Getting to grips with Consumer Duty

The UK regulator Financial Conduct Authority (FCA) is at an advanced stage of implementing its new “Consumer Duty” directive. This wide-ranging regulation seeks to build on previous rules and initiatives over the last twenty years.

Increased wealth, diverse investment solutions, more informed investors and the accelerating capabilities of technology make today’s world very different from the one at the start of the century, when the Financial Services and Markets Act 2000 created the Financial Services Authority (FSA), the forerunner of the FCA. This act formalised the whole notion of regulated business, firms and individuals in the UK for the first time.

Consumer protection at the heart of regulation

The need to explicitly protect investors can be traced back to “Treating Customers Fairly” introduced by the FSA in 2007. Since that date there has been the Retail Distribution Review (RDR), Product governance (PROD) and thematic reviews on many sectors including structured products (twice), asset management, insurance and others. At the European level there has also been MiFID and PRIIPs.

The Consumer Duty concept itself was first defined in 2021 through an initial consultation paper. Various points in the implementation timetable have now passed, final guidance has been issued and the directive will go live for existing products in July 2023.

Before looking at the detail of Consumer Duty we should try to understand the motives and processes of the regulator in bringing this significant piece of regulation forward. Why has the regulator issued such an array of new directives in a relatively short period of time?

Major regulation is a slow and progressive process, driven by economic and political factors. It can be dictated by major events such as the global financial crisis of 2008 and is also subject to long term re-positioning and trends such as the departure of the UK from the European Union.

Regulation fatigue in the industry

It would be understandable if manufacturers and distributors felt a certain amount of regulation fatigue having recently come through TCF, RDR, MiFID II and PRIIPS amongst others. However Consumer Duty has been positioned to be a signature directive designed to refresh and change culture and processes across the industry. This is not a simple exercise with easily defined goals, like producing a KID under PRIIPs right from the day the rules went live. The final Consumer Duty guidance is a long document with overlapping themes repeated throughout to give a sense of what the regulator is after. In my opinion there is likely to be some leeway granted as firms seek to strengthen their processes, and the regulator may follow up with further Q&A, feedback and warnings in the first twelve months of operation. It is probably true to say that the regulator itself does not know exactly what tangible benefits the Duty will bring and how the industry will react. Therefore this signposts a period of adaptation for all concerned.

Consumer Duty is quite clearly descended from Treating Customers Fairly but with significant extra scope as a re-read of that paper highlights. The naming itself is a strong clue, Treating Customers Fairly implies an action primarily at the point of sale, whereas Consumer Duty indicates holistic and all encompassing responsibilities. Consumer Duty will be enshrined as the twelfth principle of the FCA which will come into effect in July - “A firm must act to deliver good outcomes for retail customers.” The Duty then proceeds to define its three “cross-cutting” rules as the second layer. This states that firms act in good faith towards retail customers, avoid causing foreseeable harm to retail customers and enable and support retail customers to pursue their financial objectives. The FCA then details four key “outcomes” which can be used to measure the implementation of the Duty and the objectives of the cross-cutting rules which get their name from the idea that the three rules have relevance across the four outcomes. These are the products and services, price and value, consumer understanding and consumer support outcomes.

The Consumer Duty is also a regulation reflective of its time. It is heavily focussed on notions of inclusivity and protecting vulnerable groups of investors (this latter term having multiple definitions). Its other defining characteristic is the heavy acknowledgement of the role of technology. This is mentioned in various ways, firstly the fact that digital or online investing is commonplace and has its own considerations around good practice. Secondly this presents potential biases because of the differential in access and familiarity between investor groups (part of the vulnerable theme). Thirdly, and perhaps of most importance the regulator expects companies to take advantage of data collection (“Management Information” or MI) to further develop practices of the right target market and to monitor outcomes to continuously improve treatment of consumers.

Focus on simple widespread services and products

While more sophisticated investments such as funds and structured products will come under scrutiny, the Duty seems likely to first concentrate on simpler and more widespread services such as consumer credit, insurance and mortgages. This is because such services are widespread and are critical because of the amounts and timescales involved. There is concern for vulnerable consumers, the potential for various investor biases and the manifest harm that can be done by getting decisions wrong, all of which play into the themes repeated throughout the duty.

Funds and structured products have been subject to thematic reviews and detailed scrutiny and the structured products industry should expect more detailed attention from the regulator. Further refinement of the target market concept and how that feeds into distribution process and product design will be important. The Consumer Duty also makes it clear that the whole distribution chain bears responsibility for consumer outcomes, as RDR and MiFID II first identified. With the current trend of fragmented distribution processes, outsourced and online sales patterns it will be challenging to demonstrate proper procedures.

The Consumer Duty also raises concerns around complexity and fee levels. Rather than simply demonstrating suitability and value, the continuous nature of the responsibilities that the regulator envisages means that further lifecycle and post-sale monitoring and improvements will be expected.

The FCA will be targeting the worst practices as part of the Duty and looking to raise standards across the board. Structured product firms are rich in technology and talent and therefore have the opportunity to pro-actively strengthen their business models not only to satisfy regulators but to benefit commercially from setting themselves up fairly and soundly.