The Financial Conduct Authority’s decision to implement a commission cap on motor finance has brought a collective sigh of relief across the industry. After months of regulatory uncertainty that had lenders bracing for potentially devastating financial impacts, the cap represents a more measured approach than many had feared.
The new rules, which limit commission to just 2.5% of the total amount borrowed, mark a significant shift in how dealerships and brokers can profit from arranging car loans. This change aims to deliver fairer outcomes for consumers while maintaining a functioning market – a balance that wasn’t guaranteed in early regulatory discussions.
“This is broadly positive news for lenders who had been preparing for much more severe restrictions,” says Martin Lewis, automotive finance analyst at Berenberg Bank. “The 2.5% cap still allows for reasonable compensation while addressing the FCA’s concerns about consumer harm.”
The FCA’s investigation into the car finance market revealed troubling patterns where some brokers were charging commissions as high as 7.5% – driving up costs for consumers who remained largely unaware of these hidden fees. The authority estimates consumers have overpaid by approximately £1.1 billion annually due to these practices.
The regulatory intervention follows years of criticism about discretionary commission arrangements that created perverse incentives for dealers. Under previous systems, brokers could often set interest rates themselves, with higher rates directly increasing their commission – a clear conflict of interest that frequently worked against consumer interests.
Mark Hamilton, director of automotive services at KPMG, told me during a recent industry conference: “The critical aspect here is transparency. Consumers historically had no idea how much commission was being earned on their financing, which fundamentally undermined fair market competition.”
For major lenders like Close Brothers Motor Finance, Lloyds Banking Group’s Black Horse, and Santander UK, the commission cap brings clarity after a period of significant market uncertainty. Their share prices had been under pressure as investors feared more draconian measures might be implemented.
Data from the Finance & Leasing Association shows the car finance market is substantial, with nearly £41 billion in new financing provided for new and used cars in 2023. This underscores why getting the regulatory balance right is crucial for both economic stability and consumer protection.
The FCA’s approach reflects a growing recognition that while consumer protection remains paramount, overly restrictive regulations can have unintended consequences. The 2.5% cap appears carefully calibrated to address exploitative practices while ensuring the car finance ecosystem remains viable.
“We’ve seen this play out in other financial markets,” explains Rebecca Carter, financial services policy expert at Ernst & Young. “When Australia implemented a flat fee model for mortgage brokers, it severely disrupted market dynamics. The FCA seems to have learned from international experiences in designing these new rules.”
For consumers, the changes should lead to more competitive and transparent financing options. The FCA estimates the average car buyer could save between £165 and £1,100 on a typical £25,000 car finance agreement under the new rules.
However, industry insiders caution that dealerships may seek to recoup lost commission revenue through other means. “We might see higher advertised car prices or additional charges for services that were previously included,” notes James Wilson, retail automotive specialist at Deloitte. “The market will inevitably adjust to maintain profitability.”
The commission cap comes amid other significant changes in the automotive finance landscape. Rising interest rates have already cooled demand for new vehicles, while electric vehicle adoption is creating new financing challenges as consumers navigate unfamiliar depreciation patterns and residual values.
The FCA has given lenders until October 2024 to implement these changes, providing a reasonable transition period. During this time, dealerships and brokers will need to revise their business models and retrain staff on the new regulatory requirements.
For publicly traded auto finance companies like S&U plc and Moneyway, the regulatory certainty – even with restrictions – provides a clearer pathway for business planning and investor communications. Their initial market reactions suggest the 2.5% cap is viewed as manageable within existing business models.
The changes also align with broader trends toward greater financial transparency across consumer lending markets. Similar regulatory interventions have occurred in mortgage broking, insurance distribution, and investment advisory services in recent years.
What remains to be seen is how digital disruptors in the auto finance space will respond. Companies like Carwow and Cinch, which have built models around transparency and online experience, may find themselves with a competitive advantage as traditional dealerships adjust to the new commission structures.
For the average car buyer, the most significant impact may be psychological rather than financial. Knowing that dealers can no longer manipulate interest rates for personal gain should increase confidence in the car buying process, potentially stimulating demand in a market that has struggled with consumer trust issues.
As the industry adapts to these new rules, one thing is clear: the era of hidden commissions and obscured incentives in car finance is coming to an end. While the transition may prove challenging for some market participants, the resulting transparency should ultimately strengthen the market’s foundations.
