In May 2021 the Financial Conduct Authority (FCA) published a consultation paper CP21/13 outlining proposed new standards of consumer protection and care in retail financial markets in the form of a ‘Consumer Duty’.
CP21/13 outlines a framework that will have a far-reaching impact across the financial services sector, despite the FCA not outlining any of the granular rules at this stage.
The proposed Consumer Duty is a significant step by the FCA towards its operational objective to secure an appropriate degree of protection for consumers as well as a further move towards an outcomes-focused approach to regulation. The Consumer Duty is not an entirely new concept, it builds on the existing concepts of Treating Customers Fairly, the six consumer outcomes and the conduct rules to push firms towards a change in culture by putting the customer at the heart of their business.
Firms should view this consultation as a clear and detailed insight into the regulator's expectations on conduct and culture. Firms should look to undertake an exercise to review their current policies and practices to gain an understanding of the likely impact of the expectations in CP21/13 on their customer's journeys, feeding back any observations or issues into the FCA consultation process.
The proposals would require firms to:
- evaluate their products and services to make sure they are fit for purpose and offer fair value
- communicate information about products and services so that consumers can make well-informed decisions
- establish the outcomes that consumers should be able to expect from their products and services
- act to enable rather than hinder these outcomes
- assess the effectiveness of their actions
The proposals apply to regulated firms, including electronic money and payment institutions, in relation to products and services that they manufacture or offer to ‘retail clients’ – even if there is no direct relationship with the end customer.
Retail clients is a broad term and the FCA has clarified that this term relates to all clients apart from:
- professional clients (as defined in COBS 3.5) such as large corporates or government bodies; and
- eligible counterparties (as defined in COBS 3.6).
The provision of financial services to SMEs would be covered under the proposed Consumer Duty. However, customers in wholesale or professional client markets will not be subject to the Consumer Duty but will remain protected under the existing principles that the FCA currently has in place.
Addressing consumer harm
The FCA has highlighted that a consumer’s ability to make good decisions can be impaired because of their weaker bargaining position, asymmetries of information, lack of understanding or behavioural biases. Firms can exploit these factors and cause harm through an array of practices such as:
- Providing information which is misleadingly or difficult for consumers to understand, hindering their ability to properly assess products/services.
- Excessive friction in firms processes, online or otherwise that prevent consumers from making decisions in their interests – defined by the FCA as “sludge practices”.
- Products and services that are not fit for purpose in delivering the benefits that consumers reasonably expect or are not appropriate for the consumers they are targeted at and sold to.
- Products and services that do not represent fair value, where the benefits consumers receive are not reasonable relative to the price they pay.
- Poor customer service that hinders consumers from taking timely action to manage their financial affairs and making use of products and services or increases their cost in doing so.
- Other practices which hinder consumers’ ability to act, or that exploit information asymmetries, behavioural biases or vulnerabilities.
Consumers may suffer harm because of the practices outlined above. The specific type of harm could include:
- finding it harder to make an informed or timely decision
- buying products and services that are inappropriate for their needs, high risk or of an inadequate quality
- incurring greater monetary and non-monetary costs
- receiving sub-standard treatment during their relationship with a firm
- finding it harder to switch or get a better deal
The new Consumer Duty aims to create an environment where all firms extend their focus on delivering good outcomes for customers in addition to maintaining compliance with specific FCA rules. It is designed to ensure the practices and harms detailed above do not occur.
The Consumer Duty would be implemented by the addition of a new principle within the PRIN Sourcebook and complemented by a suite of new rules and guidance to set higher standards of conduct for firms. The FCA believes this will present a clear statement of expectations that goes beyond existing Principles and rules to provide a framework for the ongoing development of retail markets.
CP 21/13 does not detail the specific rules or regulations that will form part of the Consumer Duty. However, the consultation paper provides an overview of the likely structure of those rules. It is expected to comprise of three elements:
- Consumer Principle - which sets a clear tone and uses language that reflects the overall standards of behaviour the FCA wants from firms. The specific expectations on firms conduct that will be required under this Consumer Principle would be detailed across the final two elements of the Consumer Duty.
- Cross-Cutting Rules - which develop the FCA’s overarching expectations for common themes that apply across all areas of firm conduct.
- Four Outcomes – rules and guidance setting expectations for firms conduct in regards to the key elements of the firm-consumer relationship.
The Consumer Principle
The proposed Consumer Principle is designed to drive change in the culture and conduct of firms. The FCA recognises that this principle, along with other existing principles must allow for a degree of flexibility so that it remains relevant as market, products and services change and evolve over time leading to consumers facing potential new risks and harms. The standard the FCA wants to set for firms goes beyond “paying due regards to the interests of its customers” in Principle 6. The intention is to make it clearer to firms that they must play a more positive and proactive role in placing consumers at the heart of their business in order to drive good outcomes.
The FCA has proposed two options for the wording of the new Consumer Principle:
Option 1: ‘A firm must act to deliver good outcomes for retail clients’
Option 2: ‘A firm must act in the best interests of retail clients’
The meaning and intention of the principle will be further amplified and clarified through the other two elements of the consumer duty, the cross-cutting rules and the four outcomes.
It is important to note that the FCA recognises that consumers remain responsible for the decisions they make. The expectation on firms is to use their judgment in a fair and reasonable way to consider the impact of their actions in respect of the consumers’ needs and circumstances.
CP21/13 acknowledges the potential overlap between the proposed Consumer Principle and the existing Principles 6 and 7. The FCA alludes to the possibility of disapplying Principles 6 and 7 at some point in the future to avoid this overlap where the Consumer Duty would apply.
The proposed Cross-Cutting Rules and guidance would require three key behaviours from firms:
1. Take all reasonable steps to avoid causing foreseeable harm to customers
The expectation is for firms to take proactive steps to avoid causing harm to customers through their conduct, products, or services. Firms should not exploit customers’ vulnerabilities, behavioural biases, or lack of knowledge. Benefits and risks related to a firm’s products and services should be fairly described and not disguised through misleading framing or omission.
The FCA acknowledges that harm may sometimes occur due to unforeseeable circumstances, or in cases where there are no reasonable steps for firms to take to avoid it. Certain financial products involve risk/external factors and firms are not expected to protect consumers from risks they reasonably believed the customer understood and accepted.
2. Take all reasonable steps to enable customers to pursue their financial objectives
The FCA does not want firms to make financial decisions for consumers but wants firms to take responsibility for establishing an environment in which consumers are empowered to act in their own interests. Harms may arise when firms fail to appropriately consider customers vulnerabilities or behavioural biases. The FCA expects firms to use their knowledge of customer behaviours to support them in making good informed decisions.
3. Act in good faith
Firms are expected to deal with their customers with honesty by dealing fairly, openly and with consistency to the reasonable expectations of the consumer.
Reasonableness is a concept that the FCA will seek to embed across all elements of the Consumer Duty in order to clarify the standard of conduct that firms would need to meet. They have done this by setting out factors that influence what is reasonable, such as:
- The nature of the product or service being offered or provided, including:
- The nature of the firm’s role and relationship with customers – the Consumer Duty will not impose requirements that change the nature of a firm’s relationship with its customers such as through a fiduciary duty or advisory service.
- The potential of the product or service to harm consumers – it is reasonably expected for firms to take greater care in targeting customers and meeting their needs in respect of higher risk products or services. Firms also need to identify points during the customer journey where there is an increased exposure to a risk of harm, such as when having trouble with repayments.
- The complexity of the product or service – it is reasonable to expect firms to take extra care and monitor consumer understanding of relative features when offering complex products and services.
- The role of the firm in the distribution chain – firms across the distribution chain will be bound by the Consumer Duty.
- The reasonable expectations of consumers – will be informed by the firm’s previous conduct and interactions with customers and will be dependent on the nature and purported quality of the products or services.
- The specific characteristics of customers, including characteristics of vulnerability - firms should recognise and respond to the diverse needs of their customers and potential customers, especially where these are associated with vulnerability, or with protected characteristics and may require additional care.
The Four Outcomes
The FCA proposes to set expectations for each of the four outcomes in a suite of rules and guidance. The four outcomes themselves represent the key elements of the consumer’s relationship with the firm encompassing all various touchpoints across the design, sale and service phases of the customer journey:
- Communications should enable consumers to make effective, timely and properly informed decisions about financial products and services.
- Products and Services should be specifically designed to meet the needs of consumers and sold to those whose needs they meet.
- Customer Service should meet the need of consumers, enabling them to realise the benefits of products and services and act in their interests without undue hindrance.
- The price of products and services represents fair value for consumers.
The consultation paper requests feedback on the proposals and questions by 31 July 2021. The FCA is then expected to release a follow up Consultation Paper by 31 December 2021 with more of the proposed wording of the specific rules and guidance in relation to the Consumer Duty. The new rules are expected to be in place by 31 July 2022 leaving firms with little time to ensure they are able to uphold their new Consumer Duty.