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The FCA’s review into discretionary commission arrangements, together with a recent Court of Appeal ruling could have widespread consequences for motor finance firms and may bring into question the operating model of many firms. Chris Laverty and Jarred Erceg outline actions for directors and senior management.
Contents
On 25 October, the Court of Appeal ruled in favour of consumers, stating that discretionary commission arrangements (DCAs) were unlawful unless they had been disclosed to the consumer, and that they had given informed consent to the payment.
While this ruling goes beyond the scope of the FCA’s ongoing review into historical use of DCAs by motor finance firms, it raises further concerns for the sector and the possibility of a remediation exercise.
The two lenders involved in the Court of Appeal case have stated their intentions to appeal to the Supreme Court, leading the FCA to say it will write to ask for a quick decision on whether the Supreme Court will give permission to appeal and if it does, to consider it as soon as possible, given the potential impact of any judgement on the market.
On 13 November, the FCA announced it's consulting on extending the time firms have to respond to consumer complaints about motor finance where a non-discretionary commission was involved, and for consumers to refer them to the Financial Ombudsman Service (FOS). If taken forward, the complaint extension could be in place by mid-December 2024. Where complaints about motor finance involve a DCA, firms have until 4 December 2025 to provide a final response.
The regulator is considering what impact the Court of Appeal’s judgement has on its review into historical DCAs in motor finance, including for both its timeline and scope. This will inevitably be influenced by any decision of the Supreme Court.
What implications does the Court of Appeal's ruling on motor finance commission have for the future of consumer finance?
Revving up the debate: unpacking the Court of Appeal's motor finance commission ruling
Meanwhile, complaints relating to motor finance remain high. In H1 2024, complaints to the FOS increased 40%, with motor finance related complaints being a key driver of this increase - a trend which is expected to continue into 2025.
Impact on the viability of current motor finance operating models
The Court of Appeal ruling and the FCA's ongoing review may cause firms to grapple with some of the following strategic and operational issues:
The ongoing use of commission models and how this may impact broker engagement, deal flow and loan origination
The impact of an increase in operational and compliance related costs driven by complaint volumes, processing of data subject access requests (DSARs) and enhanced disclosure requirements
The repercussions of any possible remediation exercise and likely challenges with the implementation (eg, data, resources, scope and quantum of compensation)
Should new revenue models be considered which have less dependency on broker relationships?
How can the firm remain competitive and retain market share?
How can the firm manage ongoing liquidity and working capital requirements, including identifying possible cost efficiencies across the business?
The FCA has noted its concern about the financial impact of their review on firms. In a ‘Dear CEO’ letter sent in April 2024 to motor finance firms the regulator highlighted the importance of conserving cash and maintaining adequate financial resources in light of increased commission complaints, and the associated costs for handling and resolving those complaints.
Director duties
In times of uncertainty, it's particularly important that directors (and senior management) take a proactive and well-informed approach to governance. Directors need to be mindful of their duties which are designed to protect stakeholders, promote good corporate governance, and maintain accountability. These include:
Promoting the success of the company
Directors must act in a way they believe will benefit the company’s members, having regard for the interests of stakeholders such as consumers, employees, and suppliers.
Exercising independent judgement
Decisions should be supported by critical evaluation of all information, for example assessing current commission models or reviewing compliance and risk management functions to ensure they're fit for purpose.
Exercising reasonable skill, care, and diligence
Directors are expected to apply their expertise effectively, act prudently and remain informed about their company’s affairs, for example remaining up to date with regulatory matters, market trends and other risk factors impacting the business.
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Actions directors can take to guide their firms through these challenges
Considering the FCA’s recent announcement and the Court of Appeal’s judgement, the below are key actions that directors (and senior management) can take now:
Assess the extent to which your firm has used brokers, together with their potential exposure to the recent ruling. Map the sales journey to understand if brokers are compliant with this new interpretation of common law
Review and reconfirm your firms’ products and services are fully aligned with the Consumer Duty’s requirements to reduce the likelihood of future claims
Identify your population of consumers whose agreements may have been subject to DCAs
Triage and investigate complaints, and process DSAR requests proactively
Ensure timely access to relevant financial and operational MI reporting. This includes information around vulnerable customers, or those in financial difficulty. Directors will be aware that additional protections for borrowers in financial difficulty came into effect on 4 November 2024, so MI should demonstrate compliance with this policy statement
Identify the operational requirements to undertake a remediation exercise, including the need for additional internal resource or third-party support
Consider the format, quality, and availability of data, including any reliance on legacy systems
Undertake detailed scenario analysis, with cash flow and liquidity modelling, to understand the potential level of claims arising from these matters and what the business can withstand, both financially and operationally. This exercise may also highlight areas of potential stress or vulnerability and triggers that may lead to business distress
Establish how any possible remediation exercise will be funded
Reassess your wind-down plan to consider how it may be affected. A robust and deliverable wind-down plan can act as a tool to build stakeholder confidence at a time of uncertainty and ensure that all risks have been appropriately considered
Where a firm may be experiencing financial difficulties or have concerns about the impact on future performance, directors should engage with their advisors (both legal and financial) early to consider options available and how best to navigate the challenges.
We have advised on restructuring engagements for many firms in the consumer credit market, including the development of large-scale remediation exercises, and can help you proactively prepare so your firm is best-placed to respond to these decisions.
