Key Themes and Developments in Financial Advertising

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Keynote speech by Nausicaa Delfas, Head of TCF Strategy, Financial Promotions and Unfair Terms
Infoline Conference "Financial Promotion of Investment Products after MiFID"
12 December 2006

Good morning. Thank you for inviting me to open your conference.

I would like to focus on three key areas:

why we continue to regard financial advertising as a priority area;
developments over the last two years – the overall improvements we have seen n the quality of advertising and certain areas of ongoing concern; and
an outline of what our move to a more principles-based approach means in practice, a short overview of the changes brought in by the revised financial promotions regime and MiFID, and our future plans.

My basic message today is this: the era of "tick box" compliance is at an end. The halving of the number of rules in the financial promotions area signals an unambiguous shift away from regulatory prescription and “tick box” compliance, towards an approach that focusses on the delivery of clear outcomes to the benefit of millions of consumers, as well business benefits to the firms which spend more than £1.5bn on financial advertising every year.

This approach is all about focussing on the key things that matter most: in this case, how to deliver fair, clear and not misleading advertising. So, for example: does an advertisement reflect what a product really is, and what it is expected to deliver? If not, then is it really fair, clear and not misleading?

Wider Context

Before gettting into my main subject, it is, of course, important to place our work on financial advertising within a wider context.

To help achieve a fair deal for consumers, we find it helpful to think in terms of the four pillars essential to delivering a more effective and efficient market in retail financial services:

helping consumers to become more capable and confident in the decisions they are required to make;
ensuring that consumers receive, and use, clear, simple and understandable information;
ensuring that firms are soundly managed, well-capitalised and that they treat their customers fairly; and
delivering a regulatory regime that is proportionate and risk-based.
Our approach to financial advertising is relevant to the delivery of all these pillars. However, the key requirement is one of the eleven principles which underpin our whole regulatory approach: Principle 7 states: ‘a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading’.

This articulates the outcome to be achieved, rather than prescribing how that outcome is to be achieved. As with any change, there is concern as to whether this is a good thing, and how this will work in practice – some see the benefits, others do not - but those capable of seeing the bigger picture will embrace the opportunities a more principles-based approach presents and use it to their competitive advantage.

Clear communication is also a key component of how firms apply in practice our overarching Treating Customers Fairly (TCF) initiative. We have set out a number of high-level outcomes for consumers to illustrate what we want to achieve and two are particularly relevant to advertising: ‘Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale’ and ‘Consumers are provided with products that perform as firms have led them to expect.' So, similar in many respects to the way in which firms handle complaints – or how fair the terms in their standard form consumer contracts are - the way in which firms handle financial advertising is an important and highly visible indicator to us of how seriously they apply TCF in practice.

Why Financial Promotions Matter

So why do we place so much store on firms getting financial advertising right? Clearly, advertising plays a highly influential role in how consumers make decisions – and I am sure you can appreciate that the consequences of misleading advertising can be painful for all concerned. Poor promotions can lead consumers to buy the wrong product, ultimately with unhappy outcomes for them and for firms.

A significant environmental factor is the low level of financial capability in the UK. An efficient retail market relies on capable and confident consumers as well as firms who treat their customers fairly. Our recent financial capability survey revealed that many consumers struggle to choose products effectively. For example, some 40% of people who own an equity individual savings account (ISA) were not aware that its value fluctuates with stock market performance, whereas 15% of people who own a cash ISA thought its value does.

Even without such a low level of financial capability, there is a clear information asymmetry between the firm and the customer – the firm knows much more about its product than the consumer: how it is priced, what its upsides and downsides are, how it has performed in the past, and its plans for the future. Through advertising, a firm wants to promote products to the market, gain market share by offering something more attractive than their competitors and attracting customers. Consumers on the other hand want to know what products are available, and gain reliable information so that they can differentiate between products and make informed choices. So, in these circumstances, it is essential that a firm’s advertising is “clear, fair and not misleading”.

And, of course, a firm's reputation comes under threat if it does not clearly represent what a product is and what it can deliver.

All these points underline why it is so important for adverts to be straightforward in communicating the nature of the product or service and the risks involved. If advertisements fail to give a clear and straightforward description of the nature of the product, how then can we expect consumers to make the right choices, and looking forward, to progress in taking greater personal responsibility for their financial decisions?

I would now like to say a few words about our proactive and risk-based regulatory approach in this area and the outcomes it is delivering for consumers.

Our Strategy

We focus on the areas of highest risk to consumers based on factors such as: the type of product, the distribution channel, the target market and scale of potential harm. So, an approach completely in keeping with our overall risk assessment framework which we call Arrow. The primary outcome we seek to deliver is a proportionate regime that protects consumers from the risk of being misled and which tackles the root causes of significant risks, not just the symptoms in the form of poor individual advertisements.

While we continue to see variations in standards across firms and across different sectors of the market, this strategy has led to overall improvements in the quality of advertising over the last two years. Significantly, this includes a marked reduction in the number of adverts posing a high risk to consumers. For example, of the 220 adverts reviewed recently by the FSA Consumer Panel, just 4 were considered high risk. In our own review of investment adverts, we found a reduction in adverts that fell below expected standards – from 52% in 2004 to 32% this year.

Our whole mindset is around being proactive and proportionate. We proactively scan promotions across all types of media – print, the internet, broadcast and so on - to focus on the areas where there is greatest risk of significant consumer detriment, often where consumers themselves have not realised the risks. This approach is vital in helping us to concentrate our finite resources in the areas that matter most and heading off harm to consumers before it crystallises. So yes, there will continue to be advertisements that do not meet the standards we expect. But, over time, we expect these instances to reduce, as indeed they have over the last two years. But we are also absolutely clear that we want to regulate in such a way as to not stifle the industry's ability to market products in an innovative and engaging way - we appreciate that consumers are inundated with enticing images from industries that they might well find more interesting than financial services, and that it is absolutely necessary to be able to advertise in such a way as to catch their attention – we know that anodyne advertisements are not the answer.

This proactivity extends to consideration of all aspects of firms' systems and controls and culture because deficient advertising is often a sign of wider problems in the way a firm is managed and controlled. Again, the imbalance in the relationship between firms and consumers means that consumers may not appreciate that they may have been misled until much later when, by that time, the product may not have met the expectations raised by the firm. That's why we think it is so important to address in a proactive way the root causes of deficiencies and to take pre-emptive action rather than relying too heavily on complaints about individual adverts.

A further critical element in our proactive approach is taking very swift action to prevent consumers being misled, often involving direct intervention with firms to force the immediate amendment or withdrawal of misleading promotions.

Over the last two years, we have investigated over 930 cases of potentially misleading advertising. Although we did not need to take action in all of these, in 60% of them adverts were swiftly amended or withdrawn altogether. Moreover, where consumers have been misled and suffered loss, firms often offer them compensation. This means that we can deliver very rapid consumer protection without needing to resort to formal enforcement action – the fact is that anything approaching a 'public censure' has to go through the formal disciplinary process which could significantly delay delivering protection. What matters here is acting fast.

In the vast majority of cases, formal enforcement action would be disproportionate. But in the more serious cases we do, of course, take such action. In the last two years, we have done so in respect of twelve firms, levying just over £1.5 million in fines.

In August this year, a friendly society was fined £55,000 for financial promotions failings including sub-standard television adverts and direct offer packs targeting older, and thus potentially more vulnerable, consumers. That case highlighted some basic lessons for firms more generally:

are you clear that you have considered the needs of your target audience?
are you clear that you provide a fair and adequate description of the risks and drawbacks of the product?
are you clear that you have described the product properly? In this case, a whole of life insurance policy was described as a funeral plan in one promotion, when it was no such thing.

Alternatively, or in addition to, enforcement, we often conduct thematic work – targeted investigations - to identify whether there is a wider market issue and, if so, how serious that issue is. We communicate our findings through our website, press releases, via our industry and consumer bulletins and by alerting relevant trade bodies as a way of communicating our expectations and driving up overall standards. We have undertaken thematic work on a range of products, such as property investments, ISAs, venture capital trusts and critical illness insurance and published the results so that all can learn from them. For those of you who have yet to see it, our August financial promotions publication - “Financial Promotions: Progress Update and Future Direction”, August 2006 - is a good place to get a feel for the outcome of this work and the lessons that can be drawn from it.

In taking this work forward, we liaise closely with the Advertising Standards Authority and we will be looking to step up our collaboration with them in the next period to see what we can learn from their approach. We will also be discussing with the industry – in which I include the advertising industry – our approach, including exploring the impact of our move to a more principles-based approach, which I will talk about in more detail later.

Getting your advertising right – key recurring issues

Now let’s drill down into the four key issues that recur in much of what we see and which can sometimes lead us to question whether firms are really applying TCF in practice – these are basic observations that we have also reflected in our February 2005 publication “Financial Promotions: Taking Stock and Moving Forward”:

senior management responsibilities and management information;
clarity of the product and target audience;
risks and drawbacks; and
percentages and headline claims.

First, senior management responsibilities and the use of Management Information (MI).

At the end of 2005 we carried out work to assess the extent to which firms’ senior management is involved in establishing systems and controls around advertising and use MI to assess their robustness.

Generally, we found firms’ senior management do not have direct involvement, although this will depend upon the size and structure of individual firms. These responsibilities tend to be delegated to other relevant members of staff, which is fair enough. But what really concerned us was that MI, if it existed at all, focused mainly on business-driven statistics, such as volumes of sales resulting from particular adverts, rather than identifying issues which could give early warning of potential deficiencies in the sales and marketing of products. Given the potential reputational impact on firms of poor promotional and sales practice, we found this particularly worrying. You wouldn't find a car manufacturer taking such a risk with a new model, so why do financial firms take such risks with their products?

But we did also identify some good practice which included:

some firms set up financial promotions fora involving senior management and including both the marketing and compliance functions; and
one firm even mailed its board members with copies of customer mailings as part of its programme to encourage senior management to interact with the firm’s advertising in the same way as its customers would.

Some of you will be aware that we recently fined an IFA £63,000 for failing properly to apportion roles and responsibilities to its senior management and for its failure to ensure that it took reasonable care to organise and manage its advertising function responsibly and effectively.

The message I want to leave you with here is this. The responsibility for meeting our standards ultimately lies with a firm's senior management and our move to a more principles-based regime will make senior management engagment more important than ever.

Second, issues around the clarity of what products do and the audience to whom they are targeted.

It is unfortunately the case that we often find ourselves reminding firms to describe their products and services in a way that is true, relevant and meaningful to the intended target audience. You should ask yourself the question, “Does the promotion describe clearly the nature of the product?” For example, we have seen a product described as a “savings bond which is safe and secure” when in reality it is stock market based and therefore any return is not guaranteed and capital not secure. Further, it is not helpful to describe products in technical terms (a) because it is unlikely to optimise the appeal of the product and (b) because of the issues around financial capability that I mentioned earlier.

So - does the advert portray, or set expectations in line with, what the product really delivers? If not, what expectations are you raising for consumers? What product do they think they are buying and for what purpose? Think about how you would describe a product to a member of your family who was interested in buying it – would you description come anywhere near the way it was portrayed in the advert? If when you step back the advert does not truly portray what the product really delivers, then it highly unlikely that it is clear, fair and not misleading.

Third, explanations of risks and drawbacks. Advertisements should include a description of the risks or drawbacks so as to provide a balanced picture of what the product or service can deliver. It is relevant to mention here that in the financial promotions review (to which I will come on to in more detail later), we are largely moving away from prescriptive risk warnings to emphasising the need for clear and understandable portrayals of a product and of what it can be expected to deliver.

We are often asked how much information on risks a firm is expected to include. We would not, of course, expect to see every possible risk detailed. We do, however, expect firms to use their judgement and common sense to identify the main issues to put upfront and to use straightforward wording which is likely to be understood by the target audience. The explanation of risks should have sufficient prominence and should not be buried in the small print or on the back page of a brochure. Believe me, people still do it.

Finally, percentages and headline claims. Plainly, unrealistic and misleading headline figures must be avoided. For example, headlines showing percentage rates that are only obtained if certain unrealistic criteria are met are just not on. I will come back to unrealistic claims in the area of general insurance in a moment.

So these are the four big areas in which we are particularly interested - getting them right will ensure that standards continue to rise to the benefit of all, not least the industry's reputation.

Areas of ongoing concern

I have already mentioned that we have seen an overall improvement in the standard of financial promotions over the last two years. But a quick word about some areas of ongoing concern.

Investment Promotions

As part of an in-depth review, we looked at advertising for children's products, pensions unlocking, structured capital-at-risk products (SCARPs), spread betting, tip sheets and venture capital trusts. We concluded that, overall, the quality is moving in the right direction. Increasingly, we are seeing:

more risk information within the main body of the promotion and;
fewer misleading headline claims.

For example, our VCT work over the past year has seen an overall improvement, particularly with intermediate websites. 90% of websites reviewed (10 out of 11) improved very quickly, some within days, after we published our concerns and contacted firms directly.

But we still have concerns about promotions with:

insufficient consideration of target audience - for example, by using jargon in advertisements aimed at the mass market;
a lack of clarity around the description of the nature of the product - for example, products marketed as ‘savings’ which are in fact equity investments; and
a lack of balance - while risk warnings are increasingly included in the main body of promotions, we still have some concerns about the clarity with which key risks and drawbacks are presented.

We conducted a review of direct mail financial promotions for investment products issued by 44 different firms, ranging from major retail firms to smaller financial advisers. We were pleased that about two thirds were clear, fair and not misleading but about one third had failings such as those I have mentioned already in other contexts: for example, a lack of balance, whereby all the benefits of the product might appear in the covering letter, but the risks and drawbacks were buried in an accompanying brochure or key features document; also, the nature target audience was not always considered.

As your interest today is in investment products, I shall cover only briefly some of the issues we have seen in insurance and mortgages, as these issues have wider application:

Insurance

An area of current key concern is in the high number of promotions failing to meet the standards required in relation to price claims – in particular, promotions which indicate or imply that a firm can: reduce the premium; provide the cheapest premium; or reduce the consumer’s costs, e.g. through price-matching or claimed savings. Our chief concern here is that people are often encouraged to think that they can benefit from such an offer when, in reality, it is only available to a few. We recently undertook some specific thematic work in this area that we shall shortly be publishing – we shall be challenging firms to consider:

Are price or savings claims made representative of those from which the target customer is likely to benefit?
Do the advertisements outline with equal prominence and sufficient clarity the basis on which the saving claims can be achieved?
And - of wider application - overall, is there a mismatch between the general impression created and the experience of the target customer?

These may sound obvious, but we are not seeing this thinking reflected in this advertising. We expect the industry to take urgent action to improve overall standards and you can expect us to be monitoring progress here very closely indeed.

Mortgages

As you may have seen recently reported, we conducted some targeted work on the promotions of sub-prime mortgage broker promotions - we consider mortgage broker promotions, and in particular those for sub-prime products, to be an area of higher risk because of the vulnerable nature of the target audience and the fact that taking out a mortgage is one of the most important transactions anyone does during their life. We continue to see too many firms which appear to be making no attempt to issue clear, fair and not misleading advertising.

We found that mortgage brokers in the sub-prime market who issued poor financial promotions usually had inadequate systems and controls overall and gave poor quality advice. In other words, poor advertising and other promotional activity is usually a sign of wider problems in the way a firm is managed and controlled

Over the past year, we have reviewed several hundred mortgage broker financial promotions, contacted over 200 of these firms to get them to withdraw or amend them, and carried out visits to the worst offenders. A number of these firms have now been referred to our Enforcement Division for further investigation.

That we are taking such action in this area is a signal of how seriously we are taking the problems I have highlighted.

Future regulatory strategy – more principles based

So, moving on to our future regulatory strategy.

As I mentioned at the beginning, we see the provision of simple and understandable information for consumers as a key element in delivering a more efficient retail market and the financial advertising regime is a key element in that equation. Our approach to making this happen is undergoing significant change as part of our move to a more principles-based regulatory regime.

Making a successful transition will prove to be a big win for everyone - firms, markets and consumers:

Firms will have greater flexibility when marketing, and scope to tailor their financial promotions more closely to the needs of the consumers to whom they are directed. Better outcomes for consumers could thus be delivered through firms’ own initiatives and actions, rather than through prescribed regulatory detail; and
A more principles-based approach challenges the FSA to keep our sights firmly fixed on addressing the big things that matter most.

However, we do, of course, acknowledge concerns about a more principles-based approach and the challenges that it poses for firms and for us.

We recognise that some firms may prefer the clarity and certainty associated with a rules-based approach. A more principles-based approach requires firms’ senior management to understand the outcomes we are trying to achieve for consumers – which in many cases ought to be shared outcomes - and to align them with their business practice. It requires firms’ compliance, legal and marketing teams to take more responsibility for delivering outcomes rather than following a pre-defined path, or a “tick box” approach. In terms of systems and controls, as I mentioned earlier, firms’ senior management should consider whether they have appropriate management information to satisfy themselves that their financial advertising is properly controlled.

From our side, it will continue to be important for us to help firms meet the principles. We will continue to use our website and publications to communicate generally on the standards we expect and highlight good practice and concerns arising from our thematic work – we understand that these have been positively received so far. The outcomes of formal enforcement action will also help here.

A more principles-based approach also requires our staff to become more experienced and confident in making good, outcome-focused judgements. Often, common sense judgement calls will be needed where there is some ambiguity in the issues at hand. In these circumstances, we recognise the importance of taking a fair and proportionate approach and for there to be grown up conversations with firms around outcomes rather than details. We are committed to helping our staff to further develop those skills.

MiFID

As we supervise financial promotions in an increasingly principles-based manner, we expect the transition to the new financial promotions regime in November 2007 to be smooth because the key outcome will remain as it is now: that communications are ‘fair, clear and not misleading’.

We have been taking on board the issues that you have raised during the consultation period - for example, we are looking at how to simplify the structure of the application provisions and at the lack of definition of "marketing communication" - and will report back in our forthcoming Policy Statement.

It might be helpful at this point to look in a little more detail at the new regime highlighting some of the differences.

The most noticeable difference is that the new rules are much shorter than the old rules. There will be a 50% reduction in the number of rules.

We have moved away from product specific detailed rules (which had mostly been introduced ex post, in response to a specific problem) to higher level rules – that way, we do not expect to have to change the regime every time a new issue comes up, or goes away.

Firms will need to satisfy the high level requirements that: all information will need to be fair, clear and not misleading; that communications will need to be accurate, and where the benefits are discussed, the promotion must also provide a fair and prominent indication of any relevant risks; it must contain sufficient information, not omitting, disguising or diminishing important facts; and it must be presented in a way likely to be understood by an average member of the audience.

This represents a significant deregulation, as we will no longer prescribe specific disclosures or actions for firms to follow - so firms will in future need to decide for themselves what information is relevant or necessary in order to comply with the high-level rules. But this will also mean that firms will have more flexibility and scope to satisfy the requirements in different ways. In terms of outcomes, none of this is really new.

We have also tried to simplify the rules by taking out jargon (e.g. specific non-real time financial promotions) and most cross references.

Past performance:

However, in some areas, we still believe that it is important to retain detailed rules, for example in the area of past performance. We do not believe that past performance provides a reliable indication of future returns and the use of past performance information in promotions will still be regulated. The rules are derived from MiFID and provide protection against some of the key areas where consumer detriment is possible (such as cherry-picking the best results and past performance being the focal point of a promotion). We have had questions about how these past performance requirements will work in practice, and we will clarify this in our forthcoming Policy Statement.

Direct offer:

We are proposing a new approach to financial promotions containing direct offers. This new approach means that the promotion does not necessarily need to contain all required disclosure about the firm and the product. This disclosure can now be made at any time in the sales process – before the promotion, in the promotion, or after it – so long as the disclosure is provided in good time before the transaction.

This gives firms flexibility to decide when is the most appropriate time for the disclosure, taking account of the product type and target audience. At the same time consumer protection is retained as consumers still receive sufficient information to make an informed decision about whether to invest.

Appropriateness test:

The appropriateness test is a new requirement derived from MiFID. It applies to certain non-advised sales (including those resulting from direct marketing) and is designed to protect consumers where they do not have the additional protections of the advised process.

At the moment we have nothing similar except for direct offer financial promotions of derivatives and warrants, where promotions may only be sent out for these products after the firm has assessed that they may be suitable for the client.

The appropriateness test requires a firm to assess that the client has the necessary knowledge and experience to understand the risks of the product before allowing the transaction. We propose to publish case studies to answer some of the more problematic questions in more depth (such as, what is a personalised communication?).

Future Financial Promotions work

And a few words on future financial promotions work.

We will continue to operate using a risk-based and more principles-based approach. In addition, we will continue our proactive surveillance of promotions and will tackle emerging risks using the full range of tools available to us. Some of the higher risk areas we will focus on include spread betting, the internet and other areas we identify through our proactive surveillance. The results of our work will be published and we will be engaging with the industry and their advisers to spread good practice.

Conclusion

I have covered a wide range of topics this morning. I very much hope that in a year's time we will be able to report on continued improvement in financial advertising and on a successful transition to more principles-based regulation, delivering real benefits to the industry and consumers.

It really does present us – the FSA, the industry, and the advertising industry - with a great opportunity to break away from the detail and focus on the big things that matter most. It is now for all of us to make the most of that opportunity.

Thank you again for the opportunity to address your conference.

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