areas of consumer credit, is motor finance just too big a target to ignore for claims management companies (CMCs) following the passing of payment protection insurance (PPI)? We look here at the implications for funders in this space following increased regulator scrutiny.
Whilst few will likely shed a tear for the end of the PPI advertising barrage, the motor finance industry may rightly be steeling itself as the next target of such interest from CMCs following recent investigations by the Financial Conduct Authority (FCA) into the sale of motor finance to consumers.
Following the FCA’s reviews of both Personal Contract Purchases (PCPs) and of certain commission arrangements between funders and brokers/dealers, a risk has arisen for motor finance providers. Not only is there the possibility of future redress payments to consumers, but there is also the more immediate risk to the overall viability of broker/dealers - and therefore to the funders own revenue streams - given the proposed ban on certain commission arrangements.
Whilst some funders may have considered remedial programmes, few will have had the opportunity to fully assess both the direct impact of the FCA’s findings for their own business models and the indirect risks associated with the future viability of those broker/dealers within their value chain.
Where are the areas of concern for funders?
In the earlier of two FCA reviews (published in March 2019), the FCA announced a specific investigation into the use of PCPs. The FCA found specifically that funders into the space were over-reliant on a broker/dealers’ FCA authorisation to imply compliance with regulation across a number of areas (information sharing, affordability assessment), each of which requires rectification.
More recently, on 15 October 2019, the FCA announced the findings of its review of certain commission practices across the industry, proposing a ban on discretionary commission arrangements that risked incentivising a broker/dealer to use a higher interest rate than the consumers own credit record may have required. Both broker/dealers and funders will need to amend systems and processes where such arrangements remain.
Watchwords of fairness, transparency and affordability for consumers have been given renewed prominence. These are key factors for improving selling practices for all in the motor finance industry – from banks and specialist funders, to brokers and dealers. It remains to be proven, however, whether this remedial activity has come soon enough to protect those in the industry from the types of redress issues seen most recently in the high cost, short-term credit industry.
The focus on PCPs
According to the Finance & Leasing Association (FLA), more than 90% of new cars in the UK are now bought with debt, an increase of 209% over the past ten years. PCPs have been a key driver of this increase, with approximately 80% of new car finance deals being financed this way. Given the popularity of this product, issues identified with underlying sales processes risk hitting the industry – both broker/dealer and funder – on a significant scale and the fall out will be exacerbated if residual values wane.
The FCA’s report has raised specific concerns on two fronts: the assessment of affordability for consumers and the adequacy of information sharing with consumers. Essentially, the FCA felt that consumers were not always able to make an informed decision before entering into a finance contract.
This is not an issue limited to the broker/dealer. Funders will be aware that they are required to ensure that broker/dealers are complying with relevant FCA guidance, and not just meeting the funder’s own credit risk criteria. One of the difficulties we know funders are facing in this regard is that whilst broker/dealers often believe that they have appropriate systems in place, they aren’t always embedded - and therefore don’t always work - to the extent that they are intended to.
Jon Sperrin, Head of our financial services regulatory team, noted that “in the automotive businesses that we have worked with, senior leaders have often believed that controls were in place and effective. The reality in some cases was that controls were either weak, had not been implemented fully, or had not kept pace with FCA expectations”.
Both the broker/dealer and the funder ultimately benefit from increased rigour in the testing of these systems and processes. The cost of failure can be wide reaching.
The work of our regulatory team on a recent assignment with one of the UK’s largest dealer groups (which came about as a result of this increased FCA scrutiny) has enabled the group to modernise aspects of its business. It's a timely reminder to put positive customer outcomes back at the heart of business, from the boardroom to the dealership floor.
Whilst it may not have come as a surprise that systems and processes are inconsistently implemented across the broker/dealer population, it may be more surprising that only five out of the 20 finance providers interviewed as part of the FCA review were able to demonstrate systems and controls considered broadly in line with FCA requirements.
Now is a good time for every funder to take stock of their systems, processes, culture and quality standards - both in terms of their own internal practices and those in place specifically for monitoring others in their value chain.
The focus on commissions structures
Whilst many consumers are likely to have assumed that the interest rate they were offered as part of their car finance deal was linked to their individual credit risk scoring, certain commission structures in place between funders and broker/dealers have meant that this was not the case.
The FCA review identified that commission arrangements that allowed a level of discretion for broker/dealers in terms of interest rates charged – primarily a Difference in Charges (DiC) model – may have incentivised broker/dealers to arrange finance at a higher rate for consumers.
The FCA has estimated that the use of such commission models could have been costing consumers (within the sample selected) a combined £300 million more per year than if a flat fee model had been used. This amounts to a potential £1,100 in interest charges over a four year period on a typical £10,000 arrangement.
However, in what can be seen as a sensible win for the fair treatment of consumers – particularly those without a degree in banking and finance – this model is now the subject of a proposed FCA ban requiring a change of arrangement between both funder and broker/dealer.
Whilst the FLA has noted that many funders have already moved away from such models, a failure or an inability either to adequately provide (financially) for past lending actions, or to act quickly enough in embedding real change for the future, may mean an escalation of redress claims. We have seen this across other industries, most recently in the high cost, short-term loans sector, with the recent insolvencies of Wonga, Curo and QuickQuid, amongst others.
What should motor finance providers be doing?
Against a backdrop of such change and ongoing scrutiny, it is sometimes difficult to identify quick wins from longer-term transformations. We are working with a number of funders and dealer groups across the sector, and we would advise any funder to consider the following:
review past sales practices to identify potential exposures, especially where DiC models have been used, and take proactive remedial action if necessary
assess the impact on your revenues and business model of a move away from DiC models, and consider the viability of the dealer groups you interact with, given this change
consider whether you can robustly demonstrate that you have sufficient controls to monitor compliance by relevant dealers and/or brokers, and
if you do not have capacity in-house or the most up to date knowledge of what is required, or of what your peer group is doing, seek the assistance of someone who does.
This is a difficult time for the automotive industry, but where there is change there is also immense opportunity. If you need assistance in assessing your operational resilience, or any of the regulatory requirements set out above, please don’t hesitate to speak to us.
For more information and advice, please contact Chris Laverty, Head of Financial Services Restructuring.