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Hot on the heels of its ambitious business plan for 2021/22, the UK’s Financial Conduct Authority (FCA) announced plans for a new Consumer Duty, which is intended to set higher expectations for the standard of care that firms provide to consumers. The proposals, which are due to take effect this summer, quickly became a headline topic for the UK financial services sector, generating significant, and sometimes controversial, coverage and discussion. This article explores the FCA’s plans to raise the bar for consumer protection in UK retail financial services markets.
Background and scope
The FCA’s proposals for a Consumer Duty are set out in two consultation papers (CP21/13 and CP21/36), the second of which still awaits published feedback at the time of writing. These much-anticipated consultation papers follow the FCA’s 2018 “Approach to Consumers” document, in which the regulator acknowledged the need for a clear statement of expectations which goes beyond its existing Principles.
In terms of scope, the proposals relate to products and services sold to “retail clients”, a wide term which includes financial services offered to SMEs. The plans cover all firms involved in the supply of such products and services, even if they do not have a direct relationship with the end customer.
In its second consultation, the FCA clarified that the scope of the Consumer Duty will be aligned to the existing scope of its sectoral sourcebooks, i.e. the scope of the Consumer Duty for insurance will follow the position in ICOBS, whilst for mortgages, the scope will follow the position in MCOB etc. The FCA has also confirmed that it intends the Consumer Duty to apply to prospective customers as well as a firm’s existing customer base.
Whilst the Consumer Duty will not apply to firms’ past actions, the FCA intends for it to apply on a forward-looking basis to existing products and services that are either still being sold to customers, or closed products and services that are not being sold or renewed but which customers still hold.
Why is a Consumer Duty needed?
Many firms which already comply with the FCA’s existing Principles and treating customers fairly (TCF) outcomes may well be wondering why this new Consumer Duty is needed and many have, in fact, voiced their concerns in this area. Indeed, the FCA does acknowledge that many firms already demonstrate good practices in consumer protection. However, it sees the need to go further. The regulator has noted that there are still poor practices in retail markets which lead to consumers not always getting the products and services that best meet their needs. The FCA says examples of poor practices which continue to cause consumers harm include:
- Firms providing information which is misleading or presented in a way which is difficult for consumers to understand;
- 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 being sold to;
- Products and services that do not represent fair value; and
- Poor customer service that prevents consumers from taking timely action to manage their financial affairs and making use of products and services, or increases their costs in doing so.
The FCA is concerned that such practices could lead to consumers being unable to make informed decisions which in turn may result in them buying products and services that are risky or inappropriate for their needs. It could also mean that they may find it harder to switch or get a better deal elsewhere.
One reason for the Consumer Duty appears, in part, to be an attempt by the FCA to tackle its own inadequacies. Ever since TCF was introduced, the regulator has found itself reacting to and dealing with issues that go against the TCF principles after the fact, which unfortunately has meant that consumers have often still suffered harm even if this is then remediated. The FCA’s current proposals therefore signal a change in direction for the regulator towards a “prevention is better than cure” approach—the aim of the Consumer Duty is to prevent consumer harm from occurring in the first place by requiring firms to operate above the current Principles and TCF standards.
A new Consumer Duty
So what actually is the Consumer Duty? Building on the FCA’s “Approach to Consumers” document, the Consumer Duty is a package of measures comprising three parts. A new Consumer Principle will provide an overarching standard of conduct for firms. This will be supported by a set of cross-cutting rules and outcomes which will set clear expectations for firms’ cultures and behaviours.
Consumer Principle
The FCA wants to introduce a new Consumer Principle to set a higher standard than the existing Principles 6 and 7. Principle 6 requires firms to “pay due regard to the interests of [their] customers and treat them fairly” and Principle 7 is the requirement for firms to “pay due regard to the information needs of [their] clients, and communicate information to them in a way which is clear, fair and not misleading”.
The new Consumer Principle (Principle 12) will replace Principles 6 and 7 for retail businesses and require firms to act to deliver good outcomes for retail customers (Principles 6 and 7 will continue to apply to firms dealing with wholesale or retail customers outside the scope of the Consumer Duty). The FCA has confirmed that the new Principle 12 will be: “A firm must act to deliver good outcomes for retail clients”. This places the focus on consumer outcomes and the impact of firms’ actions on consumers. The FCA recognises that the concept of a “good outcome” does not have an established legal meaning but says that the rules and guidance in the consultation papers should help firms establish what “good” means. The regulator has also stressed that Principle is not limited to delivering the “four outcomes” (discussed below) alone.
Cross-cutting rules
The FCA’s view is that firms will achieve the best consumer outcomes if they take an holistic approach. The regulator is therefore planning to introduce a set of new cross-cutting Handbook rules and guidance that will help to develop the standards of conduct it expects under the Consumer Principle.
These new rules will require the following three key behaviours from firms:
- Take all reasonable steps to avoid foreseeable harm to customers — the FCA says this applies to firms’ conduct, products and services, and moreover that firms should take proactive steps to avoid this harm wherever they can. This is about understanding consumers and not taking advantage of their vulnerabilities, behavioural biases or lack of knowledge. It is about firms making sure the information they provide to consumers is fair, does not disguise benefits and risks, and does not bury key terms in documents firms know consumers won’t read.
However, the FCA does note that many products are simply just risky and so it does not expect firms to protect consumers from risks they reasonably believed the consumer understood.
Take all reasonable steps to enable customers to pursue their financial objectives — the FCA acknowledges that consumers should be empowered to make their own choices and ultimately must be responsible for their own decisions. However, it expects firms to create an environment in which consumers can act in their best interests. Firms should use their knowledge of how consumers behave, taking into account any customer vulnerabilities, to support them in making good decisions.
Act in good faith towards customers — the FCA notes that there is generally an imbalance in bargaining position, knowledge and expertise between consumers and firms and so it is critical that firms act openly and honestly with consumers. If they don’t, consumers cannot reasonably be expected to take responsibility for their decisions.
Four outcomes
Building on the first two elements of the Consumer Duty, the four outcomes are intended to set clear expectations for firms’ cultures:
Outcome 1: Communications—“communications equip consumers to make effective, timely and properly informed decisions about financial products and services”. The FCA wants firms to consistently support consumers through their interactions with them, by giving them the information they need, at the right time and in a way they can understand. Firms should put themselves in consumers’ shoes and make sure their communications are understandable at each stage of the lifecycle. Firms will not need to verify that all individual customers have in fact understood the information but they need to have taken appropriate steps to satisfy themselves that any communications are reasonably likely to be understood by the recipients.
Outcome 2: Products and Services—“products and services are specifically designed to meet the needs of consumers, and sold to those whose needs they meet”. The FCA is concerned about products on the market that, for instance, generate a high proportion of profits from late payment fees or relending. It is also concerned about distribution strategies that are not properly targeted, for example selling packaged bank accounts to consumers for whom the benefits are unlikely to justify the price. Product providers and distributors should work to ensure that products and services meet an identified need and are fit for purpose. The FCA considers this an essential element of representing fair value to customers.
Outcome 3: Customer Service—“customer service meets the needs of consumers, enabling them to realise the benefits of products and services and act in their interests without undue hindrance”. The FCA is concerned about practices which deliberately hinder consumers from taking action that would benefit them, for instance discouraging exit from a product or service by requiring an in-person branch visit to do so. The FCA is therefore looking to firms to design pre- and post-sale processes in a way that actively take consumer needs into account. Firms should ensure they deliver customer service that meets consumers’ needs throughout their relationship with the firm.
Outcome 4: Price and Value—“the price of products and services represents fair value for consumers”. Firms should set prices so they represent fair value. Firms should be assessing this at the design stage, before they offer the benefits, and then should actively assess the costs throughout the product’s life. When considering the pricing, firms will need to be particularly aware of vulnerability and protected characteristics which might have the effect of charging certain consumers more.
Other elements
In its second consultation, the FCA provided detail on other elements of its proposals. In terms of firms’ monitoring of the Consumer Duty, the FCA expects firms to produce and regularly review MI on consumer outcomes which should be appropriate to the nature, scale and complexity of their business, considering the size of the firm, the products or services it offers and the consumer base it serves. The FCA also expects a firm’s board to deliver an annual report assessing whether it is acting to deliver good outcomes for its customers which are consistent with the Consumer Duty.
In relation to the Senior Managers and Certification Regime (SMCR), the FCA proposes to amend the SMCR individual conduct rules in the FCA’s Code of Conduct by adding a new rule requiring all conduct rules staff within firms to “act to deliver good outcomes for retail customers” where their firms’ activities fall within scope of the Consumer Duty. Where this new rule applies, the existing Rule 4, which requires conduct rules staff to “pay due regard to the interests of customers and treat them fairly” would not apply.
On timescales for implementation, the FCA considers at this stage that firms should have until 30 April 2023 to fully implement the Consumer Duty. However, it is asking for views on this timescale and, given the comments from some of the respondents to the second consultation, we anticipate this deadline being extended when the FCA finalises its rules. Firms are expected to be able to demonstrate progress when asked during this implementation period and the FCA intends to monitor firms and provide assistance where needed.
The second consultation also included non-Handbook guidance which sets out more detail for firms on what the Consumer Duty does and does not require (at Appendix 2) and which provides examples of good and bad practice on the four outcomes.
Key concerns
The regulator also used the second consultation as an opportunity to clarify and expand on a couple of the more controversial components of its proposals which had come under fire in the feedback to the initial consultation. Whilst many of the 235 respondents to the first consultation agreed with the concept of a Consumer Duty and the need for a “reset”, they did have a number of concerns, for instance about the proportionality and design of the proposals.
Private right of action
The first consultation raised the possibility of introducing a private right of action (PROA) to give individuals remedies if they have suffered because a firm breaches the Consumer Duty. The responses to the second consultation indicated that this was one of the more controversial elements of the FCA’s proposals. Most consumer organisations were in support of a PROA, whilst the majority of industry respondents were strongly against.
In light of the concerns raised, the FCA is not intending to make a PROA available for the Consumer Duty at this stage. The regulator’s view is that the existing redress framework is likely to be a more appropriate route for almost all consumers and it is working closely with the Financial Ombudsman Service (FOS) to improve awareness of the existing regime. That said, the FCA will keep the possibility of a PROA under review, including in light of the evidence it sees of firms’ embedding of and compliance with the Consumer Duty. Whether or not a PROA is introduced in the future, the FCA will be keen to weigh consumer protection against the significant risk that firms may become risk averse and thereby limit consumer choice.
Duty of care
The recently enacted Financial Services Act required the FCA, amongst other things, to consult on whether it should make general rules providing for a duty of care and therefore, in its initial consultation, the regulator sought feedback on whether its proposals amounted to such a duty. This point caused much discussion in the sector. A significant number of industry respondents voiced concerns about labelling the proposals a duty of care or even a “consumer duty” as they argued this implied a legally enforceable obligation which would hinder firms’ and consumers’ understanding of the Consumer Duty.
Following the feedback received, the FCA has clarified its position. It does not agree that the “label” Consumer Duty implies a legally enforceable obligation. The FCA has not branded the Consumer Duty as a “duty of care” nor do its proposals comprise a “one-line duty”, rather, they are a package of measures specifically designed to tackle consumer harms, and their causes, more effectively.
Other issues
Whilst the FCA may have allayed or at least addressed the concerns raised in response to the first consultation, others have arisen in response to the second consultation. For example, in its published response, UK Finance said its members have concerns about:
- The implementation period—as mentioned above, the FCA is proposing that the entirety of the Consumer Duty will apply from 1 May 2023. However, the vast majority of firms feel that nine months is too short given the need for firms to review current products, prices, policies, systems, processes and documentation and to amend and supplement them where necessary. UK Finance suggests the implementation period needs to be at least two years to allow firms enough time to comply
- Retrospection — many firms believe that it is inappropriate to apply the products-and-services and price-and-value outcomes, requiring terms and prices with which consumers agreed before the Consumer Duty came into effect to be revisited
- Interpretation by the FOS — in line with the initial consultation feedback, many firms are still concerned that the outcome-based nature of the Consumer Duty (as opposed to more detailed rules) is confusing and therefore that there is a risk that the FOS may take an inconsistent approach.
Terms and themes
The duty is a “consumer” duty. The consultations suggest that when formulating its thinking, the FCA had in mind the investment marketplace, because it suggests that when it says “consumer” it actually means someone who is a “retail customer” for the purposes of the Conduct of Business sourcebook — which is of course a term reserved only for designated investment business. In the other conduct of business modules, different terms are used, and sometimes different thresholds. However, despite this initial apparent focus on investment, it is clear that a number of the concerns that have led to the proposals come from the insurance and retail banking and lending markets, as many of the examples in the consultation papers illustrate. Moreover, the consultations are littered sometimes with references to “consumer” and sometimes to “customer”—a difference which the FCA seeks to explain by saying that when it refers to “customer” it refers to an actual, specific customer of a firm, whereas “consumer” is a term designed to include all potential customers. This is significant in the context of many of the comments made in the consultations about the suitability for products for target markets and the responsibilities of all in the distribution chain.
It is also interesting to note the stress the consultations place on specific behaviours, some of which other regulatory initiatives are already addressing. For example, there are many parallels with the recent initiatives in the insurance markets, including the most recent rules on addressing the loyalty penalty, and the FCA makes many references to “sludge” practices in certain markets—by which it means elements that will hinder consumers in making decisions which are in their best interests, such as making it hard for them to find details of cancellation rights. Whilst this has been a concern for some time, the consultation notes that the increasing use of mobile apps highlights the problem. The concerns on the clarity of communications is also closely related to the current initiatives to review the way in which financial promotions are made and approved.
What is the impact on consumers and firms?
The new measures should give consumers confidence that the financial products and services they buy represent fair value and are designed to deliver the benefits they expect. They are also designed to ensure that consumers receive clear and comprehensive information from firms to enable them to properly assess which products and services are most likely to meet their needs. That said, and as the consultation papers acknowledge, the information-intensive requirements of sectoral legislation can create a challenge, especially in the increasingly digital environment in which consumers now choose their financial products. However, what the FCA hopes is that the Consumer Duty will result in markets becoming easier for consumers to navigate online which, in turn, will hopefully drive down certain harms, for example instances of customer manipulation and scams.
What does the Consumer Duty mean for firms in practice? Does it not simply codify the good practices most firms already demonstrate in relation to TCF and consumer outcomes? Whether it does or not, there will be added burdens on firms to prove compliance with the Consumer Duty, through ongoing monitoring and testing of their processes and procedures. Firms should also be prepared to provide evidence of such compliance to FCA if required. Firms will welcome the acknowledgement in the consultations that consumers should be able to take their own decisions, but firms must provide them with all the relevant information to enable them to do so. They will also welcome the recognition that sometimes there will be poor outcomes that are not the fault of the firm, yet they will also be concerned about when, in practice, the regulator will accept a no-fault poor outcome.
Of course, it is not just UK firms that will be impacted by the measures. The Consumer Duty will extend to international firms operating, for example, via a UK branch. There is also the potential for the Consumer Duty to have an even broader reach as the FCA’s proposals may influence other financial services regulators globally.
What’s next?
The Financial Services Act requires the FCA to have made rules on the Consumer Duty by 1 August 2022. The FCA therefore intends to publish its policy statement and final rules in time to implement the proposed changes by 31 July.
In the meantime, firms should be well underway with their own planning for implementation so that they are prepared to hit the ground running when the final rules do arrive. However, whilst the rules are still in draft, the suggested focus for firms’ planning at this stage should be on those measures that are likely to become a supervisory reality, for example the proposals relating to the improved quality and clarity of customer communications. This focus will allow firms to adequately prepare for the changes whilst still retaining the flexibility needed to be able to adapt to any last-minute amendments made by the FCA.
There are clearly still significant issues to iron out and, even once finalised, there will need to be a period of bedding in but the FCA’s hope is that the Consumer Duty will put businesses and the regulator on the front foot in avoiding foreseeable harm and delivering good outcomes for consumers. Whilst the FCA’s intentions are certainly admirable, until the Consumer Duty is finalised and the tangible results of implementation are known, it remains to be seen whether prevention really is better than cure.
This material was first published by Thomson Reuters, trading as Sweet & Maxwell, 5 Canada Square, Canary Wharf, London, E14 5AQ, in Journal of International Banking Law and Regulation as Lucy Hadrill and Emma Radmore, “Prevention is Better Than Cure: The UK’s Proposals for a New “Consumer Duty”” (2022) 37 J.I.B.L.R. 257–261 and is reproduced by agreement with the publishers.
