A proposed ban by the Australian Securities and Investments Commission (ASIC) on flex commissions is likely to result in a significant shake up to credit distribution arrangements, particularly those in the motor vehicle industry.
Given the scope of the proposed ban on flex commissions (discussed in detail below), there seem to be three possible remuneration models that will now be explored within the industry.
- Credit providers may continue with existing commission structures but in that case will eliminate any capacity of the distributor of credit (eg a car dealer) to influence pricing of the credit.
- Credit providers may retain existing functions of the distributor but change commissions to a flat structure (eg where the amount of commission is a percentage of the principal amount) or a “fee for service” structure (where the distributor is paid a fee for arranging the credit, which is disconnected from the amount of the credit or the amounts payable under the contract).
- Credit providers may retain existing functions of the distributor but elect to specify a base rate and provide a restricted flexibility for distributors to recommend a rate for a particular consumer within a range of 200 basis points beneath that specified rate.
ASIC’s proposal and consultation
On 3 March 2017, ASIC announced that it would ban the payment of “flex commissions” by consumer credit providers or lessors (each a licensee) to distributors that engage in credit activities in respect of consumer finance provided by the licensee. Under a typical flex commission arrangement, a person who introduces a consumer to a licensee (eg a car dealer) may be rewarded by receiving a share of the interest payable by the consumer above a base rate specified by the credit provider. In this way, the introducer is given an incentive to achieve a higher rate of interest for the credit contract when assisting the consumer to apply for the credit.
ASIC proposes to make ASIC Credit (Remuneration Arrangements) Instrument effective in April 2017, with the ban commencing on 1 September 2018 (therefore allowing for a maximum 17 month transition period). ASIC has indicated that it will monitor the interest rates set by licensees, with the view of considering whether further action needs to be taken against licensees charging higher interest rates.
Further details of the proposal and ASIC’s consultation is set out in Consultation Paper 279: Flex commission arrangements in the car finance industry. And the three week consultation period ends on 27 March 2017.
The ban on flex commissions is consistent with the continued focus on remuneration arrangements in the financial services industry (ie the Future of Financial Advice reforms and Life Insurance Framework reforms) and the credit industry (the final report of the Retail Remuneration Review, which examines product sales commissions and product based payments, will be published by 31 March 2017).
Why is ASIC proposing the ban on flex commissions?
ASIC’s investigation into flex commission arrangements found that those arrangements can result in consumers paying significantly more in dollar terms under a credit contract or lease. It also found that the remuneration structure incentivises a distributor (or its associated persons) to do so.
Relevantly, ASIC discovered that distributors could earn commissions that were between:
- four to seven times higher than commissions received under the base rate offered by licensees; and
- $1,246 and $2,827 per contract higher in dollar terms.
ASIC also discovered that, of the 25,500 contracts written by seven lenders for May 2013, about 15% of consumers (or approximately 3,800 consumers per month) were charged an interest rate of 700 basis points or more above the licensee’s base rate.
Although ASIC’s investigation focussed on the car industry, the proposed ban on benefits paid under flex commission arrangements will apply to all credit contracts and consumer leases regulated under the National Consumer Credit Protection Act 2009 (Cth) on the basis that the same policy considerations would apply across the board.
To which distributors will the ban apply?
The ban on payments made by a licensee will apply to payments to any party that performs a relevant distribution function. The distributor does not have to be a licensee or credit representative. It may be a party that relies on an exemption from the licensing regime.
Many car dealers rely on the “point of sale” licensing exemption in regulation 23 of the National Consumer Credit Protection Regulations 2010 (Cth).
What is “flex commission” for the purposes of the ban?
For the purposes of the proposed ban, a “flex commission arrangement” includes an arrangement between a licensee and distributor:
- for the distributor (or an associated person) to engage in credit activities in respect of a credit contract or consumer lease (credit activities include acting as an intermediary between a consumer and a licensee, or suggesting that the consumer apply for credit from the licensee); and
- under which the distributor (or an associated person) can determine, propose or influence:
- in the case of a credit contract, the annual percentage rate under the contract or the amount of any fees or charges payable in relation to the contract; or
- in the case of a consumer lease, the amount of the rental payable under the lease or the amount of any consumer lease fees or charges not included in the rental payment under the lease.
Benefits that will be banned
The ban applies to benefits (whether monetary or non-monetary) provided to a distributor (or any associated person) under a flex commission arrangement where:
- the amount of the benefit is determined (in whole or in part) by reference to the annual percentage rate, or the amount of any fees or charges, under the contract; and
- the annual percentage rate, or the amount of the fees and charges, have been determined, proposed or influenced by the distributor (or an associated person).
In other words, the benefit will only be banned if the value of the benefit is calculated by reference to interest, fees or charges where the distributor (or an associated person) has a role in the pricing of interest, fees or charges.
The ban will not be triggered if the distributor (or an associated person):
- can propose or influence the type or identify of the goods to be purchased or rented;
- merely provides the licensee with information about the consumer’s requirements, objectives or financial situation.
The ban does not apply to the following benefits:
- In the case of credit contracts, a benefit that is calculated by reference to an annual percentage rate that falls within an allowable range (proposed to be between: (a) 200 points less than the rate specified by the licensee before any determination, proposal or influence is made by the service provider (specified rate); and (b) that specified rate).
- In the case of consumer leases, a benefit that is calculated by reference to a rental charge that falls within an allowable range (proposed to be between: (a) 4% less than the rental charge specified by the licensee before any determination, proposal or influence is made by the distributor (specified rental charge); and (b) that specified rental charge).
- Benefits that are not determined by reference to the amount of any fees or charges that have been determined, proposed or influenced by the distributor (or an associated person).
- A benefit given by the licensee to its directors or employees.
Limited grandfathering will apply to credit activities engaged in, or a credit contract or a consumer lease that was entered into, before 1 September 2018.
Consequences of breach
The failure to comply with the ban on flex commission arrangements attracts a maximum penalty of $1.8 million (for a body corporate) or $360,000 (for an individual). A person who engages in conduct in breach of the ban may also attract a penalty of $90,000 (for a body corporate) or (in the case of an individual) $18,000 or 2 years imprisonment, or both.
What do you need to do?
Licensees that pay flex commissions will need to review their pricing models and, if the existing remuneration arrangements are banned, will need to negotiate new remuneration models with their distributors before 1 September 2018.
Contact Tony Coburn (firstname.lastname@example.org, +61 2 9322 4976) or Hong-Viet Nguyen (email@example.com, +61 2 9322 4092) if you have any questions or if you would like to discuss what the changes might mean for you.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2019