Khepri's A to Z: Consumer Duty - Buy and Sell-Side Compliance
Introduction
The FCA hopes the Consumer Duty will lead to a cultural shift in how firms’ approach the development and sale of products and services to customers.
The Customer Duty introduces a new Principle, Principle 12, within the FCA’s Principles for Businesses which reads “a firm must act to deliver good outcomes for retail customers”.
The rules are extensive and the time to plan is now. These are the key dates:
31 July 2023: Consumer Duty live for existing and open products and services
31 July 2024: Consumer Duty live for closed products and services, that are no longer offered
31 July 2024: First annual board attestation
What issues are the FCA aiming to address?
The FCA is of the view that risky investments are still too often finding their way into the hands of investors for which they are not suitable.
In addition, the FCA is concerned that there is a general market failure where investors are not making rational decisions based on the information presented to them as part of the investment journey.
In the context of the “cost of living crisis” this will become particularly important as consumers face increasing pressures. Therefore, it is vital they make informed, effective decisions and firms support them to make decisions that are in their best interests, considering financial objectives and priorities.
What type of business activity will be impacted by these new rules?
In the context of the investment business that Khepri supports, it is important to note that the rules will impact the following types of activities:
making financial promotions with respect to services (e.g. investment advice, discretionary management, etc) or investment products (e.g. funds, specific securities, etc) to Retail Consumers;
receiving and transmitting orders in connection with public or private market investments involving Retail Customers;
providing personalised or non-personalised recommendations to Retail Customers;
managing funds where the investors are Retail Customers; and
distribution of financial promotions or the intermediation of investment services, where the end client is a Retail Customer e.g. a platform provider.
What is a Retail Consumer?
In relation to the new Consumer Principle, a Retail Customer is a person that is not a Professional Client. The definition includes prospective as well as actual customers. This would include persons such as High Net Worth Investors, Certified and Self-Certified Sophisticated Investors and ordinary Retail Clients.
What is the Consumer Principle?
The headline Consumer Principle is contained in a new Principle 12 – “A firm must act to deliver good outcomes for Retail Customers”. This is further defined and refined in PRIN 2A which has the following key sections:
overriding purpose;
cross cutting obligations;
products and services;
price and value;
consumer understanding;
consumer support;
governance and culture;
monitoring of customer outcomes;
redress or other appropriate action; and
sale and purchase of product books.
What outcome is the FCA expecting from this new Consumer Duty?
The FCA hopes the new Consumer Principle will fix these issues and advance their consumer protection and competition objectives by:
setting higher and clearer standards by requiring firms to ensure their products and services are fit for purpose and offer fair value, and to help consumers to make effective choices or act in their interests;
focusing on outcomes, the Consumer Duty will help to ensure that the level of consumer protection is both appropriate for the environment in which consumers currently transact and for those in which they will transact in the future;
supporting a more agile and assertive supervision so to prevent harm before it arises and that, where harm occurs, it is addressed more effectively;
creating a fairer and more consumer-focused playing field on which firms can compete and innovate in pursuit of good outcomes; and
acting in the interests of consumers through the design of products and services which meet consumer needs.
How will the Consumer Principles be codified?
These are codified in two places:
Principles for Business (PRIN): The Consumer Principle will be a brand-new 12th Principal for Business – “A firm must act to deliver good outcomes for Retail Customers”. The FCA expects its Principles for Business to guide all the activities that it undertakes.
Conduct Rule (COCON): The FCA has added additional, 6th, Individual Conduct Rule – “You must act to deliver good outcomes for Retail Customers” relevant to directly authorised firms which are subject to the Senior Managers and Certification Regime (“SMCR”).
Does this mean that Consumers have no responsibility for poor decisions they make?
No, it does not mean that.
Customers should best understand their own circumstances and financial needs and objectives, the requirements do not remove their responsibility for decision making or prevent them from making decisions that are not in their interest. The Guidance makes it clear that, while firms should empower customers to make choices for themselves, customers remain ultimately responsible for their decisions and actions, but firms must understand and take into account behavioural biases and the impact that vulnerability can have on consumer needs and decisions.
Does this create a fiduciary responsibility for me vis-à-vis my Consumers?
No, the FCA has made clear in PRIN 2A.1.11 G that “it does not create a fiduciary relationship where one would not otherwise exist nor require a firm to provide advice or carry out any other regulated activity where it would not otherwise have done so”.
What is the geographical scope?
The scope of Principal 12 and PRIN 2A is with respect to activities carried on with Retail Customers located in the United Kingdom unless the rules governing the activities apply irrespective of the location of the Retail Customer.
Examples of how this may work in practice would include:
Financial promotion: the UK’s Financial Promotion rules apply to the extent that the promotion is capable of having an effect in the UK. This would mean if a firm were merely sending promotions to persons located outside the UK with respect to products located outside the UK, it may not fall within the Consumer Duty rules.
Advisory contract with non-UK person: If a UK firm provides a service (e.g. advisory, arranging of deals or managing an AIF with non-UK investors) to a non-UK person it is often the case that the rules are agnostic of location of the client and therefore the Consumer Duty rules would apply.
How will the FCA enforce this?
The Consumer Duty is underpinned by the concept of reasonableness which is an objective test. The obligations on firms will be interpreted in accordance with the standard that could reasonably be expected of a prudent firm carrying on the same activity in relation to the same product and services, taking appropriate account of the needs and characteristics of customers in the relevant target market.
This includes (amongst other things), paying appropriate regard to:
the nature and scale of characteristics of vulnerability that exist in the relevant target market;
the impact of these characteristics on the needs of customers in the target market; and
the needs and characteristics of that customer.
What is reasonable will depend on a range of factors reflecting a firm’s role in the distribution chain and its ability to determine or materially influence the outcomes customers receive.
What is the timeline?
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. However, the FCA have given firms longer, until 31 July 2024, to apply the Consumer Duty to products and services held in closed books.
The rules are extensive and the time to plan is now. These are the key dates:
Now past: 31 October 2022: Implementation plan should be approved by the board / executive committee of the firm
Now Past: 30 April 2023: Manufacturers review existing products and share information with Distributors
31 July 2023: Consumer Duty live for existing and open products and services
31 July 2024: Consumer Duty live for closed products and services, that are no longer offered
31 July 2024: First annual board attestation
Examples of poor practice
The list below shows examples of poor practice identified by the FCA (with the exception of those indicated by a *) during the review:
Products and Services:
Some products that were designed, either intentionally or through insufficient consideration of consumer outcomes, with aspects that exploit behavioural biases. For example, the FCA have seen complex investment products where the complexity disguises high risks, high costs, or poor prospects of the product delivering a return commensurate with the risks and costs.
The FCA saw products designed with features which can deter customers from acting in their best interest. This included online services where there is a lack of clarity on whether customers are purchasing products on an advised or non-advised basis, unreasonable exit fees preventing customers from getting better deals or leaving products which are no longer right for them and practices or contract terms which discourage exit such as requiring customers to go into a branch to close a product or cancel using registered post services.
The FCA identified weaknesses in the design and governance of some structured products with products designed without due consideration of customer needs, characteristics and objectives and were of limited value to the customers they were sold to. This was caused by inadequate testing of product performance, inadequate consideration of a product’s value compared to alternatives and distribution strategies based on factors deemed to be attractive to customers rather than seeking identified needs, characteristics and objectives.
Price and Value
The estimated expenses of the fund over its life are higher than the expected gross IRR disclosed to investors. In such situations, it is unlikely that investors will receive a return on their investment commensurate to the risks that they are taking.
Consumer understanding
Mandatory disclosures require firms to produce a summary of their products including main features and risks. Firms have discretion on which features and risks they want to highlight and also how they will be explained. The summary is produced without considering the Consumer Duty which includes requirements under the consumer understanding outcome. The summaries are complex and full of technical terms and jargon making it difficult for consumers to gain product understanding and therefore assess whether it meets their needs.
The FCA has seen cases where firms have sent a single and very long communication to all customers covering a range of issues with customers left to work out which bits of the communication are relevant to them. The FCA states that firms should consider segmenting or target communications to make them more relevant to their recipients rather that a ‘one size fits all approach’. This will not affect all communications just those where there are information needs for different groups of customers.
Consumer Support
A firm used an automated telephone system for customer support however this system can only provide options to progress with queries on a few commonly raised issues with no route for customers to seek support regarding other issues. As a result, customers are unable to obtain needed support or information on how to pursue the issue further.
During the FCA’s work on the Coronavirus Tailored Support Guidance they identified some firms using digital tools when providing financial help. The FCA discovered some ‘sludge’ practices which add friction to a customer journey and can prevent customers from pursuing their financial objectives. The practices include customers using third party digital tools having to register and log on more than one system to complete the automated forbearance journey and customers having to select multiple boxes to reveal additional text to help decision-making.
