RETAIL FINANCIAL SERVICES FORUM
Wednesday, 15 October 2003
Carol Sergeant
Managing Director, FSA

My proposition to you today is that the retail sector poses significant strategic risks to you, your top management and Boards and, moreover, that these risks are all too often not explicitly identified, monitored and managed, to the potential detriment not only of individual consumers but also of market confidence and ultimately shareholder value – which is I think a major pre-occupation for most of you. As I will explain later, this is a regulatory issue but it goes wider even than this in its overall effect on your reputation and standing with your own customers and the wider community.

Past Misselling and Current Challenges

Sadly, there are still many – too many – cases of misrepresentation and misselling. The facts speak for themselves. £11.5bn of compensation will have been paid for pensions misselling, another £300mn for FSAVCs. Work on endowments continues and the compensation paid to consumers is heading towards £1 bn. And now we have splits and precipice bonds. Add to this the administrative costs of dealing with compensation – estimated at £2bn for pensions alone – and you are talking about a lot of money and literally millions of consumers affected. There are clear signs that past misselling is deterring customers from buying savings products, which is neither good for consumers nor firms.

The retail market place is confusing, indeed incomprehensible, to many consumers and continues to be a risky and dangerous place for firms which do not understand the social, political and economic context in which it operates. Actions by both government and companies are requiring individual consumers to take on much greater responsibility for their current and in particular their future financial health. The changes to state and personal pensions are well rehearsed – but there are other issues too, including the rising levels of personal indebtedness.

The consumer, your customer, is having to take responsibility for deciding how much to save, when to save and what savings instruments to use – in many cases for the first time in at least two generations. They will also have the usual liabilities – mortgages and consumer debt, both of which are at historically high levels. Consumers will have to actively manage their assets and liabilities over their lifetime in a way neither their parents or grandparents have had to do – and they will have to do this over a lifetime which may well see much more change in working and employment patterns than hitherto and more changes in lifestyles, more divorce, co-habitation and single person living. This will all – happily – have to be managed over a lifetime, which will on average be longer, and during which most people expect to enjoy a higher standard of living.

How well equipped are consumers - your customers - to deal with the planning responsibilities and risk management issues - including volatility risk - that this will demand? Most people are notoriously poor at long-term planning. People in the UK are also relatively inexperienced and unsophisticated when it comes to matters financial. This is hardly surprising after two generations of mainly welfare state and employer provision. Many consumers have also still not fully adjusted to the implications of a low inflation environment and probably don’t understand the liability side risks they are running any better than their savings and investment risks.

Financial illiteracy remains a major challenge for some consumers. Research by DFES has shown that one in four adults cannot calculate the change they should receive out of £2 after buying three items costing less than that. A significant number thought 10% of £300 was worth no more than £25. A more recent survey by NOP for Invesco found that half of investors surveyed (and over two-thirds of the public at large) do not understand the difference between equities and bonds.

The FSA’s own research and that of the independent Consumer Panel is also revealing. One quarter of pension and endowment policy holders did not realise that their money was invested in the stock market. Consumers find financial information difficult to understand and frequently fail to read or retain the information provided. Even products designed to be simple confuse consumers – only 33% of consumers thought cash ISAs were straightforward for example.

The FSA will very shortly be launching a broadly based approach to tackling the deficiencies in consumers’ financial capabilities. This will need to involve a wide range of interested parties, including the financial services industry, but given the nature of the challenge, delivery will only be possible in the medium term. In the meantime, there will continue to be a severe imbalance between the financial capabilities of most consumers and the sophistication of financial firms.

The FSA’s regulatory expectations of firms and senior management

The FSA’s principles, rules and guidance place responsibility on senior management for incorporating the fair treatment of customers into the firm’s corporate strategy, delivering that strategy and monitoring its effectiveness. But in some firms these issues are treated in a minimalist, box-ticking way and are buried in Compliance Departments. They are not owned by senior management and therefore, hardly surprisingly, have little impact on the culture and behaviour of the individual members of staff who make up the firm.

For those of you who like chapter and verse, you will find the FSA’s regulatory requirements set out clearly in the Principles for Business – especially Principle 6 – the requirement for firms to pay due regard to the interests of their customers and treat them fairly; in the Senior Management Arrangements, Systems and Controls which explains the requirement for senior management to adequately understand, monitor and control their business and in the conduct expected of Approved Persons. Other key areas include the parts of the Handbook that deal with financial promotion and complaints handling.

What do we expect senior management to do in practice?

We expect senior management to incorporate their approach to Treating Customers Fairly into the firm’s corporate strategy, to support delivery of the strategy with an appropriate framework of controls, and to monitor the effectiveness of the strategy. This is simple to say, but I accept not easy to do, particularly in large complex organisations of many thousands of people. In practice effective delivery will include ensuring that the firm:

  • has in place a process to identify the needs of the customers for whom they are designing, manufacturing and/or distributing products;
  • understands the financial capabilities of its customers and the impact and effectiveness of its communications on their ability to understand sometimes complex issues;
  • provides clear, fair and not misleading advertising, marketing and disclosure materials as well as communications after the point of sale;
  • maintains a balance between increasing sales and not exposing customers to inappropriate risks, particularly in the design and marketing of new products;
  • measures, monitors, controls and reviews the risks arising from products for both existing and potential new customers. This includes dealing with current changes in the economic or market environment as well as stress testing against possible future changes in the environment;
  • finds a way to ‘stress test’ possible risks to the firm arising from its retail business taking into account product types, sales methods and after sales requirements;
  • puts in place appropriate control functions to enable delivery of the strategy;
  • provides timely, informative and relevant management information to monitor the effectiveness of the strategy.

In designing their strategy, we would expect senior management to have regard to all stages of the product lifecycle. This would therefore include: product design; financial promotions; advice (including remuneration of advisers); information at the point of sale; treatment after the point of sale; and complaints.

We have already emphasised the importance of fair, clear and not misleading financial promotion and effective complaints handling processes. Enforcement action on these issues has already take place or is in the pipeline. I would also highlight remuneration and reward strategies as requiring particular attention.

What is the FSA doing?

The FSA is working both to increase the financial capabilities of consumers and to improve the performance of firms in treating their customers fairly. As I have already mentioned, our proposals on how to address consumer’s financial capabilities will be published very soon.

So far as firms are concerned, the FSA has in train some pilot work assessing firms’ overall retail strategies on which we will be providing feedback on good practice and bad practice. We will be placing even greater emphasis on senior management oversight of the way customers are treated – this will be made very explicit in our ARROW risk assessment work and remedial programmes and, as I mentioned earlier, we will, where necessary, be deploying our enforcement powers.

We will continue to consider the effectiveness of our regulatory arrangements in supporting a high performing retail market place. We have already addressed some issues, including polarisation, and will have more to say on how this strategic work is to be taken forward.

As John Tiner and Callum McCarthy have signalled, treating customers fairly will, if anything, become an even higher priority in our work programme in the period ahead. We hope to engage senior management of firms in helping to develop pragmatic, clear and fair minimum standards, which leave plenty of scope for differentiation and competition between product providers and distributors. And I should emphasise again, we are looking for pragmatic approaches – not more rules.

The flipside of risk is opportunity and there is a real opportunity to be grasped.

We look forward to developing approaches together with consumers and the industry which will create a healthy market place with increased sales of the right products, to the right consumers at the right time.

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