Series 3 Episode 6: Consumer duty - preparing for a shake-up to conduct regulation

Andrew Strange:

Hi everyone, welcome back to Risk & Regulation Rundown. I'm Andrew Strange, your regular host, and in today's episode, we're talking about the FCA’s consumer duty proposals. Joining me for today's discussion are David Kenmir, who's a Partner in our Authorisations and Conduct practice, and Tessa Norman, a Manager in my Regulatory Insights team. The FCA’s consumer duty proposals represent a major shake-up in conduct regulation for all firms involved in the manufacture or the distribution of products or services to retail clients, so a really broad cohort. The regulator issued a second consultation on its proposals in December at the end of 2021. While we don't have the final rules yet, it did give us a very clear direction of travel, and certainly will hold firms to greater account to deliver good outcomes for retail clients. Now Tessa, we covered some of this in a previous podcast episode last year, around the time of the first consultation, so do you just want to start off by giving us some reflections on the proposals in the second paper from last year?

Tessa Norman:

Absolutely, I'll just start by giving a very brief recap on what it is that the FCA is proposing. It's proposing to introduce a new principle, which would require firms to act to deliver good outcomes for their retail clients. That's going to replace two of the existing principles, 6 and 7, so the TCF principle and the one around communicating in a way that's clear, fair and not misleading. That's going to be underpinned by three cross-cutting rules, and then four of what the FCA calls consumer outcomes, so basically the really key aspects of the customer relationship. There were a couple of changes between the first and the second consultation. The FCA removed a proposal around introducing a private right of action. Firms were really pleased to see that, but there's still quite a lot of challenges in what the FCA is proposing.

Overarching thoughts on what the FCA is proposing - this is partly an evolution from where we've been before. We've had TCF since 2006, and since then the FCA has carried out a lot of work, which has built on that. It’s done work on culture, and we've had the vulnerable customers guidance in February 2021, plus we've seen quite a lot of an increasing focus on things like product governance, and price and value. I think it is quite interesting to look back at those TCF outcomes. You could be forgiven, if you look back at that wording, for thinking, is this really a significant change? The FCA has described this as a paradigm shift, and there are certainly some areas where there is a distinct difference from the current rules. There are a lot more onerous proposals around how firms monitor consumer outcomes, how they evidence that to the regulator. The new value assessment is going to be quite a new requirement for a lot of firms, that's going to feel quite different. In lots of areas, the FCA is basically putting more onus on firms to help consumers get good outcomes. It's more of a recognition of the barriers that consumers face to acting in their own interest.

In a lot of places, the FCA is working to make its rules consistent across all sectors. Certain sectors have been subject to more scrutiny than others on certain things, so the price and value piece being a good example there. In some areas, although what the FCA is proposing isn't radically different, it's clear the FCA isn't happy with how some firms are complying with current rules, the fact the FCA feels the need to introduce this, the fact it is describing it as a paradigm shift, I think suggests the FCA is not quite happy with how firms are complying in certain areas.

Andrew:

I'd agree, the value assessment is something that some firms are used to, it's good the asset managers are ahead of the curve for once, it's unusual. David, you're an ex-senior regulator, broadly is this an evolution of TCF, and we're dating ourselves thinking about TCF when that came around about 15 years ago, or is this more revolutionary in its approach, and is it the paradigm shift that the FCA and Tessa just referenced?

David Kenmir:

It is probably a little bit of both. As Tessa said, it is a natural evolution. She mentioned TCF, she mentioned a number of other things. I could cite the conduct risk agenda that Hector Sants launched, you’ve also got all the action that Chris Woolard and Andrew Bailey took in relation to the payday market and the high cost short term credit, all of which was around delivering better customer outcomes. Obviously, as we've seen with Nikhil Rathi coming into an organisation that's under some pressure, partly because of operational issues, and partly because of past scandals, he's clearly very keen to put his own stamp on the FCA’s consumer protection agenda. This really in consumer protection is the flagship initiative on which the FCA is going to be judged for the next few years. Firms should very much expect to see it in their, both strategic and day to day supervisory engagement with the regulator.

Andrew:

That's true, and we will come back to that. Tessa, what kind of response have you heard from firms or from the industry on this, do they agree with David's view?

Tessa:

We are hearing a really broad range of views actually from firms, which is interesting. You've got some firms, who are in the camp of thinking ‘oh, this is just TCF plus a bit more,’ and they think that they are broadly already complying with it, and that they don't have a huge amount to do. Then, at the other end of the spectrum, there's plenty of firms who are really concerned about this. I mentioned that there were a few changes between the first and second consultation that firms were pleased to see, but even despite those changes a lot of firms recognise the scope and significance of this. Firms are concerned about it.

There's a couple of areas that come up again and again when we're speaking to firms about this. The monitoring requirements that I touched on earlier, that's a really big concern for firms. Firms are hoping to get a bit more clarity from the FCA on that in terms of exactly what the FCA expects, and how the proposals are going to apply to existing products and services and to closed products, is also a pretty big concern for firms. This is going to be a significant undertaking. Firms are going to have to review their product terms across every single product. If you are a large firm with a big back book, that's quite a big undertaking.

This is an example of a principles-based proposal, and whilst there are some positives in that for firms in terms of it gives them a bit more flexibility in how they apply it, it does mean that firms are going to have to make some pretty big judgment calls. There are lots of different concepts and terms within these rules that firms are going to have to interpret for themselves, for example, what does fair value mean, what’s an unreasonable barrier to a consumer accessing their cash, and what is a good outcome? Firms are going to have to define that for themselves, and lots of firms are struggling with that.

There are also things like a concept of proportionality, which the FCA talks about, which runs throughout the proposals, and that means that for firms who don't have a direct relationship with the end customer, so asset managers being a good example, the FCA wouldn't expect as much of them as it would fit for those with a more direct relationship with the customer. But firms are struggling a bit with what exactly does that mean for them? Again, when you've got multiple firms in the distribution chain, where exactly does each firm's responsibilities start and end? For some of the other firms, so thinking about life insurers, pension providers, where they're not having that really regular interaction with customers, as banks would do, they're thinking about some of the challenges around, do they know their customers well enough, do they have a good enough understanding of their customers’ needs, and will they be able to get enough engagement with their customer? So thinking about the proposals around communications and consumer understanding, that's potentially a big challenge. Bearing all that in mind, the current nine-month implementation period is a major challenge for a lot of firms. For many, that's actually their biggest concern over and above the substance, is just how are they going to be able to get all this done within nine months?

Andrew:

Yeah, I agree and the consumer engagement bit is not new and it's something that firms and the regulator have struggled with for decades. It's interesting as well, you saying about the proportionality concept and the fact that asset managers therefore as a product manufacturer might be slightly less hit. If you look at their compliance with some of the PROD rules that the FCA put out a report on last year, I don't think the results are necessarily brilliant. So I don't think they can afford to rest on their laurels assuming they're doing the right thing at the moment. There's lots of messages there. I'm sure firms have played those back into the regulator, because this is a consultation paper, it closed in mid-February.

What should firms be doing now, so it's a consultation paper, can they afford to sit back and do nothing, or are there steps they can take now in terms of preparing for this, what do you think Tessa?

Tessa:

So certainly some firms are waiting till we get the policy statement, and usually firms would wait for that before they embarked on a costly change programme, but this is a little bit different for a couple of reasons. Firstly, this is the second consultation paper we've had. So the FCA has already had a lot of industry feedback. A lot of firms feel and we probably agree that the FCA is unlikely to make really significant changes from the second consultation. I am sure there'll be some tweaks and hopefully a bit more clarity, but we've got a pretty clear direction of travel.

The other point is, as I've mentioned, these changes are really wide ranging, they're significant, and we've only got nine months. For lots of firms, they are thinking about, are there any no-regret actions that they could take now or between now and the policy statement. Most firms are carrying out a gap analysis at this stage as you’d probably expect, but some of the actions that firms are thinking about that they could take at the moment are things like defining what a good outcome would mean for them and for their customers. They need to think about doing that on a product by product basis. So maybe taking a couple of example products, thinking about what does a good outcome look like, and then thinking about how they're going to evidence that. So what data and metrics would you need, what have they already got, what additional data are they going to have to gather, so that’s helping them take those initial steps towards the monitoring requirements. Also, thinking about whether there's any priority products or services that they can identify now where they might have to make changes. So without doing a wholesale review of all your products at this stage, are there any particular products where firms have got an inkling that actually in the FCA’s eyes, they might see the pricing or the terms as not meeting the FCA’s expectations on fairness.

Identifying any priority products there and doing the same on sludge practices, so any unreasonable barriers in the FCA’s eyes, the FCA is particularly worried about things like complaints and claims. Another really helpful step that firms can take at the moment is to reflect on some of the work they’ve hopefully already done to comply with the FCA’s vulnerable customers guidance, as there is quite a lot of overlap. There should hopefully be some learnings that firms can take from that, they could potentially reuse any frameworks or models they've introduced there. Things like, if they've introduced a framework for monitoring outcomes for their vulnerable customers, is there something they can reuse from that, any work they might have done to gain a more detailed understanding of their vulnerable customers’ needs, could they apply that to their broader customer population, or perhaps they’ve developed tools to assess the impact that a product might have at the design stage. There should definitely be some learnings that firms can take from that.

Andrew:

Yeah, it's interesting, because you're right, there is overlap between things like vulnerable customers or value assessment in these particular areas. Firms are taking some steps to prepare themselves. Are we seeing the FCA make any public pronouncements about this or is it beginning to apply this focus on consumer outcomes in its approach as well?

Tessa:

We've seen a few things publicly, so although it was a little while ago now, it's worth reflecting on the latest business plan, that was from July 2021 and that makes clear that some of the concepts that underpin the duty are already central to its approach. That business plan talked about things like disclosures that enable consumers to make effective investment decisions. It talked about sludge practices, fair value in the digital age, which has been one of its business plan priorities for a couple of years now. In a few areas, we're seeing the FCA reference the consumer duty as being part of its solution for other initiatives. The consumer investment strategy piece is a good example there of where the FCA has listed consumer duty as a reason for perhaps why it's not introducing some more interventions, because it knows that that's coming and that's going to address some of the issues that it’s seeing in that market.

In the retail banking space, there was an interesting update recently. In January 2022, the FCA gave a bit of an update on its review of retail banking business models. It said it’s found that competition is increasing in retail banking, but it was highlighting that that competition might not always deliver the same benefits for all customers. It said it's going to continue to challenge firms to meet the needs of those customers, and that it is monitoring how banks are implementing any new charging structures or business models to make sure that charges aren’t falling disproportionately on low income consumers or vulnerable customers, and also that firms aren't reducing the services that they offer to those customers. That's quite an interesting one in terms of current supervisory work and how some of this thinking is already feeding in.

Andrew:

David that plays to your point that actually this is a big key priority for the regulator and for Nikhil going forward as well. So it is permeating a number of policy areas at the moment, are you seeing it begin to come through in any of the FCA interactions that our clients are having?

David:

Yeah, if it's okay, I'll touch both on firms and SMFs. As you know, I often get dragged in when firms have got some sort of tricky situation with the FCA. I've seen several letters now, where as part of the FCA asking the firm to deal with a tricky situation, they are specifically saying, ‘look, and can you bear in mind you need to look at this through a consumer duty lens.’ That's quite interesting, not least because it's supposed to be a forward-looking agenda, but it is very much reminding management teams and boards that actually they need to have it as part of their thinking. Related to that and building on Tessa’s point about no-regret actions, typically the larger firms need to make sure that boards and their executive level SMFs are briefed on consumer duty, because it's going to start coming up in face-to-face meetings or virtual meetings between regulators and those SMFs. The FCA will expect them to have an answer as to what the firm is doing to prepare and what they're doing within their reasonable steps framework or perhaps thinking about doing in future.

Andrew:

Okay that is interesting, because when you're brought into tricky situations on occasion, some of those are historic, so firms have had some problems or have discovered something that has not gone entirely right, is there a retrospective element to this you're seeing as well?

David:

I would say there's an element of ambiguity in the letters. What the FCA is nudging the firms to do, is to make sure that the outcomes they deliver in relation to whatever the tricky issue is, are customer centric, and are aligned at least at a principle level with what the FCA is trying to get at through consumer duty.

Andrew:

Tessa’s talked about some of the actions firm can take now as we're heading towards final rules, we’re not expecting the policy statement until July time this year in the summer. What actions are firms going to be looking at from July onwards, David?

David:

Well, to some extent, it will be dictated by the rules obviously, but when I speak to people in the industry, when I speak to our competitors about what's going on, there's a number of themes that come up. First of all, what changes to products, services, communications, processes, and procedures need to be made. Those are both external facing ones and internal facing ones, presumably everybody's code of conduct training is going to have to be updated to reflect consumer duty going forward, to give you an example. Maybe some contract reviews to make sure the contracts balance the legal needs of the service or product provider, but also the consumer duty angle, and making sure that contracts are clear and intelligible, and that's always a difficult thing. Testing outcomes, both in terms of customer understanding of products, which is key and goes to the product marketing thing I was alluding to, but also, testing customer outcomes. When I look across the clients I work with, they tend to be pretty good at testing whether the process works, and therefore they can pick up, did they send that document to the customer, did they therefore comply with an MCOB rule or a CCA provision or whatever it might be. What they're less good at, because actually it is quite difficult, is testing individual customer outcomes over the lifecycle of the product, which is particularly challenging of course, when as you were alluding to earlier, some of the pension products and so on, are 10, 20, 30, 40, 50 year products. Then linked to that, changes to MI, how do you make sure your executive team and your board are properly informed around the outcomes you're delivering, because if you go back to my starting point, if you aren't delivering the outcomes, you're not delivering what Nikhil wants, and that's going to come back and bite you through supervision or enforcement.

Andrew:

Are we seeing individual SMFs actually being accountable for this, is it being built into people's job description, role description, and their profile and things like that?

David:

It will have to be. I can’t remember, Tessa you might remember, in the detail of the rules, if there are new prescribed responsibilities or whatever, but whether there's something built into the plumbing of the rules or not, absolutely it’s got to be built into the accountability framework that goes with SM&CR.

Tessa:

Yeah, the FCA is not taking a very prescriptive approach to the governance around this. Senior managers will be accountable for each aspect of it, it makes that clear, but it's giving firms some flexibility in terms of how they set up the governance and accountability around it. That process is going to be really crucial: what process have you got for identifying issues and taking action to address them once you spot them in your MI. Hopefully, the FCA won't expect things to be perfect, but it will expect firms to be able to identify problems at the right level and to take swift action.

Andrew:

You would hope maybe that there's an element of this being iterative, because it is going to take firms a while to get their heads around it and to develop their approaches. David, in terms of the FCA’s supervisory approach to this, how is this going to feel different for firms, do you think?

David:

Well, I think initially it'll be more that they will perceive different language, so either in their annual supervisory letters for the larger firms or in their interactions, the FCA will start talking about consumer duty more and TCF less. What's really interesting is, when the rubber hits the road, when the supervisors are out asking for information and so on, are they going to see things look different to how they looked in a TCF world. Going back to my points about outcome testing, about the way people think about customer documentation and think about products, that's the sort of thing the FCA is going to be looking for. Look, in the longer term, if and when an issue arises, we all know that the FCA and the PRA assert that you’ve breached a principle rather than rule, and that's because, almost without exception, the principles are more subjective, and therefore they give the FCA or the PRA more flexibility in the judgement about what they bring action against. We will see, perhaps in 3, or 4, or 5 years, the first consumer duty-led enforcement action coming through against the bigger firms. We might see it earlier in smaller firms, because they tend sometimes not to have as much money to fight or whatever, but we should expect to see that coming through in the longer term.

Andrew:

If we're seeing this as such a significant development, is there a broader market impact that we might see from this?

David:

Well look, I hope not. Ultimately, the FCA is accountable to Parliament for its statutory objectives. I'm sure consumer duty will be effectively something that was discussed when Nikhil was being appointed. The difficulty with all types of regulation is the unintended consequences. None of us will want to see less innovation in the market. None of us will want to see greater financial exclusion. The question which none of us know the answer to quite yet is, to what extent will firms’ risk appetite change, because of the uncertainty around how this will be operated in practice. It's important that all stakeholders keep an eye on that, because the FCA is well intentioned, but it is the unintended consequences that always come back to bite you.

Andrew:

I agree. Okay finally, let's end on a positive note. Tessa, I will come to you first, how can firms embrace the opportunities that this presents, and not just see this as a fairly substantial compliance exercise and cost?

Tessa:

Absolutely, my main message here would be for firms to think about this as part of their broader strategy and purpose, and the FCA has certainly said in its messaging that it wants firms to really embed this in their culture, in their business model, and not just see it as a compliance exercise. There are some important links here between the consumer duty proposals and another initiatives and priorities from government and regulators. There's a link to the diversity and inclusion agenda, as we've talked about, there's an overlap with vulnerable customers and also related to that, the work around inclusion and accessibility. It makes sense for firms to think about this in the round.

Really regulators are looking for firms to embrace quite a fundamental change. When you put all that together, it wants to see businesses that are more representative of the societies that they serve, firms which design inclusive products and services, which improve consumer outcomes and meet the diverse needs of their customers. There was quite an interesting line in the first consultation paper, where the FCA says it wants to see firms starting from a position of identifying the customer needs that they can profitably serve, rather than starting off by thinking about what products and services they can profitably sell. It's about that mindset change really, and hopefully moving more to a place where firms are making money from solving society's problems and from meeting consumers’ needs rather than inadvertently creating problems. There is a real opportunity for the industry to embrace this, they’ve shown through the pandemic that they can be part of the solution rather than part of the problem as they continue to move out of the long shadow of the financial crisis. If they really engage with this purpose, they'll find that it can deliver benefits as well, things like more motivated staff, improved customer engagement, and improved decision making, and that profit and purpose can go hand in hand.

Andrew:

Thank you Tessa, and David can you build on Tessa’s wonderful vision of the future anymore?

David:

I wonder if there's a way of linking up consumer duty and ESG. Actually going back to something that Tessa said, going right back to the purpose of organisations. If organisations think really creatively about this, there's a way of almost changing the purpose of an organisation or at least changing the description of the purpose of an organisation, changing the way you market both individual products, and more generally, how you promote your brand. If you think about some of the subjects we've touched on, there's a link between consumer duty and good environmentally friendly products in the financial services market, there's a link to social inclusion, diversity and inclusion, and there's good governance sitting over both ESG programmes, and consumer duty programs. So I think here's some really innovative thinking that can go on about how you link up consumer duty with your existing ESG programme.

Andrew:

That's a really interesting point, thank you.

Well, thank you both for joining us today, that was a really interesting discussion. For me, there were a number of takeaways. Given this is a really high priority issue for the regulator, there is the risk of an expectations gap in terms of what we're hearing from senior regulators, from supervisors and some firms as well, so I think there is a lot to do. I am very taken by the breadth and the nuanced impact on individual firms depending on who they are, so those people with legacy systems and back books, who’ve had acquisitions in the past are probably in a very different place to some of the tech-enabled new entrants, for example. I think that each firm probably needs to think about this in their own way. Then, the final takeaway from me is: 9 months. If we get the final rules this summer, and then, it’s an April 2023 implementation date, that is not long. No regret actions aside, there's an awful lot for firms to do.

To our listeners, I really hope you've also found this conversation interesting and informative. Please subscribe to future episodes and rate and review this series. I look forward to our next episode next month.