Consumer Duty reforms will disrupt retail banking in 2023

When the Financial Conduct Authority (FCA) confirmed at the end of 2021 that it would introduce the Consumption obligation, companies reacted little. Maybe it’s because they thought it was an inconsequential development that would have little impact on the way they do business. However, the new obligation – proposed in 2017 by the Financial Services Consumer Panel – is among the most far-reaching reforms FCA has overseen.

The fundamental requirement for businesses to “focus on supporting and empowering their customers to make good financial decisions” sounds simple and most businesses will say they are already doing it. But dig deeper and the ambition for change is evident.

Joanne Owens is Regulatory Partner Consumer Financial Services and Retail Financial Services at Eversheds Sutherland. She says the consumer duty is a seismic change and “arguably the most significant upheaval in FCA regulation since the introduction of the Financial Services and Markets Act 2000”.

Principle 6 of the FCA Business Principles obliges companies to “due regard to the interests of customers and to treat them fairly”, while principle 7 concerns “due regard to the information needs of its customers and to communicate information to them in a clear, fair and not misleading”. The new requirement replaces those principles with one that enforces higher standards of conduct: “A business must act to deliver good results to retail customers.”

The obligation lists four key outcomes: customers are equipped to make informed decisions; the products and services are suitable for the use for which they are intended; the service meets customer needs; and products and services represent fair value. “This is a sea change in the way the FCA regulates, with companies having to continually prove that they are delivering good results to their clients,” says James Daley, managing director of Fairr Finance. “It could spur a race to the top of quality.”

But with the FCA expecting the new obligation to be fully implemented by April 30, 2023, companies must act quickly. “There is no doubt that the entire retail financial services industry is working hard on initial assessments and a gap analysis to understand where the current delta is between existing policies and procedures and new higher standards,” says Owens.

This is a daunting task, given the wide scope of the obligation and its application to new and existing products. The new rules make it clear that companies must not continue with business models that rely on poor results. This puts certain product lines at risk; 0% no-fee credit cards, for example, depend on some customers not clearing their balance and paying higher interest rates as a result. Likewise, it will be harder to justify leaving mortgage customers on high standard variable rates.

It is an opportunity for companies to shape and define their products and services

The extent to which customer choice may shrink in certain product areas due to the reforms will partly depend on how companies judge whether they can still offer good value for money under the obligation, says Neil Mitchell, head of client risk at TSB Bank. “There is also a risk of a lack of consistency in approach as companies follow their business models the way they do.”

Price increases may be needed to cover the costs of implementing the right. The FCA estimated one-off direct costs at £2.4bn and ongoing annual direct costs ranging from £74m to £176.2m. Businesses can change the way they price products, as prices must be commensurate with the overall benefit to the consumer.

“It’s not just about assessing the financial cost, but other non-financial costs to the consumer, including the use of their data,” says Owens. “This could impact the length of distribution chains for some introduced products, especially where a commission is charged.” The scale of the challenge means some companies will see consumer duty as a threat, while others will see opportunity, Owens says.

“It’s an opportunity (for businesses) to shape and define their products and services and think about how they deliver the right results to their current and future customers.”

TSB Bank established a program to comply with the new requirements in January 2022, Mitchell said. “We are assessing all TSB business units on their current position in relation to the consultation and draft rules – this is our discovery phase. Once the rules are finalized, we move on to our delivery phase.

Much of the initial business work focuses on communications. Suppliers often write their terms and conditions from a compliance perspective – if the FCA signs them, that’s fine. But duty will require them to ensure that customers can understand what they are being told.

“The bottom line of understanding the customer means customers need to understand communications and we know that people can’t head or tail the terms and conditions (T&C) documents or letters they get from companies,” explains Daley.

“We’ve been helping businesses rewrite letters and terms and conditions for years, but we’re seeing a spike in interest.” The challenge for banks is the tension between the outcome of understanding the customer and complying with existing consumer credit rules that require them to include prescribed statements in communications with customers.

The cross-cutting nature of the bond gives it the potential to be a catalyst for cultural change in banks and across the industry. It will likely change how customers are treated, what and how retail products are sold, and to whom they are sold.

The desired long-term outcome from a regulatory perspective is a more stable market that requires fewer interventions and fewer rule changes.

“From a consumer perspective, we won’t see a big change overnight, but over time it has the potential to improve the standards and quality of financial services,” says Daley.

With the final rules expected in July 2022 and businesses expected to be fully compliant by April 2023, businesses have no time to waste.

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