Q&A: FCA Consumer Duty
This Q&A contains important information on the new rules made by the Financial Conduct Authority (“FCA”) in the following publications:
- FCA Policy Statement: A new Consumer Duty.
- FCA Finalised Guidance: FG22/5 Final non-Handbook Guidance for firms on the Consumer Duty.
These new rules will come into effect from 31 July 2023.
If you wish to contact us about any items in this Q&A please feel free to reach out to us, Mike Booth (Mike.Booth@MJHudson.com) / Vasco Vicini (Vasco.Vicini@MJHudson.com).
The following Q&A is not exhaustive and is focused on businesses in the investments space and should be read alongside the Policy Statement and Finalised Guidance. To download the PDF version of this Q&A, please click here.
The FCA is of the view that risky investments are still too often finding their way into the hands of investors for which they are not suitable.
In addition, the FCA is concerned that there is a general market failure where investors are not making rational decisions based on the information presented to them as part of the investment journey.
In the context of the “cost of living crisis” this will become particularly important as consumers face increasing pressures. Therefore, it is vital they make informed, effective decisions and firms support them to make decisions that are in their best interests, considering financial objectives and priorities.
In the context of the investment business that MJ Hudson supports, it is important to note that the rules will impact the following types of activities:
- making financial promotions with respect to services (e.g. investment advice, discretionary management, etc) or investment products (e.g. funds, specific securities, etc) to Retail Consumers;
- receiving and transmitting orders in connection with public or private market investments involving Retail Customers;
- providing personalised or non-personalised recommendations to Retail Customers;
- managing funds where the investors are Retail Customers; and
- distribution of financial promotions or the intermediation of investment services, where the end client is a Retail Customer e.g. a platform provider.
In relation to the new Consumer Principle, a Retail Customer is a person that is not a Professional Client. The definition includes prospective as well as actual customers. This would include persons such as High Net Worth Investors, Certified and Self-Certified Sophisticated Investors and ordinary Retail Clients.
The headline Consumer Principle is contained in a new Principle 12 – “A firm must act to deliver good outcomes for Retail Customers”. This is further defined and refined in PRIN 2A which has the following key sections (relevant Q&A):
- overriding purpose (4.1);
- cross cutting obligations (4.2);
- products and services (4.3);
- price and value (4.4);
- consumer understanding (4.5);
- consumer support (4.6);
- governance and culture (4.7);
- monitoring of customer outcomes (4.8);
- redress or other appropriate action (4.9); and
- sale and purchase of product books (4.10).
This requires firms to act to deliver good outcomes for Retail Customers. The new Principle is “outcome focused” and intended to go beyond Principle 6 (treating customer fairly) and 7 (paying due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading).
The FCA does not expect firms to protect their customers from risks that they understood and accepted. Instead, the FCA expect consumers to only take responsibility for their actions, if they have the information and support they need to be able to make informed decisions.
The cross-cutting obligations apply to all types of activities and include:
- act in good faith: described under the rules as a “standard of conduct characterised by honesty, fair and open dealing and acting consistently with the reasonable expectations of Retail Customers”;
- avoid causing foreseeable harm: a firm could cause foreseeable harm through its action, or by failing to act either in its direct relationship with a customer, or through its role in the distribution chain. This does not mean that the Duty makes firms responsible for the activities of other firms or requires them to oversee the actions of others in the distribution chain. But where a firm can reasonably foresee harm to a Retail Customer, it should act where it can and raise any issues with other relevant parties. Therefore, monitoring and regularly reviewing outcomes is essential to prevent causing foreseeable harm; and
- enable and support Retail Customers to pursue their financial objectives: the requirement for firms to enable and support customers to pursue their financial objectives does not remove customers’ responsibility for decision making or, prevent customers from making decisions that are not in their interests. Customers should best understand their own circumstances including their financial needs and objectives. However, the FCA expect firms to take responsibility for establishing an environment in which consumers can act in their own interests.
Notwithstanding the above, it is important to note the following caveats:
- pursuing commercial interests: Acting in good faith does not mean a firm is prevented from pursuing legitimate commercial interests or seeking a profit, provided it does so in a manner which is compliant with Principle 12;
- not a zero-risk framework: foreseeable harm does not include situations where the harm identified was caused by risks inherent in a product, provided the firm reasonably believed that Retail Customers or the relevant Retail Customer (as the context requires) understood and accepted those risks; and
- capturing information from customers: Enabling and supporting Retail Customers to pursue their financial objectives does not mean that a firm is expected to go beyond what a prudent firm carrying out the same activity in relation to the same product, taking appropriate account of the needs and characteristics of Retail Customers, would do. For example, it does not require firms to go beyond what is reasonably expected by Retail Customers in the delivery of the product.
The obligations above apply at all stages of the customer journey and during the whole lifecycle of a product.
All products and services that are sold to Retail Customers should be fit for purpose. They should be designed to meet their needs and targeted at those whose needs they are designed to meet. This is an essential requirement for products and services to represent fair value for Retail Customers.
NB: In the context of investment business, many firms must or choose to comply with PROD. Therefore, for most investment businesses they will not need to comply with PRIN 2A.4. Therefore, we haven’t explained this section in any detail within this Q&A. If you wish to receive our template PROD Policy please reach out to us.
Value is about more than just price, and the FCA want firms to assess their products and services in the round to ensure there is a reasonable relationship between the price paid for a product or a service and the overall benefit a consumer receives from it.
To assess if a product or service provides value, firms must consider at minimum the following:
- assess if a product or services provides value by considering elements such as the nature of the product or service, any limitations of it, the expected total price customers will be including all applicable fees and charges;
- when performing value assessments, firms should also consider factors to demonstrate that the price paid is reasonable compared to the benefits, e.g. costs firms incur to manufacture or distribute the product, market rates and charges of comparable products, etc;
- conduct customer research, testing or use of internal data to assess fair value;
- take action where a product or service does no longer provide fair value;
- assess value at the design stage but also throughout the lifecycle by monitoring; and
- if a product or service has no financial cost, firms should still consider if their customers are incurring in non-financial costs, if so, then the FCA will not expect firms to do a value assessment.
NB: In the context of investment business, many firms must or choose to comply with PROD. Therefore, for most investment businesses they will not need to comply with PRIN 2A.4.
Firms’ communications should consistently support consumers by enabling them to make informed decisions about financial products and services. Consumers should be given the information they need, at the right time, and presented in a way they can understand.
In supporting the understanding of Retail Customers through its communications, a firm should:
- explain or present information in a logical manner;
- use plain and intelligible language and, where use of jargon or technical terms is unavoidable, explain the meaning of any jargon or technical terms as simply as possible;
- make key information prominent and easy to identify, including by means of headings and layout, display and font attributes of text, and by use of design devices such as tables, bullet points, graphs, graphics, audio-visuals and interactive media;
- avoid unnecessary disclaimers; and
- provide relevant information with an appropriate level of detail, to avoid providing too much information such that it may prevent Retail Customers from making effective decisions.
Firms must also:
- ensure that the medium of communication is appropriate;
- test consumers’ understanding; and
- if asked, provide information to other firms in the chain to enable them to comply with these obligations.
Firms should provide a level of customer service that meets consumers’ needs throughout their relationship with the firm. Customer service should enable consumers to realise the benefits of the products and services they buy and ensure that they are not hindered from acting in their own interests.
Firms should ensure that the interests of their customers are central to their culture and purpose, embedded throughout the organisation. The rules require firms to ensure their strategies, governance, leadership, people and policies lead to good outcomes for consumers. This means that it is expected that a firm’s board, or equivalent governing body, review and approve whether the firm is delivering good outcomes at least annually. This review should consider results of the monitoring undertaken by the firm on the product and service, an overview of the actions taken to address any risks or issues and how the firm’s future strategy is consistent with the principles.
Culture is critical to delivering good outcomes and there are four drivers of culture which firms are expected to place at the heart of each driver:
- Purpose: the firm’s purpose should be consistent with the Consumer Duty.
- Leadership: the firm’s leaders should be competent and accountable, and they should demonstrate commitment to delivering good outcomes for customers.
- People: delivering good outcomes for customers should be reflected in the way in which people are managed and rewarded.
- Governance: the firm’s controls and key processes should be set up in a way which enables it to identify where the firm is not delivering good outcomes for its customers, and it should have a strategy in place to understand and tackle the root causes, managing and mitigating poor outcomes.
A firm’s governing body is required to review and approve the firm’s assessment of whether it is delivering good outcomes at least annually. The firm has to gather meaningful data and MI to assess outcomes. This takes place through the firm’s monitoring of customer outcomes, which expects firms to:
- identify and manage any risks to good outcomes for customers;
- spot where customers are getting poor outcomes and understand the root cause;
- have processes in place to adapt and change products and services, or policies and practices, to address any risks or issues as appropriate; and
- be able to demonstrate how they have identified and addressed issues leading to poor outcomes.
Key to effective monitoring is data. What data or information should firms gather to monitor outcomes? Whilst complaints data is a valuable source of information, firms are expected to develop strategies and methodologies to collect MI which goes beyond complaints data. Examples can include customer support data, transaction data, sludge audits, outcome from focus groups, etc.
Firms must be able to identify poor outcomes and take appropriate action to rectify the causes of the poor outcomes.
Where poor outcomes are identified, firms are expected to intervene by:
- adapting, amending or discontinuing a product or service;
- adapting product or service design, fees or charges;
- making appropriate changes to the firm’s operations;
- updating customer support processes or distribution channels;
- modifying communications to make them more easily comprehensible; and
- providing redress where customers have suffered harm (where appropriate).
It is expected the governance process behind how decisions regarding appropriate action or interventions are taken and firm’s board, governing bodies, engage in key decisions aimed at pursuing good outcome objectives. Firms need to explain how they reached a decision and demonstrate how that intervention has delivered better consumer outcomes.
N/A for investment business.
The FCA hopes the new Consumer Principle will fix these issues and advance their consumer protection and competition objectives by:
- setting higher and clearer standards by requiring firms to ensure their products and services are fit for purpose and offer fair value, and to help consumers to make effective choices or act in their interests;
- focusing on outcomes, the Consumer Duty will help to ensure that the level of consumer protection is both appropriate for the environment in which consumers currently transact and for those in which they will transact in the future;
- supporting a more agile and assertive supervision so to prevent harm before it arises and that, where harm occurs, it is addressed more effectively;
- creating a fairer and more consumer-focused playing field on which firms can compete and innovate in pursuit of good outcomes; and
- acting in the interests of consumers through the design of products and services which meet consumer needs.
These are codified in two places:
- Principles for Business (PRIN): The Consumer Principle will be a brand-new 12th Principal for Business – “A firm must act to deliver good outcomes for Retail Customers”. The FCA expects its Principles for Business to guide all the activities that it undertakes.
- Conduct Rule (COCON): The FCA has added additional, 6th, Individual Conduct Rule – “You must act to deliver good outcomes for Retail Customers” relevant to directly authorised firms which are subject to the Senior Managers and Certification Regime (“SMCR”).
No, it does not mean that.
Customers should best understand their own circumstances and financial needs and objectives, the requirements do not remove their responsibility for decision making or prevent them from making decisions that are not in their interest. The Guidance makes it clear that, while firms should empower customers to make choices for themselves, customers remain ultimately responsible for their decisions and actions, but firms must understand and take into account behavioural biases and the impact that vulnerability can have on consumer needs and decisions.
No, the FCA has made clear in PRIN 2A.1.11 G that “it does not create a fiduciary relationship where one would not otherwise exist nor require a firm to provide advice or carry out any other regulated activity where it would not otherwise have done so”.
The scope of Principal 12 and PRIN 2A is with respect to activities carried on with Retail Customers located in the United Kingdom unless the rules governing the activities apply irrespective of the location of the Retail Customer.
Examples of how this may work in practice would include:
- Financial promotion: the UK’s Financial Promotion rules apply to the extent that the promotion is capable of having an effect in the UK. This would mean if a firm were merely sending promotions to persons located outside the UK with respect to products located outside the UK, it may not fall within the Consumer Duty rules.
- Advisory contract with non-UK person: If a UK firm provides a service (e.g. advisory, arranging of deals or managing an AIF with non-UK investors) to a non-UK person it is often the case that the rules are agnostic of location of the client and therefore the Consumer Duty rules would apply.
The Consumer Duty is underpinned by the concept of reasonableness which is an objective test. The obligations on firms will be interpreted in accordance with the standard that could reasonably be expected of a prudent firm carrying on the same activity in relation to the same product and services, taking appropriate account of the needs and characteristics of customers in the relevant target market.
This includes (amongst other things), paying appropriate regard to:
- the nature and scale of characteristics of vulnerability that exist in the relevant target market;
- the impact of these characteristics on the needs of customers in the target market; and
- the needs and characteristics of that customer.
What is reasonable will depend on a range of factors reflecting a firm’s role in the distribution chain and its ability to determine or materially influence the outcomes customers receive.
Firms will need to apply the Consumer Duty to new and existing products and services that are open to sale (or renewal) from 31 July 2023. However, the FCA have given firms longer, until 31 July 2024, to apply the Consumer Duty to products and services held in closed books.
The rules are extensive and the time to plan is now. These are the key dates:
- 31 October 2022: Implementation plan should be approved by the board / executive committee of the firm
- 30 April 2023: Manufacturers review existing products and share information with Distributors
- 31 July 2023: Consumer Duty live for existing and open products and services
- 31 July 2024: Consumer Duty live for closed products and services, that are no longer offered
- 31 July 2024: First annual board attestation
The table below shows examples of poor practice identified by the FCA (with the exception of those indicated by a *) during the review:
Products and Services:
- Some products that were designed, either intentionally or through insufficient consideration of consumer outcomes, with aspects that exploit behavioural biases. For example, the FCA have seen complex investment products where the complexity disguises high risks, high costs, or poor prospects of the product delivering a return commensurate with the risks and costs.
- The FCA saw products designed with features which can deter customers from acting in their best interest. This included online services where there is a lack of clarity on whether customers are purchasing products on an advised or non-advised basis, unreasonable exit fees preventing customers from getting better deals or leaving products which are no longer right for them and practices or contract terms which discourage exit such as requiring customers to go into a branch to close a product or cancel using registered post services.
- The FCA identified weaknesses in the design and governance of some structured products with products designed without due consideration of customer needs, characteristics and objectives and were of limited value to the customers they were sold to. This was caused by inadequate testing of product performance, inadequate consideration of a product’s value compared to alternatives and distribution strategies based on factors deemed to be attractive to customers rather than seeking identified needs, characteristics and objectives.
Price and Value
- The estimated expenses of the fund over its life are higher than the expected gross IRR disclosed to investors. In such situations, it is unlikely that investors will receive a return on their investment commensurate to the risks that they are taking.
Consumer understanding
- Mandatory disclosures require firms to produce a summary of their products including main features and risks. Firms have discretion on which features and risks they want to highlight and also how they will be explained. The summary is produced without considering the Consumer Duty which includes requirements under the consumer understanding outcome. The summaries are complex and full of technical terms and jargon making it difficult for consumers to gain product understanding and therefore assess whether it meets their needs.
- The FCA has seen cases where firms have sent a single and very long communication to all customers covering a range of issues with customers left to work out which bits of the communication are relevant to them. The FCA states that firms should consider segmenting or target communications to make them more relevant to their recipients rather that a ‘one size fits all approach’. This will not affect all communications just those where there are information needs for different groups of customers.
Consumer Support
- A firm used an automated telephone system for customer support however this system can only provide options to progress with queries on a few commonly raised issues with no route for customers to seek support regarding other issues. As a result, customers are unable to obtain needed support or information on how to pursue the issue further.
- During the FCA’s work on the Coronavirus Tailored Support Guidance they identified some firms using digital tools when providing financial help. The FCA discovered some ‘sludge’ practices which add friction to a customer journey and can prevent customers from pursuing their financial objectives. The practices include customers using third party digital tools having to register and log on more than one system to complete the automated forbearance journey and customers having to select multiple boxes to reveal additional text to help decision-making.