The Financial Conduct Authority (FCA) undertook a study in 2017-2018 which focused on three key aspects: commissions, information disclosure, and affordability. The review eventually led to a ban on discretionary commission models in the motor finance industry, which took effect on Jan. 28, 2021. The ban had potential implications for U.K. auto asset-backed securities (ABS) transactions. Discretionary commission arrangements (DCAs) linked the broker's commission to the customer's interest rate. They allowed dealers wide discretion to set or adjust that interest rate and, according to the FCA, "typically, the higher the interest rate, the more commission the broker received."
This resulted in a potential conflict of interest and created strong incentives to set higher interest rates to earn larger commissions. The FCA raised "serious concerns" that under the discretionary fee model, customers would pay significantly higher interest rates than they would under a flat fee model. The flat fee structure is similar to the pricing model implemented in the mortgage industry, where brokers are paid a fixed fee for each credit agreement processed or arranged. The FCA initially estimated that under such commission models certain car dealers were overcharging motorists by over £1,000 in interest over the lifetime of the loan in order to increase commission payments.
In January 2024 the FCA confirmed that most customer complaints regarding overcharging before the ban have been rejected by providers (lenders and brokers) because they had not acted unfairly or prevented customers from obtaining better rates. The FCA is now reviewing motor finance loans provided between 2007 and 2021, has extended its timeline for a final response to Sept. 25, 2024, and has not yet announced its full assessment of compensation costs.
We have reviewed the U.K. auto ABS transactions that we rate and believe that the outcome of this probe will not have a material impact on collateral or ratings. Of the 14 U.K. auto ABS transactions we currently rate, eleven deals contain pre-2021 originations and so could potentially be affected by the probe. However, in three of these deals the originator has confirmed that DCAs have never been used. Another six of these transactions have exposures to pre-2021 originations of 10% or less by outstanding balance. The remaining two deals with exposures of above 10% have pool factors of below 30% and have benefited from significant credit enhancement build-up. Furthermore, some originators also stopped implementing DCAs before the 2021 ban.
In summary, most outstanding deals have a low proportion of loans originated before January 2021, while not all of the pre-2021 loans will have been originated via DCAs. Also, the outstanding deals with higher exposures to pre-January 2021 originations generally have a low pool factor and have built up significant credit enhancement.
Finally, the motor finance company would be liable for any claims. For an auto ABS transaction to be affected by potential setoff claims, the originator would first likely have to be insolvent. Therefore, the risk would typically only materialize following the seller's insolvency, given that until then the seller is usually obliged to compensate the issuer for any such losses, typically via a seller repurchase mechanism or indemnity. We also do not believe the FCA probe will significantly affect delinquency and default rates, given existing deals' low exposures and that borrowers do not have a strong incentive to stop making payments on their auto loans while the claims process is ongoing.
We have contacted the issuers of the deals that contain a material exposure to loans that could be subject to the FCA review. Along with the confirmation that exposures are generally low or credit enhancement is high combined with low pool factors, the issuers generally indicated that they do not expect a material and adverse effect on the collectability of any affected loans and that even in cases where a complaint had been made, borrowers had typically continued to make their auto loan payments. However, the investigation is confidential and at an early stage, so it is likely that issuers will disclose additional information in the following months. The FCA has also confirmed it plans to provide an outline of any follow-up action in Q3 2024.
We will continue to monitor delinquencies and gross losses in securitized pools, while also considering any developments related to the FCA probe.
Related Criteria
- Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
- Methodology And Assumptions For European Auto ABS, Oct. 15, 2015
Related Research
- European Structured Finance Outlook 2024: Pushing On Through, Jan. 9, 2024
- Global Structured Finance 2024 Outlook, Jan. 10, 2024
- European Auto ABS Index Report Q3 2023, Nov. 9, 2023
- Global Auto Sales Forecasts: The Pricing Party Is Coming To An End, Oct. 9, 2023
- A Primer On European Auto ABS, Nov. 21, 2023
- How We Rate And Monitor EMEA Structured Finance Transactions, March 24, 2016
- Scenario Analysis: How Much Shock Can European Auto ABS Take?, July 31, 2023
This report does not constitute a rating action.
| Primary Credit Analyst: | Doug Paterson, London + 44 20 7176 5521; doug.paterson@spglobal.com |
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