Discretionary Commissions: How to prepare for the fallout

Hot on the heels of the rollout of Consumer Duty, following an earlier announcement from the FCA that possible bad practice within the motor finance industry will be investigated, discretionary commission arrangements have been making headline news.

What are discretionary commission arrangements?

Prior to January 2021, lenders permitted brokers to adjust interest rates offered for car finance and the practice was widespread. The broker or dealer's commission was subject to the interest rate agreed upon in the contract – hence, the higher the interest rate, the greater the commission. The controversy surrounding these arrangements revolves around their potential to create conflicts of interest, incentivising dealers to prioritise commissions over the financial well-being of customers, which has raised significant concerns regarding transparency and fairness in the industry.

This practice, termed a discretionary commission arrangement (DCA), was prohibited by the FCA in January 2021, although some in the industry had already taken it upon themselves to cease it and work within a more fixed and transparent framework. The timeline below shows how the DCA story has evolved over the last few years.

Timeline of the FCA's review of discretionary commission arrangements

Date	Event
Oct 2019	FCA propose a ban on commission models within the motor finance industry where the amount received by the broker or dealer is linked to the interest rate that the customer pays and which the broker or dealer has the power to set or adjust, known as discretionary commission arrangements (DCAs).
28 July 2020	FCA confirm deadline of 28 Jan 2021 for the ban of commission models that give motor finance brokers or dealers an incentive to raise customers’ finance costs.
Sept 2021	FCA start monitoring how well firms are complying with the ban on DCAs by carrying out supervisory work across a sample of firms and mystery shopper exercises.
11 Jan 2024	FCA initiates a review into DCAs to assess industry compliance with the ban. This follows the Financial Ombudsman Service (FOS) publishing several decisions about discretionary car finance commission, including one against Black Horse and one against Barclays Partner Finance. These FOS decisions open the way to a large number of claims for refunds from people who took out car finance before 28 January 2021 and as a result, the FCA has taken the unusual step of pausing complaints to give motor finance companies longer to respond so that they are “dealt with by providers in a consistent, efficient and orderly way. Given the high number of possible complaints, there’s a risk this might not happen.”
7 Feb 2024	UK consumer champion and founder of MoneySavingExpert.com Martin Lewis discloses that 262,500 complaint emails submitted.
25 Sept 2024	The FCA's investigation is scheduled to conclude and reimbursement per agreement is expected.

Who will be impacted?

The FCA has indicated the scope of the investigation will look back to before 2021 to see what commission models were in place and what information was provided to customers at the time. Current indications are that it could look back as far as 2007 and may affect individuals who purchased cars, vans, or even motorcycles up to January 28, 2021.

On February 7 this year, Martin Lewis, founder of MoneySavingExpert.com, disclosed that in just a few days a remarkable 262,500 individuals had already submitted complaint emails using his free online tool. Prior to the FCA’s ban claims against motor finance companies were low, which could suggest customers were happy with the outcome of their finance agreement, or they were just unaware they had reasonable cause for complaint until it was highlighted in the media. It's estimated that 40% of these cases will involve hidden DCAs. The anticipated reimbursement per agreement, expected once the FCA concludes its investigation in September, is approximately £1,100, resulting in a conservative projected payout of £115 million.

Viewers of the Martin Lewis show would have heard big lenders named such as Barclays, Black Horse Finance, Santander Consumer Finance, and financial services divisions of major dealers such as BMW Group FS and Mercedes Benz FS. However, it's estimated that over 100 firms are implicated. Lloyds holds the largest exposure to car loans among high street banks, with a loan book totalling £15.3 billion as of the previous year's end and has allocated a provision of £450 million to cover potential expenses related to this issue. This provision is part of the bank's total £541 million set aside for bad loans, significantly surpassing analysts' projections of £126 million and a substantial increase from the £187 million reserved in the third quarter. Analysts at RBC Capital Markets estimate that costs and redress for complaints regarding DCAs associated with lending by Lloyds' Black Horse motor finance subsidiary could amount to £2.5 billion.

Parallels have been drawn between this situation and the PPI scandal that dominated from the 1990s which cost the industry nearly £50 billion. Interesting to note that Lloyds set aside £3.2bn to deal with PPI compensation, but their eventual final bill came to £22bn. Considering that over 80% of new cars are funded through PCP, a significant portion of the market could be implicated. The financial toll on the industry is currently unknown, but it could be huge. Another current unknown is the period over which the compensation is being sought. It may date back as early as 2007 and it is the combination of both which makes the total payouts outcome potentially enormous.

What steps do car finance firms need to take now?

1. Firms need to evaluate the impact of the FCA's announcements and start with an internal assessment to determine their vulnerability to the investigation and the readiness of their data systems to help them effectively respond.
2. Firms should anticipate a rise in customer interactions. It's advisable for them to establish a comprehensive complaints management plan to handle the influx of customer complaints effectively. This involves ensuring that their teams or automated systems are well-equipped to address complaints promptly, in accordance with regulatory standards, and provide timely resolutions.
3. Firms should conduct a thorough review of past complaint handling procedures, particularly those related to car finance and interest rates. They should assess whether there's a recurring pattern of improperly rejecting valid complaints, as this could heighten their exposure. This assessment should coincide with a review of customer accounts and loan agreements from the relevant period to identify instances where interest rates were adjusted, potentially resulting in overcharging.
4. Firms should consider collaborating with financial experts or regulatory consultants to assess potential financial liabilities, including overpaid interest, commissions, and associated charges on affected customer accounts.
5. Lastly, firms should consider outsourcing the operations of claims management to reduce costs and allow them to focus on the core business.

Restoring confidence and trust

The recent spotlight on DCAs has revealed another significant issue that could be damaging for reputations and revenues within the motor finance industry. The potential impact of this investigation is substantial, the scale of affected parties is evident from the overwhelming number of complaints already received, and highlighted by the monetary provisions lenders are already starting to make. 

Moving forward, car dealers, finance firms, and credit brokers must take proactive measures to address the fallout. By preparing now, firms can navigate the challenges posed by the investigation and work towards restoring trust and integrity within the industry.

Whatever the intensity of the investigation and the level of complaints that come to light, IT systems to support data retrieval and analysis will be required. This should be linked with effective CRM and accounting systems to identify and access customer data relevant to the investigation, including loan agreements, financial information, and communication records. Just as an example of how to reduce workload associated with the investigation, a customer communication platform could be implemented to automate and personalise communication with potentially affected customers and integrated with the CRM system.

As associate members of the BVRLA, CGI are proud to be working with influential stakeholders across the fleet, rental, leasing and automotive industries to leverage new technology and deliver innovation. In this rapidly changing environment, if your organisation is potentially affected by this investigation, or you have already started to build a response and you need advice on the best approach, feel free to get in touch. We can help you facilitate readiness to respond to customers and the regulator before the investigation concludes in September.