The Financial Inclusion Centre has submitted its response to the Financial Conduct Authority’s important consultation paper CP21/36 on proposals for a new Consumer Duty for the financial services industry. Our response can be found here: Financial Inclusion Centre Submission FCA Consultation CP21-36 A New Consumer Duty FINAL VERSION
We very much welcome the intent behind the new Consumer Duty. If it was implemented properly, and robustly supervised and enforced, it could improve the way the financial services industry is regulated.
But, there are serious flaws in the proposals. As it stands, we do not think the Consumer Duty will make much difference to how well financial services meet consumers’ needs. Indeed, taking into account the government’s Future Regulatory Framework (FRF) Review, consumer protection in the UK could take a backward step. The government wants to give the FCA an international ‘competitiveness’ objective. This is likely to compromise the independence of the FCA and the ability of the regulator to focus on its primary consumer protection objective.
The positive aspects of the Consumer Duty
There are a number of potentially positive aspects to the Consumer Duty. The FCA intends to apply the Consumer Duty throughout the financial services distribution chain, and to unregulated financial activities which are ancillary to regulated activities. The Consumer Duty would apply to existing products and services and products or services sold or renewed after the Consumer Duty comes into effect.
The FCA wants to improve the way firms pre-empt and mitigate harm. It wants to toughen up rules and guidance on how financial services firms: test and approve products before marketing them; and better identify target markets (including those with vulnerabilities).
The FCA would expect firms to: monitor and regularly review the outcomes customers are experiencing; ensure products and services they provide are delivering the outcomes that they expect in line with the Consumer Duty; identify where they are leading to poor outcomes or harm to consumers and take appropriate action.
Moreover, the FCA would expect a firm’s board, or equivalent management body, to consider a report produced by the firm assessing whether it is acting to deliver good consumer outcomes consistent with the Consumer Duty, at least annually. So, it is positive that boards will be expected to pay more attention to ensuring that their firm’s activities are not causing harm, and are delivering better value.
The flaws in the FCA’s proposals
But, there are serious flaws in the proposals which will undermine the new Consumer Duty.
Data, metrics, and reporting
The main concern relates to how the FCA intends to monitor and evaluate the impact of the Consumer Duty. The FCA’s proposals for monitoring and reporting could seriously undermine the effectiveness of this flagship reform.
It must be said that, even now, we cannot actually tell whether the FCA is doing a good job at making markets work for consumers due to the lack of meaningful performance data and metrics.
There is much data in annual reports and business plans on how much the FCA spends each year, how many people it employs, how much activity the FCA is engaged in. But, this does not tell us how well financial services are delivering against the consumer outcomes. And if we cannot tell how well financial services are performing, we cannot tell how well the FCA is performing.
To be fair, we can observe that the FCA has been effective in reducing the number of systemic misselling scandals. So, it is has been doing well on ensuring markets treat consumers more fairly.
But, there is little meaningful data or metrics on how well financial markets are performing on the other outcomes such as financial inclusion, the quality and social utility of financial products, the efficiency of financial markets, and value for money.
The Consumer Duty should have provided the ideal opportunity for the FCA to fundamentally change its attitude to transparency and holding markets to account.
Greater market transparency helps drive up standards of behaviour and practices in markets. It is an aid to better policy making and regulation, and promotes regulatory accountability.
The FCA is delegating far too much responsibility to firms’ boards to ‘mark their own homework’ on compliance with the Consumer Duty. The FCA should stipulate that reports to the board (or equivalent management body) should be independent and published.
Moreover, the FCA is not specifying what metrics firms should collect and report on. This will make it more difficult for the FCA to gather information on a consistent basis to allow for meaningful comparisons.
But, the most worrying aspect is that the FCA will not require firms to report to the regulator on compliance with the Consumer Duty. The FCA would expect firms to collect suitable data and information to assess consumer outcomes, and be able to give the FCA evidence of such actions if requested [our emphasis] by the FCA.
We are at a loss to understand the FCA’s thinking on this. The FCA says it wants to be a ‘data led’ and proactive regulator. But, relying on requesting information will make it more difficult for the regulator to obtain performance data and metrics.
Intermittent and inconsistent data (or after-the-event thematic reviews and market studies) is an inefficient way to identify detriment at an early stage and to monitor the effectiveness of the Consumer Duty.
Moreover, it will make it very difficult for external stakeholders (including Parliament) to identify whether the Consumer Duty is having the intended effect so undermining regulatory and corporate accountability.
Therefore, we are proposing that:
- firms should be required to report regularly to the FCA on compliance with the Consumer Duty, based on data and metrics specified by the regulator after consultation with stakeholders;
- the FCA should produce regular reports on how well markets are meeting the needs of consumers (based on the established consumer outcomes);
- the FCA should produce regular audits of how well the financial services industry is complying with the Consumer Duty;
- the FCA should produce regular financial inclusion audits assessing the performance of the industry (and sectors) against financial inclusion metrics with a special focus on households with protected characteristics;
- the FCA should report to Parliament and government on the extent to which the commercial financial services industry is able to meet the needs of vulnerable and excluded groups (especially those with protected characteristics);
- the FCA should report to Parliament and government on the impact of policy decisions on financial inclusion – for example, changes to the Universal Credit system; and
- individual firms should be required to produce financial inclusion audits similar to those produced by US financial services firms – see below.
Firms acting reasonably, delivering fair prices and value, and product regulation
The FCA wants firms to act reasonably to deliver good outcomes. The FCA talks about firms addressing problems with: ‘products and services that do not represent fair value, where the benefits consumers receive are not reasonable relative to the price they pay’.
But, it is not clear what is meant by fair value or reasonable relative to the price paid. There is a worrying lack of ambition from the FCA on improving the price and value of financial products and services.
The FCA’s approach is unlikely to make a difference in markets where poor practice and value is standard. A firm selling a high price product could be considered to be offering a fair price and value because the rest of the market is doing so. So, the FCA’s approach risks embedding existing market inefficiencies, high prices and poor value.
The payday lending market was an example of this. Payday lenders used to argue that costs were so high because of the higher risk associated with the target market. They argued the price was fair value. But, the poor value and detriment was intrinsic to the payday lending business model.
Another example can be found now in the overdraft market. Quoted rates for new overdrafts stand at 34% compared to the 10 year average of 22% despite the FCA recently introducing rules to try to promote competition in the market. With the FCA’s Consumer Duty approach, a firm providing overdrafts at high rates could be considered to be acting reasonably because the rest of the market was providing overdrafts at these high rates.
Competition theory holds that products are fairly priced and represent good value if product margins are low (the theory is that market forces compete away high margins).
But, in key market sectors, product margins may be low, yet the product still offers poor value for consumers – because the market overall is inefficient. In this case, the final price paid by the consumer may represent fair value from the provider perspective (as margins are low). However, the products would not represent fair value for consumers.
Therefore, the FCA should make it clear, in the guidance, that acting reasonably must be judged on its own terms not according to what are standard pricing practices in the market. If the assessment tells firms that the products do not represent fair value, then the firm must stop selling those products.
It is very unfortunate that the FCA has not taken this opportunity to make greater use of product regulation such as price capping, and product approval and banning. Direct interventions such as price caps have been shown to be a much more effective method for constraining harmful market practices and dealing with market inefficiencies than indirect methods such as promoting competition or tackling information asymmetries.
Despite competition interventions having little impact on making markets work, the FCA sees product regulation as a last resort preferring to wait to see if its competition or market led remedies take effect. The FCA’s reluctance to use product regulation leaves consumers exposed to harm for longer than is necessary.
Consumer responsibility and the precautionary principle
The FCA reiterates the point that the new proposals do not mean that consumers can or will be protected from all harm or remove the principle of consumer responsibility. But, this is only reasonable if firms have taken necessary steps to comply with the relevant regulatory requirements (in this case the Consumer Duty requirements). Ideally, the definition of consumer responsibility in legislation should be amended to say this. In the meantime, FCA should make this clear in regulatory guidance.
It would be more effective if the FCA required firms and intermediaries to adopt the precautionary principle when determining whether products and practices are likely to cause harm. Firms and intermediaries, with all the huge financial and technology/ data resources at their disposal, are well placed to determine the likelihood of harm. They should be required to take steps to proactively prevent or minimise harm occurring, and report to the FCA on how they have done this.
The FCA might say that the pressure of competition will prevent harm. But, this is not realistic. Indeed, fierce competition can increase the risk of harm as providers compete to acquire business.
Acquisition costs push up prices. The dynamic of competition can compel providers to use harmful marketing practices to persuade consumers to buy their products or services (made easier by the adoption of digital and data based market research and advertising practices).
This aggressive-competition dynamic is the main cause of harm in financial services. This is what a new Consumer Duty must seek to constrain. If the Consumer Duty is to make markets in financial services work better for consumers, it must set new, objectively higher standards. It should not embed and retain unreasonable or aggressive practices in dysfunctional markets.
We are particularly concerned about the increased use of digitalisation and digitisation in financial services. The FCA should require boards of regulated firms to pay more attention to the risks created by the use of digitalisation and digitisation in financial product design, promotion, and distribution. This is particularly important when it comes to the use of technology and big data to target vulnerable consumers and exploit behavioural biases – see below.
In our response to HMT’s Financial Services Future Regulatory Framework Review, we proposed that the FCA should be given a new statutory objective to promote fair access to financial services.
We appreciate that the FCA is not a social policy regulator. It is for Parliament and government to mandate policy solutions where markets fail to deliver.
But, there is still much the FCA can do to promote inclusion. In particular, the lack of data and information on financial inclusion in the UK is holding back efforts to promote financial inclusion. The approach in the UK is contrast to the obligations faced by US financial institutions under the Community Reinvestment Act (CRA) and Home Mortgage Disclosure Act (HMDA). To support our fair access objective, we argued for a rethink on the type and relevance of data published on market access and inclusion – see above.
Unnecessary complexity is retained
It is currently difficult to understand the boundaries of the regulatory ‘perimeter’, which rules apply to different types of financial consumer (including SMEs) and, therefore, what consumer protections apply.
The FCA’s proposals would retain the unnecessary complexity and confusion in the current system. We urge the FCA to introduce a single standard definition of client which should incorporate retail consumers, SMEs, and a category of non-professional clients such as pension fund trustees, local authorities, and charities.
Technology and big data
The Consumer Duty proposals are weak on protecting consumers from harmful use of technology and big data. Increasingly financial services use technology and big data to design, market, and distribute financial products and services. There are growing concerns that digital techniques are being used to exploit consumers behavioural biases and vulnerabilities, and can exacerbate financial exclusion and discrimination.
But, digital services firms are not regulated to the same standards as financial services firms. We are asking for clarification on how the Consumer Duty applies to digital firms, and for the FCA to issue clear guidance for boards of financial firms to pay more attention to the risks created by the use of digital and data services in financial services.
The FCA should require firms to do more to ensure consumers understand the products and services sold. Observing how consumers actually behave is the best way to measure consumer understanding of products and services.
Firms, through the use of digital services and big data, now have the capacity to analyse the behaviours of vast numbers of consumers on an almost real-time basis. They are able to identify patterns which can show that product design and marketing practices are causing harmful consumer behaviours.
Firms should be required to test the impact of digital marketing techniques on consumer behaviours and take remedial action where there is evidence that these techniques are causing consumers to behave in a suboptimal way.
Non-UK and unregulated products and services
UK financial services firms sometimes use non-UK regulated products and services. It is important that consumers be made more aware of the risks associated with this. The FCA should also require UK regulated firms who use non-UK firms to provide additional support to consumers in the event of misselling or administrative failures.
Regulated firms can facilitate access, and provide a ‘halo effect’, to providers, intermediaries, products, and activities which might fall outside the regulatory perimeter.
The FCA should emphasise that the proposed enhanced Consumer Duty applies to non-regulated activities where the regulated firm has an influence over consumer behaviour and decision making. Boards of regulated firms must pay much more attention to activities that are not regulated by the FCA, but which are integral to the design, promotion, and distribution of regulated financial products.
ESG financial products have become very popular with the growing attention paid to the environment. Third-party information and ratings agencies (who rate the green credentials of products) will play a significant role in the marketing and selling of ESG products to consumers.
But, these intermediaries and ratings agencies are largely unregulated. There is a clear risk that regulated financial product providers and intermediaries will select third party providers with the least onerous rating standards.
It is to be hoped that the FCA will soon regulate these third party intermediaries and agencies. Until then, the FCA should protect consumers by making it clear that, as part of the Consumer Duty, regulated financial providers and intermediaries must exercise due diligence when selecting third party providers of ESG information and ratings.
The steps firms take to check the integrity of third party ESG information and ratings should form part of the FCA’s Consumer Duty supervision regime.
Consumers in financial difficulty
The FCA did a very good job protecting consumers affected by the Covid financial crisis. But, the Consumer Duty proposals do not place enough weight on the need for firms and others in the market to treat consumers fairly throughout the whole of the firm/ customer relationship especially when consumers might be in difficulty.
An example of this, relates to the very low level of county court judgments (CCJs) that are marked as ‘satisfied’ on the Register of Judgments. Only 15% of CCJs are marked as satisfied. It is not common knowledge that CCJs are marked as satisfied only if the debt is repaid and proof of payment is supplied to the courts in England and Wales (and to Registry Trust for other jurisdictions).
This problem could be addressed by the FCA and other regulators requiring creditor firms within their remit to notify the courts when a debt has been repaid as part of treating customers fairly obligations (and now as part of the proposed Consumer Duty).
Closed products such as older insurance based personal pensions continue to cause harm to consumers with high charges, low net returns, and punitive exit penalties which mean that consumers continue to be, in effect, locked into these products.
Firms should be required to review closed products to assess what remedial action can be taken to protect consumers from further harm and report to the FCA on how they intend to redress the harm caused.
Private Right Of Action (PROA)
The FCA is not going to introduce a PROA alongside the Consumer Duty. We do not understand the logic of the FCA’s arguments. Of course, we agree that the existing redress framework will remain the more appropriate route for almost all consumers to seek redress. Consumers can indeed pursue redress in a way that is low cost and consumer friendly.
But, this does not negate the argument for a PROA. A PROA can only act as a further deterrent against poor corporate behaviours and practices. The FCA’s decision to not allow a PROA is also likely to limit the opportunity for collective redress in the form of class actions.
Allowing firms until end of April 2023 to fully implement the Consumer Duty would seem reasonable. However, we would urge the FCA to publish a schedule for firms to follow to ensure that the timetable does not slip.
The FCA should resist arguments from the industry to delay the implementation. If the FCA has identified a need for the new Consumer Duty, this means that consumers are currently exposed to poor practices. The longer it takes to implement the Consumer Duty, the longer consumers are left exposed to these poor practices.
Moreover, there are some elements of the work which the FCA could begin immediately such as requiring creditors to inform the courts when a CCJ has been settled and developing performance metrics to judge the success of the Consumer Duty.
 Future Regulatory Framework (FRF) Review: Proposals for Reform – GOV.UK (www.gov.uk)
 access to products and services that meet consumer needs (economic and social utility of products and services); affordability and value for money; quality of products and services; fair treatment of consumers; security of products and services; access to appropriate information and advice; and rights to redress.
 These still occur. The defined benefit transfer misselling scandal is a case in point. But, the number and scale of system wide misselling scandals have been reduced.
 Financial Inclusion Centre analysis of Bank of England data on quoted household interest rates
 See s3B(1)(d) FSMA 2000
 Community Reinvestment Act (CRA) | OCC
 The Home Mortgage Disclosure Act | Consumer Financial Protection Bureau (consumerfinance.gov)
 which defines what products and which types of financial users are covered by FCA regulation
 See, for example, the Gloster Report into the regulation of London Capital & Finance (LCF) Gloster_Report_FINAL.pdf (publishing.service.gov.uk)
 Such as OFGEM, OFWAT, and OFCOM