Preparing for the new Consumer Duty
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The UK Financial Conduct Authority’s (FCA) latest consultation and feedback on the proposed Consumer Duty engages with some of the sticking points as well as providing draft rules and guidance.
Whilst time is of the essence, firms should be alive to the need to flex their programmes of work while the regulator and industry work through the “iterative” implementation process and clarify some of the thornier details.
The overarching “package of measures”
The FCA’s “package of measures” still comprises a 12th Principle for Businesses, three cross-cutting rules, and four consumer outcomes.
The regulator has now landed on an obligation to “deliver good outcomes for retail customers” for both the new Principle for Businesses and a new individual conduct rule. Likewise, the three cross-cutting rules for firms will be reflected in new granular rules for individuals within the Senior Managers and Certification Regime.
The three cross-cutting rules will require firms and individuals to act in good faith, avoid foreseeable harm to retail customers, and support those customers to pursue their financial objectives. The four outcomes focus on products and services, price and value, consumer support and consumer understanding.
Final rules will be published by the end of July 2022 and firms are expected to have until April 2023 to fully implement them.
Scope – more detail but less clarity
At this early stage, the key concern for most firms is mapping out the scope or potential scope of the new obligations. Understandably, firms are anxious to start planning what, for many, will be a significant review and implementation exercise.
The draft definition of “retail customer” seeks to align the scope of the new Consumer Duty with that of existing FCA sectoral sourcebooks. Whilst recognition that one-size does not fit all is appreciated, this approach places a significant burden on firms to root through overlapping rules and guidance to determine which of their activities fall within the Consumer Duty and to what extent.
- This definition includes prospective customers and, in most cases, small and medium enterprises.
- It will not include retail customers who elect to be treated as “professional clients” under COBS – although it should be noted that the client categorisation process will be assessed in the context of Consumer Duty to ensure that retail clients are not being incorrectly classified.
For clients not within scope of the Consumer Duty, Principles 6 and 7 continue to apply.
The proposed definition of “retail market business” pulls in unregulated activities, which are ancillary to regulated activity. The FCA gives the example of activities relating to product design as well as activities in connection with the provision of payment services or issuing e-money.
Application to wholesale firms
The Consumer Duty is expected to apply to those wholesale firms that have a material influence over
- the design or operation of retail products and services;
- the distribution of retail products and services;
- communications issued to retail consumers in relation to these products or services; and/or
- direct contact with retail customers on behalf of another firm.
Those firms closest to the customer in the distribution chain are most likely to be caught by the Consumer Duty, even if they operate in the wholesale sector. For example, an investment bank that designs a structured product for sale to retail customers would be subject to the Consumer Duty but investment banks providing wholesale instruments as component parts of a product created by a third-party firm may well not.
The Consumer Duty will not apply to past business but will apply in full to products and services sold or renewed after the duty comes into effect.
It will also apply on a forward-looking basis to existing products and services, and to closed products. Firms will be expected to identify whether there are aspects of the design that could cause the product or service to breach the cross-cutting rules and deliver poor outcomes for retail consumers.
Respondents to the FCA’s initial consultation expressed concern about the proportionality and design of the new duty and potential unintended consequences.
Firms will be assessed against the standard that could reasonably be expected of a prudent firm, carrying out the same activity, in relation to the same product, making assumptions about the needs and characteristics of an average retail customer.
In practice, the “average retail customer” will vary depending on the business area, product line and service in question. This concept of an “average retail customer” does not sit neatly with the FCA’s narrative in some of its more recent guidance and enforcement notices.
Thankfully, in response to strong opposition, the FCA has reeled back on its proposal for a cross-cutting rule requiring firms take “all reasonable steps” to avoid foreseeable harm to retail customers. The spirit of the rule remains but firms are directed to focus on acting reasonably rather than on processes and the steps they take.
Firms will still be expected to conduct regular reviews and if a harm, that was not foreseeable at the outset, later manifests or becomes foreseeable, firms will need to take action to reduce the risk of this harm crystallising.
When determining whether an individual has complied with the new individual conduct rules, the FCA will apply (and will expect firms to apply as part of internal assessments) an objective standard of a prudent employee, carrying on the same activity, in relation to the same product, for the average retail customer.
Individuals that are more senior and those in customer facing / sales roles might be best positioned to influence retail customer outcomes. However, the scope and nature of an individual’s role, as well as their seniority should be taken into account in assessing what can reasonably be expected of them.
Governance and oversight
Ultimately, the firm’s board or equivalent management body will be responsible for assessing whether it is delivering good outcomes for its customers, consistent with the Consumer Duty.
Boards will need to
- consider (at least annually) the results of the firm’s monitoring of consumer outcomes as well as any evidence of poor outcomes and actions taken to address the root causes
- evidence that the firm’s future business strategy is focused on delivery of good outcomes for consumers
- think critically about how they document their assessments and how they have interpreted the FCA’s cross cutting rule as to “avoiding foreseeable harm” to consumers
Assessments may include criteria such as business persistence, pricing fees and charges, value interpretations, behavioural insights, training & competence records, customer feedback and experiences; and complaints data (including root cause analysis).
Litigation and enforcement risk
Private right of action
The FCA will not be introducing a private right of action (PROA), allowing customers to bring civil action against firms for breach of the Consumer Duty.
Acknowledged as a “polarising issue”, the FCA considers the existing framework is likely to be a more appropriate route for almost all consumers to seek redress and pursue complaints, without legal representation and at no additional cost to them. The FCA’s complaints rules already require firms to investigate complaints competently, diligently and impartially and the Consumer Duty will strengthen the requirements on firms to support customers with complaints, particularly under the consumer support outcome.
However, the FCA has left open the possibility of it introducing a PROA in the future, saying that it will keep the matter under review.
Alignment with the Financial Ombudsman Service (FOS)
Many firms remain concerned that FOS might adopt a different or wider interpretation of the Consumer Duty than the FCA,
The FCA has reassured firms that it will work closely with the FOS with the aim of ensuring a consistent view on the interpretation of the Consumer Duty. However, it remains to be seen how effective this co-ordination will be in practice. Firms may still need to reconcile inconsistent FOS decisions while the new duty beds in.
The new Consumer Duty will bring with it new and increased enforcement risks for firms and their employees. The FCA will undertake thematic / multi-firm work once the Consumer Duty has come into force, to see how it is operating in practice. These exercises often result in referrals to the FCA’s enforcement division in those cases where the FCA identifies significant shortcomings.
In line with its new approach, the regulator will be keen to use data gathered through this early monitoring to identify harm and intervene quickly, to prevent harmful practices become entrenched. In such cases, the conduct of senior managers is likely to be scrutinised.
Whilst enforcement investigations based on breaches of the new duty are unlikely to materialise for a couple of years, we expect the Consumer Duty to feature heavily in firms’ interactions with FCA Supervision and Authorisations almost immediately. For live investigations, it may also start to creep into discussions about remediation and settlement.
Driving good practice - be prepared
The FCA itself has estimated the total one-off direct costs firms may incur to comply with the Consumer Duty to be in the range of GBP688.6m to GBP2.4bn, and the ongoing annual direct costs to be in the range of GBP74.0m to GBP176.2m. This includes costs to firms to understand the Consumer Duty, perform gap analysis on their policies and processes, make relevant adjustments through change projects, train their staff on the new requirements, IT costs for any system changes and costs to monitor and test consumer outcomes. A significant transformation programme by any measure.
Senior Managers with accountability for overseeing their firm’s implementation of the Consumer Duty can expect to receive questions from the FCA about how they are approaching this project, and will face tough questions if the FCA subsequently identifies concerns that the Consumer Duty has not been implemented or applied properly.
It would be a mistake to see this new Consumer Duty solely as an exercise in driving out bad practice. For the FCA, it is just as much about driving good practice, by encouraging firms to get their products and services right in the first place.
Once introduced, the FCA intends the Consumer Duty to comprise an integral part of its regulatory toolkit, supporting its aim to become a more agile and assertive regulator and enhancing consumer protection.
Given the volume and complexity of the draft rules and guidance, firms need to give careful consideration to developing a robust programme of work to ensure they are ready for April 2023.