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Speech by Sarah Wilson, Treating Customers Fairly & Insurance Sector Leader
FSA Summer School, St John's College, Cambridge
7th August 2007

The FSA’s Treating Customers Fairly initiative is one of the over-arching strategic projects within our regulatory agenda for retail markets. As such it is designed to play a major part in delivering a retail marketplace characterised by:

• capable and confident consumers;
• simple and understandable information for, and used by, consumers;
• well managed and adequately capitalised firms who treat their customers fairly; and
• risk- and principle-based regulation.

Furthermore, it is one of the earliest aspects of FSA work to have adopted a principles-based approach. It was not the only early adopter – for example, we have long had a principles based approach to our supervisory work on corporate governance; we adopted a principles based approach to the introduction of individual capital standards for insurers in 2005; and we have in the recent past worked with the industry to find solutions to market failures without introducing new rules in the areas of soft commissions and unbundling of costs in trade execution and contract certainty in the general insurance market.

However, the Treating Customers Fairly initiative is a very good example of an area where we chose a principles based approach because existing extensive detailed rules were not working well. In particular, in too many parts of the retail markets, all serious thought about the meaning of the FSA’s Principle that firms must treat their customers fairly was delegated to the compliance department, who in turn thought about it only in terms of compliance with the letter of under-lying rules. As a result, there was too little focus on the outcome for the customer, and we repeatedly found instances of consumer detriment in our supervisory work.

Treating Customers Fairly therefore provides a good illustration of what principles-based regulation means in practice. And my resulting agenda today is first to talk about how we have taken Treating Customers Fairly forward to date in a principles based way; and then to address our current priorities. These are of two kinds – to challenge firms both to embed long-term cultural and behavioural change (where necessary), and to develop and use management information that demonstrates that they are delivering against the Treating Customers Fairly outcomes; and meanwhile to continue to protect consumers through targetted supervisory work in higher risk areas.

Treating Customers Fairly - the approach to date

We have worked intensively with the industry on Treating Customers Fairly and what it means. Through this particular initative it is possible to illustrate that putting principles based regulation into practice means:

• encouraging a greater focus on the outcomes we wish to achieve;
• finding new ways by which the FSA can help firms think through the meaning of the Principles, and on occasion the publication of new Guidance (for example our work on provider and distributor responsibilities which I will return to); and
• a greater emphasis on senior management responsibility.

Principles-based regulation – more outcome focused

TCF is about delivering improved outcomes for consumers. Firms have found the notion of a product life-cycle useful in thinking through all that they do that impacts on consumers - product design; identifying target markets; marketing and promoting the product; sales and advice; the remuneration of sales force and advisers; after sales information and service; and complaints handling. We have challenged firms to ensure that they treat their customers fairly throughout that lifecycle, with a view to delivering the following outcomes:

• Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture. We expect senior management to satisfy themselves that fair treatment of the customer is built into the operations and processes throughout the firm. And the emphasis is on senior management taking responsibility for the behaviour of their firm. I will say more about this later.
• Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly. We expect firms to design products with target audiences in mind, and to ensure then that those products are targeted at customers for whom they are appropriate. For example high risk products should be marketed only to customers who could be expected to have a high appetite for risk.
• Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale. Customers need to understand the characteristics of the product or service they are buying, and to receive appropriate information after the sale. Alongside this, we (and often individual firms) play our part in improving consumer understanding of financial services through our parallel key strategic project on financial capability.
• Where consumers receive advice, that advice is suitable and takes account of their circumstances. Firms must take steps to satisfy themselves that the advice they are giving to customers is suitable.
• 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. This is not about customer satisfaction. It is about the product or service delivering what is promised. Of course, firms cannot be blamed for movements in the market which affect the return on investment products or the price of a mortgage but they are responsible for the expectations which they create.
• Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint. Firms are expected to engage constructively with existing customers.

Principle based regulation - FSA help in interpreting what is required

Throughout our work on Treating Customers Fairly we have experimented with new ways of publishing material to allow for a dialogue with industry about the standard required by the Principle. So, for example, we have made extensive use of case studies and so-called cluster reports that give examples of good and poor practice that we have seen in particular areas. We have also published materials specifically aimed at smaller firms. Most recently, we have concluded that in one area we should provide new Guidance – that is the respective responsibilities of providers and distributors in the product life-cycle.

Provider-distributor responsibilities

The challenge to ensure that they treat their customers fairly throughout the product lifecycle was considered straightforward by most firms where they were individually responsible for design, manufacture and distribution of a product. However, many firms were unsure of their proper role in circumstances where the product lifecycle involves more than one firm.

Our starting point was that a customer’s experience should not be affected by whether a product was provided and distributed by a single institution or by several. And, following consultation, we have now published Guidance on the relevant Principles at each stage of the product lifecycle, setting out the responsibilities for delivering fair treatment which fall to providers and distributors at each stage. This is a principles-based solution – we have avoided prescriptive rules and have instead assisted the market by setting out our interpretation and thereby giving certainty. Firms that choose to adopt the Guidance in circumstances for which it was intended will not face action from the FSA.

While we think the market should now be able to use our Guidance and apply it to the variety of structures that they face, we have agreed to consider saying more about circumstances where there is a platform – as this market development is relatively new and much uncertainty exists. We will shortly publish further material for discussion with a view, perhaps, to publishing case studies thereafter to illustrate the position in this particular case. More generally, there may be a role for trade bodies to develop sector specific guidance should they see a benefit from doing so.

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Principles Based Regulation - Senior Management responsibility

The responsibility for delivering the Treating Customers Fairly outcomes rests firmly with each firm's senior management. We believe that senior management are in the best position to drive and to embed change throughout their firms, and we are encouraged that the majority of senior management can now articulate what treating customers fairly means to them and how this is reflected within the firm's strategy.

We have acknowledged that in many firms the scale of change required is large and that cultural change takes time. In setting deadlines, we have therefore adopted a gradualist approach. By March this year, all firms were expected to be at least implementing Treating Customers Fairly in a substantial part of their business. Our aim in setting this deadline was to stimulate action in firms that were slow to take action; and to maintain momentum in those firms that had risen to the challenge. We were pleased to find that an encouraging number of firms successfully met our March 2007 deadline, and were implementing necessary change in a substantial part of their business.

However, implementing change is not of course the same as delivery of fair treatment to customers. It simply means firms had allocated appropriate resources and responsibilities, developed plans and processes, and created capability to meet the Treating Customers Fairly principle. Indeed our wider supervisory work (which I will come to later) continues to show a gap between the aspirations of senior management and the actual experience of customers. We have now said that this gap must close by December 2008 – by which time all firms must 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 Treating Customers Fairly consumer outcomes we have identified.

Current priorities – the challenge to senior management

I said that the first of our current priorities was a twofold challenge to senior management - to embed long-term cultural and behavioural change (where necessary), and to develop and act on management information that measures whether they are delivering against the Treating Customers Fairly outcomes. I would like now to turn to each of these.

First, cultural change. Whilst we acknowledge that it does take time to deliver change, it is our experience as a result of supervisory work of all kinds and some targeted visits to discuss the issues specifically, that in many firms there are organisational, cultural or behavioural barriers which impede progress with Treating Customers Fairly. In our view, if senior management fails to tackle these issues, the gap between their commitment and actual consumer experience will not be closed.

Accordingly, to help supervisors to identify such barriers and discuss them with senior management, we have developed a new supervisory tool to support supervisors in undertaking TCF culture assessments, and to identify potential risks in delivering fair consumer outcomes. Our so-called ‘culture framework’, published in full two weeks ago, explores some of the organisational and management arrangements that can encourage or inhibit the consistent delivery of fair treatment of customers in all parts of a firm's business. We have also developed a similar tool for use in smaller firms which focuses on management behaviours. We have identified those factors which we believe have a significant influence on behaviour. These factors are:

Leadership In this respect we mean leaders at all levels within the firm. Where we see strong leadership with a clear vision of what treating customers fairly means for the firm, it is more likely to have a culture which is geared towards delivering fair consumer outcomes. A critical aspect of such leadership is good internal communication to ensure that the senior management's vision is communicated, implemented and understood throughout the firm.

Strategy Consideration of the impact on the fair treatment of customers should be an automatic feature of any forward looking plans for the business – be they change management programmes, the development of significant new products or target markets, or outsourcing arrangements. We would expect a firm that takes Treating Customers Fairly seriously to be actively considering it, for example, in their implementation of MiFID or of the new investment business sourcebook (NewCOB), and in their current thinking about the impact of the Retail Distribution Review and their response to it.

Decision-making Any situation within the firm where an individual is expected to make a decision could have an impact, directly or indirectly in delivering TCF outcomes.

Controls These are essential to satisfy managers (including senior managers) that the firm is delivering fair outcomes for consumers. They enable the firm to manage customer risks and to identify poor performance. Management information is an important aspect of controls and I will talk more about this later.

Recruitment, training and competence A firm can influence the delivery of fairer outcomes by recruiting staff with appropriate values and skills; training staff effectively and assessing and monitoring their competence. Related to this is -

Reward A reward strategy will often include salary, bonus and commission, but may also include profit sharing and other (perhaps non-financial) staff incentives. We recognise the need for firms to establish targets, where appropriate, which will lead to growth in the business and sustainable and increasing profits. However, we also believe that firms can and should motivate their staff to deliver good TCF outcomes at the same time through rewarding performance and recognising success, and through putting in place controls to ensure that unbalanced reward schemes are not allowed to skew behaviour.

Where appropriate we intend to integrate the culture framework into our ARROW risk assessments and thematic work. This framework will enable supervisors to assess TCF culture in a more structured and in-depth way. It will include spending more time talking to middle management and staff, to assess how well the TCF visions and values of the senior management translate into fair consumer outcomes and to consider the potential risks that might exist towards delivering these outcomes. Where we do identify potential risks these will be reflected in our feedback to firms, including risk mitigation programmes where appropriate.

Firms are already required to have systems and controls that deliver compliance with the regulatory system so the second challenge to senior management is to ensure that management information measures whether they are delivering Treating Customers Fairly – and then, naturally, to act on it. Indeed being seen to take an interest in and act on such measures will itself have a cultural impact in many firms. In order to be able to satisfy the December 2008 deadline, firms will need to have such MI in place – and such is its significance that we have set an intermediate deadline of March next year to introduce this.

We understand that firms are finding it hard to identify, collect, interpret and use the relevant management information to monitor TCF effectively and to demonstrate that they are treating their customers fairly. Even when appropriate management information is collected many firms do not complete qualitative analysis or provide effective commentary for those within the firm that receive the information. We issued a publication two weeks ago to give firms more help in this area and intend to provide more support to both supervisors and firms in the coming months.

Senior management that rise to these challenges – on culture and management information - can expect the FSA to recognise this. A firm that can demonstrate that it has closed the gap between senior management commitment and customer experience by producing robust management information that shows that it consistently treats customers fairly will face less intrusive supervision. In such instances, the supervisor will have every reason to limit their dialogue to discussion with the senior management and review with them of their management information.

Current priorities – targeted supervisory work

Finally, I would like to mention the other side of our work on Treating Customers Fairly – that is the day to day supervisory work to identify and take action in respect of actual and potential consumer detriment and so to protect consumers. While we are allowing committed senior management time to review their firms’ practices and introduce necessary change, it is essential that we simultaneously act proactively where aware of significant risks to consumers. Indeed such work also helps both us and firms understand the scale of the gap that they still have to close.

It is in this context that we challenge individual firms as a result of Arrow reviews or thematic work. The latter has recently included work on product design; on the sub-prime mortgage market; on payment protection insurance, quality of advice processes; on post sale disclosure on life products and on-going advice on with-profits; and on general insurance call centres and client money controls.

It is also the case that the existence of actual or potential consumer detriment is one of our criteria for taking enforcement action. We can be expected to consider the use of enforcement alongside, or instead of, supervisory actions if any of our work (including on a firm’s TCF culture) leads us to the conclusion that actual or potential consumer detriment may exist.

Conclusion

The Treating Customers Fairly initiative is a programme requiring a significant change of behaviour by many firms and, because we have chosen a principles based approach, by the FSA also. We are encouraged by the way that senior management have responded to the challenge posed by TCF in many firms, and are working hard ourselves to deliver on our part. We hope and expect to see a successful outcome in December 2008.

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