Financial Promotions: Principles in Action

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Speech by Nausicaa Delfas, Head of TCF Strategy, Financial Promotions and Unfair Terms
FSA Financial Promotions Conference, London
20 June 2007

Today I will be focussing on the new financial promotions regime for investment products – which takes effect from 1 November this year – and our move to more principles based regulation: what this means for firms, and what it means for us as regulator.

The first thing I would like to emphasise is that this is not something new, but a consolidation of the direction in which we have been moving for some time: in supervising the financial promotions regime, we have been and will continue to focus on the key issue of whether a promotion is "fair, clear and not misleading", senior management responsibility and treating customers fairly (“TCF“).

Why financial promotions matter

So, first of all, why do we care so much about financial promotions?

Unlike in many markets where consumers can compare the physical attributes of a product, by seeing, holding and/or tasting it, in the world of financial services the product is less tangible.

Before purchasing, say, an MP3 player you will compare what is on offer in the shops, look at friends' models or visit a price comparison website. Equally, you will know soon enough if it does not play or function as you expected; in which case you can return it. Consumers of financial products must rely on the information presented to them by firms to work out which is the right product for them. Any problems with the product may not come to light for many years after the purchase. This is why we put so great an emphasis on promotions getting the right information across.

The clearer the advert and easier it is to understand, the more likely the next step taken by the consumer will be to be the correct step, whatever that might be - to buy; to seek more information; or to walk away.

Although firms can produce adverts which may be technically compliant, consumers soon switch off if they do not understand them. Alternatively , if consumers fail to understand fully what is being offered to them and do go on to buy, there is a risk that the products will not meet their expectations. Either way, this is not good for business as firms may face reputational damage or complaints. So, there are clear benefits to firms, consumers and to us as regulator in acting to remove this possibility.

In addition to the need to be honest and clear about what you are selling, you need to create accurate expectations about the nature of the product. Unfortunately, we are still seeing many promotions that fail to adhere to this.

For example, we recently reported on GI price savings claims in promotions which create an expectation that large savings will be available to consumers, when in reality the stipulated saving will only be available to a small percentage of those who respond. We would expect such promotions to explain prominently the qualifying criteria and the basis for the claim. By failing to do so they fail the clear, fair and not misleading requirement and create unrealistic expectations. We were very pleased to see the response from firms with deficiencies being reduced from 45% to 6% in a three-month period.

Principles-based regulation and financial promotions

I am sure you are all by now familiar with the FSA's move to principles-based regulation and our focus on outcomes. But what does this mean in practice? It means that we recognise that there is more than one way to achieve the outcome of “fair, clear and not misleading” promotions. Giving firms more flexibility – and responsibility - should lead to overall improvements in promotions.

Both the requirement for firms to communicate in a way that is fair, clear and not misleading, and the requirement to treat customers fairly, are embodied in two of our 11 Principles for business (Principles 7 and 6).

At the heart of principles-based regulation is the move away from prescriptive rules, towards senior management deciding how best to meet the outcomes we expect. Financial products and firms' target audiences are not all the same, and it is the firms themselves that are therefore in the best position to determine the content and form of information for their customers.

Principles-based regulation is not intended to be process-driven. What matters is the outcome achieved. However, if you do not achieve the desired outcome of producing fair, clear and not misleading promotions then we will want to dig deeper and find out why - I will speak more on this in a moment.

Key recurring issues

The new COBS rules are not new and reinforce many of our messages over the past few years. In fact, we have outlined in numerous communications and at conferences, our key areas of concern that come up time and again in our monitoring in all media:

Prominence of important information
- Explanation of risks and drawbacks
- Percentages and headline claims
- Use of small print
Clarity of product information (including use of jargon) for the target audience.

These issues will still be covered by the new regime for investment products and arise equally in relation to mortgage and general insurance promotions, and we will continue to address them going forward.

New regime for investment products

As reflected in the new rules published on 31 May in PS 07/6, the new regime will see the removal of many detailed and prescriptive COB rules. As was eloquently put to us by a firm recently, ‘the current rules-based approach at times limits our ability to present information to consumers in the clearest way possible’. We agree and we have taken action.

Some examples of the rules and guidance we have removed include: product specific rules (such as on SCARPs, income withdrawal, EIS, penny shares) and excess guidance (such as two pages of guidance on risk warnings for investment value fluctuations).

Investment firms will have to stand back and take a broader view of their promotions with the key focus on the overall outcome: is the promotion fair, clear and not misleading?

With less detail to follow, we expect that firms will tailor their promotions to a specific audience; taking account of the nature of the product and the means of communication. But fewer rules do not mean lower standards and we would expect to see that the new rules, combined with our approach to TCF, has a positive effect on the level of compliance after 1 November of this year.

At the heart of the rules will be a series of high level requirements which expand on the meaning of 'fair, clear and not misleading'. These are that:

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;
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. They will apply to all information communicated by a firm (including financial promotions). Whilst MiFID has not been the main driver of the financial promotions review, we were pleased that it is largely supportive of the direction of our overall policy. As a result, we have adopted many of its provisions for non-MiFID business.

Our proposals for amended rules for general insurance following our review of the Insurance: Conduct of Business Sourcebook (ICOB) will be published at the end of this month. Consistent with our principles-based approach, we are proposing the removal of the detailed rules and guidance and refocusing on a high-level rule requiring all communications to be clear, fair and not misleading.

So, going forward, high level rules will be central to our supervision of promotions. The increased flexibility will allow for a more proportionate approach, allowing firms to include in their promotion appropriate information depending on all the circumstances, considering: is the information provided sufficient and presented appropriately taking into account the target group and the purpose of the promotion?

Although we have removed much of the detailed product-focused rules, some detail will remain necessary to achieve the desired regulatory outcome, for example in past performance. Also, our ability to apply a principles-based approach will continue to be restricted in some areas, for example with regard to mortgages where the handbook is still quite prescriptive. In this area our approach will continue as now – has the firm complied with the detailed rules and, more generally, does the promotion as a whole meet our high-level TCF outcomes?

Whilst the new regime offers flexibility and firms will need to interpret and apply the high-level rules for themselves, I want to emphasize that financial promotions must be standalone compliant. By this I mean that a principles-based approach is not an opportunity to make promotions more compelling by postponing the supply of important information to later in the sales process. Risks and conditions cannot be ‘back loaded’. Within every promotion, reference to benefits should be balanced by reference to appropriate risks. One promotion cannot just discuss benefits because the risks will be fully explained later in the sales process. We expect firms to ask themselves what the key risks for the target audience are and to consider how they can be presented in a manner which will be understood.

Firms will need to determine for themselves what the differences in the new regime will mean for their financial promotions systems and controls and whether changes need to be made to them. This leads me on to consider financial promotions in the context of wider treating customers fairly responsibilities.

Financial promotions and TCF

Clear communications are a key component of how firms apply our overarching TCF objective in practice. Of the six TCF outcomes, three are directly relevant to financial promotions, and I have summarised these on the slides to reinforce how integral financial promotions are to TCF:

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; and
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.

Providing fair, clear and not misleading information to customers is a very visible means by which a firm can display adherence with the TCF principles. For us, financial promotions are therefore an important indicator of how seriously firms apply TCF in practice, and may well signpost to us deficiencies in the corporate culture or in the underlying systems and controls which could lead to poor outcomes.

TCF in financial promotions means firms standing in the shoes of their customers and judging objectively what they will take away from an advertisement. At our TCF conference last November, the delegates were asked to vote on which of the outcomes they thought would be most difficult to achieve: the clear winner was that products perform as consumers have been led to expect. Will consumers' perception of the product being offered be met by the reality of what the product does? In the words of a well-known advert - Does it do what it says on the tin? If not, then firms are not helping consumers achieve a fair deal.

Senior management responsibility

I now want to turn to firms' culture and processes for achieving "fair, clear and not misleading" promotions - responsibility here lies with senior management.

TCF is a cultural issue that we want to see embedded in the behaviour of firms towards their customers and which we expect will have real and identifiable benefits for consumers. In May this year we were pleased to report the positive progress many firms have made to meet our deadline for implementation of TCF by allocating appropriate resources and responsibilities, developing processes and creating capability.

The challenges, as we now see them are to ensure that this senior management commitment filters through the business and that the appropriate culture, systems and controls are in place to achieve improved outcomes.

We have set a further deadline for firms to have completed their work on TCF and be able to demonstrate that they are consistently treating their customers fairly by the end of December 2008.

For financial promotions, the key cultural risk in which we see problems arising is in the relationship between marketing and compliance. Is senior management satisfied that the relationship between the two is governed satisfactorily and, if so, how? Is compliance being engaged sufficiently early in the product design/marketing process? Is there consistency of approach from product design through to marketing? What is compliance telling marketing? These are some of the issues that we expect senior management not just to be asking but also to be able to answer.

In our experience, many firms still face a tug of war between marketing and compliance. It is difficult to see how marketing and product design can work effectively if TCF principles are kept in the compliance silo. Compliance expertise needs to be shared from the outset with marketing and product design.

We recently heard one firm stating that over 80% of its promotions were rejected by compliance the first time they were received from marketing. Aside from being extremely inefficient, how can a fair outcome be achieved by a firm if marketing and compliance do not communicate effectively, and pull in different directions: marketing for example focusing on preserving the integrity of the original advert and compliance inserting risk warnings to meet the perceived regulatory requirements?

Since marketing and compliance have the same goals – to attract those consumers whose needs are matched by what the product has to offer – we believe that this is a challenge all firms are capable of meeting. As part of our TCF initiative, we are developing a cultural assessment tool which looks at the key cultural factors within a business that inform whether a positive TCF outcome is achieved. The tool will point very firmly towards the importance of good leadership and excellent internal communications throughout the business.

Senior management is best placed to decide what processes and controls are most appropriate for their business. But, for the compliance function to be up to the task of responding effectively to a principles-based regime for financial promotions, compliance staff may need to understand more about the product and how it is being marketed.

When we challenge a promotion we will ask how the firm has satisfied itself that it is fair, clear and not misleading. The firm may also be asked to demonstrate why it believes that its processes will result in promotions that deliver a fair deal for consumers. The ability to stand back and objectively assess and record this will be a crucial strength of the compliance function going forward.

Management Information

You will have heard it said about principles-based regulation generally, and I will say it again, that senior management needs to make more effective and imaginative use of Management Information (MI). Indeed, in our recent TCF statement, as well as setting the December 2008 deadline for the outcomes to be achieved, we set an interim deadline. By March 2008, we expect firms to have in place sufficient MI to tell them whether or not they are meeting the TCF outcomes. In line with the principles-based approach, we are not setting a prescriptive format here – firms need to judge for themselves what they need.

But far too often the focus of attention on MI is about sales volumes resulting from particular adverts. However, it can also provide valuable data, collated from various sources, including from consumers and potentially from distributors, which could give early warning of potential deficiencies in the sales and marketing of products. It will also become an increasingly necessary tool to justify why promotions have been designed as they have. What information is relevant will be determined by the nature of the firm and its business as well as the nature of the target audience and the product. Some examples might include:

Testing the understanding of consumers and distributors of promotional material aimed at them;
Analysis of the customer profile in comparison with that expected;
Reasons behind cancellations and / or account closures or consumers not proceeding with the sale;
Root cause analysis of customer complaints;
Analysing feedback from distributors; and
Looking at the reasons why financial promotions (including those from other firms) are withdrawn, or lead to published regulatory action.

Our strategy

In terms of our own strategy, I started by saying that we will continue to move in our existing direction of travel, being risk based, outcomes focussed and proportionate.

Our risk-based and proportionate approach to financial promotions fits within our overall risk assessment framework, ARROW II. This means that we focus on areas of highest risk to consumers based on factors such as the type of product, the distribution channel, the target market and the scale of potential harm. Our assessment of risk informs our resource allocation.

Being proactive is also crucial to our objective of preventing consumer detriment and may involve swift direct intervention with firms to force the immediate amendment or withdrawal of misleading promotions. Where potential detriment may already have arisen, we ask firms to write to customers who may have been misled offering appropriate redress.

The fact is that what our financial promotions team monitors is a highly visible side of firms and as such is easily open to criticism. Indeed, a common misconception about our approach is that this means that we only look at promotions relating to high-risk products. This is not the case. Lower risk products mass marketed to the general public, may give rise to problems on a large scale if our rules are not properly implemented. However, we seek to act in a proportionate way and therefore may not tackle every breach on an individual basis. We may use thematic work, as a way of identifying common problems and communicating our concerns generally.

Our mortgage broker work is an example of how we use a combination of the regulatory tools available to us to communicate our messages to firms. Last year we specifically assessed the level of compliance with our MCOB financial promotions rules by mortgage brokers. We followed this up with firm visits and a communication on our website highlighting our concerns. A subsequent review of mortgage promotions earlier this year showed good progress by firms in the level of compliance. For example, a sample of websites showed that 48% of non-compliance was reduced to 29% following our work. We saw 90% compliance in promotions in the national press. Despite this good progress we remained concerned about the areas of non-compliance, especially given the vulnerable nature of the audience. We will therefore continue addressing our concerns both through firm specific and thematic work, and we will work closely with the OFT to ensure consistency of approach and reduce any regulatory overlap.

TCF and principles based regulation call for greater transparency, not only by firms in the way they deal with consumers, but also from us in terms of the way we supervise and communicate expectations. As I mentioned earlier, communication plays a vital role in our approach and, as always, we will continue to look at ways in which we could make our expectations more explicit and raise industry standards still further.

In addition to the need to be more transparent, principles based regulation poses other challenges for us as supervisors. We will need to identify where the boundaries are being pushed and to communicate this to firms; we will need to accept that there may be more than one way of achieving the desired outcome and be prepared to engage in open dialogue with firms about their promotions. We will also need to be aware of, and adapt our strategy to reflect, changes in the market. It is now commonly said of the industry that traditional forms of advertising such as direct mail are on the decline, and that the most significant growth area in terms of advertising budget is on-line advertising. We need to be flexible in our approach in terms of what we do and how we do it.

Collaboration with other regulators

One further key area in our overall strategy is our collaboration with other regulators. At a time when there have been a plethora of proposals and Directives coming out of Europe that impact on the way that financial services are sold and marketed, it is vital that we implement these requirements in a way that avoids overlap not only with our own rules, but also those of other regulators.

At a macro level, we ensure that as an organisation we are involved in discussions about new legislation at an early stage. This way we can seek to influence outcomes and ensure that they are articulated in a way that is consistent with our own regulatory objectives.

At a micro level, from a financial promotions point of view, we have been, for example, working closely with the OFT to identify actual and perceived overlaps between our respective regimes under the CCA and FSMA. As part of a more strategic approach we and the OFT are working together:

to assess the impact and extent of the burden of dual regulation;
to determine how our rules can be changed or clarified to reduce the regulatory burden for dual-regulated firms and to increase the clarity and fairness of mortgage advertising; and
to achieve greater co-ordination of our respective work, through, for example, joint thematic work and an alignment of messages to firms to achieve coherence and clarity of approach.

We and the OFT will regularly publish the progress of our joint work.

What we do – some figures

The supervisory approach we have adopted has, to date, been effective. To give you a flavour of what we have achieved, here are some facts and figures:

70 - the number of complaints per month to our financial promotions hotline. We also proactively monitor direct mail, TV, internet-based advertising and the press and conduct thematic work to identify whether there is a wider market issue and, if so, how serious that issue is;
300 - although we investigate many more, this is the average number of adverts a year swiftly amended or withdrawn altogether following our intervention;
12 - the number of firms we have fined since 2004 for financial promotions failings resulting in total fines exceeding £1.5m. Of course, as you may expect, there are a number of further cases currently under enforcement investigation;
20 - the percentage by which the number of promotions we have seen falling below expected standards fell in between 2004 – 2006 (52-32%);
6% - as I mentioned, the number of GI promotions which still lead on misleading price claims (where the saving is based on a very small or unrepresentative sample of the target audience) – down from 45% at end 2006;
90% – mortgage broker compliance in national press;
4000 – the number of unique downloads of our latest financial promotions bulletin.

What next?

Our main focus in the coming months will be a smooth transition to, and helping firms get to grips with, the new regime for investment firms. We will be publishing case studies, offering industry training and using speeches to reinforce our messages. And we will be working on a post implementation review to identify how the rules are working in practice.

Our proactive monitoring is and will continue to form a vital part of our work in preventing consumer detriment. In particular, we will be focusing on promotions on the internet and the risks they pose. Our efforts to raise standards in the mortgage arena will continue – especially in the sub-prime area and of newly regulated home reversion plans. Ensuring that the messages we have recently published on GI press promotions are carried across all media and all aspects of insurance promotions will also be a focus.

Concluding comments

So, in conclusion, if there was one key message to leave you with it is this: compliance with financial promotions rules is no longer about complying just with the letter of the rule. The move to more principles-based regulation means that firms will have to stand back and look at what their promotions convey as a whole. Firms should also be in a position to justify them based on outcomes – is the promotion fair, clear and not misleading: does it clearly explain the nature of the product? is it targeted at the right audience? does it raise accurate expectations? If you deliver the right outcome we will not be interested in how you got there. But, get it wrong, and we will want to dig deeper. We may want to know more about the product - what is it and who it was intended for - and what processes you have in place to ensure your promotion meets the high-level requirement? In short, if the promotion does not truly reflect the nature of the product and raises expectations that are unlikely to be met, then it is unlikely to be fair, clear and not misleading.

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