Marc Ireland on the FCA’s Motor Finance Commission Investigation

“…the only question is how far and wide the FCA and Skilled Person can reasonably rationalise going from a remediation and redress perspective…”

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Foreword from MERJE

Since the FCA released its publication on discretionary motor finance commission complaints in January 2024, we have seen a variety of commentaries which seek to explain the issue, clarify the FCA’s expectations, and provide some insight as to how firms should respond.

Here, senior regulatory compliance consultant Marc Ireland brings together the key themes of the discussions around the FCA’s investigation and shares his thoughts and insights as a seasoned motor finance professional.

Marc has previously built and led middle market focussed regulatory teams at Deloitte, KPMG, and EY, and is now supporting motor and other asset finance firms on an independent basis.

An FCA Skilled Person, Marc has delivered a variety of gap analysis, transformation, and remediation related engagements within the motor finance sector (many of which have been at firms under direct FCA scrutiny), meaning he has first-hand experience and can provide useful insights into what recent events mean for the sector.

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Introduction

There is a lot to say here as you work through the root causes, the issue itself, the FCA’s intervention, and what motor finance firms should be doing to mitigate the impact of this.

Giving each of these topics the coverage and level of explanation they deserve would lead to a detailed and very lengthy article.

To avoid this, I have decided to present my key messages via a series of headlines with clear and concise points which deliver the supporting narrative.

Let’s get into the detail of the topic at hand: the crystallisation of the discretionary motor finance issue.

Section One

There was a certain inevitability to this, and the direction of travel is clear.

It is arguable that the PPI/Plevin Case (2014) was first to focus attention on the non-disclosure of commission received by brokers or dealers.

The question being debated is whether said non-disclosure created an unfair relationship with customers on the basis that they may have made a different purchasing decision had they been aware of the amount of commission paid, and how this might have distorted the distributor’s behaviour.

Ever since then, Claims Management Companies have tried to make this concept/these principles ‘stick’ to other products in different parts of the market.

The FCA’s first motor finance thematic (which was announced in July 2017, delivered an interim update in March 2018, and issued a final report in March 2019) facilitated this.

The thematic had set objectives, one of which was to determine whether the commission models in place generated conflicts of interest that might lead to higher finance costs for customers and ultimate harm.

The core conclusions in the Final Report were hard hitting (at least from a commissions perspective) and it is arguable that they make what we are now experiencing somewhat inevitable.

Within this publication, the FCA:

• Outlined their concern about the widespread use of commission models which gave the brokers discretion to increase the interest rate paid, whilst linking the commission that the broker received to that interest rate.

• Outlined their concern that the way that commission arrangements were operating may be leading to consumer harm on a potentially significant scale (which is quite a bold statement and would have been challenging to make without sufficient evidence, especially when considering the lobbying/other external pressures exerted during this thematic).

• Concluded that some customers were paying significantly more for their motor finance because of the way lenders choose to remunerate their brokers (and estimated that this was costing customers £300m more annually).

This ultimately led to the FCA banning discretionary commission arrangements in January 2021.

It is interesting to note that in the Policy Statement that confirmed this ban, the FCA noted that respondents to the Consultation Paper (many of which were motor finance lenders) had ‘largely recognised that discretionary commission models were a source of harm’.

“…there is a clear direction of travel here that may be taking the motor finance sector to an unpleasant destination.”

At this point, the FCA’s actions were all forward-looking in nature and were silent on what should be done with the large volumes of past business that was written under discretionary commission arrangements that was, in the FCA’s and markets own views, likely to have led to customer harm.

Given these factors, it was inevitable that this past business would be tested within the courts and at the Financial Ombudsman Service (FOS).

Perhaps it was also inevitable that one or more of these court decisions or FOS referrals / adjudications would be of a nature that would have a real impact on the market, prompt a flurry of further cases and, ultimately, drive the FCA to action.

The crystallisation was certain and, as set out below, there is a clear direction of travel here that may be taking the motor finance sector to an unpleasant destination.

Section Two

It is arguable that the FCA’s intervention is an attempt to buy some time and wrestle back control.

Since the FCA’s ban on discretionary motor finance commissions was announced, we have seen:

• Hundreds of thousands of Data Subject Access Requests be submitted by CMCs seeking information on the commission arrangements in place.

• Multiple cases working their way through the UK courts, with the aim being to get to the Court of Appeal or High Court where a precedent will be set.

  There are estimated to be up to 10,000 cases within the court system. The current score (as of Apr 2024) is circa 231 cases found in favour of firms and circa 108 cases in favour of the customers. The gap appears to be widening in favour of firms; however, a couple of decisions in favour of firms are now at the Court of Appeal.

• A dramatic increase in case referrals to the FOS.

  There were 10,000 cases with the FOS in January 2024 and insiders suggest that this has risen to over 18,000 as of April 2024.

As outlined above, it was perhaps inevitable that these court cases or FOS referrals would lead to decisions being made and rationales being provided that would drive the FCA to action.

This occurred when the FOS made two adjudications in favour of customers that took a bullish stance on several of the key points being tested, more specifically:

• The existence of the discretionary commission arrangement created an inherent conflict of interest (which was contrary to the Principle for Business 6 which compels a firm to treat its customers fairly, and CONC 4.5.2 which only allows lenders to pay differential commission rates when it is justifiable via the level of work performed).

• There was an inequality of knowledge as the customer’s deliberations and decision making would have been impacted by:

• the lender’s failure to disclose the basis on which it would pay commission, or

• the fact that the broker had the ability to determine the interest rate.

• The broker’s failure to provide sufficient detail on the structure of the commission relationship was contrary to CONC 4.5.3 (which requited the broker to disclose the existence or the existence and nature of any commissions, depending on when the business was written), Principle for Business 7 (which requires a firm to pay due regard to the information needs of customers), and Principle for Business 8 (which requires a firm to manage conflicts of interest).

• The broker was acting for themselves and as an agent of the lender when selling the motor finance, which means that the lender can be held responsible for the broker’s acts/omissions.

It is not unreasonable to suggest that the bullish stance taken and rationale sitting behind these adjudications would have opened the proverbial floodgates.

The FOS makes decisions based on the circumstances of each individual case; however, it is not unreasonable to suggest that:

• Many of the discretionary finance commission complaints that the FOS were sat on at the time would have shared similar characteristics and may have led to similar decisions; and

• It would have invited hundreds, thousands, if not millions more complaints.

As the FCA points out within their own Consultation Paper, once complaints are within the Financial Ombudsman’s jurisdiction, there are significant barriers to it intervening and using its own powers to investigate and resolve them through alternative approaches.

This being the case, the FCA had no choice but to intervene and take back control.

Section Three

It will be interesting to see how the FCA, FOS and courts’ philosophies and approaches are reconciled over time.

This issue is being investigated by the FCA, FOS and courts, all of which are described as independent bodies and have different roles, objectives, scopes, and investigative and decision-making processes/powers.

If you delve into the documentation that governs (or tries to govern) the interrelationships between these bodies, they state that whilst each one is compelled to pay due regard to the decisions of the others, they are not obliged to follow them.

The Financial Ombudsman Service and numerous courts have made decisions in this space (as outlined above) and there have been some material differences in the interpretations and resultant decisions made.

It is, however, notable that within two of the FOS decisions referenced above, there was commentary that the courts would likely agree with their conclusions.

It will be interesting to see where the Financial Conduct Authority goes and where its lines in the sand are drawn (which will be informed by the independent Skilled Person review that it has commissioned).

Whether the FOS and courts will be compelled to follow this will also be interesting to see, as any solution that the FCA proposes will fail its objectives if complaints continue to be sent to or upheld by the Financial Ombudsman Service.

Certainly, there may be an inclination for the Financial Conduct Authority to take a view or propose some actions that will deliver outcomes not too dissimilar to the FOS, otherwise there is chance that this may all end up there anyway and the last few months will have only served to merely ‘kick the can down the road’.

The judicial review brought by Barclays against some FOS decisioning will also have on impact on the above and, perhaps, the timescales for the FCA’s review and next steps.

Section Four

It was always going to be a deep and wide issue, but media commentary has made it deeper and wider, quicker.

When the FCA’s Policy Statement was first issued, there were some questions regarding the potential size and scope that weren’t immediately clear without a careful reading of the publication and/or without some clarification from the FCA.

We’ve now had time to do that careful reading and the FCA, to their credit, have provided some clarification on the FAQ section of their website and on their webinar.

We are now at a place where we know that:

• The FCA’s moratorium only applies to DC complaints where DC structures existed.

  Ironically, this means that firms that did not use DC structures but receive speculative DC related data subject access requests or complaints are compelled to consider these now.

• The in-scope period goes back to when the FOS assumed jurisdiction for consumer credit related complaints, i.e. April 2007.

  This was some 16 years ago and will create some challenges from an information retrieval perspective, given that many firms set their record retention periods at six years, in line with the statute of limitations.

  It should be noted that this tends to be the end-result for all consumer credit related remediations, irrespective of the arguments put forward by firms for earlier end dates.

• It is challenging to put exact values on motor sales over the years; however, over the last 10 years there has been:

• An average of 2m new car sales per year, with around 80% of these involving finance; and

• An average of 7.5m used car sales per year, with around 20% of these involving finance.

  It should be noted that these volumes vary depending on market conditions.

• The FCA estimates that 40% of car finance was sold with discretionary commission models.

• There is a lot of commentary on the range of redress, with figures ranging between £6b and £18b being quoted.

  Either number would be staggering and would make this issue the second biggest financial services scandal in the UK, behind PPI at circa £53b and ahead of interest rate derivatives at £4.85b, mortgage endowments at £1.9b, and packaged bank accounts at £1.6b.

• There has been a significant amount of media attention on this issue.

  Most newspapers and trade journals have run articles, and it has also featured in a couple of television programmes.

  The Martin Lewis Money Show and podcasts have raised attention amongst customers, urged them to complain, and provided tools and templates that facilitated this.

  Indeed, there has been a general grumbling about the FCA appearing in the programme which was considered akin to them endorsing the call to complain.

• All of this has led to complaint levels ramping up more quickly than they might have done.

  1.3 million complaints have been made via Martin Lewis’s website – if all these cases find their way to FOS then this will generate the best part of £1b in handling fees (surely something will be done on this).

  Firms have anecdotally reported receiving hundreds, thousands, or tens of thousands of complaints a day, depending on their size.

  It is arguable that we would have always gotten to this point; however, it is also arguable that we have gotten there much more quickly due to the media scrutiny.

• Clearly firms will have had a lot less time to ramp up because of this.

  There are considerable time, resource, and financial costs associated with processing this (as outlined in Section 8).

  Also, we have had several successive years of events preventing firms from enjoying a BAU environment and being able to focus on the longer-term strategic initiatives that will make their businesses thrive going forward.

  The COVID pandemic, the mini financial crisis and subsequent cost of living crisis, the war in Ukraine (which has led to various supply chain challenges of certain raw materials that are essential in motor production), and perhaps even focussing on implementing the Consumer Duty in recent years; all such events mean it looks like businesses may need to wait a little while longer for that return to BAU.

Section Five

As the first phase of Skilled Person Reviews comes to an end, firms should still have time to influence the outcome given the data constraints and delays that the FCA has alluded to.

The FCA has imposed a moratorium on the need to manage motor finance related discretionary commission complaints within an 8-week period and extended the time within which customers must refer complaints to FOS whilst a Skilled Person review is underway.

The FCA has appointed the Skilled Person themselves, to assess whether practices exhibited across the market are inconsistent with the Principles for Business and the Consumer Credit Sourcebook and/or are delivering poor outcomes to consumers.

There has not been a great deal of information shared on the timescales and no Requirement Notice has been published (notwithstanding that circa 10 businesses are subject to this and many more have started their own work on this and are observing with interest).

The general view is that the firm specific reports were to be delivered towards the end of April 2024.

The FCA needs to analyse these, draw its conclusions, determine next steps, and send these through its internal governance by the end of September 2024.

In a recent market update, the FCA acknowledged that some firms were struggling to provide the data needed, which suggests that there may be some delays with the s166 being concluded.

This being the case, I thought it may still be worth providing a few pointers on how the end stages of these s166 might best be managed by firms.

This leverages my experience of being a Skilled Person and leading or managing multiple Skilled Person reviews over the course of my career:

Proactive and persistent communication is key –

There will be a Skilled Person, an Engagement Manager, and a delivery team delivering the reviews across the in-scope firms.

This will include a Quality Partner or a team of Quality Partners who will be monitoring the review (potentially at arm’s length) and will have a material influence over the work performed/conclusions drawn, to ensure that the review is performed correctly and to manage the risks, brand, and reputation.

Some of these individuals will have had some prior experience of working in the motor finance space, but others will not. Most will not have needed to undertake a detailed deconstruction of a motor finance deal before. It is essential that these individuals be left in no doubt about what they are looking at.

This being the case, there should be a robust engagement strategy that captures all key Skilled Person stakeholders and decision makers up until the point at which the draft report is delivered to the FCA.

This should be driven by a suitably senior level of the firm’s own management, to ensure that the communication is persuasive. This will ensure that there has been full consideration of all material facts and no misinterpretations / misunderstandings.

The devil is in the detail, so ensure that the Skilled Person focuses on this –

Taking a simple view, the existence of a discretionary commission structure, the non-disclosure of that discretionary commission structure, and the dealer’s use of that discretion to elevate the customer to a higher rate of interest than they would have paid sounds like a poor outcome. It is, however, not as simple as that.

Many motor deals can be quite complex. There can be lots of negotiation between the lender/dealer and dealer/customer and tinkering of the deal, to get it to a place where it is acceptable to all parties.

This may involve discounting the vehicle price, dealer contributions to the deposit, flexing the value applied to any part exchanges, the provision of extras (i.e. alloy wheels, parking sensors or even service plans) or changing the term of the finance. The borrower may have paid a higher interest rate, but was the overall cost higher once these factors have been taken into consideration?

It is essential that firms make the Skilled Person aware of this (I am sure that they have). Presenting this detail in a way that is easily digestible (i.e. not using internal dialects and terminology) will help with this.

It is also essential that the Skilled Person takes the time to deconstruct these deals and use this to form an overall view on the outcome delivered to the customer.

The question is, to what extent will it be possible to do this given the data constraints and the aggressive timescales for this review?

What is it reasonable to accept from a burden of proof perspective –

Skilled Person reviews are supposed to be based on facts derived from tangible evidence.

The challenge here is that the in-scope period goes back to April 2007 and many firms’ record retention policies do not cover that length of time. The FCA has announced that there has been a real challenge in terms of accessing complete records or indeed any records in places!

“Firms will need to figure out what they are prepared to accept and not accept from an evidence and balance of perspective…”

This raises an initial question of what the s166 is trying to prove. Is the FCA and Skilled Person looking to positively evidence that there was customer detriment or that there was no customer detriment?

Ironically, the end conclusions and next steps may be completely different depending on the starting question.

Firms will need to figure out what they are prepared to accept and not accept from an evidence and balance of perspective when it comes to the findings and the rationalisation that is presented for these.

As far as I am aware, neither the in-scope motor firms or the Skilled Person are reaching out to customers to see if they can plug any information gaps at this stage.

Can clear and definitive conclusions be drawn on whether harm has or has not occurred or what the next steps should be when there is a lack of evidence for large swathes of customers that may be impacted by this? Does this give an indication of potential next steps?

Could the FCA make the end date of the period for any next steps more recent (which would be a good outcome for firms)? Could the FCA ask for a customer contact exercise to try and gather any additional addition that might help form a clear and definitive view on the outcomes achieve (which would be time consuming, expensive, unlikely to yield a significant amount of new evidence and a bad outcome for firms)?

Use any case clinics that are offered –

Skilled Person reviews often use case clinics to evidence how cases are assessed and to set out illustrative findings and the rationale for these. Firms should embrace the offer of case clinics and ensure that they cover as many cases or case categories/cohorts as possible.

They will provide an insight to the Skilled Persons thinking and an opportunity to check and challenge this (in an appropriate way) before formal reporting.

Remember that results will extrapolate upwards, so anything that suggests an unfair outcome has occurred that the firm does not see or chooses not to challenge will likely flow through to the report and inform the FCA’s conclusions on the firm’s and the broader market’s next steps.

Insist that you have sufficient time to review the report and do so with a fine-tooth comb –

The timescales on s166 are usually quite aggressive. This seems to be the case here.

Both the Skilled Person and the firm subject to the review will want to hit the reporting timetable set out in the Requirement Notice or agreed within the delivery plan.

The Skilled Person and the Quality Partners will want to check and then double check the work performed and reach consensus on the conclusions to be drawn.

This can be a time-consuming process which may eat into any time that the firm may have to review the aspects of the report that they are able to review before submission to the FCA (quite often, Requirement Notices say that the full Draft reports should be shared with the FCA and firm at the same time).

Given what is at stake here, it is imperative that firms demand that they get sufficient time to carefully consider the aspects of the report that they can review. If this impacts delivery of the report within the specified deadlines, so be it. It is better to take a few extra days to get the report as accurate as possible. The FCA should be understanding of this.

Whether it be within the original or any renegotiated timescales, firms should ensure that they focus on the detail and be mindful that this may feature in the appendices! S166 reports can be long form. There is a natural inclination to focus on the main body of text and give up on the appendices. If this is where the case-by-case findings are located, ignore them at your peril as the FCA certainly will not.

“Given the short timescales associated with this, my suspicion will be that the FCA and Skilled Person will want to keep their eyes very firmly on the prize…”

Don’t be frightened to agree to disagree with the Skilled Person –

Quite often, the findings within Skilled Person reports come down to interpretations and subjective judgements. If there are rational grounds for disputing those interpretations or subjective judgements, then firms should not be frightened to do so (provided they are intending to do it in an appropriate manner).

If a firm is not invited to provide a management comment or statement within the report, it should ask to do so.

Keep the Skilled Person report focussed on the issue at hand –

The s166 Requirement Notice and engagement letter will set out the scope of the review. Experience suggests that there may be lines in these documents which suggest that any non-scope related material or systemic weaknesses relating to the governance, oversight, control or conduct of the business that come to the Skilled Person’s attention should be disclosed to the FCA.

It will be challenging to look at one aspect of the dealer relationship, without delving into detail about the broader diligence, onboarding, contracting, and ongoing monitoring arrangements.

It will be challenging to look at one aspect of sales disclosure, without seeing details on the broader disclosures and overall sales process (including the affordability assessment).

It will be challenging to read through a deal file looking for one issue, without identifying other issues that may be present.

Given the short timescales associated with this, my suspicion will be that the FCA and Skilled Person will want to keep their eyes very firmly on the prize and firms should encourage this when reading the draft report.

Think about the bigger picture –

My understanding is that there will be one Skilled Person report per in-scope firm, which makes sense. The findings in each individual report will combine to drive the FCA’s overall findings and proposed next steps.

Whilst I would encourage firms to get busy in addressing the specific issues identified in their own report, I would also encourage them not to get totally distracted by this and lose sight of the bigger picture.

Firms should be trying to hard to engage and influence the FCA as it does its own analysis, forms its overall conclusions an