Financial Services Regulatory Enforcement mini-series, season 2, episode 4: Doing the right thing: Consumer Duty enforcement risk

Nathan:

Hello and welcome to the Ashurst Regulatory Enforcement Podcast. I'm Nathan Willmott, and I'm joined here in the Fruit and Wool Exchange in London by two fellow specialists in FCA and PRA Regulation, my colleagues Jake Green and Adam Jamieson.

Adam:

Hey Nathan.

Jake:

Hello.

Nathan:

Now between the three of us, I think it's fair to say we have quite a few years of grappling with regulators on tricky matters representing all types of financial services firms as well as their senior management. And our mission for this podcast series is to share with you the new approaches and strategies that we're seeing from the regulators to highlight any areas of concern about how they're conducting their investigations and to suggest what they should be doing differently to ensure that they're acting both fairly and effectively.

And in terms of our topic for today, we're focusing on the FCA's Consumer Duty, which first came into force in July 2023, and which introduces new standards of consumer protection across financial services, requiring firms to put their customer's needs first. And if I could start with you, Jake, perhaps you could tell us a bit more about the Consumer Duty and how you think firms are getting on with embedding the core elements of the Duty.

Jake:

I think embedding is the right word. So to date, we've almost changed the airplane engine mid-flight, and it's been difficult. So as a reminder, it came in in 2023, we had about a year to do it. And I think that year was the engine change, if you'd like. And from that point onwards, we've gone into the embedding mode. I think firms are doing well and indeed the FCA's feedback to date has been pretty positive. I think the real next steps are about embedding more at a governance level where I think firms are still perhaps not there yet. Potentially compliance is there and some of the control functions are there, but whether or not it runs right through the heart of an organisation, I'm not entirely sure. So that's what we're going to see.

And then I think we're going to see a few potential challenges around some of the thornier issues such as fair value. And as recently as today, so today being relatively early in December, FCA's put out another paper forecasting what they're going to look at next year. And to my view, they have also highlighted the fact that there is still a lot of confusion around fair value. And my view is the FCA is saying fair play, perhaps it's not as easy as we thought, and perhaps the guidance isn't as clear as we thought on this one. I think we're all still learning, including the FCA.

Nathan:

The fair value in particular seems to involve the collection of a lot of information, a lot of data, and then feeding that through the firm's governance processes and then seeing what it tells firms and them acting on it appropriately.

Jake:

I think that's right. So fair value assessments and policies are by no means uniform. You probably have the most eclectic mix of different approaches around fair value than anything under the Consumer Duty. And that's because everyone has a different approach. Some people use qualitative data. Some people use quantitative data. Some people do it at services level. Some people do it at products level. I think you're meant to do it at each product and each service level, but we are very much learning on this. But you are right, the idea is a lot of data fed through, reviewed on a routine basis and challenged very much at the board, are we doing the right thing?

Nathan:

And one of the approaches that the FCA has taken, which seems to me to be very different from previous rule implementations, is that there's been a very high degree of communication with firms about what the FCA expects, what it's seeing from firms in different areas. Do you feel that that's helped firms in getting ready for implementing the Duty or has it caused confusion?

Jake:

We did a briefing last week and we counted up how many communications there had been on vulnerability over the last couple of years, and we think it's close to 100. And on the one hand, fantastic, brilliant, and there is a lot of information out there. On the other hand, I think people are struggling a little bit smaller firms in particular drowned by information, always feeling that they are chasing and behind the eight-ball or not behind the eight-ball, should I say. So I actually think overall commendable from the FCA on the Consumer Duty. But, it is difficult. We are a tough market to get into from a retail perspective. And I suppose the FCA take a bit of delight in that we are a strong market for retail, but the cost of doing business and the cost of entry is exceptionally high at the moment.

Adam:

You mentioned changing the engine mid-flight, to what extent, in your experience, do firms already have some of this stuff in place through product governance they already had, MI they already had or has it been a complete rewrite?

Jake:

That is a really good question. So taking a step back, as the Consumer Duty was coming in, everyone's initial reaction was, "Well, we've already got this. We've got this from product governance. We've got this from our TCF policy. And we are already really good, so this is just a bit of paint around the edges." I think, and it comes back to all of the collateral that the FCA has been putting out, that approach came under a lot of scrutiny, particularly the turn of 2023 where people realised actually this wasn't a repurpose, this was a redo. So I think the better firms weren't in a bad position. But in general, this is a very much a new look approach to regulation, a new look approach to governance, a new look approach to the way in which people engage with management information. So I would say more significant than we had thought and more significant than our clients had seen coming.

Nathan:

And a real focus of Consumer Duty seems to be vulnerable customers. Can you talk us through a little bit what the FCA's expectations are in terms of vulnerable customers?

Jake:

Yes and no. So let's start with no. I think the FCA is learning a lot at the moment. So vulnerability is difficult. But the FCA's starting position is we are all currently vulnerable or live or work with people that are likely to be vulnerable. Around 50% of the population by the FCA's mind is vulnerable or will be vulnerable in the short term. So the starting position is we don't think about vulnerability enough. This is difficult because it slightly depends what type of business you are in as to whether or not one can see vulnerability or one can suspect vulnerability or indeed does one have the ability to do anything. That's always the question we're asked particularly by execution only providers or providers that are one step removed from the actual final offering. "Can I do anything?"

So on the one hand, what does the FCA want? They want you to consider the fact that more people are vulnerable than you think, and therefore you might need to have different approaches to a wider audience, perhaps better information, perhaps different ways of providing information. On the other hand, this is another area whereby again, I think the FCA's learning. Some of the questions the FCA ask about vulnerability are easy to ask, but whether or not the FCA even has a firm view as to what they mean, I'm slightly doubtful.

Adam:

How blurred is the line between tailoring a service for someone who's vulnerable and/or deciding we just need to switch it off?

Jake:

So very few firms in our view are switching off services because of perceived vulnerability. There is a separate question as to at what point do I have to or can I re-price? I.e., you want the information in a different way, that's fine, but there might be a cost associated with that. The market's not very keen on that approach and very nervous about that approach. I think we will see certain providers exit markets or have a higher entry point to markets because of vulnerability. I'm also not entirely sure that's what the FCA wants. There's a difference between vulnerability and let's say appropriateness and suitability, although they do sometimes fit hand in glove, but not all the time.

But I'm not quite sure the market is very mature on that particular question.

Adam:

We've asked Jake lots of questions, but I've got one more question in relation to the way the Duty's been embedded. If we'd have gone back to July '23 and we'd have said by the time we come to Christmas '24, what do you think we would've seen from the FCA on the Duty? Do you think it's gone how you expected?

Jake:

I think it's gone better than the FCA expected. So as examples, I think they're really proud of what they've done with respect to cash interest as an example. I think they're really pleased that firms have embraced it, that we've seen a different approach to terms of business and disclosures of information. I think they are very pleased, again with the way in which firms have tried and not necessarily have passed the test, tried to engage with the ideas of vulnerability training around those things.So I think more firms have done better than the FCA thought and they would give themselves a tick. And in general, I was quite critical of the Consumer Duty as a concept, but in general, everyone would... Well, sorry in general, we run lots of polls on this, firms are saying this is, pardon the pun, a good thing. It is creating a good outcome. Whether or not it is now becoming too costly and almost eating itself I think that's what 2025, 2026 will bring.

Adam:

It's a bit like SMCR. You know, get a lot of feedback from firms that actually SMCR, as onerous as it might've been from an administrative perspective, it has actually felt to have a positive impact culturally.

Jake:

I couldn't agree more, and hopefully a bit like SMCR when after a couple of years we do a bit of pruning, we're like this is a good regime. However, there are a couple of things to the left and the right that perhaps are overkill. And I do wonder if on Consumer Duty there might be a bit of more relaxed attitudes over certain areas. But we shall see.

Nathan:

We're obviously yet to see a Consumer Duty enforcement case, although there've been a number of cases fairly recently that were very much pitched as Consumer Duty-esque cases, particularly on arrears management. I'm interested, Jake, in what are the likely areas for enforcement action? Is vulnerability likely to be a key factor there? And what sort of sectors or issues do you think are most likely to be focused on in the seemingly very few cases that the FCA is referring to enforcement at the moment?

Jake:

Okay, so first I'm going to give you a no enforcement answer, which you are not going to like. But let's go for the no enforcement answer. I think the strength of Consumer Duty is potentially in what I'm going to describe as pre-enforcement. Their ability, they being the FCA's, ability to filibust a new service or new product, or ability to hit you with a public voluntary restriction, i.e., no new products or no material growth because of concerns around Consumer Duty. And because Consumer Duty is relatively subjective, it's outcomes based, they can ask for more. More please, more please. So I think their ability to stop, to inhibit firms, is really beginning to show its teeth and we're seeing a lot of that at the moment. You'd appreciate that some of that is more private than others.

Nathan:

Yep.

Jake:

So I gave you the non-answer, i.e., the FCA will be more preemptive with respect to voluntary restrictions, et cetera, and now I'll give you the answer answer. I think in the shortest term it'll be around costs, excessive costs or loss lead costs. That is your principal costs that I say to Adam, it's a free service or my share dealing cost is low.

However, there is a perhaps more hidden cost, be it in an FX conversion fee or a withdrawal fee. I think that's where they might look. But again, will they do this through an enforcement on firm A or on a dictate to market B I don't know.

Adam:

I mean it's hard to predict, isn't it?

Nathan:

Yeah.

Adam:

The reality is you would expect they're going to want... From the FCA's perspective, there's going to be a big splash around the first Consumer Duty enforcement case. There's going to be a lot of attention on it, everybody's going to be interested in it. So they're probably, from their perspective, they're going to be quite targeted in thinking about what they want that to look like. They're probably going to want a crystallised risk probably with some quite clear, I would've thought, consumer harm in their view, possibly lots of complaints, there might be redress aspects to it. I'm sure, Jake, you're right with the governance and oversight piece, I'm sure that there will be governance aspects to it. The board wouldn't have been properly aware of the issue, wouldn't have assessed it properly, wouldn't have had the right MI.

And then I think picking the sector is really difficult, because obviously we've seen lots of cases in the banking and the lending space around TCF in the past. So obviously those types of cases could come under the Duty. As to other sectors, it's tricky. I mean within insurance, for example, for over a decade now in one form or another, not under the Duty guise, but they've been talking about value in the context of distribution chains, complex distribution chains where you've got somebody paying a premium for an insurance product and large amounts of commission being paid to various different parties within the distribution chain, and question the value of that. I think that it's possible that insurance could be one in the fair value aspect that gets looked at, but it's really hard to predict, isn't it?

Nathan:

I mean obviously insurance, general insurance got fair value early and so it's had longer to implement it, but if I was putting my money on an area from enforcement, particularly in the context of fair value, I think it would be on a firm that is not collecting the right information. Because I think it's quite difficult for the FCA to second guess a genuine assessment that the firm is making based on the right information in terms of the relationship between the value of the product or service as against the price paid. But if the firm is not getting the right information in, and the rules are quite prescriptive in terms of the information that you're required to pull in, then for me that's quite an easy case for the FCA to take as you say, particularly if that has together with that been some sort of crystallised risk.

Jake:

Right. And agree that comes back to Adam's point on governance. I suppose the only caveat is when we've seen these governance cases, it has been egregious behaviour. I can think of one or two where you look at it and its policies out of date, not following policies, there being no board meetings, the board meeting's not documenting anything. So I think those kind of cases, whether or not they would require the Consumer Duty to take action or action could have been taken under TCF Principles Six and Seven, as they did exist. Maybe it's Consumer Duty isn't necessarily the catalyst, it's just another stick with which to beat. Which I suppose is why I said costs, which is a bit narrower, where they might want to show the market that they really mean change, i.e., change as to how products are offered. But again, timing's a point. How many SMCR cases have we had to date crystallise? And again, Consumer Duty, when do I think they might be able to do a cost one? Could be quite a few years.

Nathan:

And I think given that the FCA's more risk averse approach to enforcement, given that its targets in terms of numbers of cases to be discontinued, I think it's quite likely that their modus operandi will be an issue they spot, a deterioration in the trust between supervisor and the firm, probably a skilled person review. And if the skilled person report that comes out is sufficiently strong, then the FCA will at that point refer to enforcement and piggyback off the report.

Adam:

Given there's been a regulatory change, the other thing that would be quite interesting is you would expect, because obviously the case is going to involve customer harm, consumer harm, post the Duty being implemented, there's bound to be, you'd think a big part of any notice about how was the Duty implemented at that firm and how ought to have been done differently in governance pieces around that too. Which that'd be quite interesting I think for firms from a lessons learned perspective.

Nathan:

And just turning more broadly in relation to that supervisory engagement. We've heard a lot from the FCA about doing the right thing and I'm interested in your views in terms of what does that mean in practice? When firms are dealing with their supervisors, they're told to do the right thing. Does that mean anything?

Jake:

I think it does. I think the critical change from the FCA is not 'can I do something', 'could I do something', but 'should I do something'? And I think the do the right thing is if you've got a really complex advice from your legal advisors that feels like you are dancing on the head of a pin to get somewhere, but taking a step back, we can all see what the FCA would've wanted or what the outcome is bringing then doing the right thing is relatively straightforward. I think that's where the FCA is going to. It's don't tell me you can defend something, we want better than just plausible defence here. We want, where was the good outcome? So forget 'sometimes', and that can play both ways. That can be, as an example, where your macro requirement says, be fair, clear, not misleading. We all understand what that means. There then might be a micro law that says you need to disclose X and Y using B and C. And if you disclose X and Y using B and C, the micro rule requirement, you might say, well, actually I'm no longer fair, clear and not misleading because there's no way my vulnerable customer, my 18-year-old will be able to understand what I really mean by A, B, C, D, in my example. So that can work both ways. So in that circumstance, perhaps doing the right thing is one's ability to maybe not ignore a law but take a view to a particular law, which I think that is potentially positive. And that probably chimes with FCA's consultation paper of earlier this year saying which laws do we think are no longer required or duplicative or create confusion. So that is again the FCA's carrot to the Consumer Duty stick if we think it's a stick.

Nathan:

Yeah.

Adam:

I mean in some cases you can still explain why your target operating model is appropriate and is going to achieve those outcomes. And then there's some cases where I think it's quite obvious that actually perhaps something more fundamental needs to change. And you need to show the FCA supervisors that you get it, you hear them, and actually you've got good proposals as to how to push through and meet expectations without the need for the sort of pre-enforcement steps that Jake talked about earlier on.

Nathan:

But do you think that doing the right thing needs to be backed up by a risk of adverse sanctions? Because in the past, there've certainly been periods where the threat of enforcement has been used to make sure that firms are at least complying with their regulatory obligations. It now seems as if the threat of regulatory enforcement action is far reduced from where it used to be. But do you see the FCA using their intervention tools as a way of stepping into that gap?

Jake:

Yes. But before intervention, we have Principle 11. So Principle 11, open and cooperative with the regulators. And what I am seeing on the retail front is more dialogue between regulators and firms and the FCA reminding firms time and time again, we want you to update us on new products. And new products is perhaps defined on a more micro level than we might've thought about that a few years ago.

So if I offered apples, bananas and pears, then oranges is a new product. But now I think the FCA's view is, "Right, you offered Granny Smith apples, but you never offered Braeburn. I want to know about Braeburn, especially if that's going to be a big part of the market. Where's your Consumer Duty analysis? Where's your cost and values thinking? Who's signed this off?" So I think that doing the right thing, engagement with the regulator, then that allows them to, as I've said, put pressure on, filibust, "Do you have the right amount of resources? You've grown by 30% this year because of your interest rate or your cash ISA product? That's fantastic. Well done, Nathan. How big is your control function? Has it grown by 30%?"

Does this add up? That is the mindset of the FCA at the moment. Well, how's about you don't come up with a new product or you don't grow until you've grown your control function. And what about your non-financial resources? This is the other area they're coming... Sorry, I said non-financial, I meant financial resources. This is the other pincer movement the FCA is doing with the ICARA, your capital requirements, your liquidity requirements. "You currently hold 10 million pounds of liquid assets, well, you've grown by 30 or 40%. Are you up to speed? Should that now be 20 million? And guess what? You stuttered and you didn't give us a very good answer. So whilst you're thinking about that answer, we'll make it 30 million and then you can bring it down when you show us your learnings and what you've done."

So that's where I'm finding them being the most tricky. And you will find that any firm beyond a certain size has probably experienced a very rough ride with the FCA recently with respect to prudential treatment. And what they are doing is they're linking the IFPR, your ICARA, your wind down plan with the Consumer Duty and then non-financial resources. It's quite clever regulation actually.

Nathan:

So basically you're seeing the FCA using a broader toolkit in terms of getting firms to do what it wants them to do?

Jake:

Well you said that in five words, I said it in a few more. Yes.

Nathan:

And just to conclude, I'm interested in your views at a high level, I mean the FCA has referred to the Consumer Duty as a journey, how far down that journey to really it being just part of how firms operate, do you think firms are? Are there sectors that are further advanced on that journey? Are there others that are being resistant to it?

Jake:

I don't think there's much resistance anymore. How far? I think we are about 50 to 60% of the way there to it being perhaps what you would describe as BAU. We're not quite there. But you've even seen from the recent correspondence from the FCA that I mentioned earlier, that they are still doing their learning and there are three or four areas that they're still doing learning. I think as we get closer to 2026, that's probably the time period, where all bets are off. That's where we are at.

They are very proud of the Consumer Duty. They are selling it the way they sold product governance to MiFID II, the way they sold research on bundling, they did really well there to Europe during MiFID II as well. But they're selling it to Australia. It's coming out in the European retail investment package, which looks like being '26, '27, which in European speak is probably 2032. But it will travel and they're proud of it and in general, no one can argue with what they're looking to do.

Nathan:

Yeah. And that's despite the occasional political ripples that you feel in terms of competitiveness of the UK financial services system?

Jake:

They haven't got that right yet. And that's where I think it'll be interesting to see some moderation. So getting into the UK market, especially retail at the moment, is exceptionally difficult. And they will ask questions, how do you comply with the Consumer Duty? And that's quite a hard question to answer when you don't yet exist. It's a philosophical question. And getting a global player to understand the Consumer Duty on the way is hard. Telling a US general counsel that you need to define what proportion of your customers are vulnerable and that figure should be potentially above 5% or close to 10%, that's anima, that is a lawsuit as far as they're concerned. So you are telling me I have to mark Adam down as vulnerable and still serve him? Absolutely not. It's very different.

So I think that's where they are learning and they will need to have a bit more flexibility if they are to achieve what Rachel Reeves, what the government wants us to do, vis-à-vis competitiveness. I suspect it will be far more political as we get into the next election round in a couple of years because this is the stick with which they're being beaten at the moment.

Adam:

Particularly on the non-financial resources front and on the financial resources points. Where there is that, "Well, look, if you are taking more risks, then we need you to have really strong control functions. We need you to hold additional capital, et cetera." It's hard to see how they can have it both ways and always achieve that sort of secondary growth objective.

Nathan:

Yeah, so it sounds like it's been a positive experience for firms and that they're progressing down that journey, but it's also been a learning experience for the FCA itself in terms of what it's hoping to see from firms. If you've got one thing you'd like the FCA to do next on Consumer Duty, what would that be?

Jake:

That's a really good question. One thing to do next on Consumer Duty, what would I like it to be? I think it would be to give firms a little bit of credit for what they've done and it's perhaps to slow down on change for the next couple of years because at some point we need to catch up with ourselves and we need to go back out to actually serving customers and stop repapering this and changing rules on that. So I think it's that to begin with.

I think the big thing that the market wants is a really bold move with respect to the advice gap. So that is me saying to you guys, "Look Adam, I can see you are wearing a green," It is green…? "…a green jumper and a blue shirt? Do you know what people with green jumper and blue shirts really like? They like to have a dog." And the answer is whether or not that having a dog is advice because I've spotted some of Adam's characteristics there and I've said, have a dog, is that advice? At the moment the problem is that law around that says it probably is advice and the FCA probably hasn't moved as decisively enough in order to reduce that gap.

But if you think about what the Consumer Duty's trying to do, it's saying learn your customers, help them, prompt them, and that might be the next stage. Reduce the legal pain, the legal uncertainty around that advice gap to let us go to the next level. I think that would be wonderful. But again, that's my secondary objective, if you like, to the first objective to now let's just allow firms to get used to this and no more radical new laws I suppose.

Nathan:

Adam, any pointers from you for the FCA?

Adam:

Well, I'm just quite grateful to have got through this one against two Arsenal fans as only being described as a vulnerable customer once. I think that the engagement with firms, from what I've seen in relation to the Duty, at least in terms of firms that are already authorised, has been along the lines of what you would've expected them to have been doing. I think that firms are going to need help with the reporting and the governance and oversight side. And I know that firms had requirements around board reports, et cetera, and assessments this year. I feel like that's an area where there'll be a lot of development over the next three to four years. And those reports will probably potentially for some firms look quite different once they've got a better handle as to what the expectations are. And the same with management information. And I know the FCA are obsessed with management information and we are as well, but I do think that it's an area where there should be more prescriptive feedback for certain sectors around what the expectations are.

Nathan:

Well, Jake, Adam, thank you so much for your thoughts in terms of the Consumer Duty and risks for firms as well as opportunities. I'm afraid that's all we have time for this edition of the Ashurst Regulatory Enforcement Podcast.

As always, thank you to you for joining us and please do reach out to any of us with your thoughts on the issues we've discussed today, please email, give us a call. We'd be very pleased to hear your views. Thank you very much.