On 4 March, the Financial Conduct Authority (FCA) published its conclusions on the consumer motor finance industry. While its interim report praised the industry for its innovation in devising PCP products, the final conclusions contain more damning findings. Bruce Wood, consultant at Morton Fraser, takes a closer look.
The key takeaway from the review is that the FCA expects both lenders and intermediaries to review their policies and procedures. Amended provisions in the Consumer Credit sourcebook (CONC) are on their way, but your review should not wait for that.
To quote paragraph 4.11 of the report, under the heading Lender Controls: “We expect lenders to review their systems and controls, to reduce risk of consumer harm. They should monitor brokers adequately and take reasonable steps to ensure compliance with CONC, where applicable.”
Elsewhere in the report’s conclusions, a similar imprecation is applied to the brokers themselves.
Where the FCA concentrates its ire is quite predictable: it believes that the award of brokers’ commissions on a Discount in Charges (DiC) basis leads to mis-selling; and it does not think lenders are doing enough to check that brokers are complying with CONC as they should.
Perhaps the most welcome surprise from the industry’s viewpoint is the clean bill of health given in the interim report to the way some residuals are set, although with no FCA involvement. High residuals are now unlikely anyway, because of the new prejudicial VAT treatment that they will attract.
In what is quite a short report, the FCA only picks out two other areas of concern: whether adequate affordability checks are being undertaken, and lack of transparency and comprehensibility of the documentation.
While in the space available to me in this article, I want to concentrate on the DiC issue, two things need to be said in passing about these two other issues. With regard to the latter, we all know that PCP documentation involves small-print overload; but, there is a lot that has to be said, and until the documentation requirements change there is not a lot that can be done – and the FCA ducks this in its latest comments on how it will approach the review of CCA reform.
Regarding affordability checks, the FCA admits its investigations preceded the inception of its new affordability rules in CONC. But a passing comment it makes is interesting: namely, that the verification of information and data obtained is not always necessary, unless there is a warning flag or it is a marginal case. To quote: “It was not always clear which CRA products were being used, and in what ways, or what might trigger asking the customer for documentary evidence.”
This may be well understood and reflect current practice, but it is a clarification the FCA has hitherto been cautious about in failing to explain how to apply proportionality to affordability checks. Oh, and PCH is not mentioned at all. The FCA’s lighter touch on hire agreements continues, leaving us still puzzled as to how the FCA will apply TCF to these lighter touch issues if problems arise.
Returning now to the commission issue: commission on a DiC basis is calculated, in part at least, on the increase in the interest rate embedded in a consumer finance agreement compared with the minimum interest rate the lender can offer. Therefore, the higher the charges paid by the consumer, the more commission the broker receives.
Subject to a challenge by the FLA to the current validity of the figures used by the FCA, this conclusion is hardly surprising, and many of us in the industry have been worrying about it for some time. The FCA suggests that consumers are paying £300m (€352m) too much annually for their motor finance because of the use of DiC. I doubt this figure, as explained below.
It has found no consumer detriment with flat-fee commission structures, and those who have already determined to move to flat fees may be entitled to feel smug. It also comments in passing on so-called Scaled Commission, where the commission varies according to certain product features; it sees this as causing possible consumer detriment if not properly controlled, but much less of a problem than DiC.
In this context, the FCA reminds lenders that, under CONC 4.5.2G, differential commission rates need to be justified based on the extra work for the broker, whereas DiC does not relate to any extra work. It also points out that CONC 4.5.3R requires brokers to disclose, in good time before a credit agreement is entered into, the existence of any commission if knowledge of the existence or amount of the commission could affect the broker’s impartiality or have a material impact on the customer’s transactional decision.
The FCA thinks these rules require more disclosure by brokers. It suggests there is a conflict of interest requiring disclosure in nearly all cases, whereas the FCA “found that only a small number of brokers disclosed to the customer, during the mystery shopping visit, that a commission may be received for arranging finance”.
It goes on to say that, even if the disclosure were made later in the process, that would not be early enough.
I suggest there are counter-arguments to the commission disclosure problem that the FCA has not taken into account. The FCA concludes that there is not enough correlation between credit risk and interest rates, so customers with better credit ratings do not seem to be getting the cheaper deals one would expect. It considers this to be good evidence of the mischief caused by brokers being incentivised to increase interest costs in agreeing a deal with the customer.
But this begs two questions, the second of which is the more significant. First, customers who can easily afford the credit may have less incentive to challenge the cost of the deal than those whose credit circumstances are strained. Whether a person seeks the best possible deal is a matter of personality of the customer where the credit is readily affordable.
The second issue, though, is this: the FCA has acknowledged in the past that it is not opposed to lenders making profits, provided a customer is treated fairly.
If motor finance were conducted face-to-face, as in the old days, the parties could negotiate terms with the bank seeking a good return and the customer seeking a good deal. In the motor finance industry, however, the lender hardly ever meets the customer; that job is left to the broker, who is an independent trader and the agent of neither party, save where s56 of the CCA applies.
The lender, therefore, has to rely on the broker to get a good deal, the lower limit being set by the lender’s funding costs. The lender does not want to do every deal at its minimum rate or its profits will be curtailed. Nor does the lender wish to do all deals at a fixed rate vis-a-vis the credit risk; that way competition in the market is stifled, which the FCA is supposed to be against.
This is how DiC has arisen. Why can the broker not be negotiating the rate? The curious result is that the lender’s profits can improve from a better rate, but not the negotiator’s; the upside may be the same whoever does the negotiating, but it cannot be shared. This is an issue that dare not speak its name, as authorised persons do not want to cross the FCA, but it nonetheless seems to justify an airing.
Anyway, better get your reviews under way, as the FCA requires.
by Bruce Wood