The FSA's approach to supervising financial promotions under the New Principles-Based Requirements

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Speech by Tony Katz, Manager, Financial Promotions team
Infoline Conference
25 April 2007

Good morning. I have been asked to come and talk to you today about the FSA's approach to supervising financial promotions under the new principles-based requirements.

At the end of this conference, I hope you will walk out with two key impressions:

that there is a great deal of consistency between our current approach and the post-1 November regime; and
that the changes represent a fantastic opportunity for increased innovation and greater flexibility. An advert is no longer the words and images inserted between prescribed risk warnings. The full canvas is yours with no constraints on the creative process. So if you are setting Wordsworth to rap, you need not wander or be lonely, but can take in the beauty of the daffodils in the comfort of a hot air balloon with chilled champagne and caviar.

While I will try to avoid going into too much detail on the requirements of the new regime, in discussing the high level issues, I will also add some key practical points that are relevant to the way we supervise financial promotions.

The role of financial promotions

The logical starting point is the role of financial promotions and why we, as regulators in the UK - and indeed across the EU - place such importance on them. Some statistics from MINTeL in their recent publication "Effectiveness of financial services Marcoms - February 2007" illustrate this:

Two fifths (42%) of adults aged 18+ have sought further information after coming into contact with financial advertising;
More than a quarter (28%) have made a purchase in direct response to a finance ad.

These figures speak for themselves. Promotions can be instrumental in influencing consumers because they are one of two things:

They encourage consumers to find out more about a particular firm’s products, or
They prompt consumers to buy a product – in which case they are the main or only information on which consumers base their decisions.

It is vital, therefore, that financial promotions meet the requirements to be clear, fair and not misleading. To do this, they must provide the right level of information depending on a number of factors, but most importantly, the nature of the product and the target audience.

The very fact that the finance sector spends more money on above-the-line advertising than any other sector itself shows how highly influential it is considered to be by the industry. The opposing argument would suggest that the finance sector derives some perverse pleasure in pouring the £1.5 bn spent on advertising down the drain each year.

However, poor promotions can cause great damage. Marketers in this room may question what a regulator means by a poor promotion. Promotions which do not stimulate sales are poor, but for business the poorest ads are perhaps those that lead consumers to buy the wrong product, with unhappy outcomes for both the consumers and firms.

Part of our strategic aim as an organisation is to create capable and confident consumers as well as firms who treat their customers fairly. The area of financial promotions is an excellent example of where these two outcomes coincide. If we take as our starting point the conclusions of our finanical capability survey of last year, we can see that many consumers have less than basic levels of financial understanding and are ill-informed. Of the responses:

Many who said they did not want to take risks with their savings were in fact taking on material risks.
Others insured themselves against risks they do not face.
Over 4 million people bought their most complex product without considering any other options at all.

Can you imagine taking out a lifetime mortgage without considering the range of other options available to provide additional income?

It is this low level of financial capability in the UK that as an organisation we are seeking to address.

On the firm side, we ask how a firm can be treating its customers fairly unless its customers' expectations are fairly generated at the advertising stage?

Misleading claims and lack of clarity in promotions can also lead to unfair competition. Take, for example, a bank that uses a headline rate on a window advertisement for a savings account to entice customers through the door. Assume the poster did not make clear that the offer was conditional on the customer taking up the bank's premier current account or buying an equity-linked product. In this case, once the customer is through the door, there is more chance they will buy the product. Alternatively, if the subsequent explanation is clear, the customer is more likely to buy another of the bank’s less attractive savings accounts without researching other better deals that may be available to them elsewhere.

FSA's approach

Our whole approach is centred on being proactive and proportionate and, of course, being risk-based.

Being proactive is crucial to our objective of preventing consumer detriment and may involve swift and direct intervention with firms to force the immediate amendment or withdrawal of misleading promotions. Therefore, while complaints are important – and we receive about 70 reports per month to our financial promotions hotline - our proactive monitoring and intelligence generation is also crucial.

Our monitoring is closely aligned to the structure of the financial advertising sector and the risks each media poses. It includes direct mail, TV, internet-based advertising and the press. On average we consider 480 new press advertisements each month.

As an organisation, we also assess new or emerging financial risks which may impact on our work in financial promotions.

We assess the potential risk to consumers of any financial promotion that we consider fails to be clear, fair and not misleading and focus on the highest risk to consumers based on factors such as the type of product, the distribution channel, the target market and the scale of likely detriment to consumers. The tools we use to address risk depend on the risk/impact profile of the promotion.

Over the last two years we have investigated over 1000 cases of potentially misleading advertising. Although we did not need to take action in all of these cases, in 60% of them adverts were swiftly amended or withdrawn altogether. Of course, in certain situations further action is required and there needs to be a strong disincentive to firms to produce deficient promotions. Aside, therefore, from the costs of asking firms to withdraw advertising campaigns, firms may be required to carry out remedial action, bring in experts to prepare a report on areas of concern, or they may be the subject of enforcement action.

Since 2004, 12 firms have been fined for financial promotions failings, resulting in total fines exceeding £1.5m.

Alternatively, or in addition to individual action, where similar issues arise in a number of firms, we often conduct thematic work to identify whether there is a wider market issue and, if so, how serious that issue is. We have recently published our Major Thematic work plan. It will come as no surprise to many that our overarching thematic priority over the next year is Treating Customers Fairly. One of the three underlying key priorities is to ensure that firms are delivering fair outcomes for consumers.

Principles-based regulation and financial promotions

Probably the first point to note is that this move to principles-based regulation is not new. Our 11 principles for business have their origins in the rules of the former regulators. Principle 7 requires that a firm must pay due regard to the information needs of its clients and communicate to retail customers in a way which is clear, fair and not misleading. And, of course, Principle 6 requires firms to pay due regard to the interests of customers and treat them fairly.

However, while principles-based regulation is not new, our commitment as an organisation to a more principles-based approach is. In the area of financial promotions however, we have been moving towards this desired outcome for some time now.

Clear communications are a key component of how firms apply in practice our overarching TCF objective. Indeed, three of the six high level TCF outcomes for consumers are particularly relevant to advertising:

Outcome 2 - Products and services marketed and sold … are designed to meet the needs of identified consumer groups and are targeted accordingly;

Outcome 3 - Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale; and

Outcome 5 - Consumers are provided with products that perform as firms have led them to expect.

So, the way in which firms handle their financial advertising is an important and highly visible indicator to us of how seriously they apply TCF in practice.

What it means for firms

TCF is a cultural issue which we want to see embedded in the behaviour of firms towards their customers and which we expect will result in real and identifiable benefits for consumers. As you will be aware, we have been assessing the progress of firms with TCF against a deadline for implementation which expired at the end of March. We intend to report back on our assessment of progress in early May.

TCF in financial promotions is about customers getting information they need when they need it. This is not about leaving disclosure to later in the sales process as all financial promotions should be standalone compliant. It is about ensuring that promotions accurately reflect what the product really delivers, and avoiding the risk of raising inaccurate expectations with the consumer.

For a firm, the responsibility to produce a fair outcome for consumers (which is at the heart of our TCF message) lies with its senior management. Ensuring the commitment to TCF at all levels of the business and that appropriate systems and controls are in place is a challenge for senior management. For financial promotions, this means balancing marketing needs against regulatory outcomes and ensuring that systems and controls are in place to: govern the relationship between marketing and compliance; to ensure that firms recruit the right staff, and that training and rewards do not inhibit these objectives. This will present a challenge to compliance officers who will need to understand what the product delivers, probably by being involved in the early stages of product design and development. This will be a different emphasis than now.

We also believe that senior management can make more effective use of Management Information (MI). It is not just about sales volumes resulting from particular advertisements. It provides data, collated from various sources, including complaints and pre-sale testing, which could give early warning of potential deficiencies in the sales and marketing of products. It will become an increasingly necessary tool to justify why promotions have been designed as they have. So my message here is that Management Information matters! I recently discussed with the senior management of a large institution the type of information a firm might collate and which could well include the introduction of new skill sets. This included:

how the firm tests customers understanding and reaction to a promotion;
the information the firm has on why customers choose not to proceed with a sale after receiving advice;
the levels of persistency and why customers do not keep the investment to its term;
the mechanisms the firm has for picking up relevant comments/complaints and feeding this back into the financial promotion process;
information about the proportion of customers for whom the product is performing as it was advertised;
considering the relationship between marketing and compliance. Who do they report to and who has the last say? Is compliance viewed as the handbrake to growing the business?
are promotions being assessed on the number of enquiries which they generate? If so, what if the enquiry level is high but the ration of conversions to sales is reducing?

The financial promotions review

I have already mentioned that for some time now we have been moving towards a more outcome-focused approach to the supervision of financial promotions. One bar to this, however, has been the detailed and often inflexible COB rules. Indeed, the existing prescription and self evident guidance have not always achieved the desired outcomes. In some cases, they have resulted in too much 'tick-box' compliance. Have a read through the money section of your paper and you will see:

past performance warnings in advertisements which do not refer to the firm's performance;
some warnings that "you may not get back the amount you originally invested", even where the capital is guaranteed, or
repetitions of "the value of your investment can fall as well as rise" without any attempt to breathe new life into what the statement is trying to achieve.

With this in mind, it has been our intention to create a regime more focused on principles where, for example, the risks and drawbacks are not included in a standard rote manner, but are presented in a manner most likely to be understood by the audience. This may mean firms refreshing the wording of their risks from time to time!

On 1 November 2007, a new set of financial promotion rules will come into effect for investment business (i.e. not MCOB and ICOB). This is the result and is part of a wider review of the COB rules and the recognition that we need a rule book that acknowledges that there is more than one way to achieve a given outcome,, that is not prescriptive about process; and that allows firms to determine for themselves how best to meet their obligations to their customers.

As a result, firms will need to take a more holistic view of promotions concentrating on outcomes. With less detail to follow, firms should be able to tailor their promotions to a specific audience, taking into account the nature of the product and the means of communication. But, as I have already touched on, the counterbalance to the greater flexibility is that firms must ensure they have the appropriate systems and controls in place.

And of course, we cannot mention the new regime without mention also of MiFID. Whilst not the main driver of the review, it is largely supportive of our policy, and we have adopted many of its provisions for non-scope business.

Key proposals

The new financial promotion rules largely remove product-specific requirements and there are fewer specified disclosure messages. This means, for example, less mechanical use of the phrase "the value of your investment can fall as well as rise".

Under the new rules, the basic requirement remains that all communications must be fair clear and not misleading and the heart of the rules will be a series of high-level requirements related to this rule:

communications must be accurate and sufficient for their purpose;
they must be presented in a way that is likely to be understood by the average member of the group to whom they are directed;
where benefits are discussed, there must be a fair and prominent indication of any relevant risks, and
firms must not disguise, diminish or obscure important items, statements or warnings.

These are all key concepts that are contained within MiFID and are compatible with our approach to principles-based regulation. It is worth adding that on the whole they are not new as they reinforce many of our messages over the past few years. Where appropriate, these high-level rules are accompanied, in places, by more detailed requirements. One such area relates to past performance. We believe that past performance is of limited use to retail consumers, a view reflected in MiFID. This is an area where we have noted a market failure and the potential for consumer disadvantage; for example, the potential for cherry picking favourable information. The new regime therefore includes a series of specific rules in this area and we have also included guidance on how the information might be presented.

Responses to our consultation – some concerns

In general, respondents agreed with our proposals but they did raise a number of concerns about the way in which provisions are presented - in particular, the use of a two-chapter approach and the complexity of the application provisions. These are valid criticisms and will be addressed in the final version of the rules. Although we received a lot of helpful comment, the responses did highlight some common areas of misunderstanding of direct relevance to our supervision of financial promotions going forward.

The first relates to the requirement to present promotions in a way that is likely to be understood by the average member of the audience. There is a concern that below-average members will be disadvantaged by this rule. Contrary to a concern expressed by several respondents, we are not expecting an arithmetic approach to this. If firms are marketing to a more sophisticated group of investors, for example, they may use more sophisticated language. Conversely, a product marketed to a mainstream audience should avoid the use of technical jargon or language that is not likely to be understood.

This brings me on to our expectations on record keeping and the concern that our proposed record-keeping guidance generated. This suggested that firms should consider maintaining a record of why they are satisfied that their financial promotions comply with our rules. Firms were concerned that this seems to impose an additional regulatory burden. This is, of course, only guidance intended to help demonstrate how a principles-based regime can work. As we will make clear in our feedback statement which falls due in Q2, this guidance is similar to current guidance that suggests that firms keep the evidence supporting any material factual statement. It reflects the more principles-based nature of the new financial promotion rules. The type and amount of information to record is not specified. Firms must decide for themselves what, if any, information is relevant and we do not believe that this will necessarily result in increased compliance costs.

Finally, a key component of the new regime will be the flexibility it offers to firms which will need to interpret and apply the high-level rules for themselves. We will not specify which risk warnings to include, for example, but will ask you to include a fair and prominent description of any relevant risks where benefits are discussed. It is worth emphasizing that the removal of our prescribed risk warnings does not mean that we will no longer expect firms to include risk warnings in financial promotions. Nor does it undermine the importance of risk warnings and the need to describe the relevant risks and drawbacks the customer needs to be aware of. But we want firms to ask themselves what the key risks for the target audience are and how they can be presented in a manner which will be understood by such people.

In terms of timetable, important dates to draw to your attention are the publication at the end of May of the NEWCOB policy statement and the implementation of the new rules on 1 November. Following publication of the new rules, and before implementation of the new regime, we will look to provide further assistance to firms preparing for the new regime by updating our website generally and the case studies that appear on it. We are also holding a conference in June that will show how we see principles-based regulation and TCF working in the financial promotion space, and will look at how the rules work in practice. We will also be offering more focussed industry training later in the year.

Implications of the new regime for firms

The key outcome for financial promotions - that they must be clear, fair and not misleading - has not changed. However, while many aspects of new regime will be familiar, some are new. Firms cannot assume that if they comply with the current rules they will automatically comply with the new. Also, the tick-box approach is unlikely to achieve the desired outcomes. But without the security of the detailed rules to guide them firms, more specifically senior management, must in future take more responsibility for the content of their financial promotions. Firms will have to determine what is appropriate for their products and customers. Firms must put themselves in the shoes of their customers. Since consumers respond to advertising in different ways – to seek more information or to buy - firms should focus on the desired outcomes when designing their financial promotions and consider who they are promoting to and what response they expect to their promotions.

The benefits are not just for consumers (in the form of higher standards), but also for firms. The new high level rules will allow more flexibility within promotions, allowing them to be more tailored and for more innovation within them.

However, whilst the removal of detailed rules creates opportunities for firms it also presents challenges many of which are challenges generally of principles-based regulation and which I have already discussed:

I cannot overstate the need for senior management to engage. In particular, firms’ systems and processes must be capable of delivering a financial promotions regime that does not dictate the process for creating financial promotions.
MI will be a vital and can be effectively used for financial promotions.
Research will also be a valuable tool to explain the rationale behind campaigns; in particular relating to the identity of target markets, their levels of financial understanding which might help you justify choice of media, use of risk warnings etc.

Finally, the challenge of integrating TCF into the firm so that senior management aspirations are transcribed into the delivery of fair outcomes at the coal-face.

FSA's approach and the challenges ahead

To some extent we have already gone a long way to change our behaviour and supervise in a principles-based way and we are seeing successes. Indeed, the number of investments we have seen falling below expected standards fell from 52% in 2004 to 32% in 2006. It will be interesting to see if this changes post 1 November. We have also seen considerable progress in the areas of our thematic work in the mortgage and general insurance sectors.

Critics have suggested that it will be impossible to enforce under principle-based regulation generally but we think that financial promotions is in fact a good area to show where it can work. Whilst cases turn on their individual facts, Principles have always played a part. Looking at our interventions, it is illuminating to see that it is the same concerns that keep cropping up – failure to be clear fair and not misleading, a failure to present a fair and adequate description of the nature of the product/service, the commitment required and the risks involved. All of which are encapsulated in the higher level rules we will have from November.

We recognise though that there will be challenges for us too. We must be prepared for more challenging discussions with senior management in compliance and marketing about delivering real world outcomes, and we must be prepared to accept that there may not be just one answer, and to accept different approaches. We will also need to be prepared to recognise and respond to changes in the market.

Part of our approach will be to identify what more we can do to help. We will maintain and update as necessary our proactive communications which includes dedicated web pages and financial promotions bulletins. We will continue to speak at conferences and events, and to report in press releases and on our website the outcomes of thematic work and financial promotions casework that will help firms cope with the high-level rules. We also propose to offer bespoke industry training on the new rules.

Some ongoing concerns

Briefly, I want to mention the three key areas that crop up time and again in our monitoring and which we will continue to monitor under the new regime:

Clarity of product and target audience;
Explanations of risks and drawbacks; and
Percentages and headline claims.

Clarity of product and target audience – As I have already mentioned, is the information and its presentation appropriate for the target audience? Our work on VCTs which we reported on in December highlights our concerns in this area. By way of example, before buying shares in a VCT a customer would need to understand the limited secondary market for VCTs and if a VCT does not meet the full subscription offer, it may be difficult to achieve a spread of investments and diversity causing it to be a higher risk product.

Explanations of risks and drawbacks - We expect firms to be assessing the key risks for consumers. As we have seen by our work on SIPPS, Home Reversion Plans and VCTs, in certain risk areas we may assess ourselves what we think may be the key risks for consumers, but it is for firms to decide on the risks and present them in a way that will be best understood by its customers.

Percentages and headline claims - I have already mentioned misleading headline rates aimed at drawing in customers which do not explain that they are conditional on part of the money being invested in a different product which offers a lower rate. This was also the key concern in relation to our work on genral insurance adverts where we found that the overall impression of the promotions did not match the savings likely to be achieved by consumers responding.

Conclusion and key messages

So what key messages do I want you to take away with you about principles-based regulation and financial promotions going forward?

Firstly, there is a consistency between our current and post 1 November 2007 financial promotion regimes in terms of the high level rules and our continuing supervision of principle based requirements. We see this as more of a step-change.

Secondly, firms cannot afford to be complacent. Senior management in particular should be questioning what changes need to be made to their internal systems and controls to embed the TCF messages in their financial promotion processes to achieve the desired outcome of fair, clear and not misleading communications.

Thirdly, firms will have to look at their financial promotions holistically and justify them based on outcomes – is it the right outcome for the consumer? Ultimately, what will consumers take away from the promotion? Firms will not be able to rely on full disclosure at point of sale as an excuse for deficient promotions. This is not what principles-based regulation in relation to financial promotions is about! Every promotion should be standalone compliant – whether it is will depend on all the circumstances of the promotion including nature of the product and who it is directed at.

Fourthly, we will be looking to see that firms comply with the spirit of the rule not just the letter and that in doing so they create expectations that are going to be met.

The changes ahead constitute a fantastic opportunity for firms to break free from the shackles of the existing rules and to produce promotions which firms, consumers and, indeed, the regulator will admire – promotions which generate fair expectations and which allow consumers to consider which products meet their needs.

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