25 August 2022
What is the Consumer Duty, and when does it come into force?
The Financial Conduct Authority (FCA) has now launched the Consumer Duty (the Duty). It’s considered to be the biggest regulatory overhaul in almost 20 years, and is part of the FCA’s mission to push firms to deliver a higher standard of consumer protection. After consultation with the financial services industry, the FCA has now issued its long-awaited Finalised Guidance.
The Duty is designed to ensure that UK retail consumers have access to a range of financial products and services that meet their needs and offer them fair value. The Duty follows on from the treating customers fairly (TCF) initiative, and marks a continued shift from a rules-based regulatory approach to one based on outcomes. As part of this, firms must consider the needs, characteristics and objectives of their consumers at every stage of the customer journey.
As well as delivering good customer outcomes, firms must understand and evidence how those outcomes are being met. The framework for achieving this has three new elements – all of which should be embedded within a firm’s culture and governance structure:
- a consumer principle;
- three cross-cutting rules; and
- four customer outcomes.
Because the Duty affects numerous stakeholders and business functions, firms are faced with a substantial volume of work to ensure compliance. The challenges of meeting the Duty are exacerbated by the very tight timelines for delivery:
- For new and existing products or services that are open to sale or renewal, the FCA’s new rules will come into force on 31 July 2023.
- For closed products or services, the rules will come into force on 31 July 2024.
- Implementation plans must be finalised by 31 October 2022 – this does not afford firms very much time.
We note that the FCA is already asking firms applying for authorisation, or variation of permissions, to explain their Consumer Duty implementation plans. So what are the Duty’s requirements, and what are the practical steps firms should be taking now?
The Consumer Principle – Principle 12
The Duty will be enshrined in a new principle of the FCA’s Principles for Businesses (the Principles), Principle 12. Firms will be familiar with Principles 6 and 7, which relate to TCF and the requirement to be ‘clear, fair and not misleading’ when communicating with clients. Principle 12 requires firms to apply a much higher standard.
Firms must now be more proactive in relation to their conduct and consumer outcomes. This means acting “to deliver good outcomes for retail customers”, regardless of whether the consumer is a direct customer of the firm or not.
How can firms prepare to meet Principle 12?
Firms should focus on consumer outcomes that may result from their actions by considering what they know, or could reasonably be expected to know, about the consumer. The FCA views this ‘reasonableness’ as depending on a range of factors relative to a firm’s role in the distribution chain, and its ability to determine, or materially influence, the consumer’s outcomes. These factors include:
- the nature of the product/service being offered;
- the characteristics of customers in the relevant target market; and
- the firm’s role in relation to the product or service.
Firms should regularly challenge themselves to ensure their actions are compatible with delivering good outcomes, and also identify and correct anything that may result in poor consumer outcomes. In our experience, firms may fall short of meeting the requirements of the Duty if they don’t continually assess their practices and outcomes, particularly as the market or consumer base evolves.
The cross-cutting rules
The Duty includes three cross-cutting rules, which set out how firms should act to deliver good outcomes for retail consumers:
- act in good faith towards retail consumers;
- avoid causing foreseeable harm to retail consumers; and
- enable and support retail consumers to pursue their financial objectives.
The cross-cutting rules articulate the standards of conduct that the FCA expects under Principle 12. They set out how firms should act both proactively and reactively to deliver good outcomes for consumers.
The four outcomes
The cross-cutting rules also inform and are supported by four outcomes. These set out more detailed rules in key areas of the customer relationship and help firms to interpret the four outcomes, which are:
- Products and services
Consumers can only pursue their financial objectives and avoid foreseeable harm when products and services are appropriate to their needs. Firms acting in good faith should design and distribute products and services to meet this aim.
Meeting the products and services outcome
The products and services outcome rules set out a range of requirements, including the need for firms to:
- ensure that the design of the product or service meets the needs, characteristics and objectives of consumers in the identified target market;
- ensure that the intended distribution strategy for the product or service is appropriate for the target market;
- carry out regular reviews to ensure that the product or service continues to meet the needs, characteristics and objectives of the target market; and
- ensure that they do not distribute a product or service if they do not understand it properly.
In our experience, firms can find it challenging to identify and/or articulate their target market, and often simply state that the target market is a consumer who requires that specific product. Under the FCA Consumer Duty and Product Intervention and Product Governance Sourcebook (PROD) rules, consideration of target market factors should filter through to all aspects of product development.
Firms must therefore define their target market in a more calculated way (eg use of market segmentation, assessment of consumers’ knowledge and experience, risk tolerance, demands and needs and financial situation). They will also need to continue assessing the target market, and periodically ensure that the product is being sold to the correct target market.
The FCA has confirmed that firms currently following the PROD as guidance may choose whether to follow the rules in PROD, or those under the products and services outcome. Failing to comply with PROD would be taken as failing to comply with the products and services outcome.
Manufacturers are not responsible for distributors’ activities, unless they have an oversight role. However, firms that are reliant on another firm in the distribution chain must inform the FCA if they discover that the other firm is not complying with the Duty.
- Price and value
Retail consumers experience harm when they do not get value for money. A lack of fair value is unlikely to be consistent with consumers realising their financial objectives, and firms cannot act in good faith if they are knowingly manufacturing or distributing poor value products or services.
Meeting the price and value outcome
Even in cases where other elements of the Duty are met, the price and value outcome rules still prompt firms to ask questions such as:
- Are there elements of the pricing structure that could lead to foreseeable harm?
- Are there fees, charges or rates that appear unjustifiably or unreasonably high when compared to the benefits of the product and the firm’s other comparable products, or comparable products supplied by other firms?
- Have changes to the benefits of the product been reflected in its price?
- Have any material changes to assumptions that underpinned pricing, such as the costs of servicing, been reflected in changes to the price?
To assess if a product or service provides value, firms must consider at least:
- the nature of the product or service, including the benefits that will be provided or may reasonably be expected and their qualities;
- any limitations that are part of the product or service; and
- the expected total price consumers will pay, including all applicable fees and charges over the lifetime of the relationship between consumers and firms.
In the past, some firms have inflated their product prices by adding ‘benefits’ to them that they know consumers are not likely to use. The regulator has also had to challenge products that seem to lack value, for example payment protection insurance and motor legal expenses.
As part of the product governance assessment, when a firm is designing new products or reviewing existing products it should assess the likelihood of all the benefits of the product being used. This will ensure the product provides fair value, and the value should be reviewed on an ongoing basis with pricing amendments made where necessary.
The rules are not intended to prevent cross subsidies between products. Nor does the Duty prevent firms from selling similar products with different prices across various brands, provided all are fair value.
Distributors are not required to duplicate manufacturers’ value assessments, and are responsible only for the prices they control.
- Consumer understanding
Consumers can be expected to take responsibility for their choices and decisions only if a firm’s communications enable them to understand:
- the product and services;
- the features and risks; and
- the consequences of any decision they take.
Meeting the consumer understanding outcome
The outcome builds on Principle 7 by requiring firms to:
- ensure that communications are likely to be understood by consumers, and equips them to make decisions that are effective, timely and properly informed;
- tailor communications based on the characteristics of consumers (including any vulnerabilities), the complexity of products, the communication channel used and the role of the firm; and
- test, monitor and adapt communications to support understanding and deliver good outcomes for consumers.
Product and service features change over time; introductory rates come to an end, for example, or variations are made to contracts. Consumer circumstances can also change over time. We often find that communications do not always continue to support consumer understanding and deliver good outcomes post-sale. Firms must communicate at appropriate frequencies so consumers are prompted to consider the product and service, and if it continues to meet their needs and objectives. This outcome should result in firms conducting more frequent testing of their communications.
Consumer understanding can be assessed through things such as claim rates, complaints or general customer feedback. Additionally, firms may wish to test their communications on consumer focus groups. As a result of this outcome, many firms may end up communicating with their customers more regularly.
In our experience, firms commonly fail to engage relevant stakeholders (eg marketing, compliance, customer service, senior management) at the early stage of new product development and miss out on the insight and challenge those groups can provide.
This outcome has been reinforced by a recently released Policy Statement on financial promotions and high-risk investments. As a result of the increased spotlight on communications and financial promotions, firms should implement robust governance arrangements for the development, approval and ongoing monitoring of these.
Furthermore, firms will need to use metrics to monitor the effectiveness of their communications. Reviewing these metrics will enable firms to identify key trends, understand which of their customers are less likely to understand and pre-emptively adapt their communications accordingly.
- Consumer support
Consumers (customers) should be supported throughout the lifecycle of a product or service. Firms must provide support that meets their customers’ needs and ensure that they can make properly informed decisions, without facing unreasonable barriers. The consumer support outcome rules should be read in conjunction with other rules that cover specific elements of serving customers, for example the FCA’s Dispute Resolution: Complaints (DISP) rules.
Meeting the consumer support outcome
Firms should monitor the support they provide, and act on feedback to address any shortfalls.
Consumers should be provided with accurate information and given appropriate time to make important decisions. Firms might build additional steps into their processes that mitigate the risk of harm, and give consumers sufficient opportunity to understand and assess their options. This may include, for example, steps designed to prevent fraud, or to ensure consumers are aware of the consequences of cancelling a contract.
Where elements of a firm’s consumer support is outsourced to a third party, we often find that systems and controls are not always adequate for monitoring the outsourced function. With the new Duty, firms must conduct and record regular and robust assessments of third-party providers, their operations, resourcing and, above all, their culture.
With the FCA’s quest to become a data-led regulator, firms cannot be excused for failing to collect and monitor data. Firms must use a combination of data to monitor and evidence that they are meeting the expectations under this outcome, for example:
- root-cause analysis of complaints;
- first-contact resolution rates and average time to resolution;
- internal quality assurance; and
- customer call monitoring.
Culture, governance, accountability and monitoring
The Duty will require a significant shift in the culture and behaviour of many firms. We anticipate that a significant number of firms will struggle to ensure that all of their strategies, governance, leadership and people policies are aligned.
All firms should use the Duty as an opportunity to look at their own culture and governance frameworks and make changes as necessary, starting from the top of the organisation. This will require firms to define, implement, measure and evidence purposeful culture that reduces harm to consumers and the market.
Boards and other governing bodies must at least take responsibility for conducting assessments to determine if the firm is delivering good outcomes for its customers that are consistent with the Duty. These assessments should be undertaken at least annually and along with any management information (MI) that sits behind them, form part of the evidence to the FCA when it determines a firm’s compliance with the Duty.
We have seen instances where boards do not fully understand what is required. Firms must have board members with the skills needed to provide effective oversight. The Duty should already feature on the agenda at each board meeting. Firms must have board members with the skills needed to provide effective oversight. Boards will also need to be provided with relevant MI on an ongoing basis, so that they can give adequate oversight of whether the firm is meeting the Duty’s requirements.
The FCA expects firms to have a Duty Champion at board or equivalent level who, along with the chair and the CEO, ensures that the Duty is discussed regularly and raised in all relevant contexts. Ideally, the Duty Champion should be an independent non-executive director.
Senior managers will take accountability through the Senior Managers and Certification Regime (SM&CR) for the role they play in complying with the Duty. The FCA will amend the individual conduct rules in its Code of Conduct sourcebook (COCON) by adding a new rule. This will require all conduct rules staff to “act to deliver good outcomes for retail customers”. Firms must plan staff training for those who are subject to the conduct rules. This training must explain the additional rule, its implications, and what this will require from the staff members affected.
Firms must also ensure that their staff incentives, performance management frameworks and remuneration structures are consistent with ensuring good outcomes for customers.
Six practical next steps
We recommend that firms that have not already done so should:
- engage all relevant stakeholders;
- assign a project lead, allocate resources and design a governance structure for the project, for example steering and working groups;
- conduct a gap-analysis of the requirements against your current practices and consider the changes that will need to be implemented;
- consider whether you have adequate resource/expertise to develop and deliver the changes;
- document an implementation plan before October 2022, ensuring that actions and deadlines are assigned to owners;
- track delivery of the plan on an ongoing basis, and ensure that updates on progress and any risks/issues are escalated to the board.
How RSM can help
We work with a diverse range of firms across the financial services sector as they assess and implement regulatory change. We can support you to:
- understand the impact of the Duty on your business;
- analyse your current practices against the new requirements and recommend actions to ensure compliance;
- develop (or quality assure) your implementation plan;
- support you to document new policies and procedures, or create new processes;
- identify key performance indicators and key risk indicators that can be monitored on an ongoing basis to provide evidence of compliance with the Duty;
train senior management and operational staff on compliance with the Duty.
Please contact Paul Jennings to discuss how we can work together to prepare your business for the new Consumer Duty, including implementing and developing these practical steps.