Business strategy in a Consumer Duty world

Too many firms approached the requirements of Consumer Duty from an operational perspective – concentrating on the Consumer Understanding and Consumer Support outcomes. There was insufficient consideration of how the new regulations might impact business strategy.

I wrote about the issue here in February 2022, and we’re now seeing this risk crystalise, with the news that the FCA is taking aim at the premium finance sector - when the FCA describes your product as “a tax on being poor” you should take that as a fairly clear indication that the model is unsustainable.

And premium finance just happens to be one that has caught the FCA’s eye, there are plenty of other examples, both within individual firms, and collectively across particular sectors of the market. And the “everyone else is doing it” excuse will not garner any sympathy from the FCA.

Problematic business models include:

?Fees calculated as a percentage

Percentage-based fees are inherently problematic. We see this in the investment space where management fees are based on a percentage of AUM. Equally in the mortgage sector where arrangement fees are based on a percentage of the amount borrowed. Unless the firms can really demonstrate there is more work involved, these practices cannot be justified in a Consumer Duty world

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Interest rate spread

One of the first actions the FCA took was to challenge the poor rates of interest banks were offering borrowers – citing the wide spread between the amount offered and base rate. This issue is equally problematic in the lending sector – if a credit card provider is charging a high APR, but can’t justify why, the model is flawed.

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Intermediation

We recently saw the FCA taking action in the motor sector in relation to commission arrangements. But any intermediated model has inherent risks if the parties in the chain can’t justify the value-add they are providing. Brokers need to be able to demonstrate what benefits the customer is getting from them, as opposed to using a direct route?

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Add-ons

The FCA has had a long antipathy to add-on sales. And plenty of that concern has been justified over the years (e.g. PPI). Firms need to ensure that the individual add-ons can justify their own fair value assessment, and that the sales process is absolutely clear. Any business models where firms are making a greater proportion of their profits from add-on sales, rather than the core product will have significantly increased risks.

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Customer behaviour

If the sales process is based on customers not understanding the product, or being unable or unwilling to go elsewhere, the model is flawed. The FCA is very focussed on the needs of vulnerable customers, which includes those experiencing financial hardship, those excluded from mainstream financial services, and those who are financially unsophisticated. For example, if a building society is offering a significantly lower AER on their branch-based savings accounts they will need to be able to justify that difference. Or a lender who charges a premium for servicing near-prime customers – the reasons for the APR increase may well be there (in the operational costs and bad debt), but they will need to be explained.

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If they haven’t done so already, firms should be taking a hard look at their business models. Because it is not only the regulator who is paying attention – Admiral and Direct Line saw their shares dip, following the FCA’s comments on premium credit, and St James’s Place took a 6% hit before Christmas when questions were raised about the methods they used to generate revenue. Any investor (public, or private equity) should see flaws in the business model as being a major red flag, in the new regulatory environment.