Mon 11 Mar 2019

FCA final findings on motor finance

On 4 March the FCA published its conclusions from its investigations over the last couple of years into consumer motor finance. While its interim report praised the motor finance industry in several respects - particularly, the innovation demonstrated by the now widespread availability of PCP products - the final conclusions contain some more damning findings. The key takeaway is that they expect both lenders and intermediaries to review their policies and procedures now - so lenders and intermediaries had better get on with it.

Amended provisions in CONC to reflect the findings are on their way, but the review should not wait for that. To quote paragraph 4.11 of the report under the heading "Lender Controls":

"We expect lenders to review their systems and controls, to reduce risk of consumer harm. They should monitor brokers adequately and take reasonable steps to ensure compliance with CONC, where applicable." 

Elsewhere in the report's conclusions, a similar imprecation is applied to the brokers themselves.

Where the FCA concentrates its ire is probably quite predictable: they believe that the award of brokers' commissions on a Discount in Charges (DiC) basis leads to mis-selling; and they don't think lenders are doing enough to check that brokers are complying with CONC as they should.

The Two Main Issues

Commission on a DiC basis is calculated, in part at least, on the increase in the interest rate embedded in a consumer finance agreement compared with the minimum interest rate the lender is prepared to countenance. Therefore, the higher the charges paid by the consumer, the greater the commission the broker receives. (The FCA draws a distinction between Increasing DiC and Reducing DiC - in the latter case there's a cap on how high an interest rate the broker can provide for in the agreement - but concludes both contribute to the same mischief.)  Subject to my philosophical objection to this finding (of which more below), and a challenge by the FLA to the current validity of the figures used by the FCA, this conclusion is hardly surprising and many of us in the industry have been worrying about it for some time. The FCA has come up with a suggested figure that consumers are paying £300M too much annually for their motor finance credit because of the use of DiC. They have found no consumer detriment with flat fee commission structures and those who have already determined to move to flat fees may be entitled to feel smug. They also comment in passing on so-called Scaled Commission - where the commission varies according to certain product features; they see this as causing possible consumer detriment if not properly controlled, but much less of a problem than DiC.

So far as CONC is concerned in the above context, the FCA makes two points under CONC as it stands (before the FCA tightens it up), the second of which is likely to have an immediate impact on market conduct. First, they remind lenders that under CONC 4.5.2G differential commission rates need to be justified based on the extra work for the broker, whereas there's no reason why DiC relates to any such extra work. Secondly, and this is the one of immediate significance, they point out that CONC 4.5.3R requires brokers to disclose, in good time before a credit agreement is entered into, the existence of any commission if knowledge of the existence or amount of the commission could affect the broker's impartiality or have a material impact on the customer's transactional decision. They then link this to CONC 3.7 requiring brokers to make similar disclosures in their financial promotions and other documents. Clearly, the FCA thinks that the thrust of these rules requires much more disclosure by brokers than may hitherto have been the norm. They suggest there's a conflict of interest requiring disclosure in more or less all cases, whereas in the mystery shopping exercise they conducted the FCA "found that only a small number of brokers disclosed to the customer, during the mystery shopping visit, that a commission may be received for arranging finance." They go on to say that, even if the disclosure were made later in the process, that would not be a sufficiently early disclosure.

They then remind lenders, in the same context, that CONC 1.2.2R requires them to take reasonable steps to ensure that persons acting on their behalf comply with CONC.

That last comment ties in with the FCA's second main finding: that lenders "may not monitor brokers sufficiently closely or act where issues are found". They suggest that lenders rely on the contractual provisions in the introducer agreements setting out brokers' responsibilities to comply with CONC and treat customers fairly, but are unduly so reliant and don't check enough in practice.

Other Issues

In what is quite a short report, the FCA only picks out two other areas of concern.

The first is whether adequate affordability checks are being undertaken. In their mystery shopping they found that some checks focused on credit risk alone and not also on affordability and that policies did not always adequately identify the two parts to the assessment - albeit they accept that their review was undertaken prior to the recent changes to CONC emphasising the affordability checks required. Lenders may take comfort though from something the FCA assumes in passing in its comments on this area, namely, that the verification of information and data obtained is not always necessary, unless there's a warning flag or it's a marginal case. To quote: "it was not always clear which CRA products were being used, and in what ways, or what might trigger asking the customer for documentary evidence." This may be well understood and reflect current practice, but it's a clarification the FCA has hitherto been cautious about in not going beyond stating that all the possible tests about affordability in CONC have to be applied proportionately.

The second concern,  inevitably perhaps, relates to the transparency and comprehensibility of the documentation, particularly relating to pre-contract disclosure and adequate explanations. They are also conscious that in many cases there's inadequate explanation of competing finance products, with a concentration solely on PCP and why it's a better deal than traditional HP. There's a flaw in their report, however, which the FCA themselves recognise, though it's questionable if they recognise the extent of it. They acknowledge that their mystery shopping exercise stopped short of actually proceeding to the agreement phase - unsurprisingly. They simply point out that the SECCI and adequate explanations have to be given before the agreement is entered into and they did not see many of these documents in the mystery shopping exercise. But we all know the documentation is presented together at the point when the inception of the agreement is imminent. And we also all know how hard it is to render a simple  adequate explanation of a PCP agreement given all that has to be said. The FCA did acknowledge that verbal explanations they received in mystery shopping as to the principles of PCP were generally quite good, apart from a failure to explain that title did not pass until the end of the deal.

Oh, and PCH isn't mentioned at all. The FCA's lighter touch on hire agreements appears set to continue.

It is worth quoting the FCA's demand in consequence of this: "We expect lenders and brokers to review their policies and procedures, to ensure that customers are treated fairly with appropriate transparency. In particular, firms should satisfy themselves that any required disclosures and explanations are clear and easy to understand, and are provided sufficiently early in the process to enable the customer to make an informed decision."


A Philosophical Problem

I wonder if there's a counter-argument to the commission disclosure problem that the FCA has not taken into account. The FCA concludes that there's not enough co-relation between credit risk and interest rates; so customers with better credit ratings do not seem to be getting the cheaper deals one would expect. They consider this to be good evidence of the mischief caused by brokers being incentivised to increase interest costs in agreeing a deal with the customer.

But this begs two questions, the second of which is the more significant. First, customers who can easily afford the credit may have much less incentive to challenge the cost of the deal than those whose credit circumstances are strained. Whether a person seeks the best possible deal in any given circumstance is a matter of personality of the customer where the credit is readily affordable. The second issue though is this: the FCA acknowledges, perhaps grudgingly, that it's not opposed to lenders making profits, provided a customer is treated fairly. If motor finance were conducted face-to-face, as it would have been in the days when a borrower met with his bank manager when any funding was required, the parties could negotiate terms with the bank seeking a good return and the customer seeking a good deal. But in the motor finance industry, the lender hardly ever meets the customer; that job is left to the broker, who is an independent trader and the agent of neither party (save where s56 of the CCA applies in some cases). The lender therefore has to rely on the broker to get a good deal, the lower limit being the lender's funding costs. The lender does not want to do every deal at its minimum rate or its profits will be curtailed; and it's not just a question of the minimum required rate varying by credit risk. This is how DiC has arisen. Why can the broker not be negotiating the rate? The FCA's answer may be that it can, but not then be remunerated for doing so. This is an issue which dare not speak its name as authorised persons don’t want to cross the FCA, but it seems to me to justify an airing.

Anyway, ignore that. Those involved in the motor funding industry need to get their reviews under way as the FCA requires.

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