Industry must collaborate to manage regulatory creep into SME lending

Asset finance providers are closely watching the Financial Conduct Authority’s (FCA) investigation into discretionary commission arrangements in the motor finance sector.

Although asset is mostly focused on non-regulated transactions there is a reasonable expectation among many that the regulations that are likely to result in industry-busting fines for motor finance will be coming their way soon.

• Asset Finance lenders should learn salutary lessons from motor finance experience with the FCA
• Leaders need to collaborate with each other to consider the impact of any creep in regulation. Building understanding between brokers and lenders is key to managing effective change
• Greater thought needs to be given to understand how the industry can engage better with regulators to help them achieve their good objectives without damaging the current diverse marketplace

Why are asset finance lenders worried that this may happen to them too?

Well, there is no doubt that motor and asset finance are organised similarly and serve similar markets. It would therefore be easy for the regulator to assume that the solutions to the problems they believe exist in the motor industry are also valid for SME lending.

Both motor and asset rely on intermediaries paid in part using commission which is embedded into the cost of finance. The SME market includes a very long tail of sole traders and others who do not always understand the language of finance just like consumers.

One lender told AFC that he believes, “regulatory creep into non-regulated transactions is inevitable”. This view seems to be widely held in the industry.

Push and pull

Lenders point at push and pull factors that are eroding the regulated/unregulated divide.

The industry believes the FCA are signalling their intention to push further into SME lending than has happened in the past. A recent example of this signalling may have come via the Federation of Small Businesses (FSB) who have raised their concern about personal guarantees made by directors on loans for their businesses. A super-complaint is usually not made by a trade body in isolation. It is made to the FCA in consultation with the FCA. As the FCA guidance notes – complainants “are encouraged to discuss their complaints with the FCA before submitting a formal super-complaint.”

The asset finance industry is also pulling regulated processes into their unregulated transactions. Many asset finance lenders tell us that they did both unregulated and regulated business (perhaps 10% or 20% regulated seems typical among those with whom we talk). Two separate processes are inefficient and lenders who serve regulated and unregulated tend to go with the more expensive demands of regulated business process for all their business including unregulated transactions. Unregulated business therefore becomes more expensive as it adheres to regulated practice. The margin is often reduced because the cost-to-serve is higher.

Losing the valuable middle

Many lenders have already withdrawn from regulated lending as the cost and risk of doing regulated business has made it uneconomic. Time Finance, for example, announced their withdrawal in January 2024, one of the few remaining at that time.

There is a danger that the unintended consequences of badly thought-through changes will next include the disappearance of small lenders serving the hard-to-lend-to start-up SMEs.

“The UK could lose the next generation of wealth-creating businesses if lending to them becomes too expensive or too difficult. That could happen if the diversity of lenders is lost,” one lender told us.

The rub – the need for consensus where there is no first-mover advantage

Lenders fear that the industry’s messages to regulators and government are not often heard.

While there are some who believe that the Finance & Leasing Association (FLA) have done a great job in coordinating a collective response on commission disclosure, this view is certainly not shared by all lenders.

AFC find that a significant number of asset finance lenders believe that the battle to limit compensation in motor and to guide the regulators to make better interventions has already been lost. They are frustrated by FCA and FOS attitudes to commission which is seen as an effective and pragmatic way to remunerate intermediaries. They are also frustrated by the trade associations, who are currently intermediating between lenders and regulators.

As one lender put it to us, “If they [trade associations] cannot deal with this, what are they for?”

The criticisms these lenders make often focus on the slow pace of change. Turf wars between associations are also blamed not just for slow progress but also for mixed messages.

Then there is the vexed question of consensus.

“The problem with managing changes like commission disclosure is that there is no first-mover advantage. We therefore need a consensus to make it happen.”

Unfortunately, the trade associations also need that consensus to act.

More than one lender has suggested that the FLA should consider whether they need to change the rules under which they operate. “They need to be prepared to forgo their fees and walk away from a lender who refuses to act in the industry’s general interest,” one told us.

Others argue that the debate for or against full commission disclosure never really took place. Insiders in the trade associations complain of low engagement from many members; and that some of those who do are outliers.

The nay-sayers view – there is no requirement for commission disclosure for unregulated transactions – has some merit. Those lenders who believe this feel that the associations decision to support full disclosure for unregulated business was at best defeatist, and at worst a siding with regulators against the industry.

There is currently no consensus on a one-size fits all alternative to discretionary commission models for unregulated transactions. One lender told us that their prices for regulated lending went up when discretionary commission was banned. An industry insider made the point that if one-size-fits-all-pricing extends into SME lending it shuts the door on hard-to-lend-to start ups who need the most work to access finance.

Lenders will scrutinise brokers more

With the prospect of increased scrutiny from regulators, and the growing cost of falling foul of regulation, managing brokers’ interaction with end customers has become a priority.

Many lenders have been assessing the effort and expense of maintaining many broker relationships and have been gradually reducing the number of brokers with whom they work.

Having a direct sales force managed cost effectively using technology is starting to look better than dealing with a wide panel of independent brokers.

Others believe that technology can reduce the cost for lenders to manage and control the channel. Simon Goldie from the FLA has been quick to identify the opportunity for lenders to use technology for real-time compliance of proposals coming from brokers.

The FLA are also exploring the possibility of a single commonly agreed review process to audit broker activities.

Currently each lender acts independently with each broker – which increases the cost to serve each individual broker and acts as a disincentive for lenders to maintain a large pool of brokers with whom they deal. This common approach may well suffer from the same flaw as reaching an agreement to mandate full disclosure of commission. It may be difficult to set review standards that every lender will agree to, harder still to find one that brokers will also consent to.

Broker discretion is seen as a risk by regulators

Both brokers and lenders are currently considering the short-term impact of regulation on their businesses. At present brokers tell us they have been wondering whether this will make it harder for them to introduce new deals generally and whether they will be asked to participate in the pain to follow for motor finance providers who are caught up in the review.

It is clear that lenders are going to want more oversight on any broker transactions, and this will certainly impact brokers’ commercial and compliance arrangements with their lenders. Brokers are already voicing concerns that changes to manage regulatory risk shouldn’t be used as a tool to shift the balance of risk and reward in favour of the lenders.

Longer term the discretion that brokers can use to deliver deals for both customers and lenders seems likely to diminish. That will make life even harder for them, and those they serve.

Last word

Over the next few weeks, we will consider the arguments people make on this topic. We would like you to engage in our debate. Whether anonymously or not. Tell us what you think, and we will try to make your voice heard.

We think that regulation could be good if it is executed well and it looks after customers’ interests in the long-term. As things stand, the size of the proposed compensation is so large that it will damage the industry, and with it the larger economy. The case for intervention was poor, the cost benefit analysis is clearly incorrect, and the effects of regulator actions will be bad for customers and the asset finance industry.

We believe that we need to have more courage about persuading the asset finance industry’s publics of the value it delivers to its customers. And what life would be like if the rich diversity of lenders we currently have is reduced.

We believe you need to engage more in the debate and question what is currently happening much more vigorously.

We believe we need to think about how we can influence policy makers – not to have more or less regulation, but to become more scientific and collaborative in working with regulators to agree changes and to measure and evidence the outcomes from regulator intervention (as well as outcomes only from the industry alone).

We believe we should be as public about regulators bad outcomes as they are about ours.

We believe we need to reimagine what our engagement should be, starting with a blank sheet, and build a machine that works for today’s world – which I have come to believe is one in which MPs do not intervene even when they see injustices like that meted on the postmasters, and unaccountable quangos like FOS and The Post Office have become used to acting badly with impunity.

But it doesn’t really matter what we think – tell us what you think. Its time to get serious.