Product Governance and Consumer Duty 

by Verena Charvet of Merlys – 01 February 2022

I have been thinking about a consultation paper issued back in December which may have slipped off everyone’s radar – CP21/36. 

The time for comments closes on 15 February so several clients have talked to us not only about what they would like to say in response but also about the potential impact on their firms and not just from a cost perspective.  This raises the question of whether there is a much bigger regulatory and cultural change within the new Consumer Duty than may have previously been apparent. 

As the FCA plans to publish a Policy Statement with final rules by the end of July 2022 and Firms will be expected to have fully implemented the requirements by 30 April 2023 it is important that impacted industry firms do submit comments and think about the ramifications of these changes.

Context

As we know “Consumer Duty” is really a package of measures, not a single duty. The FCA is proposing the introduction of a new “Consumer Principle” requiring firms to act to deliver good outcomes for retail customers. The FCA has chosen this formulation in favour of an option that it socialised in the first consultation — “A firm must act in the best interests of retail clients”.  That statement alone should give pause for thought about what the FCA is looking to achieve, even if it is not adopting that formulation, and whether we are seeing the FCA taking a new approach to its regulatory duties.

Despite the age-old statement “the Customer is King” there appears to be a concern that, despite decades of regulation, a set of rules is needed to explain how firms should act to deliver good outcomes and so firms will be required to:

• Act in good faith towards retail customers
• Avoid causing foreseeable harm to retail customers
• Enable and support retail customers to pursue their financial objectives

Importantly, the FCA says it wants firms to focus on acting reasonably, rather than merely creating more steps and processes. But what does this really mean?  One issue for many firms will be how they can demonstrate that they have approached the requirements appropriately, proportionately and “reasonably” to implement a culture that supports the Consumer Duty without simply creating more processes which, based on the FCA’s stated approach, could be seen as ineffectual.

It is also proposed that there should be a set of four outcomes (and associated rules) which is clearly not just about “acting reasonably” as these outcomes look more like rules.  If we examine the consultation paper more closely, is that the wrong conclusion to draw?

The governance of products and services

This will have to lead to extending product governance requirements across all retail products, with different rules for manufacturers and distributors. For example, manufacturers will be required to undertake a product approval process, identify a target market, and ensure appropriate distribution channels for their products.  (Of course many manufacturers already have to do this.)

Price and value

The FCA says that it does not propose to set out detailed requirements for how firms assess fair value, but emphasises that value needs to be considered in the round — and that low prices do not always mean fair value. The regulator does not intend to set price caps or limit profits – if it did that would appear to be a regulatory step out of synch with the potential for appropriate post-Brexit reduced regulation.

Consumer understanding

This outcome is to ensure that customers are able to make effective, timely, and properly informed decisions. To achieve this result, firms will clearly need to tailor their communications appropriately as well as monitor, test, and adapt their communications on an ongoing basis to ensure that the communications are suitable. 

Consumer support

Focuses on firms providing an appropriate standard of support to customers, so that customers can use products as reasonably anticipated, and do not face unreasonable barriers in doing so.

The FCA is proposing that the framework will apply proportionately, taking account of the firm’s role in relation to the product or service, the nature of the product or service, and the characteristics of the consumers in question.  However, to support a contention that a firm was “acting reasonably” it seems that there will be regulatory rule changes and internal governance changes for firms.

So how is this not regulation? 

What are the FCA’s expectations?

The FCA has been clear in that it expects to see a cultural shift in how firms focus on consumers. The regulator will expect firms to monitor the outcomes their customers are experiencing, consider whether they are consistent with the Consumer Duty, and to then act when they identify issues or concerns.

 At present, the FCA does not propose to require firms to report on specific metrics.  That said, firms will need to ensure that they can demonstrate effectively how they are meeting the FCA’s expectations and be able to explain their actions to the regulator. This will include maintaining appropriate records. The FCA expects that firms will produce and regularly review management information on consumer outcomes that is appropriate to the nature, scale, and complexity of their business.

Is it a crumb of comfort that the FCA has emphasised that it does not expect firms to be able to prevent all poor outcomes, or to protect customers from risks that they understand and accept?  It seems that this is not anything different from the recognised historic position.

How does the FCA plan to supervise and enforce the Consumer Duty?

The FCA has stated very clearly that it plans to shift its supervisory mindset.  This means that it will make the Consumer Duty an integral part of its regulatory approach throughout the authorisation, firm supervision, and enforcement processes. Therefore, the FCA will consider the Consumer Duty throughout all of its work rather than as a stand-alone regime.  Again this does not seem to be a radical change.

It seems that, initially, as one would expect, the FCA plans to focus on tackling the most serious misconduct and intervening before harmful practices become entrenched as market norms. The FCA intends to use what it calls “assertive supervision” to intervene quickly when it identifies actual or potential harm.

However, as the Consumer Duty aims to reduce the extent to which consumers suffer harm in the first place, the FCA suggests that over time the need for the regulator to intervene after things go wrong will decrease. Given this overall approach, it seems that firms can expect the FCA to take a strict approach to supervising and enforcing the Consumer Duty. Indeed, many firms are already seeing the FCA applying similar principles in its supervisory work.

Who will be responsible for compliance: the board and/or Senior Managers?

As indicated above, for some firms this aspect will require changes to the level of information delivered to their management teams and may impact their internal governance as issues previously reserved to “middle” management in the first instances and then escalated as per the SMCR will now need to be reviewed at a more senior level.  The FCA has stated its expectation that a firm’s board will receive and consider reports from the firm assessing whether it is acting to deliver good outcomes for its customers that are consistent with the Consumer Duty. 

The indication is that this should be at least annually reviewed. The FCA emphasises that the SMCR already makes clear that Senior Managers are responsible for compliance with the requirements and standards of the regulatory system, and that these standards will be raised by the Consumer Duty. There is a clear message from the FCA that it will look to hold Senior Managers to account if a firm fails to achieve what is required by the Consumer Duty. 

This needs to be well-understood by firms and appropriate reporting processes put in place. Once again this seems to be a continuation of the existing regulatory processes.

How will “acting reasonably” come about at an individual level?

Will this be an area of cultural change rather than regulation?  The short answer is: no.

To explain, the FCA is planning to add a new individual conduct rule requiring all conduct rules staff (including Senior Managers) within firms to “act to deliver good outcomes for retail customers” when their firm’s activities fall within scope of the Consumer Duty.  

A potentially hoped for lightening of regulations might have been the disapplication of the existing individual conduct rule 4, which requires conduct rules staff to “pay due regard to the interests of customers and treat them fairly”, but the proposal is a rule substitution.  While the FCA emphasises that the scope of a person’s role and their seniority could affect the scope of their duty it is clear that the driver will be a new rule.

How can firms meet these new rule changes?

The FCA has said that the cost of implementation for firms will be “large”.  How can this be reduced and the likelihood of a firm successfully meeting the requirements at an early date and avoiding regulatory sanctions and reputational risk be increased?

The answer seems to lie in the FCA, ultimately, seeking organisational and cultural change within firms.  This cannot be achieved by rules and this is why the FCA perceives this new Consumer Principle as not being merely rule-driven but the beginning of a sea-change in both regulatory oversight and how firms implement the FCA’s purpose.

Firms will obviously need to consider their own governance and to provide staff with training on their obligations under this new conduct rule.

The FCA emphasises that it expects firms to use the implementation period fully and to be able to demonstrate progress when asked. The FCA suggests that it will monitor firms’ implementation during this period, so firms will need to ensure that they dedicate sufficient resource and commitment to implementation.  This will be considerably more than meeting rules!

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Verena Charvet MBA,
Managing Director at Merlys Consulting

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Email: verena.charvet@merlys.uk

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This briefing note is intended to act as general guidance. Merlys is happy to assist with any aspect of the content in this article, as it relates to your business.