In case you missed it over the August holidays, the first significant legal case against motor finance providers over commissions has started.
Doug Taylor Class Representative Limited, an entity set up specifically to bring the claim with one director, consultant Doug Taylor, is reported to have filed a ‘collective actions’ case in early August at the Competition Appeals Tribunal (CAT).
The company has instructed Scott+Scott UK LLP as solicitors and Nicholas Gibson of Matrix Chambers is acting for the class representative.
The claims are against loan providers Black Horse, Santander Consumer and MotoNovo Finance. Anyone who entered into motor finance agreements with these companies between October 2015 and January 27, 2021, when the FCA ban on Difference in Charges (DiC) commission models for motor finance started, is covered by the claim.
For those not close to these matters, DiC is where the car dealer adds its introductory commission to a rate set by the lender, so that the rate paid by the customer is set by the dealer and includes the commission. The alternative is for a finance company to set the rate paid by the customer that includes the dealer commission.
The website set up by the claimant suggests that a million consumers could be entitled to claims totalling £900 million, based on the number of consumers obtaining finance for used cars over the period.
There are some tests the case must pass at the CAT before we get close to any consideration of the merits of the arguments. The CAT needs to 'certify' the application, to confirm it meets the criteria for a collective action, a completely separate process to considering the substance of the claim. It will check, for example, that the case is not being led by law firms, third party funders or special purpose vehicles. Without the backing of any major consumer organisations, that might prove tricky.
But let’s assume the case is certified so that it proceeds. This article sets out why I don’t expect a collective action to be successful - even if there have been some problems with the way some car finance agreements were sold. Much of the content is taken and updated from my December 2019 article on LinkedIn, Why the FCA should apply the SSNIP test to finance broker commissions.
1. The commission models applied were in line with FCA rules at the time
The claim relates only to the period before when the FCA banned Difference in Charges (DiC) commissions.
On its own, that doesn’t count for a lot, as all FCA authorised firms still needed to meet the FCA Principles, including Principle 6 - A firm must pay due regard to the interests of its customers and treat them fairly.
But it means that it would have to be proven at the Tribunal that using DiC was contrary to the FCA rules at the time, including Principle 6 - or otherwise unfair under UK consumer rights legislation (but given the nature of this case, the FCA handbook rules are likely to prevail).
In many respects, this case - if it proceeds - would become an independent review of the FCA’s conclusions that led to its decision to ban the DiC model. If the CAT was to conclude that the FCA’s judgement was wrong, it could even lead to a rethink of the ban.
2. Most car dealers manifestly did not earn ‘excessive’ profits from DiC
Many small to medium-sized car dealers, who dominate the 8,000 or so dealers in the used car market, were not eligible to use DiC for some, or all, of the period of the claim. Those that could are likely to have only been able to do so with the lenders in this case within tight limits (i.e. a cap on the rate, so that even the highest amount that might be added was modest).
Commissions on used cars sold by smaller dealers would typically be of the order of £200, and the work involved to earn that could be substantial, taking account of both the time spent with the customer, and the overheads such as staff training and systems implementation. In many dealerships, that’s time when staff are unavailable to sell cars, so it can have a high opportunity cost.
Larger dealer groups may have had more discretion about their use of DiC. However, these groups typically would provide a full broking service, researching the customer’s situation and matching them to an appropriate lender from their panel. That helps to secure the lowest rate given the customer’s situation. The work involved varies considerably from case to case, so it makes sense that the commission is not set at a fixed amount.
I certainly am not suggesting that every DiC commission earned by car dealers was perfectly reasonable, no more than I would argue that every car sold was in reasonable mechanical order. But the vast majority of commissions paid almost certainly were within a reasonable range, particularly for the largest lenders named in this case.
3. If there were cases of ‘excessive’ profits, finding them will be highly complex
It follow that the only meaningful way for the CAT to reach a judgement would be to look at the arrangements in place at individual dealer level. In fact, even that wouldn’t be enough, as within the portfolio of loans brokered by a dealer using DiC, there would usually be a range of different commissions, some lower than average, some higher.
The CAT would have to consider whether the average commission was reasonable, and whether variances from it were justified. For example, was the deal with a higher commission a particularly complicated one to arrange? And given this is an 'opt-out' collective action, meaning that all car buyers are automatically included unless they contact the claimant to request they are excluded, how would the CAT deal with the cases where dealers charged very low commissions?
In short, trying to pin down exactly who has lost money from DiC is likely to be incredibly difficult.
It’s a challenge already being faced by the Financial Ombudsman (FOS), which at the end of July noted that ‘while there is quite a lot of nuance across the individual complaints and each will turn on its own individual merits, we are beginning to see some commonalities in groups of cases that will help us to further establish our approach to investigating these complaints'.
4. The FCA analysis supporting its ban on DiC could be challenged
Let's return to the core issue - did the FCA get it right when it assessed that DiC was causing harm to consumers by increasing prices paid for motor finance? Here are some factors that should be considered.
The FCA analysis was based on complicated econometric modelling. If this case proceeds then presumably the details will be made available to allow them to be properly reviewed. From my experience of working in the competition regulator, for every econometric model, there’s another model proving the precise opposite. The point being that these models are useful tools for understanding market dynamics, but no more than that: Theoretical models cannot be relied upon as a key basis of important policy decisions.
Many car lenders moved away from DiC several years before the FCA ban. So if the data used was historical (the FCA modelling was based on a sample of around 1,000 motor finance agreements from 20 lenders representing about 60% of the market, covering the period January 2017 to July 2018) it could have led to misleading results.
There is nothing wrong with DiC used responsibly in a competitive market. Pricing arrangements like this are routine in business sectors across the economy for firms that sell products and services to set prices, and in so doing, set their own profit margin or commission. Equipment dealers do it, travel agents do it, retailers do it. DiC usually works well for consumers, because it allows the cost of providing the distribution service to be factored into the price without using crude averages.
Where regulators get concerned is where firms take advantage of a lack of competition to exploit customers. This can happen at ‘point of sale’ in some situations. When a consumer has just purchased their car in the dealership, there is only one firm selling a finance solution: the dealer. The dealer has a ‘point of sale advantage’. But how much of a concern is that? After all, most consumers are likely to be aware of other finance options in the marketplace.
There’s a standard test used by regulators to answer this question. It is the Small but Significant Non-Transitory Increase in Price (SSNIP) Test. It reviews whether a firm could profit by charging higher and uncompetitive prices on an ongoing basis. Given how price-sensitive consumers are when buying cars, it’s far from obvious that a dealer could systematically overcharge for finance. (Alongside the SNNIP, it’s usual to consider the ‘cellophane fallacy’ – but see my 2019 article for more on that!).
Clearly there’s a lot of economic theory and jargon involved in this. The point I want to emphasise is that there’s nothing new about the ‘point of sale advantage’ problem, and there's a long history of the problem being assessed in different markets (usually by the Competition and Markets Authority, formerly the Competition Commission) and proportionate remedies being applied.
But banning a commission model entirely, when in most cases it has clear advantages for consumers? The rationale for that was always a bit shaky, and some are likely to welcome a thorough review by the CAT, should the case get to that stage.
5. Since the FCA’s ban on DiC, there is evidence that cost of loans for most consumers have increased
The premise of the FCA’s intervention to ban DiC, and the basis of the collective action case, is that consumers paid more than they should have done for their finance. But if that was the case, we would expect average commissions (and prices) to have decreased since the ban took effect?
Most dealers now are faced with a single rate for every customer because it is set centrally by the finance company. Or, they may have two or three rates to use, perhaps one for ‘standard’ customers, another for ‘higher risk’. As a result, some customers who used to be eligible for lower rates (e.g. because their loans were straightforward to arrange) now have to pay more.
Does that also mean that other consumers are paying less? Yes, certainly the FCA's ban has removed outliers, the small minority of cases where particularly high commissions were added to rates set by lenders. But dealers now face having to put a lot of time into more difficult cases without being appropriately paid for doing so. Increasingly, they are simply not offering a broking service in such cases. The result seems to be reflected in the growing non-prime direct car finance market, as more consumers are now unable to source finance from the mainstream (prime) lenders through dealers.
This case, ostensibly seeking to compensate consumers for the DiC model, might actually has the effect of proving that DiC usually works in their interests - with suitable controls in place - and should be reinstated.