Impact of Discretionary Credit Arrangements in UK

Where an arrangement exists between a lender and a credit broker, where the latter is rewarded for adjusting the price a customer pays for motor finance, which includes any element in the total charge for credit and is remunerated on that basis. The U.K Financial Conduct Authority (FCA) published an instrument in January 2021, that banned such arrangements within the motor finance industry. The DCA does not apply to consumer hire but does apply to hire purchase.

A finding from FCA’s motor finance review, identified certain commission models caused harm to consumers. Where brokers were allowed discretion to set rates, which were linked to its commission, this created conflicts of interest for brokers to earn more commission by increasing the rate customers pay. In line with FCA’s objectives, consumers should be afforded protection by providing a fair deal.

The review also led FCA to publish additional guidance which allows consumers to receive appropriate and timely information on interest charges and commissions, to better assess its finance options. These led to amendments to CONC rules (Consumer Credit Sourcebook) and is applicable to all consumer credit markets, not just motor finance.

Disclosure of the nature of the commission is required when making a financial promotion as well as on a recommendation. Disclosure should be prompt, before entering a credit agreement, covering:

• How the commission arrangement could affect the price payable by the customer
• The existence and nature of any commission payable to the broker

On 25th October 2024, the Court of Appeal handed down judgment in the cases of:

• Johnson v FirstRand Bank Limited;
• Wrench v FirstRand Bank Limited; and
• Hopcroft v Close Brothers.

All three cases shared a similar scenario, the customer (claimant) purchased a vehicle at a dealership by obtaining finance. The credit agreement entered into, resulted in the dealership receiving a commission from the lender, where the dealer had a level of discretion to set the interest rate. The higher the rate, the more commission the dealer earned.

Other points of particular concern were:

• In the case of Hopcroft, there was no mention of commission in the paperwork
• In Wrench, the terms and conditions stated commission may be paid in a subheading under the heading ‘General.’
• In Johnson, the terms and conditions disclosed the possibility of a commission.

The court did not use FCA’s rules in deciding the cases, as far as the judge’s opinion shows. The FCA, through the Financial Services Ombudsmun, will provide a statement in due course on the large number of complaints it received on the matter, in which its own rules should be applied.

There are three points of interest from the judgement:

1. Does a general statement in the terms and conditions that a commission may or will be paid negate secrecy if the borrower has neither read nor been directed to the statement?
2. Is the lender liable for the repayment of the commission?
3. As in Johnson, was the relationship between Johnson and FirstRand Bank Limited unfair under section 140 A-C of the Consumer Credit Act 1974 (CCA)?

For the first point, the judge deemed such a clause is insufficient for effective disclosure, as it does not actively inform the borrower an awareness of the commission arrangement. Effective disclosure, the court explained, requires banks to direct customers to commission details so they are aware and understand its potential impact on recommendations.

If the lender fails to ensure adequate disclose and the arrangement disadvantages the customer, the lender may be liable to repay the commission. 

The undisclosed commission payable is viewed as “unfair relationship” under the provisions of the CCA. In the case of Johnson, the relationship was deemed unfair, as a lack of adequate commission disclosure created an imbalance. 

The overall conclusion from this judgment, in addition to the changes made by the FCA, is there is a shift towards greater transparency in consumer credit arrangements in regards to sufficient disclosure, shared liability for brokers and lenders and informed consent.   

 

To assist the Board in effective risk management, internal audit can provide value by its nature of being independent, use of its professional scepticism and experience of reviewing regulations, by reviewing the judgement, in addition to the FCA rules, to assess potential impact of:

• Other credit services offered by its bank that could be captured for inadequate commission disclosure and unfair relationships created by its practices. Where these exist, establish root causes and agree with the business on remediation and better controls
• Adequate governance and framework created by the business’s first and second lines of defence in assessing and resolving complaints received from customers on such matters.