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Friday 3 March 2017

17-049MR ASIC acts to address unfair outcomes from flex commissions in car finance market

ASIC announced today that it will prohibit 'flex commissions' in the car finance market. The prohibition will still allow lenders to pay other types of commissions to car dealers.

Flex commissions are common in car finance but not generally found in other markets. Flex commissions allow car dealers to arrange car loans at a higher interest rate than the lowest available rate (700 basis points higher – or more), and thereby earn a much higher commission. As a result, some consumers can end up paying thousands of dollars more in interest charges over the life of the car loan.

ASIC is implementing the prohibition because of these poor outcomes for consumers and because flex commissions operate in a way that is unfair under the National Consumer Credit Protection Act 2009 (National Credit Act).

ASIC's Deputy Chair Peter Kell said, 'Most consumers would be surprised to learn that when you are buying a car on finance, the car dealer can, for example, decide whether you will be charged an interest rate of 7% or one of 14% - regardless of your credit history. Flex commissions do not operate in a fair and transparent way, and ASIC's action will ensure that consumers are not charged excessive interest rates.'

Mr Kell said ASIC has conducted two rounds of written consultations with targeted stakeholders, including industry bodies, lenders, car dealers and their associations and consumer groups on various options to respond to the harm caused by flex commissions. Based on this consultation, ASIC has decided on a prohibition as a comprehensive, industry-wide solution that will deliver broad changes for the benefit of consumers.

'There was a broad recognition that flex commissions create poor consumer outcomes. However, lenders who cease paying flex commissions unilaterally risk putting themselves at a competitive disadvantage. It is therefore necessary to implement the change through an industry wide approach that would ensure a level playing field for all lenders,' Mr Kell said.

ASIC proposes to use its statutory power to modify provisions of the National Credit Act to prohibit the use of flex commissions so that the amount paid in commissions is not linked to the interest rate, and therefore that 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 in order to secure a deal. It is therefore proposing to allow a limited capacity for car dealers to discount the interest rate and receive lower commissions, as this will benefit consumers through a lower cost of credit.

ASIC has prepared a draft legislative instrument to implement the prohibition and is conducting a three-week consultation on technical aspects of the instrument (see the Consultation Paper below).

Mr Kell said, 'We are confident this prohibition will benefit consumers by removing incentives that increase the interest rates they are charged. We consider that average interest rates on car loans will fall as a result of more efficient pricing models and lower losses through defaults. We expect lenders will work with car dealers in moving to fairer and more sustainable models'.

ASIC welcomes feedback from stakeholders. Submissions are due by 27 March and can be sent to FlexCommissions@asic.gov.au

Further detail about ASIC's decision to prohibit flex commissions is set out in a Regulation Impact Statement (RIS) that has been approved by the Office of Best Practice Regulation.

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Background

Operation of flex commissions

Lenders in the motor vehicle finance industry have a practice of using ‘flex commission’ arrangements to remunerate their distribution network (primarily car dealers but also finance brokers). Under these arrangements:

  • the lender and the dealer agree that the cost of credit is not fixed and that a range of interest rates will be available to any consumer (from a 'base rate' up to a prescribed maximum rate);
  • the dealer has the discretion to determine or recommend the interest rate for a particular loan within that range and will earn a greater upfront commission from the lender the higher the interest rate; and
  • the discretion to increase the interest rate from a ‘base rate’ specified by the lender is not determined by objective criteria and so can result in opportunistic pricing arrangements (rather than consumers with similar credit risk levels obtain similar price outcomes).

In a flex commission arrangement, the commission payable on a particular contract is determined by the ‘flex amount’. This term describes the amount of the interest charges payable according to the difference between:

  • the base rate or agreed minimum interest rate; and
  • the contract interest rate under the loan provided by the lender.

The lender and the intermediary share the flex amount according to a formula agreed in the commission plan. The percentage of the flex amount that could be retained by the intermediary can vary significantly from plan to plan, and can be up to 80% of the interest charges.

Harm from flex commissions

ASIC has obtained information from lenders to assess the impact that increasing the interest rate above the lender’s base rate can have on the amount of commission received by the dealer.

The table below sets out the difference in commission for five transactions reviewed by ASIC, based on the amount payable under the base rate and the amount earned by the car dealer. It shows that, compared to the sum payable if the contract was written at the base rate, intermediaries could earn commissions that were:

  • between four to seven times higher than commissions received under the base rate; and
  • between $1,246 and $2,827 higher in dollar terms.

Comparison of commissions payable under base rate and contract rate 

Example    Base rate    Contract rate    Commission if paid at base rate    Commission paid under contract rate   

Consumer A

8.24%

10.95%

$303

$1,549

Consumer B

8.24%

12.99%

$316

$2,488

Consumer C

7.99%

10.45%

$354

$1,717

Consumer D

6.24%

13.04%

$346

$3,173

Consumer E

6.24%

8.99%

$209

$897

ASIC has also obtained data from some of the major lenders offering flex commissions to assess the extent to which consumers are charged higher interest rates. The data covered approximately 25,500 contracts written by seven lenders for May 2013 (noting that the results for this month were typical of consumer outcomes). Our research found that about 15% of consumers (or approximately 3,800 people a month) were charged an interest rate of 700 basis points (7%) or more above the base rate.

ASIC’s view is that a consumer who enters into a contract at 700 basis points or more above the base rate is likely to be less financially literate and more likely to be financially vulnerable. If these consumers were price-sensitive and able to negotiate lower rates (as was the case with the remaining 85% of borrowers) there would be a much smaller percentage of contracts written at higher rates.

Last updated: 03/03/2017 02:37