Treating customers fairly
Speech by John Tiner, Chief Executive, FSA
Asset Management Conference
21 September 2006
Introduction
Thank you, Dan. Good morning ladies and gentlemen. I wanted to add my warm welcome to you today at this year's FSA Asset Management Conference. I particularly wanted to extend my thanks to all of our external speakers for giving up their time and putting in the effort to participate in the various panel presentations and discussions today. I predict that you will have a fruitful and informative day ahead of you.
The asset management sector is experiencing a period of considerable regulatory challenge: implementing the new bundled brokerage and soft commission rules which took effect this year; preparing for MiFID and CRD; dealing with UCITS 3 and the Simplified Prospectus debate; and considering our consultations on Hedge Funds, Wider Range Retail Investment Fund Products, the FSCS Funding Review, and dual and single pricing for authorised collective investment schemes – to name a few.
Some of these are initiated by us, but many have come from Europe as EU- wide Directives and as always, we value your co-operation either directly or through relevant trade organisations.
I am going to concentrate today on another significant regulatory theme, our Treating Customers Fairly programme. The intention and purpose of the TCF initiative is by now familiar to all of you. But I want, today, to put it in the broader context of our stated intention to move towards a more principles-based approach to financial services regulation – an approach that has in many ways been spearheaded by TCF and which will be informed by it.
By more principles-based regulation I mean a shift more consciously and explicitly to focus on outcomes for firms, markets and consumers, rather than the prescription of detailed rules and formal guidance. TCF is a good illustration of this; we have been concentrating our efforts on the high level aim of ensuring that customers of financial firms are treated fairly. Another example is our commitment to the principle that firms must hold sufficient financial resources for the risks they run. We all know from the experience of TCF that taking this high level, more principle-led approach is not always comfortable or easy. In delineating the boundary of legal risk, rules provide comfort and safety to firms and to regulators. But if we are to foster innovation and competition in our markets we must all be prepared to accept the uncertainty brought by principles-based regulation. The cost of not doing so – firms and markets whose flexibility and manoeuvrability is hampered by detailed rules – is simply too high. But more principles-based regulation in general, and the successful delivery of TCF in particular, makes demands on all of us. It requires trust between the regulator and the regulated. It relies on the regulator having the experience, market knowledge and intuition to make good judgements, and we are working to develop these qualities more deeply at the FSA. And by bringing good business practice and good regulatory practice together, it reinforces the principle that senior managers are responsible for running a company's business, not the regulator.
Issues to be covered
Having set the scene, therefore, I want to talk about how we are progressing on TCF and about some of the more complex issues that are now surfacing to do with the responsibilities of producers and distributors; a set of issues to be covered more fully in a Consultation Paper, to be published next week. And I want to conclude with some remarks about how we will be gauging the success of the TCF programme.
Setting the scene on TCF
You will all by now be familiar with the broad purpose and outline of our work on TCF.
TCF is central to the delivery of our work in the retail market generally. Our aim is to ensure an efficient and effective retail market and we group our activities under what we call the four pillars. These focus on our strategy to improve the current level of consumers' financial capability; the provision of simple, understandable information to consumers; well managed and capitalised firms who treat their customers fairly; and risk-based supervision and policy making.
Our TCF work is related to all of these. For example on the first of these, financial capability, we accept that the current level of consumers' financial capability has an impact on our approach to TCF. We have instituted a major programme of work beginning with the five year plan we set out in March of this year alongside the outcome of our baseline survey of financial capability in the UK.
The second of these, the provision of clear, understandable information to consumers, is also a key element of TCF. For example, an asset management firm marketing a new fund directly to retail customers might ask itself whether the staff devising the marketing and promotions for the new fund fully understand it; whether the selected marketing channels are suitable for the product, in other words, can those channels convey a fair and adequate description of the product, given the financial capability of the target audiences. It might ask itself whether the customers for whom the fund is designed would understand the wording in the marketing materials and whether there would need to be different materials for different audiences. Or whether the firm has the necessary arrangements and resources for servicing and managing customer queries and complaints?
For this kind of work to happen, senior managers must embed the principle of TCF in their corporate strategies and build it into their firms' culture and day-to-day operations. Only in doing this can we address the risk of consumers misunderstanding and or being mis-sold products – in other words, the risk of another Precipice Bonds or Split Caps-type crisis.
Where are we now?
Overall I would say progress on TCF has been mixed, with some firms lagging a long way behind others, and firms must now focus on driving change through from senior managers to their frontline staff and operations. That is certainly the message of our most recent progress report on Treating Customers Fairly, which we published in July, and I would urge those of you who have not read and digested it to do so. We have now set a deadline for firms to reach the implementation stage of their TCF work in a substantial part of their business by the end of March 2007 – in other words, in just over six months' time.
That said, I have been encouraged by the progress many firms are reporting, and I hope to see this continue. I also want to acknowledge publicly the effort made by trade associations to foster TCF understanding and good practice in their own sectors. We have liaised closely on the publication of much of our TCF material with the TCF Consultative Group, which is made up of representatives of trade associations from a range of key industry sectors including AIFA, APCIMS, and the IMA and representatives from consumer bodies. Many trade associations are also co-ordinating training events for their members and some trade associations are developing guidance and good practice procedures on specific aspects of TCF. We welcome these initiatives as a means to help firms familiarise themselves with our expectations and seek to deliver on them.
What next – the interface between provider and distributor
I want to turn now to something I know is especially relevant to asset managers - the interface between product providers and distributors. I mentioned that we will be publishing a Consultation Paper on this aspect of TCF next week; but in advance of that I want to explore some of the dependencies throughout the chain from asset manager/fund provider through to the distributor and on to the consumer.
'Provider' firms that are not directly selling products to or advising customers themselves still need to consider the impact of their actions (or inactions) on the end-customer during the various stages of the product life-cycle. Providers are not only likely to be involved in designing and targeting products but also in providing communications to those firms that sell those products to consumers or to the consumers themselves. And where post-sale service is concerned the product provider acquires an ongoing contractual relationship. But it is clearly the case that a product provider, in isolation, will rarely be able to ensure the fair treatment of customers. Distributors, for their part, will generally be responsible for the sale including information they provide to the customer and for the suitability of any advice. The chains created to link the two are often complex and questions of TCF responsibilities commensurately difficult to undo. This is precisely the subject of the Consultation Paper which we will publish next week.
Product Provider Responsibilities
I want to focus today in particular on the responsibilities of product providers. Your firms typically stand at the beginning of a chain of actions associated with the design, targeting and testing of a product that affects the fairness of the ultimate product offering. If a fund management firm is offering a new, target-return product for retail customers, for example it should give thought to the vulnerability or level of financial sophistication of the target consumer profile and it should seriously consider how it can best satisfy itself, through stress testing or other methods, that the fund will be able to meet its targeted return.
Product providers should also, where they are able to, consider their approach to matching products and distribution, for example considering whether their product is one where customers would be wise to seek advice, and what this means for its distribution strategy.
And although the responsibility for provision of advice falls on the distributor, one of the issues for our consultation is the provider’s responsibility for providing the right type of information to the distributor at the right time, so that the distributor can properly advise on and recommend the product. This could include establishing what information the distributor needs to satisfy the needs of customers, the distributor's likely level of knowledge and understanding, and what medium would best meet these needs. To take my earlier example of the fund management company launching a new, target-return fund, the firm should provide its distributors with sufficient information for them to understand the fund, target the right customers, and treat their customers fairly. The information provided should be accurate and clearly explain the nature of the fund and the risks associated with it.
It is also imperative - for business as well as regulatory reasons - that providers take an interest in the overall quality of their distribution - not necessarily by proactively monitoring the behaviour of individual distributors but rather by considering what the aggregate statistics tell them about the quality of sales. Firms can, for example, monitor sales volumes and trends that can then be checked against projections. Firms can monitor persistency rates. Or where the sales and marketing data produces 'outlier' information such as a high amount of firm-specific sales or an unexpected geographical concentration of sales, firms can explore the reasons behind that data. In none of these examples do the data necessarily mean there is a problem but in certain situations it could prompt a provider to provide more or different information, or adapt distribution. The key thing is that data, once gathered and analysed, is acted upon.
It is surprising to us that many product providers are cautious about this - putting their reputation in the hands of others who "own" the relationship with customers without necessarily either providing clear, accurate information or actively considering distribution quality. It is a harsh commercial reality that much brand damage can be incurred in this way - the customer remembers the fund brand name when it comes to complain and not the smaller local distributor.
Product provider responsibilities to the customer after a product sale has been completed are, of course, clear, even though in some cases the contact between provider and consumer is not direct.
As I hope my remarks about principles-based regulation have suggested, it is not our intention to provide detailed rules in this area. Consistent with our approach on TCF up to now, we will be looking for providers and distributors alike to consider their own responsibilities in how to treat customers fairly at all points of the distribution chain - where these should reflect the content of our Principles. In particular it means that firms must take reasonable care to organise and control their affairs responsibly and effectively, with adequate risk management systems. It is therefore relevant for me to remind you of the findings we reported on the range of problems in small and large retail intermediaries (and other firms) that neglect corporate governance and high-level controls, including financial controls.
Since then we have been pursuing these issues closely in our supervisory work with retail intermediaries. And indeed, these and other issues will be addressed in the review of retail distribution that I announced in June. But notwithstanding our important responsibilities, product providers too should consider their own ability to improve distribution and avoid reputational damage – for example by enhancing information to distributors and by considering and acting on high level information about distribution quality.
How will we assess success/failure?
A critical element of any initiative is to be clear about how to measure the success or failure of its delivery. In the case of TCF, this can be gauged at several points in the market and in the FSA's own monitoring of its objectives. I want to close by giving an indication of where I think the key measures lie.
In the spirit of principles-based regulation, the primary means by which we will see the success of TCF is the real difference it makes to consumers of retail financial services. There are a number of specific outcomes which we will use to enable us to recognise this difference. Consumers will be dealing with firms that have the fair treatment of customers at the centre of corporate culture. Products marketed and sold in the retail market will have been designed to meet the needs of identified consumer groups and will be targeted accordingly. Consumers will be given clear information and will be kept informed before, during and after the point of sale. Consumers will receive suitable advice that takes account of their circumstances. Products will perform as firms have led their customers to expect. The associated service will not only be of an acceptable standard but will also be as consumers have been led to expect. And consumers will not face unreasonable post-sale barriers to change product, switch provider, submit a claim or make a complaint.
For our part, TCF is at the core of our regulatory approach for the retail market and we will continue to embed it within all aspects of our regulatory and supervisory approach. This includes aligning all relevant thematic work with our TCF priorities and taking forward work to review firms’ own assessments of progress with their TCF initiatives. We will look to firms to continue to demonstrate – for example using their own management information – how they are building TCF into their strategy and approach. We will also carry out targeted work on those aspects of the consumer outcomes where we are less informed, notably on product design and the cultural questions around how firms translate good intentions into delivery in the form of improved outcomes for consumers.
At the FSA we are developing measures for our own performance framework to identify firms' progress towards TCF outcomes and we will be discussing them with our TCF consultative group of industry and consumer bodies. Some indicators we will use are the findings from our thematic work and our day-to-day supervision; our Financial Capability Baseline survey (and its repeats), an important source of intelligence on financial literacy and consumer behaviour; our own consumer research; and data provided to us by firms or the Financial Ombudsman Service (FOS). The baseline for our framework will be set in October, and early trends may be observable next year.
I do want to make clear, though, that while we can and do take enforcement action on the basis of principles, including Principle 6, we do not regard high numbers of enforcement cases on TCF as a sign of success. Where we find that a firm is failing to treat its customers fairly, we will consider the most suitable course of action. In many cases, we will agree with the firm a means of addressing shortfalls including, where necessary, providing redress to consumers. Some cases may lead to enforcement action, in particular where a firm has not responded to indications of a problem, has failed to identify shortcomings and to develop a strategy to remedy them, and has committed a serious breach of the Principle. But we do not expect to take enforcement action if we see that firms are making a genuine attempt to deliver on TCF and there has not been significant risk or actual detriment to consumers.
Conclusion
In conclusion, I hope I have made clear the continuing significance of the TCF programme, for the UK's consumers and financial services markets and also for the future of regulation. In many firms, considerable senior management commitment and careful work is going into reviewing business and making changes – we are encouraged by this and we expect to see this work manifest in real changes for consumers. We are pleased with the progress to date, but much remains to be done. Ultimately, we want to encourage and foster good business practice throughout the financial services sector, including firms operating in the asset management arena, by recognising firms' duties to their customers. Providing firms with the flexibility to decide more often for themselves what business processes and controls to operate so that compliance with the principles is secured 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 lead to a shared appreciation of the regulatory outcomes we are seeking to achieve. And, by taking a more overtly risk-based approach to our assessment of whether firms are operating in line with these principles, we should create incentives for firms to do the right thing in return for a regulatory dividend – that is less regulatory intervention.