In its 2017/18 business plan, the Financial Conduct Authority (FCA) made a commitment to review the motor finance market, largely due to it being the third largest lending sector in the UK worth £64bn.
Its aim was to understand the use of motor finance products, assess sales practices and the potential for consumer harm in this sector. Sushil Kuner from Gowling WLG’s Financial Services Regulatory team explores the FCA’s findings and its new rules which are being introduced next year.
In March 2019 the FCA published its findings which highlighted particular concerns over the widespread use of commission models that link the broker’s commission to the customer’s interest rate under the finance agreement and allow brokers wide discretion to set or adjust that rate. The FCA viewed such commission models as creating a conflict of interest with strong incentives for brokers to earn more commission by increasing the rate of interest which customers pay. In fact, it found that broker earnings varied significantly across the various commission models.
Commission structures identified in the FCA’s review
The review identified four main types of commission structure:
- increasing Difference in Charges (DiC) – also known as ‘Interest Rate Upward Adjustment’ where brokers are paid a fee which is linked to the interest rate payable by consumers. The contract between the lender and the broker sets a minimum interest rate, and the fee is a proportion of the difference in interest charges between the actual interest rate and the minimum interest rate;
- reducing DiC – also known as ‘Interest Rate Downward Adjustment’ which is similar to the Increasing DiC, except that the contract between the lender and the broker sets a maximum interest rate;
- scaled commission – also known as a ‘variable product fee’ where the broker is paid a fee which varies (within parameters) according to certain product features such as the type of credit agreement or the interest rate; and
- flat fee commission – where brokers are paid a fixed fee for each credit agreement they process or arrange.
Excluding extreme outliers, the FCA found that the difference between the average and highest commission was around £2,000 for the DiC and scaled models, compared to £700 for the flat fee commission model. It estimated that 560,000 customers of the firms in its sample under review could be paying in £300m more in total in interest costs compared to flat fee models.
The FCA also identified high levels of non-compliance with existing commission disclosure rules. In October 2019 it set out its proposals for a ban on certain discretionary commission model for amendments to parts of its existing rules and guidance on the disclosure of commission arrangements with lenders.
After a period of consultation the FCA has now finalised its new rules which will come into force on 28 January 2021.
What will be banned under the new rules?
All discretionary commission models will be subject to the ban. This will include any arrangement where a commission, fee or other financial consideration is payable directly or indirectly by a lender to a broker in connection with the regulated credit agreement, and where this is wholly or partly affected by the interest rate (or other item within the total charge for credit) set or negotiated by the broker. By including ‘financial consideration’, the FCA is looking to ban any practice where a broker is rewarded for adjusting the price a customer pays for motor finance.
The FCA is intending to break what it perceives to be a strong link between customer interest rates and broker earnings in order to decrease financing costs for consumers and hopes that its wide definition of discretionary commission models will prevent firms from being remunerated on other aspects of the total charge for credit. The FCA is encouraging firms to interpret its new rules in light of their purpose.
However, there are certain ‘permissible’ commission models and commercial arrangements which are not subject to the ban, including commissions linked to the size of the loan, interest rates varying by product type, brokers having the ability to negotiate different commission levels between lenders and lenders being able to price for risk.
Who will the ban apply to?
The ban would apply to credit lenders and credit brokers who operate discretionary commission model structures between them. To be caught by the ban, a broker would need to be both:
- negotiating or determining what the consumer pays for motor finance; and
- being rewarded by the lender for doing so.
Notably, in the FCA’s review, many secondary brokers were not satisfying both of the above requirements and it therefore viewed the risk of consumer harm posed by such firms to be weak.
Commission disclosure – key changes
There will be two key changes to existing disclosure rules which the FCA hopes will lead to commission disclosures being more prominent and early enough in the process to influence a customer’s decision making about whether to enter into a certain credit agreement:
- firms will need to disclose the nature of commission in their financial promotions (as well as when making a recommendation). Guidance clarifies that firms should consider the impact commission could have on a customer’s willingness to transact and that firms should consider whether and how much commission can vary depending on the lender, product of other permissible factors and tailor their disclosures accordingly; and
- the existence and nature of commission arrangements where the commission varies depending on the lender, product or other permissible factors should always be disclosed prominently. The disclosure must also cover how the arrangements could affect the price payable by the customer.
Firms affected by the FCAs’ new rules have until 28 January 2021 to comply but should take action now. Contracts between lenders and brokers will need to be renegotiated and systems changes may be required. Firms are also reminded about the need to communicate these changes to staff and provide training to ensure that the new rules are understood and embedded with staff at all levels
by Sushil Kuner, Principal Associate – Gowling WLG