It has been 4 months since implementation of the UK’s Consumer Duty on 31 July 2023, which requires product issuers and distributors to ‘act to deliver good customer outcomes’.
The Consumer Duty marks a significant shift towards outcomes-focussed regulation.
It aims to ensure that retail customers can access products and services that are not only fit for purpose and represent fair value, but also that customers understand how to use and for which they receive appropriate support throughout the product life-cycle.
There has been a flurry of supervisory activity by the UK’s Financial Conduct Authority (FCA) that has been positioned under the Consumer Duty banner, with a particular focus on fair value – an area many regulated entities in the UK have been grappling with.
This article considers the parallels between the UK and Australia’s regulation, summarises recent observations from the FCA regarding fair value, and our views on why we think it is important for Australian financial service providers to take note.
The Consumer Duty: a recap
Our article Consumer empowerment through the new UK Consumer Duty: Will Australia follow suit? | Australia | Global law firm | Norton Rose Fulbright provides a comprehensive overview of the package of measures introduced but to briefly recap, the Consumer Duty comprises:
- A new Consumer Principle that requires regulated entities to act to deliver good outcomes for retail customers.
- A set of over-arching rules that underpin the new Consumer Principle.
- Four broad outcomes, that represent the key elements of the regulated entity and customer relationship against which the FCA will measure adherence to the Consumer Principle, as follows:
- Products and services: products and services are expected to be fit for purpose, i.e. they are designed to meet customers’ needs and targeted at those needs;
- Price and value: the price of the products and services represent fair value for customers, i.e. the price a customer pays for a product or service is reasonable compared to the overall benefits they can expect to receive (this is also referred to as the “fair value” outcome);
- Consumer understanding: communications equip customers to make effective, timely and properly informed decisions about products and services; and
- Consumer support: support provided to customers enables them to use the products and services as anticipated, without unnecessary barriers to accessing benefits and services.
Why is the Consumer Duty relevant for Australian financial service providers?
The Australian Securities and Investments Commission (ASIC) has repeatedly reinforced the importance of good product governance and adherence to the Design and Distribution Obligations (DDO) in its surveillance and enforcement agenda.
The DDO came into effect more than 2 years ago. Like the Consumer Duty, it represented a shift away from disclosure towards customer outcomes-based regulation, with the intent of breaking the cycle of customer harm caused by poor product design, distribution and marketing. ASIC initially focused on lifting the standard of target market identification. ASIC’s recent supervisory activity signals a move towards assessing how product issuers and distributors are meeting their reasonable steps obligations, with the expectation that enforcement action (including targeted stop orders) will increase in this area.
While clear parallels can be drawn between the ‘products and services’ and ‘consumer understanding’ outcomes in the UK’s Consumer Duty, and the DDO’s requirement to design products that meet the needs of an identifiable customer base, the role that “fair value” plays under the DDO regime is less apparent.
Unlike the Consumer Duty, the DDO does not expressly require issuers to assess that products will deliver ‘fair value’ as part of product design, and on an ongoing basis, so they can proactively demonstrate that the benefits of their products and services are reasonable relative to their price. ASIC’s Regulatory Guide 274 Product design and distribution obligations refers to collecting and analysing relevant “consumer, product, performance, value and transaction data” to feed into product design and ongoing review processes.
Nevertheless, in order for financial service providers to confidently demonstrate that they have satisfied the intent of the DDO – i.e. good consumer outcomes – it will be necessary for them to consider the value of the products offered to their customers, especially given the current socio-economic environment and escalating cost-of-living pressures.
So what can Australian financial service providers learn from the FCA’s recent guidance on assessing fair value?
Assessing fair value – observations from the FCA
In May 2023, the FCA published the findings of its review of the fair value frameworks for 14 large regulated entities in the retail banking, payments and consumer finance sectors .1
As noted above, the specific focus of the fair value rules under the Consumer Duty is on ensuring the price the customer pays for a product or service is reasonable compared to the overall benefits the customer can expect to receive. Entities need to undertake fair value assessments as a way of demonstrating whether the price paid for a product or service is reasonable compared to the overall benefits. There are 3 mandatory attributes all fair value assessments must consider:
- the nature of the product or service,
- any limitations that form part of the product or service; and
- the total cost the customer will pay throughout the customer journey.
There is extensive guidance as to what elements regulated entities should consider including in these assessments, depending on their business model, products and services.
The FCA observed that most of the frameworks they reviewed set out a reasonable view of how the concept of fair value would be applied across business and product lines, including the assessment of benefits and total costs payable. However specific areas for improvement included:
- The need for greater adaptation of generalised templates for assessing fair value to appropriately accommodate products with significantly different attributes serving different target markets. In other words, some firms had failed to properly apply the rules at a sufficiently granular level for particular products.
- More detailed information to be provided on profit margins across different products and services, which the FCA views as a relevant factor in assessing fair value.
- Further consideration of non-financial costs (e.g. time and effort involved in amending or cancelling a product) and benefits (e.g. level of consumer service, quality of the product).
- Less reliance on average customer outcomes, which could disguise outliers and pockets of poor value, with a greater focus on detailed analysis using segmented groups.
- More critical analysis of the use of fair value ratings (e.g. points based or red/amber/green ratings), including how thresholds between points/ratings are drawn and whether decision makers have sufficiently detailed information to review and challenge the fair value assessment.
In July 2023, the FCA published a 14-point action plan to ensure banks and building societies were passing on interest rate rises to customers, and proactively offering customers better savings rate deals2. Part of that plan required firms offering the lowest interest rates on savings to provide their fair value assessments to the FCA by 31 August. The FCA noted it would take enforcement action by the end of the 2023 against those unable to demonstrate fair value. An update on the FCA’s findings is expected soon.
Interestingly, the FCA recently highlighted industry-wide improvements in the saving rates offered to customers, at the same time as the FCA started scrutinising these fair value assessments by banks and building societies. This appears to demonstrate that the Consumer Duty enables quick intervention to achieve tangible benefits, where customers are not getting good outcomes. This is likely to be of interest to ASIC or the ACCC given the domestic comparable is the ongoing Retail Deposits Inquiry which was directed by the Treasurer in February 2023, with the final report due at the end of this year.
In August 2023, the FCA released key findings from its review of the processes used by authorised fund managers to assess the value of the funds they operate3. The UK introduced obligations to assess the value of funds at least annually in 2019. This was a consequence of a thematic review, which found that weak demand-side pressure on fund prices was resulting in uncompetitive outcomes for investors. Fund managers must now assess whether their fees and charges are justified by the value provided to investors, measured against minimum considerations. The details of that assessment must be reported to investors. The quality of the service provided to investors must also be assessed (e.g. fund manager expertise, quality of investment processes).
Although the assessment of value rules for fund managers came into force before the Consumer Duty, and act in lieu of the “fair value” outcome, the FCA noted that many of its observations may be relevant to the application of fair value outcome for other products and services. The FCA observed that:
- The tension between fund profitability and assessing a fund’s value for money for investors, appeared to be exerting too much influence on the assessment of value decision making and outcome. It warned fund managers that those who failed to make decisions to deliver good outcomes would likely fall short of the expectations. It was important for boards to manage this conflict appropriately, as the board and senior management remain accountable for overseeing that funds were in the investors’ best interests.
- Too frequently, boards were accepting the assessment of value at “face value” with limited or no challenge, and there was an over-reliance on attestations from senior managers about the quality of their own operations.
- Low complaint volumes and investment breaches were “hygiene factors” that the FCA considered should not in themselves contribute to positive service quality scores.
- The metrics some firms used to assess fund performance were asymmetric – they applied relatively undemanding hurdles to decide whether a fund had good levels of performance, while the “poor performance” threshold was disproportionately high, and in some cases almost impossible to achieve.
Finally, the FCA recently issued a stark reminder to boards of regulated entities, regarding their annual obligation, to review and approve an assessment of whether the regulated entity is delivering good outcomes for customers4. This assessment should include the results of the monitoring undertaken to determine whether the products and services are delivering outcomes consistent with the Consumer Duty. The FCA also reminded boards they need to agree on the actions required to address identified risks or poor outcomes, and on any changes to their future business strategy.
We expect this assessment will need to encompass broad criteria such as:
- pricing fees and charges,
- behavioural insights,
- customer experience feedback,
- fair value assessments; and
- training records.
The assessment will be part of the evidence used to assess entities ongoing compliance with the Consumer Duty. Regulated entities need to be able to provide this assessment, together with supporting management information, to the FCA on request.
So what does this mean for Australian financial service providers?
We expect the FCA’s focus on fair value is likely to be considered carefully by other regulators globally, including ASIC and the Australian Competition and Consumer Commission (ACCC), both in near-term supervisory action and longer-term legislative reform.
In preparation for similar regime changes in Australia, Australian financial service providers should start considering:
- the extent to which their product governance life-cycle considers the concept of value from the customers’ perspective,
- how the value of their products and services are measured, monitored and evidenced through quantitative data; and
- how the concept of fair value ultimately feeds into qualitative decision-making throughout the product life-cycle.
Proactive Australian financial service providers may also want to revisit how their board and senior executive teams actively monitor the delivery of good customer outcomes across product and business lines, adopting some of the metrics and frameworks utilised by UK peers.
Our global financial services regulatory team and risk advisory specialists have supported clients across sectors with Consumer Duty implementation - from retail banks to investment firms, asset and wealth managers, mortgage lenders and consumer credit firms – and are continuing to assist these firms in achieving compliance with the Consumer Duty as it is embedded within the market. If you would like to know more about how our valuable insights can help your business, please contact one of our team members below.