FCA Commission Disclosures: A closer look
In January this year, the UK Financial Conduct Authority (FCA) launched a review into the historical use of discretionary commission arrangements within the motor finance industry.
What is a Discretionary Commission Arrangement?
Before the practice was banned by the FCA in January 2021, some lenders allowed brokers to adjust the interest rates they offered for car finance.?
The amount of commission earned by the broker was determined by the interest rate that the agreement had been contracted at. Therefore, the higher the agreed interest rate, the higher the rate of commission received by the broker. This was known as a discretionary commission arrangement (DCA).?
The investigation now being conducted by the FCA will look at whether DCAs were driving poor customer outcomes by incentivising brokers to agree finance arrangements at a higher rate to drive better commission, rather than provide the customer with the best deal.
What will the impact on the financial industry be?
Well, it currently remains to be seen. The FCA has not yet provided significant detail on the scope of the investigation, with more details promised in the third quarter of 2024. At time of writing, we are unsure how far back the investigation will look or how far forward, if any, redress will extend.
If the outcome of the review is that the FCA decides practices to have fallen foul of fair outcomes, the biggest impact will be on large scale lenders, some of whom are already challenging the FCA’s position. They argue that the rules at the time were being followed and therefore retrospectively penalising brokers for practices that were technically allowed is the wrong approach.
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However, despite the uncertainty, one outcome of the investigation that does seem likely is that the FCA may now choose to look at broker commission schemes more broadly, outside of motor finance. And this may well include the asset finance and commercial finance spaces.
If this is the case, brokers will need to take a look at how they earn. Under the current model, the broker originates a deal, places it with a funder at a certain rate, sells to the customer at a higher rate, and the profit difference becomes their income. Therefore, brokers are incentivised to sell as high as possible to the customer.
This practice, which has also been highlighted by Consumer Duty, will become very challenging for brokers if they suddenly need to disclose their commission figures. They may find it hard to justify their fees and risk losing customers as a result.
Therefore, now is a great time for brokers to get ahead of the game and look to change their model. We may see some brokers looking to transition to lenders due to no longer being able to chase the immediate reward of upfront broker commissions, and instead needing to generate income over time and motivate/pay their sales team differently.
By building their own lending book, brokers can actually earn more over the lifetime of the finance agreement, rather than a quick win. This can be through net interest income, title income, and fee income, not to mention the additional incentive for their sales team to place business on their own book, rather than a rather than a ‘buy low, sell high’ model.
Whatever the outcome, the VLS team will be watching closely and are ready to support both our current and prospective customers.
For more information on how the FCA Commission Disclosures investigation may affect you and your business, or to discuss changing your model ahead of the investigation outcome, our friendly team can help!