Commission and staff incentives – Retailers in the FCA Spotlight

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Up until now, most of the FCA’s regulatory action relating to consumer credit has been focused on those firms whose main business relates to the provision of credit. We have seen implementation of the price cap in high-cost short-term credit, new rules introduced for credit brokers and new guidance for guarantor lenders.

However, recent publications from the FCA have focused more on retailers of good and services which offer their customers credit as an ancillary service. These include motor dealers, renewable energy firms, replacement window companies and home improvement providers, many of which are lending or broking credit on a daily basis, sometimes in customers’ homes.

In 2015, the FCA launched a thematic review looking at how consumer credit firms paid or otherwise incentivised their staff and agents to sell credit and whether firms were effectively managing the risks associated with incentives. The review has rumbled on for nearly two years, with the FCA gathering information from a sample of 98 firms and finally publishing its findings and setting out its proposals in consultation paper CP17-20, published in July.

One of the FCA’s key findings was that of the firms it sampled, 64% of those whose primary business was not financial services (including firms selling goods and/or services on finance) currently operated pay, bonus and other incentive schemes for their sales staff which the FCA considered to pose a high or very high risk of customer detriment.

The FCA is aiming to introduce new rules and guidance in Q1 of 2018 to impose more specific obligations on consumer credit firms in relation to how their performance-based pay and bonus schemes operate. The following summarises the FCA’s key findings and what firms need to do to redress the FCA’s concerns.

What the FCA found and how it has responded

The FCA found that many of the retail firms in the sample had high-risk pay structures and/or performance management practices likely to encourage high-pressure sales. The FCA noted that firms’ understanding of these risks was often limited and accordingly that their associated monitoring and risk management practices were not up to scratch.

The FCA looked at how both front-line staff and management were paid. Some of the key risk areas identified include:

  • arrangements where staff had a high degree of performance-based pay, predominantly driven by sales volumes;
  • schemes which paid staff commission per finance sale (which could encourage staff to sell finance inappropriately);
  • arrangements where commission or a bonus is linked to the terms of the credit offered to each customer or otherwise has some form of product bias (so staff could earn more commission by selling a longer term and/or more expensive finance option);
  • schemes which are tied to cumulative targets, such as monthly rolling targets, where a difference of one or two sales towards the end of each period could make a significant difference to a staff member’s take home pay;
  • bonuses for managers which were linked to team performance measured against sales volumes;
  • competitions and promotions to increase sales volumes; and
  • pay and bonus schemes that combine one or more of the above risk factors.

At first glance, most pay arrangements for sales staff are likely to tick at least one, if not more of the above boxes.  Retail firms which sell goods and services on credit will often take (false) comfort in the fact that they don’t pay their staff to sell credit, as although commission-based, their remuneration is the same for each sale whether it is by cash or on credit.  This conveniently ignores the fact that they are actively incentivising credit sales where the availability of credit serves to maximise sales.  This is especially true in higher value purchases like cars, home improvements and replacement windows, where the average customer is unlikely to have the full cash sum readily available and would be unable to complete the purchase without taking the credit.

While the FCA is not proposing to ban commission-based sales, or to significantly restrict the terms on which firms can operate bonuses and pay which is linked to performance, the message and direction of travel is clear – firms must ensure that the risks to customers are adequately counterbalanced and controlled in order to remain compliant with the FCA’s Handbook of rules and guidance.

To help firms, the FCA’s draft guidance outlines some examples of pay arrangements which may reduce the risk of customer detriment, as well as identifying a number of good and bad performance management practices which can impact on the level of risk. Key points to note include:

  • performance-based pay which relates to quality or customer service measures, or which incorporates a significant quality element (such as compliance and customer satisfaction) can encourage positive customer outcomes;
  • mechanisms for reducing or clawing back performance-based pay can help to mitigate the risks which are inherent in sales incentive schemes (for example, a sales bonus is reduced where staff fail to meet quality criteria, or a sales commission is clawed back where an agreement is cancelled due to mis-selling);
  • good monitoring and performance management is key and examples of good practice the FCA has highlighted include making sure that customer outcomes are a prominent part of performance management discussions, employing quality-based targets alongside or instead of volume-based targets and implementing mechanisms for recognising good performance which is linked to customer outcomes to encourage appropriate behaviour; and
  • poor practices in relation to performance management can amplify risks, including pressurising staff to meet volume-based targets (for example, with potential disciplinary action) or failing to ensure those who are carrying out the performance management operate with a sufficient degree of independence.

Next Steps

The FCA’s proposed rules and guidance are currently under consultation (the deadline for responses being 4 October). However, given the amount of work the FCA has already undertaken in relation to this thematic review, we think it is unlikely that the regulator’s position will shift significantly.

In the meantime firms should review their arrangements as a matter of priority and begin preparing themselves any transition to updated incentive schemes. If you believe your firm will be affected by these changes we recommend the following steps:

  • review your current arrangements and map out the performance-based, variable and bonus pay schemes you operate and any associated controls that you currently have in place;
  • document the risks to customers and potential conflicts in relation to each aspect of your pay scheme(s) and performance management practices;
  • assess how these risks are mitigated and controlled and document your findings;
  • consider introducing or enhancing existing performance measures and incentives which are linked to customer-outcomes and compliance measures rather than purely sales driven; and
  • Canvass the views of your front-line staff about what they see as the pros and cons of your current arrangements and whether it is leading to good customer outcomes.

Every business is different, but in a retail sales environment it is commercially vital to ensure that not only are you treating your customers fairly, but that you are keeping your sales staff happy and properly motivated. Particularly for firms that operate in retail sectors where competitors may not have a finance offering, firms will now have a difficult balance to strike to ensure that in following the FCA’s guidance, they do not go too far and end up losing sales staff to competitors in the process.

Need some help, want to find out more, or bounce some ideas off us?

We are here to help. This is going to be a challenging process for firms and we are on hand to give you commercially-focused advice which considers the full picture, not just the compliance points. We can support you with a review of your existing incentive schemes and any proposals you may have to change them. We can also provide you with advice on the adequacy of your current monitoring and controls. So, if you need a hand, please get in touch with me or any member of our Regulatory and Compliance Team.

We are also available to support firms that wish to respond to the FCA consultation – but be quick, 4 October is approaching fast!