Introduction to the proposed new Consumer Duty:
The FCA’s final rules (PS 22/9) and guidance (FG 22/5) on the new Consumer Duty represent an important step in the regulator’s efforts to address the ‘Consumer Priorities’ set out in its 2021/22 Business Plan. The new rules seek to remedy harm to consumers resulting from poor practice by firms operating in the retail financial markets. The FCA intends that this higher standard of conduct and consumer protection under the new duty, will see consumers benefit from improved outcomes realised across all stages of the customer journey, considering their individual circumstances.
The new Consumer Duty rules will apply to all FCA regulated firms who provide products and services to retail clients. This includes firms within the entire distribution chain that can influence material aspects of the design, target market or performance of a retail financial product or service. The rules should be applied by firms throughout the entire product lifecycle of regulated activities for retail business, and unregulated activities which are ancillary to the regulated activity. Whilst the rules are not retrospective and will apply on a forward-looking basis from go-live, firms still need to consider existing products and services where appropriate.
The finalised rules extend the implementation deadlines: all in-scope firms will now have until 31 July 2023 to ensure new and existing products and services that are open to sale (or renewal) are compliant with the duty, whereas products and services held in closed books will have until 31 July 2024 to comply. Although this is a welcome extension, a firm’s* Board or equivalent Management Body must sign-off a completed Consumer Duty implementation plan by end October 2022 and firms should be prepared to display the plan and demonstrate its robustness to the regulator. It is therefore recommended that firms quickly initiate the necessary activities, in particular a regulatory impact assessment, without delay.
*Manufacturers specifically should aim to/must complete all the reviews necessary to meet the four outcome rules for their existing open products and services by the end of April 2023. At this point, manufacturers must share with distributors the information necessary for them to meet their obligations under the Duty; and identify where changes need to be made to their existing open products and services, to meet the Duty and implement these remedies by the end of July 2023.
The FCA has broadened the scope of existing handbook requirements which aim to protect consumers. The new rules introduced as part of the Consumer Duty are proposed to include:
- A new Consumer Principle (Principle 12). The new consumer principle requires that ‘firms must act to deliver good outcomes for retail customers.’ It sets a higher standard than is currently required under the similar Principle 6 and Principle 7 and will replace those principles for in-scope firms and the activities to which they already apply.
- Cross Cutting Rules: The Cross Cutting Rules apply across all stages of the customer journey and lifecycle of a product or service and help to interpret the four outcomes (see below). They require that firms must:
- Act in good faith towards retail customers
- Avoid causing foreseeable harm to retail customers, and
- Enable and support retail customers to pursue their financial objectives.
- The Four Outcomes: The Four Outcomes represent the ‘key elements of the firm-consumer relationship which are instrumental in helping to drive good outcomes for customers’, they include:
- Products and services
- Price and value
- Consumer understanding, and
- Consumer support.
In addition to the core components above, firms must also implement the following:
Testing and monitoring:
A firm must ensure they have the appropriate processes in place to identify whether they are meeting the four outcomes for their retail customers, and the root cause of anything preventing them from doing so. Where a product or service is found not to be meeting the necessary outcome(s), appropriate action must be taken to remedy the situation.
Annual board assessment:
A firm must produce an annual assessment of whether it is delivering good outcomes for is customers that are consistent with the Consumer Duty, which must be reviewed and approved by the firm’s governing body at least annually.
The assessment should include the results of the monitoring activity, and the Board should use this information to agree: (1) action required to address any identified risks that retail customers may not receive good outcomes; (2) action required to address an identified instance where retail customers have not received good outcomes; and (3) any amendments to the firm’s business strategy to ensure that it remains consistent with meeting the firm’s obligations under the Consumer Duty. In instances where the applicable outcomes are not being met, the appropriate action to address the situation must be agreed by the Board as part of the approval process.
A new Senior Managers & Certification Regime (SM&CR) Conduct Rule:
Senior Managers will be accountable for delivering ‘good outcomes for retail customers’ within their areas of responsibility, in line with the SM&CR Duty of Responsibility and the Conduct Rules. Where applicable, it replaces the current SM&CR Conduct Rule 4 (‘You must pay due regard to the interests of customers and treat them fairly’), as it covers a higher standard in relation to a firm’s retail market business relative to what is currently covered by Conduct Rule 4.
The new Conduct Rule is closely related to the cross-cutting rules – complying with the former will fulfil the latter, and vice versa. As such, firms should look to the implementation approach previously adopted to meet compliance with the Conduct Rules under SM&CR and consider the extent to which it can be re-used for the cross-cutting rules and the new Conduct Rule itself.
How should firms address the requirements?
Will implementing the new Consumer Duty rules require significant effort from firms or modest updates?
As with most regulatory change initiatives, firms should start with a gap analysis of their current state environment against the rules. Understanding how a firm’s business model, and the activities they undertake, brings them into scope of certain requirements will present the first obstacle to overcome. Amongst other complexities, firms will need to consider the inclusion of ancillary activities in relation to a regulated product or service provided to a retail client and the concept that a customer should still be treated as a retail client for the purposes of consumer duty, even where the firm does not have a direct relationship with them.
There are many overlaps between the Consumer Duty and existing obligations on relevant firms, which the FCA has highlighted in the rules. For example: firms subject to PROD rules will not be subject to Products and Services Outcome under the Consumer Duty; there’s significant consistency between the ‘Consumer Understanding’ outcome and existing Treating Customers Fairly (TCF) rules; and the pricing and value requirements overlaps with the fair value rules in PROD 4 for non‑investment insurance, COLL 6.6, COLL 8.5 or COLL 15.7 for asset management, and PROD 7 for funeral plans.
However, care should be taken to not assume that existing obligations to meet certain rules, and activities in place to support these, automatically renders them compliant with the Consumer Duty. Furthermore, regulatory reviews have identified numerous failings by firms to meet the above obligations, and they have indicated the possibility of further investigation. A similar supervisory approach is expected under the Consumer Duty Rules; firms should be prepared to demonstrate how their business model, the actions they have taken, and their culture are focused on delivering good customer outcomes, at every stage of the regulatory lifecycle. Where the FCA has concerns, they may undertake a such as requiring a skilled person review or use other similar tools.
Firms should capitalise on the opportunity to address any shortfalls against existing requirements in parallel with meeting the Consumer Duty requirements, which will offer delivery efficiencies and cost benefits.
What is the best approach to implementation?
The completion of the gap analysis will drive the impact assessment and subsequent requirements for any remediation activity and the solution design. As the application of the rules should be proportionate, the effort required by firms will depend on their role within the distribution chain, their relationship with the end customer, and the level of compliance and effectiveness of existing processes already in place. Even where existing processes are place that can support the Consumer Duty, firms must take this opportunity to reassess whether they are meeting the standard expected by the Regulator.
For most firms, we expect their implementation focus to cover six key areas (with varying degrees of effort):
1. Consumer Duty solution design
Firms will need to start by defining their ‘house view’ of the core components under the Consumer Duty and the aspects they need to design or improve e.g., products and services, consumer communications testing, pricing models, product governance processes etc. The cross-cutting rules are ambiguous, and firms will need to agree their own interpretation and define what amounts to a breach. Conversely, the four outcomes are reasonably prescriptive, but firms will need to define their view of ‘what good looks like’.
2. Products and services remediation activity
Firms must address any shortfalls in their current retail products or services against the cross-cutting rules and the four outcomes. This will require a review of their products and services under all aspects of the Consumer Duty before the end of the implementation period, which may result in updates to contractual terms and conditions of products or services held by existing customers, and before they can be sold to new customers. As the Consumer Duty is forward looking, firms will only need to review closed products against the cross-cutting rules rather than the four outcomes.
3. Data, analytics, and monitoring
The availability of the necessary data and the appropriate monitoring processes must be in place to ensure firms are consistently providing good customer outcomes in line with the Consumer Duty. Firms will need to look at their existing data sources (qualitative and quantitative) and assess whether these are sufficiently robust, and provide the information required to understand whether the intended outcomes for customers are being met.
The regime pays particular focus to customer vulnerabilities, including those identified as protected characteristics under the Equality Act 2010, and how they may impact a customer’s ability to use a product or service. Firms need to understand the nature and scale of characteristics of vulnerability that may be present in target markets, leveraging relevant data available to identify the vulnerabilities within their customer base. From a process perspective, the FCA has identified information sharing between manufacturers and distributors as an area requiring improvement across the industry, and something that will drive greater understanding of the firm’s customer’s (potential) vulnerabilities.
Once firms have established what data they need and how it will be used, they will need to design and implement a data model and monitoring framework for issues or trends that arise. As part of this, firms will need to establish their process and governance to ‘assess, test and understand’ data to accommodate periodic reviews, in addition to any triggers which would drive an ad hoc review of a product or service as a whole, or as it relates to a specific target market or customer. During the implementation period, firms should expect the FCA to ask them to share their approach to monitoring the Duty.
4. Governance and Board Reporting
Successful governance will not only support effective product governance and the identification of the target market; it will also ensure accountability for decision-making and drive senior ownership of Consumer Duty processes. It is important that the Duty is reflected in firms’ strategies, governance, leadership and people policies, including incentives at all levels. Firms will need to consider: if existing governance arrangements are sufficient to facilitate the new Consumer Duty requirements, or is there a need for new committees to provide better oversight and decision-making required; how will MI be used to review and assess Consumer Duty compliance and how will this be presented, and how will Board level responsibilities be planned, aligned to existing responsibilities, and embedded?
The required changes to governance processes provide further opportunity to address current weaknesses or realise efficiency gains. For example, the Value Assessment required to be published by Authorised Fund Managers (AFMs) was poorly received by the FCA during the first attempt in 2021, who cited concerns regarding the ‘quality of analysis and decision making within processes and the judgements reached by AFM Boards’, and a lack of clearly articulated rationale for decisions made based on information presented. There is overlap between the price and value aspect of the annual Board assessment under the Consumer Duty and the Assessment of Value report, and all firms (not just AFM’s) should look to the FCA’s findings to ensure they are improving existing and future proofing new Board reporting processes.
5. Culture, conduct and SM&CR
As the introduction of the new Conduct Rule will require a change to existing Conduct Rules training, firms should explore the opportunity to expand on SM&CR training already in place. Building on the underlying principles of SM&CR, the Consumer Duty seeks to drive a shift in the culture and behaviour of firms operating within the retail financial markets sector. Firms will need to develop their ‘house view’ for how individuals comply with the new Consumer Duty. The impact of this will vary based on their role and the relationship they have to the retail consumer and their position in the distribution chain, so firms will need to develop a tailored training framework and content (see below), that provides the necessary level of support and guidance to clearly define the standards and expectations on each individual.
6. Operating Model Design, transition to BAU and deliver training
It is important that the design of the Consumer Duty operating model and planning for the transition to BAU are looked at concurrently to the development of the solution. It must not be left to the final phase of implementation. Instead of simply ‘bolting on’ new activities to potentially sub-par processes or assigning further responsibilities to existing owners (usually already operating at full capacity), firms should take the opportunity to assess whether their existing operating model is applying the most effective approach to maintaining both ongoing compliance and best practice, whilst being flexible enough to support the continuing pace of change across financial services. Getting the operating model right will build adaptable foundations that can support further change.
A successful transition to BAU will require clear individual accountability to embed the changes and new activities in existing frameworks, in addition to tailored training specific to different roles impacted by the requirements (i.e., in branch customer facing roles vs. marketing teams).
The Consumer Duty will bring fundamental changes and cause significant implementation challenges for many firms. The rules go further than existing regulation and they aim to remedy the poor implementation of previous regulations by many firms. The inclusion of all firms and activities within the distribution chain widens the regulatory landscape and should ensure that, over time, consumer focus becomes an implicit part of the product life cycle.
It is highly likely that enforcement in this area will increase, made easier through the application of SM&CR which will hold named individuals to account, who must be able to demonstrate that their regulatory accountabilities have been fully discharged. Coupled with the increased ease of access to information, a firm’s brand will suffer if they are deemed to not be adopting proper practice. In scope firms should already be planning their road map to implementation and, as a minimum, should be performing a regulatory gap analysis to determine the impact on their business.