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Speech by Sarah Wilson, Director Responsible for TCF, FSA
Treating Customers Fairly in Retail Finance Conference
28 September 2006

Introduction

Good morning, and thank you to FT Business for giving me the opportunity of speaking to you this morning about Treating Customers Fairly.

It goes with out saying by now, I hope, that the FSA’s so-called ‘TCF initiative’ is of great importance for retail financial markets in the UK. Alongside our longer-term work on the financial capability of consumers, this initiative is directed at improving the outcomes for consumers in these markets. Specifically we have asked all firms to reflect on the meaning of the FSA’s Principles for Business insofar as they apply to the treatment of retail consumers (including Principle 6 on Treating Customers Fairly); to consider whether there are gaps in their own approach; and where gaps are found, to implement change. As a result of such work, we hope the industry will move to a position where it is more generally the case that:

• consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture;
• products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly;
• consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale;
• consumers receive suitable advice;
• consumers are provided with products that perform as firms have led them to expect, and the associated service is both of an acceptable standard and as they have been led to expect; and
• consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.

We recognise that a lot of progress has already been made. And while there is no presumption that every firm will find gaps that need filling, it is our experience that the senior management in firms from all sectors often find more to do than they expected once they stop to reflect on the position.

Product life-cycle

We have found in our discussions with firms that the idea of a ‘product life-cycle’ has helped many to think through what it means to treat a customer fairly. Specifically, we have encouraged senior management to consider how at each stage of that cycle, they need to direct their attention to the fair treatment of customers - whether it be, for example, in the design of a product for a target audience; or in ensuring that marketing enables consumers to understand product features. A fundamental aspect of this approach is recognition of the inter-connectedness of the life-cycle – product designers need to work closely with marketing departments; those creating product information need to liaise with those responsible for product sales; and the claims department has much to teach those who designed the product in the first place.

Given that the product life-cycle and its inter-connections has proved a fruitful way of thinking through the issues, it is not surprising that questions have increasingly been raised about the proper relationship between firms where that life-cycle occurs across more than one legal entity. In particular, firms are increasingly asking us for our view of the respective responsibilities of product producers and distributors. Doubts of this kind are of significance – they indicate that consumers might expect a differential outcome depending on whether any given product is designed and distributed by one firm or by several. We do not think this is desirable. Following extensive discussion, we are therefore publishing today a Discussion Paper on this subject – and it is this that I would like to focus my main remarks on today.

Specifically, I should like to cover:

• our approach to setting out FSA views in this area – specifically the focus on Principles;
• what the Draft Statement contained in the Discussion Paper says; and
• how we hope the industry will respond.

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Our approach

First, as with all aspects of the TCF initiative, our approach has been principles based. We have set out the FSA’s view of what the existing Principles mean for the responsibilities of product providers and distributors - to one another and to the end customer. As generally with more principles based regulation, this enables us to make statements about desirable outcomes without detailed instructions on how to achieve them. Importantly, it therefore allows for the wide (and evolving) range of existing market structures without creating pages of detail to cover all eventualities. As I will mention in a moment, quite apart from a conventional producer-distributor model, we have taken account of:

• multiple distributors acting in a chain;
• distributors that commission (or possibly aggregate) products and which might therefore properly be responsible for product design; and
• multiple manufacturers responsible for contributing components subsumed into a retail product designed and marketed by just one ‘retail manufacturer’.

Second, given that our aim has been to describe existing responsibilities, we have not introduced new requirements. The Statement does not for example say that any firm must take on the regulatory responsibilities of other firms – producers are not being asked to police intermediaries.

Third, we have thought equally about the responsibilities of producers and distributors. In the case of producers there is relatively little detail in the Handbook as it stands, and consequently more to explain in a Statement. Equally, and notwithstanding the existence of many detailed rules for distributors, we have taken the opportunity to reinforce aspects of distributor responsibility. In both cases, our experience (and industry comments) suggests that, for some firms, compliance with the statement would lead to changed behaviour and improved consumer outcomes.

Fourth, we have considered how our work sits alongside industry initiatives. We welcome current initiatives by trade associations to help their members better understand how responsibilities are divided between different firms in the distribution chain. And we are especially pleased to see that in some cases these initiatives are joint efforts by trade associations which represent providers and distributors respectively. Nevertheless, we have concluded that industry action alone will not lead to the change in some firms’ behaviour that we think is needed in this area. This is because trade association activity is unlikely to cover the whole area of the financial services sector. Furthermore we consider that, without our intervention, at least at a high level, trade associations will have no baseline on which to build their efforts. Instead, our Statement is complementary to trade association work, and we would be happy to see a combination of our work in this area and industry initiatives leading to fairer outcomes for consumers.

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What the Draft Statement says

In this context, I should like to turn to what the statement says.

First product providers. By product providers we mean those who offer services such as portfolio management through distributors, as well as those who develop, manage or package products such as life insurance, general insurance, or investment products or those who develop or enter as lenders into mortgages. But we are also aware that it is not always this easy to define a provider. When a distributor firm commissions a product from a second firm, for instance, is it right to say that the second firm provides the product as far as the customer is concerned? For example, if a retail Brand designs an insurance package that it asks an insurer to underwrite, does the underwriter provide the product to the customer? Clearly not if the underwriter has had no part in design, and in this instance we would say that the retail Brand is responsible for ensuring that the customer is treated fairly at the level of product design as well as at the level of distribution. The distributor takes over some of the responsibilities of the provider.

Similarly, when a provider firm supplies one of its products to be used as a component in the manufacture of another product - without involvement in the design of second product and possibly without even knowledge of it - then can we say that the firm provides a product to a customer? For example, if an investment bank sells a bond to a High Street bank, and the High Street bank later uses the bond to manufacture a structured retail product for onward retail sale, then does the investment Bank provide the product as far as the customer is concerned? Again we would say no, and in drawing a distinction between the 'pure manufacturer' of the component product and the 'retail manufacturer' of the finished retail product, we would say that it is the retail manufacturer that takes responsibility for ensuring that the customer is treated fairly. Of course the insurance underwriter and investment bank both owe the usual duties of care to the final retail providers of the product.

We note five key responsibilities for product providers.

First, providers should design products for specified target markets. They may identify consumer types for whom the product is likely to be suitable or carve out consumer types for whom the product is not likely to be suitable. The provider of an investment product could state that prospective customers of the product will have certain risk appetites, for example; in the same way that the provider of a sub-prime mortgage could state that their product is not suitable for customers who have access to cheaper prime mortgage products.

Once a target market is identified, a full product design process should involve consideration of stress-testing – to identify how the product might perform in a range of market conditions and how the customer could be affected as a result. Clearly products which have no variance in their performance (e.g. a straightforward general insurance product) need not be stress tested, and we take a similar view where product performance simply reflects, in a linear way, market movements. Stress-testing becomes more important where a product is, for example, geared or has pay-outs which are promised but not guaranteed, or when there are features which could lead to sharp variations in the product’s performance. (The provider of a UCITS III fund that uses a wider range of long and short selling techniques would need to stress-test a wider range of possible scenarios than the provider of a fund that does not use the same powers.) And, on longer-term investments, firms should consider the need to carry out further periodic stress-testing. Stress test results should cause firms to check the appropriateness of the target market - their vulnerability and financial capability.
Second, providers should give thought to the channels through which their products should be sold. For example a firm should consider whether a product should be channelled through direct sales on the internet or only through face-to-face advice from a handful of key distributors. In our view, part of the answer involves considering whether the nature of a product might mean that customers would be wise to seek advice. For example, the provider of the same UCITS III fund might think it is important for consumers to understand the differences between long-only and long-and-short strategy funds before committing to a purchase. This might lead to the conclusion that the consumer would be wise to seek advice and to the strategic decision to distribute the fund through advisers only (at least in the first instance).

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Third, providers should assess the information needs of the distributor (and, where their material is passed on, the information needs of consumers). This could include, amongst other information, details of the generic risks that the product presents and the target market. Account should be taken of the distributor’s likely level of knowledge and understanding. We do not mean that providers should take over the Training and Competence of distributor firms - only that they should ask how they might best support distributors' fair treatment of customers with information already in their possession or that is readily realisable. A firm may choose to offer a one-off-training session on the key points a customer must grasp in order to understand the nature of a complex product, for example, or may choose to share any relevant findings of research or stress-testing that might help inform distributors' own sales and advice strategies.

Fourth, providers should keep the quality of distribution under review at a high, strategic level. This could include consideration of sales volume in relation to the expected size of the target market and of whether a distribution channel remains appropriate for the product being sold. The provider should act when it has concerns, for example by ceasing to use a certain channel. Again it is important to stress what we are not suggesting that providers are responsible for what the distributor says when the distributor gives advice or makes sales (although where a provider has not supplied sufficient, appropriate and comprehensible information to a distributor, the distributor may be entitled to seek redress in the courts under the general law). Similarly, providers are not responsible for policing the actions of individual distributors. What we are saying is that providers have an obligation to monitor their distribution channels "at a high strategic level", for example, by mapping their projections for sales volumes and distribution patterns (perhaps set out in the original marketing plan) onto actual volumes and patterns achieved. Any unexpected peaks or dips should be taken as a cue for the firm to take a closer look at a particular distribution channel and to question whether the arrangement remains appropriate for the product being sold.

Fifth, providers are responsible for the fair treatment of customers after the point of sale in a number of areas including the information requirements already contained in the specific rules. For instance, firms should regularly review products (in particular the more risky products) whose performance may vary in order to ensure the product is continuing to meet the general needs of the target audience for whom it was designed or to match the performance that the provider originally projected and communicated to distributors. If the product is failing to meet these criteria (in a way that looks likely to have a material negative impact on the customer) then the provider should consider whether and how to inform the customer of this and (if necessary) of their option to seek advice. Firms should also consider communicating to customers any contractual 'breakpoints' that might apply, such as the end of a long tie-in period, that may have a material impact on a customer and that the customer cannot reasonably be expected to recall or know about already. And, of course, firms should act promptly when handling claims or when paying out on a product that has reached maturity, meeting any reasonable expectations that may have been created in the customer's mind. The same naturally applies to handling customer complaints.

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It is perfectly possible that the provider may not have direct interaction with the customer after the point of sale (e.g. if intermediation is undertaken by a wrap platform and the customer is held in an aggregate account). In such circumstances the application of the Principles will depend on the precise relationships involved, but, as a minimum, the provider should ensure that the information it provides to the distributor is rendered with due skill, care and diligence.

Turning to distributors. By 'distributor' we mean those who make up the rest of the distribution chain taking the product or service to the customer. These might be financial advisers, third party administrators, appointed representatives, banks, building societies, portals, wrap platforms, multi-ties, fund supermarkets or those who sell insurance as a secondary part of their business. Importantly, any one of these may also be one of multiple distributors acting in a chain. For example, a customer's request for boat insurance might be taken by a local insurance broker, passed to a specialist marine insurance broker and then passed on to a Lloyds broker before arriving with a Lloyd's underwriter. In such circumstances any distributor not dealing directly with a customer nevertheless should consider what information and service levels their counterparty needs in order that they may be put into a position where they can treat the customer fairly.

We note three key responsibilities for distributors.

First, distributors need to ensure that they understand information about the product given to them by the provider and, if they are not clear about that information, they need to question it and, if necessary, request clarification from the provider before deciding to distribute the product. Providers often tell us that they market their products twice - in the final instance to the retail customer, but in the first instance to prospective distributors for their product. As recipients of a first wave of marketing communication, then, distributors need to ensure that they understand sufficiently the product 'beneath' the marketing and that they are happy that this is the type of product they want to distribute. If necessary distributors should ask further questions of providers or request additional information, and they might take advantage of any of the tools that providers offer (from distributor hotlines to actual training-sessions).

Second, where the sale is advised, distributors are responsible for fully considering the customer's needs and circumstances, so that the product can be fully matched to the customer. This requirement is laid out in the detailed rules of our Handbook, and we recently published the results of work that showed that some distributors are not managing themselves in a way calculated to ensure that advice is indeed suitable.

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Third, distributors are responsible for ensuring that the post-sale service is consistent with that they led the customer to expect. A distributor's responsibility to a customer after the point of sale in many circumstances is in part determined by any contract or agreement with the customer. For example the distributor may have an arrangement to provide ongoing advice or periodic reviews of a product's performance for the customer. In order to do this the distributor should, in turn, maintain adequate systems and controls to enable it to deliver on such reviews. The distributor should also consider any implied or express representations it made (during meetings, correspondence or promotional material, for example). Where a customer has reasonable expectations based on the prior statements of a distributor, for example that a product's performance will be monitored the distributor should meet these expectations if it is to treat its customers fairly. Likewise, in handling any complaints it might receive, the distributor should meet any reasonable expectations that may have been created in the customer’s mind with regard to how the process would be handled.

Industry response

I would like to conclude with a few remarks about how the industry might respond.

We all recognise that more principles based regulation requires changes both at the FSA and at regulated firms. In essence, at working level on both sides we need to become more comfortable with regulatory material that requires interpretation and the exercise of judgement. At present, we encounter firms that over-interpret regulatory requirements – creating what they perceive to be regulatory costs where none exist. It is this tendency which I very much hope firms will avoid in reviewing and responding to what we are publishing today, and which I have tried to steer us away from in remarks on what our Statement is not intended to mean. Of course, you might well wish to point out that much though we claim otherwise, we have not expressed ourselves clearly enough in some areas. But that is rather different from immediately jumping to the conclusion that, for example, we really intend to require producers to 'police' distributors.

Conclusion

In conclusion, we continue to encourage the industry to rise to the challenge of the TCF initiative and collectively to make a step change in its treatment of customers – recognising of course that what this might require of individual firms will vary widely. Some firms are currently making good progress (with a high level of commitment from senior management) but others have more to do. Next year we hope to start seeing measurable change in outcomes for consumers. In the meantime, we hope that the material that we are publishing today will lead to a principles-based dialogue with the industry, and that it will further strengthen the ability of senior management to identify areas that they need to change.

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