Challenges arising from the new Consumer Duty

Summary

On July 27, 2022, the Financial Conduct Authority (FCA) introduced a new Consumer Duty to shift the industry’s mindset and culture, focusing on an outcomes-based proactive approach. Achieving ‘good outcomes’ is the primary focus of the new Consumer Duty, moving away from simply treating customers fairly.

The recent Asset Finance Connect Consumer Duty Unconference, moderated by Shoosmiths, brought together a broad range of participants from the lending, sales, compliance and legal communities to reflect on how the asset and auto finance sectors should be addressing and implementing the new Consumer Duty principle and rules.

“The regulators are opening up Pandora’s box.”

Wayne Gibbard, Commercial Clients and Strategy at Shoosmiths called the new Consumer Duty a process of “continuous learning” as it will require firms to constantly review and challenge processes and policy to ensure it is delivering good customer outcomes.

Wayne Gibbard emphasised that “the customer must be at the heart of everything” and there must be a change in culture with Consumer Duty embedded in a company from top to bottom.

All firms need to have completed their implementation plans (deadline was the end of October) along with supporting evidence of discussions and critical challenges to the plan. Companies should currently be conducting their gap analysis, business mapping, identifying key individuals in the company and designing regulatory processes.

Price and value

Under the new Consumer Duty rules, the focus is on the relationship between the price the customer pays to the overall benefits they can reasonably be expected to obtain from a product. The price and value outcome rules seem to be one of the most challenging aspects of the new principle.

In Consumer Duty particular attention must be paid to the key words of the price and value outcome — “assess”, “consider” and “evidence” — when assessing the relationship between price and fair value.

Many participants questioned if the price and value of a product had to be reassessed part way through a contract due to changing market conditions or a changing consumer situation. The FCA has proposed that firms will review the value of a product or service throughout its lifecycle. The frequency of reviews depends on the nature and complexity of the product or service, any indications of customer harm, the distribution strategy, the cycle of product or service review under the product and service outcome rules and other factors. A range of information will be taken into account and firms will need to ensure they have systems in place to collect whatever information they consider is needed.

When assessing value, the FCA noted that companies need to assess that the value the customer is taking from the product is reasonable, but is value different for each customer? For each customer, value may indeed have a different meaning. Companies need to consider whether there is fair value to consumers in respect of all products and services and differential pricing increases the risk that products and services do not represent fair value, particularly where consumer groups include customers in vulnerable circumstances and customers with protected characteristics. In this respect, it is critical to ensure there is a defined market for products and the sales are targeted to them, with value being assessed to ensure this is delivered to these customers.

With many financial sectors seeing a change in product type from product to a service, most notably in the motor finance sector from ownership to usership to membership (or subscription), many participants wondered if the same rules of price and value would apply. Would the customer be looking for different definitions of price and value between delivering a service and an asset? The price and value outcome of the Consumer Duty focuses on the relationship between the price the consumer pays and the overall benefits of a product, whether it be an asset or a service.

Finance products

The Consumer Duty applies to a vast array of regulated financial products from short-term low-risk to long-term high-risk products. All products must be analysed and deconstructed under the Consumer Duty with all rationale and evidence recorded.

The FCA want parity between the way a product is originated (at the front-end) and the way the customer is supported (at the back-end) throughout their journey.

Many participants noted that familiar long-standing simple products, especially those from the motor finance sector, become more complex when adding a Consumer Duty lens. When analysing products, companies should constantly refer back to the cross-cutting rules to see how they apply to each product. Data points must also be reviewed and added to product reviews, and tailored to different groups of customers. This must all be evidenced in the implementation plan.

New products to the auto and asset finance markets such as subscription and pay-per-use models are not specifically mentioned in the Consumer Duty. However, due to the flexible short-term features such as easy to onboard and easy to leave or switch, subscription is seen as a low-risk transitional product.

Other products with long-term commitment, high exit fees and ancillary products are highlighted and scrutinised in more detail by the FCA as they are seen as high risk. The FCA is focused on ‘sludge’ practices which include a number of imbalances and can cause potential harm to the consumer.

It is recommended that customers are contacted throughout long-term contracts, showing that the company have thought about possible changing situations for the customer and potential harm for the customer and how to mitigate it.

One participant noted that a company must now provide limitless information to the customer to cover every and any eventuality. Some problems arise as consumers do not read all of the legally required terms and conditions of an agreement. The information therefore must be streamlined to be understandable for different consumer groups; for the same products you will need different communication going out to different groups of customers.

With the current cost-of-living crisis, people’s circumstances can change quickly as they did during the Covid pandemic. However, the FCA have noted that not all harm is foreseeable especially during such unknown eventualities.

“The FCA have noted that not all harm is foreseeable especially during such unknown eventualities.”

Managing the distribution chain

At this stage in the Consumer Duty journey, companies should be mapping out their distribution chain and identifying any problems or concerns. Consumer Duty responsibility extends to the value chain with certain firms taking a higher level than others, e.g., captives and finance companies.

All companies in the distribution chain must know where all products originate, the components of a product and if all parts of the chain are compliant.

The main problems noted in the value chain include companies who do not have that consumer loyalty and instead purely focus on the commercial side, as well as the presence of unregulated companies who may not bound by Consumer Duty but who still need to provide information to other members of the chain.

Consumer Duty has highlighted that any detrimental activity or non-compliance with Consumer Duty within the chain can be reported by another company in the chain; this is the oversight of other parties in the chain to call out others, but this could generate friction between the parties of the distribution chain.

Many participants noted the extreme complexity of introducing a unique company process for Consumer Duty, with one participant highlighting the “challenging timeline and complexity, with no single prescribed process” within the value chain.

A recurring issue raised in the sessions was that brokers and retailers in the value chain are not receiving product information from lenders/funders/manufacturers regarding their products. They are naturally concerned that such companies might leave this transfer of information until April 2023 when companies will only have a couple of months to implement the information.

Participants found that some lenders have no urgency in providing product information and unregulated lenders won’t provide information at all, and therefore the broker or retailer will have to make a decision whether or not to use that lender going forward.

While the Consumer Duty applies to regulated activities, there was a general consensus among the unconference participants that there should be an aspiration to apply the same standards and approach to both regulated and unregulated business in the value chain, with the same culture across all businesses.

“All companies in the distribution chain must know where all products originate, the components of a product and if all parts of the chain are compliant.”

Communication

In the Consumer Duty guidance, PRIN 2A.5.3R(1) notes that a firm must support retail customer understanding so that its communications:

(a) meet the information needs of retail customers;

(b) are likely to be understood by retail customers; and

(c) equip retail customers to make decisions that are effective, timely and properly informed.

Wayne Gibbard highlighted the importance of the words “support” to enhance the customers’ understanding and “equip” so that the retail customer can make a decision that is effective and timely.

If we focus on the language, companies need to demonstrate that they are “supporting” and “equipping” their customers at a higher level than currently exists to comply with principle 12.

Many questions and issues were raised during the session focusing on communication ranging from commission disclosure to communicating risk.

The first issue when discussing consumer understanding is that it is critical to identify the target market so that the product design, communications, etc., can be built to meet the target markets’ needs. The original concept of the ‘average customer’ was removed by the FCA in the final Consumer Duty paper so it is fundamental for an organisation to know their target market and the characteristics of those specific customers, not a general population. The vulnerable customer was also a key point in the principle with communication to be adapted accordingly so as to prevent harm and mitigate risk.

Communication must be clear and transparent to the customer when detailing the product offering. It is critical to evidence all customer communication and its effectiveness as this will be measured by the FCA.

With regards to risk, many Unconference participants asked at what point should a customer be informed about product risks and should these risks be reinforced throughout the contract? The main point with risk is that if it is not communicated with the customer, then the company has not met their obligation to avoid unforeseeable harm to the customer.

While there can be an enormous amount of information for the customer to digest, they still need to be made aware of certain elements and risks within a product contract e.g., termination process and exit fees, excess mileage fee, and refurbishment charges.

There are a number of steps to analyse to mitigate risk and that involves looking at where the responsibility lies. The lender must equip the intermediary/broker with information within the distribution chain where everybody has an element of responsibility.

However, while Consumer Duty can be followed to the highest standard, there may still be risk as the company cannot totally insulate the customer. The company must highlight the risks and convey to the customer to “equip” them.

Following a change in a customer’s circumstances, the communication to the customer should be adapted to account for the changing customer’s needs. During the lifecycle of a contract, customer communication can change. There needs to be more discussions with the customer so that the company can really understand the customer and their needs and circumstances so that communication can be tailored accordingly.

Commission disclosure

Despite the fact that commission disclosure was not mentioned in the Consumer Duty guidelines, the issue was inevitably raised during the Unconference with many participants asking how a customer will see that earning commission is value for money.

Shoosmiths’ Wayne Gibbard pointed to existing rules on commission, including the Consumer Credit sourcebook (CONC) which provides guidance around what is reasonable for intermediary commission and the FCA review around commission in motor finance sector (in particular), banning certain models of commission payment.

With Consumer Duty, when analysing all elements of distribution and communication, we must ask how commission may influence or change a customer’s decision? One participant noted that commission increases competition because there is a choice.

“We must keep the customer at the heart of everything.”

Looking forward

Wayne Gibbard notes that Consumer Duty is a “challenging implementation”. With implementation plans being completed by the end of October 2022, all companies within a distribution chain must be prepared with supporting evidence available of discussions surrounding the gap analysis and the implementation plans. Any challenges to the plan must also be documented and available for the FCA.

Businesses need to mobilise on the implementation of the Consumer Duty immediately. While there will be challenges ahead, businesses must complete a full and critical review of their products and services, remain focused on the deliverables and ensure engagement with boards, senior managers and the distribution chain, but above all they must “keep the customer at the heart of everything”.