Driving into the past: FCA investigates motor finance agreements – what do motor dealer/credit brokers need to know?

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Driving into the past FCA investigates motor finance agreements

Driving into the past: FCA investigates motor finance agreements – what do motor dealer/credit brokers need to know?

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March 4, 2024

Background

On 11 January 2024, the FCA announced that it will exercise its powers under section 166 of the Financial Services and Markets Act 2000 (FSMA) to launch "skilled person review(s)" into historical motor finance discretionary commission arrangements (DCAs) and sales involving DCAs across several firms.

DCAs refer to a commission structure whereby motor dealers are given wide discretion by lenders to determine the interest rate within an accepted range to apply to a customer's motor finance agreement. The amount of commission the motor dealer/broker earns in such a structure is linked to the interest rate charged to the customer. The consequence being, the higher the interest rate, the more commission the motor dealer/broker receives. As a result, several motor dealers for many years charged customers a higher interest rate for their motor finance.

In response to this industry-wide issue, the FCA previously implemented a ban on DCAs in 2021, to eliminate incentives for dealers to charge higher interest rates. This was after finding in its report in 2019 that very few brokers disclosed to the customer the commission they received for arranging finance and that lenders were not taking reasonable steps to ensure that brokers complied with the Consumer Credit Sourcebook (CONC) in this regard. However, despite the prohibition, there continues to be a persistent influx of complaints from customers claiming compensation for DCAs established before the ban, with a notable surge in the past year.¹

The FCA has observed that an overwhelming 99% of complaints, received between January 2019 and the end of June 2023, were rejected.² Firms appear to have maintained their position that they complied with the legal and regulatory obligations which applied at the time and that, as a result, customers were treated fairly.

A significant number of these disputes have been referred to the Financial Ombudsman Service (FOS) for resolution and claims have also been brought in the county courts, some of which have been upheld. Given this, there continues to be significant dispute between some firms and consumers on whether firms have breached legal and regulatory requirements. It is against this backdrop of cases (see further below) that the FCA is taking further action. This article is intended to flag the key developments that motor dealer/broker firms should be aware of looking ahead. We will summarise the outcome of recent county court cases, the relevant FOS decisions and the FCA's direction of travel (including the new rules it has introduced). Finally, we will consider what motor dealer/broker firms can do to navigate the evolving regulatory landscape.

What are the cases in the county courts involving DCAs?

The recent rise in cases in the county courts typically stem from two scenarios where customers allege:

that they were not informed about the terms of a DCA, or that the details were hidden in the fine print, making them effectively secret; or
the existence of a commission was known, but the amount was concealed, or they were unaware that dealers could offer lower interest rates through such agreements.

These county court claims are being pursued through various causes of action, including through allegations of bribery, breach of fiduciary duty by the dealer/broker, breach of statutory duty under FSMA and/or through challenges of unfair relationships under the Consumer Credit Act 1974.

Two recent appeals namely, Wrench v FirstRand Bank Ltd (Wrench)³ and Hurst v BMW Financial Services (GB) Ltd (Hurst),⁴ have shed some light on how these cases are trialled. Both cases dealt with situations where customers were not made fully aware of commissions paid to car dealers who arranged their finance agreements.

Initially, the ruling for the Wrench case suggested that commissions were secret and akin to bribery because customers were not explicitly informed of the commissions. However, on appeal, it was determined that car dealers do not have a duty to be impartial or offer single-minded loyalty to a customer when providing information about the financing and noted that the dealers were primarily interested in selling the car. The judge also stated that the dealer was not involved in the decision-making process in a way that would influence the customer's decision and, hence, the commission should not be deemed secret or be classified as a bribe. Similarly, in Hurst, the appeal court ruled that the dealer did not have a fiduciary duty to the customer and so the bribery and secret commission claim could not succeed.

Collectively, these rulings suggest that it will be difficult for customers to argue that car dealers should be completely neutral when offering financing options. However, the position is different in respect of matters decided by the FOS.

What has the FOS decided in respect of complaints involving DCAs?

In relation to DCAs, the FOS has recently ruled in favour of consumers in two separate final decisions concluding that:

the discretionary commission model, in both cases, created an inherent conflict between the interests of the broker and the interests of the complainant, incentivising brokers to charge a higher interest rate than what lenders might have otherwise approved to increase their commission earnings;
by establishing and maintaining the discretionary commission model with the brokers on the terms it did, the lenders contravened guidance in section 5.2G of CONC (which requires lenders to only offer commission payments where it is justified based on the extra work of the firm involved). The lenders also failed to have due regard to the customers' interests and treat the customers fairly as required by Principle 6 of the FCA's Principles for Businesses;
a court is likely to find that the relationship between the lenders and complainants was unfair under section 140A of the Consumer Credit Act for a number of reasons.⁵

In light of these findings, the FOS has directed each lender to compensate the affected complainants by paying the difference between the charged interest rate and the lowest possible flat rate that would have been available without any discretionary commission.

What is the FCA doing?

In response to the FOS decisions, the FCA anticipates that there will be an increase in customer complaints which could result in disorderly, inconsistent and inefficient outcomes for consumers and the motor finance market. To address this, the FCA is introducing a series of measures and changes impacting motor finance providers, motor finance credit brokers (including dealers) and consumers with motor finance agreements involving DCAs.

Skilled persons review

As mentioned above, the FCA is using its powers to appoint a "skilled person" to review historical motor finance DCAs and sales across several firms, from as early as 6 April 2007. Notably, this includes sales before the FCA assumed responsibility for the regulation of motor financing and other consumer credit firms in April 2014.

In particular, the review will consider: (i) the arrangements between lenders and broker; and (ii) the information provided to consumers at the point of sale, including how commission was disclosed. The findings will help the FCA to consider whether consumer complaints should continue in their current track or if an alternative approach, such as a redress scheme, is needed.

It is expected that the initial diagnostic review by the FCA will be completed in September 2024. However, the timeline is contingent upon the progress and outcomes of the skilled person's review.

Temporary complaints handling rules

To preserve its ability to use an approach to redress that best meets its statutory objectives, the FCA has introduced temporary complaint handling rules for complaints about motor finance agreements involving a DCA. The rules, which have been in place since 11 January 2024:

pause the eight-week deadline for motor finance firms to provide a final response to complaints for a period of 37 weeks beginning from 11 January 2024 and ending on 25 September 2024 (the Pause). During this period, firms are not obliged to provide a final response within eight weeks and, unless the firm decides to do so, consumers will not be able to refer their complaint to the FOS; and
extend the time consumers have to refer complaints about DCAs to the FOS from six to 15 months. This extension will apply where the firm has sent its final response between 12 July 2023 and 20 November 2024.

The FCA has defined a motor finance DCA complaint as having the following characteristics:

the complaint is about a regulated credit agreement taken out before 28 January 2021;
the agreement financed the purchase (including via hire purchase) of a motor vehicle;
there was a DCA between the lender and the broker of the agreement; and
the firm received the complaint between 17 November 2023 and 25 September 2023 inclusive, and/or sent its final response to the complaint between 12 July 2023 and 20 November 2024.⁶

Complaints that do not meet the above criteria are not subject to the Pause. This exclusion covers civil claims, complaints already referred to the FOS, complaints that are not about motor vehicle finance (i.e. caravan finance) and complaints that have already received a final response.

The Pause will end on 26 September 2024, which is the earliest point at which firms will be expected to provide a final response to complainants and resume providing responses within the standard eight-week deadline. Unless the FCA takes further action, consumers will also be able to refer complaints to the FOS again. For instance, if a complaint was made three weeks before the Pause, then the firm will only have five weeks to issue a final response (or a holding response where a final response is not possible) after the Pause ends. For complaints received during the Pause, the eight weeks will start to run from 26 September 2024.

What should motor dealer/brokers do now?

Firms must comply with all changes to the complaint-handling rules that are relevant to their business. We have summarised the key actions for impacted firms below:

Do not sit back – keep investigating

Despite the Pause, firms are required to assess and investigate complaints promptly and diligently. Where possible, the FCA encourages firms to continue to progress DCA complaints by investigating and collating evidence that could help resolve the complaint.

Support consumers

On receiving a complaint, a firm must send the complainant a prompt written acknowledgement which includes an explanation of the Pause to the time limit rules.

If a firm has already sent acknowledgments or final responses before the Pause began, it is required to update the complainant in writing about the Pause and the extended FOS time limit (unless the complaint has already been escalated to the FOS).

Additionally, for any complaints that fall within the Pause period, firms also have to:

guide the complainant to the information published on the FCA's website that explains the reasons for the rules; and
keep the complainant informed of the progress of measures being taken to address their complaint.

Consider whether you can or want to provide a final response?

Final responses will not be required until, at the earliest, 26 September 2024 and we note that FCA will provide commentary shortly before this. Firms can therefore choose to hold off providing any final responses to consumers. This may allow firms to take into account what the FCA says. However, this will need to be balanced against the requirement to provide a final response where the DCA is not relevant to the consideration of the complaint, or the DCA element can be separated from other issues.

Where the DCA is clearly not relevant to the resolution of the complaint, or where the DCA element can be separated from the other issues, firms are encouraged to provide a final response. An example where this may be relevant is where a consumer who has already complained about commission has received a response and now wishes to raise a different complaint.

It is important to note that the Pause does not prevent firms which wish to respond to DCA complaints from sending final responses. Firms that opt to issue final responses or offer redress during the Pause must ensure they are in compliance with the standard requirements outlined in the Dispute Resolution: Complaints Sourcebook. For example, this approach may be considered in respect of vulnerable customers, where extended timing may create further financial pressures.

Maintain adequate financial resources and be prepared

Brokers (and their lenders) should remain vigilant as the FCA has alluded to its power under section 404 FSMA to set up an industry-wide redress scheme. While not set in stone, the FCA is considering redress schemes and this could signal substantial implications for the industry, potentially rivalling the scale of the Payment Protection Insurance (PPI) mis-selling scandal in the UK financial markets.

With an estimated 75% of all agreements from 2007 to 2020 containing some form of DCA, the number of affected customers could be extensive.⁷ Should a redress scheme be enacted, it could lead to substantial compensation payouts and the administrative burden on firms could be considerable, requiring extensive resources over a prolonged period of time.

The FCA has alerted firms to the importance of maintaining adequate financial resources to cover any operational cost from customer complaints and queries, and also where applicable to meet the cost of resolving the complaints.

Review and maintain record retention

The FCA has emphasised the importance of record retention, particularly given that the scope of potential complaints dates back to 6 April 2007. This is a long time frame and may pose challenges for firms, especially if they do not have access to or have not preserved data from that period. Most firms will likely not have access to records dating back to 2007, as General Data Protection Regulation rules dictate that firms should keep data "for as long as is needed" and, as a matter of common practice, firms tend to keep data for six years.

In instances where information is missing, firms are expected to conduct a fair and thorough investigation into complaints. They should actively engage with customers to collaboratively gather necessary information, ensuring that customers receive the support they need. This may include liaising with others on the transaction – for example, as between broker and dealer.

Looking ahead, firms should be mindful of the need to retain and preserve records relating to pre-28 January 2021 DCAs that could be relevant to existing or future complaints or civil claims. Firms are required to adhere to these record retention obligations until at least 11 January 2025, ensuring they are prepared to address any enquiries or issues that may arise during this period.

Keep the FCA informed

During its webinar on 24 January 2024, the FCA reminded firms of their duty to adhere to Principle 11, which requires them to be open and cooperative with the regulator. This includes notifying the FCA if the firm is considering setting up a proactive redress or remediation exercise for customers potentially affected by DCAs or considering making any structural changes to its business.

Expect the FCA to ask about this in the handling of other regulatory communications and applications

We are already seeing the FCA asking questions in connection with this issue in relation to other matters, such as applications for new approved persons. Be prepared for this to be the case, be ready to explain what you are doing and getting prepared to do, and expect FCA applications to take slightly longer if you are in this sector. Firms should also be mindful of how the FCA might use this information, not just in that particular application.

Looking forward?

The FCA confirmed that it will not be providing an interim update as it will focus efforts and resource on completing the diagnostic work. A decision on next steps is likely to be communicated, at the very latest, by 24 September 2024 which is before the pause to complaint-handling time limits is due to end. At that stage, the FCA will announce whether it is extending the Pause or making any other changes.