The FCA has reached this decision on the basis of the findings from its review, which raised concerns that the widespread use by lenders of commission arrangements which (1) link fees paid to brokers or dealers to the interest rate paid by a consumer and (2) allow the same broker/dealer a wide discretion to set the interest rates gives rise to a conflict of interest and inflicts substantial additional costs on consumers (an estimated £500 million per year). The FCA believes it is necessary to ban motor finance commission arrangements that incentivise brokers and/or dealers to set customers a higher interest rate to earn more commission. It is of the view that breaking the strong link between customer interest rates and broker/dealer earnings should decrease financing costs for consumers.
The FCA further observed that the existing rules on disclosure of commission arrangements were poorly understood and implemented by brokers/dealers.
Proposed ban on discretionary commission arrangements
Having considered the costs, benefits and effectiveness of a number of options the FCA has decided to impose a ban on discretionary commission arrangements in the motor finance industry (it is aware that these models are also used in other sectors but does not currently have the evidence to support a more extensive ban). The FCA understands that some lenders want to move away from these models but are wary of losing contracts with motor dealers to those lenders that do not. Banning discretionary commission arrangements would remove this potential competitive disadvantage.
In particular, the three most common commission arrangements the FCA seeks to prohibit are:
- Increasing Difference in Charges (“DiC”) – this model is also known as ‘Interest Rate Upward Adjustment’. Using a DiC model, commission is paid to the broker based on the interest rate paid by the consumer. The contract between the lender and the broker sets a minimum interest rate and the commission paid to the broker is based on the difference between the minimum interest rate and the actual rate paid by the consumer.
- Reducing DiC – also known as ‘Interest Rate Downward Adjustment’ whereby instead of a minimum the lender sets a maximum interest rate and then gives the broker discretion to set interest rates below this. Commission is calculated in the same way as for the DiC model.
- Scaled commission models whereby the broker is paid a fee which varies according to the interest rate.
The FCA estimates that the ban will save consumers around £165 million per year as well as giving lenders greater control over the pricing of credit and increasing competition in the motor finance sector. In the draft rules published alongside the consultation paper, the FCA proposes to define ‘discretionary commission arrangement’ with reference to the ‘total cost of credit’ to prevent firms from circumventing the ban. The proposed rules would still allow brokers/dealers to charge both fixed and variable fees, determined on the basis of the amount of work they have undertaken, provided these are not linked to the interest rate charged.
Amendments to the existing rules on disclosure of commissions in CONC
During its review of the motor finance sector, the FCA observed that the majority of firms sampled failed to adequately disclose commission arrangements to consumers in line with the existing rules. As a result, the FCA intends to make what it considers to be minor amendments to clarify its expectations as to the timing and content of these disclosures. These changes are to:
- CONC 3.7.4G to make it clear that firms should disclose the ‘nature’ of any commission in their financial promotions.The FCA has also issued guidance to clarify that firms should consider the impact commission could have on a customer’s willingness to transact and that firms should consider whether and how much commission can vary depending on the lender, product or other permissible factors and tailor their disclosures accordingly.
- CONC 4.5.3R to make clear that firms should disclose promptly the existence and nature of commission arrangements where the commission varies depending on the lender, product or other permissible factors. This disclosure must also cover how the arrangements could affect the price payable by the customer.
The FCA's consultation and implementation timeline
The deadline for the consultation is 15 January 2020 with the FCA expecting to issue a policy statement by Q2 2020. Firms will then have 3 months to implement the proposed ban on discretionary commission arrangements, whereas the proposed changes to CONC on commission disclosure will come into force on the day the rules are finalised.
In many cases the ban on discretionary commission arrangements will require lenders to renegotiate or amend their agreements with brokers and dealers. Lenders should consider approaching the brokers and dealers with whom they contract to begin this process in advance of the ban coming into force.
Lenders will also have to consider carefully the steps they will need to take to ensure that the brokers and dealers they work with comply fully with the clarified commission disclosure requirements in CONC.