ASIC announced in March that it will prohibit flex-commission in the car finance market but will still allow lenders to pay other types of compensation to car Dealers.
ASIC considers flex-commissions “are arrangements in which a party other than a lender (typically either a car Dealer or a finance broker) can effectively set the interest rate payable by the consumer, and earn a higher commission the higher the interest rate above a Base Rate agreed to with the lender (providing that the transactions otherwise are within parameters set by the lender). This means the intermediary can earn a larger commission if, for example, the interest rate is 10% rather than 8%”.
ASIC has decided on a prohibition as a comprehensive, industry-wide solution that will deliver broad changes for the benefit of consumers. It will apply to car Dealers and finance brokers.
ASIC will, however, allow Dealer financial benefits for arranging finance, including upfront commissions for individual loans, volume bonuses, soft dollar benefits and origination fees. A Dealer can offer a lower interest rate up to a maximum of 200 basis points below the nominated minimum interest rate.
A summary of ASIC’s proposals includes:
- flex-commissions will be banned but other financial benefits will be allowable, e.g. reverse flex
- the lender will set the rate which the Dealer can discount by a maximum of 200 basis points
- origination fees are set by the lender subject to certain conditions
- there will be transition period, with the prohibition commencing on 1 September 2018
- a legislative instrument will be introduced into the Parliament and subject to review, and;
- the prohibition does not apply to novated leasing and salary packaging companies, as ASIC does not have statutory powers to regulate them.
ASIC proposes to use its statutory powers to modify provisions of the National Consumer Credit Protection Act 2009 (National Credit Act) so that the amount paid in commissions is not linked to the interest rate and the lender has responsibility for determining the interest rate that applies to a particular loan. ASIC acknowledges that it is desirable to allow car Dealers some flexibility to reduce interest rates to secure a loan.
ASIC has prepared a draft legislative instrument with a transition period of around 18 months to implement the prohibition. The draft legislative instrument modifies the National Credit Act using ASIC’s statutory power in s109(3)(d) of the Act.
Legislative Instrument (LI) – ASIC Credit (Remuneration Arrangements) Instrument 2017
As currently drafted the LI would apply to all credit contracts and consumer leases regulated by the National Credit Act. Car Dealers would be able to reduce the interest rate by up to 200 basis points and receive a lower commission.
Dealer fees charged to a customer for providing services in relation to arranging finance is to be controlled by lenders to ensure the amount of fees charged cannot be varied up or down.
ASIC recognises the need to allow a reasonable period of time for lenders to develop different pricing models, with the interest rate linked to the risk of the individual transaction. The draft LI sets a commencement date for the prohibition of interest rates.
Remuneration arrangements in the car finance industry
ASIC considers that Dealers have two main sources of finance-related income from a sale:
- financial benefits, including upfront commissions for individual loans, volume bonuses according to the level of business arranged and soft dollar benefits.
- a Dealer origination fee (Dealer fee) for assisting in the provision of finance.
Dealer origination fees
Lenders must set a maximum price for origination fees (which are likely to be based on reasonable reimbursement of the costs associated with arranging a loan and intermediaries are prohibited from influencing or proposing the amount of the fee where any benefit to that person increases or decreases by reference to an increase or decrease in the amount of the fee).
Point-of-sale (POS) exemption in Reg 23 of National Credit Regulations
ASIC does not consider the need to remove the POS exemption that applies to Dealers.
ASIC understands that the majority of car Dealers engage in credit activities by relying on the POS exemption rather than as credit licensees or as credit representatives. This does not make the Dealer an agent of the lender.
Under the National Credit Act lenders are under an obligation to ensure that car Dealers exercise their discretion to determine or propose interest rates in a way that is efficient, honest and fair.
Section 180A of the National Credit Act provides for remedies against brokers and other intermediaries for engaging in conduct that is unfair or dishonest where that conduct has the result of a consumer entering into a contract they would not otherwise have entered into, or the terms of which are different from a contract the consumer would otherwise have entered into.
This remedy also extends to Dealers operating under the POS exemption.
ASIC noted the views of some stakeholders that the continuation of the POS exemption means that the market is not competitively neutral. They argued that it means there is greater regulatory burden on licensees and credit representatives when arranging finance, compared to car Dealers.
ASIC considers there would be merit in considering this issue further if the financial disadvantage from flex-commissions was the result of car Dealers who operated in reliance on the exemption.
However the practice is not limited in this way and is engaged in by intermediaries who hold credit licences or have been appointed as credit representatives by a licensee.
Novated leases are not regulated by the National Credit Act, and ASIC does not have the powers to regulate them in the same way in respect of flex-commissions. Dealers affiliated with novated lease providers would, therefore, be entitled to receive flex-commissions. ASIC indicated it could monitor conduct in this market to see if further reforms are needed in the future.
Dealer can offer a lower interest rate than the nominated interest rate
A Dealer can offer a lower interest rate than the nominated interest rate in the following circumstances:
If the negotiated contract interest rate is lower by 200 basis points or less than the interest rate nominated by the lender, the amount of the commission can vary (so that the car Dealer compensates the lender for lower interest charges through a lower commission).
If the negotiated contract interest rate is lower by more than 200 basis points than the interest rate initially nominated by the lender, then the amount of commission cannot vary. This would mean the lender needs to decide whether or not to provide a discount given that they would bear the entire amount of the reduction in revenue (whereas currently, under flex-commission arrangements, the cost of this reduction is shared between the lender and the car Dealer).
ASIC’s analysis considers that lenders are likely to design ratings for risk pricing within parameters that mean they receive a similar level of income in interest. There would be a smaller percentage of contracts written at very high interest rates. ASIC expects that the main impact on intermediaries would be costs arising from the need to renegotiate existing agreements (as with lenders).