Piyasi Mitra speaks with UK and European players about the UK Consumer Duty and asks if this regulation will ultimately hit Europe.
In a few months, all eyes will be on the UK’s financial fraternity as the Consumer Duty regulation comes into force. The regulation is significant because its implementation will set in motion the Financial Conduct Authority or FCA’s three-year strategy of preventing “failing firms from causing significant harm to consumers and market participants”.
Consumer Duty will be effective from July 31, 2023, for new and existing products and services open to sale or renewal, and from July 31, 2024, for off-sale or closed products and services.
So, what challenges await the UK and non-UK fund managers offering products and services to retail customers? How is technology driving this paradigm shift? And finally, will Europe follow suit?
The rules require firms to “deliver good outcomes for retail customers” and “act in good faith”. FCA guidelines say firms should exercise caution about causing retail customers “foreseeable harm” while supporting them in their financial objectives.
Firms should also consider diverse customer needs – particularly “vulnerable” customers who are more susceptible to financial risks due to personal circumstances. A “one-size-fits-all” approach to meet the new requirements is not viable, and the finalised rules recommend firms “use their judgment”.
Transparent mechanisms
Serving the needs of investors is at the heart of investment management, says Chris Cummings, chief executive of the Investment Association (IA). “Our members are working at pace to implement the Consumer Duty amidst a busy regulatory environment, with multiple FCA initiatives affecting the industry simultaneously,” he says.
While the IA is working closely with firms to support the implementation of the Consumer Duty, he would like the FCA to assume a “pragmatic approach” when supervising firms, recognising the scale of implementation to date.
“As the FCA becomes a more data-driven regulator, we anticipate a greater focus on clear, transparent mechanisms to evaluate the success of FCA’s regulatory requirements placed on firms,” says Cummings.
Data-driven operations, powered by cutting-edge technology, will be instrumental to this revolution in regulation. Some tech vendors are responding from within the burgeoning world of ‘regtech’. For example, Voyc, a technology firm founded in South Africa, has applied the FCA guidelines to its artificial intelligence or AI system. The software, made of built-in alerts for vulnerable customers, monitors sentences spoken on calls to help firms prove avoidance of consumer harm to the regulator.
“Our members are working at pace to implement the Consumer Duty amidst a busy regulatory environment, with multiple FCA initiatives affecting the industry simultaneously.”
Regulatory technology firm Model Office has released a client data analytics tool for dashboards, benchmarking the quality and value of client data against the four Consumer Duty outcomes-acting in good faith, avoiding foreseeable harm, and helping consumers achieve their financial objectives.
Under the new regulations, firms will have little choice but to turn to a “machine line of defence”, and the only way they will be able to analyse and understand data from interactions is through machine assessment – or, as a blog by the UK-based regtech platform Aveni highlights, at least by using machine learning fused with human intelligence.
The company’s AI platform, Aveni Detect, helps firms with data and management information to prove their compliance with the FCA’s Consumer Duty by conducting machine assessments for customer interactions, flagging hints of dissatisfaction or vulnerability, and offering data-driven thematic reviews.
The challenge for firms is defining and measuring “good consumer outcomes”, especially authorised fund managers who may be relatively remote from the end consumer, says Brandon Horwitz, senior adviser and non-executive director of governance organisation the Fund Boards Council.
With the Duty coming into effect soon, a recent FCA multi-firm review assessing implementation blueprints spotted plans with “a shortfall in budget or technology resource but without setting out plans for addressing [them]”.
The review came with a warning: “If firms assume they can get by largely with repackaging or supplementing existing data, then they risk not thinking deeply or afresh about the types and granularity of data that they will actually need to monitor and evidence outcomes under the Duty effectively.”
While AI and machine learning technology, as well as other approaches to data analytics, can help firms obtain insights from their measurements of customer outcomes, they come with a caveat. Horwitz says: “They can only do so with robustly articulated customer outcomes and credibly collected data. With good outcomes defined, firms can then measure achievement through relevant data collection from internal sources and seeking consumer feedback.”
SDR: The sustainability connection
When Consumer Duty is under the spotlight, could sustainable disclosure requirements (SDR) be far behind? The FCA recently closed the SDR’s public consultation comprising anti-greenwashing measures, sustainable investment labels, disclosure requirements and restrictions on sustainability-related terms in product naming and marketing. The crux of the Consumer Duty regulations and the SDR is identical – to protect consumers from potential harm.
As Horwitz puts it, Consumer Duty builds on existing and long-established FCA requirements for all products, specifically investment funds. “This includes the principle that products should have clear, fair and not misleading communications, how the names and objectives of investment funds must be properly articulated and how the authorised fund manager is responsible for overseeing that the fund delivers against its objectives – and delivers value.”
Horwitz also envisages that the Consumer Duty regulations will continue to focus the hearts and minds of those responsible for authorised investment funds (ultimately the fund board) to ensure that duty requirements are met for ESG features promised in fund objectives.
The IA has expressed reservations about the SDR and investment labels to regulate sustainable funds, citing the high probability of several legitimately sustainable funds falling outside stipulated labels. The “overly prescriptive” proposals would exclude many existing funds being sold legitimately to satisfied customers based on responsible, sustainable investment strategies. Without amendments, the IA has raised concerns about the proposals not serving consumers effectively, ultimately undermining the UK’s competitiveness.
“If firms assume they can get by largely with repackaging or supplementing existing data, then they risk not thinking deeply or afresh about the types and granularity of data that they will actually need to monitor and evidence outcomes under the Duty effectively.”
The FCA clarifies that proposals do not exclude any existing funds from the market. Instead, the proposed labelling regime aims to help consumers to navigate the complex landscape and rebuild their trust “by differentiating between products that are genuinely seeking to achieve positive sustainability outcomes and those that are not”.
The UK regulator also confirms that the final version will be released in due course. “Products that meet the criteria will be able to use one of the labels; those that do not meet the criteria will either need to reclassify to remove certain terms from their names and marketing or amend their standards to meet the criteria for a label,” says the FCA.
The watchdog affirms that it has sought, as far as possible, to achieve international coherence with other regimes – notably the Sustainable Finance Disclosure Regulation (SFDR) in the EU and proposals by the Securities and Exchange Commission in the US.
However, while the FCA “welcomes” the work the EU has done in the space as a “first mover”, it stresses that the proposals are not the same as those in place in the EU. “Our regime is a consumer-focused labelling regime, while the EU and USA proposals categorise products for disclosure requirements. While we seek to be compatible to the extent possible, we also need a high bar to protect consumers,” the regulator says.
Notables for non-UK products
Any firm selling or servicing financial products and services through a contact centre to UK retail clients will come under Consumer Duty regulations. There is a question, however, about how non-UK managers and manufacturers of underlying products who otherwise fall out of scope or are indirectly caught by contracts or commercial arrangements could deal with the new regime.
The FCA forewarns of risks if UK retail customers are sold products from firms that are not subject to equivalent requirements: “UK distributors of non-UK products must take all reasonable steps to understand the product, the target market it would serve, and the value it provides to ensure appropriate sales.”
Firms outside the UK wanting to sell into the UK are likely to be asked to provide additional information, the FCA says. “If those firms are unable or unwilling to provide the necessary information, UK distributors would need to consider if they can find this information elsewhere. Firms should not distribute a product if they do not understand it sufficiently.”
Coming to Europe soon?
Is a similar overhaul underway on EU soil? Yes. The European Commission is currently in the “final phase” of preparing its long-awaited “retail investment strategy”, says the European Fund and Asset Management Association (Efama). Vincent Ingham, director of regulatory policy at Efama, says: “The elements included are a closely guarded secret, but value for money has been discussed, among many others. We are not yet sure if it will feature in the final proposal and/or whether it will take inspiration from either the UK’s assessment of value or Consumer Duty. The proposal is slated for unveiling in early May, so hopefully, we will have more clarity on the concrete elements by then.”
Do all firms have a ubiquitous understanding of Consumer Duty phrases such as ‘acting in good faith’ or ‘reasonably prudent firm’? Many are still in the dark. Data and payments firm Moneyhub reported that 38% of senior decision-makers admitted having limited or zero knowledge of this upcoming legislation in October 2022.
“We have spoken at over 50 industry and stakeholder events since the final rules were published. Almost 9,000 people attended our sectoral webinars, with almost 6,000 later views on demand.”
Has the scenario improved with the deadline inching closer? Citing guidelines published last July and external engagement programmes with firms to answer queries, the FCA responds: “We have spoken at over 50 industry and stakeholder events since the final rules were published. Almost 9,000 people attended our sectoral webinars, with almost 6,000 later views on demand. Attendees were significantly more confident that they understood the duty after the webinar – with a 29% increase in highly confident raters.”
The FCA has also developed a programme of regional in-person events. These started in February and are expected to reach roughly 2,700 smaller firms.
The road to the UK’s revamped regulatory landscape will not be free from bumps and potholes. The question is, will it lead consumers and the industry into a better place?
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