Tue 22 Aug 2017

The FCA, Intermediaries, and Commission Payments

The FCA has recently issued its "Consultation" on staff incentives and remuneration in consumer credit (CP17/20).

Consultation it may be, but we can regard it as more or less their finished thinking on the topic.  Draft amendments to CONC are in the Consultation which we can expect to be in force from the end of the year.  This note, however, concentrates on the asset and motor finance markets and asks to what extent a Consultation on staff incentives carries over to the payment of commission to intermediaries such as motor dealers and asset finance brokers or other introducers?  There has been a dearth of comment from the FCA over the last couple of years on intermediary remuneration but there's little doubt there are lessons to be learned from this Consultation in relation to this other topic.

The issue which will perhaps focus the minds on this more than any other is the emphasis in the Consultation on how the new Senior Managers' Regime will aid the FCA in enforcing proper management of staff incentives.  The purpose of the proposed new rules and guidance they say will be to amplify firms' obligations under PRIN 3 to ensure they identify and manage risks to customers that may arise out of their remuneration policies and practices.  This will then link to the Senior Managers Regime where there will have to be someone in the chain of command who understands how incentives may impact on customer outcomes and monitors that impact.

The starting point for commission payments to intermediaries is CONC 4.5.2:

"A lender should only offer to, or enter into with, a firm a commission agreement providing for different commission rates or providing for payments based on the volume and profitability of business where such payments are justified based on the extra work of the firm involved in that business."

Apart from the poor grammar, that's unambiguous (though, as so often with the FCA, vague) and I feel is often lost sight of in the complexities of some broker arrangements.  The aim of the guidance of course is to prevent credit (or hire agreements) being mis-sold with the result that customers are not treated fairly.  Mis-selling is the central theme of the new Consultation and the mischief which senior management ought to look to prevent.

So, if you have a volume related bonus arrangement with your broker, can it comply with CONC as it currently exists?  If the arrangement is based on profitability, it may not comply either unless you take account of issues which could lead to bad consumer outcomes.  The FCA finds itself speaking in contradictory terms here.  On the one hand, it's concerned that if an intermediary gets higher reward for maximising the interest rate at which a credit agreement is signed up by the customer, then that may lead to mis-selling.  On the other hand the FCA has also been at pains in the past to say that it accepts that finance companies are entitled to make a profit and the FCA shouldn't be stopping that.  But it seems that incentivising the intermediary to help maximise that profit may be challengeable.  That is awkward and puts the FCA at risk of putting itself in a dubious position. The industry meanwhile has to deal with what it's being told.

Against that conundrum, pricing for risk is a concept which the FCA accepts.  They realise that an HP agreement for a sub-prime hirer will carry a higher APR than for a prime hirer. Subject then to not incentivising the intermediary itself to maximise the APR, can the intermediary simply receive commission based on the APR within the rules?  I think it would be hard for a simple scheme like that to fall within the FCA requirements, given the plain terms of CONC.  However, the creditor and intermediary can recognise that business with sub-prime hirers, inevitably with higher APRs, will involve the intermediary (and the finance company) in more work dealing with affordability and credit-worthiness and therefore, by the back door as it were, a higher APR, where it results from pricing for risk, can lead to the intermediary being better rewarded while still complying with CONC 4.5.2.  It may be a question of how you phrase the wording of the relevant reward scheme and what other factors you may take into account.

Against that background, what is the new "draft" guidance telling us and how should it impact relations with intermediaries?

It focuses on types of staff incentive and remuneration which could lead to mis-selling.  Examples given (ignoring issues relating to salaries and collections which have no application to third party commissions) include: accelerators and step payments, where the more that is sold the higher the reward; thresholds where payments increase (or only begin) once a minimum target is reached and where there is particular risk of mis-selling where the staff member is managing nearly to attain the threshold); disproportionate awards for marginal sales; large payments for add-ons.  A further issue which is tangential to this but always worth bearing in mind relates to how supervisors of those incentivised are remunerated: if the manager is rewarded by the volumes or profitability of his team rather than by the team's consumer outcomes, he must have a conflict of interest when over-seeing his team's conduct.

Trying then to carry this across to intermediary remuneration, what lessons can we learn? Here are some thoughts:

  • Motor dealer staff shouldn't be being rewarded disproportionately for selling the finance and add-ons compared with fulfilling their basic role of selling the car; have you checked how your intermediary rewards its staff?
  • Clawback arrangements are good.  If commission is clawed back, as it often is, where a customer cancels his agreement or defaults within a three or six month period, that should dis-incentivise the intermediary encouraging the customer to enter into unsuitable contracts.  Early default is an indicator of possible mis-selling or inadequate affordability checking.
  • Is clawback enough or should there be another quality measure, such as an annual review of customer outcomes with some mark down for a percentage of poor scores?  Or could there be two measuring criteria: one based on volumes or profitability; one on quality outcomes with the lower being the award?  And so on? How you assess the outcomes is a matter for each business to consider, as methodology is harder with third parties than with your own staff.  It may be possible to do a telephone survey of customers or to send a mystery shopper to show interest in a car at a motor dealership, for example.
  • In addition, it's suggested you use clawback data to investigate how the terminated agreements were sold.  Can you ensure you find out why the customer is cancelling?  Can you ensure you have MI as to cancellations and early terminations and spot issues arising?
  • In summary, while detailed arrangements may vary, the FCA expects good customer outcomes to be your mantra, so have some quality measures in the intermediary remuneration arrangements.
  • Use complaints to understand issues arising.  If your business starts with a car salesman, it's no use throwing up your hands in horror when things are over-sold.  That's part of your business model so deal with it.
  • Ensure you have regular intermediary visits where you check what they are doing and can you use MI to fill in the gaps between visits?
  • Keep the commission arrangements under regular review - at least annual.  If you change the structure and see a drop in the quality of the deals or an increase in complaints, be ready to take prompt action to reverse the change.

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