Commission disclosure and the FCA intervention into auto finance

Summary

The Financial Conduct Authority (FCA) announcement of an in-depth review of discretionary commission arrangements (DCA) within the motor finance sector at the start of the year triggered a seismic disruption within the market. The subsequent avalanche of consumer complaints saw some lenders make substantial financial provisions for compensation claims, but many remain unsure of the impact of the regulator’s intervention or of the appropriate actions to take – all good reasons for the auto finance stream at this summer’s AFC Connect conference to take a detailed look at developments in the first six months.

While the FCA’s review is fresh news, its roots go back a long way, and with his “historical lens” Wayne Gibbard, partner with law firm Shoosmiths, opened the session with a guide to the key events, starting with June 2007, the date of the first iPhone launch, which also saw the Financial Ombudsman Service (FOS) take over complaints handling for the sector, which is why the current FCA inquiry is potentially investigating contracts from almost two decades ago.

Gibbard pointed out that the FCA has thus far rejected 99% of mis-selling complaints, but was forced to intervene in the wake of two FOS decisions upholding compensation for consumers which threatened to create chaos, noting: “this was the only action the FCA could take to stabilise the market and provide some respite.”

Since then, the regulator has been conducting skilled persons review and, in Gibbard’s view, been surprised both by the level of data provided and the complexity of the market, neither of which had been anticipated.

Speaking some three months before the FCA’s original September 2024 deadline for concluding the review, (which has now been extended to May 2025) Gibbard said there had so far been only “breadcrumbs” of information about the regulator’s aims, but pointed to a speech given in March by the FCA CEO which stated that “market integrity, consumer protection, and the promotion of competition requires a constant balancing act,” and underlined the desire to reach a speedy resolution, unlike the protracted process of handling PPI claims in the 1990s.

FCA and FOS tensions

The FCA review, in Gibbard’s eyes, illustrates the tension between the FCA and FOS, as the latter’s remit to reach “fair and reasonable” decisions can see it delivering outcomes which have the effect of creating new regulations and which can sometimes run counter to FCA rules and guidance. “That’s a very odd outcome, where one of the principal arbiters in our space is able to create decisions which are potentially contrary to law,” Gibbard noted.

Barclays has brought a judicial review of one of the FOS mis-selling decisions, which Gibbard explained would need to meet a high threshold for success, with the three key grounds being illegality (unlikely as FOS was acting within its remit); an irrational or unreasonable decision; or procedural impropriety.

Previously such challenges have seen the courts give FOS a “wide and free hand”, although the courts themselves have seen a decline in the number of new cases concerning DCA, along with some decisions which run contrary to FOS.

Balancing act

Looking ahead to potential outcomes, Gibbard highlighted the FCA’s operational objectives, which are to protect the consumer; protect the integrity of UK financial services; promote competition; and to promote international growth. “It’s a balancing act. But we can say that the

FCA would not propose a redress scheme for all consumers which delivered an economic shock to our ecosystem, as that would fail one of their statutory objectives,” he said.

However, it is unlikely that the skilled persons review will find no evidence at all of consumer wrongdoing. More likely, it will identify practices that existed at a certain period and in some business models which resulted in consumer harm, but not in all and every case.

“The most likely option is consumer redress under section 404 of the Financial Services and Market Act, which would have the benefit of providing certainty as to the extent of any remediation,” Gibbard forecast.

Potentially this would also mean that the backlog of cases with FOS could be sidestepped and resolved within the consumer redress scheme. Such schemes are rare and require consultation – which the FCA has recently indicated is likely in its announcement of an extension to the timetable for its review, something which Gibbard also predicted at the conference session.

Fiduciary duty

Answering questions from the audience, Gibbard said many of the cases coming to court rested on legal arguments around fiduciary duty between the broker, dealer and customer. “Our analysis is that the role of the dealer in motor finance is not acting on behalf of the consumer – it’s an odd conclusion that the dealer would act in one capacity in supplying finance and then assemble the deal and act on their own behalf. It’s a B2B argument applied to B2C where different roles are played by the parties, and that’s why courts are finding in favour of lenders.”

Consumer trust

Looking at the impact of the FCA intervention, Rachael Jones, director of automotive finance at Auto Trader, cited its research with 2000 consumers which found 38% were aware of the FCA review but only 20% wanted to act on it. “There’s been a huge flood of consumer interest after Martin Lewis got involved, but that’s dropped off since. Around 70% of claims come from claims management companies and are not consumer-driven,” Jones pointed out.

The survey also showed that 37% of consumers now trust lenders less, with similar views on retailers. “This could dent the industry’s reputation, but we’ve seen no change in activity regarding finance on our site and we’re getting exactly the same levels of inquiry each month. Finance is so important to affording a car, and this is a well-developed market in the UK,” Jones added.

Consumers must be told of the existence of any commission payment, but there is no requirement to inform them of the amount. Jones said research asking consumers what would help build trust in any finance deal identified three priorities: firstly, a commitment from the dealer there were no hidden fees, and secondly a choice of finance options, which could include a choice of products and a choice of rates. Having the commission amount laid out clearly came third in this poll.

“What consumers want is clarity and transparency on the deal, and you’ve got to think about the whole journey,” Jones said.

Commission disclosure

Asked if the FCA would move to mandate compulsory disclosure of commission amounts, Gibbard pointed out that the regulator had had the opportunity to do this, and was encouraged to do so, two or three years ago in a policy statement, but had chosen not to go ahead

“That was a bit surprising, and it’s odd that they didn’t want to harmonise with, for example, other areas like mortgages, so there is a disconnect there. But it’s inevitable that this will return as an issue, given all the data around motor finance they are collecting as a result of the skilled persons review which goes much further than just DCA,” Gibbard argued.

As David Betteley, the panel chair, pointed out, full commission disclosure is a contentious issue, with the main industry trade association seeking to mandate this as part of its code but seemingly unable to get the necessary unanimous decision from members.

Stephan Reeve, managing director, financial services, at Mazda Motor Europe made the point that dealers are “endlessly adaptable”. While commission opportunities in the new car space remain limited, in the used car market there are indications that dealers are favouring lower rates to ensure volume. Reeve also pointed out that younger buyers are financially savvy, often doing research online into deals before buying.

Jones said some lenders have indicated they might go ahead in advance of any “official” push to do so, but there is a nervousness around breaking ranks on commission disclosure. “It would be a bold but brave move, but ultimately if you can give better transparency to the consumer, it does bring confidence and trust to the deal and to the transaction.

“A few years ago, at Auto Trader, we started putting price tags on the cars listed, showing low, medium and high. Retailers were originally against it, but they’ve come to realise that anything that helps build transparency is good.”

Dealer impact

The final portion of the question-and-answer part of the session examined how the different players in the market might be impacted by the FCA’s decisions following its review. Betteley pointed out that discussions so far had focused on the lenders’ unfair relationship with the consumer, but FOS had a different view as to whether other intermediaries were involved. That opened up the possibility that if the FCA compensation package was too painful, lenders might look to push some responsibility onto dealers and brokers.

Gibbard outlined how this might occur but cautioned that upsetting the distribution network risked creating the financial exclusion of some categories of consumer.

While agreeing from a consumer point of view that “dealers are not off the hook”, Jones said so far there was little evidence of nervousness in the market about this. However, retailers are likely to be impacted, if only indirectly.

One way this might happen is around the concept of “fair value”, given that dealers will put together many different elements in a final package. Describing this an a “minefield”, particularly post Consumer Duty, Gibbard identified tension as to who is responsible for delivering fair value. While it is seen as the lender, others may have an impact – a dealer could be seen as a co-manufacturer of a product – so it is more difficult to assess, and consumers are often confused about who is selling a product.

With the motor finance sector remaining in the regulatory spotlight for some time to come, Gibbard concluded that “transparency, and educating the regulator and the consumer to understand what is being achieved through the product are essential.”

Analysis from David Betteley, Asset Finance Connect’s head of content

Two issues spring to mind; unintended consequences and uncertainty.

Taking uncertainty first, the lack of information from the FCA regarding their ultimate intentions and the deferral of the date when those intentions will be detailed, simply pours oil on the fire and encourages the CMCs to build up an ever-growing war chest of customers who all think that they are in line for a bumper payout.

It seems now more likely than not that the FCA will decide on some form of compensation which will in effect tie the hands of FOS (not a bad thing) but, at the same time, the FCA will wish to protect the industry from payouts that could be structurally debilitating for individual firms.

Considering unintended consequences, we have to return to the old chestnut as to whether a dealer has a fiduciary duty towards the customer. The courts to date have generally dismissed this idea as the purchase of a car has many moving parts…..the price of the new/used car, the part exchange valuation, the addition of accessories or additional services (that are sometimes offered free of charge as a sweetener) and the monthly payment.

The Consumer Credit Act (1974) introduced the concept of “APR” which was designed to enable customers to compare the cost of financial agreements. Recent research has shown that less than 50% of customers understand what an APR is and surprisingly, this lack of understanding is higher amongst the under 25s.

So, the unintended consequence could be that by focusing on the amount of commission earned (like APR) is not a good way for customers to compare and understand the overall deal that they have negotiated.

A second unintended consequence could be the impact on intermediaries (dealers) To date the focus has been on the relationship between the lender and the customer. As discussed in the session, if the compensation level decided by the FCA is considered to be unjust, then lenders may look to defray some of the cost of that compensation onto the dealers that introduced the business in the first place, using old DCS (debtor, creditor, supplier) rules.

We will have to wait and see on all the foregoing.

Concluding on uncertainty………it’s a bit of a cliché, but uncertainty is an enemy of business. It disrupts long-term planning and destroys investment. The sooner we see white smoke from the FCA, the better.