FCA Consumer Duty new regulations - what do the final rule changes mean?

In late July 2022, the Financial Conduct Authority (FCA) issued its final rules and guidance for the new Consumer Duty. This is the outcome of lengthy consultation, as the FCA sought to identify the right means to improve consumer protections. 

It will require potentially significant changes in business practices, and increase scrutiny on regulated entities and their directors. It is important that regulated firms understand what implementation involves and the impact on their business, including on their insurance coverage, as well as their interactions with third parties.

The most pressing concern for regulated firms is the tight deadline set by the FCA. By the end of October, firms should have an implementation plan in place.

In our previous article, published during the consultation period, we discussed why the FCA is taking action and which harms they are seeking to address. Here we explain what changes have been made as a result of the consultation, and what the final rules mean for firms.

What is the finalised Consumer Duty?

The new Consumer Duty will take effect from 31 July 2023 for new and existing products, and 31 July 2024 for closed books.

The main thrust is the Consumer Principle, requiring firms “to act to deliver good outcomes for retail customers”. The ultimate intention of the new rules is “to fundamentally change industry behaviours by setting higher and clearer standards of consumer protection” according to the FCA consumer and competition chief.[1]

While the 60,000 FCA-regulated firms are already under an obligation to treat customers fairly, the Consumer Duty requires that companies also “avoid foreseeable harm” to customers. This demonstrates one of the FCA’s central objectives – to compel firms to proactively respond to harm (rather than reactively, after complaints are made).

As financial products usually include some level of risk, what constitutes “foreseeable harm” will be a hotly debated topic. Nonetheless, and with an eye to the FCA’s perceived inertia in allowing recent scandals to occur (e.g. collapse of mini-bond firm LCF), the watchdog is anxious to boost its consumer protection credentials.

The FCA is maintaining its focus on culture, describing it as “critical” to the success of implementation. In a practical sense, this includes setting a company purpose that aligns with the Duty, appointing leaders who are committed to delivering good consumer outcomes, and structuring pay and incentives correctly. Above all, the FCA is firm on the fact that culture comes from the top down. 

The Consumer Principle will take effect as Principle 12 in the FCA Handbook, and requires firms “to act to deliver good outcomes for retail clients”. The principle will be supported by three cross-cutting rules, which clarify the FCA’s expectations on firms under the new Principle:

• act in good faith;
• avoiding causing foreseeable harm; and
• enable and support retail customers to pursue their financial objectives.

The purpose of these rules and the Principle is to deliver four good consumer outcomes across the following areas:

• products and services;
• price and fair value;
• consumer understanding; and
• consumer support.[2]

Changes and clarifications

After a four-year consultation process, the final version of the rules and guidance seek to clarify various areas of concern.

Timetable extended - When is the new deadline?

A revised timetable has extended the deadline for firms to enact the changes by 3 months, to 31 July 2023 for products that are open to sale (or renewable), and 31 July 2024 for closed books. While the extension is welcome, the implementation period remains challenging. Already imminent is an expectation that boards will have agreed an implementation plan by the end of October 2022 (which the FCA may review and critique).

Some firms may have to employ additional resources to properly implement the new rules. For instance, additional compliance or customer support staff may be necessary, or a supplementary IT system to assist in tracking and reporting emerging harms.

Differing needs of customers an important recurring theme

The definition of “retail customers” was a sticking point during the consultation, with firms arguing that applying the higher standard of care to SME customers would be difficult. Ultimately, the FCA rejected these criticisms, and the scope of the Duty will match the existing sourcebooks – including some SMEs and micro-enterprises.

The standard of care owed to different retail customers was also disputed. The FCA originally referred to “average” customers needing to understand communications sent by firms. Following criticism from consumer rights groups, communications now need to be understood by the customers that actually receive them.[3] This results in some tension, as the FCA states that it does not expect firms to tailor communications to each individual depending on their needs – but firms should be aware if a particular group are likely to have specific needs or increased vulnerability.

The needs of vulnerable consumers were a recurring theme in the guidance, and firms should pay particular attention to these groups. The watchdog raised concerns with respect to financial exclusion – for instance, barriers preventing customers from accessing customer support must be removed.

Distributors beware– responsibilities are changing

Firms that distribute rather than manufacture products are subject to the Duty for those products, but only to the extent they can “determine or materially influence” the 4 consumer outcomes.

Whilst each firm will only be liable for their own acts and omissions, the FCA has included a new rule that obliges distributors to notify the FCA if they suspect a Consumer Duty breach by another firm in the distribution chain – and to notify others in the chain if they think they have caused harm.[4]

As a result, wholesale markets may be in scope of the Duty to the extent they have a “material influence” on the outcomes, even if they do not have a direct relationship with retail consumers.

Funds and asset management, who’s to blame?

Funds and similar investment structures are considered “products” for the purposes of the Duty. If, therefore, a regulated firm includes a fund or an investment trust within a customer’s portfolio, they may be responsible for harm caused by the fund or trust – even when that has an independent board of directors. The FCA has taken a measured response to these issues, clarifying that firms’ duties extend only “within the context of their role”. Therefore, while a firm might be expected to raise concerns about a particular investment company to its board, it is not expected to force a change.[5]

How are closed books policies affected?

Closed book policies, i.e. those that are no longer sold but for which a premium or interest is still charged, pose significant challenges. The FCA is adamant that the Duty will not apply retrospectively, while also maintaining that firms must consider whether products sold before the Duty comes into force meet the new standard. This might include changing the payments a customer makes for legacy products that fall short of the fair value outcome. Firms acquiring a closed book must ensure that they receive sufficient information from the seller to allow them to comply with the Duty.[6]

The added difficulty in meeting the new standard for closed books is reflected in the extended deadline (i.e. July 2024). Firms with long-term products on their books (e.g. mortgage lenders and life insurers), will likely be grateful for this additional time.

Who will be your champion?

The watchdog has added new rules requiring the Duty to be reflected in firm’s strategies, governance and leadership policies (including with respect to incentive and pay structures). Moreover, the guidance stipulates that firms should have a “champion” at board level who is a Non-Executive Director and will raise the Duty in discussions.

More generally, the FCA has made clear that it will hold senior managers accountable for the outcomes experienced by their customers, in accordance with the Senior Managers & Certification Regime.

Foreseeable harm – a predictably difficult situation

The rule requiring firms to avoid “causing” foreseeable harm is something of a compromise, designed to protect firms from being held responsible for foreseeable harm that was outside its responsibility or control. However, under pressure from consumer rights groups, the FCA has cautioned that this does not remove the obligation of firms to consider the acts of other parties (e.g. when it is part of a distribution chain).

Firms should keep up-to-date on new and developing areas of harm, which may be exposed through FCA communication, complaints and media coverage. 

Additional responsibilities for Directors and Officers

Directors have additional responsibilities under the new regime, including needing to sign off an assessment that the firm is delivering good outcomes in line with the Duty. The FCA has confirmed that the Duty will be applied as part of the Senior Managers & Certification Regime, adding that directors bear “full responsibility” for ensuring the Duty is embedded in the firm’s culture.

While FCA fines are not insurable, the costs of responding to an investigation might be. These costs can be extensive, as indicated by the FCA’s recent report revealing that the average length of cases is now close to two years.

Directors and officers should ensure that they purchase sufficient limits to reflect the increased risk (and consider whether any sub-limits reduce effective cover).

Immediate issues for regulated firms. Things you need to think about right now

The tight summer 2023 deadline, coupled with the even tighter October deadline for the implementation plan, will be the top concern for in-scope firms. The FCA may expect the plan to include the following (although the precise form will vary depending on your business):

• reviews of the effects of products for the target market, against the higher expectations of the Duty
• analysis of the marketing and product material distributed to consumers, and
• evaluation of whether products meet the “fair value” criteria.

Products on closed books must also be reviewed, particularly with respect to price and value (albeit the deadline for this is extended).

Unfortunately, ambiguities remain, particularly around the extent to which firms must consider the Duty at an individual customer level. For instance, it remains to be seen how the FOS will adjudicate after a customer who suffered harm refers a complaint, even when the target market as a whole did not.

Moreover, the extent to which firms along the distribution chain can “materially influence” outcomes for customers is uncertain, and will likely be a point of contention between claimant law firms and distributors, particularly where supply chain are complex or contain overlapping responsibilities. UK distributors of non-UK products face these same issues, but could be required to undertake a more stringent review process, as the non-UK manufacturers are not subject to FCA rules (e.g. on price and fair value).

There is much work to be done, but it is expected that the new Consumer Duty will materially increase exposures for regulated firms and their directors and officers. It is inevitable that some firms and individuals will be subject to enforcement action, and insurance will be a vital tool for managing this risk. It is important to ensure that your coverage reflects those exposures. Please contact your usual Howden representative to discuss further.

Authors:

Carey Lynn, Executive Director, Legal, Technical & Claims, Financial Lines at Howden

Neil Warlow, Divisional Director, Legal, Technical & Claims, Financial Lines at Howden

Sam Vardy, Divisional Director, Legal, Technical & Claims, Financial Lines at Howden

James Wakefield, Claims Handler, Legal, Technical & Claims, Financial Lines at Howden

[1]https://www.ft.com/content/62e75501-20b1-46b7-9ddc-75c056a22b9b

[2]https://www.fca.org.uk/publication/finalised-guidance/fg22-5.pdf

[3]https://www.fca.org.uk/publication/finalised-guidance/fg22-5.pdf, p91

[4]https://www.fca.org.uk/publication/finalised-guidance/fg22-5.pdf, p13

[5]https://www.fca.org.uk/publication/finalised-guidance/fg22-5.pdf, p11

[6]https://www.fca.org.uk/publication/finalised-guidance/fg22-5.pdf, p18-20