Consumer Duty: a seismic change

Summary

On July 27, 2022, the Financial Conduct Authority (FCA) introduced a new Consumer Duty to drive a fundamental shift in industry mindset. The new plans will ensure a higher and more consistent standard of consumer protection for users of financial services and help to stop harm before it happens.

The new Consumer Duty is intended to represent a “paradigm shift” in how the FCA regulates the retail financial markets, part of the move to an outcomes-based approach. Achieving ‘good outcomes’ is the primary focus of the new Consumer Duty, moving away from simply treating customers fairly.

Why do we need a new Consumer Duty?

The FCA is concerned that currently financial services do not always work well for consumers. The new plans will fundamentally shift the mindset of firms. Through its previous interventions, the FCA has seen practices by some firms that cause harm. These include firms presenting information in a way that exploits consumers’ behavioural biases, selling products or services that are not fit for purpose, or providing poor customer support. New rules will tackle the causes of harmful practices and will raise industry standards by putting the emphasis on firms to get products and services right in the first place. There will also be a focus on ‘vulnerable’ consumers.

Sheldon Mills, Executive Director of Consumers and Competition at the FCA said: “The current economic climate means it’s more important than ever that consumers are able to make good financial decisions. The financial services industry needs to give people the support and information they need and put their customers first.”

“Consumer duty will provide a framework, giving enough space to innovate and think about things without just making it a tick box.”

Toby Poston, Director of Corporate Affairs, BVRLA

The new rules will require regulated firms to focus on supporting and empowering their customers to make good financial decisions and to avoid causing foreseeable harm at every stage of the customer relationship. Firms will have to provide consumers with information they can understand, offer products and service that are fit for purpose, and provide helpful customer service.

The Duty will extend to all firms that are involved in the distribution chain — the manufacture, provision, sale and ongoing administration and management of a product or service to the end consumer, even if they do not have a direct relationship with the end customer. All firms that have a material influence over, or determine, the consumer outcomes will be monitored under the new rules of the Duty. Paul Parkinson, CEO and Founder of Synergy Car Leasing believes that the Consumer Duty “causes us to have a look at ourselves, and look at our people and look at our processes.”

This ongoing drive by the FCA to set higher expectations for the standard of care that firms provide to consumers will require many firms to make a significant shift in their culture and behaviour.

Helena Thernstrom, Head of Legal, Asset & Invoice Finance at Natwest concludes that “the consumer duty is kind of heralding and has as an ambition a culture change across the whole of the industry.”

The first consultation paper (CP21/13) was issued in May 2021 with the second consultation paper (CP21/36) following in December 2021 after a period of consultation. The new rules were published on July 27, 2022 with a very challenging expectation for all firms to have a gap analysis completed by October 2022 and delivery of their implementation plan by July 2023 for all ‘open’ product sales and by July 2024 for all ‘closed’ products.

How will the new Consumer Duty be implemented?

The Duty is made up of an overarching Consumer Principle, three cross-cutting rules and four outcomes that support the new Principle which are summarised below:

Principle

With Consumer Duty we have a new FCA principle where a “a firm must act to deliver good outcomes for retail customers”. Many people will be aware that there are currently 11 principles, but this will bring in a 12th principle which will consistently focus on consumer outcomes. When regulators visit firms, they will want to see how the firm is demonstrating that they are complying with this in a similar way that they will expect to see the firm demonstrating how they comply with the other principles and rules that the FCA have implemented.

Principle 12 will place a higher standard of conduct on firms than Principles 6 and 7. Principle 6 is that a firm must pay due regard to the interests of its customers and treat them fairly, while Principle 7 is that 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.

Principles 6 and 7 will continue to apply to conduct outside the scope of Consumer Duty e.g., certain SMEs and wholesale business.

There will be a shift to achieving fairer customer outcomes in all areas of the product or service chain. Firms will not be held accountable for overseeing the action of other firms, but should have written agreements establishing mutual responsibilities with, for example, lenders, brokers, dealers, OEMs, captive OEMs.

Cross-cutting rules

The three cross-cutting rules, so called because they cut across every sector, set out how firms should act to deliver good outcomes for consumers. They are not aimed specifically at one particular financial services product or another, but they require firms to:

1. Act in good faith to retail customers: Firms must conduct honest, fair and open dealings and show consistency.
2. Avoid causing foreseeable harm to your retail customers: Firms must not cause harm to customers through conduct, products or services, and they must take proactive steps to avoid it. Consumers are not necessarily protected from all negative outcomes.
3. Enable and support retail customers to pursue their financial objectives: Focuses on the financial objectives of the consumer in relation to the financial product or service and applies throughout the customer journey and lifecycle of the product. Firms should create an environment in which consumers can act in their own interests.

Outcomes

There are four outcomes, which are the four elements that represent the firm-consumer relationship. The expectation from the regulator is for firms to think through and to show that they are demonstrating the cultural changes and the right culture for their businesses when they are demonstrating compliance with the consumer duty. The good outcomes the FCA wants to see relate to four areas:

1. Consumer understanding – communication
2. Products and services
3. Consumer support – customer service and support
4. Price and value

For each outcome, the firm will need to think about what the meaning is for them and their sector, and what the implications are for the firm in their value chain for each of these rules:

1. Consumer understanding: Increased requirements to make sure that you are communicating clearly with customers and that your communication provides support and enables the consumer to make informed decisions about financial products and services. The consumer must be given the information they need at the right time and presented in a way they understand. Poor communication includes promoting products and services in a misleading way or presenting customers with incomplete or distorted information. Good communication, on the other hand, is communicating clearly and highlighting key risks and considering consumers’ information needs after the initial point of sale. Communication will be key to promote understanding and help customers avoid foreseeable harm and pursue their financial objectives. Firms must: (i) tailor communication; (ii) ensure information is provided on a timely basis; (iii) look at the communication channel used; (iv) test communications to support understanding; and (v) monitor the impact of communications. The FCA confirms that ‘testing’ will be an important part of the consumer understanding outcome
2. Products and services: The products and services must be fit for purpose, designed to meet consumers’ needs and targeted at the consumer whose needs they are designed to meet. Examples of insufficient consideration include unreasonable exit fees, insufficient controls, sludge practices that discourage exit. The FCA expects firms to monitor their products and services to remain consistent with the needs of the target market and deliver the expected outcome. They must ensure that future sales meet requirements too.
3. Consumer support: This outcome goes further than existing rules. The firm must consider the support the customer needs and make sure their customer service meets the needs of the consumer, enabling them to realise benefits and act in their best interests. Firms should make it as easy to leave of switch a product as it is to buy the product or service in the first place. Customers should get what they paid for without unreasonable barriers such as lengthy phone calls to cancel a product or service.
4. Price and value: This is one of the largest areas in need of review within the consumer credit marketplace. Products and services should be fit for purpose and represent fair value. The firms must assess the price at the design stage and through ongoing monitoring. Firms should introduce a requirement to set prices so that they represent fair value for their target customers. Firms must ensure that the price of their products and services are proportionate to their value. For credit products for consumers with higher credit risk, the APR should still represent fair value. There are already rules on price and value so it is unclear how the existing rules will work alongside the new rules.

“The consumer duty is heralding and has as an ambition a culture change across the whole of the industry.”

Helena Thernstrom, Head of Legal, Asset & Invoice Finance, NatwesT

Impact on the asset finance sector

The new Consumer Duty will have a significant impact on the asset finance industry as it goes beyond the simple good conduct of the company to the good conduct of the industry as a whole. It is going to have a significant effect on financial services where they have long and complex distribution chains, which could potentially involve non-regulated businesses.

Adrian Dally, Director of Motor Finance & Strategy at the Finance & Leasing Association believes that moving toward a high-level principle and outcomes-based regulation will result in a seismic change for the asset finance industry. As Dally highlights, “this is all about a significant culture change. And it’s a significantly different way of looking at things going forward. And that will be seismic.”

Pros and cons

The new Consumer Duty is going straight to the core of what the FCA is seeking to do by ensuring a higher and more consistent standard of consumer protection for users of financial services and help to stop harm before it happens. The Duty puts the financial practitioner in the driving seat about how to achieve good outcomes for their customer. As a result, existing problems caused by outdated guidance and unintended consequences will fade.

The Duty positions good customer outcomes as a differentiator; rather than enforcing uniformity, it encourages the flexible and innovative servicing of customers. In the FCA’s opinion “clarity on our expectations and firms focusing on what their customers need should lead to more flexibility for firms to compete and innovate in the interests of consumers.”

As Helena Thernstrom highlights, the new Consumer Duty can be embraced by many businesses as a way to enhance existing consumer protection as well as increasing competition.

In addition to elevating the support given to consumers by firms, there is also an opportunity with the new Consumer Duty guidelines to claim competitive advantage by being transparent. Transparency and communication will be key going forward with the new Consumer Duty. The more transparent a company can be, the better the outcome for the consumer.

Many asset finance companies have already implemented excellent compliance and customer services in their business, skills that have been “honed during the pandemic and in the aftermath”. Toby Poston, Director of Corporate Affairs at BVRLA points out that many of these skills are seen as a key part in competing with their professional colleagues and the Consumer Duty will simply give businesses a roadmap to carry on trying to compete while giving them a framework in which to excel. As Poston highlights, “it’s giving them enough space to innovate and think about things without just making it tick a box.”

In changing the culture, behaviour and focus of businesses, the new Consumer Duty guidelines will allow each company to be innovative in the way they implement the new rules and principles focusing on an outcome-based process.

“It’s about changing the culture where ultimate responsibility is on you, the firm to deliver that. And the regulator won’t be giving you yes and no answers anymore. Because that hinders innovation, that hinders the focus on the customer, or the ultimate customer whom we exist to serve,” indicates Dally. “We have to get used to a new world where the future regulator won’t be telling you do and don’t. They’ll be there. It’s an outcome-based process. It is uncomfortable, but it unlocks innovation, and customer focus in many ways.”

However, there are many concerning issues relating to the new Consumer Duty including cost, implementation difficulties, monitoring issues, involvement of prominent unregulated businesses, and, at the end of it all, not knowing if the firm is actually compliant.

The new Duty will result in additional work and mounting cost when it is unclear what the impact of the Duty will be on SMEs and consumers of current practice.

Further concerns point to the implementation of the new Duty and whether simply adding the new principle on top of current ‘treating customer fairly’ rules which focus on conduct is likely to create conflicts. It will be harder to implement the new rules than current principles, with difficulties resulting from the need to monitor the effect on customer – are they receiving the intended good outcomes? The new 12th principle can be seen to be lacking in rigour.

A firm needs to consider much more than their own behaviour. Even if a firm behaves well, it can still potentially breach the new Consumer Duty if the outcome for the customer is bad. This is magnified where there are lots of people involved in determining an outcome as you need to consider the behaviour of all companies in the chain and the effect of all of them.

The Consumer Duty has implications for firms in the distribution chain who do not have a direct contractual relationship with a consumer, but who nonetheless are involved in the manufacture or supply of products and services to the consumer and who can determine or materially influence retail customer outcomes. This will require better communication between the regulated captives and the unregulated OEMs, with more data and information flow required between the partners in the chain.

For many firms, asset based or otherwise, the consumer duty may apply to unregulated business where there is a connection to any ancillary service or where the FCAs existing rules capture certain SMEs. It does not apply to any SMEs.

The implementation of the new Consumer Duty will also require a high level of data gathering and management information, with all senior managers being responsible for ensuring that their business complies with the Consumer Duty requirements. Firms will have to consider every step of the customer journey throughout the product lifecycle, including design, communications, and customer service to assess any areas which may give rise to customer harm.

The Duty must be reflected in firms’ strategies, governance, leadership and people policies, and therefore good governance and controls will be required. Internal processes will need to be reviewed and amended, while customer outcomes will need to be tracked and measured. Customer service processes may need to be re-thought, and firms could have to review their complaints handling processes to ensure issues are identified and reported with product changes effected quickly if necessary.

Many firms will simply see the new Consumer Duty as an unnecessary, timely and costly administrative overhead, and any value gained may well be outweighed by the increase in price that finance providers will need to charge to make providing finance profitable given all the extra work. And in spite of all the extra work and cost, firms will still be unsure if they are actually being compliant with the new rules.

A further concern is whether the new rules might not actually have the desired effect – for example, it may make it harder for brokers to charge for the value they add to customers. Customers do not always understand the value of a service and cheaper is not always better.

What should firms be doing now?

Now that the final Consumer Duty guidelines have been published, firms need to ensure that their gap analysis is complete by October 2022. Companies need to look at their business and make sure that their processes are in line with the new rules, and look at the following areas:

• Assess the customer journey throughout the product lifecycle, including design, communications, and customer service.
• Project management – look at internal processes and implement a robust set of systems in order to track customer outcomes.
• Look at customer service systems and communications.
• Assess product governance – what is the benefit, what is the value of your products and services?