In July 2022, the FCA published its final guidance on the new Consumer Duty for financial services firms. Schellion Horn and Alexandros Achilleos look at the implications of this guidance and what firms can do to get ahead.
The Consumer Duty represents a shift in the regulation of financial markets and sets “the standard of care that firms should give to customers in retail financial markets”1. Simply put, the new Duty requires firms to place customer outcomes at the core of governance and be able to articulate to the FCA how they deliver for their customers. The new rules apply from 31 July 2023 for open products and services and a year later for those which are closed.
An evolving approach to regulation
The Consumer Duty continues the FCA’s shift from prescriptive rules and towards a focus on consumer outcomes. The FCA previously set detailed requirements for firms to follow. The Consumer Duty overlays a broader requirement to ensure financial products and services deliver good outcomes for consumers. Therefore, firms can no longer satisfy prescriptive regulatory requirements, but must consider and, critically, demonstrate to the FCA that they are delivering good outcomes. In this way, the new regulations shift some of the FCA’s responsibility for ensuring financial markets are delivering for consumers back onto the firms.
This shift in regulatory approach by the FCA is not new. For example, the Senior Managers and Certification Regime (SM&CR) introduced greater accountability, with the aims of increasing market integrity and reducing harm to consumers. The Conduct Rules set out high level principles, which apply to all staff in regulated firms, encouraging a culture of personal responsibility and duty of care towards their customers. The focus on principles and shift of responsibility towards regulated firms is in common with the Consumer Duty. The Consumer Duty can also be seen as a more robust statement of the Treating Customers Fairly principles.
The FCA’s new ‘broad axe’
The Consumer Duty can be seen in light of several market reviews and interventions, which have highlighted how financial markets were letting consumers down. These reviews indicate the state of the industry and where firms are failing to meet their targets.
The FCA’s General Insurance market study, published in 2018, found that a number of firms employ practices that could lead to consumer harm. For example, firms increased the prices of long-standing customers, termed ‘price walking’, such that the most loyal customers were paying the highest prices. Similarly, FCA’s 2018 Retirement Outcomes Review, focusing on the pension and retirement sector, found that some providers would default consumers into cash or cash-like assets, which could cause harm to consumers looking to build their pot over a longer term. The review also looked at charges. It found that consumers might have been paying too much in charges during the review period as well as that products could have as many as 44 different charges, making it increasingly difficult for consumers to compare products and shop around.
These findings indicated that the existing regulations and market forces were not sufficient to ensure that consumers enjoy fair value for their products and receive the best possible outcomes. This has led the FCA to introduce more regulation, with the new Consumer Duty being a significant milestone.
Consumer Duty operates at three levels:
The Consumer Principle: The Consumer Principle states that firms need to ‘act to deliver good outcomes for retail customers’. It does not imply that firms will need to be responsible for protecting consumers from any possible poor outcome, but rather those which are within their control.
The cross-cutting rules: These rules aim to guide firms on how to act to deliver good outcomes and they provide the standards of conduct that are expected of regulated firms. The three cross-cutting rules are:
- Acting in good faith: financial firms would usually have a higher bargaining power, as well as higher knowledge and expertise, compared to their customers, and it is therefore important that the firms act in good faith to support their customers reach their financial objectives.
- Avoid causing foreseeable harm: firms should take appropriate steps, both proactive and reactive, to ensure that customers do not face foreseeable harm, irrespective of whether they have a direct or indirect (through the supply chain) relationship with the client.
- Enable and support customers to pursue their financial objectives: firms should enable customers to make informed decisions by ensuring easy access to relevant documents and taking into consideration potential biases that consumers might have.
It is also important that firms consider the the third principle, mainly the four outcomes highlighted in the New Consumer duty:
The products and services outcome: Firms are responsible for ensuring that the products and/or services they manufacture and distribute are in line with the needs and objectives of the target market for which they are aimed for and that the distribution strategy of the products is fit for purpose for the relevant target market.
The price and value outcome: Firms should be satisfied that the price consumers pay corresponds to the value they receive, taking account of key product attributes. However, this does not imply that firms should only offer low-priced products or services, since value also captures non-price elements.
The consumer understanding outcome: Firms are responsible not only for ensuring that their customers receive timely information about the product or service they are selling, but to ensure that these are provided in an easily accessible and understandable way while also providing support to their customers and clarifying any considerations they might have about the product.
The consumer support outcome: This outcome is closely related to outcome three on consumer understanding. While outcome three involves firms providing clear and easily understood communication to their customers in order to enable them to make informed decisions, the fourth outcome requires that firms can support customers to act on these decisions without facing any potential harm.
Despite these being four separate outcomes, there is a clear link and no one outcome can work by itself. Similarly, if a firm fails to prove that it acts in accordance with one of the four outcomes, it is very probable that it will also fail another outcome.
Price isn’t everything
The four outcomes, and the Consumer Duty more broadly, raise several key considerations for firms seeking to comply with the new regulations and requires:
Assessing fair value: Price and value outcome is arguably the most challenging for firms since the considerations are necessarily customer and product/service specific. There are multiple parameters which can affect fair value, such as the type of product, the target group of consumers, and the benefits that consumers derive from that product. it will require a separate discussion on how a product can justify that its price is indeed fair to the consumers.
Design with customer needs in mind: Design means that the product or service is created with the target market in mind, and it will serve their requirements and needs. It is important that firms evaluate their products in line of the target market to ensure that these do indeed serve the purpose they were aimed to serve.
Testing consumer understanding: Consumer understanding aims to address a common market failure in economics, information asymmetry. This implies that the seller of a product would have information about the product that the buyer wouldn’t know, and similarly the buyer would have information about what their aims are that the seller wouldn’t know. Often however, consumers are not actively engaging with the information, either because of inertia, biases or limited understanding of the complexities of these products and markets. In these cases, the price and value outcome becomes even more important and vital for the product to provide fair value.
Offering the right support: Consumer support requires firms to ensure customers enjoy a seamless experience when using their products. Firms should provide support to their customers, including appropriate measures for vulnerable customers, but also ensure that customers do not face any barriers during their product journey and can use the product as intended. If appropriate data is collected, data analysis can help firms to understand where gaps may exist and what areas they can focus on to facilitate better customer support for their clients.
The concept of reasonableness
The FCA has acknowledged that financial firms do not have unlimited resources to devote towards complying with the new rules. It likely expects firms to prioritise their reviews against the new rules. This relies on the concept of reasonableness within firms. The Consumer Duty should be interpreted in line with how a prudent firm which offers the same products or services and targets the same target market, would be reasonably expected to act. The reasonableness test takes into consideration:
- The nature of the product or service
- The characteristics of the targeted consumers
- The firm’s role related to the product or service.
Despite the fact that all firms are required to deliver good outcomes to consumers, it is not expected that all the firms will deliver that in the same way, since characteristics such as the size of the firm or the activities it performs, will affect this outcome.
The new Consumer Duty is an important milestone in the FCA’s regulatory journey and financial services markets in the UK. It makes firms responsible for delivering and demonstrating good consumer outcomes through their products and services. The FCA has not provided a clear manuscript of how the new Consumer Duty needs to be implemented or what are the exact steps and procedures firms need to take. It can therefore become a challenging task for firms trying to navigate the complexities of the new Consumer Duty, so taking action now is important to get ahead.
For more information, contact Schellion Horn.