Treating Customers Fairly - Progress and Next Steps
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Speech by Sarah Wilson, Director Retail Firms Division, FSA
Freshfields Bruckhaus Deringer: TCF Seminar
19 March, 2007
I plan in my remarks to cover five areas. First, a very brief reminder of the case for a Treating Customers Fairly initiative. Second, to note the outcomes that we are looking for. Third, some comments with reference to the initiative on our experience of putting principle based regulation into practice. Fourth, I will come to the March deadline, and finally, the next steps as we see them.
At its baldest, the case for a Treating Customers Fairly initiative remains extremely clear to us. Despite the existence of an FSA Principle (or rule) requiring firms to pay due regard to the interests of customers and treat them fairly, retail customers in UK financial markets are repeatedly not treated in this fashion. We entirely acknowledge that some firms behave well, and that few firms deliberately set out in the Boardroom to treat customers poorly. However, our supervisory work repeatedly uncovers problems on a scale that warrants serious thought and a determination on our part to deliver change.
You will all be familiar with the range of past mis-selling episodes in the UK - personal pensions, mortgage endowments, split capital investment trusts and ‘precipice bonds’. Some of these are of course rather historic. However recent work does not give us confidence that much has yet improved – we found last year that firms’ controls over investment advice quality were poor in half of cases, and (more recently) that their controls over mortgage advice quality were poor in two thirds of cases. We also continue to find that product features and risks are poorly disclosed to consumers – most recently, work on the quality of investment business post sale communications (as yet unpublished). We also published a report in January pointing to inadequacies in general insurance advertising. In the past twelve months, we have issied financial penalties in fifteen cases involving a breach of Principle 6. We have recently fined nine firms for poor sales practices in respect of payment protection insurance, six of which were in breach of Principle 6. And, last year, a stockbroker has was fined for using unacceptable sales practices and failing to treat its customers fairly when selling shares to private customers.
Faced with this position, we concluded that a ‘step change’ was needed in the behaviour of firms. And we concluded also that it was wise for us to rethink our own approach (one of writing rules to address emerging or crystallised specific risks), and find a new way of engaging senior management attention.
Senior Management responsibility
It is worth stressing in passing the focus on senior management. Of course, it is generally true that we place great store by senior management responsibility in our regulatory approach. In this particular context, we saw an additional reason to do this – we found that many of the retail market problems we encountered reflected a lack of joined up thinking within and across businesses. So, for example, product designers failed to work closely with marketing departments; those creating product information failed to liaise with those responsible for product sales; and the claims department failed to pass what it learned back to those who designed the product in the first place. It is of course the responsibility of senior management to take that 'holistic' or 'cultural' view and to ensure that the firm's systems and controls support a 'joined up' approach.
And as you well know we chose to engage the attention of senior management by taking a principle based approach. Specifically, we developed the notion of a ‘product life-cycle’ to assist their thinking; and 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 consumers – 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. We have not produced new rules.
Consumer outcomes
Principle based regulation requires of course an understanding of the outcomes you are trying to achieve. We took the product life-cycle as the starting point for the six consumer outcomes that we have now developed. Before this audience in particular jumps to point this out, I should emphasise that we know that these outcomes are not themselves FSA rules. They are instead a description of the characteristics that we think a retail market will have if customers are to be treated fairly. Conversely they are a signal that we would expect a firm that does not achieve these outcomes to be less likely to be treating its customers fairly and more likely to be allowing potential or actual consumer detriment to persist. And in several cases they are in fact a high level summary of existing Principles or rules which need to be complied with in their own right. They are designed above all to assist firms in understanding what fair treatment is all about.
The first of our six outcomes is that consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture.
As I have already commented, Treating Customers Fairly is a cultural issue and needs to be driven from the top. So we look to senior management to lead the process and to ensure that high-level commitment to TCF translates to good outcomes for consumers 'at the coalface'. We have found that weaknesses in a firm's corporate culture can lead to poor quality outcomes for consumers. For example, firms with poor training and competence arrangements tend to offer poorer quality of advice. And if a firm relies heavily on rewards driven by sales-based commissions then this may – without adequate controls – lead to mis-selling. We are currently developing and piloting a framework to help us and firms to consider whether the various elements of a firm's corporate culture (including leadership, controls, internal communications, training and competence, and reward) are geared towards treating customers fairly.
Secondly we want to see products and services marketed and sold in the retail market that are designed to meet the needs of identified consumer groups and are targeted accordingly. We have seen cases in the past of high risk investment products, which should have been designed for sophisticated customers with a high appetite for risk, being targeted at customers who had a low appetite for risk. For example, split capital investment trusts and precipice bonds. We believe that the fair treatment of consumers requires firms to ensure that this does not happen.
Our third consumer outcome is that consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale.
We expect all financial promotions to be clear, fair and not misleading both in the lead up to the sale and after the point of sale. Post sale disclosure can also be important to ensure that consumers are kept abreast for example of product performance and opportunities to act at certain points in the product life-cycle.
Our fourth outcome deals with advice and requires that, where consumers receive advice, the advice is suitable and reflect their needs, priorities and circumstances. I have already noted our particular concerns in this area.
The fifth outcome is that 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.
We want firms to be clear about what product or service is being provided and the range of possible results and experience for the consumer. We entirely acknowledge that consumers can be fairly treated even if the product they purchase performs poorly, but there can be fairness issues where the consumer is misled about possible performance or is led to expect a different standard of service to what is received.
Finally, the sixth outcome is that consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
We expect over the next few years to make periodic assessments of how far the industry has travelled in terms of delivering on these outcomes and our assessment will influence the future programme of TCF work.
More-principles-based regulation
So what of putting this into practice?
My first observation here is that, while the senior management in many firms support a more principle based approach, those engaged in thinking through the implications of Treating Customers Fairly in practice often ask for more detail. We do understand that a fundamental requirement for the application of a principle is predictability. In order for consequences legitimately to be attached to the breach of a Principle, it must be possible to predict, at the time of the action concerned, whether or not it would be in breach of the Principle. Consequently we recognise that more principles based regulation may require a greater readiness on our part to issue explanatory material that assists firms in understanding where they stand. (I should add in passing that this is not however about publishing a ‘minimum standard’ – something that some trade associations, in particular, have asked us for. The minimum standard is clear – it is the Principle; our objective is to help all parties explore what this means in practice.)
In the context of TCF, we have experimented with a range of means of promoting discussion. In particular we have issued a range of case studies setting out hypothetical situations and so-called ‘cluster reports’ giving examples of good and poor practice encountered by supervisors. And in order to check their general relevance and accuracy, these are always reviewed and debated before publication by our TCF Consultative Group.
In our experience, senior management and other staff in firms have found such material thought provoking at times and certainly useful. If anything we are asked to produce more material than we wish to, and to consider more marginal or complex situations than we typically choose. It is important to stress here (as we do in the material itself) that these case studies and cluster reports are not issued as general guidance, and do not impose additional requirements on firms and authorised persons. Instead, they are designed to facilitate the taking of principle based judgements by senior management – specifically in this case, judgements about what constitutes treating customers fairly.
Beyond the various case studies and cluster reports, we have also recently experimented further by setting out for comment in a Discussion Paper our interpretation of the Principles in a particular area – that is the responsibilities of product providers and distributors in delivering fair outcomes for customers. We chose this approach because, whereas the product life-cycle concept had been found to be useful and uncontroversial when applied to individual firms, there was much doubt in firms’ minds about circumstances where that lifecycle occurred across several legal entities, and a widespread request for further clarity. Moreover, given the very wide range of market structures (some rapidly evolving – such as, for example, the creation of WRAPS), neither we nor the industry thought that this particular uncertainty would be resolved simply through publication of case studies. Instead, there was desire for some overarching commentary to provide a context in which specific structures could be considered. We are currently considering the responses to the Discussion Paper – both on the substance and on the form and status of the material - and will respond in due course.
Finally on types of explanatory material, you will be aware that we also see appropriately formulated industry codes and guidance as a means to help firms understand how to comply with our high level principles. Our Discussion Paper on this subject set out plans to encourage this.
The growth of material outside the FSA Handbook has led to concerns about accessibility and transparency. Notwithstanding my comments about the status of much of this material, we acknowledge this issue. We will do further work this year to improve the way we organise our TCF website and other materials so that they are easy for firms – including smaller firms – to access and understand. Equally of course it is important that FSA staff have access to information on precedents set with individual firms in the course of more principle based regulation – and we are investing in our knowledge management systems to ensure that this will be the case.
Supervision
Treating customers fairly continues to be a supervisory priority. A firm’s progress is considered as part of the Arrow risk assessment for relationship-managed firms. We currently often find a mismatch between senior management aspirations and the interaction with consumers ‘at the coalface’. That mismatch is sometimes evident from the Arrow work itself – if we have chosen to complement conversations with senior management with more detailed sampling of consumer interactions for example. But our targeted work on risks in particular sectors or products – what we call 'thematic work' – is more usually the means by which we establish what is happening to individual transactions and whether there is real progress in meeting the consumer outcomes described earlier.
And enforcement? We have consistently said that we are less likely to take enforcement action where a firm has considered the implications of TCF for its business, where senior management have played the role we expect of them in relation to TCF; where a firm has made a genuine attempt to deliver on what TCF means for it; and where there has not been significant actual – or risk of – consumer detriment. Conversely, we are more likely to take enforcement action in cases where a firm has not responded to indications that there are problems, has failed to identify shortcomings and to develop a strategy or action plan to deal with them, where there has been a serious breach of Principle 6 or other relevant principles, or where there has been significant actual or potential consumer detriment.
We have also made clear that we expect senior management to take responsibility for ensuring that their firms treat their customers fairly, including identifying risks, having appropriate systems and controls in place to mitigate these risks, and ensuring these are effective. Where we detect a breach which requires enforcement action we will consider taking action against individuals within the firm if we consider that senior management have failed in their responsibilities.
Progress of firms
Turning then to the March deadline.
What is this measuring? To achieve the change in behaviour needed, we challenged firms to take a fresh look at what treating customers fairly really means, to identify the gaps as against their current practices, and (where such gaps were found) to draw up and to implement plans – proportionate to business size and complexity – to address them. We have further argued that, in order to understand whether they have achieved what they set out to do, senior management in firms should in future receive management information that enables them to assess their performance against the TCF principle (which is likely to involve performance as against some if not all of the six outcomes noted earlier).
In Spring 2006 we asked firms to tell us how far their work had progressed in their own view. The results from the survey of 143 firms indicated that 80% of large firms/groups and 51% of medium-sized firms considered themselves to be in the process of implementing change.
To stimulate action in firms that were so far being slow to appreciate the significance of TCF, we introduced a deadline. We said that all firms should be at least in the ‘implementing’ phase of their TCF work in a substantial part of their business by the end of March 2007. Clearly, the March deadline is not a rule. It is a helpful supervisory tool to maintain focus and momentum. In a similar way, we normally set dates for the completion of any follow-up actions arising in the course of risk assessments for individual firms, known as risk mitigation plans. Equally, given the extent of prior discussion on the importance we attach to firms actually treating their customers fairly, we do not consider it to be anything other than entirely reasonable to expect all firms by the end of this month to be well on the way to implementing changes that they have decided for themselves they need to implement in order to comply with the FSA Principles.
Over the last few months we have been undertaking our own assessment of whether firms are on track to meet the deadline. For larger (relationship managed) firms we are making an assessment of each firm. This review takes account of all relevant information available to us including that obtained in the course of usual supervisory contact (e.g ARROW or thematic visits) and from specific TCF visits to look at TCF related issues.
For small firms we are conducting a major qualitative survey of a statistically significant sample of 700 firms coupled with visits to look in more detail at some specific issues.
Taken together these activities will allow us to form a view as to approximately what proportion of firms are meeting the deadline. It will also allow us to target our resources to those areas where progress is not as swift as we expect.
Finally then our next steps. And I think I can usefully split that between firms that miss the deadline (in our view) and those that have progressed more quickly.
The population of firms that miss the deadline includes those where the senior management is taking least seriously the need to take action to comply with our Principles. We will develop a bespoke strategy for each such firm (or population of firms if they have general or sectoral characteristics). There are a range of supervisory tools that we can consider – including the creation of risk mitigation programmes that place relatively little reliance on senior management action, and the use of skilled persons.
Given the enforcement criteria I have already mentioned, it will also in our view be right that we consider the case for a referral to enforcement in all such cases. It is important to stress that, if we proceed with a referral, it will be on the basis of alleged actual or potential consumer detriment – not failure to meet the deadline per se.
We anticipate that there will be a substantial number of firms at the other end of the scale who are making good progress with their work on TCF. For these firms, we will focus on encouraging them to complete implementation work and embed change. After all, even they are only as yet saying that they are implementing a plan to comply with a Principle. We have consistently said that we understand that delivering cultural change is challenging and may take some time. We expect firms to recognise that the process of embedding change is a continuous one which requires sustained leadership from senior management. It will also require the production and use of targeted, intelligent management information to enable firms to satisfy themselves – and us – that their efforts are translating to improved outcomes for their customers. Because at the end of the day, this project is not about process at all – it is about finding the best way to stimulate senior management to improve outcomes for consumers.