What’s changed from the consultation proposals?
Many firms will already be familiar with the content of the draft rules and non-Handbook guidance, even if they have not undertaken large-scale implementation activity yet.
The final rules and guidance contain a number of changes to what was previously being proposed, including:
- Implementation - timetable and expectations for firms: There will be a phased approach to implementation. Firms will need to apply the Consumer Duty to new and existing products and services that are open to sale (or renewal) from 31 July 2023. The FCA has given firms longer (until 31 July 2024) to apply the Consumer Duty to products and services held in closed books. It sets out its expectations and has provided a roadmap for how firms will use this implementation period to effectively embed the Consumer Duty.
- Application of the Consumer Duty to existing products and services: The FCA confirms that the Consumer Duty will apply, on a forward-looking basis, to existing products and services, including closed book products and services. It has, however, added to the final rules and guidance in relation to how firms can apply the price and value rules specifically to existing products and services, and how they can conduct the review in a proportionate manner. There are also new rules to help in future sales of product and service books.
- Scope: The FCA is retaining the proposed scope of the Consumer Duty to include customers with whom a firm does not have a direct relationship, but it has introduced additional guidance to clarify and set out its expectations of different parties in the distribution chain. There is also additional guidance on liability of firms in the distribution chain and for non-UK activities/customers.
- The cross-cutting rules – foreseeable harm: The FCA has reverted to the wording in its first consultation (CP21/13) where it proposed requiring firms to ‘avoid causing foreseeable harm to customers’. This had been shortened in its second consultation (CP21/36) to ‘avoid foreseeable harm’, in response to concerns that this could have made firms liable for harm outside of their responsibility or control.
- The four outcomes: The rules (and guidance) have been amended to address respondents’ concerns about overlap of the products and services outcome with the existing PROD product governance rules. On price and value, the policy statement accompanying the final rules contains further commentary on the FCA’s fair value requirements, including confirmation that its rules are not intended to prevent cross subsidies between products, or require firms to move onto cost plus pricing. For the consumer understanding outcome, the rules have been changed to move away from references to the ‘average’ customer and clarify that the FCA wants firms to ensure their communications are likely to be understood by the customers intended to receive the communication.
- Governance and culture: There are new requirements for the governance process, including for the governing body to receive reports and carry out an annual review.
Issues for firms to consider in light of the final rules and guidance
Firms only have 12 months to implement the bulk of the requirements, and there is a significant amount to fit into that time. In particular, we think firms will need to consider or (for those who have already made a start on implementation planning) look again at the following areas now that the final rules and guidance are out:
- Understanding the regulators’ expectations: The Consumer Duty includes new concepts, such as “avoiding causing foreseeable harm”, which firms will need to interpret in the context of their business.
- Price and value: Firms will be required to carry out value assessments, and for many firms there is little or no guidance or precedent on how to approach that exercise.
- Product governance: Firms will need to consider whether their existing product governance arrangements are adequate. For example, we believe that the FCA will expect a more granular assessment of target markets, and more product testing. There will also be new challenges for many firms, such as identifying behavioural biases.
- Customer understanding: With an increased emphasis on customers being able to understand the risks of a product or service, firms may need to revisit their customer-facing materials.
- Third party relationships: Firms may need to reconsider the nature of their relationships with third parties (e.g. manufacturers, distributors and outsource providers).
Firms will also need to continue to bear the risks of litigation and regulatory action in mind as they implement the Consumer Duty requirements:
- Private right of action: No private right of action (PROA) will be introduced for breaches of any part of the Duty at this time. However, the FCA has made several changes to the Duty that it says may help to replicate the benefits of a PROA, including (i) strengthening governance and accountability requirements; and (ii) strengthening its redress requirements under the Duty: the FCA sees proactivity by firms in providing redress where appropriate as a crucial element of the delivery of good outcomes for customers. And a PROA has not been finally dismissed: the FCA has confirmed that any future decision to attach a PROA to the Duty would be subject to further consultation.
- FOS: Consumers’ main route for redress will be via the Financial Ombudsman Service (FOS), with whom the FCA is working closely. The FCA has specifically identified FOS final decisions on complaints about fees or charges, or inappropriate product or service sales, as one of the ways in which it can monitor whether consumers are getting products and services which meet their needs and provide fair value, making it even more important that firms engage with the FOS process.
- Intervention and enforcement: Once the Duty is in force, the FCA will focus on monitoring, detecting, triaging and acting on breaches. It will use its intervention powers to manage ongoing or immediate risks and require corrective action where necessary. Where the FCA identifies serious misconduct by firms, it will use its full range of powers, including investigating, and where appropriate, its deterrent and remedial powers including issuing fines and securing redress for customers who have suffered harm.
- Individuals: The FCA has made clear that the focus on delivering good outcomes must be supported by individual accountability and personal conduct resulting from the Senior Managers & Certification Regime (SMCR). Each senior manager should be clear about what they are responsible and accountable for, and how they are ensuing that the business of the firm complies with the requirements of the Duty on an ongoing basis. A new Individual Conduct Rule 6 requires all conduct rules staff to act to deliver good outcomes for retail customers where the activities of the firm fall within the scope of the Duty. The FCA has also amended its guidance to make clear that firms should have a champion at board level who, along with the Chair and the CEO, ensures that the Duty is discussed regularly and raised in all relevant discussions.
The above are concerns that apply across the whole of financial services. However, there are also more nuanced concerns that will apply to particular sub-sectors. For example:
- The FCA has added an example in the guidance for the price and value outcome, indicating a focus on business current accounts for SMEs and on transparent and clearly sign-posted pricing that allows customers to understand the price and to compare it in the market.
- There is also a focus on possible weaknesses in banks’ procedures, for example their bereavement procedures in terms of over-complex and inconsistent processes and excessive demands.
- The FCA has responded directly to comments from the e-money and payments industry that the application of Consumer Duty would be disproportionate and there was limited risk of harm.
- The FCA states that it has identified several harms in the e-money and payment services sectors in which the Consumer Duty is expected to play a key part in raising standards, pointing in particular to availability of customer support.
- The FCA has provided guidance on the application of the concept of the “distribution chain” in the context of payments and e-money.
- Intermediaries – even those playing a peripheral role - will need to take greater steps to ensure the credit products they offer to their customers are suitable for their customers.
- As information gained as part of an affordability assessment may indicate the financial objectives of the consumer lenders may need to put in place extra steps to ensure that they examine the information from this perspective and not purely from an affordability point of view.
- Whilst the FCA has acknowledged that the Consumer Duty does not prevent firms from selling similar products with different prices across various brands, extra steps may be needed where lenders have multiple brands to demonstrate fair value.
Investment business and wealth management
- Relationships with product manufacturers and distributors will need to be revisited (particularly where a firm in question is not subject to the Consumer Duty).
- Applying the Consumer Duty obligations in the context of relatively sophisticated retail customers will potentially be challenging especially where firms deal with a range of customers.
Insurance-based investments (life insurance)
- Insurers may be faced with applying the Consumer Duty retrospectively to long-term products that are already in force – e.g. will they be expected to give up vested rights and do things beyond the confines of an existing contract?
- Assessment of price and value in respect of a long term product will be challenging for insurers where long term can mean many decades.
General and protection insurance
- The scope of the Consumer Duty applies to both consumers and commercial policyholders (except in relation to reinsurance, contracts of large risks (i.e. MAT covers, credit and suretyship) and certain group policies.
- The standards expected to be applied need to reflect the policyholder’s reasonable expectations in relation to the insurance – does that include the extent of cover?
- There is new “outcome”-oriented language in relation to assessing fair value. One specific change is that any insurance within a packaged suite of insurances will need to be assessed for fair value separately from all other insurances in the package – which will clearly impact add-on insurances.
The road ahead: the importance of project planning for a cultural shift
Whilst the implementation times have been extended by a short period, for some firms there may still be a lot to get through in the time available. We would recommend firms undertake robust planning to ensure a road to readiness for implementation. The FCA has laid out the requirement that by the end of October 2022, firms’ boards (or equivalent management body) should have agreed their implementation plans and be able to show they have scrutinised and challenged the plans to ensure they are deliverable and robust enough to meet the new regulatory standards.
Implementation of the Consumer Duty is broader than uplifts to existing arrangements: this is a cultural shift to the way firms operate, from the development of propositions through to servicing customers. Whilst a project may require review of policies, processes, frameworks and technology, a key focus is testing the outcomes of changes made. The questions that firms need to ask are:
- How will we test what has changed?
- How will we test effectiveness?
- What will we measure?
- Does governance provide the right visibility and demonstrate appropriate action is being taken?
The practicalities: what should firms do now?
To make best use of the available time, we recommend firms do the following:
- Set up projects with multiple workstreams covering a combination of top-down gap analysis and updating reporting requirements (including identification of appropriate sources of information).
- Look at more detailed bottom-up analysis of specific product expectations (including whether they present fair value), existing support arrangements, appropriateness of communications and operational monitoring of good (and poor) outcomes.
- Relevant stakeholders throughout the firm will need to be engaged from the outset to ensure all parts of the business understand the requirements and support the changes required to implement the Consumer Duty effectively.
It is also important that effective project governance and control is put in place to ensure analysis and implementation activity is carried out in line with the initial plan. Any potential blockers should be identified by the project team at an early stage to allow decisions to be taken by senior managers on how to move forward.
How Hogan Lovells can help
The Hogan Lovells Financial Services legal and consulting teams are already working with a range of firms on their gap analysis and implementation projects. As a result, we are aware of the challenges and difficulties implementing the Consumer Duty requirements can bring, including defining scope, assessing processes, updating operational activity and communications, and ensuring monitoring is effective. If there are any areas of Consumer Duty implementation that you would like to talk through, please do not hesitate to get in touch.
We will be hosting an upcoming series of webinars to assist firms with their plans for the Consumer Duty and to help them work through the more challenging issues. More details will follow in due course.
Authored by Victor Fornasier, Arwen Handley, Roger Tym, Dominic Hill, Julie Patient, Grace Wyatt, Matthew Handfield, Mark Aengenheister, Daniela Vella and Virginia Montgomery.