Consumer Duty just in time for summer

Just in time for some light holiday reading, the FCA has published its final rules and guidance on the Consumer Duty. Firms now have 12 months to implement the Consumer Duty for new, open or renewal products, and a further 12 months until July 2024 for all closed products – much more generous than the original April 2023 deadline.

This is the end of the beginning for the Consumer Duty. The FCA launched its first consultation paper on a new Consumer Duty over a year ago (see Frontier’s consultation response on behalf of the FCA Practitioner Panel here).?But the Duty itself is the culmination of an evolving process since the FCA was established over nine years ago as it has moved towards “outcomes-focussed regulation”. (Former Chair Charles Randell’s speech last year on the FCA’s journey is well worth a read.)

How did we get here?

The FCA has introduced the new Consumer Duty because it recognises “financial services markets do not always work well for all consumers”, but that it could not fix this even by more rigorously supervising and enforcing existing rules. Instead, it “intends to set higher standards in new rules informed by our experience intervening in markets and firms”. It has concluded that “a reset around a new Principle is needed”.

It is helpful to look back at the experience of intervening in markets – things like unarranged overdraft charges, the ‘loyalty penalty’ in general insurance pricing and PPI. When we think about these three issues in particular, there are a couple of things that stand out.

First, for each of these particular issues it was clear to regulators and consumer groups from the start that something had to change. By the time each issue was resolved, substantial changes were indeed forced on the industry. But they took a long time – 14 years in the case of overdraft charges from the initial study by the Office of Fair Trading until the FCA’s ban on charges. PPI was 6 years, and general insurance pricing 8 years. These drawn out processes are partly why the FCA believes something different is required in the toolkit.

Second, there are some common patterns as to how the FCA (and the Competition and Markets Authority) tried to resolve these issues. For PPI and overdraft charges, there were initially some very substantial competition investigations. The premise for these investigations was that the outcomes of concern were driven by competition not working, and therefore there must be something that could be done using a competition toolkit. These competition investigations went on for 2 or 3 years each, but ultimately failed to come up with solutions, and notably ducked any form of price regulation.

Instead, there was an attempt to resolve each issue (and later general insurance pricing) through remedies informed by behavioural economics – making it easier to switch and shop around, and prompting people to do so. These remedies again took a long time to implement, but ultimately failed to have the desired impact.

Then in the case of overdrafts and general insurance pricing, the FCA took a different approach. It started to focus on the specific harms it was worried about through the use of its fair pricing framework and expectations around customer vulnerability. It was with these tools that it ultimately felt it had the power to take action and ban the pricing practices it didn’t like. So the FCA got to a solution on these issues, but it did not do so through supervision and its existing treating customer fairly principles, rather it adopted market wide interventions. ?

The Consumer Duty then is the next step in this evolution – an attempt to give the FCA the supervisory powers to tackle these issues head on. And avoid such practices establishing themselves in the market in future.

That is not the limit of the rationale or purpose of the Duty – there are lots of other issues in there from sludge practices to price discrimination to retail distribution that the FCA have been building towards over recent years. But I think these issues and the FCA's experience dealing with them are a useful lens to think about the Duty.

Champions of culture

The final rules and guidance largely confirm what the FCA has previously put forward in its earlier consultation (although with a new timetable). A big change though is the increased emphasis on culture. The FCA have added a separate chapter in the guidance on culture, and the FCA now expects firms to appoint a ‘Consumer Duty Champion’, an independent NED (if possible) who along with the Chair and CEO should ensure that the Duty is being discussed regularly.

The FCA has also added some ‘key questions for firms’ for each outcome that go above and beyond the detail of the rules and guidance, and which the Duty Champion should be asking. In relation to the overall governance of the Duty, these include:

• How does the organisation ensure that individuals throughout the organisation understand their role in delivering the Duty?
• How does the firm define good outcomes (over the short, medium and long term) for customers using its products and services?
• What data does the firm have about its customers and how they use its products? Are there any gaps in the data?
• What outcomes are customers getting? Are they getting good outcomes which align with their reasonable expectations?
• Are certain groups of consumers getting different outcomes, and if so why? What’s driving any adverse outcomes?
• What actions is the firm taking to improve outcomes? (Who’s accountable for this work, what will improvement look like and when will it happen?)

Four stages of Duty

Firms can now finalise their plans for how they will implement the Duty. There has been lots of activity already since the draft rules and guidance were published. We see the work to implement the Duty in four stages.

1. Updating internal policies. The Final Duty includes 68 pages of rules and 120 pages of guidance on what is required to implement the duty. Some of this is very specific – examples include that “key information is provided upfront with cross-references or links to further detail”. We would expect that firms have mostly all completed an initial gap analysis on what is missing in their existing policies compared to the draft rules and guidance. This includes some changes in standards to existing areas (such as stipulating that key communication should be at least as good as that used to deliver revenue) and some wholly new areas (such as providing information to distributors to allow them to conduct a value assessment of the product). This work can now be finalised with the new rules and product areas can start to implement the updated policies.
2. Outcome MI. Given the principles based nature of the Duty, firms must evaluate for themselves whether customers receive good outcomes. This requires judgement, and an effective audit trail to demonstrate and explain that judgement, supported by the right MI. Firms have been working through what MI they already have and what gaps there may be. The challenge is that there is no one size fits all approach to MI for all products and customer groups. We think the aim should be for an 80/20 dashboard of MI (i.e. 80% of the insight for 20% of the investment) that can be consistently applied across products and customer groups within a business. This may draw on existing data, but needs to be mapped to the four outcomes and will likely need to be supplemented with new MI. Key components of such a dashboard could be customer complaints, distributions of revenue per customer, correlations between revenue and vulnerability characteristics, and % of customers outside target market.
3. Product deep dives. The FCA's ‘key questions for firms’ need to be answered for each product area, and neither outcome MI nor compliance with rules and guidance will be sufficient. Product teams will need to be involved closely to answer these questions. For their specific products and customers, teams will need to: define what a good outcome is; complete the outcome MI with the final 20% of insight needed; identify whether customers are getting good outcomes and where customers may be getting different outcomes; undertake the root cause analysis to explain any adverse outcomes including behavioural and economic analysis of the underlying drivers (where these aren’t simply a failure to comply with rules and guidance); and develop and deliver any actions required to improve outcomes.
4. ?Narrative. The last stage is to produce the product narrative that answers the FCA's 'key questions'. This narrative should be completed in a way that can be handed over to the Duty Champion or the FCA and gives the complete story. Whilst there may be much detail behind it, including original strategy papers and further analysis, the product narrative itself should be a clear, concise, open and understandable articulation of the how the Consumer Duty Principle and outcomes are met.

So far, before the rules were published of course, firms seem to have made good progress on 1 and 2 based on the draft rules and guidance. But the more substantial process of answering the FCA's key questions in each product area is just beginning. There is another year at least to complete this, although there is much to do particularly where issues are being identified. Something to look forward to after the holidays...