The Consumer Duty (Duty) imposes higher standards and expectations on firms regulated by the Financial Conduct Authority (FCA). It is the tool the FCA is employing to enhance consumer protection in the retail market.
The Consumer Duty consists of:
- A new high-level Principle, Principle 12,
- Three cross-cutting rules, and
- Four customer outcomes.
Principle 12 requires a firm to “act to deliver good outcomes for retail customers”, the cross-cutting rules set out the FCA’s expectations as to how firms should behave, and the customer outcomes set out the FCA’s expectations as to how firms will deliver good outcomes to customers in practice.
The Duty is a shift from a rules-based approach to an approach that focuses on customer outcomes. Our briefing published in March 2022 on the Duty (March briefing linked here), sets out further detail on the Duty.
The Duty comes into force for new and existing products and services that are open for sale or renewal on 31 July 2023 and for closed products or services on 31 July 2024. The FCA expects firms to make full use of the implementation period and to plan and prioritise implementation work effectively so that they meet the expected standards in a timely manner.
This briefing discusses some of the practical steps that lenders providing regulated mortgages (particularly those in the private banking sector lending to high net worth mortgage customers) may consider as part of their preparations for meeting the requirements under the Duty. It should not be viewed as an exhaustive checklist, as the implementation steps a particular lender will need to take will necessarily be bespoke to their own product offering and borrower base. We have focused on aspects that are likely to be particularly relevant to lenders and have not addressed matters of more general application, such as outsourcing and dealing with vulnerable customers.
What is the scope of the Consumer Duty for regulated mortgage lenders?
For mortgage lenders, the application of the Duty follows the position in the Mortgages and Home Finance Conduct of Business sourcebook (MCOB) and so applies to all regulated mortgage contracts within the regulatory perimeter. The Duty does not apply to unregulated buy-to-let contracts or commercial lending.
The Duty applies to existing and prospective mortgage customers. This means that in addition to dealings with existing customers, the Duty will apply when the lender approves or communicates a financial promotion, when answering questions from prospective borrowers, and where prospective borrowers apply for a mortgage. The Duty can also apply where a lender declines a prospective borrower’s mortgage application, for example in relation to communications or customer support.
Identify which of your mortgage products and services are within scope of the Duty.
Does the Duty apply to regulated mortgages sold before the Duty comes into force?
The Duty does not have a retrospective effect. However, the Duty does apply on a forward-looking basis as explained below.
The Duty applies to mortgages that were sold before 31 July 2023 and are still on sale to new borrowers or available for renewal on or after 31 July 2023 (Existing Mortgages). If a lender identifies an issue with an Existing Mortgage, the issue needs to be addressed before the mortgage can be sold to new borrowers. The lender will also need to consider how to address any potential harm to borrowers with Existing Mortgages, for example in relation to fair value.
The Duty also applies to mortgages where there are existing contracts with customers entered into before 31 July 2023, but which are no longer on sale to new borrowers or available for renewal after this date (Closed Mortgages). Certain aspects of the Duty will not apply to Closed Mortgages, for example, as there will be no more sales of the Closed Mortgage product, the lender will not need to develop a target market or distribution strategy. However, lenders are expected to ensure that Closed Mortgages continue to offer fair value and that they meet the consumer understanding and support outcomes for these borrowers.
In respect of both Existing Mortgages and Closed Mortgages entered into before 31 July 2023, unless a lender identifies a breach of rules in force at the time, the appropriate action a firm must take under the Duty does not require the lender to waive its vested rights (eg payments already due, remuneration for services and charges on termination) under those existing contracts.
Lenders should aim to complete a review of how their Existing Mortgages meet the four outcomes under the Duty by the end of April 2023. This will enable the lender to identify where changes need to be made so that these can be implemented by the end of July 2023. For Closed Mortgages, lenders have until the end of July 2024.
- Identify which of your mortgages are Existing Mortgages and which are Closed Mortgages,
- Review your mortgage books against all aspects of the Duty before the end of April 2023 to identify whether there are aspects of the mortgage that do not meet the cross-cutting rules or consumer outcomes. Take appropriate action in respect of Existing Mortgages before the end of July 2023, and in respect Closed Mortgages to mitigate harm where issues are identified, and
- Where necessary, the findings from the pre-end of April 2023 review should be shared with the lender’s distributors so that the distributors can meet their own obligations under the Duty.
Mortgage product governance
A lender will be a manufacturer of its mortgages under the Duty. This means that before a mortgage can be marketed or distributed, the lender must approve its mortgage products, and significant adaptations to the same, to ensure that the mortgage meets the four outcomes under the Duty. As part of the design process, the lenders will need to ensure that the mortgage:
- Does not adversely affect groups of borrowers within the target market (including those with characteristics of vulnerability), and
- Avoids causing borrowers in the target market foreseeable harm.
The target market in this context is the group or groups of borrowers sharing common features whose characteristics, needs and objectives the mortgage is designed to meet.
As well as at the initial mortgage design stage, lenders will need to review and test their mortgage products on an ongoing basis, including whether the distribution strategy remains appropriate and whether the mortgages are reaching the target market. To support this review the lender should use information supplied by its distributors, for example sales information. The lender should consider events that could materially affect potential risks to the target market and assess whether the mortgage continues to meet the needs and objectives of the target market (including those with characteristics of vulnerability). Where this is not the case, the lender must take appropriate steps to mitigate the situation.
Mortgage offerings change over time and many lenders offer deals for a limited period, replacing them from time to time with new deals with different interest rates. Helpfully, the FCA has clarified that where other terms and conditions remain the same, including the charging structure (such as entry and exit fees), a change to the rate of interest rate offered would not amount to a new product. In contrast, significant changes to the mortgage terms and conditions are likely to result in a new mortgage product that would need to be approved. Significant changes include those that could have a material impact on borrowers or the target market, for example changing the benchmark used for a variable rate mortgage.
If lenders collaborate to manufacture a mortgage product, a written agreement setting out their respective roles and responsibilities in the product approval process must be entered into.
- Review or, if you do not have in place already, design a mortgage approval, review and testing process for Closed Mortgages, Existing Mortgages and new mortgages. This must cover both approval of any new product and any significant adaptations to Existing Mortgages, in each case before they are marketed or distributed to retail customers. Your product governance process for Closed Mortgages can be narrower in scope than for Existing Mortgages or new mortgages and if you also conduct MiFID business you may wish to use your current MiFID product governance process as a base,
- Identify your target market(s) for your mortgage products and the evidence that will be used to demonstrate the steps you have taken to match the mortgage design with the needs, characteristics and objectives of the target market, and
- Consider if you have collaborated to manufacture a product, and if so set out, in a written agreement, the respective roles and responsibilities of each manufacturer in the product approval process.
A lender’s mortgages may be sold by a broker or other intermediary, and such third parties will be distributors of the lender’s mortgages. Additionally, a lender as a seller or arranger of its mortgages will also be a "distributor" under the Duty. In either case, the lender must maintain, operate and review its mortgage distribution arrangements for each of its mortgage products to ensure that they are appropriate for the target market and avoid causing or, where that is not practical, mitigate foreseeable harm to borrowers, support the management of conflicts of interest and ensure the needs, characteristics and objectives of the target market are considered. For example, should the mortgages only be sold on an advised basis or are execution-only sales appropriate?
MCOB sets out the standards mortgage distributors should observe when advising a borrower on the suitability of a regulated mortgage contract or when selling on an execution-only basis. However, the requirements under the Duty introduce a step change for these standards. In practice this means that where mortgages are sold the lender will need to ensure that its distributors are able to identify the target market so that the mortgage is only sold to borrowers within this group. The lender will need to review and test its distribution strategy on an ongoing basis to verify that the mortgage is not being sold to borrowers outside the target market.
The Duty also requires a lender to enable and support borrowers to pursue their financial objectives. Where a lender declines to provide a borrower with a mortgage or refinance an Existing Mortgage, for example because the borrower does not meet the lender’s eligibility criteria for that distribution channel, the lender should consider whether there is information or support it could provide the borrower with to pursue their financial objective, such as signposting them to a third party.
- Review your distribution strategy to confirm that it is appropriate for the target market and what evidence you will need to gather to evidence this,
- Review your agreements with distributors. These should include, among other things, agreement from the distributor, on request, to provide you with relevant information, including sales information and information on the regular reviews of the distribution arrangements conducted by the distributor, and
- Consider how to support a borrower whose application is declined, for example because they are not eligible to proceed on an execution-only basis, and what processes will be put in place to do this.
Information and documentation
As well as ensuring individual communications are fair, clear and not misleading, lenders will need to consider their overall approach to communicating information to borrowers to make sure they equip borrowers to make effective, timely and properly informed decisions and to monitor the outcomes borrowers receive. Firms should consider behavioural biases, the work the FCA has been doing on risk warnings and communications, and the needs of vulnerable customers.
The Duty does not remove the borrower’s responsibility for their choices and decisions, so individual customers will not always get good outcomes. For example, a borrower with a mortgage risks losing their home if they do not keep up with payments. However, a borrower can only be expected to take responsibility for their decision to take out a mortgage where the lender’s communications enable them to understand the mortgage, its features and its risks. As such, lenders will need to take steps to ensure that the information provided throughout the lifecycle of the mortgage supports the borrower’s understanding, for example that the borrower understood and accepted the risk of repossession. Whether such a belief is reasonable would depend on, for example, the adequacy of lender’s communications and the services provided.
- Explain or present information in a logical manner,
- Use plain and intelligible language and, where use of jargon or technical terms is unavoidable, explain the meaning of these terms as simply as possible,
- Make key information prominent and easy to identify, including by means of headings and layout, display and font of text, and by use of design devices such as tables, bullet points, graphs, graphics, audio-visuals and interactive media,
- Avoid unnecessary disclaimers, and
- Provide relevant information with an appropriate level of detail to avoid providing too much information, such that it may prevent retail customers from making effective decisions.
A lender is unlikely to have acted in good faith where the lender, for example, buries key terms in very small font in the documents or web pages the lender knows the borrower is unlikely to read. Lenders should support the borrower’s understanding by communicating the terms clearly and highlighting key risks. Using layering techniques, important information boxes and other visual aids are some of the methods that might help a borrower to understand significant risks.
All communications, regardless of medium, are within scope of the Duty and should deliver good outcomes to borrowers. After-sales communications and information provided to borrowers in financial difficulty are equally as important as those used to sell the mortgage. Lenders should be asking whether communications advising a borrower on how to switch or complain are at least as clear as those used to sell the mortgage, with both being clear and understandable.
The FCA also wants lenders to ensure that borrowers are given the information they need at the right time and in way that they can understand. An example of good practice would include where a lender, who identifies that a borrower does not have sufficient funds in the account servicing the mortgage payments, sends the borrower a short, effective message to make them aware of the lack of funds so that the borrower has time to deposit the funds needed and avoid additional charges. This tailored messaging helps the borrower avoid foreseeable harm.
- Review all customer communications and consider whether you need to change your approach and style. Could they be shorter with more visual aids or layering? Remove jargon or technical terms or, if they are needed, explain what you mean by them. Do your communications exploit behavioural biases? Do they support the needs of borrowers with characteristics of vulnerability?
- Ensure that client facing staff are trained appropriately to ensure that the language they use is clear and easily understandable by the target market, and
- Identify how to and carry out testing on the communications to borrowers on a regular basis, for example using focus groups and information from customer complaints.
When designing mortgage products, the lender needs to determine whether their products represent fair value and take appropriate remedial action where a value assessment identifies that this is not the case. An initial value assessment must be carried out for each mortgage product as well as any significant adaptation of a product, in each case before it is marketed or distributed to a retail customer. This requirement applies to Existing Mortgages, Closed Mortgages and new mortgages.
The Duty does not operate as a price cap, and lenders continue to have flexibility in setting prices. The FCA has also made it clear that lenders are not expected to apply the same pricing to all borrowers. However, borrowers will experience harm when they do not get value for their money and lenders are expected to ensure that their mortgages offer fair value.
Fair value is more than just price, and the Duty aims to tackle factors that can result in mortgages which are unfair or poor value. A mortgage that meets all other elements of the Duty (for example, it is designed to meet the needs of its target market, is transparently sold, borrowers can choose to switch or exit, and are properly supported) is more likely to offer fair value. However, even where this is the case the lender should still be asking whether there are elements of the pricing structure that could lead to foreseeable harm.
The value assessment must include consideration of the following:
- The nature of the mortgage product, including any benefits that will or may be reasonably expected and its quality,
- Any limitations that are part of the mortgage product,
- The expected total price to be paid by the retail customer or that may become due from the retail customer (the FCA rules set out what must be taken into account in the total price), and
- Any characteristics of vulnerability that retail customers in the target market display and the impact these characteristics have on the likelihood that retail customers may not receive fair value from its product.
The FCA guidance confirms that when determining fair value the lender must take into account the charges associated with the mortgage. This will include considering the overall charges that the customer might pay for the mortgage, for example, any that might be levied as a result of the firm’s distribution strategy. Lenders should factor such average intermediary fees in their value assessments and must also ensure that distributors have the necessary information to carry out their own assessment of value.
Lenders may consider a range of other factors, the FCA rules include the following as examples:
- The costs incurred by the firm in manufacturing or distributing the product,
- The market rate and charges for a comparable product,
- Any accrued costs and/or benefits for Existing Mortgages or Closed Mortgages, and
- Whether there are any products that are priced significantly lower for a similar or better benefit.
The FCA has confirmed that the price and value outcome rules do not require firms to charge all customers the same amount. Differential pricing between new and existing customers in the form of clear, transparent, up-front discounts for either set of customers is not prohibited. However, where lenders do charge different prices to separate groups of borrowers, the lender must consider whether the price charged provides fair value for borrowers in each pricing group, while having regard to whether any customers who have characteristics of vulnerability may be disadvantaged.
The FCA has also confirmed that the Duty does not require lenders to move away from designing products with an introductory rate that is lower than the rate the borrower pays later. When considering whether a mortgage offers fair value, firms should consider the overall price of a mortgage including any initial discounted rate, fees and charges and the reversion rate applicable at the end of a fixed rate period.
Lenders are not allowed to rely on the views of individual retail customers to consider whether they believe the mortgage provides fair value in place of the lender’s own assessment.
If lenders collaborate to manufacture a mortgage product, a written agreement setting out their respective roles and responsibilities in the value assessment must be entered into.
The FCA does not expect lenders to give up vested rights (contractual rights the lender has legal entitlement to), though a lender can choose to do so. As such, the FCA does not expect all borrowers to be moved onto the latest version of a contract or to standardise pricing models for all legacy business. However, a lender should review each of its mortgage products on its own merits and address issues it identifies.
- Design your value assessment process, include the required factors and consider which other factors you will or may take into account in your value assessment,
- Consider if you have collaborated to manufacture a product, and if so set out in a written agreement the respective roles and responsibilities of each manufacturer in the value assessment process.
- Carry out a value assessment of your mortgages, documenting how each mortgage product offered provides fair value to your borrowers, and
- Where potential issues are identified during the value assessment, you should take appropriate steps to remedy the position so that borrowers are not at risk of suffering foreseeable harm.
If you require further information about anything covered in this briefing, please contact Katy Ruddell or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, November 2022