A new Consumer Duty of care briefing
The grand plan
Following on from its 2018 discussion paper (DP 18/5) and subsequent feedback statement (FS 19/02); and in reaction to the requirements imposed by s.29 of the recently enacted Financial Services Act 2021, the Financial Conduct Authority (FCA) is consulting on its proposition to introduce a new Consumer Duty. This will be in the form of a new Principle, supported by a set of cross-cutting rules and guidance, focused around four key outcomes.
The aim is to affect a significant shift in firms’ culture and behaviour to focus on customer outcomes and put customers in a position where they can act and make decisions in their own best interests. There is also an emphasis on eliminating “sludge practices”, which create excessive friction that hinders consumers from making decisions in their best interests, by taking advantage of behavioural biases (eg. requiring attendance at a branch to cancel a product purchased on-line).
The new duty applies in relation to products and services sold to “retail clients” (everyone except professional clients and eligible counterparties) and will capture sales to small and medium sized enterprises (SMEs). It will apply to all firms involved in the manufacture or supply of products and services to retail clients, even if they do not have a direct relationship with the end customer. The new duty will not apply retrospectively and will not be applied to past business.
The full scope of the new duty may not become apparent until the FCA publishes draft Handbook text in its second consultation, later this year. It is possible that it will touch on unregulated products where they are developed, distributed or serviced by authorised firms. This would certainly help the FCA to police some of the perimeter issues it has struggled to tackle in recent years, for which it has received significant political and public attention.
There is a heavy emphasis on proactively considering the reasonable expectations of consumers and the barriers to delivering good outcomes; and being able to demonstrate this thought process through data, management information (MI) or some other record. This must be considered both at the product development stage and throughout the life cycle. The FCA expects firms to be able to deliver data and other feedback to demonstrate: proactive monitoring; issue identification; and where necessary, the steps firms have taken to address poor outcomes (which could include adapting or withdrawing products/services or paying redress).
For a long time the FCA has been moving away from rules based regulation and towards Principle based supervision and investigation. Supervisors will shift their focus to probe on consumer outcomes. They will expect firms to have documentary evidence of how these have been considered and addressed and may require periodic reporting of relevant data. The new duty will provide an additional ground for investigation (holding firms to account to higher standards than those set out in Principle 6 and 7) and breach of that duty could easily result in enforcement action being taken against a firm.
This consultation is open for comment until 31 July 2021.
In December, the FCA will publish a second consultation setting out the proposed draft text; the impact on the exiting Principles; and further consideration of a private right of action for breach of the new duty.
Any new rules will be made by 31 July 2022, although it seems likely that some will be subject to implementation periods to enable firms to make the necessary adaptations.
The new Principle
The new Consumer Duty Principle is intended to be a “fundamental obligation” akin to the Principle 11 obligation to deal with regulators in an open and co-operative way. The FCA is considering two options for framing this new Principle:
“A Firm must act to deliver good outcomes for retail clients”; or
“A Firm must act in the best interest of retail clients”.
The latter feels like the better option. “Good outcomes” has no established legal meaning and while the regulator assures us that the accompanying rules and guidance would give some clarity, a duty to ““act in the best interests of retail clients” seems clearer and is likely to be an easier message for firms to embed and monitor.
A duty to act in the best interest of retail clients is not intended to give rise to a fiduciary duty (where one does not already exist) nor would firms be required to achieve the absolute best outcome for every customer. Instead, firms will need to satisfy themselves that ““their conduct could reasonably and objectively be said to be in the consumer’s best interests”.
Cross-cutting Rules and Guidance
The cross-cutting rules and guidance will focus on three key behaviours.
- Taking all reasonable steps to avoid causing foreseeable harm. Firms will be expected to take proactive steps to avoid causing harm, for example, to ensure that the benefits and risks of a product or service are described fairly. Firms will not be under an obligation to protect customers from risks that the firm reasonably believed the customer understood and accepted (eg. that your house is at risk if you fail to meet repayments on your mortgage).
- Take all reasonable steps to enable customers to pursue their financial objectives. Firms will be expected to take reasonable steps to understand behavioural biases and the impact of characteristics of vulnerability and use their knowledge of how consumers behave to enable and support them to make good decisions.
- Acting in good faith. Firms should be honest, fair and open when dealing with consumers.
All three of these behaviours focus on the concept of reasonableness; taking reasonable steps, and meeting consumers reasonable expectations. This is an objective standard of conduct. When considering what is reasonable, firms should take into account the following.
- The nature of the product or service being offered: the firm’s relationship with the customer; the propensity for harm; and the complexity of the product or service.
- The role of the firm in the distribution chain.
- The reasonable expectations of customers in the target demographic.
- Any specific characteristics of customers (eg. vulnerable customers or those with protected characteristics).
The four outcomes
There are four outcomes that the FCA seeks to achieve from the new Consumer Duty, which will ultimately be crystallised in Handbook provisions.
- Communications: must equip consumers to make effective, timely and properly informed decisions about financial products and services. Think, “what, how, when”. Consumers must be given the right information (about features, costs, risks and benefits) at the right time, to enable them to make informed decisions. Key information must be clear and visible and firms must ensure they are not exploiting information asymmetries or behavioural biases. Example: when notifying a customer of an amendment to terms, firms should highlight the specific changes made, rather than just sending out set of the full revised terms.
The communications outcome will also apply to firms who approve financial promotions. However, unless the firm is performing an advisory role, it will not extend to advising customers on alternatives available in the market.
- Products and Services: should be specifically designed to meet the needs of consumers and sold to those whose needs they meet. Firms need to specifically identify both a target market and a need/objective of that target market that they aim to meet. All costs, benefits and performance of products and services should then be in keeping with the reasonable expectations of the identified target market. Firms should take proactive steps to prevent distribution outside the target market. There will be an obligation to convey (and request) sufficient information from other firms in the distribution chain to enable a firm to meet its obligations in this respect. Example: a product where profits are intended to be derived from late payment fees is not designed to meet a consumer need.
- Customer service: should meet the needs of consumers, enabling them to realise the benefits of products and services and act in their interests without undue hinderance. Customer services should not cause consumers to incur additional costs (be that time, money or inconvenience). It should be as easy for a customer to switch or exit a product as it is for them to purchase it. Prompts and incentives to retain a customer are acceptable provided they do not impact the ease of switching or exiting. Example: requiring customers to contact the firm by phone if they want to switch to a different provider and then engaging them in a lengthy process during which they are encouraged not to switch, would constitute “undue hinderance”.
Firms retain responsibility for meeting services standards where they choose to outsource customer services.
- Price and value: the price of products and services must represent fair value to consumers. Firms should proactively assess the benefits (including non-financial) consumers can reasonably expect to get from the product or service, against the total “cost” to the customer (including any collateral use of the customer’s data). This should happen both at the design stage and through ongoing active monitoring. When assessing fair value, firms should take into account: the nature of the product or service; the benefits provided or reasonably expected; the type and quality of product; and the limitations. Value assessments should take into account manufacturing and distribution costs. Firms should avoid complex pricing practices (which can make the lifetime cost of a product unclear) and practices that take advantage of consumers’ optimism bias. Example: it may be appropriate to earn higher margins where a firm has developed a genuinely innovative product or more efficient service.
It is accepted that different costs will be appropriate for different groups of consumers. Fair value does not mean that all consumers should receive the same outcome and the FCA still expects consumers to be able to benefit from “shopping around”.
Monitoring and testing
The FCA expects firms to put systems and controls in place (to the extent that they are not already) to enable them to identify when particular groups of customers are receiving systemically poorer outcomes. Firms will need to be able to identify this, consider the root causes, and consider if more could reasonably be done to improve customer outcomes. Firms will be expected to take proportionate steps to review, test and adapt products and services (and the communications relating to them). A firm should be prepared to demonstrate the steps it has taken to put itself “in the shoes of the customer”.
When determining what level of testing would be proportionate, firms should take into account: the purpose of the communication and relative importance of the decision to be taken by the customer; the context, timing and frequency of the communication; the reasonably foreseeable information needs of the customer; and the scope for harm. Suitable methods of testing might include: customer surveys or the monitoring of MI.
Testing products and services.
Firms should be able to demonstrate that they have tested the performance of products in all markets. It is essential that robust stress-testing is incorporated into product approval processes. It is also important to identify customers for whom the product or service is not suitable and to conduct proactive monitoring to ensure the product or service is not mis-sold. If an issue is identified, firms should consider the most appropriate action to take: discontinuing the product, adapting it; or even paying redress.
Customer service testing
Firms should proactively identify the barriers a process might create and reduce them wherever possible. Monitoring could take into account: data on abandoned calls/claims, reduced claim/successful claim volumes; information on customer behaviour; root cause analysis of complaints; and identifying and investigating unusually low switching rates.
Price and value testing
Firms will need to be able to demonstrate that they have conducted a fair value assessment and be able to demonstrate why they consider the relationship between the price and the benefits of a product or service is reasonable. Senior managers will be accountable for the outcome of fair value assessments. Where the price is held to be unreasonable the firm will need to consider withdrawing or amending the product or service.
Private right of action
The FCA has temporarily parked the decision on whether or not to introduce a new private right of action for breach of the Consumer Duty. It continues to invite views from interested stakeholders but appears to be leaning towards not introducing anything new.
It is possible that customers who suffer loss as a result of a firm breaching any of the new cross-cutting rules will be able to bring a case by relying on s.138D FSMA 2000; however, it remains within the FCA’s power to disapply this in relation to all or some of the new rules.
The FCA is expected to provide greater clarity on this point in its second consultation, later this year. We can only assume that this decision will be heavily influenced by responses received to this consultation.
The FCA seems fairly set on the idea of introducing a new consumer duty via an additional (or perhaps amended) Principle, supported by new Handbook rules and guidance; and is simply seeking views on the best formulation of these. In any event, this consultation paper is a clear and detailed statement from the regulator of the standards of conduct and shift in culture it expects to see at firms over the next couple of years. The statements about risk of harm and ensuring fair outcomes for consumers are nothing new; and we have seen these supported and emphasised in recent guidance and enforcement outcomes.
The FCAs proposals are clearly being developed in parallel with other customer-centric efforts such as: revisions to payments services guidance, the Woolard Review, strengthening the financial promotion rules for high-risk investments, and the recent guidance of treating vulnerable customers fairly. It has also been heavily influenced by the results of recent industry reviews, many of which are expressly referenced in the consultation.
Where it applies, the Consumer Duty will overlap with existing Principles 6 and 7, as well as the six treating customers fairly (TCF) outcomes. The FCA is clear that where conduct meets the requirements of the new Consumer Duty it “would generally meet our expectations under Principles 6 and 7 as well”. However, the FCA will shift towards relying more on the new Consumer Duty and has even suggested it might disapply these exiting rules where the Consumer Duty also applies.
Much of the existing non-Handbook material relating to TCF and Principles 6 and 7 echoes the requirements of the new Consumer Duty; both in terms of the language used and guidance to firms on how to comply; and this remains relevant. Firms that have successfully embedded the TCF outcomes in their culture and processes may find that little additional work is required; however, feedback from the regulator suggests that many firms are struggling to embed this consistently, across all business lines, on a continued basis. The regulator is expecting to see a noticeable cultural shift away from “what can we profitably sell” and towards identifying consumer needs that can be “profitably served”. At the very least, the introduction of this new duty should prompt firms to conduct a root and branch review and consider whether improvements can reasonably be made.
The true scope of the new duty may not become clear until the FCA publishes draft Handbook text, later this year. With that in mind and taking the overarching sentiment into account, firms should look to have consistent and robust product development, approval and monitoring in place for all lines (whether or not regulated). This consultation sets a governance expectation and, as with most other public statements from the FCA, emphasises institutional mindset and management responsibility.