The Financial Conduct Authority’s (FCA) long-awaited report on the motor finance industry was released early last month, identifying a number of concerns that could be causing potential harm to consumers. Chris Lemmon looks at the response to the report, and assesses its potential impact on the market.
The main concern raised by the FCA centres around Difference in Charges (DiC) commission structures that have led to higher finance costs for customers.
Such structures have been criticised by the watchdog due to the financial incentives they create for brokers. In such cases, the broker has discretion to set the interest rate payable by the customer, within parameters set by the lender.
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According to the report, a 1% increase in broker earnings is associated with a 1.3% increase in customer interest costs under the Reducing DiC model. With this in mind, the FCA estimates that consumers entering a typical motor finance agreement of £10,000 could end up paying around £1,100 more in interest charges as a result of the higher broker commission – totalling an annual cost of £300m for consumers.
Adrian Dally, head of motor finance at the Finance and Leasing Association (FLA), suggests that these figures are overestimates, but nevertheless agrees that the policy conclusions remain valid.
“The current rulebook and current needs of the market are not in alignment,” notes Dally, who outlined plans in 2019 between the FCA and the FLA to undertake policy work – which will see the rewriting of the current regulations. This review and intervention process will likely take up the rest of the year, with new regulation expected in 2020.
Dally recognises that the FCA is a relatively new regulator for consumer credit, and suggests that the new report and follow-up intervention is the watchdog’s way of putting a stake in the ground of motor finance. “This will be the way we interpret the rules moving forward, which is a welcome thing for the FLA,” he says. “Any clarity about the regulator’s approach is always welcomed by operators in the market.”
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Potential changes outlined in the report may involve new consumer credit rules to strengthen existing provisions, or perhaps a bolder strategy of intervention such as banning DiC and similar commission models altogether.
James Tew, chief executive at tech vendor iVendi, believes the FCA could align itself with the more-transparent mortgage industry, where full commission rates are disclosed to the consumer as part of the mortgage offer. “The motor finance industry is nothing like that,” he says. “Commission levels are set by the introducer, and they can be calculated on a case-by-case basis.”
Such measures, according to Jo Davis, partner at legal practice Locke Lord, could perhaps disrupt competition in the market. “The FCA may need to be educated more on the commission models used within the motor finance industry, so there is more work to be done before final conclusions are reached on any changes to models being used going forward,” she warns.
In the meantime, Davis advises firms to “carry out a thorough and unprejudiced risk assessment of their current commission structures, as well as other aspects of the FCA’s findings, to identify whether customers are at risk of suffering harm because of them”.
Davis believes some of the market may not be interpreting the rules in the Consumer Credit sourcebook (CONC) effectively when agreeing commissions, and suggests that lenders and brokers should look to FCA papers on incentives and commission models for “a good steer on what commission models would be acceptable to reduce any risk they may still find in their existing structures”.
Another concern explored by the report suggests that some firms are falling short of their obligations on pre-contract disclosure and explanations, as well as affordability assessments. “This is simply not good enough, and we expect firms to review their operations to address our concerns,” says Jonathan Davidson, executive director of supervision for retail and authorisations at the FCA.
The FCA arrived at these conclusions through a mystery shopper exercise, visiting 122 motor retailers and other brokers to ascertain whether the information provided to potential customers is sufficiently clear and transparent, helping them to understand the risks involved.
The findings reveal: “Where disclosures were given, they were not always complete, clear or easy to understand. As a result, customers may not be given enough information to enable informed decisions.”
According to the Standard European Consumer Credit Information (SECCI) form, the pre-contract disclosure must be made available “in good time” before a credit agreement is made. If the SECCI is not provided in good time, or is deficient, the report explains that the credit agreement is improperly executed and is therefore unenforceable against the customer without a court order.
Tew acknowledges that there is a tendency in the UK market to join the pre-contract and main agreements together. This, according to Tew, could be an area where new rules come into play.
The FCA says in the report that it will be following up with individual firms that failed to reach the required standard of care in the mystery shopper exercise, while the iVendi boss would not be surprised to see similar ‘legal pause’ regulation that was introduced to Guaranteed Asset Protection (GAP) a few years ago.
“I would foresee finance agreements being clearly split into two elements, making it easier to get pre-contract information to the customer in advance of the main agreement,” he explains. “The FCA wants to see a greater degree of transparency, and wants more time for consumers to consider their agreement.”
Fair and Transparent
As outlined in the findings, the FCA expects lenders and brokers to go back and reassess their current policies and procedures, ensuring that customers are treated fairly and with adequate transparency. Firms are encouraged to disclose clear information early in the process, enabling the customer to make an informed decision.
The FCA also expresses doubt over the controls lenders have in place to monitor broker compliance with current CONC rules. “While lenders may require brokers to comply with CONC requirements on disclosure of status and remuneration, there appears to be very little monitoring of this,” the report reads. “We were particularly concerned 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.”
Tew highlights the difficulty in this for lenders, who tend to first hear about finance deals when they receive an application. As a result, they have little way of overseeing the application process, which predominantly takes place in the showroom.
“If there needs to be greater evidence that the introducers are acting responsibly, then there are going to have to be some changes around this,” he states.
This could see a more digitally led approach introduced to finance agreements, making the application process more transparent and easier to evidence. As outlined by the report, some showroom POS systems now require e-signatures from customers to demonstrate that pre-contract disclosures have been made. Tew believes technology like this could become the industry standard, as lenders seek better disclosure to meet FCA requirements.
Figures across the motor finance industry have expressed disappointment with the findings of the report, condemning firms that continue to blur the lines of regulatory practices.
“The time for excuses has now passed,” argues Gerry Keaney, chief executive at the British Vehicle Rental and Leasing Association (BVRLA). “There is no place in the motor finance sector for companies that are unwilling to embrace the FCA regime and actively demonstrate their compliance.”
A similar sentiment is conveyed by Stephen Dawson, head of financial services at Shoosmiths, who notes the good work seen in the market over the last 12-18 months. “It is disappointing that the lenders who have responded positively to both the FCA guidance and the new rules, find that the market is being led towards much stricter governance because of a broader failure in some parts of the market,” he says.
The general consensus among the motor finance industry is that businesses should take careful note of the concerns identified in the report, review their current processes and “embrace industry professionalism”, as stated by Dally.
Policy intervention is inevitable – and will probably be introduced in 2020 – moving to a more consumer-centric model of clarity and safety. With the FCA beginning to flex its muscles in the motor finance space, companies would be wise to heed Dally’s advice.
