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THE future profits of some Australian car dealerships potentially hang on a final decision soon to be announced by the Australian Securities and Investments Commission (ASIC) which could change forever the way dealers earn significant slabs of their revenue.

ASIC has, for some years, been considering the payments of vehicle loan commissions by finance companies to dealers on the basis of the interest rate achieved by the dealer in selling the loan contract.

Dealers that sell at an interest rate above the base rate, which is generally set around the home loan rate, earn significantly higher commissions on the basis that the loan will generate much greater revenue for the finance company over the life of the contract.

Dealers have traditionally shared in the greater revenue generated thus creating a great incentive for dealers to sell a loan at the highest interest rate possible. As dealer margins are squeezed across their businesses, these flex-over-base-rate commissions have become a key contributor to the ongoing financial viability of many dealerships.

ASIC has made it known it wants to stop the flex-over-base-rate incentive because it sees the structure as a conflict of interest for dealers that disadvantages car buyers.

ASIC is also on record as saying that the arrangement “is costly” to finance companies and that some finance companies “are uncomfortable” with them. ASIC says that it is difficult for any one finance company to end flex commission arrangements as they risk losing market share to those that continue it.

ASIC is therefore asking for broad intervention powers to address the issue.

ASIC said in a submission in 2014: “We could, for example, seek to prevent flexi commissions from operating or apply a cap on the commission payments payable to dealers by financiers.”

Industry sources have told GoAuto that an announcement of the final rules devised by ASIC and the government “are imminent” and some are saying as early as the next few weeks.

Dealers will be looking at two things: the severity of the limit on commissions devised by ASIC and the degree to which their finance companies devise new commission structures for dealers to offset any loss or reduction in flex-over-baserate commissions.

Dealer consultant Wayne Pearson, a former managing director at Deloitte Motor Industry Services who until recently ran six dealerships in Sydney, told GoAutoNews Premium the issue with the government was not in the commissions earned by dealers but the method used to earn them which encouraged dealers to “stretch the envelope” on loan interest.

He said that in dealer briefings he attended the government was not saying the dealers were earning too much money, but that the mechanism that people are paid more money based on charging people a higher interest rate was wrong.

“So their argument was not so much getting commissions but the motivation for selling high interest rates,” he said.

Some dealers are very dependent on high interest rate finance for most of their profitability or even all of their profitability

“If you turn the mechanism into a volume bonus, for example, where you are incentivised to write more finance deals, the government says that is fine because that is competitive. Sell more, earn more: that is your job. That makes sense.

“But by earning more money just by charging people a higher interest rate, they see that as being offensive.”

Mr Pearson said changes could hurt dealers “particularly if there is no flexover-base-rate at all”.

But he said dealers were told in industry briefings that the government would accept a “reasonable” flex-overbase-rate.

“I was under the impression that when this final ASIC review was complete that the government might accept three per cent as being fair because some people need to pay some margin over base rate (to cover credit risk) but it was the big deals that were going to get killed,” he said.

“So I was under the impression that they would cap the rate. So as a dealer you can sell up to, say, three per cent over base rate.”

Mr Pearson said that 90 per cent of dealers sold finance at up to three per cent over base rate but dealers which rely on selling finance at very high interest rates would have to rethink their business model because they will be precluded from doing so under the legislation and this would especially be the case if the finance companies went back on “verbal undertakings to dealers in dealer group meetings that they would find another way of compensating them”.

“There is no doubt that dealers can significantly improve their profitability through writing high interest rate finance. But some dealers are very dependent on high interest rate finance for most of their profitability or even all of their profitability,” he said.

“If the finance companies don’t come to the party on this then those dealers are going to significantly struggle. There is no doubt about that.

“If that means they will make less money from a big return, or just make no money at all, it will definitely impact on those dealers and they will have to go looking elsewhere to make money.

“So dealers will have to have a good hard look at their business model to look at where they can pull back expenses and look at how they can trim the cloth. That might be an opportunity to significantly pull back on the commissions they pay their own finance people by changing commission structures to reduce their costs there. They will look at their real estate costs, the cost of advertising and they will look at their people.

“If the final decision is that there will not be any commission for selling flexover-base-rate the finance companies will have to go back and change their model for paying dealers.

“But if the final result is that you can only make so much over base rate, say three per cent, then 90 per cent of dealers will be fine.”

By John Mellor

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