The FCA's final findings
Regulatory focus on motor finance
Due to the reported rapid growth in the motor finance sector, following the Bank of England's 2017 Financial Stability report, the FCA has been undertaking analysis to understand more about the motor finance sector and ascertain whether the credit products offered in this sector present harm to customers.
On 4 March 2019, the FCA published its final findings into its review of the motor finance sector. The review focussed on:
- Commission structures;
- Commission disclosure & sufficient, timely and transparent information; and
- Assessment of affordability and creditworthiness and broker oversight by lenders.
Commission structures and business models
The FCA found four different types of commission structure used within the motor finance sector:
- Increasing Difference in Charges models (DiC): an agreement between a lender and a broker that sets a minimum interest rate, and the fee given to the broker is calculated based on the difference between the actual interest rate the customer pays against the minimum interest rate provided by the lender. In these instances, many brokers charge higher interest rates than what the lender has stated, resulting in the customer paying more money than necessary;
- Reducing DiC models: similar to the above, except the lender and the broker set a maximum interest rate;
- Scaled commission models: where the broker is paid a fee which varies according to product features i.e. the type of credit agreement; and
- Flat fee commission models: where brokers are paid a fixed fee for each agreement they process or arrange.
The FCA found that broker earnings varied significantly across the commission models, particularly for increasing DiC, reducing DiC and scaled models. The FCA has concerns therefore, that these models are causing customer harm on a significant scale, as they provide incentives for brokers to charge the highest interest rates, given the associated increase in commission levels that can be achieved, thus alluding to the possibility of a conflict between brokers and the interest of their customers.
The FCA found that flat fee commission models were more prevalent in the higher credit risk sector whereas DiC models more prevalent in the mid-range of credit risk, however concluded that DiC models broke the link between the customer interest rate and their credit score, whereas the same could not be said for scaled and flat fee models.
As a result of the findings into DiC commission models, the FCA are considering policy intervention and potentially banning DiC commission models and as these models are not confined solely to the motor finance industry, a decision to do this could have impacts across a wider set of point of sale intermediated models especially where there is price negotiation included in the customer dialogue.
In addition to concerns around the different commission models used between lender and broker, the FCA is unclear as to why brokers have such wide discretion to set or adjust interest rates to earn more commission, and are therefore concerned that lenders are not doing enough to monitor and reduce the risk of harm. As a result, the FCA are considering limiting broker discretion.
These changes could have unintended consequences to some dealer business models and there is also the possibility of increased customer complaints fuelled by CMCs.
Commission disclosure and sufficient, timely and transparent information
Following a mystery shopping exercise, the FCA noted concerns over the timing and nature of information provided to customers to enable them to make an informed decision before entering into an agreement. The FCA called out that when brokers explain information to a customer or provide advice/give recommendations to a customer at the point of sale, they must pay due regard to the customer’s needs and circumstances. Most importantly, they must pay due regard to whether the credit product is affordable and whether there are any factors that might make the product unsuitable for that customer. These are issues that the broker as an authorised firm is required to consider even before the customer data is submitted to the lender for full underwriting.
Following the FCA's findings that DiC models introduce an inherent conflict into the process between the broker and the customer, the FCA state that the presence of this conflict requires the broker under CONC 4.5.3 to disclose, without being asked, whether they are going to receive commission as a result of the finance sale.
The FCA found that some brokers appeared to assume what a customer wanted and started negotiating a finance deal with the customer, focussing on one finance product over another. The FCA found that with new car sales, the sales journey focussed heavily on Personal Contract Plans (PCP) with recommendations being made to suggest the lower payments on this plan were more beneficial than on Hire Purchase (HP), even when the customer indicated a desire to own the car outright at the end of the agreement.
In addition, the FCA felt that disclosures and explanations given during the sales process were misleading and they found only a small number of brokers to disclose to the customer that a commission may be received for arranging finance. However, the FCA were unable to complete the sales process and so were unable to analyse pre contract disclosures, but from what they did witness, this has caused concerns for the FCA over compliance with disclosure requirements. The FCA also noted that it had doubts as to what extent lender controls over broker sales practices were implemented in practice as there was a reliance on contractual arrangements.
The FCA intends to consult on changes to CONC as a result of this to make the rules clearer to firms.
Creditworthiness and affordability
The FCA has concerns that lenders are not complying with the FCA rules on assessing creditworthiness and affordability. The FCA noted that there were instances where it was unclear as to what information was being used to conduct affordability checks and how this information was to be verified.
It was also unclear as to how indicators of affordability risk were taken into account, i.e. the costs and risks to the individual customer, and how these would be reflected in metrics used. This caused concerns that lenders were focussing more on credit risk to them, as opposed to affordability to the customer, i.e. conducting insufficient checks to ensure a customer can repay the debt.
On 1 November 2018, the FCA sought to clarify its requirements in respect of creditworthiness and affordability with new rules and guidance in the handbook at CONC 5.2 (PS 18/19). In the FCA's final findings into motor finance, they remind firms to refer to this guidance and review their policies and procedures in light of the new rules and guidance to make changes where needed.
The FCA noted that whilst documented broker oversight policies and processes seemed compliant, there is evidence to indicate that lenders are not monitoring brokers closely enough and certainly not mitigating the DiC risks correctly.
The FCA noted that firms should test the effectiveness of their systems and controls in line with SYSC and their compliance with CONC, to review contracts that they have with dealers and review current dealer monitoring processes.
What should you do now?
- Check your commission structures to identify whether there are any aspects which align with the FCA's areas of concerns and consider any necessary amendments.
- Review customer journeys and assess the quality and timing of information disclosures including any commission disclosures in line with handbook requirements.
- Understand your oversight of brokers and assess whether improvements are needed to ensure rigour of compliance.
- Consider whether your underwriting processes comply with the additional rules and guidance published by the FCA in November 2018.
How Addleshaw Goddard can help?
Within the regulatory Risk and Compliance Practice Group, we have a blended team of both legal and regulatory risk and compliance professionals, who can provide you with holistic solutions to enable you and your senior managers to have confidence and assurance in management of both legal and regulatory risk with a commercial focus. We can conduct an in-depth assurance review of your current broker oversight procedures to ensure that your brokers are complying with all regulatory requirements.
If you would like to know more, please contact us: