The Financial Conduct Authority’s (FCA) concerns about motor finance date back to April 2017, when it announced it would be investigating motor credit products in general. In March 2019, its final findings offered the damning conclusion that “the way commission arrangements are operating in motor finance may be leading to consumer harm on a potentially significant scale”.
Essentially, the FCA found that the widespread use of motor finance commission models linking the broker commission to the customer interest rate, and allowing brokers wide discretion in setting this rate, meant there was a strong incentive for brokers to charge a higher interest rate.
The FCA estimated that, on a typical motor finance agreement of £10,000, the discretionary commission model could lead to the customer paying £1,100 more in interest over a four-year term.
“We consider that change is needed across the market to address the potential harm we have identified,” the FCA announced (FCA to ban motor finance discretionary commission models).
A ban on discretionary motor finance commission models was announced in July 2020 and came into force on 28 January 2021. The FCA estimates this will save consumers £165 million.
So what does the change in motor finance commission models mean for brokers, lenders, and dealerships? And how can you ensure that, in the event of further scrutiny by the FCA, you'll be found to be compliant?
Clearly, the immediate impact of the ban is that brokers need to stop using discretionary commission models and introduce alternative arrangements. There's been no specific advice on which motor finance commission models – existing or new – should be used, but follow-up scrutiny can be expected.
The FCA has said that it plans to scrutinise a sample of firms starting in September 2021, looking at the motor finance commission models they are using together with the range of interest rates and commission earnings. Point-of-sale mystery shopping exercises, to see whether lenders are ensuring compliance with the new requirements, should also be expected.
Given this enhanced scrutiny, motor finance lenders will want to consider their obligations and whether they're doing enough to ensure compliance with FCA rules, particularly on assessing creditworthiness.
In its final findings, for example, the FCA noted that some lenders “seemed to focus unduly on credit risk (to the lender) rather than affordability (for the borrower)”.
Motor finance lenders will also want to review their procedures for checking that customers have received the sufficient, timely and transparent information they need to make an informed decision.
Here, the FCA said: “Our work suggests that some lenders may be unduly reliant on contractual requirements and the provision of standard documentation and procedures, and may not monitor brokers sufficiently closely or act where issues are found”.
It went on to say that it was particularly concerned by the way some motor finance lenders took the view that it was sufficient for a broker to be FCA-authorised. Clearly, for their part, brokers will want to make sure they are compliant with FCA rules and that they’re giving borrowers transparent and timely information.
Turning to the dealerships, all should expect to see firm-specific challenges over the coming months. Dealerships I work with tell me they're experiencing a significant increase in requests for information from the FCA.
These requests range from financial data to assess firms’ ongoing viability, to specific conduct issues identified through regulatory returns, audit reports, mystery shopping exercises or whistleblowing disclosures.
Those firms that don’t meet the FCA’s standards can look forward to a period of increased scrutiny, challenge and potentially costly interventions that will distract management and act as a drag on the business.
At some point in the future, consumers deemed to have overpaid interest under discretionary motor finance commission models may seek compensation. The sums could be considerable, but who will pay for this?
Looking further forward, the FCA may broaden its scrutiny to look at other aspects of automotive finance, including balloon payments on personal contract purchase (PCP) agreements. These are a form of hire purchase where the consumer pays lower monthly instalments ending with a final ‘balloon’ payment linked to the residual value of the vehicle.
In its March 2019 report, the FCA highlighted the growth in this type of agreement and indicated that it was an area of potential concern.
Given the importance of motor finance to the sector, I'd advise all players to consider the steps they need to take to improve their regulatory compliance. Early action and co-operation with regulators could ease regulatory relationships.
For support in staying compliant under new FCA scrutiny in the motor finance sector, contact our team.