Regulatory update: FCA zeros in on discretionary commission models

The Financial Conduct Authority (FCA) has provided an update on its review into the motor finance industry – setting out proposals to ban discretionary commission models. Motor Finance explores the latest report and gauges industry reaction.

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The Financial Conduct Authority (FCA) has provided an update on its review into the motor finance industry – setting out proposals to ban discretionary commission models.

Such models enable brokers to set and adjust their own interest rates, with inflated rates being passed onto consumers. The FCA highlighted three examples currently being used in the motor finance market:

  • Increasing Difference in Charges (DiC), where brokers are paid a fee which is linked to the interest rate payable by the customer.
  • Reducing DiC, which is similar to DiC, but the contract between the lender and the broker sets a maximum interest rate.
  • Scaled commission models, where the broker is paid a fee which varies according to the interest rate.

The regulator explained that these models “create an incentive for brokers to act against customers’ interests”.

The FCA collected data from 20 lenders for its research, reviewing around 1,000 motor finance transactions – representing 60% of the market. The data represented a range of customers with different credit risk profiles, as well as a range of brokers.

The study found that flat fee commission models were the most prevalent among transactions involving higher credit risk customers, accounting for 60% of lending. In the mid-range of credit risk, Increasing and Reducing DiC models were more prevalent, accounting for three quarters of lending within that segment.

Broker earnings varied significantly across the commission models, the report found, particularly for discretionary commission models. The difference between the average and highest commission was around £2,000 for the DiC and Scaled models, compared with £700 for the flat fee model.

By preventing the use of such commission structures, the FCA is seeking to remove the financial incentive for brokers to increase the interest rate that a customer pays and give lenders more control over the prices customers pay for their motor finance.

“We have seen evidence that customers are losing out due to the way in which some lenders are rewarding those who sell motor finance,” says Christopher Woolard, executive director of strategy and competition at the FCA. “By banning this type of commission, we believe we will see increased competition in the market which will ultimately save the customers money.”

Industry response to the announcement has been one of general positivity, with Adrian Dally, head of motor finance at the Finance & Leasing Association (FLA), declaring the proposed measures “good news for the industry and consumers, as it delivers clear rules and a consistent approach to commissions”.

James Fairclough, chief executive of AA Cars, agrees that the proposed regulation will have a positive impact on the market and could even bring the price of finance down – with greater competition on interest rates between lenders.

"The FCA has concluded, quite rightly, that there is no inherent problem with car finance products themselves. However customers are poorly served if they are not shown all the options best suited for them, whether though a lack of transparency, deliberate misinformation or because brokers are trying to steer them toward a particular product purely in order to secure a discretionary commission."

James Fairclough, chief executive of AA Cars

Implementation of new regulations will look to save consumers around £165m annually, says the FCA, helping them to make better informed decisions, consider alternative options, find cheaper deals elsewhere and negotiate on the finance or other costs associated with their purchase. 

Under new rules, firms would be required to disclose the nature of commission in their promotional material and when making a recommendation. Guidance clarifies that firms should consider the impact commission could have on the willingness of a customer to transact. 

Firms have also been told to consider whether and how much commission can vary depending on the lender, product or other permissible factors, and tailor their disclosures accordingly. 

The FCA expects the new rules to cost lenders and brokers a combined £35m in implementation costs in the first year. Brokers will be expected to bear the brunt of annual revenue losses following the introduction of legislation, accounting for 75% of the £165m predicted customer savings (£125m). Lenders will face the remaining £40m of expected losses, according to FCA predictions.

Industry response

Sue Robinson, director of the National Franchised Dealers Association (NFDA), said: “Franchised vehicle retailers are committed to helping and providing clarity to the consumer. Clear rules are positive for the industry but we would urge that they are proportionate so there is a satisfactory outcome for both consumers and retailers. NFDA will be responding in-depth to the consultation.”

"The FCA is proposing to ban car dealers and brokers from charging a discretionary commission, linked to the interest rate charged. In some deals, it was the case that the higher the interest rate charged, the more commission paid by the customer, so there was an incentive for the broker to set a high rate. There will also be increased transparency under the proposals, as firms will be required to disclose the nature of the commission charged in their marketing and promotional materials."

Ian Mason, head of financial services at legal firm Gowling WLG

Stephen Dawson, financial services sector head at Shoosmiths, said the principal impact of the proposals will be both for brokers and motor finance providers creating a level playing field for commissions. “The challenge in this market is not necessarily commission itself, but more so the discretion afforded to brokers in setting the rates that directly affect the cost of motor finance for consumers. The discretion element, creating an obvious conflict of interests, is where we see the real impact of this consultation.

"I certainly welcome anything that builds trust, maintains competition and allows innovation in the market. The one risk being that flat fee models and reduced commissions in one part of the customer transaction could push up costs in other parts (the vehicle cost itself for example) or encourage more pushy sales of additional products, making the transaction more complex.

If we do have rules in place for the end of Q2 2020 then the industry will need to respond quickly to the consultation and continue with the evolution that is already under way."

Stephen Dawson, financial services sector head at Shoosmiths

Moving forward, Sean Kulan, consumer credit sector lead at regulatory consultancy firm Huntswood, believes the move is likely to be the first of several remedies implemented across the industry. He suggests that providers should be looking to minimise the potential for consumer harm by reviewing current processes and controls, “taking proactive steps to address any historic issues to ensure both compliance and good customer outcomes.”

The FCA is consulting on the new rules until 15 January 2020 and plans to publish final rules later in 2020.