Commission disclosure: between a rock and a hard place?

The Finance and Leasing Association (FLA) has decided not to mandate commission disclosure as part of its lending code currently, opting to wait for the Financial Conduct Authority (FCA) to lead the way, in a move which has split opinion and thrown open the debate once more on whether, when, and how the amount as well as the existence of commission payments should be presented to buyers entering a financial agreement.

Discussing the association’s decision, announced in late April, FLA director general Stephen Haddrill said: “Across the whole asset finance spectrum, there’s a strong degree of recognition that disclosure is the right thing to have. We did consider including it in the Code and consulted broadly with members, and the broad feeling was that this is a significant change which should be actioned by the regulator.”

Haddrill would not be drawn on whether an outright majority of members favoured mandatory commission disclosure in principle, although of those who did, a majority supported the view that it is preferable to wait for the regulator to instigate any change rather than start by amending the industry code.

“We didn’t want to end up having two goes at this and be in a situation where if we do something, it then has to be amended afterwards once the regulator has made its decision. And we are not simply waiting for the FCA to make an announcement – we are proactive about this and putting pressure on,” he noted.

While Adrian Dally, director of motor finance & strategy, says the FLA will be “holding the regulator’s feet to the fire” to ensure there is progress, the FLA’s decision has fanned the flames rather than extinguishing the argument about commission disclosure, which has long been a hot topic within the asset finance sector.

Inevitability

The FLA’s view is that the clear direction of travel is towards commission disclosure. Dally highlights the FCA’s commitment to review the operation of commission rules after three years made in the regulator’s Policy Statement PS20/8 July 2020, which laid out the background leading to the January 2021 ban on discretionary commission models in the motor finance market.

However, PS20/8 states: “We accept that disclosure has limited benefit. We are not convinced that issuing more prescriptive rules and guidance would improve customer outcomes in a way that would justify the costs involved. Increasing prescription on what to disclose, how and when, is likely to be counter productive given the range of products and commission arrangements across the entire consumer credit industry.”

More recently, the FCA has introduced Consumer Duty, which does require a greater emphasis on “good outcomes” for consumers, while in January this year the regulator launched a nine-month review of the use of discretionary commission arrangements (DCAs) in motor finance deals following the Financial Ombudsman Service (FOS) rulings in two cases.

Dally points out that the FCA review focus is on whether there is evidence of widespread misconduct and that consumers have lost out, suggesting that the FCA could reach a different decision on consumer harm from FOS.

Fairness

The FOS ruling argued that the lender and broker’s failure to disclose the existence of DCAs resulted in consumers taking out finance at a higher rate than the average available at the time, to their detriment.

This may have been the case – although one of the purchasers had already been turned down by four other lenders, suggesting the rate offered reflected the applicant’s credit status. However, motor finance is typically bundled as a part of elements of the deal in selling a car, which may also include part-exchange for a vehicle being traded in, so in order to achieve a lower interest rate for finance the buyer may have had to accept a lower part-exchange offer. As it is, the rates quoted were not out of step with those prevailing in the market at the time.

Currently the FCA rules only requires disclosure of the amount of the commission if such disclosure is requested by the customer – and experience within the auto finance industry indicates it is very rare indeed for a prospective purchaser to ask, since their focus is more usually on the overall deal and the size of any monthly payment.

Moving to full commission disclosure raises two questions: how to calculate the quantum of commission and how to communicate that information to the consumer. Disclosing the exact amount of commission would need to be recalculated and reissued each time a proposal is amended, creating a laborious – and costly – customer experience, while the prospective buyer would need to understand the impact of the interplay of the APR for the finance agreement and the broker’s fee for that service on the total amount they are paying for a car, when presented with a number of different scenarios.

One size fits all?

In contrast, in the asset finance sector the typical buyer is most likely an entrepreneur or business with a greater understanding of the role – and rewards – for intermediaries. Asset, motor and consumer finance differ in key areas, most notably the degree to which lending is regulated. Devising a commission disclosure regime which mirrors the complexity of the sector as a whole is a challenge.

The FLA represents all three sectors, and needs to find an approach which meets regulatory requirements when required but does not prove a burden on non-regulated business. The FCA, meanwhile, has stood accused of wanting to increase its regulatory perimeter but has shown little interest thus far in extending its scope further into the asset finance market.

Rear view mirror

The FCA motor finance review is looking at the use of DAC in motor finance agreements as far back as 2007, the date from which they came under FOS jurisdiction, although this commission model was not banned until January 2021. This raises alarm bells for some as it suggests the regulator is, in effect, judging claims on a retrospective basis.

There are similar concerns around any moves to mandate commission disclosure, with fears this would suggest to consumers that previous behaviour was not good practice, and open the floodgates further to claims management companies.

Looking ahead

These concerns are, in part, underpinned by a binary view of commission disclosure, whereby the lender and broker will show the consumer a specific figure of commission for each deal, something which has not happened previously.

But a number of funders are examining different approaches to rewarding intermediaries, which would also open the way for different kinds of disclosure. Options include using KPIs to assess a broker’s performance with a client, focused on delivering good outcomes and building the relationship, and so is particularly appropriate for brokers who have long term collaborations with clients. Such a concept emphasises the additional elements present in a funder/broker relationship other than the purely financial.

Given the practicalities around calculating commission amounts, it might also be that funders develop a series of templates showing how commission operates and the impact on finance deals of a certain size, or in a particular category.

This may help with the difficulty of the requirements under FCA rules to disclose commission details “in good time”. This is an easier process to achieve in the motor finance area, since funders and brokers are dealing with a more standard product, but more challenging for bespoke asset finance arrangements. As asset finance brokers are unlikely to know the commission until the agreement is about to be signed, they run the risk of being judged as having left disclosure too late in the process.

Sharing an illustration of how commission is calculated in general terms with the consumer very early in the sales process meets requirements to disclose the existence and nature of the commission; the illustration could also include an indication of the parameters for any commission and the likely quantum, with lenders only choosing to disclose the exact amount at the final stages of the sale if it is markedly outside the original indication.

As it is, the total cost of credit (including commission) is already provided to customers. If the FCA made it compulsory to highlight this and signpost would-be purchasers to the figure, that would offer a useful comparative measure by which to judge different finance offers, which could be released early in the process.

Challenge

The FLA’s options are stark. Mandating full commission disclosure for members, which the association has swerved away from doing currently, risks creating dissention among its members and the sense that there is a problem to be fixed.

Not taking action now places the FCA in the driving seat and it remains to be seen what, if any change, will emerge from its review of PS20/8 and the findings of the motor finance review due in September.

In these circumstances, communication is critical, both within the industry (to ensure all those across the asset finance spectrum feel their voice is heard) and outside the industry (so that regulators understand how the sector operates).

Haddrill concluded: “We want members to work with us to build the case effectively and make sure the regulator intervenes effectively.”