The Proposed FCA Consumer Duty – Overview Ahead of Consultation Closure

On 14 May 2021, the FCA issued a consultation[1] on proposals to strengthen consumer protection with the introduction of an overarching ‘Consumer Duty’. This would be supported by what are called ‘cross-cutting rules’ requiring firms to act in good faith and avoid causing foreseeable harm to customers. The proposals are intended to address what the FCA regards as poor practices in retail financial markets that lead to some consumers purchasing unsuitable products and services including the selling of products and those that do not represent fair value, and generally the exploitation of informational asymmetries.

The proposed new duty is the main thrust of the FCA’s consultation paper, by which it would seek to hold firms to a higher standard when dealing with customers – in addition to their current obligations to ‘treat customers fairly’ (TCF) under Principle for Business 6 of the FCA Handbook.

Ahead of closure of the consultation on 31 July 2021, we provide a reminder below of the proposed changes and consider the potential expanded private right of action that has been mooted as a means of enforcement. This would be a concerning prospect for many financial services firms (and their insurers), but is one advocated by some consumer rights groups. Without an expanded private right of action, the new duty would be enforced in the same way as existing principles such as TCF – so would increase regulatory exposures at a minimum.

In that context it will be important for policyholders and industry bodies to consider the potential impact of the rule changes on their business, and engage now with the FCA to make their voices heard. From an insurance perspective, in a market where many policyholders are already facing challenging renewals, increasing premiums and/or restricted cover, additional exposures are unlikely to be welcomed by policyholders or by their insurers. As we reported in our previous article,[2] insurers are particularly focused on the scope of cover for regulatory investigations; changes such as those proposed are unlikely to lead to any shift in that position in the near-term.

Outline of the Proposed Changes

• A new Consumer Duty, or Principle, to increase standards over and above Principle 6. Two options have been proposed: either requiring firms to ‘deliver good outcomes for’ or ‘act in the best interests of’ retail clients.
• Cross-cutting rules – these inform and add context to the Consumer Duty by outlining three behaviours the FCA would expect firms to uphold.
• ‘Four Outcomes’ in the firm-consumer relationship - concerning communications, products and services, customer services, and price and value. The FCA has released a suite of rules and guidance setting more detailed expectations for firm conduct within each area.
• A private right of action? The FCA is considering extending the private right of action to breaches of FCA principles. Currently, customers can only bring actions for breaches of FCA rules under section 138D of FSMA.

Background to the Proposals

While the FCA admits that many firms ‘are already delivering the right outcomes for consumers’ by offering good products at fair prices, the watchdog asserts that bad practices persist which result in products being offered to consumers that do not provide the promised benefits or deliver good outcomes. In the FCA’s view, the conduct that leads to consumer harm is the result of informational asymmetry that benefits firms at the expense of customers – PPI and pensions mis-selling being oft-cited examples. The FCA typically regards transfers out of defined benefit pensions as being the product of customers’ lack of information and behavioural biases, and several IFAs who offered advice on pension transfers have been pressured by the FCA to quit the transfer advice business or shut down entirely. 

This example provokes a question – if the FCA has taken action against IFAs in this area, and the TCF principle already exists, what is the need for the Consumer Duty? Well, according to the FCA, the answer is two-fold.

Firstly, while it views the TCF as having had a positive impact, they perceive too many firms continuing to rely on informational asymmetry and consumer bias or inertia to exploit customers. They hope that a more explicit duty to act in the ‘best interests of’ or ‘deliver good outcomes for’ customers will clamp down on this behaviour.

Secondly, the consumer duty is designed to apply to all levels of a firm and across all Retail Clients (which may include SME as well as consumer clients). As such, it is intended to encourage a more proactive approach to delivering positive consumer outcomes. The aim is to boost key behaviours in firms, such as acting in good faith and avoiding customer harm, which will precipitate a culture change to put customers’ interests at the forefront of decisions.

The FCA summed up the reasoning for a Consumer Duty as there being a ‘need for something more – a clear statement of expectation that goes beyond our existing Principles and rules’ and sets a ‘higher standard of care and expectation’.

Consumer Duty – Two Options Proposed

The FCA has proposed introducing a ‘Consumer Principle’ as a new Principle for Business, with two options being put forward (though in reality the FCA will expect firms to achieve both these outcomes in any event):

Option 1: A firm must act to deliver good outcomes for retail clients

This outcomes-based option would encourage firms to take a proactive approach in their treatment to consumers, focusing not only on processes, but on the impact of their actions on consumers (and actually deliver beneficial outcomes). A ‘good outcome’ is not a legal term, but achieving the Four Outcomes discussed below is likely to be indicative.

Option 2: A firm must act in the best interests of retail clients

The ‘best interests’ option may appear more demanding, but the FCA has clarified that it would not mean firms have to deliver ‘the absolute best outcome for each and every customer.’ Rather, that their conduct could ‘reasonably and objectively’ be said to be in the consumers’ best interests – something sure to be the subject of litigation if a private right of action is introduced. The ‘best interests’ concept is found in other Handbook Rules for MiFID regulated and insurance distribution firms when dealing with retail clients, but would be extended across the Handbook.

Implications for firms and consumers of the proposals

For firms and senior managers

• A firm would need to consider the Consumer Duty at every stages of processes and every level of its organisational structure. This should be viewed through the lens of the FCA’s ongoing effort to increase accountability among senior management.
• A firm must carry out continued testing and monitoring of products and services to ensure they remain fit for purpose and that firms ‘get it right in the first place’ – and this will be something on which the FCA will rely as part of their own supervision, so it will be important for firms to put in place adequate mechanisms.
• Despite the FCA asserting that the Consumer Duty would ‘complement’ rather than replace existing principles, it also describes it as heralding a ‘paradigm shift’ in their expectations of firms in retail markets. It aims to remove any ‘first mover disadvantage’ for firms that set higher standards of practice.

For consumers

• Greater confidence that firms are acting in good faith.
• Consumers will receive clear and understandable information allowing them to assess the products they are being offered.
• Products and services offered to consumers will deliver the benefits consumers reasonably expect them to. This signals that the FCA will continue to take a harsh view on any products that, in retrospect, turned out to be a poor investments. To avoid penalty, any and all foreseeable risks must be clearly and unambiguously explained to consumers – conveying them in lengthy and/or complex documents will likely be insufficient.
• Consumers will receive high standards of customer service that meet their needs. In this regard, the FCA mentions the need to eliminate the ‘friction’ that prevents consumers from acting in their best interests. One such example might be the difficulty in cancelling a policy, or neglecting to clearly signpost the cancellation policy.

Cross-Cutting Rules

These rules would apply across the Handbook and seek to ‘develop and amplify’ the standards of conduct expected under the Consumer Duty. They focus on three areas the FCA considers essential in all firm-consumer dealing.

• Taking all reasonable steps to avoid causing foreseeable harm to customers - not exploiting vulnerabilities, behavioural biases or informational asymmetries. This includes ensuring that products and services are fairly described and not cloaked through misleading framing or advertising (e.g burying important conditions in lengthy documents). Thankfully the FCA has, however, made clear this will not apply where risks have been fully explained, or where harm is due to unforeseeable circumstances, and here firms will not have breached the rule.

• Taking all reasonable steps to enable customers to pursue their financial objectives – consumers are empowered to make choices, but firms have a responsibility to ensure they have the necessary information to make those decisions.

• Acting in good faith – so to act honestly, fairly, openly and consistently in their dealing with customers, and not exploit the bargaining imbalance that typically exists.

At an overarching level, the cross-cutting rules would apply at all levels in a regulated firm (senior management downwards) and would differ depending on the nature of the client. The FCA proposes using an objective standard of reasonableness in determining whether a firm has met its obligations to consumers - determined in the context of each case, and having regard to the vulnerability of the customer or the complexity of the product or service.

The Four Outcomes

These are what the FCA is seeking to achieve through the Consumer Duty, so form a guide on what is required to realise the best interests/a good outcome for customers.

• Communications – equip customers to make effective, timely and properly informed decisions about products and services, through the product life-cycle (e.g. including post-sale). The FCA identifies a series of poor communications practices, which include hiding information in lengthy documents, providing insufficient information or generally exploiting informational asymmetry (e.g. by misrepresenting purported benefits).

• Products and services – these must be specifically designed to meet the needs of consumers, and sold to those whose needs they meet. The FCA asserts that too many firms are more concerned with profiteering than detecting ‘a consumer need which they can profitably serve’, with an eye on examples such as packaged products where the price doesn’t justify the benefits. The provider must carry out regular reviews and testing of its products to ensure that it continues to remain fit for purpose throughout its life-cycle.

• Customer service – that meet consumer needs and enable them to realise the benefits of products and services and act in their own best interests. The FCA states that too many firms have deliberately  inaccessible customer service so as to prevent consumers from realising benefits (e.g. stopping a policy automatically renewing).

• Price and fair value – the price all products and services provided to consumers must represent fair value. The FCA notes that this does not mean intervention in pricing (e.g. setting price caps), but warns that they may have to resort to this if ‘markets are failing to deliver fair value’. The level of customer service might justify a higher price.

Private Right of Action (PROA)

The consultation paper also raises the prospect of introducing a private right of action for breaches of FCA principles, but added that it was not the focus of the current proposals. Nonetheless, the FCA is canvassing views for a new PROA, which if created would make the Consumer Duty directly enforceable by consumers against firms for damages in court.

While the FCA acknowledges that a new PROA could ‘act as a powerful deterrent’ that encourages firms to ‘get it right in the first place’, they also observe that it might stifle competition by discouraging innovation and, ultimately, reduce positive outcomes for consumers. The FCA cannot use powers under FSMA to impose an industry-wide redress scheme for breaches of principles, but being able to do so following a breach of the Consumer Duty would ‘ensure firms gave the Consumer Duty an appropriate standing.’

The key concern for market participants is likely to be the FCA’s acknowledgment that claim management companies (CMCs) might see a PROA as a business opportunity (and specifically mentions CMCs’ search for new business following PPI). This would yet further increase costs across the industry, at a time where regulatory intervention and claims activity has already driven up internal costs and insurance pricing.  

Finally, and perhaps signalling their own uneasiness with a new PROA, the FCA observes that courts would play a significant role in interpreting the Consumer Duty. Given the lack of precedent from FOS and FCA decisions on the new duty (and the fact that, e.g. ‘best interests’ could be interpreted in various ways), the FCA might find itself playing catch up with the decisions of judges.

Given the tenor of the FCA’s comments, it seems unlikely that a PROA will be introduced in the short-term – but it is certainly something to which the industry will need to pay close attention.

Conclusion

The Consumer Duty is an important development, but iterative rather than revolutionary – and perhaps ultimately unsurprising given the regulatory focus on consumer (including SME) protection. Consumers are still regarded as best placed to make personal financial decisions, but the consultation paper clearly conveys frustration that too many firms rely on the bargaining imbalance between firm and consumer which leads to consumers being sold unsuitable products.  Firms should bear this in mind as indicative of the FCA’s approach to regulation generally – whether or not an expanded private right of action ultimately comes into being.

This article was authored by members of Howden’s Legal, Technical & Claims team. The Legal, Technical & Claims team is made up of senior insurance lawyers and experienced claims professionals, and provides support on insurance claims, policy wordings and legal and regulatory developments as they impact your business. If you have any queries on the issues raised, please feel free to contact a member of the team directly.

James Wakefield, Claims Handler:

T: +44 (0)2038 087561 E: [email protected]

Neil Warlow, Associate Director:

T: +44 (0)7923 208441 E: [email protected]

Sam Vardy, Associate Director:

T: +44 (0)7719 928600 E: [email protected]

Carey Lynn, Executive Director:

T: +44 (0)7923 229882 E: [email protected]