In its Business Plan for 2017-18, the Financial Conduct Authority (FCA) announced that it intended to conduct a review of the motor finance sector. In particular it wanted to assess the sales processes employed by firms and whether their products could cause consumer harm. The FCA identified 4 key questions it wanted the review to answer:-

 ·        Are firms taking the right steps to ensure that they lend responsibly, in particular by appropriately assessing whether potential customers can afford the product in question?

 ·        Are there conflicts of interest arising from commission arrangements between lenders and dealers and, if so, are these appropriately managed to avoid harm to consumers?

 ·        Is the information provided to potential customers by firms sufficiently clear and transparent, so that they can understand the risks involved and make informed decisions?

 ·        Are firms managing the risk that asset valuations could fall and ensuring that they are adequately pricing risk?

In March 2018, the FCA published an update report setting out its initial indings:-

 •              The motor finance sector had continued to grow, particularly for personal contract purchase (PCP) agreements.

 •              The largest lenders were adequately managing the prudential risks from a potential severe fall in used car sales, but firms should regularly consider relevant changes in the market.

 •              Growth in motor finance had been strongest for lower credit risk consumers (higher credit scores), who are less likely to face repayment difficulties.

 •              Arrears and default rates generally remained low, but had increased somewhat, particularly for higher credit risk consumers (lower credit scores), despite relatively benign credit and macro-economic conditions.

 •              If not properly managed, some of the commission arrangements in place could provide incentives for dealers to arrange finance at higher interest rates.

 •              In some cases, information to consumers on websites and in contact documentation was not sufficiently prominent or easy to understand. 

In addition, in its March 2018 update the FCA committed to focussing, in the remainder of its review, on what its considered to be the issues of greatest potential harm to the consumers, which included:-

 •              Whether lenders are adequately managing the risks around commission arrangements, and whether commission structures have led to higher financecosts for customers because of the incentives they create for brokers.  

 •              Whether customers are being given the right kind of information, at the right times, to enable them to make informed decisions, and whether firms are complying with relevant regulatory requirements.  

 •              Whether firms are properly assessing whether customers can afford to repay the credit, particularly when lending to higher-risk consumers.

 The FCA issued its final findings this year finding:-

 Commission Arrangements

The FCA is concerned about “the widespread use of commission models which link the broker commission to the customer interest rate and allow brokers wide discretion to set the interest rate . This gives rise to conflicts of interest and creates strong incentives for the broker to charge a higher interest rate. This is an issue which the FCA has identified as causing real consumer harm and, in its analysis, estimates could be costing consumers £300millionannually.

The FCA found that commission rates between lenders and dealers calculated on:-

 •              increasing difference in charges (increasing DIC); and

 •              reducing difference in charges (reducing DIC)

 provide strong incentives for brokers to arrange finance at higher interest rates, because the amount of commission the consumer is charged increases with the interest rate that the consumer is charged.

The FCA does not consider that all lenders are doing enough to limit risks from their commission models and is considering its options for policy intervention. It has indicated that this might include banning DIC and similar commission models, limiting broker discretion, or amending CONC 4.5.2G which provides that a lender should only offer or enter into a commission agreement for differential rates, or for payments based on the volume and profitability of business, where this is justified based on the extra work for the broker. This could include where the commission rate as a percentage of the amount of credit varies according to the interest rate charged to the customer. The onus, therefore, is on a lender to show that any differences in commission rates are justified, based on the work involved for the broker.

Transparency

CONC1.2.2R imposes an obligation on lenders to take reasonable steps to ensure thatpersons acting on their behalf, for example, dealer/credit brokers, comply withCONC. This includes compliance with rules relating to the disclosure ofcommission, in addition to the relevant rules regarding pre-contractualdisclosure and explanations. The FCA in its final findings expressed particularconcern about the disclosure of commission, "especially in respect of DICand similar commission models.  The FCA is concerned that some lendersappear to take the view that it is sufficient that a broker is FCA authorisedand that the they can, therefore, assume that the broker is compliant. 

Affordability Assessment

The FCA is not satisfied that all lenders it surveyed as part of its review, were complying with FCA rules on assessing creditworthiness, including affordability.  It commented that some lenders appeared to "focus unduly on credit risk (to the lender) rather than affordability (for the borrower), and there were gaps or anomalies in information provided.

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