Details of the FCA’s long-rumoured investigation into the motor finance sector are gradually emerging. It is important that additional regulation remains proportionate, is tailored to the automotive sector and does not inadvertently damage the sector itself, writes Charles Kirk, associate at Birketts
The Financial Conduct Authority (FCA) has announced that it will look at lending practices in the motor finance market and at products that have become commonplace in that market.
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As part of its business plan for next year, it has stated that it is “concerned that there may be a lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry” and wants to identify “whether the products cause harm”. It will then decide whether and how to intervene in the market.
In the context of other mis-selling investigations in other sectors, this intervention has been long-rumoured. While the FCA has not indicated which aspect of motor finance it intends to concentrate on, our expectation is that personal contract purchases (PCP) and affordability are likely to primarily come under the spotlight.
We expect that the FCA will focus on whether customers understand who they are contracting with, and whether the fees, charges and other costs are influenced by the way in which those involved in the finance supply chain are paid.
The private sector has been looking closely at this too. Credit report and credit score provider Experian recently sounded an alarm bell by claiming that a high number of consumers that enter into auto financing to make their purchase belong to what it defines as “stressed income” households.
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By GlobalDataPCP finance deals have powered the new and used car markets over recent years, and are said to account for over 70% of dealer retail sales – and for some car brands over 90%! While it has made usage of vehicles, especially premium brands, more affordable and can have the effect – especially in conjunction with service plans – of locking in customers, it can also potentially render the motor industry vulnerable to economic shock if the PCP ‘merry-go-round’ cycle were to be severely impacted.
In our view, this is a risk that the industry itself faces, rather than consumers. However, as we have seen with the credit crunch following the collapse of Lehman Brothers in 2008, losses in one sector of the economy tend to also affect other sectors.
In respect of envisaged enforcement measures post-investigation, we do not expect that the FCA will prohibit PCP – or PCH or HP – motor finance.
However, it may well seek to better regulate the valuation of balloon payments (the end-of-contract price for the expected residual value of the vehicle) and, where relevant, seek to ensure that lenders are better capitalised to guard against the risk of loss. It may also look to ensure that demand for the PCP product is better controlled by mandating more robust affordability criteria.
On the affordability aspect, whether as a way to soften demand or simply as an additional consumer-protection measure, the FCA – and indeed the Bank of England – is alert to the fact that, other than passing basic credit checks, customers can agree to contracts without proving they can afford to make repayments.
In its business plan, the FCA said indebtedness was on the rise, with 16m UK residents now holding savings of less than £100. Given that over the past eight years more than £30bn has been lent in the motor finance space, this could certainly trigger or exacerbate an economic crisis if significant numbers of consumers are unable to make their monthly repayments. In fact, the Bank of England has previously warned about this, but as with previous examples of commercial habits, the ship has accelerated rather than being turned.
As a result, it seems to us quite likely that providers of motor finance – already regulated by the FCA – would, like mortgage lenders, be required to subject customers to more rigorous affordability tests. Such tests could require lenders to request additional, more-detailed and evidenced information regarding customer spending and income, slowing up the contracting with customers, and therefore directly impacting the efficiency of the point-of-sale process. The use of third-party guarantees may also become more common.
That said, we feel that it is important that additional regulation remains proportionate, is tailored to the automotive sector and does not inadvertently damage the sector itself. Any regulation should not simply ‘copy and paste’ the mortgage lending rules, and should recognise that vehicles are a far more liquid commodity than property, with significantly lower amounts at risk.
Further, as the FCA already regulates providers of motor finance, we suspect that any changes will build upon the existing regime rather than knocking it down and replacing it with a new one, particularly with so many dealers having risen to the task of providing transparency and clarity to consumers in the showroom.
With diesel-vehicle owning consumers already facing uncertainty from the government, it may be seen as politically inexpedient for wholesale changes to be made to motor finance.
