The new FCA Consumer Duty: a higher standard, better culture and good outcomes

The term "consumer" – a word of caution 

In some ways the term "consumer" is a misnomer; and it is dangerous to dismiss the new regime on the basis that your firm doesn't deal with consumers or do retail business. As will be seen:

• the identity of the "consumer" to whom the duty is owed differs depending on the sector;
• it doesn't necessarily depend on whether there is a client relationship for regulatory purposes; and
• although there are some marked similarities with the existing product governance requirements in this regard, firms that manufacture products can find themselves on the hook despite being remote from the end customer in a distribution chain.

The application of the Consumer Duty

First, in terms of overall application, the Consumer Duty only applies:

• where a client is a "retail customer" (as newly defined) or there is a distribution chain which involves such a retail customer; and
• in respect of a firm's "retail market business" (including in respect of existing products and closed products).

However, both of those terms are defined with specific meanings in the context of the Consumer Duty: assumptions based on preconceptions about retail business and the retail market should not be made.

Scope: What is a "retail" customer"?

By and large, the FCA has settled on the definition that it consulted on.

This means that, for the purposes of the Principles for Business sourcebook (PRIN) and the Code of Conduct for the purposes of the SMCR regime (COCON), the term "retail customer" is being aligned with the existing scope of the FCA's sectoral sourcebooks as follows:

• Business subject to COBS (including new fund distributions): In relation to activities to which COBS applies, a customer who is not a professional client (as both those terms are defined). However, note the additional glosses below, particularly in relation to fund marketing.
  
  
• Banking and non-bank PSP business: In relation to activities to which BCOBS applies – and so this will be relevant to payment service or e-money providers as well - a banking/non-bank PSP customer or prospective banking/non-bank PSP customer (i.e., broadly, a consumer, micro-enterprise or small charity with annual income of less than £1 million). Payments and e-money firms are not subject to client classification obligations per se but may already have classification processes in place as certain regulatory obligations under the payments and e-money rules and regulations can be switched off if the relevant firm is only dealing with non-retail clients. Those processes in particular may need revision with the Consumer Duty in mind – for example, to ensure adequate transparency with customers as to any protections that will be lost in such scenarios. Payments and e-money products that can be used by both retail and non-retail customers will also be within the scope of the Consumer Duty. It should be noted that the FCA expects the Consumer Duty to also apply to unregulated ancillary activities carried on in relation to regulated payments or e-money services.
  
  
• Insurance distribution business: In relation to activities to which ICOBS applies, a policyholder or prospective policyholder (excluding one who does not make the arrangements preparatory to the conclusion of the contract of insurance).
  
  
• Other types of business: In relation to any other activities, a customer (as defined) – which, broadly speaking, means a client who is not an eligible counterparty.

Where different definitions are used within a sourcebook, such as the different MiFID and non-MiFID definitions of professional (and therefore retail) clients in COBS, the new rules do not specify which definition should be used. We think the natural reading is that firms should use the definition applicable to the business in question.

So far, so relatively straightforward. However, the definition in the final rules goes further, and is more explicit, than the consultation draft in a number of respects.

Retail customers and UK AIFMs/UCITS/distributors – and application of the elective professional "opt up" process

In the light of the above UK AIFMs may, on the face of it, be caught since their fund investors (brought in directly or via a distribution chain) will be "retail customers" as defined, unless those investors are or would be professional clients. Therefore, using the COBS opt-up process to categorise such investors as professional clients ought to disapply the Duty.

However, significantly the Duty will nonetheless apply to the process of opting the customer up. UK AIFMs and fund distributors, including MiFID firms with adviser/arranger functions, may therefore need to stress test the process they currently use to categorise fund investors as "professional clients" (e.g. for PRIIPs purposes) as against the new rules. At the very least this is likely to necessitate changes to the wording of the "opt-up" letters they have used to date to ensure that they are not inconsistent with the "consumer understanding" outcome rules, bearing in mind that these go beyond the existing Principle 7 requirements (paying due regard to the information needs of customers and communicating information to them in a way that is clear, fair and not misleading).  For instance, it may be necessary to include a plain English description, in the schedule of the protections that the customer will lose because of the opt-up, of the elements of the Consumer Duty protections which will not apply.

To the extent that there is a distribution chain, the firm will need to focus on the end investor and will need to re-examine any distribution arrangements.

MiFID investment managers 

MiFID investment managers will be caught if any of their clients (under COBS) is a "retail client" – i.e. a customer who is not a professional client. Again, the COBS client categorisation rules will be relevant – per se and elective professional clients will be excluded. Further analysis will be required if the professional client has underlying retail clients in respect of the mandate. See, for example, the next point regarding activities in relation to occupational pension schemes.

Retail customers and occupational pension schemes

This could be highly significant for a number of firms. For instance, where the MiFID investment manager is specifically managing the assets of an occupational pension scheme the extended definition of retail customer is potentially worrisome. This appears to require the manager to ignore the OPS trustee as its direct (and, almost certainly, professional) client and "look through" the scheme to the underlying beneficiaries (i.e. the pensioners). This would be a significant development for MiFID investment managers with a professional-only client base. However, the Finalised Guidance says (in the context of guidance on whether a firm is able to determine or materially influence retail customer outcomes) that, where the manager is managing assets under a mandate that has been determined by a professional client that is independent of the manager, the Duty will not apply. The example the FCA gives is of a segregated portfolio manager which is managing part of the portfolio of a defined benefit pension scheme. Although certainly not free from doubt, we think this means that, provided that it is clear that the OPS Trustee has determined the mandate without material influence from the manager (and is categorised by the MiFID investment manager as a professional client), the manager should not need to "look through" to the beneficiaries under the scheme. MiFID investment managers managing OPS assets may want to revisit the investment guidelines/mandates governing their existing contractual arrangements to ensure that this is not an issue.

However, the above argument, which is predicated on the fact that the manager is not able to materially influence the consumer outcomes for the pension scheme beneficiaries, will be much harder, if not impossible, to run in other cases. For instance, on the face of it, the FCA guidance appears to offer little comfort to OPS firms, fiduciary managers, white label providers and other bespoke providers in the market which are much more "hands on" in terms of the mandate.

Scope: prospective customers

It is important to note that, following on from the above, the Duty will extend not only to actual customers with whom the firm has contracted, but also to prospective customers (even if those prospects never become an actual customer). So, the Duty applies to firms:

• Where they approve or communicate financial promotions.
• When they respond to queries raised by prospective customers.
• Where the prospective customer applies for a particular product or service.

Scope: What is "retail market business"?

This is defined broadly to include the regulated activities (and ancillary activities), payments services and electronic money issuance of a firm in a distribution chain (including a manufacturer and distributor) which involves a retail customer. However, it should be noted that this definition excludes (among others) the following:

• Activities carried on in relation to "non-retail financial instruments" – these are instruments where either (a) the marketing materials/prospectus have prominent and clear disclosures that they are only being offered to investors eligible for categorisation as professional clients or eligible counterparties and are not intended for retail customers and the issuer or distributor has taken reasonable steps to ensure that the offer/associated promotional communications are directed only to such professional client/eligible counterparties, or (b) a minimum denomination/investment of £50,000 (or equivalent) applies to the instrument. This is likely to be a useful exemption for many firms that might otherwise be caught where the terms for subscription provide for such a minimum denomination/investment.
  
  
• The manufacturer of a product that is only marketed and approved for distribution to "non-retail customers" where that product is not provided by one firm to another to enable the other to distribute another product to a retail customer (or operate a specified investment held by a retail customer). This exclusion from the definition of "retail market business" is not without some uncertainties.
  
  

Scope: distribution chains 

Additional limb of the definition of "retail customer"

The definition of "retail customer" has been expressly extended where a firm is involved in a distribution chain: here the Duty applies across any distribution chain to the end retail customer in that chain, even though that person is not a direct client of the firm – so any firm involved in the chain leading from the manufacture of a product or service, to the provision, sale and ongoing administration and management of that product or service that is ultimately provided to an end "retail customer" is caught, broadly speaking where that firm can determine or materially influence retail customer outcomes.

Material influence

This means the Duty will apply to firms (including those that operate exclusively in the wholesale markets but which are part of a distribution chain for retail products/services) where they can determine or have a material influence over:

• the design or operation of retail products or services (including their price and value);
• the distribution of retail products or services;
• the preparation and approval of communications that are to be issued to retail clients, and/or
• engaging in customer support for retail customers.

Turning that around, there is an effective exemption from the obligations under Principle 12 where a firm's role in a distribution chain is such that it is unable to determine or materially influence retail customer outcomes in connection with a product. Whether a material influence exists depends on the extent to which a firm in practice exercises discretion over customer outcomes. This may not be a question with a binary answer: the extent of a firm's responsibility will depend on its role and the extent of its influence over retail customer outcomes. The rules therefore envisage there being a "sliding scale" of responsibility along a distribution chain based on a firm's actual role and influence. A firm at the beginning of the chain, a long way from, and with no direct contact with, the end retail customers, may have more limited obligations than, say, a firm with such direct contact, subject to the extent to which it influences material aspects of e.g. the design of a product.

Responsibility for own activities 

All firms will need to comply with the Consumer Duty for retail business for their own activities but, generally, would only be responsible for their own activities and would not need to oversee the actions of other firms in the distribution chain. In other words, while the FCA will generally expect firms with a direct relationship with the end user to have the greatest responsibility under the Consumer Duty, "all firms that have an impact on consumer outcomes will need to consider their obligations".

Payments and e-money institutions

The rules, products and customer journeys that are relevant in the context of payment and e-money services differ significantly from those that apply to other firms that may be caught by the Consumer Duty. (The rules that apply to them derive from the Payment Services Regulations 2017 and the Electronic Money Regulations 2011, supplemented by certain limited sections of the FCA Handbook that are switched on for them.) Accordingly, payments and e-money institutions are likely to need to consider the Consumer Duty differently. By way of example, the impact of the Consumer Duty along the "distribution chain" may be quite specific to the sectors, where "white label" or intermediate payments and e-money platforms often facilitate transactions for indirect end-user customers.

Payments and e-money firms also often rely heavily on external payments networks and systems and other actors (e.g., correspondent banks, account servicing banks). The FCA helpfully stresses in its Finalised Guidance that in-scope firms are generally subject to the Consumer Duty only to the extent that they have a material influence of retail customer outcomes (see above). Payments and e-money firms will need to consider the potentially complex "chain" in which their products sit, and their exposure to direct and indirect end-user retail customers – which will influence the extent to which such firms are responsible for complying with the Consumer Duty.

Listed investment companies 

In respect of listed investment companies, including investment trusts, the FCA has included additional guidance. It recognises that firms must comply with the Duty within the context of their roles.  The investment company structure means FCA authorised firms cannot always ensure issues are resolved, but the FCA expects authorised firms working with investment companies to take reasonable steps to address issues where they can. A fund manager will usually have material influence over product design, branding, distribution and other matters and so will need to comply with the Duty more fully in relation to those aspects, while recognising the ultimate decision is for the board.  In other respects the practical steps it can take may be more limited (for example, it could discuss any concerns it has with the board).

Whistleblowing 

There is a new rule now which requires firms to notify the FCA if they become aware that another firm in the distribution chain is not complying with the Duty.

There is also a new "self-whistleblowing" rule which requires firms to notify other firms in the distribution chain if they think they have caused, or contributed to, harm to retail customers.

Territorial scope 

Only firms conducting regulated activities in the UK are potentially subject to the Consumer Duty. So, broadly and subject to the other scoping provisions above, this includes UK investment managers and UK AIFMs.

By way of default, this captures activities carried on with retail customers located in the UK. It will also apply to TP firms in the temporary permissions regime (TPR) and the financial services contracts regime (FSCR), whether from an establishment in the UK or on a cross-border basis into the UK. Gibraltar-based firms are also caught.

However, the territorial scope extends beyond that default position if another applicable FCA rule or an onshored regulation has a different territorial scope. Put another way, the Duty will apply to UK firms conducting business for non-UK retail customers where the relevant business is within the scope of the applicable sectoral sourcebook (e.g. COBS) and that has extraterritorial application. So, it may apply to a UK manufacturer where there is a chain of distribution with non-UK distributors. In this case, the UK manufacturer (which will be subject to the Consumer Duty) may struggle to obtain requisite information from a relevant non-UK distributor (who will not be subject to that Duty). In this example, the FCA essentially says that the UK manufacturers should consider what is reasonable in the circumstances in terms of obtaining information, but that it would not be expected to obtain information from firms that are not subject to the Duty.

In outline 

The term "Consumer Duty" is one of convenience, to describe a collective set of rules, at different levels, that will apply to in-scope firms. At a high level, and in structural terms, the new Consumer Duty has three main elements:

• A new Consumer Principle – that will apply instead of Principles 6 and 7 for relevant in-scope business.
  
  
• Cross-cutting rules – setting out how firms should act to deliver good outcomes (and which therefore exhaustively define the FCA's expectations under the Consumer Principle).
  
  
• Rules relating to the four outcomes that firms will be expected to deliver in respect of the Consumer Duty (which help to define what is required by the cross-cutting rules (and therefore the Consumer Duty Principle) but which are not exhaustive of those rules.
  
  

The new Consumer Principle – Principle 12

The first element of this hierarchical rule structure is the new Consumer Principle (Principle 12) (though as pointed out below, it is the cross-cutting obligations which actually flesh out what the Principle means). This provides that "a firm must act to deliver good outcomes for retail customers". Where the Consumer Duty applies, Principle 12 will apply instead of Principle 6 (a firm must pay due regard to the interests of its customers and treat them fairly) and Principle 7 (a firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading). As with all FCA Principles, this is a rule, breach of which will be actionable by the FCA.

While both Principles 6 and 7 will be disapplied for these purposes, they will nonetheless remain in the Handbook because they will continue to apply to conduct that is outside the scope of the Consumer Duty.

Also, somewhat confusingly, the existing formal guidance on Principles 6 and 7 will remain relevant to firms in considering their obligations under the new Principle 12. Broadly, to the extent that a firm is not acting in accordance with the existing guidance on Principles 6 and 7 and such behaviour would amount to a breach of Principles 6 or 7, the behaviour is likely to be seen as a breach of Principle 12. However, acting in accordance with the guidance on Principles 6 and 7 should not be relied on alone in considering how to comply with Principle 12.

The cross-cutting obligations – the rules that exhaustively describe the Principle 

The cross-cutting obligations set out the overarching conduct which firms must demonstrate when acting to deliver good outcomes for retail customers. The cross-cutting rules (the rules in PRIN 2A.2) are said to exhaust what is required under Principle 12 and define how firms should act to deliver good outcomes for retail customers. In other words, they define Principle 12. They are, therefore, what in-scope firms should focus on. They require firms to:

• Act in good faith towards retail customers – this is a standard of conduct characterised by honesty, fair and open dealing and acting consistently with the reasonable expectations of retail customers. Guidance indicates that acting in good faith does not require a firm to act in a fiduciary capacity where it is not already obliged to and it doesn't mean that the firm cannot pursue legitimate commercial interests or seek a profit (provided it does so in accordance with the Consumer Duty).
  
  
• Avoid causing foreseeable harm to retail customers – this means firms must be both proactive and reactive in avoiding foreseeable harm, which can be caused both by act and omission. There is some useful guidance (with examples) to the effect that avoiding foreseeable harm is not an absolute obligation and does not mean that the firm has the responsibility to prevent all harm. Among other things, in-scope firms must ensure that all aspects of the design, terms, marketing and sale of, or support for, its products avoid causing foreseeable harm. Mitigating harm may require the firm to update or even re-design a product and/or its distribution strategies.
  
  
• Enable and support retail customers to pursue their financial objectives – again, to meet this, a firm will have to revisit all aspect of the design, terms, marketing, sale of and support for its products to ensure that they enable and do not frustrate these objectives. Where a firm is providing an execution-only or non-advised service, the firm can assume that the financial objectives of the retail customer are to purchase, use and enjoy the full benefits of the relevant product, unless, that is, the firm knows or could reasonably be expected to have known otherwise. A firm which provides advisory or discretionary services can rely on the financial objectives that its retail customers have disclosed to the firm (e.g., on the fact find) unless it knows or could reasonably be expected to know that the disclosed information is manifestly out of date, inaccurate or incomplete.
  
  

The four retail customer outcomes 

The most detailed rules and guidance in the new Chapter 2A of PRIN are dedicated to the "four outcomes". These build on the Consumer Principle (Principle 12) and the cross-cutting obligations above. They help to define what is required by the cross-cutting rules (and therefore the Consumer Duty Principle) but they are not exhaustive of those rules. 

Products and services

MiFID investment managers and UK AIFMs with top-ups (i.e. CPMIs) are already subject to the MiFID II product governance rules. In addition, UK AIFMs without a top-up (CPMs) are required to take account of the rules in PROD 3 as if they were guidance on the FCA Principles. In either case, the FCA does not expect firms to "double-up" on the broadly analogous (though far from identical) rules in PROD and those relating to the products and services outcome under the Consumer Duty. Essentially, the rules provide that a firm has the choice as to whether to comply with existing PROD requirements or the products and services outcome rules under the Consumer Duty. Any failure to comply with PROD will be taken as a failure to comply with the products and services outcome of the Consumer Duty.

Broadly speaking, for those firms that are already familiar with the requirements of the existing product governance regime, the products and services outcome – if applicable – should not present many surprises. However, firms not already subject to product governance rules (for example, payment services and e-money firms) may well need to adjust their product and service development processes significantly in order to comply with the Consumer Duty. Manufacturers and service providers will need to institute, maintain and review product/service testing and approval processes, both at the design and adaptation stages. Firms will need to consider their direct and indirect exposure to retail customers which can be complex, particularly in the payments sector. Products and services will have to be regularly reviewed and any remediation actioned. Distributors will need to institute product distribution arrangements that avoid foreseeable harm to retail customers and manage conflicts of interests and that take the needs and characteristics of the target market into account.

The product governance frameworks used by payments and e-money firms in the highly innovative payments landscape will also need to be flexible enough to respond nimbly to new and rapidly evolving products coming to market, while still remaining compliant with the Consumer Duty. Firms that make use of agents or representatives, including payments and e-money institutions, will also need to consider how they, as principal, can ensure compliance by their agents and representatives.

Price and value 

The detailed rules in relation to the price and value outcome are designed to ensure fair value and pricing along the distribution chain. These go further than the existing value assessment requirements imposed on authorised fund managers and are entirely new for AIFMs. As a manufacturer, among other things, the manager will need to ensure that its products provide fair value by carrying out a "value assessment" prior to marketing or distribution and will be required to provide distributors with the results of that assessment. While the FCA says that the manager will not be required to provide sensitive or confidential information (such as a breakdown of margins or risk-based pricing), it will nonetheless be required to analyse and assess the benefits to the target market, set out information on overall prices or fees and provide a confirmation that the firm considers the total benefits and proportionate to the total costs.

Although the cross-border payment services sector is highly competitive in terms of pricing, other payments and e-money institutions, particularly in their start-up phase, may offer their services for minimal or zero fees (though in some cases, only until they have scaled-up sufficiently). They might operate in this way as they intend to monetise customer data as a material part of their business model instead of charging a fee. The Consumer Duty will still apply to such "non-financial" costs to consumers as firms must consider whether there is "fair value" for the customer when comparing the non-monetary "payment" made by the customer against the benefits of the product or service. Customer transparency around these types of indirect costs to the customer will also be needed (see the requirements below).

Consumer understanding 

These rules will apply before, during and after any sale of a product. All communications – including, but not limited to, financial promotions – must meet the requirements of the rules. The subject matter of the communication will also affect what the firm is expected to do to ensure adequate consumer understanding. For example, the FCA's Finalised Guidance notes that it would likely be poor practice for an e-money firm to only warn customers of the lack of FSCS protections for e-money payment accounts in the product's terms and conditions. Considering the importance of such information the FCA would expect the information to be prominently brought to the attention of the customer.

Consumer support 

The consumer support outcome rules will apply to all firms interacting directly with, and supporting, end retail customers (e.g. through their customer services functions, including where firms outsource such functions), or are responsible for such interaction and support. The rules will apply to all support at all stages (e.g. pre-sale and post-sale) and whether or not that support applies to a specific product. Firms will be required to design and deliver such support so that it meets the needs of retail customers and ensure that they can use their product as reasonably anticipated. The support should ensure that retail customers do not face unreasonable barriers (including costs) during the lifecycle when they want to do certain things – such as switch, transfer, complain or cancel. In scope firms will need to revisit their investor/customer relations processes and arrangements to determine whether they need to be enhanced to meet the outcome rules. The Finalised Guidance provides examples of poor consumer support. For example, a firm using automated telephone systems, with limited options to progress queries, may not provide adequate support. Another example is of a payments firm which operates limited channels of support: even where the firm has clearly informed customers of this fact prior to purchase, it could still be found not to have provided adequate customer support (for example, by only offering a limited online chat function).

Over and above the cross-cutting and consumer outcome rules, in-scope firms will be required to comply with some additional obligations. For instance, they will need to monitor consumer outcomes on an ongoing basis and institute redress procedures to apply where they identify that foreseeable harm has been caused to retail customers. There are also rules that address governance and culture which will require in-scope firms to revisit their strategies, governance, leadership and staff policies to ensure that retail customer outcomes are embedded within risk control arrangements and internal audit functions.

The SMCR Code of Conduct (COCON) is being amended by the addition of a new Rule 6 requiring all conduct rules staff to act to deliver good outcomes for retail customers. This individual conduct rule will apply where the firm's activities fall within the scope of the Consumer Duty. New rule obligations underpinning that conduct rule gloss it by requiring the relevant individual to act in good faith towards retail customers, avoid reasonable harm to them and enable and support them to pursue their financial objectives (i.e., essentially making the individual subject to the same cross-cutting rules that apply to the firm). The new conduct rule will be interpreted in accordance with a reasonableness standard. Where it applies, individual conduct Rule 4 (requiring the individual to pay due regard to the interests of customers and treat them fairly) will be switched off – i.e., Rule 4 and Rule 6 will be mutually exclusive.

The FCA expects firms to provide training to their relevant staff on these changes – so, in-scope firms will also have to factor such training into their project plans for preparing for the new regime within the implementation period (see above and below).

Although the "hard" implementation dates on which the new rules will apply to existing and closed products might suggest firms have just under a year to effect changes, firms have even less time than they think. The FCA has signalled clear expectations of what firms should be doing during the "phased" implementation period leading up to those implementation dates, so there are some "soft" deadlines:

• By end of October 2022:
  
  
  • a firm's board/management body must:
    • have agreed implementation plans;
    • be able to evidence (e.g., through board papers, minutes other documents) that they have scrutinised and challenged the implementation plans to ensure that they are deliverable and robust;
• • firms must be prepared to receive FCA requests for implementation plans, board papers and minutes and to be challenged on them.
    
    
• By end of April 2023 - manufacturers should have completed all reviews necessary to meet the four outcomes rules (see above) for all existing open products and services, to enable them to:
  
  
  • to share with distributors all the information necessary for them to meet their obligations under the Consumer Duty (e.g. in relation to the price and value outcome and the products and service outcome);
  • identify what changes need to be made to their existing open products and services, so that those changes can be effected by the implementation date.
    
    
• From 31 July 2023 – first implementation date (open products/services): the Consumer Duty applies in respect of new and existing products and services that are open to sale, or renewal; the board/management body must ensure that the firm is compliant and that any gaps or weaknesses have been addressed.
  
  
• From 31 July 2024 – second implementation date (closed products/services): the Consumer Duty applies in respect of products and services held in "closed books" (i.e. products where there are existing contracts with retail customers entered into before 31 July 2023 but which are not marketed or distributed to such customers (including by way of renewal) on or after that date); the board/management body must ensure that the firm is compliant and that any gaps weaknesses have been addressed.

It should be noted that, despite the end of October 2022 deadline for the board/management body to have agreed implementation plans, this is not a one-off involvement: they are expected to maintain oversight throughout the whole process, ensuring that product review and implementation is going to plan. We believe it is also advisable for those firms that conclude, on analysis, that they are outside the scope of the Consumer Duty to make a written record of the basis on which they reached that conclusion.

It is clear that in-scope firms have much to do in the coming months and for many this will prove to be a challenging exercise. The task will be commensurately higher for those firms with large books of both open and closed products and services to review. Changes – some quite substantial - will be required to firms' policies and procedures, as well as their governance processes. Terms and conditions in client agreements may need updating; repapering may be required.

If you would like further information or assistance in understanding and analysing the Consumer Duty and its implications and how you should be preparing to meet the October deadline for agreeing implementation plans, please speak to your usual Travers Smith contact or any of the individuals below.