On 6th November last year, the FSA published a paper entitled “Treating customers fairly: measuring outcomes”. This paper reports on the progress made by firms in delivering the six Treating Customers Fairly (“TCF”) outcomes and also draws firms’ attention to the importance of meeting the final TCF deadlines in March this year (by which time firms must have appropriate Management Information (MI) measures in place) and December this year (by which time firms must be able to demonstrate to themselves and the FSA that they are treating their customers fairly).
Whilst the FSA found that senior management in many firms are taking TCF seriously and there are signs that some firms are building fair treatment of customers into their culture, based on the data available to it the FSA saw little evidence that firms’ work on TCF is translating into improved outcomes for retail customers. This creates a clear risk that many firms will fail to meet the FSA’s December 2008 deadline.
The FSA, therefore, expects firms to undertake a significant amount of further work to ensure that they build on progress to date and focus on the two deadlines. It intends to monitor their progress closely and warns that enforcement or other regulatory action may be appropriate now if it finds significant actual or potential consumer detriment. On the other hand as a carrot to temper its whip, the FSA states that firms that meet the deadlines will benefit from less regulatory intervention in the future.
To help firms further with meeting their obligations in relation to MI, the FSA has also published real examples of MI for each of the TCF outcomes, but unfortunately they are only illustrative rather than best practice.
This article examines the FSA’s report in more detail.
1. The Background
1.1 Treating Customers Fairly: How?
In order to allow firms flexibility and creativity in cultivating TCF within their organisations, the FSA refuses to define “fairness”, saying that “fairness means different things to different people”. What is fair will depend on the values, experiences and expectations through which consumers interpret what is fair. The FSA has instead issued six TCF outcomes, which firms must aim for by making necessary changes. The six outcomes which the FSA aims for are that:
· consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture;
· products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly;
· consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale;
· where consumers receive advice, the advice is suitable and takes account of their circumstances;
· 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; and
· consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
1.2 FSA approach to Treating Customers Fairly
The FSA has signalled a commitment to TCF, which is “one of our major initiatives in the retail market”. By encouraging firms to cultivate TCF within their organisations, the FSA aims to create a fairer and more prosperous financial services market. Sarah Wilson, Director for Treating Customers Fairly at the FSA, recently spoke of the advantages of persisting with the TCF project: “over time, consumers would regain lost confidence and markets for well-designed and targeted products could be expected to grow”.
However, the FSA has resisted the temptation of supplementing its already sizeable rulebook with TCF rules. The FSA will not issue rigid TCF rules with which firms must comply. Rather, the FSA takes an approach to TCF which Sarah Wilson labelled as “determinedly principles-based”. Senior management are given space within which to develop their own regimes in order to comply with the TCF requirements, and space in which to develop the requisite cultural change within their organisations. The FSA will merely provide TCF goals and deadlines, support and advice, and incentives for meeting the TCF outcomes.
1.3 Incentives: Carrots and Sticks
TCF arises out of the FSA’s 6th Principle for Business, which states that a firm must “pay due regard to the interests of its customers and treat them fairly”. TCF is therefore binding upon firms and the FSA can take a number of steps against firms who do not meet the six TCF outcomes after the TCF deadline:
· section 166 skilled person reports;
· remediation work for customers;
· private warnings;
· requiring firms to draft risk mitigation plans;
· varying or cancelling a firm’s permissions;
· prohibiting individuals; and/ or
· fines.
For firms that can prove a thorough TCF regime, however, the FSA have offered a “supervisory dividend”: supervisors will not need to request further detailed questions if a firm is able to produce and use well constructed measures of its TCF performance. The FSA have also said that it is in a firm’s commercial interest to raise the standards by which its customers are treated, as its reputation will rise, along with the reputation of the financial services industry as a whole.
2. The Treating Customers Fairly Report
In November 2007 the FSA issued Treating Customers Fairly: Measuring Outcomes (“the TCF Report”). In researching and writing the TCF Report the FSA had two aims:
· to establish the progress that firms have made towards treating their customers fairly; and
· to accelerate the rate at which firms institute a TCF regime by setting two new deadlines.
The FSA acknowledged that many firms have progressed towards implementing the six TCF requirements, but was concerned that “we have seen little evidence that firms’ work on TCF is translating to improved outcomes for retail customers”. Oliver Page, speaking in February 2005, had said that “the success of a solution based on the TCF principle, which makes clear the requirement to treat customers fairly but allows firms the flexibility they need to deliver it, depends on firms taking the action needed to ensure that the principle of fair treatment of customers is a reality.” The TCF Report signalled that the fair treatment of customers is not yet a reality across the range of retail customers.
In order to accelerate the rate at which TCF is incorporated into the operations and the culture of firms, the FSA set two new deadlines. “Deadlines help to maintain momentum”, said an FSA spokesperson, “so we have set two more”:
· by March 2008 firms should have in place adequate Management Information (“MI”) or measures to test whether they are treating their customers fairly; and
· by December 2008 firms must be able to demonstrate through MI that they are consistently treating their customers fairly.
2.1 To what extent have firms succeeded in meeting the six TCF Outcomes?
2.1.1 Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture
In the FSA report of July 2007 Treating Customers Fairly - Culture (“the Culture Report”) the FSA stated that “it is only through establishing the right culture that senior management can convert their good intentions into actual fair outcomes for consumers”. A firm’s culture effectively drives the behaviour of its staff and management: until TCF is deeply embedded into a firm’s culture, superficial changes to the firm’s procedures will not result in customers being treated fairly.
The FSA found some evidence of firms making the cultural changes necessary to ensure that customers are consistently treated fairly. Middle and larger firms are increasingly able to articulate what TCF means in their organisation. Smaller firms tend to be less well informed. However, once such firms turn their attention to TCF, they generally find it easier than larger or medium firms to create a culture in which customers are treated fairly.
The FSA singled out payment protection insurance as one area of particular concern: “it is disappointing that there have not been more substantial improvements in PPI sales practices”.
Practical Suggestions for Firms
The FSA recognise that TCF is not always at the top of a list of priorities for senior management but stresses that senior management must allocate sufficient time and resources to developing a culture in which consumers are treated fairly. The Culture Report states that senior management implement the following measures in order to gear a firm’s culture towards TCF:
· support the middle management in instituting a TCF regime;
· develop realistic TCF targets for the firm;
· develop a system whereby Management Information (“MI”) can be collected and monitored;
· ensure that individuals within the firm understand their TCF related objectives;
· implement reward schemes for reaching TCF targets; and
· ensure that all employees, and especially the middle management, “feel empowered to challenge policies and procedures” which may be obstructing the development of a fair culture.
2.1.2 Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly
The FSA places particular importance on this TCF outcome as a means of preventing mis-selling and mis-buying. The FSA gave the PPI market as one in which consumers were at particular risk. Customers may be treated unfairly where firms sell single premium PPI policies, regardless of what is appropriate to the target customer base. The FSA found examples of customers being sold expensive PPI policies where they had only a narrow gap in their cover, for which a tailored product would have been more appropriate.
However, the tone of the FSA’s findings in this area is mainly positive. Many firms have improved their product design processes, and the FSA were able to point to an improvement in consumer outcomes.
The major area of concern for the FSA is that many firms demonstrate a tendency to design products by benchmarking competitors’ products, rather than by identifying the real needs of the consumers in target markets. The FSA gives the example of the popularity of property funds within the fund market. In 2006, around 23 per cent of net sales were of property funds, despite warnings from many commentators that property prices were unsustainably high. “It is unclear whether firms always launched these products to serve identified consumer needs or whether the motivation was to provide funds firms could encourage consumers to buy”. The effect of this practice has now become clear, with consumers facing losses comparable to those suffered in the early part of this millennium by investors in technology funds.
Practical Suggestions for Firms
The FSA recommends the following practices in order that firms comply with this TCF outcome:
· use of qualitative research to identify target markets;
· tightening sign off procedures between marketing and technical teams; and
· collecting expertise in identifying risks involved in innovative new products, or products for new markets.
2.1.3 Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale
This TCF outcome derives from the FSA’s 7th Principle for Business: 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”.
Regarding the quality of pre-sale information provided to consumers, there has been an improvement in the standards of financial promotions and some improvements in mortgage and general insurance disclosure. However, in other areas, more work is needed to ensure that information given is fair and clear. The FSA is particularly concerned that, with so many competing providers of financial services vying for market advantage, many firms resort to “poor behaviour” in an attempt attempting to differentiate their products. For example, in a review of 57 firms from 2006, the FSA found that half of motor insurance savings claims were either unclear or misleading.
Regarding the quality of information provided to consumers at the point of sale, the FSA pointed to three particular failings:
· key feature documents (“KFDs”) are often ineffective or poor. Over one third of KFDs provided for investment products were found to be ineffective or poor in 2006;
· sales conversations do not always give a complete and balanced description of a product’s key elements; and
· some firms fail to disclose all relevant policy information before a contract is concluded.
After the point of sale, some firms are still failing to provide “a flow of clear information” and “quality updates” about their products. A number of firms within the life and pensions policy field were found to be using jargon and providing information that fell short of “clear, fair and not misleading”, in particular failing to mention and/or explain Market Value Reduction free-dates or Guaranteed Annuity rates.
2.1.4 Where consumers receive advice, the advice is suitable and takes account of their circumstances
TCF Outcome 4 derives from the FSA’s 9th Principle for Business, which states that “a firm must take reasonable care to ensure the suitability of its advice… for any customer who is entitled to rely upon its judgement”. In judging this TCF outcome, the FSA relied upon “limited direct evidence”. To improve the quality of the direct evidence available in the future, the FSA is piloting a “shadow shopping” survey, which will follow real consumers making real decisions through the advice process to assess the suitability of the recommendations given.
In assessing the extent to which firms are achieving this TCF outcome, the FSA investigated a number of different markets. Amongst firms who provide investments or pensions, an “unacceptable number… had failed to take the steps necessary to reduce the risk of mis-selling”. The FSA stated that “things are moving in the right direction” amongst mortgage providers, many of whom performed an “inadequate assessment of a customer’s ability to afford the mortgage… [and] customers’ needs and circumstances”.
2.1.5 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
Firms should not encourage consumers to buy products or services based on false expectations of how the product will perform, or the level of service they will receive, through use of poor information, advice or sales technique.
Broadly speaking, the FSA found that financial services generally function as consumers expect them to. For instance, consumers buying a pension product will receive an income after retirement.
However, drawing upon customer experience, the FSA found two specific areas of concern:
· the Financial Ombudsman Service has received a steady number of complaints from consumers purchasing travel insurance. In particular, consumers’ expectations are raised by poorly drafted policy documents and confusion on the part of the providers, who often sell travel insurance as an add-on and, consequently, do not fully understand the products that they are selling; and
· customers taking out mortgage policies are often given false expectations regarding fee disclosure, early repayment charges and mortgage exit administration fees. The FSA, when writing the TCF Report, was particularly concerned about the sub-prime mortgage market in this regard.
Practical Suggestions for Firms
Firms must be careful that:
· they do not create unrealistic expectations at any stage of the product lifecycle; and
· they deliver upon any expectations which they have created.
2.1.6 Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.
Unreasonable post-sale barriers may include:
· tight time limits;
· long notice periods;
· onerous information demands;
· difficulties in communicating with firms; and
· administrative delays.
Regarding post-sale barriers, certain barriers are, of course, essential- for instance, barriers relating to the prevention of money laundering or financial crime. “Proportionality is the key”. The FSA found a high volume of retail business is being switched from one product to another, which is suggestive, though not conclusive, of a relative lack of post-sale barriers. A particularly high volume of switching exists in the mortgage market with 66 per cent of consumers finding it “very easy” to switch, and 32 per cent finding it “fairly easy”.
The FSA also found improvements in claims handling and the complaints procedure of most firms, particularly in the handling of complaints regarding mortgage endowment policies. However, improvement is needed in some firms’ approaches to handling complaints. The FSA pointed to complaints about unauthorised bank charges as an area for improvement.
3. Management Information
MI is “information that is collected during the course of day to day business”. MI may relate to customers, staff, calls, visits, meetings, sales opinions or parts of a process, and may consist of quantitative data, opinions or commentary.
By March 2008 the FSA expects senior management to have in appropriate MI or measures in place to test whether they are delivering against the TCF outcomes. The rationale for this deadline seems to be that:
· once senior managers have appropriate evidence as to the TCF performance of their firms, they will have nine months to judge which outcomes require attention and to implement the necessary changes to improve their TCF regime;
· collecting and collating MI will, it is hoped, have a galvanising effect on senior management in firms who need to make substantial changes before the December 2008 TCF deadline; and
· if the senior management are seen to monitor and place importance on TCF this attitude will trickle down throughout the organisation of the firm.
Senior managers should ensure that the nature and quantity of the MI they collect is appropriate to the size and nature of their business. Each firm must have appropriate practices in place for gathering and monitoring MI, and must be able to use this MI to demonstrate that they are treating their customers fairly.
Practical Suggestions for Firms
MI should include data on how well the firm is managing to:
· ensure that recruitment and reward structures lead towards a TCF culture;
· ensure that education and training are in place to further the incorporation of TCF into working practices;
· provide customers with clear, fair and not misleading information which is appropriate to their needs, at all stages of the product lifestyle;
· learn lessons with regards to what helps, and what hinders, TCF within the organisation;
· monitor the standard of performance and of service; and
· instil a culture of TCF throughout the firm.
The FSA have published real examples of MI for each of the TCF outcomes, which may be accessed on the FSA website.
4. Conclusions
The FSA have recognised that the introduction of rigid TCF rules could result in firms becoming defensive, inflexible and uncreative in meeting the six TCF outcomes. It has therefore adopted a principles-based approach which allows firms freedom within which to find the best way to provide fair services and products. The FSA will provide firms with goals and deadlines, advice and supporting documentation. To this end, The FSA has created a TCF library on its website, which lists papers, case studies and specialist help for small firms. In addition, several industry bodies have produced guidelines on how their members can meet TCF guidelines. For instance, the Investment Management Association has published draft TCF guides on its website.
Firms have the lure of supervisory dividends if they can prove to the FSA that they are treating customers fairly. However, the FSA has made clear that wayward firms will not be spared the supervisory stick should they fail to meet the six outcomes.
“The pace of progress against the six outcomes needs to increase”, and, therefore, have set a deadline of
December 2008, states the TCF Report. “We have given you as much space… explanation and illustration as you could possibly need…” says Sarah Wilson, “but you need to deliver”.
Adam Carvalho
Financial Services Team
Farrer & Co
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