Principles-based regulation and treating customers fairly
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Speech by Nausicaa Delfas, Head of Department, Treating Customers Fairly
and Sarah Harding, Manager, Treating Customer's Fairly
National Australia Bank
11 July 2007
I have been invited to talk about the FSA's Treating Customers Fairly initiative. TCF is central to the delivery of our retail regulatory agenda as well as being a key part of our move to principles-based regulation. I will speak to you today about: our TCF journey so far; the types of poor consumer outcomes we are still seeing, but hope to eradicate; our approach to enforcement action; and, what we have planned for the next phase of the TCF initiative.
However, for the benefit of those of you on the other side of the world, I will begin by telling you about the FSA, our statutory objectives and our eleven Principles for Businesses. And I will also explain our ground-breaking move towards a more principles-based approach to regulation.
What is the FSA and what is its purpose?
We are the main statutory regulator for the UK financial services industry. We were established by an Act of Parliament in 2000 and formally gained our powers on 1 December 2001. The FSA is governed by a Board comprising the chairman, chief executive, three managing directors and ten non-executives, from industry, consumer and other backgrounds, all representing the public interest.
We regulate some 29,000 firms – these include EEA firms passporting into the UK, ranging from global investment banks to very small businesses, and around 165,000 individuals. This industry contributes 6.8% of UK GDP and employs 1.1 million people, providing products and services to millions of consumers.
We were given four specific, and equal, objectives by Parliament. These are: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
In our day-to-day operations, we aim to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve our own business capability and effectiveness. In practice, this means that we want to make markets work effectively to deliver benefits to firms and consumers.
In the retail market we believe there are 4 elements to this:
First, consumers are capable and confident. We are working to achieve this with our Financial Capability programme.
Second, firms and ourselves are putting out simple and understandable information for, and used by, consumers.
Third, an effective market requires that there are well-managed and adequately capitalised firms that treat their customers fairly – and it is this final point which I am here to talk about.
Fourth, our regulation is both risk-based and proportionate.
So our treating customers fairly initiative is a key part of our four-pronged strategy to deliver a more effective retail market.
There are eleven high-level Principles for Businesses for firms that have been in place in their current form since 2001 and they have their origins further back in the rules of the former regulators. These Principles provide the backbone of the FSA's regulatory regime.
The Principles express what the FSA and firms should be trying to achieve in broad terms rather than detailed rules. They focus on where we want to be rather than how we get there. By setting out what action and behaviours we expect, firms can decide how best to achieve them
The principles are:
- Integrity. A firm must conduct its business with integrity.
- Skill, care and diligence. A firm must conduct its business with due skill, care and diligence.
- Management and control. A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.
- Financial prudence. A firm must maintain adequate financial resources.
- Market conduct. A firm must observe proper standards of market conduct.
- Customers’ interests. A firm must pay due regard to the interests of its customers and treat them fairly.
- Communications with customers. A firm must pay due regard to the information needs of its customers, and communicate information to them in a way which is clear, fair and not misleading.
- Conflicts of interest. A firm must manage conflicts of interest fairly, both between itself and its customers and between one customer and another.
- Customers: relationships of trust. A firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment.
- Customers’ assets. A firm must arrange adequate protection for customers’ assets when it is responsible for them.
- Relations with regulators. A firm must deal with its regulators in an open and cooperative way, and must tell the FSA promptly anything relating to the firm of which the FSA would reasonably expect prompt notice.
So, why are we moving to a more principles-based approach to regulation? There are two main reasons for this.
First, we want a stronger focus on the outcomes that really matter – better outcomes for consumers, for investors and for markets; and therefore better outcomes against our four statutory objectives. It is important to stress here that we are not changing our Principles and other high level requirements – the move to a more principles-based approach is absolutely not about any lowering of the standards we are seeking to achieve.
Second, a more principles-based approach should deliver these outcomes more effectively, in particular by emphasising the responsibility of the senior management of firms to engage with the Principles and to ensure that their firms deliver outcomes that meet these high level requirements.
Detailed rules clearly have limitations. They have not always delivered the outcomes they were supposed to achieve. First, some firms do not follow all of these detailed rules. Second, detailed rules cannot cover all circumstances and eventualities. We cannot hope to devise a set of detailed rules to cover all types of business and all types of firm; and we cannot expect detailed rules to be responsive to market innovations and structural changes. Third, detailed rules tend to address processes, not outcomes. This can encourage a narrow approach to compliance. Fourth, regulators are too often drawn into tackling problems by shutting the stable door after the horse has bolted – writing yet more detailed rules to address yesterday's problems. And finally, detailed rules can inhibit innovation and competition.
Detailed rules have not been successful in preventing major mis-selling episodes in the UK such as personal pensions, mortgage endowments, split capital investment trusts and ‘precipice bonds’. We have consistently seen examples of firms giving poor quality advice, selling complex, opaque products to consumers without fully identifying or explaining the associated risks; and providing unclear product information.
In the course of our work in the retail market we consistently found that while firms may be complying with the detail of the rules, they can be involved in practices which were less than fair to their customers. We therefore decided to focus on the principle, to highlight the areas where customers were vulnerable to unfair treatment and to encourage firms to really challenge their operations and processes and ensure that they do treat their customers fairly.
For example, our ongoing investigation into the sale of Payment Protection Insurance (PPI) remains a major piece of work and we are determined to see better practice in PPI sales. It builds on earlier phases of thematic work in 2005 and 2006.
It’s a great example of testing ‘at the coalface’ to make sure firms are doing what they say they’re doing. We have successfully used mystery shopping and we’ll continue to do so. As part of our latest phase of work we’ve planned an extensive programme of both follow-up work with firms whose practices were earlier identified as deficient and visits to a sample of firms not previously visited.
It has been a high profile piece of work which has received a lot of media attention. By the end of June the FSA visited over 200 PPI firms in two years. Around 10 firms have so far been referred to enforcement, with the outcomes published in relation to six of these. The FSA will continue to take disciplinary action against firms that fail to meet appropriate standards.
As part of this drive, we’re also working with other regulators and industry representatives to get them to work with their members to improve standards. There is clearly a long way to go before customers are really being treated fairly in this area.
We have seen other widespread examples recently of poor TCF outcomes for consumers. Only a couple of months ago we told firms that they must improve the standards of cold calling when selling general insurance over the telephone to ensure they are treating their customers fairly. In a review of 43 firms we found the standard of sales was poor when insurance policies, such as personal accident insurance, health cash plans and accident and sickness insurance, were sold through cold calling. The main weaknesses were found in training programmes, supervision of staff and a lack of management information other than for sales and call volumes.
I could give many more examples, such as unfair increases in Mortgage Exit Admin Fees (MEAFs) - where consumers are being charged higher exit fees than they had expected to pay - and general insurance firms using misleading 'savings claims' in their financial promotions; just two recent pieces of work which have kept staff within my team busy over the past few months .
Treating Customers Fairly (Sarah Harding)
Turning specifically about the Treating Customers Fairly initiative. This is a key element of our strategy to make retail markets work more effectively and thus to deliver benefits to consumers.
As Nausicaa has mentioned, the requirement that firms treat their customers fairly is enshrined in the sixth of our Principles, which states that “A firm must pay due regard to the interests of its customers and treat them fairly.”
Our work in the retail market has consistently found that some firms do not treat their customers fairly. To address this, and given the limitations of detailed rules, we decided four years ago to focus more on the Principle itself; to highlight the areas where customers were vulnerable to unfair treatment; to encourage firms to challenge themselves to ensure that they do treat their customers fairly; and to stress the responsibility of the senior management of firms to deliver this.
We therefore challenged firms to identify any shortfalls against meeting our high level requirements in this area; to draw up and to implement plans to address any shortfalls; to embed the necessary changes throughout their business; and to measure the outcomes. Where firms are already delivering fair treatment then there is no need to change.
Our overall goal is to ensure that all firms treat their customers fairly in all parts of their business and throughout what we call the “product life-cycle” – product design, marketing and promotion, sales and advice, after sales information, and complaints handling. We want to see a real and measurable change in the behaviour of firms towards their customers. And this in turn should lead to real and identifiable benefits for consumers.
There are many misconceptions about what treating customers fairly does, and does not, mean. So let me put the record straight on some of these.
It is not about requiring firms to design or market products specifically for individual customers. We are not, and do not want to be, a product or price regulator.
Treating customers fairly is not about requiring all firms to match 'best practice', or requiring all firms to follow the same, bureaucratic processes.
And treating customers fairly does not mean that customers are exempt from taking decisions or responsibility for their decisions.
Rather than defining detailed rules to explain what the Treating Customers Fairly principle means, we have produced six consumer outcomes which explain what we are trying to achieve through the Treating Customers Fairly initiative and the behaviours we wish to see exhibited by firms.
Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture.
Treating Customers Fairly is a cultural issue and needs to be driven from the top. So we continue to look to senior management to lead the process. 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 deliver TCF. I will say more on this in a moment.
Our next five outcomes all relate to different stages of the "product life-cycle".
Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly.
Products and services need to be designed with the intended market in mind and marketed appropriately. We have seen cases in the past of high risk investment products, which should only be sold to sophisticated customers with a high appetite for risk, being sold to customers who had a low appetite for risk. We expect firms to take action to ensure that products are sold only to the customers for whom they are appropriate. How firms manage their relationships with other firms is a key issue here. In today’s retail marketplace, products can be sold through complex supply chains involving a number of firms, any one of which can have an impact on the end retail customer whether they have a direct relationship with that customer or not. That is why we have been clarifying what we see as the respective responsibilities of providers and distributors in delivering the fair treatment of customers. We will be publishing a feedback statement shortly.
Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale.
Before and at the point of sale we expect all financial promotions and other information to be clear, fair and not misleading. Post sale disclosure can also be important to ensure that consumers are kept informed of product performance and of opportunities to act when circumstances change.
Where consumers receive advice, the advice is suitable and takes account of their circumstances.
We continue to find too many cases where customers are sold products that do not meet their needs.
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. 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.
Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
Post-sale barriers can be cultural, contractual or competitive. The consumer ought to be able to switch providers without incurring excessive penalty. Similarly firms should not make it unnecessarily difficult for consumers to make claims or make a complaint.
A more principles-based and outcome-focused approach should encourage senior management to focus more on the Principles and the outcomes we want them to deliver; and should enable these outcomes to be delivered more effectively. Many firms have already invested substantially in changing the way they conduct their business to ensure that they are meeting the requirements in FSA Principle 6. We have worked with the industry on TCF since 2004, and have encouraged firms to use a structured approach to reviewing their business and introducing change.
First firms need to be aware that they need to look at their performance in this area. Secondly they go through the strategy & planning phase – determining their approach and planning how they will take it forward.
We then move into the delivery of TCF during the implementing phase. The implementing phase could be very lengthy depending on the size of the firms, what it needs to do, the approach it is taking and the resource being directed to it. Equally, it could be relatively short for a smaller firm offering simple products.
Finally we have the embedding phase. We do see TCF as a continuous process. It is not a project that firms can just deliver and put to one side. We are looking at TCF becoming an underlying principle of how firms do business. So we will only consider firms to be embedding when we see evidence that they are conducting reinforcement exercise through evaluation of, and modification to, existing TCF practices. Even when a firm is embedding TCF the risk that customers might not be treated fairly will continue as new products, practices and processes emerge over time. So, this should not be seen as just a project but should be integrated into a firm's culture.
In July last year, we set a target for the minority of firms that were lagging behind the rest of the industry. We said that we expect all firms to have reached the 'implementing' stage of their Treating Customers Fairly work in a substantial part of their business by the end of March 2007.
This was the first time we have carried out an industry-wide measurement of progress against the phases of TCF. Previous assessments were based on firms’ self reporting.
For larger (relationship managed) firms engaged in retail markets we looked at each firm individually. We considered all relevant information available to us at that time, including information from usual supervisory contact (e.g. ARROW risk assessment or thematic visits on specific subjects). And, in some cases, we included the results of specific visits we made to look at particular TCF-related issues.
The following number of firms successfully met the March 2007 deadline:
- 37 major retail groups (93%);
- 379 (of a sample of 436) medium-sized firms (87%);
- 49 (of a sample of 66) wholesale firms where TCF is materially relevant (74%); and
- 273 (of a sample of 659) directly authorised small firms (41%)
Overall an encouraging number of firms successfully met the March 2007 deadline. We concluded that imposing the deadline had helped to focus firms’ efforts on TCF and to generate momentum within the industry as a whole. In particular larger and medium-sized firms have made good progress with their TCF work. Senior management in these firms remain committed to making progress with TCF and to making the principles-based approach work.
Given that TCF has been a priority for some time, we are disappointed that a sizeable number of firms failed to meet our March deadline. We can place limited reliance on senior management in these firms, and will intensify our supervisory focus accordingly (including through use of enforcement where warranted).
We have assessed performance against the deadline by looking at the progress firms have made with their TCF initiatives rather than whether they are delivering fair outcomes in all cases for their customers. In some cases, a firm may have failed to meet the deadline, but this does not automatically mean that the firm is not treating its customers fairly. Equally, a firm that has met the deadline may still have a substantial programme of work to complete.
However, the deadline helped us to identify those firms which had fallen behind and why; whether they were failing to engage with TCF, had made poor quality progress or simply were taking too long to implement TCF in a substantial part of their business. We have begun follow-up with these firms, including visiting those firms who have made the least (or 'worst') progress. We will continue to test whether these firms have made sufficient progress and will apply remedial action, including enforcement, where progress has not been made.
We all need to be confident that we are making progress. How can we, and firms, demonstrate that this initiative is making a real difference to consumers and how do we expect firms to measure progress towards the outcomes we have set?
We are developing a framework within which we will set out how we will measure progress towards each of the six consumer outcomes industry wide. We will use a range of data sources, including our day-to-day supervisory and thematic work; information from our work on complaints and financial promotions; our consumer research, including mystery shopping; our financial capability baseline survey; industry data on sales and persistency; and the types of complaints reviewed and upheld by the Financial Ombudsman Service. In this way, we can build a picture of whether the actions of firms are delivering fairer outcomes for consumers. These sources will provide both industry-wide and firm-specific measures.
We will also provide examples of good and poor practice we have seen among individual firms on how to develop TCF management information for the different outcomes.
In addition, to assist us in testing firms that are unable to evidence that fair outcomes are being delivered, we are currently developing and piloting a framework through which potential TCF risk areas in a firm’s culture can be identified. This framework has been developed not only from our experiences in TCF, but also from our other work on specific themes, which provide powerful information on the factors, or ‘drivers’, within an organisation which can lead to fair or unfair outcomes. We anticipate that using this framework will help us (and the senior management in firms) to understand some of the root causes of unfair outcomes, and therefore reduce the risk that customers are treated unfairly.
So far, we have identified the key cultural ‘drivers’ to be leadership (including internal communication), strategy, decision making, controls , recruitment, training and competence and reward. We believe these drivers are likely to have a significant influence on behaviours of management and staff, and therefore on consumer outcomes. For small firms, not all these drivers will be relevant, but we have identified the key management behaviours in a small firm which can have an impact on whether a customer is treated fairly.
Where relevant, we intend to integrate work using the culture framework and management behaviours into ARROW risk assessments and thematic work, and we will also conduct bespoke visits outside the usual ARROW cycle. We will publish more details, as well as examples of good and poor practice, in July.
We believe it is essential that senior management drive real change as rapidly as possible. As I have said, the March deadline helped to focus firms’ efforts on TCF and generated momentum within the industry as a whole. We now need to increase this momentum so we have decided to set further deadlines.
We expect that by the end of December 2008 all firms to be able to demonstrate to themselves and to us that they are consistently treating their customers fairly. One method of doing this will be to show that they are delivering, in particular, the six TCF consumer outcomes we have identified.
Firms need to have information to enable them to comply with their regulatory obligations. Demonstrating delivery of the TCF outcomes will require using management information proportionate to the size and complexity of the business. We are therefore setting an interim deadline to encourage firms to focus on and make progress in this area. Therefore by the end of March 2008 firms are expected to have appropriate management information or measures in place to test whether they are treating their customers fairly.
Many firms have found identifying, collecting, and using management information for TCF challenging. We have already provided supporting material on this subject. The key is that firms use information proportionate to the size of their business to demonstrate that they are treating their customers fairly. To support firms in meeting the March 2008 deadline for management information we will work more with the industry to help develop and share good practice, including in our forthcoming publications on the findings of our work on culture (in July), and on measuring industry-wide progress against the TCF outcomes (in October). In addition, management information will continue to be a key theme in the next phase of TCF.
As we have stated before, we want to be satisfied that all firms are working towards delivering on their TCF obligations. And if in our view they are not, we will want to take a view on whether there is any potential or actual consumer detriment, and we will wish to be satisfied that senior management recognise their regulatory obligations. Our approach will depend on the answers to these questions and how open firms have been in keeping us informed of their position.
If we are not satisfied we will consider enforcement action.
We are less likely to take enforcement action where the firm has considered the implications of TCF for its business, where senior management have played the role we expect them to in relation to TCF and attempted to deliver on what TCF means and where there has not been significant actual – or risk of – consumer detriment.
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 a significant actual or potential consumer detriment.
And we will also consider taking enforcement action against individuals. We have been clear throughout that responsibility for TCF rests with senior management. If a firm is in breach of its TCF obligations, it is senior management who are culpable.
So, what's in it for firms?
If we are satisfied that a firm has robust systems and controls and the senior management are reviewing and using reliable management information which demonstrates that they are treating their customers fairly, we will significantly reduce the level of testing we carry out on the firm’s culture and at the consumer interface.
Where firms cannot demonstrate this, we have warned that we will take a greater interest in them to determine what might be going wrong and why. This may include further testing of the outcomes for customers involving interviews with staff from the top to the bottom of the organisation, reviews of client files and listening to calls. We will use the cultural framework we have developed to examine what really happens within the firm, and to look at whether the aspirations of senior management are really being realised throughout the business at the 'coalface'.
For our part, the assessment of TCF progress will continue to be central to our retail strategy - TCF is an overarching priority for all our retail thematic work. We intend to build on this approach in the next phase of the initiative, including monitoring progress against the new deadlines.
As I have mentioned, we will publish more details on our cultural frameworks, as well as examples of good and poor practice, later this month. This will include a short guide on management information too. And we plan to publish our measurement of industry-wide progress against the TCF outcomes in the Autumn.
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 shortly.
So to conclude, as FSA increasingly adopts principles-based regulation, TCF is an important example of how it will work in practice. We want to make a real difference – to consumers, investors and markets. We believe that there is a clear way to deliver this, albeit one that poses challenges for both firms and us. The senior management of firms need to recognise and meet the responsibilities that a more principles-based approach places on them, just as we need to deliver our side of the equation.