Fairness in consumer contracts
Speech by Katherine Webster, Retail Themes Division, FSA
British Bankers Association seminar, Pinners Hall, London
20 September 2005
Ladies and gentlemen, good morning and thank you, Chairman/Paul for your kind words of introduction.
I should like to say straightaway how much we welcome the initiative the Association has taken in organising this seminar, following publication of our Statement of Good Practice on the fairness of terms in consumer contracts in May of this year. I would also like to thank the Association for giving the FSA the opportunity to give this opening presentation.
This seminar is important because it gives us all an opportunity to think about what we mean by "fairness". It also enables us to focus on the particular importance of contracts in delivering that fairness and to remind us that what is written into them is more than a simple legal responsibility. I say that with some feeling, being a lawyer myself.
Truth to say, fairness is hardly a new concept. It is one which has an instinctive meaning to every one of us. We all have a feel for what is fair and what is not. So, in a perfect world, there should be little more that needs to be said about it. However, unfortunately, there have continued to be examples of consumers being treated unfairly. To combat this, several legal and regulatory fairness obligations, originating at both national and EU level, have been introduced over recent years.
For example, there is common law which seeks to protect against particularly onerous clauses being hidden in the body of a contract without attention being drawn to them, the Financial Services and Markets Act, through our own Principles for Businesses, requires firms to treat consumers fairly and, looking to the future, we have, for example, the Unfair Commercial Practices Directive which will prohibit unfair practices by businesses in their dealings with consumers. Also, some requirements to behave fairly are imposed by the industry itself, such as through the Banking Code and we welcome these.
So, should the introduction of such fairness obligations, of itself, be something to worry about? I do not think so. Put simply, to think otherwise would seem to argue in favour of unfairness. My starting assumption is that we are all working to the same goal of achieving fairness and that any differences between us are more at the level of detail and timing.
That said, where these differences exist and may, in some cases, be endemic, there are risks to your businesses and that is why we have focussed so energetically on developing our treating customers fairly initiative, on which we published an update report a couple of months ago. The key message in that report was simple and to the point: much has been achieved but more needs to be done.
The Statement of Good Practice focuses, in the main, on firms' statutory obligations under the Unfair Terms in Consumer Contracts Regulations. However, it does acknowledge that there are other fairness measures in place and that the Regulations exist – and must co-exist – with all of these. Both the FSA and you in the industry must have regard to each of these measures in order to satisfy yourselves that you are treating your consumers fairly in the round.
Talking about risks, let me further reflect on the reasons that stand behind our decision to take a closer look, in the Statement, at your obligations under the Unfair Terms in Consumer Contracts Regulations and how they might be satisfied. If terms in your standard form consumer contracts are not drafted fairly then several risks arise: the reputational risk of consumers simply not trusting you and so not wanting to do business with you, the operational risk of having to spend management time and energy on putting right the wrongs as they emerge and the prudential risks that may arise because you cannot enforce the term that has been judged unfair.
The Statement is intended to help you mitigate these risks and, recognising this, the BBA and other FSA stakeholders worked with us to develop it. We are grateful for this and also for their contribution to our roundtable discussion back in July. The message from the industry during that discussion was clear: we welcome the Statement of Good Practice which has brought clarity to some difficult legal issues and we recognise our responsibilities to make sure our contracts are fair.
We, in turn, welcome this positive response and the readiness, in the industry, to address the issues that we raised. Contracts are sometimes overlooked as tedious and long-winded documents to be poured and argued over by lawyers but which are of no interest to anyone else. However, this is not the case. It is worth remembering that a contract defines the relationship between firm and consumer. Fairness of terms in consumer contracts is an important part of treating customers fairly throughout the whole product life cycle.
The Unfair Terms in Consumer Contracts Regulations, although since amended, have been in force since 1995 and so you should have been aware of and complying with them for the past 10 years. They are an important piece of legislation containing, as they do, a key test of when a term in a standard form consumer contract will be unfair. Standard form consumer contracts are those which have not been individually negotiated with the consumer and, therefore, sway the balance of power in favour of the firm. By way of reminder, this key test states that a term will be unfair if "contrary to the requirement of good faith, it causes a significant imbalance in the parties' rights and obligations arising under the contract, to the detriment of the consumer". The Regulations also say that where a term is unfair then it is unenforceable.
As well as being a reminder to firms of the existence of the Regulations and the need to comply with them, the Statement is also intended to help regulated firms interpret and apply the Regulations. The Regulations apply generally across diverse business areas (not just to the financial services sector) and, therefore, are written in general terms and, to a large extent, do not give any indication as to how they are to be interpreted in any specific context. Although ultimately the interpretation of legislation is a matter for the Courts, in the absence of any specific case law the Statement gives a commentary which is intended to help firms interpret and apply the Regulations to their standard form consumer contracts for regulated financial products and services.
Finally, the Statement also addresses some specific issues. It contains a section on interest rate variation clauses and a section on the variation of long term insurance premiums. Of particular interest to you in the Banking sector, is the section on interest rate variation clauses. In the Statement, we make clear our view that the power to vary interest rates during the lifetime of a contract is not inherently unfair. Indeed, a variable rate may be the most attractive for many consumers. It may also give firms the flexibility they need to manage their business prudently and remain competitive. However, the contract terms should not be drafted in a way which allows the firm, in varying these rates, to take unfair advantage of the consumer.
The Statement sets out what we consider to be good practice in relation to contracts which contain an interest rate variation clause. Examples of what we say about this include: that it is likely to contribute to the fairness of a term if it sets out if, when and how the interest rate may change; that variation clauses must be drafted in a way which is fair having regard to, amongst other things, the power to change rates and the power to decline to change rates, or to delay a change; and, that firms must ensure that product literature is clear, fair and not misleading, including as to whether and, if so, how the interest rate will track an external benchmark rate. The Statement addresses these and other aspects of fairness at a high level and using generic examples. The detail is, or will shortly be, dealt with in the Banking Code.
A question that we have sometimes been asked is "why has the FSA published the Statement now?". We said some time ago that we would publish our views on the fairness of interest rate variation clauses. And, so far as clauses for the variation of long term insurance premiums are concerned, there is now valuable accumulated experience among firms in carrying out these reviews and the practical and financial impact they may have on consumers. As I said, the Statement is simply intended to help regulated firms interpret and apply the Regulations in the specific context of contracts for financial products and services.
The lead enforcer of the Regulations, across the diverse business areas to which they apply, is the Office of Fair Trading so it was very important to us to ensure that what we say about the Regulations in the Statement is consistent with the OFT's interpretation and application of them. This is, amongst other things, to ensure that you in the industry are not required to meet double or conflicting standards. I am pleased to confirm that we did reach an accommodation with the OFT about the content of the Statement and that the OFT welcomed publication of it. And, I should just like to take this opportunity to thank the OFT for the time it took in discussions with us.
It was also important to us to have discussions with the Financial Ombudsman Service about the content of the Statement. Although the FOS is not under any statutory obligation to adhere to what we say in the Statement, it is testament to the work that went into drafting it that, since its publication, the FOS has recognised the Statement as a useful tool to promote its understanding of the FSA's approach to the Regulations.
Issuing the Statement forms just part of the work that we are doing with a view to firms ensuring that their standard form contracts are drafted fairly. The FSA is not a "contract approval authority" however it will take action when unfair contract terms come to light – and this may be through dealing with individual consumer complaints, through the work of FSA Supervisors or through thematic work in relation to a particular product or a particular type of contract clause, such as variation clauses.
The FSA has a Consumer Protection Powers team which deals with unfair contract terms that are referred to it on a case by case basis and, also, carries out theme work. There are various ways in which this team can deal with contracts which are referred to it that contain unfair terms. In keeping with the FSA's risk based, pragmatic approach, the team is likely to seek an undertaking from a firm. The firm will undertake to operate an unfair term in any existing contract in a way which is fair. It will also be asked to undertake to amend the drafting of future contracts so that they are fair. So far the FSA has obtained nine such undertakings from firms and these are published on the Consumer Protection Powers pages of the FSA's website. The undertakings that we obtain are published so that other firms may look at and learn from them. We would encourage you to review these undertakings regularly and to put what you learn from them into practice at your firm.
However, the Consumer Protection Powers team is not limited to obtaining undertakings from firms. It does have other means available to it of dealing with unfair contract terms. For example, under the Regulations, an unfair term is unenforceable and, if necessary, the FSA could seek an injunction against a firm to prevent that firm relying on any unfair term.
So, how should we all carry these issues of fairness and the messages in the Statement of Good Practice forward? Well, we at the FSA will continue with the work of our Supervisors, of our Treating Customers Fairly initiative and with the work of the Consumer Protection Powers team - which will include regular updates to the Consumer Protection Powers pages of the FSA's website. This will include publishing any new undertakings, as and when we obtain them from firms. It will also extend to publishing further commentary to help regulated firms interpret and apply the Regulations to specific types of contract term and to set out what we consider to be good practice in relation to them.
As for the industry, well, the momentum generated by the Statement is being carried forward by industry initiatives such as Advice to be issued by the Association of British Insurers to its members about the practical implications of the Statement. And, as previously mentioned, the Banking Code will give detail to some of the issues surrounding interest rate variation clauses that were addressed at a high level in the Statement. We very much welcome the fact that the Banking Code sponsors have said that any necessary amendments to the Banking Code will be made by the end of the first quarter of next year. Finally, seminars and conferences such as this one organised by the BBA, are a welcome means of keeping the Regulations and the requirement for firms to draft terms in consumer contracts fairly at the forefront of all our minds.
And, for all of you here to today from firms, the Statement does not trigger any specific or immediate requirement for you to carry out a review of existing contract terms. However, you may well wish – not least in light of the reputational, operational and prudential risks that I outlined earlier - to consider whether your firm's existing contracts contain terms which have been drafted and are being operated fairly and you will certainly want to ensure that, going forward, your standard form consumer contracts are drafted fairly. Ultimately it is the responsibility of boards and senior management to see that their firm has the necessary systems and controls in place to ensure that this is the case.
Thank you for your time this morning.