On 7 December 2021, the FCA announced a second consultation period on its new ‘Consumer Duty’ for financial services firms dealing with consumers. Chris Laverty looks at issues firms need to consider when preparing to comply with it.
The Consumer Duty was first proposed in May 2021 with the intention of setting higher expectations for the standard of care that firms provide consumers. The FCA has observed that some firms have poor practices in place which can ‘hamper good decision making’, or ‘exploit behavioural biases and vulnerabilities’ of the consumer.
In brief, this new Consumer Duty is intended to have three components:
1 A new over-arching consumer principle:
A firm must act to deliver good outcomes for retail clients
2 Three cross-cutting rules. Firms must take all reasonable steps to:
avoid foreseeable harm to customers
enable customers to pursue their financial objectives
act in good faith towards customers.
3 Four outcomes, representing the following elements of the firm/consumer relationship:
Price and value
This article is not an overview of the proposed regulations, or a 'to do' list. Rather, I believe it is helpful to highlight areas that financial services firms will need to manage when preparing to comply with the Consumer Duty.
Management must be proactive
This consultation paper (CP) is intended to represent a paradigm shift in how the FCA regulates the retail sector, part of the move to an outcomes-based approach. The FCA believes that many firms are reactive in response to regulatory requirements, with a ‘tick box’ approach. Instead, leaders must be proactive, asking themselves whether their products and services actually meet the needs of those they are sold to.
The wording of ‘all reasonable steps’ on the cross-cutting rules sets a very high bar to be met by firms. For context, the Senior Managers and Certification Regime requires managers to take ‘reasonable’ steps to fulfil their responsibilities.
What does compliance require?
For some firms, the Consumer Duty will be the continuation of the evolution of processes that they already have in place. However, for others, this will be more of a revolution and will require significant time and resource to implement.
Firms will have to consider every step of the customer journey throughout the product lifecycle, including design, communications, and customer service to assess any areas which may give rise to customer harm.
Internal governance processes will need to be reviewed and amended. Customer outcomes will need to be tracked and measured. Customer service processes may need to be re-thought, and firms should review their complaints handling processes to ensure issues and trends are identified and reported with product changes effected quickly if necessary.
What resources will firms need?
From a resource perspective, there are several questions firms need to consider:
What IT will be required?
How much will enhanced MI, reporting and testing cost?
Will it be necessary to hire more senior resource to apply the framework and nuanced judgement?
Are their systems and processes agile enough to capture issues and adapt where required?
The FCA proposes that where a firm does not have a relationship with the end-consumer, but still able to influence the outcome, target market or performance of a product or service, it will still be bound by the Consumer Duty.
This obligation does add another layer of cost and complexity for firms who frequently rely on counterparties to provide products and services. All parties must agree on roles and responsibilities for applying the duty. Some counterparties may be less familiar with the TCF principles already in place, and therefore embedding appropriate processes may become onerous and costly.
Will there be an impact on profitability?
Some of the requirements set by the outcomes have the potential to impact profitability.
For example, outcome 3 states that customer service should meet consumers’ reasonable needs and expectations.
The FCA is concerned about examples of ‘sludge’ tactics where customer service processes hinder consumers from taking action that would benefit them, for example switching to a more appropriate product.
Complying with the duty would mean that firms need to make leaving, cancelling, or transferring out of a product as easy and frictionless as it is to buy. It's easy to imagine circumstances where some firms experience significant customer loss, and firms will need to carefully manage the impact on cash inflows and profitability.
Outcome 4 sets the expectation that the price of a product or service will need to reflect fair value.
Firms may need to consider introducing triggers linked to profitability or commission rates to assess whether that product is still delivering fair value for the customer:
What impact will it have on a firm should a key and profitable part of their offering be judged not to deliver fair value?
How would this impact a business operating in a competitive market place?
What is certain is that firms will need to carefully document their assessment of fair value in their pricing structures
Will the risk of redress increase?
The FCA had initially proposed to bring a private right of action (PROA) for breaches of the Consumer Duty. While a PROA exists for most FCA rules, this does not include the FCA principles. This would have enabled the FCA to impose an industry-wide redress scheme where there were breaches of the Consumer Duty or other Principles.
The proposed PROA was a polarising issue, with most consumer representatives strongly supporting it and most industry respondents warning against it. As a result of this feedback published on 7 December, the FCA is no longer proposing to introduce a PROA, stating they believe that the existing redress framework is likely to be a more appropriate route for consumers to seek redress.
The FCA specifically highlights that they're working closely with the Financial Ombudsman to improve awareness of the redress system, and that ‘the Consumer Duty will provide a further opportunity to help consumers “know their rights”’. Will this lead to an increase in redress claims against firms? Will claims management companies (CMCs) turn their attention towards potential breaches of the Duty? CMCs are able to generate large numbers of claims in a very short time, as we have seen in the high-cost short term credit sector, which can lead to significant stress or distress.
What can firms do now?
The FCA will be consulting on the Consumer Duty proposals (CP21/13) until February 2022, with final rules expected to be confirmed in July 2022. The FCA acknowledges that many firms are already delivering good outcomes for consumers. The path to compliance will require all firms to undertake detailed documentation of all decisions made together with recommended actions. Management should also give careful consideration to the increased costs involved with compliance and potential impact on profitability.