In our previous article, Consumer Duty – A Different Approach to Financial Services Regulation, we set the scene for the “paradigm shifting” regulatory change now approaching the financial services industry and discussed the FCAs intention to place clear accountability for compliant implementation of the Consumer Duty with a firm’s governing body, in most cases the board.
To help firms prepare, the FCA announced a series of webinars, which were held in October and November 2022. The webinars were split by sector, giving the FCA one of its first opportunities (since publication of the final rules) to publicly engage with firm and industry representatives.
During each of the sessions, the FCA focused on what the consumer duty (the “Duty”) may mean for the represented sector, offering thoughts and observations via its team of managers and technical specialists.
In this article, our sector specialists combine a summary on the FCAs comments with our deep sector knowledge to provide analysis and advice on what the changes may mean for your firm and associated sector.
Consumer Investments, Pensions and Asset Management
It is, perhaps, unsurprising that the new Duty will have a significant impact on the retail wealth management and pensions sectors, given the FCA’s focus on these sectors over the recent years. We discuss each of these below from a manufacturer and distributor viewpoint.
Asset Managers Offering Retail Investment Products (incl. Pension Funds)
At one end of the distribution chain, we have the manufacturers of products and services, traditionally, asset managers. Here the FCA is keen to point out that good governance is essential to ensuring that the products sold, and the services offered meet the needs of the people they are designed for.
During the webinars, the FCA explained that the key to good product and service governance is appropriate establishment of target markets at each stage of the distribution chain, and then robust oversight of the distribution of the products and services being sold.
Through our own work with asset managers, we have identified improvements that can be made to how firms undertake due diligence of distributors. Firms often need to collect further information to understand if the distributors’ intended product recipient, and distribution strategy, matches their own expectations and, where it doesn’t, they may need to intervene to provide further clarity or make changes.
Fair value is also one of the core tenets on which the Duty is being built. However, the FCA recognizes that the asset management sector is well-placed in this regard, having been subject to remedies under the Asset Management Market Study (AMMS), whereby authorized fund managers (AFMs) have been required to carry out an annual assessment of the overall value offered by their funds to investors.
Firms complying with the annual Assessment of Value (AoV) rules are likely to be considered compliant with the price and value outcome under the Duty, although some caution should be noted in this regard. In 2021, the FCA published findings following a review on the value assessments of 18 AFMs, concluding that most failed to meet the FCAs standards and that “more rigor” was necessary.
Based on this prior review, It seems that the asset management industry should not conclude that it will necessarily be compliant with the price and value outcome based on its existing value assessment process without conducting an independent review of procedures in place and adjusting these against the FCAs prior findings.
Distributors of Retail Investment Products
At the other end of the distribution chain are the distributors of retail investment products typically intermediary firms such as platforms or financial advisers. Again, we see a focus by the FCA on product and service governance, with emphasis on the importance of distributors collecting sufficient data to ensure that products are reaching those for whom they are designed, that appropriate distribution channels are being used, and that fair value is being delivered. This applies not only for the products being recommended but also for the services being offered by the distributor, of key importance for financial advice firms who need to consider the overall cost to the customer, which includes the advice service(s).
We recommend early engagement on the customer understanding outcome, and we have seen that firms who are reviewing their suite of client-facing documents, including suitability reports, to ensure they meet the higher bar set by the Duty, are placing themselves in a stronger position to be able to evidence and demonstrate good outcomes.
The FCA webinar points out that customer contact is crucial to sense-check the outcomes the firm believes it is delivering. Testing the quality of disclosures, financial promotions and information relayed during automated customer journeys (where relevant) provides valuable insight through which to improve client understanding.
We see firms benefitting from this more objective approach, which allows a firm to wear the client’s glasses. Often, we find that firms believe that the way they communicate with clients is clear, fair and supports good decision-making when, in reality, this isn’t the client’s perception. Customer feedback, and/or independent reviews can be valuable evidence to demonstrate that a firm has recognized, and taken steps to mitigate, any potential bias it may have when reviewing its own processes and procedures.
Much like consumer investments, the FCA considers that many of the rules introduced in the insurance sector over the past five years are aligned to the Duty. The FCA reiterated that where brokers and insurers are already meeting the existing insurance product governance rules then they would be largely expected to be meeting the intent of the Duty, which is positive news for a sector that has seen much regulatory change in the recent years.
However, while there is nothing in the Duty that requires the insurance sector to fundamentally change its core business purpose or strategic direction, the new standards expect firms to go further on consumer support outcomes than the current Treating Customers Fairly (TCF) framework requires.
Consumer understanding and support
It is encouraging to hear that the regulator recognizes that insurers will have different capabilities depending on their size and resources. So, while all firms should focus on good outcomes for their customers, the approach that is adopted for testing and monitoring is expected to vary according to the size and complexity of a firm. To assist firms, the FCA detailed some examples of improvements to practices, which may be useful in gauging firms’ current alignment with the raised standards of the Duty.
For example, unnecessarily complex claims processes that may deter customer action and allowing customers to easily purchase a product online but then requiring them to call a customer services representative (and wait on hold for a lengthy period) to either switch or cancel the product, were both cited as case studies of poor practice by the FCA.
Both the examples above are what the FCA refers to as “sludge practices,” whereby the firm has introduced friction into the customer journey to seek a more favorable outcome for the firm, rather than the customer. The FCA notes that such practices are unlikely to be consistent with the new Duty principle.
We suggest that firms should identify all channels of communication and support that customers currently have access to and evaluate how each meets the new standards, with a focus on identifying and reducing friction points that may benefit the firm at the expense of the customer.
The FCA also noted that insurers should be considering what information they give to customers, the timing of the communication and the content of presentation of information. We believe a major area of focus in this space for insurers should be policy exclusions, where firms should be confident that distributors (e.g., an insurance intermediary) ensure that such exclusions are bought to the attention of the customer at the point the policy is sold and appropriately communicated throughout the continued lifespan of the policy.
Further, identifying and removing possible instances of foreseeable harm (such as not providing customers with the right information, at the right time) is likely to be considered a positive step when evidencing compliance with the new Consumer Principle.
Insurance scope clarification
The FCA again clarified that the Duty will only apply to retail customers, following the position in the Insurance Conduct of Business Sourcebook (ICOBS). The Duty will not apply to reinsurance, contracts of large risk sold to commercial customers or other contracts of large risk where the risk is located outside the UK. It will also not apply to activities connected to the distribution of group insurance policies.
Retail lending has, perhaps, had less of a head-start than the other sectors covered in this article, and therefore, arguably may have more ground to cover during the allotted time frames to ensure the new Duty standard is being delivered by the July 31 2023 deadline (for new products and services).
The FCA was keen to emphasize that the Duty would be relevant to firms that deal with retail customers, and those that are completely hands-off would have a lesser responsibility. This comment appears to be in recognition of the differing distribution structures within retail lending, emphasizing the importance of retail lenders understanding to what extent they may be influencing outcomes for retail customers.
We have had positive discussions with firms to help them determine where they may have consumer duty obligations and the impact these may have on current arrangements. In our view, the interpretation of scope, particularly where there might be a complex distribution chain, can be nuanced, with consideration needing to be given to factors such as small-medium enterprise (SME) lending or products being distributed via non-UK distributors.
Price and value
Price and value were an area of focus in the webinar. The FCA considers that some firms may need to undertake significant work to reach the new Duty standard. For instance, the FCA noted that it has seen examples of “troublesome” retail lending business models, which rely on customers penalty charges to be profitable, where the core business strategy is predicated on encouraging poor outcomes for customers.
Firms should be clear that this type of relationship between price, value and business strategy is unlikely to be consistent with the objectives of the Duty. Such models may need to re-think their approach.
Affordability and forbearance
Other areas of focus for retail lending activities were the assessment of affordability, particularly for small lending amounts, and the way in which lenders treat customers with regards to forbearance.
On the former point, the FCA was keen to emphasize that it has evidence that some lenders do not check affordability as stringently for smaller amounts as they may for larger amounts, despite there being a risk that certain vulnerable customers could be impacted should the repayment of a small loan amount become problematic in a similar way to another customer who is borrowing a larger amount but who is not in a vulnerable position.
In relation to forbearance, the FCA expects lenders to treat customers as individuals, rather than applying one-size-fits-all solutions, a practice that the FCA points out is unlikely to be compliant with the intent of the new Duty.
In our experience, forbearance measures work best for customers when they are supported with effective data, to allow the firm to identify customers who may be having financial difficulties as early as possible, as well as having a flexible approach to dealing with payment difficulties whereby multiple solutions are available to help the customer achieve full recovery. Retail lenders should also be considering how easy it is for customers in financial difficulty to complete the forbearance journey, which should be clear, fair and must avoid any harmful frictions, which may create unreasonable barriers to customers acting in their own best interests.
Retail Banking and Payments
The FCA used the webinar as a platform to describe the new Duty as an opportunity for retail banking and payment service providers to adapt themselves to the changing industry landscape, splitting the session between the two sectors, which we summarize below.
UK Retail Banking
The extent to which UK retail banking (and building societies) will be impacted by the Duty will depend on the complexity and maturity of business models and distribution strategy. The FCA acknowledged that the role a bank plays in the distribution chain can be complex and will require careful consideration by each firm.
Retail banking services cover a broad spectrum of activities, often as product manufacturer, co-manufacturer, distributor of own products and distributor of third-party products and services, and they can also include the provision of outsourced critical functions to third-party suppliers.
As has been mentioned elsewhere in this article, identifying, and understanding the firm’s responsibilities throughout the distribution chain is an important first step to take, however, where a complex distribution strategy exists across multiple service lines, this can require a significant amount of time and resource.
The FCA was also keen to mention the close links between cost-of-living challenges, customer support and the customers understanding of products and services. The FCA believes that banks should ensure they have the capacity to support worried or vulnerable customers and should be considering how they can proactively identify and reach out to customers who may be struggling.
Building on the above, the FCA provided examples of practices firms should be avoiding, most notably inadequate support of customer-channels (e.g., under-resourced or inexperienced staff), poorly conceived and designed digital support channels, and an over-reliance on chat bots to provide support, particularly in circumstances where they may not be appropriate (e.g., where a more complex customer query is likely or a more individual and tailored response is necessary).
We have seen many examples where firms have deployed digital innovation to deliver an improved experience for customers. Recent lockdowns increased the urgency for firms to develop digital communication channels, in particular retail banking services. Firms should, however, be continuously evaluating that such solutions remain fit-for-purpose and are providing for the evolving needs of their customers.
Banks and building societies must carefully consider how they embed the new Duty requirements, keeping in mind that the FCA expects to see a clear transition from compliance with processes and procedures to good outcomes for customers. Given the impact the economic situation is having on UK consumers, retail banks should not be waiting for the Duty to take effect before changes are made.
UK payment service and e-money firms should proactively check that customers and good outcomes are at the heart of their business models and practices. While much of the messaging given was aligned to that of other sectors in this article, the FCA conveyed the importance for firms in having a specific focus on understanding their role in the distribution chain, understanding what amounts to a good outcome for the firm’s customers and how the firm’s charges may impact the end customer.
The FCA also confirmed that it expects payment service and e-money firms to communicate through the distribution chain where, for example, it identifies a concern that may be leading to poor customer outcomes. This is so the issue can be addressed by the firm at the appropriate point in the process.
We consider that the shift from rules-based to outcomes-focused regulation may be a larger jump for some firms in this sector but that those with more developed conduct risk frameworks are well-placed to comply with the new requirements.
Payment service and e-money firms should consider their obligations under the Duty when products and services are developed, tested, launched and reviewed. Developing this thinking further, we believe that outcome testing can be an underutilized tool If applied correctly as a testing strategy, it can be a valuable source of information and evidence, something that will be a necessity under the Duty if firms are to show the regulator they are complying with the spirit, as well as the letter, of the new conduct regulation standard.
How We Can Help
The FCA expects firms to have sufficient resources to implement the Consumer Duty between now and 31 July 2023 (new and existing business) and 31 July 2024 (closed-book business).
We have deep knowledge of consumer protection matters, enabling us to help our clients understand their regulatory obligations, identify gaps where further work may be needed, and design and deliver robust, proportionate solutions. Our services include:
- Reviews of implementation plans with board and management oversight
- Support with interpretation of rules, including advice on implementation, specific to the needs of your business and strategy
- Advice on effective data collection, analytics and reporting practices for the Duty
- Independent outcomes testing of customer journeys to identify changes that may be required
- Independent “sludge audits” to proactively identify where existing customer journeys may benefit from improved outcomes by removing perceived negative fiction points
- Development of documentation to support your transition
If you would like to discuss this article and its specific contents, please get in touch today with Mark Turner.