The Financial Conduct Authority (FCA) published an update last week on its investigation into the car finance sector, and has identified the key questions it wants answered. The update, however, fails to clarify whether dealer selling practices will be investigated.
The FCA is working to identify “potential areas of consumer harm” in how car finance is sold, and is zeroing in on the way lenders are selling car finance products to buyers.
Of particular interest is the sale of personal contract purchase (PCP) car finance, and the FCA has had a few things to say about those. It also expresses concerns at how car finance is being used as a means of increasing profits on used car sales.
The FCA says that it is working with FCA-authorised lenders to analyse the market, and that other work will include “careful scrutiny of firms’ sales practices and processes”.
However, the implication from the report is that the word “firms” only refers to car finance companies, rather than the dealers who are actually selling these products to car buyers.
This suggests that the FCA will be placing responsibility for selling practices on the finance companies, which is far less likely to achieve a positive result than directly regulating how car finance products may be sold at a dealership level (as the FCA has already done with GAP insurance, for example).
Key questions the FCA wants answered
The FCA has identified the following key questions that it is now focusing on:
- Are firms taking the right steps to ensure that they lend responsibly, in particular by appropriately assessing whether potential customers can afford the product in question?
- Are there conflicts of interest arising from commission arrangements between lenders and dealers, and if so are these appropriately managed to avoid harm to consumers?
- Is the information provided to potential customers by firms sufficiently clear and transparent, so that they can understand the risks involved and make informed decisions?
- Are firms managing the risk that asset valuations could fall and ensuring that they are adequately pricing risk?
So what does that all mean in plain English?
1. Lending responsibly and assessing affordability
There has been considerable concern that finance companies are lending money to people who are likely to struggle to repay it. This puts both borrower and lender at risk in the event of the borrower defaulting on the loan.
This also one of the areas that the Bank of England is looking at, with concerns that ‘sub-prime’ car finance is growing too fast and risking the rest of the industry.
2. Conflict of interest from commission payments
Most buyers will be unaware of the extent that dealerships and their staff are paid in terms of commission for selling finance. Buyers understand the concept of car salespeople working on commission, but not necessarily the level of financial incentives to sell every customer a PCP or other form of finance product.
This inevitably leads to concerns that dealers are trying to flog PCPs to every customer to hit their own targets, regardless of whether the customer wants one or if their circumstances are appropriate for a PCP.
3. Clear and transparent provision of information
From the earliest stages of a conversation, car salespeople are pushing customers to take PCP car finance. Other finance options are not explained adequately or even at all. The responsibilities and risks associated with a PCP, or any other form of car finance, are not explained adequately. As a result, customers do not understand their rights and obligations when entering into car finance contracts.
Many customers are also unaware that car finance, and PCP finance in particular, is being used to increase the profit margin of a sale. Interest rates and fees are all negotiable, especially on used car finance where there are no manufacturer subsidies or low advertised rates.
4. Adequate assessment of pricing risk
Used car values are gradually falling each year, even without any major disruptive events. This is largely a result of the overwhelming popularity of PCPs and leasing agreements, which have created increased volumes of used car stock.
If you also consider potential events that could affect used car values, like plummeting demand for diesels, or economic troubles that may arise over the next few years, and there is a risk that cars could be worth much less than their guaranteed values when their PCP agreements end.
Let’s say that every car currently on a PCP ends up being worth £1,000 less than predicted at the end of its agreement. That’s several billion pounds that would be lost. Some of that loss would be felt by customers and some by lenders. Customers expecting to have equity in their vehicles would find that they have less (or none at all), while lenders would potentially have millions of cars coming back worth less than their finance settlements.
Protecting customers yet ignoring dealers?
The FCA update talks a lot about how the car finance companies operate, and responsible lending behaviours like assessing customer affordability and setting realistic residual values. But it makes little mention of the biggest weak link in the current system – the car dealers and their salespeople.
It’s relatively easy to regulate a small number of lenders and their on-site staff, but it’s another thing altogether to enforce standards on hundreds of thousands of car sales executives and finance managers, operating up and down the country.
The biggest issue when it comes to customers being misled on car finance is the way that salespeople are actually selling the products. Yet there is virtually nothing in the FCA update that addresses this point.
Car dealers are generally not owned by the car manufacturers or the car finance companies, and it’s unclear whether the FCA intends to actively get into customers’ shoes and assess how the average car salesperson is explaining how a PCP works.
The FCA plans to report back in the first three months of 2018. But unless the face-to-face sales behaviour at dealer level is addressed, there will be no real consumer benefit from all this investigating.