Motor Finance: a summary of the FCA’s proposal to ban discretionary commission models and enhance the credit broking disclosure rules
By Jourdain Tambo, Technical Director at The Compliance Company
The FCA published CP19/28 setting out its proposal to ban discretionary commission models within the motor finance market and enhance the credit broker disclosure rules and guidance in the Consumer Credit sourcebook (‘CONC’).
The FCA conducted a review of the motor finance market and explored whether commission models in the motor finance space gave rise to conflicts of interest. The FCA’s review consists of collecting data relating to 1,000 motor finance transactions from 20 lenders representing about 60% of the market.
As a result of the motor finance review, the FCA identified the following:
- Discretionary commission arrangements – The prevalence of commission arrangements which link broker commission to the customer interest rate and allows brokers wide discretion to set the interest rate may be causing consumer harm in potentially creating a landscape where consumers pay significantly more for their motor finance because brokers are incentivised to ‘sell’ more expensive motor finance to maximise their commission income. The FCA found that discretionary commission arrangements linked to interest rate creates an inherent conflict of interest due to the information advantage that brokers enjoy in having knowledge of the credit products on offer and their commercial interests in arranging more expensive credit balanced with the fact that consumers are reliant on them to source suitable finance solutions. The FCA’s conclusion was supported by data showing a significant difference in the amount of interest customers pay when taking motor finance deals arranged through a broker who benefits from a discretionary commission model compared to a flat fee commission model, with the former group of consumers paying in total around £500m more in additional costs.
- Commission disclosure – The FCA found that only a small number of brokers in its sample disclosed to consumers that a commission may be received for arranging finance. The FCA found that those brokers in its sample who did disclose the existence of a commission arrangement with lenders often did not communicate the disclosure prominently. This potentially creates a landscape where consumers are not being equipped with the relevant information, at the right time, to enable them to make informed transactional decisions.
Discretionary Commission Arrangements
The FCA propose to address the potential consumer harm caused by discretionary commission arrangements by banning discretionary commission models that are linked to interest rate. The FCA seeks to remove the conflict of interest inherent in discretionary commission models by removing the link between interest rate and commission. The FCA envisage that this should remove the incentive for brokers to set higher interest rates.
The FCA expect interest rates to be based on, for example, credit risk rather than driven by misaligned incentives for brokers. The FCA’s proposed ban seeks to create a landscape in the motor finance market where the cost of credit is based on the credit risk of consumers rather than the financial incentives of brokers. The ultimate benefit for consumers, in the FCA’s view, is that their financing costs should decrease as a result of the proposed ban.
- Applicability: It is to be noted that the scope of the proposal to ban discretionary commission arrangements is limited to the motor finance market. The FCA acknowledges the existence of similar discretionary commission models linked to interest rate in other markets (for example, asset finance and premium finance) however state that there is insufficient evidence to demonstrate consumer harm in those other markets which justifies a similar intervention.
- Extent: The FCA propose to define ‘discretionary commission arrangement’ with reference to the total charge for credit, rather than just the interest rate to prevent firms from circumventing the proposed ban. In other words, the proposed ban seeks to abolish any discretionary commission that is linked to the total charge for credit (not just interest rate).
- Limitation: It is to be noted that the proposed ban does not seek to ban variable commission models that are not dependant on interest rate. For example, brokers will continue to be allowed to operate models where the amount of commission is determined by the amount of work carried out by the broker (for example, in the case of customers who are a higher credit risk and where the broker undertakes more work on the lender’s behalf to gather information to enable the lender to carry out a more detailed assessment of affordability).
The FCA propose to adjust the credit broking disclosure rules and guidance in CONC to provide greater clarity on the level of disclosure brokers are expected to provide to customers to enable customers to make informed decisions.
The FCA propose ameliorating the credit broking rules and guidance in CONC by requiring:
- Brokers to prominently disclose the nature of any commission arrangement in addition to the existence of a commission arrangement and how the existence and nature of the commission arrangement may affect the amount payable by the customer under the proposed credit or hire agreement (with the requirement for prominence to be made express in the rules); and
- Brokers to disclose to consumers, where applicable, the fact that its commission varies due to a factor specified in the arrangement with the lender. It is proposed that this disclosure can be in general terms however should nonetheless enable the customer to reasonably appreciate the effect of the arrangement on them.
It is to be noted that the proposed revised credit broker disclosure rules and guidance is to apply to consumer hire brokers.
The FCA consider that the proposed enhancements to the credit broking disclosure rules and guidance will increase the likelihood of consumers receiving more relevant information about commission arrangements and how they would potentially impact on them in order to make informed transactional decisions. The FCA consider that the benefit to consumers, as a result of the proposal, is that they are more likely to compare prices, find or negotiate cheaper deals and ultimately obtain better value credit products.
- Applicability: It is to be noted that, unlike the proposed ban, the proposed enhancements to the credit broking disclosure rules and guidance is to apply across all consumer credit markets (as opposed to just the motor finance market).
The FCA propose to publish a Policy Statement including the final rules at the beginning of Q2 2020. The FCA propose to give brokers 3 months from the proposed implementation date (at the beginning of Q2 2020) to implement the proposed ban on discretionary commission models. It is to be noted that the proposed changes to the credit broking disclosure rules and guidance is proposed to apply to all brokers from the day the rules are finalised.
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