How will the FCA’s Consumer Duty affect retail banks and consumer credit firms?

This blog was published on 16 May 2022.

At a glance:

• The FCA’s proposals for the new Consumer Duty (“the Duty”) are far reaching and represent a “paradigm shift” in the FCA’s expectations of firms. For retail banks, building societies and consumer credit firms, we expect the price and value and consumer understanding outcomes to present the greatest challenges. This blog focuses predominately on these two outcomes.
• The impact of the Duty will vary depending on the volume and complexity of a firm’s products and distribution channels as well as the maturity of its existing frameworks and controls. Firms should look to leverage existing data and insight to understand how to deliver the outcomes the FCA expects.
• Consumers are facing increasing financial pressure and the FCA is sharpening its focus on the outcomes they get from credit markets. Firms should not wait until the Duty is in place to start thinking about how they support customers experiencing financial pressure, in line with the consumer outcomes.
• Immediate actions for firms include completing their gap analysis of the requirements of the Duty against product lifecycles and customer journeys; developing and testing a value assessment framework; developing a risk-based approach to establish which customer communications will require review; and continuing to identify the enhancements required to MI to monitor outcomes for consumers.

Overview

In December 2021, the FCA published its second consultation on the Duty, which it is proposing all firms implement by 30 April 2023. This blog focuses on the implications of the Duty for retail banks, building societies and consumer credit firms (“firms”). You can access our insights on the key takeaways from the consultation overall, and the implications for other sectors, here.

To recap, the FCA intends to create a “paradigm shift” in firms’ treatment of retail customers by introducing:

• A new Consumer Principle: “A firm must act to deliver good outcomes for retail customers”
• Cross-cutting rules that firms must:
  • Act in good faith towards retail customers
  • Avoid foreseeable harm to retail customers
  • Enable and support retail customers to pursue their financial objectives
• Four outcomes for the key elements of the firm-consumer relationship:
  • Price and value
  • Products and services
  • Consumer understanding
  • Consumer support

Treating customers fairly has long been a key regulatory tenet, but the new Duty requires firms to be even more proactive and to focus on the outcomes they achieve for their customers on an ongoing basis. Boards must review at least annually an assessment of whether their firm is delivering good consumer outcomes in line with the Duty, and approve plans to address poor outcomes. All staff (except ancillary staff) will need to comply with the Consumer Principle and the cross-cutting rules, to the extent that is reasonable and proportionate to their role. The rules and guidance underpinning the Duty will give the FCA additional avenues for enforcement.

Scope

The Duty applies across the distribution chain from product origination (manufacture) through to distribution and post-sale activity.  However, firms are subject to different requirements depending on their role in the chain and the extent to which they can influence end outcomes for consumers. The role firms play in the distribution chain can be complex. Retail banks, for example, may manufacture and distribute their own products, manufacture products for distribution by third parties (e.g., retailers, brokers) and distribute products manufactured by third parties (e.g., general insurance underwritten by a third-party insurer). In addition, many firms outsource activities to third parties (e.g., customer service) yet remain responsible for compliance with the Duty.

To begin to understand their obligations under the Duty, firms must first unpack this complex matrix of roles and responsibilities. With less than a year to the proposed implementation date, firms should already have made progress with their gap analysis of the requirements of the Duty against their product lifecycles and customer journeys. They should identify the points where they have the greatest potential to influence customer outcomes and ensure there is clarity around the respective responsibilities of third parties.

Price and value

The Duty requires manufacturers to ensure that their products or services provide fair value to retail customers, taking into consideration the nature of the product or service (including the benefits that will be provided), any limitations on the product or service, the total price customers are expected to pay and any characteristics of vulnerability in the target market.  

All firms will need to review their pricing models and develop or enhance value assessment frameworks but we expect the increased scrutiny of value under this outcome to add further pressure to high-cost credit lenders, in particular. This sector has already been the subject of numerous interventions to address the value of specific products and the FCA has highlighted business models that are reliant on practices that may harm consumers. For example, relending and charging late payment fees or arrears.

The Duty may also result in downward pressure on certain distribution charges. In its 2020 letter to mortgage intermediaries, for example, the FCA identified that “customers potentially pay excessive fees and charges for the service they are provided”. The FCA continues to raise concerns, particularly in relation to lifetime mortgages, and intermediaries should expect robust challenge of whether their fees and charges are justified by the quality of advice and services they provide.

The value assessment will be a considerable undertaking. It will require firms to ask fundamental questions about where and how they make money from their customers, and the utility and quality of their products and services. Firms will need to develop or enhance assessment frameworks soon, to provide sufficient time to gather the necessary information and data, validate results and take action to address poor value. The FCA also expects firms to consider the non-financial costs customers may incur which may include firms’ use of customer data. This will be relevant to firms looking to leverage the benefits of customers' data to develop and sell new products and services (e.g., via Open Banking).

Legacy systems will create challenges in obtaining sufficient information to inform value assessments, but firms should look to leverage other available insight. For example, records of customers’ eligibility to claim on insurance policies provided as part of packaged bank accounts may help inform the value assessment of the bank account overall. Banks with asset management or insurance arms should also look to leverage the experience of those entities in undertaking value assessments, particularly insights on assessing more subjective factors such as “quality of the product or service” provided.

Consumer understanding

The requirements under this outcome build on, and go further than, Principle 7 by requiring firms to focus much more on consumer understanding throughout the customer journey. In summary, firms need to review their approach to communicating overall, ensuring they are equipping consumers to make effective, timely and properly informed decisions and are not communicating in a way which exploits consumers’ information asymmetries and behavioural biases.  The requirements of this outcome apply across all products and channels but, in our view, have particular implications for consumer credit products (where FCA reviews have identified the potential for bias to affect consumer decision-making) and digital customer journeys.  The latter, as they become increasingly frictionless, may not strike the right balance between ease of use and ensuring customers properly understand the products they are purchasing.

Under this outcome, firms need to monitor, and, where appropriate, test their communications to determine if they are likely to be understood by the intended target market. Many firms have programmes in place to test the clarity of certain communications (for example, as part of the Crystal Mark-Clear English campaign) and these will be a useful starting point in demonstrating how they are acting to deliver this outcome. Nevertheless, most firms will still need to put in place a robust risk-based framework to identify which communications require testing, and to ensure their approach to testing is sufficient for the purposes of the Duty. This should help firms to determine a proportionate approach.

In achieving this outcome, firms also need to decide how best to deal with information they are required to provide to customers under other regulatory or legislative provisions (e.g., by the Consumer Credit Act or the European Standard Information Sheet -ESIS - for mortgages). The prescriptive nature of these information requirements means firms have little flexibility in adapting them. However, the FCA’s guidance suggests that firms may adopt a layered approach to providing such communications, organising them in a logical way with key information (for example, features, benefits, risks, and costs) upfront and signposts to more detailed information further on.

Products and services 

Though covering much of the same ground as the existing FCA guidance on the Responsibilities of Product Providers and Distributers (RPPD), the requirements of this outcome are more prescriptive and will require firms to revisit, and potentially strengthen, aspects of their product governance arrangements. For example, under the Duty, manufacturers are required to specify the target market for their products “at a sufficiently granular level, taking into account the characteristics, risk profile, complexity and nature of the product”. Though firms currently identify target markets, in our experience, these assessments are often high-level and, for some products, may be insufficiently granular to meet the requirements of this outcome, particularly for products considered to be “mass retail”.

Investment products and some insurance products are already subject to the more detailed product governance requirements of PROD 3 and 4. Firms which manufacture or distribute these products may be able to leverage more widely their product governance approaches, subject to addressing any concerned raised by the FCA[1] and performing a gap analysis against the detailed requirements of the product and services outcome.

Consumer support

The consumer support outcome aims to set an appropriate standard of support that all firms must provide, so that consumers can use products and services as anticipated and do not face unreasonable barriers. Firms are already expected to ensure that customers do not face unreasonable post-sale barriers under the FCA’s existing Consumer Outcomes, but the Duty spells out what this means in more detail. For example, the non-handbook guidance provides a helpful distinction between “friction points” that are introduced largely for the benefit of firms (i.e., to discourage the customer from taking action such as making a complaint), and “additional steps” in the customer journey, which are added for customers’ benefit (e.g., to protect them from scams).

The FCA says that firms should “carefully consider the support needs of their customers” and “deliver support through appropriate channels that enable firms to respond flexibility to their customers’ needs”. These expectations will be particularly important in the context of planned branch closures or ATM conversions. In recent feedback, the FCA identified a number of poor practices where firms had failed to consider the needs of customers adequately, particularly vulnerable customers, when planning a closure or conversion. The introduction of the Duty will heighten the FCA’s expectations in this regard.

The Duty and the cost-of-living crisis

In recent speeches[2], Brian Corr (Interim Director of Retail Lending, FCA) and Sheldon Mills (Executive Director, Consumers and Competition, FCA) have spoken about the increased financial pressure consumers face following the rise in the cost of living. The FCA is anticipating greater consumer demand for credit and expects borrowers may find it harder to pay off their debts.

As they implement the Duty, firms should be mindful that the FCA is sharpening its focus on the outcomes consumers get from credit markets. Importantly, Mr Corr says the FCA “is not waiting for the Duty to come in before we act to improve consumer outcomes”. Notwithstanding that many in the industry have called for a longer implementation period, the FCA is clear that it expects firms to start thinking now about how they support customers experiencing pressure from the rising cost of living, in line with the expectations it has set out under the Duty. More insight on the action firms can take manage customer outcomes during the cost-of-living crisis is available here. 

Actions for firms

We suggest that firms take the following actions:

• Complete gap analysis of the requirements of the Duty against product lifecycles and customer journeys. Understand the firm’s responsibilities throughout the distribution chain, and identify enhancements needed to systems and controls, particularly in relation to third parties. Prioritise actions, based on the findings of the gap analysis.
• Develop and test the value assessment framework. Gather data on the fees and charges customers pay throughout their relationship with the firm and any additional benefits provided as part of the product.  Leverage insight on how to assess factors including quality of service and non-financial costs.
• Develop and test a risk-based framework to identify customer communications that require review. Commence review of highest risk communications. Consider whether it is possible to consolidate or reduce the overall communications library as part of the review.
• Continue to identify the enhancements required to MI to monitor and evidence outcomes for consumers across each of the Duty’s four outcomes. Our paper - Improving Customer Outcome Testing - provides suggestions to firms on improving their approach to outcome testing.

Footnotes

[1] In its MiFID II product governance review performed last year, the FCA found that  “some asset managers are not undertaking activities in line with MiFID II’s PROD regime”. 

[2] https://www.fca.org.uk/news/speeches/supporting-consumers-through-tough-times-priorities-credit-regulation; and https://www.fca.org.uk/news/speeches/supporting-consumers-challenging-times