Features | 11/03/20

The UK has a large and active motor finance market, reported to be worth over £34bn in 2017. Considering its size, it is perhaps no surprise that the Financial Conduct Authority (FCA) decided to carry out a review of the market, assessing how motor finance products were being used, the sales processes employed by firms and whether the products could cause harm to consumers. 

The FCA’s final report was published in March this year, with the investigation drawing attention to some grave concerns, particularly around commission arrangements and affordability assessments. On top of this, the FCA has called for greater transparency and lender controls, in order to ensure firms are delivering better customer outcomes. 

Firms that get this right straight off the bat will find themselves in an advantageous position, especially considering the regulator has said that, where necessary, it may consider supervisory or enforcement action. It may also ask individual firms to provide progress reports on how they are addressing these issues. 

The widespread use of certain commission models was identified in the report as the most immediate risk to consumers. The regulator expressed ‘serious concerns’ about the way some lenders are choosing to reward car retailers and other credit brokers. 

For example, it discovered that the widespread use of the ‘increasing difference in charges’ (DiC) commission model, allowing brokers discretion to set interest rates, has created conflicts of interest that are not being adequately controlled. Specifically, by linking their commission to the customer interest rate, brokers are incentivised to charge higher prices to customers so that they can take home better earnings for themselves. 

The FCA found that consumers could be over-paying a combined £300 million per year for their motor finance products because of these arrangements. In a typical agreement of £10,000, a customer being charged as part of a DiC model could end up paying £1,100 more over a four-year term than they would under a different model.

The regulator has already started weighing up its options for policy intervention, which could include a blanket ban on commission models such as DiC, most likely in favour of single fixed/flat fee arrangements. To ensure they’re operating responsibly, firms should start undertaking a thorough review of their existing commission arrangements and
ask themselves the following questions:

• how transparent are brokers being in disclosing commission arrangements
to customers? 

• are customers entirely aware of the interest they will be paying? 

• how does the commission vary and how could this influence the product
the customer is steered towards? 

It’s important that firms start having these difficult conversations now rather than risk regulatory intervention in the future.

The FCA also raised issues around affordability assessments, specifically firms’ ability to assess and record customers’ creditworthiness. It found that some firms focused more heavily on the credit risk to the lender than on what the borrower could afford to repay.

Under new rules published by the FCA in 2018 (CONC 5.2A), a number of considerations must be addressed before lenders are legally allowed to enter into a credit agreement with a customer, including the risk that the customer will not be able to make repayments. Factors that may help to determine affordability include:

• the customer’s sole or joint income, including from savings or assets

• whether the customer has to borrow to meet the repayments

• whether the customer will fail to make any other repayments because of a new agreement

• whether the repayments will have a significant adverse impact on the customer’s financial situation.

Firms looking to stay on the right side of the regulator should be evaluating their own procedures to ensure they truly reflect their customers’ risk and affordability status. This is especially important in circumstances where a customer is considered vulnerable, as
the ramifications for late or non-payment are likely to impact them more severely. 

It’s important to note, however, that ‘vulnerability’ has a broad definition, including those with life-long physical conditions and disability, as well as those impacted by temporary life events such as divorce, redundancy or bereavement. 

With regulatory scrutiny in this area increasing, lenders must make it a priority to ensure customers in vulnerable circumstances are dealt with appropriately and sensitively. Front-line staff, for example, should receive specialist training to help them better identify and support vulnerable groups. Developing a robust vulnerable customer framework should be a major and immediate consideration for any firm wanting to build a responsible, customer-first business.

The results of the FCA’s ‘mystery shopper’ exercise saw the regulator raise a number of concerns in relation to pre-contractual disclosure and explanations. It claimed that these were either not made early enough in the process, were incomplete or were otherwise difficult to understand. The FCA concluded that customers are not being given enough detail with which to make informed decisions, something that goes against its own guidance on reasonable care.

As a result, the regulator is cracking down on brokers who do not meet the basic requirements of the Consumer Credit Sourcebook, such as the disclosure of any commission or other financial arrangements with a lender. Any disclosure should be clear and readily comprehensible. Brokers must also be prepared to disclose the amount (or likely amount) of any commission upon request.

To ensure they remain compliant, firms should be reviewing their degree of transparency with customers, and that of the individual brokers who sell their products. As a starting point, firms must consider whether information, including details around commissions, is being given early enough and clearly enough when talking to potential customers. 

Firms should be aiming to meet industry best practice and ensure that they are delivering the best possible outcomes for customers.

Despite lenders’ claims that they have broadly reasonable controls in place to monitor their brokers’ compliance, the FCA has doubts over whether, and to what extent, these controls are currently being implemented. 

The FCA expects lenders to review their systems and controls to reduce the risk of consumer harm, however the best firms will already have oversight of the performance of their brokers. They will also make this a standing item at various risk, conduct and oversight committees within their own risk frameworks, to ensure that the issue is getting the attention it deserves. 

The precautions firms take are down to the individual business. However, some lenders also follow up directly with customers to verify that key information has been provided and explained to them as well as to determine whether customers understand their contractual obligations. To this effect, lenders need to increase their focus on ‘weeding out’ any irresponsible brokers who may cause further problems down the line.

Brokers should expect to report a range of information in future, such as the percentage of applications denied, percentage of loans sold with insurance or warranties, sales volumes (actual vs expected), and complaints data by location and individual. 

There are a number of specific issues firms should be assessing and reviewing across each of the four key areas identified. We recommend a broad framework of ‘assess, assure and act’ for guiding any action in this space. 

Assess – Collate a dashboard of key risk indicators (KRIs) for intermediaries and consider what action is most appropriate once completed. For example, this could be a field visit, an ad-hoc (focused) visit, a sector review, or even a mystery shopping exercise.

Assure – Conduct relevant field visits with a risk-based approach. These should include documented review of items such as business performance, governance, regulatory checks, evidence of fair outcomes for customers, affordability assessments, complaints handling, treatment of vulnerable customers and record keeping.

Act – If these activities reveal or confirm issues, then prompt action should be taken. Remedial actions should be agreed, results and issues tracked on an ongoing basis, and consequence management brought into the picture if no improvement is seen.

As a result of increased market scrutiny, all firms operating within the motor finance industry should be implementing a robust programme of third-party oversight and looking at how they can improve their operating models. The FCA is likely to propose more regulation in future to restrict certain behaviours and encourage more responsible lending. With this in mind, lenders need to get ahead of the issues now so that they can evidence a more customer-centric culture in future.

Sean Kulan
Sector Lead Consumer Credit,