Stephen Bassett, AFC’s community head for UK asset finance professionals, looks at the background to the FOS decisions over discretionary commission in vehicle lending.

The news that Barclays is mounting a legal challenge to the Financial Ombudsman Service (FOS) ruling over unfair discretionary commission arrangements on a conditional-sale agreement for a car purchase is the first sign that lenders are challenging regulators to answer the obvious question about the motor finance market: what exactly have they done wrong?

The FOS ruling centres on an agreement signed by a Miss L, who borrowed £13,333 under a deal with Barclays Partner Finance at a flat interest rate of 4.67% a year where the APR was 8.9%.

She subsequently made a complaint to FOS saying she was unaware the commission was linked to the interest she paid on the loan, and this meant that she was not given the best interest rate available.

In its evidence to FOS, Barclays PF stated that while there was no regulatory requirement to disclose anything about commission, nevertheless the terms of the credit agreement shown to the buyer stated: “You agree to us paying commission to any broker or supplier acting as your agent in relation to the agreement”.

FOS ruled Barclays PF “did not act fairly and reasonably in its dealing with Miss L”, citing the “inequality of knowledge and understanding” created by its failure to disclose the precise structure of the discretionary commission arrangement. In doing so, it has opened the floodgates for thousands of claims, and encouraged calls for mass compensation from consumer guru Martin Lewis and a slew of claims management companies.

Regulatory push

On the surface, the FOS decision could be seen as part of a global move to put consumer interests first – in the US, for example, the Federal Trade Commission has finalised the Combating Auto Retail Scams (CARS) Rule, to tackle what it terms “bait-and-switch tactics and hidden junk fees”.

However over here, for a very long time indeed, thanks to the Consumer Credit Act (CCA), no individual will have borrowed money without being very clearly shown what the difference was between what they were borrowing and what they would need to pay back, using the APR comparisons.

Borrowers have long been able to ask for a breakdown if they want, but very few do, presumably because they are content that the overall work that has been undertaken to obtain credit for them, on their chosen car, for the amount they have agreed to repay, is all acceptable and affordable.
And the word “work” is key to countering the widespread view that interest and commission represent “something for nothing”.

In the motor market, a cash sale at the advertised price is ideal for the dealer, who is then guaranteed the required margin. However, if credit is required, a customer with weaker finances might struggle to get approved, so to assist, the dealer can reduce the amount needing to be borrowed by perhaps offering a bigger discount on the car, or a more generous part exchange (p/x).

The income generated by the commission on the finance can substitute for the income lost on the p/x and/or discount, which can then normalize the dealer’s expected income, but also allows the borrower to spread the overall cost over the credit period. In other words, it makes getting the car they want more achievable.

Unfair profit?

Of course, a problem arises if a dealer does not trade each income stream off against the others, but instead piles all the elements on top of one another such that it makes a “super profit”, and the vulnerable or naïve customer ends up paying well over the odds for everything.

Unfair treatment of a customer could be an issue in circumstances where the income generated by the overall transaction is more than would have been achieved if the car was just sold for cash.

Even then, lenders may be able to evidence in line with the Financial Conduct Authorities Guidance (CONC 4.5.2) that the additional income value was warranted by the extra time and effort involved in, for example, collecting all the relevant data from the customer in order to make a sensible finance proposal and finding a responsible funder willing to lend in the light of the particular circumstances.

Reframing this extra income as the “fee” the potential borrower needs to pay to have the credit arranged for them illustrates how commission is payment for the work the dealer has had to do on their behalf, plus a margin for profit. Not so dissimilar, then, from the arrangements many potential complainants will enter into with claims management companies.

As Barclays’ judicial review announcement indicates, the time has come for lenders to take the fight to the regulators.

AFC’s UK summer conference on 6th June at etc venues, County Hall, London will look at the issues raised by the FCA motor finance review in depth. For more details, visit the event website at https://afcconferenceuk.com/assetfinanceconnect2024/en/page/home