Treating Customers Fairly (TCF)
Speech by Sam Tymms, Head of Department, Retail Business Unit, FSA
ASIM Annual Conference
19th May 2006
Good morning Ladies and Gentlemen.
Thank you for inviting me to speak at the ASIM annual conference. I am delighted to be here.
I am aware that David Kenmir and Mike Lord have given speeches in previous years on the architecture of the FSA and last year's key issues.
Today, I would like to look at one of our key initiatives – Treating Customers Fairly or TCF - which is a good example of our move towards a more principles-based approach to regulation. I will then look more closely at the principles-based approach before considering where we see ourselves in the future.
So, I would like to cover three points in the next half an hour.
- TCF as an example of principle-based regulation
- Principles-based regulation
- What we have achieved so far and what remains to be done
What is Treating Customers Fairly (TCF)?
Treating Customers Fairly (TCF) is encapsulated by Principle 6 of the FSA's existing 11 Principles for Businesses – it is not a new obligation.
TCF is highly consistent with what we aim to achieve as part of our wider regulation of the retail markets:
- Capable and confident consumers
- Simple and understandable information for, and used by, consumers
- Well-managed and adequately capitalised firms that treat their customers fairly
- Risk-based and proportionate regulation
TCF is about balancing the customer’s needs with the firm’s needs, being absolutely clear about what the firm and its services offer and being transparent about fees and levels of service. It is an example of where the FSA is allowing firms the flexibility to decide how to best deliver the outcome of ‘paying due regard to the interests of customers and treating them fairly’ – principle-based regulation in action, more of which later.
Why is TCF important now?
TCF has been given renewed emphasis recently as we move towards a more principles-based regime - we are challenging firms to review their position and wherever necessary to make a step change in their approach. So what are the reasons behind this renewed focus on TCF?
Firstly, although our regulatory toolkit has achieved much, it has limitations. We feel that creating rules is not the only solution, especially as in some cases compliance with the rules has become an end in itself. In the face of innovation, we are always on the back foot and the rule book gets even longer. Widespread issues, such as pensions and endowment mis-selling, are less prevalent but problems like this, albeit smaller ones, (such as splits and precipice bonds) are still occurring. That's why we have decided to focus more on the principle of TCF, to allow firms to decide for themselves how best to treat customers fairly, in an attempt to eradicate consumer detriment.
Secondly, our work on Treating Customers Fairly is complemented by our work on financial capability, which is designed to increase consumer understanding and awareness. You may be aware that the results of the UK Financial Capability Survey, the largest and most comprehensive study of its kind, were released on 28th March this year. This survey provides a baseline measure of financial capability in the UK. The overall message is that unless steps are taken to improve levels of capability, people are storing up trouble for the future.
Consumers have a limited influence on the financial market. This is due to the inadequate understanding they have of their own financial needs and the products that might meet those needs. Consumers of UK investment products do not behave like consumers in other UK markets: they do not always shop around. People tend to buy even their most complex financial products without considering other options. Possible reasons include lack of transparency or understanding of the nature of what is being offered. This is where TCF comes into play. Firms should be clear about the services on offer and their associated price and make sure this information is provided to consumers in a way that is clear, fair and most importantly not misleading. In this environment where consumers may not be financially capable, it is vital that firms take appropriate steps to embed TCF throughout their business culture.
What is TCF not?
I have talked at some length about what Treating Customers Fairly is and why it is important. I now want to touch on what it is not.
TCF is not about being nice to customers but about treating them fairly and establishing a culture of fair treatment of customers throughout your business. The crucial point, in a market where there is a large gap in understanding between the firm, and the consumer, is that there is a big difference in consumer satisfaction and consumers that are treated fairly. Put bluntly, satisfied consumers may have been treated very unfairly (and of course, the reverse may also be true). Churning is a good example of this.
TCF also isn’t about offering high quality all the time but it is about making sure that you are clear and understandable in your dealings with consumers. Charging structures for products should be transparent and the risks associated with a particular product should be clearly explained so that consumers are aware of costs and risks in all possible circumstances.
An example of this is benchmarks - an important area for the industry in terms of fairness. Can you be sure, when you take FUM, you can deliver a suitable investment that the client understands what he is getting and the associated risk? We recently visited a firm where they used an Interest Rate Benchmark for an Equity Portfolio and were taking performance related fees from the performance over benchmark. This could be an example of customers not being treated fairly because when the equity markets are strong, it would appear to the customer that performance is better than it actually would be against an equity benchmark. To treat customers fairly, wealth managers need to ensure their benchmarks are appropriate and easy to understand.
Clear information from firms will help consumers be able to make better and more informed financial decisions and whilst it is vital that firms fulfil their responsibility to provide this, it is important to recognise that consumers are also responsible for the decisions they make.
We do not work against innovation; we expect the markets to determine what products should be produced and distributed. However, we do expect firms to be able to satisfy themselves that they have given sufficient thought to their TCF responsibilities in developing a new product – that they have thought about their consumers at every stage of the product life cycle and that they have made sure they are clear and transparent in explaining the risks and rewards associated with the product to consumers.
What does TCF mean for you?
We have not defined precisely what Treating Customers Fairly means. Instead, we have challenged you as senior management to consider this in the context of your particular business activities and the consumers you deal with. Senior management commitment is at the heart of the Treating Customer's Fairly initiative and although the application of TCF will always be different in different firms, establishing and maintaining that philosophy should come from the board.
In the early stages of our TCF work, we ask senior management to analyse areas of their business where they may not be treating customers fairly. We also suggest that thinking about Treating Customers Fairly in terms of the product life cycle is a useful starting point in analysing a firm's response. Depending on the precise nature of a firm's business, this could mean addressing the fair treatment of customers from product design and governance at one end to after sales information and complaints handling at the other. This may also encompass a review of your literature, how you choose products and the training you provide to staff.
We then expect senior management to consider what is needed to address any shortcomings identified during this analysis, to embark upon a programme to address these gaps and to set clear priorities and targets to track progress.
Senior management now need to take responsibility for embedding Treating Customers Fairly into the processes, procedures and most importantly into the culture of a firm, at all levels. Embedding means that the fair treatment of customers is established throughout the business, so that it has become business as usual.
In our supervision of firms, we are not only looking at systems and controls but at all aspects of the business and culture and how TCF has been embedded at all levels. This includes people issues such as training and competence; remuneration; and performance management. We also expect senior management to ensure that they have the right management information (MI) and other data to satisfy themselves that they are treating their customers fairly in practice. We focus on how you know you are meeting your TCF obligations.
Which brings me on to a few practical considerations.
Client literature should be clear. Firms must ensure that they conduct reviews of the target audience for a particular product when creating client literature – are the target consumers financially sophisticated or will they be of mixed financial capability? How should the client literature be adapted accordingly? And are these the customers who are responding to your literature?
Firms must also consider how customers would assess the product or portfolio alongside competing products. Have they ensured that the risk-reward trade off has been clearly explained so that the customer understands and can then make fair comparisons?
MI will be vital in allowing senior management to monitor progress with regards to TCF. The good news is that we are not suggesting firms should have to develop a new set of MI for TCF. It is likely that you already have much that could be used for this purpose.
You may have found that you could use MI as part of the gap analysis stage. MI can also be used to ensure that TCF behaviours are being embedded effectively and as part of the feedback loop illustrated on the previous slide. If firms establish trends in MI they will be able to identify where issues are occurring and take steps to resolve them. For example, if a firm notices a large number of queries or complaints associated with the same product where they are not at fault, they can feed back this information to the product designer.
This reminds me of a motor insurance brokers we visited recently. The chairman was puzzled by the number of complaints his firm had been receiving. They had successfully rejected all these complaints, but he wanted to know why his customers had been complaining in the first place. It turned out that in most cases this was because his customers had not understood that their claims would not be valid if they had lied about various matters when taking out their insurance cover. So the firm added some wording in big letters to the relevant forms, telling its customers that if they did not fill in certain details correctly when they took out their insurance then future claims would be invalid. The number of complaints at this firm has since fallen to almost zero.
Good MI is only a benefit if you have it in a form that makes it usable. But without MI you have no way of knowing whether your firm is delivering TCF nor will you be able to demonstrate it to us or others. Those of you who are part of a governing body should be asking for it.
What is principles-based regulation?
As I have mentioned, our renewed focus on TCF over the last 2 years is a good example of the evolution of our approach to principles over prescription. We have been advocating a more principles-based approach to regulation for a while and our risk-based approach to supervision is well established: principles-based regulation does not represent a radical change of direction for the FSA.
However, we are accelerating the pace of change, pushing forward with several specific pieces of work to move us further in the direction of a more principles-based approach and to embed our risk-based approach even more.
The focus in this principles-based regime will be on the 11 Principles for Businesses, of which TCF is one. They are not new – they have been in force since 2001. What is new is the renewed focus which we have placed upon them as part of the principles-based regime. The Principles provide the backbone for the FSA’s regulatory regime setting overarching high level requirements for all financial services firms; they articulate what actions and behaviours we expect from firms.
We see a principles-based approach as a positive move for our stakeholders. Firms will face less prescription and more autonomy in how they meet their regulatory responsibilities, reaching their own understanding of our high level principles to achieve the required outcomes. We also believe that consumers will benefit as they will receive better treatment through a firm’s own initiatives as opposed to regulatory detail. In this new era, outcomes are what count.
Why Principles-based Regulation?
So why the move to a more principles-based regime?
We want to provide firms with the flexibility to better align good regulatory outcomes and good business practice
Providing firms with the flexibility to decide for themselves what business processes and controls they should operate will better align good regulation with good business practice. This approach will provide greater clarity about the outcomes that really matter to us, and will engender a shared appreciation of the regulatory outcomes we are seeking to achieve.
Better treatment of customers can be delivered through a firm’s own initiatives and actions rather than through regulatory detail
Firms who are seriously committed to treating their customers fairly are in the best position to judge how they deliver fair treatment to their customers and then align that with their commercial objectives in terms of customer service and retention.
We believe a principle-based approach will further consolidate the UK and London’s competitive position as the location of choice for mobile capital
In its policy making, the FSA has a duty to have regard to the international competitiveness of the UK markets. We believe the move towards a principle-based regime and the pragmatic system of regulation adopted by the FSA will reinforce the phenomenal success experienced by the City of London and the UK as a whole and further consolidate the UK’s position as a location of choice for international capital.
It forms a key element of our response to the challenges posed by the Better Regulation agenda
There is a clear recognition at the political level that regulatory costs and ‘red tape’ can impact on productivity. A focus on principles over prescriptive rules, unless unavoidable, gives firms the independence to decide how they comply without necessarily having to adhere to prescriptive rules, so long as they deliver the required outcome. Where we do need to introduce a new rule, we will only do so if it passes a series of tests, proving the benefit of the new rule exceeds its cost. We are now proposing to apply the same series of test to existing rules. Where the cost of a rule outweighs its benefit, it will be a candidate for elimination.
A principles-based approach combined with a risk-based assessment of whether firms are operating in line with the 11 principles should create incentives for firms to ‘do the right thing’. In return we should create incentives, such as less regulatory intervention, or a ‘regulatory dividend’. This last point will be explored in more detail during the coming months.
What has been done so far?
The key to the success of this shift to a principle-based regime lies with firms and their senior management but the FSA also has a part to play.
I imagine you may find this shift to principles as sounding attractive, but I am aware that a number of firms worry that they will be entering into a period of greater regulatory uncertainty and risk. We understand these concerns and recognise that the FSA has a key role to play in establishing an environment which firms find reliable and predictable, where communications from the FSA are relevant, clear and timely and guidance is useful.
Constructive, grown up dialogue is absolutely key to a successful relationship between the FSA and the financial services industry. To this end we are involving firms more in the ARROW process and have introduced initiatives such as ‘How was it for you’ discussions with firms after an ARROW visit. We have also written to all firms explaining the changes to our supervisory approach, what we expect of firms and what they should expect from us. We will be monitoring our performance against our new service standards and publishing the results on our website.
This shift to a principles-based regime will be critically dependent on our people making good judgements based on a good business understanding and an ability to communicate clearly.
ARROW is our means of determining whether firms are adhering to the Principles and we are in the process of introducing significant improvements to the ARROW process. Our supervisors are attending a 5 day training course on the revised ARROW framework and a core curriculum has been introduced which will help our people meet the challenge of the principles-based regime. The new ARROW framework will give us better control over the supervisory process to ensure a more consistent approach is applied. Improved training and guidance for supervisors, plus better expert analysis of sectoral risks and issues will support more effective supervision.
We know that many firms have questions. Our response to this has been to develop case studies and publications of good and bad practice. We have changed the information at the bottom of our emails and letters to firms so that you may now rely on any comments contained within them. We will use guidance to supplement principles, where we think this would be helpful in setting out the standards we expect, or in assisting firms to decide what action they need to take to meet the necessary standards.
We will take care not to replace rules with lots of other information. However, there will be times when we will continue to use detailed rules, in order to implement directive requirements for example. We will not, however, “gold plate” directives by adding specific UK requirements over and above the text of the Directive. Indeed, where possible we will directly ‘copyout’ a Directive unless the proposed addition addresses a market failure and meets a cost-benefit test: only if the benefit of a new rule exceeds its cost will we impose it. Nor will we retain rules and regulations superseded by a Directive, unless retaining those rules or regulations addresses a market failure and meets the cost-benefit tests. An example of this is the simplification of the COB sourcebook under MiFID.
What more needs to be done?
Although much work has already been completed, there is still much more to be done before we reach a place where TCF is embedded in all levels of a firm.
In our assessment of progress in TCF we can see that many firms are making significant advances. They are doing so in a variety of ways and we see examples of very good practice. Unfortunately, others are still at the beginning and have a long way to go – to them there is a warning: you are increasingly being left behind by competitors who are finding commercial advantage in putting customers at the heart of their business; you will also find that the FSA has less and less patience with inactivity and starts to consider greater use of enforcement action. This would particularly be the case where a firm has failed to identify shortcomings which lead to consumer detriment, has not developed a strategy to remedy them and has committed a serious breach of the principle, whether or not there has been a breach of a detailed rule.
Our focus is fixed on senior management as the drivers behind the TCF programme in your firms but this approach requires you to understand what we are trying to achieve and to align your business practice to reach the required outcome. We expect you to be in a position where you can satisfy yourselves and us that fair treatment is being embedded and actively delivered at all levels of your business and demonstrate this in the fair outcomes for your consumers.
Inevitably, however, being less prescriptive brings greater uncertainty and greater responsibility for all involved, particularly senior management. We have more work to do in explaining what exactly principles-based regulation means in practice. And there are difficult questions to answer on exactly where a firm's responsibility begins and ends, and the extent of consumer responsibilities when they engage with financial services providers. These are important questions on which we continue to focus and make progress.
Conclusion
This morning I have covered principles-based regulation and Treating Customers Fairly as an example of this. In this new era of principles over prescription we are giving firms and most importantly senior management, the flexibility to decide how they comply as long as they reach the required outcome. In the case of TCF, this outcome is the fair treatment of customers.
We view improvements to the fair treatment of customers in the retail market place to be fundamental to our work to improve the efficiency and effectiveness of that market for consumers. Although considerable progress has been made, we have more work to do before Treating Customers Fairly becomes fully embedded: when customers recognise they are being treated fairly and when firms can demonstrate clearly and convincingly that they are treating customers fairly.
Thank you for your time today.