1. Introduction and policy background
In May, the FCA published ‘Consultation Paper 21/13: A new Consumer Duty’ (CP21/13). The consultation paper is significant as the FCA proposes to introduce a new “Consumer Duty” for financial services firms dealing with consumers.
The new Consumer Duty is proposed to have three components:
- A new Consumer Principle, which would be a new addition to the FCA’s Principles for Businesses (Principles) and go further than Principle 6 (A firm must pay due regard to the interests of its customers and treat them fairly).
- Cross-cutting rules designed to support the new Consumer Principle.
- Four outcomes setting out more detailed expectations for how firms can meet the new Consumer Principle.
The proposals in CP21/13 should not have come as a bolt out of the blue for financial services firms. The FCA has been discussing introducing a duty of care in financial services for some time now. For example, in July 2018 the FCA published a discussion paper on a duty of care and sought feedback on what form such a provision might take. A feedback statement followed in April 2019 (Feedback Statement 19/02) where the FCA identified two possible options which included new or revised Principles.
More recently, the Financial Services Act 2021 included a provision requiring the FCA to carry out a public consultation about whether it should make general rules providing that authorised persons owe a duty of care to consumers. The Act provided that the FCA’s analysis of the responses to the consultation had to be published before 1 January 2022, with a view to any new rules coming into force by 1 August 2022.
It’s also worth noting that following the publication of the discussion paper in 2018 the FCA has developed a number of related strands. The most obvious being the regulator’s work on vulnerable customers. In February the FCA published ‘Finalised Guidance 21/1: Guidance for firms on the fair treatment of vulnerable customers’. Other strands include the FCA’s recent discussion paper on strengthening the financial promotion rules for high-risk investments.
2. Scope of the proposals – includes firms that don’t have a direct relationship with a customer
The FCA’s proposals for the new Consumer Duty have a very broad scope for two key reasons.
The first is that the proposals are applicable to financial services and products provided to ‘retail clients’. This is a broader category of customers than ‘consumers’ – a term which, in consumer protection legislation refers to individuals acting for purposes outside their trade, business, craft or profession.
By contrast, ‘retail clients’ is a broader category of customers which includes corporate entities such as SMEs and also, potentially much larger organisations as well as entities such as local authorities. Clearly, there will be important questions for firms to understand how the new Consumer Duty should be interpreted across the different customer groups in scope of the new rules and guidance. For example, consumers are currently afforded protections pursuant to the Consumer Rights Act 2015 relating to unfair contract terms, as well as in connection with misleading practices, pursuant to the Consumer Protection from Unfair Trading Regulations 2008. Meanwhile sectoral legislation such as the Consumer Credit Act 1974 contains extensive and valuable rights for ‘individuals’ (a broader term than just natural persons).
Consequently, the new Consumer Duty will add to a well-developed and sophisticated area of law relating to consumer protection. Navigating the differing levels of rights and obligations could prove complex, even as the FCA looks to create clarity in terms of its own expectations for regulated firms through the new Consumer Duty.
At a practical level, firms who are attuned to the requirements of consumer protection legislation may be at a relative advantage when seeking to interpret the new Consumer Duty for the broader category of retail clients. Whilst it is likely that the application of the new Consumer Principle and cross-cutting rules will be contextual, understanding the legal baseline in terms of consumer protection could assist in establishing what these new requirements will mean when dealing with retail clients.
The second way in which the proposals have wide reach is that, as consulted the new Consumer Principle, as well as certain of the cross-cutting rules would be applicable to firms who do not have a direct contractual relationship with a retail client, but who nonetheless are involved in the manufacture or supply of products and services to retail clients.
3. New Consumer Principle – consulting on two options
The FCA has proposed two options for the wording of the new Consumer Principle, which it is seeking feedback on.
Option 1, which states that “a firm must act to deliver good outcomes for retail clients”, places emphasis on consumer outcomes, and firms’ obligations to proactively deliver them. This option extends Principle 6 and underlines the fact that firms should focus on the impact of their actions on consumers, and not simply on processes. Whilst “good outcomes” are not legally defined, the four outcomes proposed and detailed below would provide further guidance on what “good” looks like, though this option of the Consumer Principle would not be limited to delivering these four outcomes alone.
Option 2, which states that “a firm must act in the best interests of retail clients”, extends the expectation for firms to act in the best interests of clients (which is already referenced in a number of rules in the FCA Handbook), and aligns the FCA’s expectations of firms’ conduct in the retail market. In practice, this does not require firms to deliver the absolute best outcomes, but firms should be comfortable that their conduct could reasonably and objectively be said to be in the consumers’ best interests, and equip consumers to be able to make decisions in their best interests.
With either formulation, firms would not be expected to go beyond what is reasonable, taking into account the nature of their role and the products or services they offer.
One area where firms may seek further clarification is the extent to which the new Consumer Principle impacts Principles 6 and 7 (Communications with customers). The FCA states in CP21/13 that it has not yet reached a firm view about whether or not to dis-apply these two Principles where the new Consumer Principle applies. In the regulator’s view where firms are complying with the Consumer Principle, they will in general also be complying with these two Principles as well as the treating customers fairly outcomes. In terms of not being expected to go beyond what is reasonable, firms may also wish to ensure there is some further guidance on this, for example identifying 'good' and 'poor' practice in particular settings.
4. Cross-cutting rules – requiring 3 behaviours from firms
The FCA is proposing to implement three key behaviours that it expects from firms, which it expects to apply on a cross-cutting basis across all of the existing FCA Handbook rules and guidance. The FCA expects these three key behaviours to develop and amplify the Consumer Principle (as discussed above).
The three key behaviours proposed by the FCA will require firms to:
- Take all reasonable steps to avoid causing foreseeable harm to customers.
- Take all reasonable steps to enable customers to pursue their financial objectives.
- Act in good faith.
The FCA expects firms to comply with these cross-cutting rules/behaviours across all of the firm’s activities, from high-level strategic planning to individual customer interactions. The FCA’s proposals note that these behaviours will need to be interpreted by firms in the context of:
- The nature of the product/service offered (i.e. high levels of complexity will require further information/assistance for customers).
- The relevant distribution chain.
- The reasonable expectations of consumers for that particular service/product (i.e. where the added value marketed by the firm is to be delivered via customer service).
- The specific characteristics of the customers (i.e. vulnerability).
Take all reasonable steps to avoid causing foreseeable harms to customers
The FCA have provided additional guidance on what this means, broadly by way of examples of what would not be consistent with this behaviour. For example, the FCA note that firms should not seek to exploit customers’ vulnerabilities, behavioural biases or lack of knowledge (i.e. by disguising/burying key terms in documents, etc).
Whilst the FCA has explicitly noted that this behaviour will not mean that firms must prevent consumers from experiencing any bad outcomes, it does appear to place a high bar on firms to comply. From a practical perspective, in order to comply with this behaviour firms will need to scope out (1) all foreseeable harms that could arise in connection with their products and services, and (2) all reasonable steps that could be taken by the firm to prevent such harms occurring for customers.
It is worth noting that ‘all reasonable steps’ is a particularly high standard, and one that has typically only been used to date by the FCA in the context of best execution requirements (where more quantitative assessments can be used to validate the firm’s compliance with such requirements). For context, the Senior Managers and Certification Regime only requires those individuals undertaking a senior manager role to take ‘reasonable steps’ in order to meet their senior manager responsibilities. This could lead to a situation whereby a firm has failed to comply with this behaviour, but the accountable senior manager within the firm has complied with their senior management requirements.
In light of the pervasive nature of the Consumer Principle, and the enhancements expected by the FCA (for example, through the four outcomes – as further discussed below), we expect that if these proposals are implemented as proposed firms will need to dedicate significant resources to the two part scoping exercise noted above.
It is important to note that firms with a large range of products and services with multiple distribution channels may not be able to wait until the FCA publish any near-final rules at the end of this year, as it may not provide them with sufficient time to undertake their internal reviews and implement any enhancements (internally and with third parties as needed) ahead of any implementation of the final rules in July 2022.
Take all reasonable steps to enable customers to pursue their financial objectives
The FCA’s proposals explain that this behaviour is intended to place a requirement on firms to establish an environment in which consumers can act in their own interests. Broadly, this behaviour appears to place an obligation on firms to consider how they can support customers to make good decisions on the basis of their knowledge of the customer’s needs and characteristics (i.e. vulnerability).
The FCA’s proposals do not provide extensive guidance on how they will seek to interpret these behaviours in practice. In light of this, we expect that firms will be keen to understand the FCA’s expectations on how much information a firm should be expected to hold for a customer, and their financial objectives (particularly where customers access financial services through a range of firms, and so firms may not have a complete picture of a customer’s circumstances).
Act in good faith
The FCA explains that this behaviour reflects a standard of conduct characterised by honesty, fair and open dealing and consistency with the reasonable expectations of consumers. This behaviour is intended to take account of the usual imbalance in the relationship between firms and customers (i.e. asymmetrical knowledge, bargaining power, expertise, etc). The FCA has clarified that these behaviours are not intended to introduce a fiduciary duty between the firm and customer that does not already exist.
5. The four outcomes - key elements of the firm-customer relationship
The FCA is proposing to implement four outcomes that represent the key elements of the firm-consumer relationship, namely how firms design, sell and service products and services, and the key contact points along the customer journey. The FCA expects these four outcomes to develop and provide greater clarity on the expectations for firms in complying with the Consumer Principle and related cross-cutting rules (as discussed above).
The four outcomes proposed by the FCA relate to:
- Communications to equip consumers to make effective, timely and properly informed decisions about financial products and services.
- Products and services are specifically designed to meet the needs of consumers, and sold to those whose needs they meet.
- Customer service meets the needs of consumers, enabling them to realise the benefits of products and services and acts in their interests without undue hindrance.
- The price of products and services represents fair value for consumers.
The FCA’s proposals state that firm’s communications are meant to consistently support consumers by enabling them to make informed decisions about financial products and services. This broadly means that firm’s will be expected to ensure that customers are given the information they need, at the right time, and presented in a way that they can understand.
Understandably, this outcome primarily focuses on firms’ marketing activities, financial promotions and pre-sale customer journey. However, it is important to note that this outcome is intended to capture all of the firm’s communications with customers (across the full lifecycle of a product/service).
The FCA has highlighted ‘sludge practices’, whereby firms deliberatively introduce friction into the customer journey in order to seek more favourable outcomes for the firm (i.e. avoid the customer cancelling/switching a product/service), as an example of behaviours that would be inconsistent with this outcome.
The FCA’s proposals expect firms to consider the Consumer Principle when approving or reviewing any communications to customers, and firms are expected to monitor how these communications are received/performed in order to determine whether they are consistent with the FCA’s desired outcomes. In practice, firms may therefore need to consider the level of management information that they receive on their communications and consider enhancements going forward in order to meet these regulatory expectations.
It is important to note that this outcome is intended to supplement, rather than replace, existing obligations relating to communications, either generally (i.e. under the Consumer Rights Act, Principles 6 and 7), or specifically (i.e. product/service specific pre-contractual disclosures).
Products and services
The FCA’s proposals on the products and services outcome primarily seek to build on the existing product governance requirements for firms. Firms are expected to comply with these obligations through the lens of the Consumer Principle and the cross-cutting rules noted above.
For example, in the design process, the FCA expects firms to take account of expected behavioural biases for customers, and aspects of the product that may deter customers from acting in their interests (i.e. sludge practices, unreasonable exit fees, etc).
The FCA also focuses on the role of distributors, including those in the distribution chain that do not have a direct customer relationship. The scope of the Consumer Principle is intended to cover all parties in the distribution chain for retail customers, but in a manner proportionate with their influence on the design, operation and distribution of the relevant product/service. As such, firms in the distribution chain may seek to renegotiate their distribution agreements to mirror the approach for co-manufacturing agreements, where regulatory responsibility for various elements of the product/service are clearly allocated between the parties.
It is likely that manufacturers and distributors with direct customer relationships (e.g. advisory firms) may also wish to introduce greater management information/reporting requirements in their distribution agreements in order to ensure that their product governance frameworks receive the necessary information to conduct product approval/review processes that are consistent with the Consumer Principle.
Firms may also need to consider to what extent they will need to review and amend their existing internal product governance processes in order to ensure that they are compliant with the Consumer Principle expectations. For example, firms may need to give greater weight to certain factors in the design process going forwards (e.g. see the discussion on price and fair value below).
The FCA’s proposals on customer service are intended to apply to all aspects of the firm’s relationship with customers. In practice, we expect that this outcome will broadly focus on the post-sale aspects of the customer’s interactions with the firm. This is reflected in the FCA’s summary of this outcome, which sets out their expectation that customers should be able to realise the benefits of their product/services, and should not be hindered from acting in their own interests.
In terms of customer benefits, the FCA’s proposals focus on concerns that firms design post-sale processes to try and deter customers from accessing the benefits of their products/services or unduly hinder customers’ from acting in their best interests. The examples used by the FCA refer to firms introducing significant friction in insurance claims processes, or sludge practices which seek to hinder customers’ ability to exit or switch from a product/service.
The FCA’s proposal also notes that firms will need to design their customer service processes to avoid customers’ suffering either costs, or non-monetary costs (i.e. the expenditure of time/significant effort), and this may have a significant impact on the resourcing that firms need to allocate to customer service going forwards.
Price and value
As the three outcomes noted above largely build on existing regulatory concepts and requirements, this fourth outcome represents a more significant step for the FCA’s approach to the supervision of firms. Although the FCA has noted that it is not intending to become a price regulator, and that it is not intending to undertake market intervention (at this stage), its expectations on price and fair value are likely to represent a new challenge for firms.
The FCA’s proposals note that this outcome is intended to ensure that products and services are fit for purpose and represent fair value. This means that firms should ensure that the benefits of the products and services offered to consumers are reasonable relative to their price.
Alongside expectations which touch on the clear disclosure of costs information to customers, the FCA’s proposals also touch on the expected pricing structures that firms should use. The FCA expects firms to consider whether different or flat rate pricing structures are appropriate for the relevant customer groups. In particular, the FCA has noted that they may consider flat rate pricing structures to be inconsistent with this outcome where the fees are volume based, but where the costs incurred by the firm for this service do not have a clear relationship to this pricing structure.
We expect that firms will need to reconsider their product governance processes to incorporate the pricing and fair value expectations set by this outcome. For example, firms may need to consider introducing new product review trigger events linked to profitability or commission rates as a prompt to consider whether a product is delivering fair value for the customer.
Given the significance of this outcome on profitability, it is likely that firms will require much greater guidance from the FCA on its expectations in this area. In this regard, it may be helpful for firms to consider the FCA’s work on ‘fair value’ in the context of General Insurance and Funeral Plans for some further information on expectations in this area.
As the FCA has less experience regulating requirements relating to pricing and fair value, it does not seem unreasonable to expect that this area may be a focus for thematic reviews from the FCA post-implementation. Accordingly, if this proposal goes forward, we expect that firms will need to establish or enhance their existing audit trails in order to justify their assessment of fair value for their pricing structures.
6. Private right of action for breaches of principles
The possibility of the FCA introducing a private right of action (PROA) for a breach of its Principles remains a contentious topic. However, in CP21/13 the FCA makes no decision on whether or not to introduce this.
Section 138D Financial Services and Markets Act 2000 allows the FCA to determine, for each of its rules, whether individuals have a PROA for damages for loss caused by a breach of that rule (subject to some limited exceptions). This PROA applies to most of the FCA’s rules, but does not currently apply for breaches of the Principles. The FCA could allow the right for private persons to bring a PROA for breaches of its Principles, including the proposed Consumer Principle, and the wider Consumer Duty, through an amendment to the FCA Handbook.
In Feedback Statement 19/02, the FCA said that it would consider the merits and unintended consequences of introducing a PROA for the breach of the Principles (including any new Principles). Following this, the FCA reports in CP21/13 that it has received equally opposing and strong views from stakeholders. Whilst the FCA considers the PROA as part of a wider mechanism for firms to be held accountable for breaches of the FCA’s rules, and for consumers to obtain redress, the FCA is not making any specific proposals at this stage. However, the FCA continues to welcome stakeholder feedback. Whilst in CP21/13 the FCA is focussed on the Consumer Duty, the regulator welcomes feedback on how a PROA could help or hinder its proposals and their intended impact on firms, consumers and markets.
7. Where does this all take us in terms of consumer protection?
At the very start of CP21/13 the FCA states that it wants to see a higher level of consumer protection in retail financial markets. With the new Consumer Duty the FCA is seeking to achieve this. The new Consumer Duty would reinforce and complement the existing FCA Handbook requirements and the FCA has stated that its new expectations would also be compatible with other consumer protection legislation such as the Consumer Rights Act 2015, the Enterprise Act 2002 and the Consumer Protection from Unfair Trading Regulations 2008.
Whilst describing the proposals as a “paradigm shift” in its expectations of firms in retail markets the FCA stresses that the new Consumer Duty would not:
- Remove consumers’ responsibility for decision making or, in itself, prevent consumers from making decisions that are not in their interests.
- Require that all consumers of a product or service obtain the same terms or outcome.
- Impose an open‑ended duty that goes beyond the scope of the firm’s role and its ability to determine or influence consumer outcomes, or protect consumers from all potential harms.
- Remove or supersede the need for specific rules or guidance, which may be necessary to mitigate specific consumer harms.
- Specify exactly how firms should act.
- Apply retrospectively to past business. Nor does the FCA intend to judge practices with the benefit of hindsight.
8. What should firms be doing now?
It will be obvious to firms with retail clients that the scope of the proposals is significant, and that preparing for implementation will require careful planning. The rules and guidance which will introduce the new Consumer Duty will be in place by 31 July 2022. Given that the FCA intends to publish those final rules in Q1 2022, firms do not have the luxury of time in order to map the impacts of the new Consumer Duty and to organise for its implementation.
To help firms in these early stages, firms may wish to consider the following:
The FCA expects that the new Consumer Duty will set clearer, and higher standards for firm culture and behaviours. Organisations impacted by it should prepare for a period of change in the way that they do business with retail clients. In order to meet existing expectations relating to firm governance, for example through the Senior Managers and Certification Regime, firms may wish to establish specific projects to understand the impact of the rules if they went ahead as consulted upon. Depending on the scale and range of retail products and services manufactured and/or distributed by firms, sub-streams may be needed on a product-line basis to assess impacts. The project should be reflected on statements of responsibilities as appropriate, and should be appropriately resourced given its fundamental importance to the firm and its business plan.
Rethinking the customer journey
The FCA has identified more that firms can be doing to enable customers to make effective financial decisions. The FCA’s ‘access, assess, act’ framework is again referred to. In order to ensure that products and services are ‘fit for purpose’, firms will need to consider the entire product lifecycle and the way that they engage with their clients at each point. The provision of information at early stages of financial promotion and marketing is an obvious area of focus, since it is through these communications that clients are provided with information on the product or service and which will be used by them to assess whether a particular product best meets their needs. However, it is clear that firms will be expected to rethink the ways that this information is communicated, thinking carefully about the needs of vulnerable customers and with a clear focus on (in Option 2 of the Consumer Principle) the customer’s best interests.
The FCA has identified concerns with the development of behavioural biases amongst retail clients in particular, and the role which ‘sludge practices’ play in facilitating inertia and poor customer outcomes from particular products and services. This may mean that firms will need to interrogate customer behaviour more rigorously to understand where this may be the case, and how information provision and communication strategies should be re-engineered to help customers achieve their financial objectives.
Rethinking product governance: what is the benefit, what is the value?
To understand the application of the cross-cutting rules, firms will need to have assessed the potential detriment which could be suffered by retail clients, and to determine what steps could, and should be taken to mitigate these risks.
Whilst there is much debate surrounding the concept of ‘fair value’, it is clear that the regulator is seeking to clearly link the costs of products and services with the benefits which they are intended to provide. Whilst retail investment products are already subject to granular requirements around product governance, the FCA’s expectations of other regulated products (such as secured and unsecured lending to consumers) has not been calibrated in the same way. Firms will wish to carefully consider the ways in which the expectations around value delivery and benefits can be accommodated within existing product governance processes, and where changes are needed.
Within this context, it is clear that firms will need to regularly monitor customer behaviour and product performance to satisfy themselves that they are achieving the outcomes required by the new duty.
9. Financial Services (Duty of Care) Bill – how does this fit in to the FCA’s proposals?
In January 2020, the Financial Services Duty of Care Bill 2019-20 was formally reintroduced to the House of Lords. The Bill was originally introduced in the 2017-19 parliamentary session as a Private Members' Bill and so had to be reintroduced for the 2019-20 session. The Bill proposes to amend the Financial Services and Markets Act 2000 by inserting a new section 137CA requiring the FCA to introduce a duty of care within 6 months of the Bill being passed into law. Whilst the Bill had its first reading in the House of Lords on 9 January 2020 it has so far not received a second reading and it remains to be seen whether further progress will be made. Given the publication of CP21/13 and the subsequent timetable the FCA has set itself it seems unlikely.
10. Consultation deadline and next steps
The deadline for comments on CP21/13 is 31 July 2021.
It’s important to note that in CP21/13 the FCA has not set out draft rules except for the Consumer Principle. Once the regulator has considered the responses to CP21/13 it will issue a further consultation paper where it will set out the proposed text for any new rules or guidance. This subsequent consultation paper will also include further consideration of a PROA and how the regulator will supervise and embed the Consumer Duty. In line with the Financial Services Act 2021 the FCA expects to publish the consultation paper by 31 December, and make any new rules by 31 July 2022.