The FCA is proposing to set higher expectations for firms operating in retail markets.
By Andrea Monks, David Berman, Jon Holland and Charlotte Collins
On 14 May 2021, the FCA published a Consultation Paper (CP21/13) on introducing a new Consumer Duty. This consultation is intended to fulfil the FCA’s new statutory obligation to consult on whether or not to introduce a duty of care in financial services.
Rather than a standalone duty, the FCA is consulting on a package of measures, including a Consumer Principle and supporting rules and guidance (referred to collectively as the Consumer Duty). While some may consider that the proposed new Principle would not add much (or anything) of substance to firms’ existing obligations, the FCA considers that it would nevertheless be helpful to its stated desire to hold firms to a higher standard. In practice, additional expectations are most likely to be set by the accompanying more granular rules and guidance. Although the FCA has not proposed drafting for these rules and guidance at this stage, the regulator is seemingly planning to use this opportunity to advance several aspects of its retail-sector work relating to, for example, customer communications, product governance, and the treatment of vulnerable customers.
What is proposed?
The FCA is proposing to introduce a new Consumer Principle, which would likely constitute an additional Principle for Businesses. This would be a high-level obligation, and much like the existing Principles, firms would need to use their judgment to consider how the Principle might apply in any given situation. The FCA is consulting on two options:
- A firm must act to deliver good outcomes for retail clients.
- A firm must act in the best interests of retail clients.
The FCA is hoping to drive a change of focus such that firms will more proactively take consumer outcomes into account as part of their activities. The FCA considers that the new Principle would go beyond Principle 6 (“A firm must pay due regard to the interests of its customers and treat them fairly”). However, its scope would be limited to what could reasonably be expected of a firm carrying out its particular role (e.g., a firm with a very limited role in a distribution chain might not be expected to ensure that a client receives a good outcome overall).
The FCA is also proposing supporting rules and guidance to expand on the Consumer Principle, in the form of “cross-cutting” rules and a set of four outcomes. The cross-cutting rules would require firms to:
- Take all reasonable steps to avoid causing foreseeable harm to customers. The FCA emphasises that this does not mean firms are expected to avoid any type of negative outcome (e.g., a customer may suffer a loss from investment risk, which is acceptable if the customer has understood and accepted that risk).
- Take all reasonable steps to enable customers to pursue their financial objectives. The FCA expects firms to establish an environment in which consumers can act in their own interests. As part of this, firms will need to consider behavioural biases and vulnerability.
- Act in good faith towards customers. The regulator emphasises that consumers can only be expected to take responsibility for their choices and decisions if firms act openly and honestly.
The FCA plans to embed a concept of reasonableness across the new measures, to provide an objective standard for firms to meet. It proposes to set out factors that influence reasonableness, such as the nature of the firm’s role and the type of product or service being provided. As part of this, firms will be expected to consider the outcomes for different types of consumers, and identify if a particular type of consumer is receiving worse outcomes.
The above measures would all be underpinned by a set of four outcomes:
- Communications must equip consumers to make effective, timely, and properly informed decisions about financial products and services. In particular, firms would be required to communicate in a way that is reasonably likely to be understood and that facilitates decision-making, including tailoring their communications to the intended audience and to the medium used. As part of this, firms would be expected to review, test, and adapt their communications to ensure they are likely to be understood by the intended recipients. While the FCA stresses that firms would not be required to verify that all consumers have understood the firm’s communications in practice, such steps might be appropriate in certain contexts. This is intended to go beyond Principle 7 (“A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading”).
- Products and services must be designed to meet the needs of consumers, and sold to consumers whose needs they meet. The FCA plans to impose obligations on manufacturers and distributors to help ensure that products are designed, marketed, and distributed to meet the needs of an identified target market. Through this mechanism, the FCA is essentially seeking to introduce product governance rules (reflecting the key obligations in the Product Intervention and Product Governance Sourcebook) across all retail markets.
- Customer service must meet the needs of consumers, enabling them to act in their own interests without undue hindrance. This includes designing processes that aid, rather than present barriers to, consumers realising the benefits of products or services, without imposing unreasonable additional costs. This also means considering the needs of vulnerable customers, as appropriate.
- Pricing for products and services must represent fair value for consumers. The FCA wants firms to assess price and value at the design stage, and through ongoing monitoring. While the FCA does not intend to set prices or introduce price caps, it wants firms to consider whether the products and services offered to consumers are reasonable relative to their price.
The FCA acknowledges the overlap of the proposed new Principle and supporting measures with Principles 6 and 7, and firms may question whether the new measures will add anything new. Although the FCA is minded to maintain all of the existing Principles for now, it is considering whether it could disapply Principles 6 and 7 when the Consumer Duty applies. There is also significant overlap with existing conduct of business rules, which require firms to act in their clients’ best interests, and with the product governance regime. However, whereas existing rules apply to business involving specific products, the FCA is proposing that the new measures will apply across the retail sector. The extent to which the Consumer Duty represents a significant shift in expectations ultimately will depend on how different it is in practice to existing standards.
Which firms would the Consumer Duty apply to?
The Consumer Duty would apply to the same firms that are subject to the Principles for Businesses at present and, like the Principles, would apply in respect of all of a firm’s regulated activities.
The FCA is proposing that the Consumer Duty would apply in relation to products and services sold to retail clients (i.e., anyone apart from professional clients or eligible counterparties). However, the relevant nexus will be whether a firm can, through its regulated activities, influence material aspects of the design, target market, or performance of a product or service that will be used by retail clients. Therefore, firms operating in the wholesale sector may be caught even if they have no direct contact with retail clients (e.g., if they have a role as part of a distribution chain for products or services sold to retail clients).
The FCA issued a Discussion Paper on introducing a duty of care in 2018, in which it explored potential different approaches. The Financial Services Act 2021 includes a requirement for the FCA to carry out a public consultation about whether it should introduce a duty of care. The FCA must carry out the consultation, and publish its analysis of the responses, before 1 January 2022. It must then publish any final rules by 1 August 2022.
Originally, the House of Lords had added a provision to the Financial Services Bill that required the FCA to make rules introducing a duty of care by 6 April 2022. The House of Commons diluted this so that the FCA is now only required to consult on whether, and in what form, it should introduce such a duty. However, given the political backdrop and pressure for the FCA to do more to protect consumers, the FCA is seemingly set on introducing new rules (certainly, the focus of CP21/13 is on how the rules should be framed, not whether they should be introduced).
What does the FCA hope to achieve?
The FCA acknowledges that greater protections are needed for consumers of UK retail financial services, and intends to introduce new measures that set a higher standard of care than the existing rules with a view to achieving a shift in mindset by firms. Undoubtedly, there is political pressure for the FCA to do more to prevent consumer harm. The FCA describes the proposed changes as representing a “paradigm shift” in its expectations of firms in retail markets, and firms should therefore view them through this lens.
In particular, the FCA expects that a firm will need to consider the new measures “at every stage of its processes and at every level of its organisational structure”. The FCA considers that, in many cases, firms will need to exercise more judgment in determining how their behaviours, policies, and processes help to achieve positive outcomes for consumers. Alongside this, the FCA expects its supervision of the rules to focus more on outcomes experienced by consumers.
The FCA will expect firms to monitor and test their policies and practices on an ongoing basis and be prepared to provide relevant information and data to the FCA. The regulator will use this information and data, alongside its own information regarding consumer outcomes, to consider whether or not a firm is meeting expectations. This obligation could, potentially, represent a significant additional burden for firms, as they will need to analyse consumer behaviour and anticipate where harm might occur. The FCA considers that it will be able to use the new package of measures to hold firms to account more readily in relation to consumer harm.
However, the FCA is keen to stress that the new measures will not remove consumers’ responsibility for their own decision-making, nor will they specify exactly how firms should act. Further, the new measures are not designed to impose an open-ended duty that goes beyond the scope of a firm’s role.
Firms that fail to comply with the new measures could face FCA disciplinary action. However, the FCA also asks whether it would be appropriate to introduce a private right of action, which would enable private individuals to take action against a firm directly and could potentially expose firms to greater liability for their actions. Introduction of such a private right of action would inevitably be a focus for Claims Management Companies, and would lead to further claims activity. Even without the introduction of such a private right of action, the new Consumer Duty could lead to additional claims against firms on the basis that firms have effectively assumed a duty of care to retail customers.
The FCA requests feedback by 31 July 2021. The regulator plans to issue a further consultation by the end of the year, in which it will set out proposed drafting for the new rules and guidance. It will also consider the impact of the new measures on the existing Principles for Businesses, and how the FCA intends to supervise compliance. The FCA plans to make any new rules in this area by 31 July 2022.
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