The outcomes of the FCA’s Policy Statement PS20/8 this July will have lasting consequences for the sector, creating opportunities and challenges for lenders and dealers alike.
In October 2019, when the world was a very different place, the Financial Conduct Authority (FCA) carried out a consultation with motor finance brokers and dealers about plans to ban commission models which would incentivise finance providers to increase customers’ finance costs.
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This consultation followed the publication of the final findings of the FCA’s motor finance review in March 2019. That consultation had already identified issues concerning the widespread use of commission models that link the broker’s commission to the customer’s interest rate under the finance agreement while allowing brokers wide discretion to set or adjust that rate.
The FCA argued that this arrangement could create conflicts of interest with strong incentives for the broker to earn more commission by increasing the interest rate the customer pays. At the same time, the FCA identified high levels of non-compliance with some existing commission disclosure requirements.
The results of this consultation were supposed to be published in the form of a Policy Statement during this year’s second quarter, but unfortunately, that coincided with the spread of the coronavirus pandemic and the UK going into lockdown.
The FCA instead used that time to incorporate the impact of coronavirus on the motor finance market, firms, and consumers in formulating their policy, but these delays are now over with.
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By GlobalDataThe new Policy Statement PS20/8, titled “Motor finance discretionary commission models and consumer credit commission disclosure – feedback on CP19/28 and final rules” was published in July this year, with rule changes that will have repercussions for the entire motor finance sector.
From January 28th, 2021, the motor finance industry bears new restrictions and responsibilities in the form of a ban on discretionary commission models and the need to disclose commission across all credit sectors. As well as the new restrictions themselves, the FCA has also instigated several technical changes to its rules to help deliver its aims.
The question now remains as to whether dealers and finance brokers are going far enough to put these new policies into place.
“January 28th is a pivotal opportunity for motor finance to reinvent itself and create a new level of consumer trust and confidence in the dealer finance model. It is also a very significant opportunity to start making major inroads into the used car finance market, increasing the share of wallet from the very modest levels we see today when compared to the new car finance sector,” says MotoNovo Finance chief executive Mark Standish.
Standish believes the new FCA regulations are a chance for the industry to build trust and confidence among consumers, helping dealers to increase the percentage of used vehicles they finance, which ranges from 20-40% penetration levels typically across the industry, where new car finance penetration is well over 90%, according to FLA data.
He also thinks the new rules can help to support used car sales and head off the increasing threat from market disruptors, many of whom focus on the trust and confidence issue.
New Regulations
To reap these benefits, the motor finance sector is going to have to completely re-evaluate their pricing models by January 28th, which is a huge step for the industry.
The effects of the changes to the rules themselves are two-pronged. Firstly there will be a ban on ‘discretionary commission models’ in the motor finance market.
‘Discretionary commission models’ here means any commission model where the amount the broker receives is linked to the rate that the customer pays, where the broker has the power to set or adjust that rate. The FCA estimates that this change will have the effect of saving motor finance consumers in the region of £165 million per annum.
Secondly, the FCA is amending its rules guidance on the disclosure of commission arrangements with lenders with the goal of more clearly reflecting its policy aims. These changes, which the FCA has said are “relatively minor” will give consumers in all consumer credit markets access to more relevant information.
Ultimately, this second change means the regulator wants there to be greater transparency on commissions. This means dealers can continue to earn some forms of commission, but customers have to be better informed about how that commission works. Brokers have always had to disclose to customers how much commission they are earning in finance if asked, but under the new rules, the broker will have to disclose the existence of a commission and the nature of the commission arrangement before a deal is signed.
To reap the benefits of these changes in customer trust, Standish argues it’s not enough to simply comply with the letter of the new Policy Statement. Businesses will need to embrace the spirit of the changes, addressing the changes this Statement requires while working towards the FCA’s objectives.
“We aim to make financial markets work well so that consumers get a fair deal and to secure an appropriate degree of protection for consumers,” Standish says.
The lending community, Standish argues, has to come together in developing a finance approach that will work for consumers, dealers and lenders alike.
“Since June, we have seen the positive impact of creating fair customer outcomes with our risk-based pricing model MotoRate,” Standish says. “Customers have benefitted from an interest rate reflecting their credit status set by us, not our dealers and dealers have benefitted from higher finance volumes and trust, something we have measured very carefully through independent research. Finance volumes from over 2,000 dealers embracing MotoRate have grown over 70% in new business terms year-on-year. Customers, dealers and MotoNovo have all benefitted, demonstrating what can be achieved with an imaginative approach. I am aware that there is the potential option of flat-rate pricing models, but I have yet to be convinced these will deliver the same winning outcome for all parties. I can also see the potential risks.”
A Matter of Oversight
An important part of the new FCA Policy Statement is that it places oversight responsibility for upholding these rules firmly in the hands of lenders.
After instigating these new rules the FCA intends to pay close attention to ensuring the “spirit and letter” of the new policies is adhered to. The Policy Statement expressly states that the FCA will “look closely at any attempt by a motor finance firm to introduce a commission model that could lead to the same harm that we have sought to ban”, so lenders and brokers looking to find a way to return to business as usual will certainly face obstacles.
The FCA will seek to monitor how well firms are complying with these new policies by carrying out supervisory work across a sample of firms starting from September 2021.
This supervisory work will include an examination of the alternative commission models firms put into place in the absence of discretionary commission arrangements, as well as the ranges of interest rates and commission earnings. Finance providers, including lenders and dealers, should also expect to see point-of-sale mystery shop exercises.
The important thing about these exercises is that their stated purpose is to “measure lenders’ control over dealer networks”. The FCA is expecting firms to take appropriate steps to ensure dealers and brokers comply with the new regulatory requirements.
That lenders are expected to have responsibility and oversight over their dealers and brokers is no small matter. A typical dealer might work with anything from three to five lenders, and if each of those lenders enforces their own standard, it will lead to a real lack of consistency across the sector.
It may be that for the industry to meet the needs of the new requirements we will have to see the creation of audit companies that can create a common, industry-wide standard. For this to happen lenders will need to communicate with one another, but it will be a challenge to do this without such audit companies potentially opening themselves up to monopoly accusations. There is still time for the industry to generate a workable model, but that time is running out.
How the motor finance industry addresses these challenges is not just a matter of compliance, but a question of how regulations will evolve. In their Policy Statement, the FCA states that its “mystery shopper” exercises and other forms of monitoring will be used not just to measure compliance, but to assess whether the potential for customer harm remains and how to address it. A review of this intervention is already scheduled for 2023 and 2024, and the results of that review will have an impact on how policies are changed in future.
A Fair Deal
In terms of what the motor finance market will look like once the new policies are enforced, Standish points to the opening pages of the FCA Policy Statement:
We believe it is necessary to ban motor finance commission models that incentivise brokers to set customers a higher interest rate to earn more commission. Breaking the strong link between customer interest rate and broker earnings should reduce financing costs for consumers.
We believe that banning discretionary commission models will lead to alternative remuneration models where lenders and brokers are incentivised to create and sell competitively priced loans. Lenders will have better control over the interest rate that consumers pay. This should mean that lenders originate more loans, and should be increasingly incentivised to offer competitive financing terms.
Ultimately, once motor finance firms move away from discretionary commission models, we expect to see consumers’ financing costs reduce.
“The FCA expects customers to get a fair deal, this is implicit in their core objectives and this, at least in part, they see as being achieved by financing costs reducing in motor finance; they have even put a £165m figure on this saving,” Standish says. “I believe all lenders recognise the FCA’s aim and the challenge in doing so in a manner that supports dealers.
“We have shown this is possible and if the lending community recognises this path, we can change the market to the benefit of all of our stakeholders. While seeing the ‘carrot’, I also recognise the ‘stick’ and everyone in dealer finance needs to realise this.”
With regards to the ‘stick’, those in the industry must realise time is running out to come up with a response to the new regulations.
While some dealers may be waiting for an ideal solution to come along, be it in the form of an auditing company or other solution, lenders and dealers owned by banks or manufacturers will want to avoid the aggravation that can come with compliance failures, and process controls and training before the 28th of January.
Between now and then there has been a second lockdown, staff on furlough, and the upcoming Christmas break, leaving little time for substantive overhauls.
The Senior Managers & Certification Regime means that in every financial services firm there is going to be an individual personally accountable for ensuring these changes are in place, and the industry is going to have to work hard to ensure that happens.
