Few in the motor finance industry won’t be aware that the FCA has published proposals to ban ‘Difference in Charges’ (DiC) commission models being paid to brokers of motor finance, which includes dealers. The consultation finishes on 15 January and the FCA has written to brokers to ask for their views. In the article, I suggest the FCA has got this partly wrong, and explain why this is important for asset finance as well as motor finance brokers.
As a starting point, it’s entirely normal in business sectors across the economy for firms that act as brokers to set the final price and, therefore, their own profit margin. Equipment dealers do it, travel agents do it, any retailer does it. It works for consumers because there’s active price competition in the consumer market. It’s why a 1964 Act of Parliament banned manufacturers from setting fixed retail prices. It’s why in 1997 publishers were stopped from controlling the prices for books by the Restrictive Practices Court.
DiC is simply how business is done. It’s how regulators and policy makers have always wanted business to be done. DiC usually works well for consumers.
'Point of sale' competition
Where regulators get concerned, and again this happens in business sectors across the economy, is where firms take advantage of a lack of competition to exploit customers. It has been proven that this can happen at ‘point of sale’ in some situations. For example, in an electrical store, there’s only one extended warranty option typically available, and there’s how a host of regulations designed to protect consumers. In a car dealership, there was typically only one provider of add-on GAP insurance, and in 2015 the FCA imposed new rules.
There’s a standard test used by regulators to determine whether there’s a lack of competition, and this can be used to review situations where there may be a ‘point of sale advantage’. It’s the Small but Significant Non-Transitory Increase in Price (SSNIP) Test. The SSNIP test considers whether firms with monopoly power can profitably increase prices above market levels. As an aside, the regulators will consider the ‘cellophane fallacy’, the problem that the test results might be affected by prices already being higher than competitive levels.
In motor finance, it’s probably true that some car dealers have overcharged customers, adding very high margins to the rates quoted by finance companies. The FCA has published some fairly impenetrable analysis 'proving' its case using econometric models. There’s really not much point anyone trying to disprove this, even if a lot of the data the FCA used may now be out of date. The leading car lenders moved away from DiC some time ago but some finance companies, particularly those offering non-prime finance, may still use it.
So, there’s at least a case for saying that a regulatory intervention is necessary or justified. This article isn’t intended to argue against that, although I would note that there may be a strong argument for retaining a quite limited degree of pricing discretion at the dealership. That could avoid dealers being inclined to push customers to more expensive non-prime lenders as a quicker option when commissions are low. This is best considered separately alongside the FCA’s wider concerns about car dealers (see my March 2019 blog here).
Where I believe the FCA has erred here is that it treats all firms carrying out the regulated activity of credit broking the same. In reality, there are two very distinct sets of firms doing this - around 8,000 car dealers; and around 1,000 motor or asset finance brokers that include brokers deal directly with the public, those sitting between dealers and lenders, and online specialists.
The FCA does not appear to have applied the SSNIP test (or anything equivalent) separately to dealers and to professional credit brokers. If the SSNIP test was applied to brokers, anyone in the business would be confident it would find that brokers do not have power to increase prices above competitive market levels. The moment brokers try to charge non-competitive rates, they are likely to lose the deal, because they don't have a point of sale advantage.
Not only is the intervention by the FCA unjustified for brokers, but it risks harming consumers. It will shift pricing power from a large number of brokers to a small (and falling) number of lenders, so taking competition further away from consumers. This is contrary to decades of previous regulatory thinking on how to optimise competition.
Fortunately, the solution is straightforward. Whatever new rules on commissions the FCA decides to implement, they should be applied only to firms authorised by the FCA with 'limited permissions' (e.g. car dealers) and not firms that are authorised by the FCA with 'full permissions' (professional credit brokers).
It’s almost as if this is what the FCA was thinking, as for part of their consultation they refer specifically to ‘dealer-brokers’, but then in their draft amendments to the FCA Handbook rules they use the wider term ‘brokers’.
This adjustment to the proposals could bring a significantly wider much wider benefit to the UK’s five million small businesses that lease their business equipment. In its proposals, the FCA states: “We are aware that DIC and similar commission models exist in other markets (for example, asset finance and premium finance). We do not currently have evidence to justify consulting on banning commission models in those consumer credit markets. However, if we identify evidence of harm in other markets, we will consider further interventions.”
That paragraph will be read by many lenders to be a strong nudge from the regulator to stop allowing brokers to set final prices using DiC or similar.
Brokers shop around for the best deal when many small business owners just don’t have the time to do this. As for motor finance brokers (‘real’ broking firms, as compared to dealers) not only is there a distinct lack of evidence to justify banning DiC, but in fact these commission models can significantly benefit competition and choice for small businesses customers.
Again like motor finance, the moment asset finance brokers try to charge non-competitive rates, they are likely to lose the deal, because they don't have a 'point of sale' advantage. Where rates are higher, this reflects the extra work that can be needed by brokers to find the most suitable finance options for their customers. There's always a place for lenders' safeguards such as maximum commission rates, and maybe a few lenders need to think these through a bit more, but these should only ever be relevant to exceptional situations.
The FCA shouldn't leave its ambiguous and speculative statement hanging over the SME finance market. It could cause real harm to small business users of financial services.