On 4th March 2019, the Financial Conduct Authority published its highly anticipated findings on the motor finance market.
Within this publication, the FCA called for:
- Lenders to assess whether their commission arrangements with dealerships (particularly difference in charges (DiC) models) are creating a risk of customer harm and whether there are appropriate systems and controls in place to mitigate, monitor and manage this risk;
- Dealers to assess whether their pre-contractual disclosures and explanations are complete, clear, easy to understand (and are consistent with the relevant CONC requirements) and put customers in an informed position at the point they decide to take out the motor finance;
- Lenders to assess the robustness of the controls they have in place to ensure that dealerships acting on their behalf comply with the pre-contractual disclosure and explanation requirements contained within CONC;
- Lenders to assess their affordability assessments in light of the revised rules and guidance that came into effect in November 2018 and that they are making and retaining sufficient records to explain/evidence that they are lending responsibly.
- More broadly, lenders and dealerships to assess whether they have policies, procedures and controls in place to ensure compliance with all relevant regulatory requirements and deliver fair customer outcomes.
The FCA has outlined that further supervisory activity is being undertaken and that there is potential for enforcement action.
A potential ban of DiC models and/or limitations on the use of broker discretion is also being considered.
How can KPMG help?
Our advisory teams have significant experience within the consumer credit sector and in completing affordability, sales disclosure and 3rd party governance, oversight and control related reviews and transformation.
The team have also conducted numerous exercises to review firm’s compliance with regulatory requirements and to help firms to assess the whether they are delivering good outcomes to consumers.
A number of these engagements have been conducted at firms under close FCA scrutiny.
In April 2017, the FCA announced in their 2017/18 Business Plan that it intended to review the motor finance sector. The FCA wanted to understand the use of motor finance products, and assess the sales processes employed by firms and whether there was the potential to cause consumer harm.
On the 15th March 2018, the FCA published its interim findings and the next steps for the review, which comprised a more detailed investigation of whether:
- Lenders were adequately managing the risks around commission arrangements, and whether commission structures have led to higher finance costs for customers because of the incentives they create for brokers;
- Customers were being provided with the right information at the right time to facilitate the making of informed decisions (and, linked to this, whether the relevant disclosure requirements were being met); and
- Firms were properly assessing whether customers can afford to repay the credit, particularly when lending to higher-risk consumers.
- An analysis of loan and commission data from 20 motor finance providers (which comprised 60% of the market);
- Reviewing contracts between lenders and dealers;
- Undertaking a mystery shopping exercise of 122 firms;
- Evaluating lenders’ responses to a processes and controls questionnaire; and
- Reviewing firms’ policies and procedures.
The final report raises concerns over the commission arrangements between lenders and dealers/brokers, the provision of information to customers, the assessment of affordability and the effectiveness of lender oversight/control of dealers/brokers acting on their behalf.
Who does this impact?
The FCA’s report is relevant to all firms acting as lenders or dealers/brokers in the motor finance sector.
The FCA have highlighted the following issues from their review:
- The FCA identified there was a conflict of interest and “potential for significant consumer harm” due to the correlation between higher interest rates and commission rates.
- A high proportion of firms were found to have commission arrangements which could incentivise dealers to arrange finance at higher interest rates for their customers. This dealer discretion over interest rates, particularly in Difference in Charges (DiC) models, created a strong association between the amount of interest charged and the commission received by the broker.
- The FCA is concerned the link between customer interest rates and credit scores will be broken, resulting in lower risk customers being charged high interest rates and higher risk customers being priced out of affordable credit.
- The FCA has identified that approximately 560,000 customers have paid a total of £300 million more in interest annually as a result of DiC commission models.
- The FCA reminds firms of their obligation to ensure that appropriate systems and controls in place to manage the risks associated with incentive schemes (see below).
Provision of sufficient, timely information
- The mystery shopping exercise found that commission arrangements were only disclosed by a small number of firms and that these were generally unclear.
- The review found that the needs of the customer and the suitability of the product were not always taken into account by retailers. Often the lower monthly cost of personal contractual purchase (PCP) was promoted to customer without a full explanation of benefits and downsides of alternative finance products available.
- Many firms did not provide pre-contractual information, both verbally and in document form, early enough or at appropriate times during the sales process.
- Where information was provided it was often incomplete and sometimes misleading.
- It was also found that product features and associated risks were not clearly set out in documentation and would be difficult for customers to find without it being explicitly pointed out. Specifically, few firms advised of the consequences of failing to repay and the effects of withdrawing from the agreement.
- The FCA reviewed the affordability assessment practices of 20 firms, representing 60% of the market;
- In 5 (or 25%) cases, the approach to the affordability assessment appeared reasonable in light of the requirements of the time (the FCA specifically made the point that revised affordability related rules and guidance came into effect in November 2018, i.e. after this work was concluded;
- In 7 (or 35%) cases, the approach to the affordability assessment appeared satisfactory; however, there were gaps or ambiguities in the information provided which meant that aspects of the assessment remained unclear;
- In 8 (or 40%) cases, the information provided was not sufficient to enable the FCA to form a view on the processes’ compliance with the affordability related rules and guidance (i.e. it was unclear how the policy rules or scorecards would operate or drive decision making – which is an increasingly common issue given increased use of automated decision making);
- In some instances, the focus was on the credit risk to the lender rather than affordability for the customer (which is a weaknesses that has been commonly quoted in the FCA’s affordability related publications in recent years).
- It was generally unclear as to when a firm would ask for documentary evidence to support an application or how indicators of affordability risk were taken into account.
- As a result, the FCA makes reference to their policy statement ‘Assessing creditworthiness in consumer credit’, which was published in July 2018 and came into effect 1 November 2018 and has asked lenders to ensure that their affordability assessment is consistent with this.
- The FCA reminds lenders of their obligation to take reasonable steps to ensure that any third parties acting on their behalf are compliant with CONC;
- The FCA suggests that whilst many lenders were able to provide a reasonable description of the oversight/control frameworks in place in respect of the dealers acting on their behalf, they were left in doubt over the extent to which these were being implemented in practice;
- Within the report, the FCA makes reference to lenders placing excessive reliance on the fact that dealerships are authorised in their own right or in the contractual documentation in place and may not be performing any ongoing monitoring or taking proactive action where issues are found.
What do firms need to do?
All firms acting as lenders or brokers in the motor finance sector are potentially impacted by the FCA’s recent review, particularly where DiC commission models are in operation.
The FCA has outlined that potential supervisory and enforcement activity is being considered, with a potential ban of DiC models and/or limit on broker discretion.
Firms will need to ensure their point of sale disclosures and information provision is in line with FCA expectations and their affordability assessment arrangements are documented and operating robustly.
Lenders in particular should look to ensure they have sufficient controls and oversight in place to monitor dealer/broker compliance with relevant regulations and are taking remedial action where any issues are found
If you would like to talk through any specific challenges your firm may be facing in this area and how you might address them, or steps you can proactively take to manage future risks we would be more than happy to talk to you.