The FCA’s interim update on its review into motor finance assessed the industry as sound, with the exception of a few potentially problematic areas. So what should lenders and brokers look out for in the second half of the investigation asks Lorenzo Migliorato

After a 2017 marked by warnings and words of caution over car finance, both by industry players and outside commentators, the Financial Conduct Authority’s (FCA) words in the March update of the motor finance industry must have come as a relief.

“We found that the asset valuations and risk management processes at [lenders] appear to be robust,” it read. “The firms were able to show that they had appropriate strategic plans in place in the event of a fall in vehicle price and their approach to managing credit risk appears to be appropriate.”

On consumer treatment, the assessment was also fairly benign: “Our review found that the contracts are generally transparent [and that] terminology and language [on websites] appears to be clear and consistent,” the FCA said, although noting exceptions.

Initial signs are promising, but lenders are not yet in the clear.
The FCA identified three main areas of focus leading into the final phase of the review: whether the structure of commissions for dealer-brokers can result in consumers being exploited through more expensive offers; whether higher credit risk customers are being appropriately managed, especially during repayment difficulties; and whether customers are being given all appropriate information at the point of sale, to be assessed through a “mystery shopping” exercise.

When the FCA’s final word comes out in September, what can lenders and dealers expect? And do they have reason to fear?

Broker incentives

According to the FCA, there is a risk that the structure of commission paid by lenders to dealer-brokers – especially when linked to an increase over the lender’s recommended interest rate – could be incentivising dealers to push for contracts that are more lucrative for them, but more expensive than they need to for the customer.

The regulator has been looking into broker and staff incentives across consumer credit firms for a number of years now. In a July 2017 guidance paper, it spoke, without naming sectors, of a number of firms having “financial incentives and/or performance management practices that [are] high-risk and likely to encourage high-pressure sales or collections”.

It makes sense that those findings should come into play while reviewing an introducer-based industry like motor finance.
“[It] is a welcome intervention into a buoyant industry that could, if left unchecked, easily develop unsavoury practices,” says Will Craig, chief executive of broker comparison platform LeaseFetcher.

“For a comparison site like [ours], this is especially concerning as we have to worry about the policies and processes of all our partners. It is simply not feasible for us to track every change in every business.

“I’m very encourage by [the] review, as it feels like they are highlighting potential issues before they flare up into problems that hurt customers.”

The FCA’s review did not mention specific mis-selling cases, and added it was still collecting data to assess the possibility that commission structures had pushed up finance costs for customers. However, even in the final review broker incentives are unlikely to be singled out as a major structural problem for the industry, says Anthony Coombs, chair at Advantage parent S&U.

“The vast majority of brokers are increasingly well aware of their obligation to fit product to customer, to treat customers fairly. They realise their futures depend upon doing that.
“The onus is on them to make sure that, irrespective of commission, the customers are guided to the appropriate lender.”

The FCA focused its warning on incentives connected to contracts’ interest rates, but Coombs says a bigger risk could be posed by volume-based commission structures.

“I cannot talk about everybody, but we do not pay additional commission for volume, because obviously that creates temptations [whereby] customers are not treated fairly,” he says. “Paying for volume would be a big mistake in terms of regulation.”


Any industry that experiences rapid growth is set to attract regulators’ attention, and motor finance was no exception. One of the FCA review’s aims was to assess how much of the explosive growth of motor finance in the last half-decade was driven by business in the lower credit quality.

Echoing some of the data that came out during 2017 around the issue, the FCA found that clients in the lowest credit score range accounted for just 3% of motor finance lending as of 2016, while customers in the top 30% composed well over half of the market.

More worrying was the finding that among higher-credit-risk customers, arrears were “relatively high” and had seen an increase over the years.

For Coombs, however, that is no reason to panic: “You will get changes, but I do not think you will get differences in the rate of changes [between prime and non-prime]. There has been an increase in arrears in the non-prime end, but that is, from our own experience, well within historical levels.”

He adds that although impairments are higher than the record lows recorded three or four years ago, they are still within historically low ranges.

“I think the reason for that is that people, irrespective of whether they are prime or non-prime, actually control their accounts in a much better way than 10-15 years ago,” he says. “Responsible lending, and the checks to ensure it, have meant that impairment levels have been constrained, even though they have been rising slightly in the non-prime market.”

As for broker incentives, the FCA’s scrutiny of subprime motor lending can be seen as the natural continuation of similar work in other markets, says John Perez, head of the lender services division at law firm DWF.

“[It] follows on from the subprime focus in other sectors, payday lending being the obvious one,” he says.

The FCA has already stated that the next part of its review will focus primarily – but not solely – on higher-risk credit segments. Perez says he would not be surprised if, following the completion of what seems to be a very point-of-sale-focused review, the FCA decided to undertake further work on motor finance debt handling.

“The subprime motor finance is in need of attention in a number of different areas, [including] the way customers in default are treated,” he says. “But I can see the default and arrears component being part of a much wider review [into subprime credit at large] by the regulator.”

Mystery shopping

The FCA also teased a mystery shopping exercise to be carried out in the second half of the review, which will help inform its final findings regarding the customer sale process. This will allow the regulator to sound out the sales process from start to end, considering that the mystery shopper will be able to get a decision in principle, and only backtrack at the point of signature, says Perez.

The exercise is likely to work better in the face-to-face POS environment than online, he says, as that allows the mystery shopper to decide the level of information put forward.
“In an online environment, it all very much depends on what information is being asked and what is being input. The more information the prospective customer can put forward, the better.”

In general, Perez expects the FCA to have three scripts in place, and assign an equal number of shoppers to each: one for the prime segment like the high street lenders and the captives, one for the near-prime independents, and one for the non-prime sector. In any case, he does not think the FCA is trying to ensnare anyone, or pinpoint pockets of mis-selling; rather, it will be more about probing the industry across the spectrum, and get an appropriate all-encompassing picture.

On the lending side, Coombs says mystery shopping is a practice to be entirely expected of the FCA. “They already do mystery shopping exercises – I certainly hope they do – in order to be able to monitor the [overall] responsibility of the market,” he says.

He welcomes the approach, and says mystery shopping is a practice S&U itself uses to get a pulse on its partners. “It is important that we ensure everybody acting on our behalf acts in a responsible way,” he says.

“Our broker partners already do that, as a result of their view on responsible lending. Just to make the point, there is no incentive for any lender to lend irresponsibly. It is generally irresponsible lending that leads to poor-quality debt.”

Looking forward

Coombs and Perez both see the FCA review as a proactive move to understand the industry, rather than a concerned or even suspicious reaction to the last few years’ growth.

“I think the FCA is still trying to understand properly the motor finance market,” says Perez. “It is a sector and industry they are still gaining experience and proper understanding in – hence why they are carrying out this very deep review of the sector, so they can gauge and better regulate and enforce [it].”
Coombs expects a positive assessment from the FCA, not in the least because of the effort bodies like the Finance and Leasing Association (FLA) have made in opening up the market’s inner functioning to the regulator.

“I think the FCA is generally very pragmatic,” he says. “[Its people] understand the reality of the market – they make it their business to.”

Coombs concludes: “I think the general tone will be very benign, particularly on the non-prime end. Motor finance will generally have a very clean bill of health.”