The Long Read: Difference in Charges09/01/2019
Julian Rose, Director of the consultancy firm Asset Finance Policy, writes:
Most readers of this Long Read column will be FCA authorised. I suspect many will see the regulation as extra bureaucracy, possibly just about worth it by helping to keep the cowboys out of the industry and giving a slight ‘badge of honour’, but otherwise not having any fundamental impact on their businesses or customers.
Some firms are spending an inordinate amount of time on compliance, to the point where it is harming the wellbeing of the proprietors, but in my view that should be unnecessary provided the basics are kept up to date (e.g. accurate standing information and basic record keeping). The broking business is all about helping customers to understand their finance options and find a good deal that meets their needs. What’s not for the regulator to like?
Unfortunately, for the first time, a possible change to the FCA regulations risks causing real harm to the broking business model. As is so often the case, if it happens it would be a knock-on impact of well-intentioned changes the FCA are making in the consumer finance sector.
This is about the Difference-in-Charges ("DiC") broker commission model. As is its way, the FCA has been sending out ‘signals’ that it has concerns about some commission arrangements for a while. But in March, DiC was singled out for attention in an update on the regulator’s ongoing motor finance review. The update noted that “without appropriate systems and controls, [DiC] structures could provide incentives for dealers to arrange finance at higher interest rates”.
In September, in a report entitled ‘Impact of credit broking remuneration models at the point of sale’, the regulator described the DiC model rather more bluntly, stating just that “the more interest the customer is charged, the more commission the broker will earn”.
In another part of the financial services market, pensions advice, it’s now likely that advisers are going to be stopped from charging contingent fees (where the customer only pays a fee if they go ahead with the adviser’s recommendations). That’s because contingent fees are seen as causing possible conflicts of interest. If that goes ahead, the FCA will have form in intervening in the details of how fees and commissions are earned.
DiC might have the appearance of incentivising brokers to charge customers more, but for business finance that’s rarely the reality of the situation, for a range of reasons. For one, many lenders cap rates or at least discuss any outlying proposals with brokers to ensure they are fair. Higher rates are needed to cover the time involved in more complicated cases, where the value the broker adds is probably at its highest. In the competitive motor and commercial finance markets brokers are ‘price-takers’ rather than ‘price-makers’, so consistently trying to charge above a market rate just wouldn’t work. FCA-authorised asset finance brokers are already required to be ethical, professional and trustworthy (and brokers were already all of these before the FCA came along). If anyone doubted any of the above, look to the profits that brokers make relative to the work they put into their businesses - this is hardly a ‘get rich quick’ sector.
If DiC was to be outlawed for business finance, what would this achieve? As above, I don’t believe there are existing problems - other than exceptional cases, that could and should be addressed separately - that it would stop. Could it actually cause harm? Unfortunately there’s a real risk that it could.
The alternative to DiC is that lenders would have to set the rate to charge each customer. To avoid being too slow and bureaucratic, there would need to be standard prices set at a high-level, that just couldn’t allow for every deal being different. This could make it less profitable or just unviable for brokers to work with some small businesses (probably the ones that most need broker support) whilst leading to higher charges for some of the most straightforward deals.
Possibly some funders might also take the opportunity to differentiate between brokers, reserving their best charging rates (and commissions) for the largest firms even more than today. On the other hand, some funders might propose new commission arrangements that might work well for all parties. Perhaps there’s some form of performance-based remuneration that fairly reflects the customer outcomes together with the roles, responsibilities and risks borne by the funder and broker?
Publication of the FCA’s motor finance review is expected by the end of the year. It seems likely to include proposals for addressing the perceived conflict of interest that DiC creates for car dealers that are likely to apply to all credit brokers. Let’s hope the FCA treads carefully in making any new rules that could unintentionally harm brokered B2B asset finance.