Is it time for asset finance to fully disclose commission?

In the wake of the shock Court of Appeal ruling on commission disclosure, the key challenge for the asset finance industry and its trade associations is to establish an effective way of balancing the interests of lenders and brokers. This means reaching an agreement on commission disclosure sooner rather than later.

Last Friday’s Asset Finance Connect webcast was its largest ever with 1,600 participants, almost four times the maximum number of sign-ups seen during the pandemic era when digital events were the only option.

What’s happened?

The Court of Appeal ruling on three motor finance agreements rocked the foundations of an auto finance industry which believed it would be protected from regulatory action if it followed the regulator’s advice laid out in CONC, the FCA handbook setting out the detailed obligations specific to credit-related regulated transactions.

But in finding that car dealers had failed in their fiduciary duty to customers, it was finally the courts that dealt the killer-blow for the industry. The decision shocked those who had focussed on CONC, but now realised that the courts would hold lenders to their different set of rules, which do not necessarily fully align with the regulator’s handbook.

The verdict will certainly have an enormous effect on the auto finance industry where there is little room for doubting the implications of the verdict. It could also have just as large an effect on unregulated lenders, including the asset finance industry, which serves SMEs (small and medium size enterprises), corporates and the public sector through brokers where there is more room to consider whether the verdict has the same implications.

The read-across

Asset finance lenders have been worrying for some time about the read-across from the regulator’s intervention on regulated transactions, to the unregulated part of the lending industry. Asset finance has many similar sorts of arrangements as motor finance, including the use of undisclosed commission which was the focus of concern in the three cases on appeal.

Is the genie out the bottle?

Last weekend, the industry spent a feverish two days considering how best to respond to this unexpected outcome and the Finance & Leasing Association (FLA) released their guidance on Monday, just three days after the verdict.

The guidance confirmed that fiduciary duty exists in a wider range of circumstances than previously understood. It went on to suggest that wherever commission is payable, there is a duty to disclose the existence, nature and amount of commission to the customer and to obtain and evidence the customer’s informed consent.

Most lenders and brokers took this to mean that all brokers, whether asset or auto must now disclose, suggesting the disclosure genie was now firmly out of the commission bottle. This was a body-blow to those asset finance brokers who believe that commission disclosure will have a destructive, possibly even an existential impact on their businesses.

Uneasy relationship

The debate over asset finance commission disclosure is nothing new. The two sides of the industry, lenders and brokers, have so far failed to reach an agreement which will suit both. The difficulty, in a relationship which seems innately tense, is that there can be an imbalance of risk and reward.

If brokers do not disclose commission, it is the lender (with their deeper pockets) who will pick up brunt of the fines; if brokers disclose then the balance of rewards will swing in favour of the lender, possibly without any benefit to the customer and at the cost of the broker.

Why should brokers have to disclose what they make from a deal, for example, when a salesman working direct for the lender, who is arguably doing the same role and may also be being paid by commission by the lender is exempt from disclosing anything?

While the balance of reward can seem like a negative sum game (one participant’s gain is another’s loss); the two types of provider share an interdependence which keeps them both at the negotiating table.

Solving the problem

The FLA may have seen the Court’s unwelcome outcome as an unexpected opportunity to finish the discussions between asset finance lenders and brokers and move on.

Last summer they had been expected to mandate commission disclosure for all their members but changed tack at the eleventh hour, perhaps because they were seeking unanimity in a bid to change the FLA code of conduct and reflecting that not all lenders wanted to adopt this approach.

They may have worried that a dissenting lender might resign from the association, leaving it free to attract business from any brokers who did not wish to disclose.

Their conclusion at that time was that mandates of this sort may be a job better achieved by regulators.

Devil is in the detail

Asset Finance Connect’s research suggests the Court of Appeal verdict is more nuanced than is reflected in the FLA guidance. The key distinction is between “sophisticated” and “unsophisticated” customers. Sophisticated customers do not require full disclosure.

This distinction clearly matters in asset finance. A broker told AFC that he had a £300,000 loading shovel that should have been paid last Monday. The customer was one of their biggest clients with a £230M turnover. The lender’s lawyers had delayed, working on a commission disclosure form which never arrived. In this instance the lender may well have been following the FLA guidance, despite having compelling evidence (from its scale) that the customer was sophisticated.

AFC has clear evidence that even the best informed have been taken by surprise. One of the larger lenders in the AF50, AFC’s ranking of the top 50 lenders, told us: “The FLA, and industry lawyers, have been firm that based on the COA [Court of Appeal] ruling, non-regulated lending now requires full commission disclosure.  There’s no ambiguity in the FLA position here. If there’s an opportunity, can you ask [verify] the above using these words in my absence.  Make sure you get a firm response.”

AFC took advice from its legal advisers.

“Every firm, as a result of the decision (as with any decision) will need to say “DOES THIS” apply to me, as a more nuanced approach to “THIS DOES” apply to me. There will be different approaches to market, contractual document and customers, so these require analysis. It is always true to say it may apply, given the nature of the findings of the court, but there are naturally points of distinction.

“We cannot rule out scenario 1 [AFC’s description of potential different treatment for sophisticated vs unsophisticated customers in asset finance] in all circumstances”.

Additional broker worries

AFC has identified other concerns among brokers and aired them in the webcast, notably around timing, and secondly around the messaging in the informed consent document.

On timing, the strong preference among brokers is to leave the disclosure to the last minute, reducing the opportunity to game disclosure (see below), but adding to the risk that the customer is not given enough time to properly consider it. Lenders, by contrast, seem to prefer early disclosure, something brokers say will make business very difficult indeed for them.

Gaming concerns

One hybrid lender suggested that lenders and brokers needed to reach agreements on how to prevent gaming, pointing out it is a generally accepted practice that in the event a client is not happy with the terms of an agreement a finance broker has provided, they would ask the broker to improve the terms with the same lender or ask the broker to seek another lender or solution. The client may also choose to seek other options for themselves without the brokers involvement.

“In the event the client approaches the introduced lender direct to seek to negotiate, the lender would normally direct the client back to the broker as the introducer. This is the axiom that brokers work under and the protection of the introduction is seen as the backbone of providing new business to banks and lenders. We have reassured our brokers that this will remain the case even if commission disclosure causes this to happen earlier. We would like to hear from the room that this will be the standard in the industry.”

On communication concerns, AFC were sent the wording for an informed consent document from one lender which stated baldly (my emphasis) “They [the broker who has just recommended you to us] have commercial arrangements with us to introduce their customers to us. When they do that, they are not acting impartially… Depending on your circumstances, you may be able to negotiate a better or different finance deal if you shop around”.

Contemplating this disclosure, an exasperated broker asked whether a lender who charges more than another should also be required to point out to the customer that their deal is less good than is available from their competitor. The suggestion that the broker is not serving the interests of their customers is unlikely to be of any reassurance to the borrower, and surely requires careful consideration before it is used.

Trade associations’ role

The FLA guidance was published at speed, at a time when lenders across both the regulated and unregulated markets were sufficiently concerned that they paused taking any new business and needed guidance urgently.  As John Phillipou, chair of the FLA pointed out in the webcast, there may be a need to make amendments later once the industry has had more time to consider the implications of the verdict.

The new CEO of the NACFB, Jim Higginbotham, who was also on the webcast, has been clear that he expects and accepts that the lending side of the industry will initially take a belt and braces approach to commission disclosure but added that he expects a more nuanced approach to follow.

This is a good start from both associations.

The danger, however, is that both acknowledged that once the stopper has been removed, that it would be hard to return the disclosure genie back inside the commission bottle. This may well not matter in auto finance, but might matter more in asset finance.

The FLA and the NACFB will now need to collaborate further to reach an agreement on the best way forward. The most pressing decision is whether they should continue to mandate commission disclosure by everyone under all circumstances as the first guidance directs.

This is unfamiliar and uncomfortable territory for the trade associations. The compelling need, where the associations can really add value, is in engaging in an unemotional and pragmatic negotiation to ease tensions.

The industry is ready to make compromises. A poll conducted during the webcast found that 86% of attendees including both lenders and brokers agreed that the pragmatic response to the ruling is to mandate commission disclosure.

That view may of course change as they too have an opportunity to digest the implications of the sophisticated vs unsophisticated customer division.

AFC see grounds for optimism with the associations’ apparent willingness to review the initial approach; and the memberships’ willingness to compromise. The industry is prepared to be pragmatic and will not remain polarised and dogmatic in the face of an existential threat.

Now is the moment to deliver on good intentions

At Asset Finance Connect, we believe that the key challenge for the whole asset finance industry and its trade associations is to establish an effective way of balancing the interests of lenders, and brokers while protecting the interests of customers.

AFC hope to assist the associations in their work by hosting a meeting of lenders and brokers at AFC’s conference in London on November 26th.

We expect that the implications of the judgment, and the effectiveness of the guidance will be a big focus of discussions between all attendees.

Both the FLA and NACFB are sending their senior team along to participate. Stephen Haddrill, director general of the FLA, and Jim Higginbotham, CEO of the NACFB, will be there.

We look forward to seeing you at this must attend event. You can find ticket information at the AFC conference website or directly from Louise Clavey at louiseclavey@assetfinanceconnect.com. We will be amending the agenda shortly to give more time to talk about commission disclosure.

In the meantime watch out for news of follow-on webcasts as this important story develops.