The missing link in the FCA’s motor finance commission scheme: Promoting effective competition

The FCA’s 360-page consultation on a motor finance commission scheme, published last week, is very clearly designed to protect the regulator from a Judicial Review (JR), the process by which the FCA could be challenged in court over its proposals. 

To win a JR against a regulator, it is necessary to show that the FCA had failed to follow the right procedures in designing and finalising its proposals.  The mere fact that the proposals might be arguably ‘wrong’ in some way isn’t relevant, providing the regulator has at least considered all relevant factors. The odds are stacked very firmly against firms.

But my reading of the consultation is that the FCA would have failed to follow the right procedures, and be exposed to a JR risk, if it were to finalise the scheme based on its current proposals, because there is a key missing link in its analysis.

It comes down to just a few pages of the consultation. The effects of a change to correct this could be fundamental to the outcomes for firms in the market, as well as benefitting consumers longer-term interests.

Most cases will be discretionary commissions

As I set out in my earlier articles, in which I anticipated what the redress programme would look like (mostly along the right lines as it turned out, but I focus here on the part I got wrong) it seem likely that most claims will be ‘only’ (the FCA’s word) for use of discretionary commissions. 

Overall, the FCA’s approach is to presume that discretionary commissions were unfair but to allow lenders to rebut that presumption in ‘some limited circumstances’. 

The regulator sets out three ‘examples’ of such circumstances that may permit rebuttal of the presumption:  where there is evidence of adequate disclosure, where the commission was set by the broker (the FCA term includes dealers) at the lowest possible rate, and customer sophistication (which appears to be drafted in such a way as to make it almost impossible to use!).  Oddly, despite calling these ‘examples’, the consultation doesn’t suggest there are any others it is considering.

The missed basis for rebuttal:  A competitive rate

Where I believe the FCA has seriously erred here, and in doing so has failed to create a fully linked chain of analysis to support its proposals, is not presenting a basis for rebuttal for the situation where the broker set a commission higher than the lowest possible rate available from the lender but still provided a competitive rate to the customer. 

There are two tests that could be used to determine when this additional 'competitive rate' basis for rebuttal could apply:  

1. Was the commission level cost-reflective (an indicator that the interest rate set by the broker was probably competitive)?
   

2. Is there supporting evidence to confirm that the interest rate was competitive? 

If both answers are ‘yes’, then there should be a basis for rebutting the presumption that the commission was unfair.  

Cost-reflective test

The first test is consistent with the FCA handbook rule (CONC 4.5.2) that differential commission rates are allowed if the difference is justified by the extra work the broker does for the business.  This rule firmly establishes the principle that a commission rate higher than the lowest possible rate can be fair.

CONC 4.5.2 is mentioned in passing as having been considered by the FCA in its consultation (paragraph 7.15) but the the FCA the proceeds to dismisses the use of cost recovery arguments (paragraphs 7.49 to 7.51).

This dismissal of cost recovery arguments appears to be a direct contradiction in the FCA’s logic, a significant broken link in the chain, as it is contradictory to the FCA's own CONC rule.

Proving that commission rates were cost-reflective and justified would need to be done at broker level.  For example, a dealer that employed specialist finance staff who searched for the lowest rates would naturally have higher costs than a broker that dealt with only one or two lenders, but its customers are likely to obtain lower rates as a result.

Competitive rate test

Having established that a discretionary commission was cost-reflective, in line with CONC 4.5.2, I expect the FCA would still require supporting evidence to confirm that the rate charged to the customer was competitive.

This might not be quite as difficult as it sounds. Customers could be grouped by key characteristics such as credit category and size of loan, and the rate charged compared to those of other firms in each year.

As a starting point, I have collated evidence of historical used car finance market rates since 2014, which I am happy to discuss with any firms or their advisers.  Clearly a cross-industry effort would be needed to build on this and collate a full dataset that could be independently reviewed. 

FCA statutory objectives

The lack of a competitive rate rebuttal is not merely a technical point. It raise a fundamental question of whether the FCA would be meeting its statutory objectives.

The FCA’s entire purpose is to meet its strategic and operational objectives set out in the Financial Services and Markets Act.  The strategic objective is to ensure that the markets it regulates function well, and one of three operational objectives is to promoting effective competition in the interests of consumers. The Government’s holds the FCA accountable for meeting its objectives, including through the work of the House of Commons Treasury Committee and the National Audit Office .

If the FCA does not add a basis of rebuttal of its ‘unfairness’ presumption on the basis that the customer obtained a competitive and fair price, it must have erred in meeting its operational objective to promote effective competition, and therefore by definition in its strategic objective.

Turning this around, if the FCA requires redress in a situation where competition has clearly worked, as the customer has obtained a competitive and fair price, that would undermine competition in direct contradiction to its objectives.

Redress in cases where competition has worked would unfairly penalise lower cost lenders as they were more likely to use discretionary rather than fixed commissions.  Meanwhile, many higher cost lenders, where fixed commissions were higher but below the levels set by the FCA as requiring redress, will pay nothing.  

This will distort the market, leading to higher rates for future consumers.  There is already evidence of this happening, see my earlier analysis here.

Need for cross-industry data exercise

Securing the extra basis for rebuttal might turn out to be the easy part of this, as otherwise the FCA is seriously exposed to a JR as well as (eventual and too late for the industry) censure from Government.

But it would only be useful if the industry can then collectively produce the extra information needed to support its use: analysis of the cost structure of thousands of brokers and analysis of historical market rates by year for different categories of agreements. 

It’s all possible - but only with a coordinated industry effort starting very quickly. At least some illustrative results would be needed before the end of the FCA’s consultation period.

Please contact me if you wish to discuss this further. Commments on the LinkedIn post are also welcome.