Article published in Fleet Leasing

Earlier this year the Bank of England initiated a review of the provision of motor finance to UK consumers, instructing the Prudential Regulatory Authority (PRA) to check how resilient lenders’ balance sheets would be in the event of a market downturn and instructing the Financial Conduct Authority (FCA) to look at whether industry practices were harming to consumers.

Very little additional information has entered the public domain since then. The FCA’s ‘Business Plan’ said only that they are “concerned that there may be a lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance industry“, and that it “will conduct an exploratory piece of work to identify who uses these products and assess the sales processes, whether the products cause harm and the due diligence that firms undertake before providing motor finance“.

Some of the newspaper headlines at the time caused a chill wind blow through the boardrooms of fleet leasing and motor finance companies and through the corridors of the BVRLA and FLA. These articles questioned whether the motor finance market was “heading for a crash” or rife with “loan mis-selling”; suggested that that car salespeople “earn thousands of pounds” every time a customer signs an agreement and even wondered whether “mis-sold car finance could be the next PPI scandal”.

On first reading these articles related solely to PCP sold through motor dealers. However, as the initial announcements referred to the sale of motor finance products to consumers, we may assume that this exercise will include the sale of PCH and PCP by fleet leasing companies. FN50 companies are big players in consumer finance, having written 156,000 new PCP and PCH deals last year.

Frankly, some of those press articles were appalling: poorly researched and lacking balance.

The fact is that most of the industry’s customers are very happy with their PCP or PCH agreements. The industry has invested heavily since the FCA arrived: rewriting procedures, recruiting and training staff and reprogramming systems to ensure that customers not only get the products they need and want, but make fully-informed decisions and are treated fairly.

The PRA is responsible for promoting the safety and soundness of financial services companies whilst the FCA is responsible for ensuring that customers are protected.

The PRA’s review will look at what would happen should interest rates rise and GDP fall. Would defaults increase, what would happen to residual values and what effect would this have on lenders?

The FCA will look at whether there is adequate transparency in the market (whether products and firms’ roles are understood by the consumer), whether lending is responsible (i.e. if consumers can afford the financial product and it is suitable for them) and whether there are conflicts of interests (arising, for example, from salespeople earning commission).

The review of the sector was triggered by the Bank of England’s concern that household indebtedness is high and rising relative to incomes, which might potentially cause problems for lenders with lax lending standards.

Household debt was at an all-time high of around 150% of household income just before the financial crash, then fell to around 130%, and it has now risen to around 133%. Of this, three quarters relates to mortgage borrowing.

Dealership car finance has grown by roughly 4.5% pa over the last few years, which suggests that it is rising rapidly. However, there is an issue with these statistics.

Historically, when people wanted to fund their next car purchase they may well have gone into their bank and taken out a car loan. This option is less popular now (in no small measure because of the guaranteed minimum future values and very low interest rates offered by manufacturer captive finance companies). So whilst the stats show that dealer finance is rising this does not accurately reflect the totality of motor finance. It is conceivable that total motor finance has remained static whilst the mix of deals within the total has changed, with more dealer finance and less bank finance.

Similarly, these statistics exclude PCH. A consumer who in the past only bought used cars might well have taken out their first PCH agreement in the last few years, attracted by the low monthly costs compared with repaying capital and interest on a bank loan. It is possible to argue that this change in behaviour is very much to the consumer’s benefit but in the stats it simply looks like one more new car has been sold via a consumer funding agreement.

It is reasonable to assume that the FCA, having dealt with major concerns about payday lenders, are now focussing on the motor finance market primarily because of the size of the market rather than because it is concerned of any specific bad practices it wishes to squeeze out.

The BVRLA and FLA are both actively working to help the regulators understand how the market works and putting forward the industry’s case.

If your company is not active within BVRLA or FLA committees, and you have insights or ideas about how the market might be improved that might be worthwhile presenting to the regulators, now might be an excellent time to discuss these with the trade bodies. It will be far better to present ideas to the regulators now rather than simply waiting for them to bring forward new draft regulations.

These are some of the point that are no doubt being made by the trade bodies to the regulators:

1. If the FCA is concerned about competition, it should be aware that, as far as industry practitioners are concerned, competition has never been fiercer.
2. If they are concerned about price transparency, perhaps more could be done to better educate consumers about the products they are buying. Lenders already do a lot to help consumers make informed choices. Perhaps the next big step would be to move forward with interactive video. This is a nascent technology in which the viewer watches a video clip and must then click to answer a question correctly to confirm their understanding of the issue, before moving to the next step of the video. An audit trail is retained as evidence of compliance.
3. The systems used by UK lenders to determine creditworthiness and affordability are the envy of lenders in other countries.
4. Levels of arrears and repossessions are historically low.
5. Customers have been attracted to low interest or free insurance/low deposit deals, but this is a good sign of a healthy market rather than a sign that something is working against the customer’s interests
6. PCP offers customers the right of withdrawal, protection against merchantable quality issues and options at the end of the contract that deliver huge, often unsung benefits for the customer. PCH offers RV protection and a very simple product proposition (effectively, a simple form of long term rental).
7. The ombudsman, BVRLA, FLA and FCA get few complaints from the industry’s customers.
8. Other than in scare-mongering newspaper headlines, is there any evidence of a growth in irresponsible lending? However, if the regulators’ reports fail to give the industry a clean bill of health this could encourage ambulance-chasing operators to turn their attention from PPI claims (which are now coming to an end) to our industry. “Have you entered a PCP or PCH agreement in the last six years? You might be entitled to claim! Apply now!” A nightmare scenario. If encouraged to believe they had the right to make some sort of claim, many customers would stop making their monthly payments – which could indeed cause problems to lenders’ balance sheets.
9. The industry is proud of what it does. PCP and PCH are great products for the consumer: good for competition, the economy, the environment, manufacturing and the customer.
10. The growth in motor finance has come about because people have felt more confident about acquiring a new car in recent years because the macroeconomic environment has been benign: low interest rates, high levels of employment, low risk of redundancy/unemployment, a strong economy, high residual values. It is therefore unsurprising that people have felt more confident about entering into these deals.

If you have any thoughts on these points or have insights, ideas or data that could help the BVRLA or FLA in their discussions with the regulators, now might be a good time to provide these to them.

Professor Colin Tourick

Article published in Fleet World

Last month’s article was entitled The Finance Bill –  a seismic shift for fleet managers and included an explanation of the new Optional Remuneration (OpRA) rules.

That article generated more reader response than we have had in nearly a decade of writing these articles, the general tenor of which can be summed up as “the Government is planning to do wha-aaaaat? Really?”

Given the importance of the Finance Bill we need to return to this topic this month. The changes will affect many fleet managers, quite possibly the majority.

We will look at the proposals again but from a slightly different angle; trying to work out why the government have introduced these changes and thinking about what you as a fleet manager need to be doing now to ensure that your company and your employees don’t end up being disadvantaged.

First let’s reprise what’s actually being proposed.

The draft legislation describes two types of OpRA; Type A and Type B.

Under a Type A arrangement the employee foregoes earnings in return for the benefit. This is the familiar scenario of a typical salary sacrifice arrangement. If an employee sacrificed salary and was given a company car emitting more than 75g CO2/km before 6 April 2017, they will continue to be taxed under the old rules (the normal company car BIK rules) until the earlier of 6 April 2021 or the date they modify or renew the deal. The new rules do not affect cars that emit less than 75g CO2/km – these arrangements continue as before.

Under a Type B arrangement, the employee receives a benefit (such as a company car) rather than some earnings. This is the one that is making people stop and think. You might think that if someone received a company car, the fact that they had been entitled to a cash allowance would become irrelevant and that they should be taxed under the benefit in kind rules for company cars. That’s what happened in the past and it made perfect sense.

However, that’s not what the draft legislation says. It says that if an employee who is entitled to either a cash allowance or a company car opts for the company car, they will be taxed on whichever generates the most tax.

In a few moments we will try (and largely fail) to explain the government’s logic but first we need to mention that the legislation contains safeguards against clever people trying to game the system.

If any OpRA is changed or renewed after 5 April 2017 the new rules will apply from the date of the renewal or change, except where this has been made necessary by a reason outside of the control of the employer or employee. For example, where the car has been written off and has to be replaced. In such circumstances the change will not be regarded as an event that triggers a move to the new rules.

So, to summarise, we now have two different arrangements:

If you want to try to work out why the government has taken this approach to Type B arrangements, it helps to remember that the benefit in kind tax rules were designed to standardise the taxable value when an employee is allowed free private use of their company car. However, in reality they do nothing of the sort. If you and I drive identical company cars and pay income tax at the same marginal rate, but I drive 20,000 personal miles and you drive just 2,000, it stands to reason that I get more personal benefit from the company car than you do. But we still pay the same benefit in kind tax, which is clearly unfair. However, the system isn’t designed to be fair, it’s designed to be simple to administer and to generate a certain amount of money for the government.

Working out the real benefit an individual derives would be an administrative nightmare involving a personal evaluation of the benefit for each employee. However, one might argue that where the employee has the choice between two alternatives they will automatically take the one that is worth the most to them. Therefore, (according to the sort of logic HMRC adopts) if the employee takes the car but the cash allowance is worth more, the employee must value the car at least as much as the value of the cash allowance.

So if I choose a company car that generates a taxable benefit of £200 per month rather than a cash allowance of £300 per month, HMRC will say that I’m placing a value on the car of at least £300 per month and they will tax me on the £300 per month. Ouch.

We can safely assume that these new rules aren’t going to go away, whoever wins the general election. So we have to learn to live with them.

With Type A contracts the situation is clear. If you operate a salary sacrifice scheme you will need to evaluate the net cost of the new rules to the company and to the employees. We have a transition period but this only applies to existing contracts: where there is a new contract the new rules have to be applied. If an employee wants to sacrifice salary for a company car they need to know how much it will cost them. Talk this through with your supplier; they will be able to do the sums for you.

With Type 2 contracts the situation requires more thought. Many company car schemes give the driver the option to take a cash allowance, though in practice most employees chose the company car. But in future the mere existence of the cash allowance option risks creating a tax liability that could be far greater than the benefit in kind tax that the employee would have paid in the past.

Cash allowances have been an important part of flexible benefits schemes for decades. If you offer them, now might be a good time to review whether you should continue, and, if so, the amounts that should be on offer. It could well be that you find that for a whole group of drivers, particularly those who are only allowed to choose from a small range of cars, it might be worthwhile withdrawing the cash option completely.

If you have a group of drivers (say all employees at a certain managerial grade) who are entitled to either a company car (lease rental max say £400 per month) or a cash allowance of say £420 per month, you will find things become complicated. The BIK tax on those cars will vary according to list price and CO2 emissions whereas tax on the cash allowance will be static – and needs to be known by the employee before they order the car, because that’s the amount that will be payable if it’s higher than the BIK.

Most employees are likely to feel mightily aggrieved if they have to pay tax on a cash allowance they have not received, rather than BIK tax on the company car they have received.

Here again a conversation with your leasing company or fleet management supplier will be the order of the day. This stuff is not straightforward.

The aftershocks of the Finance Bill will be felt for some time to come.

Professor Colin Tourick