FCA Reminds Motor Finance Firms to Maintain Adequate Funds amidst Ongoing Review of Commission Practices

The Financial Conduct Authority (FCA) reminds motor finance companies across the UK to ensure they maintain sufficient financial resources at all times. This directive, issued on Friday (12 April 2024), follows the regulator’s ongoing review of historical discretionary commission arrangements (DCA) within the motor finance industry.

The FCA is doing a thorough investigation into whether or not DCAs lead to financial harm to consumers. The purpose of the directive is to ensure that businesses are financially ready to deal with any potential future costs that may be associated with the handling of complaints and the provision of redress.

Why Is the FCA Making This Reminder?

The FCA’s reminder is part of a larger review launched in January 2024. This investigation focuses on the use of discretionary commission arrangements by motor finance firms in the past. DCAs allowed sales agents or brokers to adjust the interest rate on car finance loans, which could result in higher commissions for brokers.

The method has generated concerns about whether consumers were overcharged when obtaining vehicle loans. The FCA is investigating whether such agreements violated current restrictions and caused financial damages to consumers.

The FCA recognises that this review has created uncertainty for both consumers and motor finance companies. The regulator’s goal is to ensure that firms are prepared to address any additional costs that may arise from complaints. This is crucial not only to protect consumers but also to maintain the overall stability of the motor finance sector.

The FCA related that while many companies have constructively engaged with the review, some firms have struggled to provide the necessary data. For one, records were stored on multiple systems or were spread between brokers and lenders. Furthermore, some companies failed to retain all relevant data for certain older cases, further complicating the review process.

What Actions Are Expected from Motor Finance Companies?

In its reminder letter sent to the motor finance companies, the FCA has outlined several actions that firms must immediately do.

Firms must conduct forward-looking assessments of the adequacy of their financial resources in covering potential liabilities arising from past implementation of discretionary commission models. The size and complexity of the business should be taken into account in these reviews. They are also told to think about how capital changes, like dividend payments, might affect their ability to pay future debts.

The FCA also expects that financial statements should reflect accurate and up-to-date information about the firm’s current situation. This includes taking into account any recent decisions by the Financial Ombudsman Service, relevant court rulings, and findings from the companies’ internal reviews of their commission practices. Where necessary, firms should engage external auditors to ensure the accuracy of their financial reports.

Additionally, motor finance firms are required to cooperate and communicate openly with the FCA. Under the FCA’s Principles for Businesses, companies must disclose any material changes in their financial circumstances that could affect their ability to maintain adequate resources. This includes notifying the FCA if they foresee any difficulties in maintaining sufficient financial resources or if they become involved in significant litigation related to motor finance commissions.

The FCA also expects the companies to engage with appropriate stakeholders groups to make sure they understand the nature of FCA's work and its potential impact to the company.

Firms must also continue to deal with customer complaints regarding DCAs, as they're still obligated to investigate complaints that they receive. This guarantees that when the halt is lifted, companies will be able to quickly address and resolve the complaints. The FCA has cautioned that companies will likely need to follow the same steps to address customer concerns, even if a separate complaint handling structure is put in place.

What Will the FCA Do Moving Forward?

The FCA has said it will keep a tight eye on automotive loan providers as part of its continuous evaluation. Through current regulatory reporting, the regulator will keep an eye on their financial resources and may ask for further data as necessary.

The FCA has also stated that it may act if a company is deemed to have not conducted a sufficient evaluation of its financial resources. The regulator will also take action if it discovers any attempts to avoid future liabilities.

In addition to monitoring financial resources, the FCA will track the number of complaints related to DCAs that firms receive. Although the 37-week pause on final complaint responses is still in place, companies must continue to comply with relevant rules outlined in the FCA’s complaints handling guide. Once the pause is lifted, companies will be expected to provide final responses to complaints promptly.

Background on FCA’s Work in the Motor Finance Industry

The FCA’s investigation into discretionary commission arrangements is part of its wider efforts to regulate the motor finance industry and of its legal obligation to ensure fair treatment of consumers. Since 2017, the financial watchdog has been expressing concerns over this matter in the motor finance sector.

By March 2019, the financial watchdog released its final report, revealing widespread practice of a commission structure that linked the dealers or brokers' commission to the motor finance interest rates that resulted in financial harm to consumers. It was also discovered that these customers, who pay a much higher interest rate than what they're supposed to pay, aren't fully aware of the commission structure.

In October 2019, the regulator proposed to ban the discretionary commission models in the motor finance sector and to clarify rules on commission disclosure in the Consumer Credit sourcebook (CONC). After months of open consultation, the FCA confirmed the ban on July 2020,

Following the ban, which took effect in January 2021, a "high number" of complaints were lodged to the lenders and the Financial Ombudsman from customers who believed they qualified to assert car finance claims for unfair finance deals entered into before the ban. The motor finance companies dismissed many of these complaints, which were then escalated to the Ombudsman, who ruled on these complaints in favour of the consumers.

The obvious disagreements between the consumers and the motor finance lenders have prompted the FCA to announce in January 2024 its plan to initiate a deeper review of historical implementation of discretionary commission models in the motor finance industry. The review will cover finance deals made between April 2007 and January 2021. A pause was also put in place on the eight-week deadline for companies to respond to DCA-related complaints from consumers.

The FCA expects to finish its review by 24 September 2024.

Industry Estimates and Lender Exposure

Since the FCA made its statement in January 2024, experts have approximately doubled their projections for the amount of compensation that will be imposed on the UK's banks and lenders operating in the automotive loan market as a result of the FCA's inquiry. Currently, industry analysts estimate the costs to range from £9 billion to £16 billion.

According to analysts, Lloyds is expected to take the biggest blow considering it owns Black Horse, a motor finance firm that has 20% market share. The Group is expected to face as much as £2.4 billion. However, Lloyds has disclosed a reserve of £450 million only relevant to the FCA motor loan review in its results for the fourth quarter and the full year of 2023 presented in February 2024. The company has stated that this reserve is their best estimate after taking into consideration a number of different circumstances and scenarios.

Close Brothers, another key player in the motor finance business, is expected to face a compensation settlement of up to £200 million, according to analysts at RBC. Close Brothers suspended dividend payments in reaction to the FCA's recent announcement in order to strengthen its capital position.

Other analyst estimates of potential liabilities related to the FCA probe include Barclays Partner Finance at £250 million, and Santander UK at £850 million.