In a welcome change in approach to financial market regulation, the United Kingdom’s Financial Conduct Authority (FCA) is requiring market participants to deliver good outcomes for consumers.

Executive Summary

On July 27, 2022, the FCA announced final rules and guidance for a new “Consumer Duty” applicable to financial services firms providing goods and services to retail consumers. The Consumer Duty requires firms to “assess and evidence the extent to which and how they are acting to deliver good outcomes” for consumers in the retail financial markets.^[1] The first set of rules and regulations implementing the Consumer Duty will become effective on July 31, 2023, while the balance are expected to be fully implemented by July 31, 2024.

The Consumer Duty rules represent a shift in FCA’s regulatory priorities. Previously, FCA deployed its regulatory and enforcement tools to ensure regulated firms conducted business in accordance with prescribed rules. Under the new Consumer Duty, FCA will instead assess whether regulated firms sufficiently improve outcomes for retail participants in the financial markets. Specifically, the new “outcome-based” rules require firms to consider the needs, characteristics, and objectives of their customers, including vulnerable customers.^[2] FCA believes that the Consumer Duty will advance its consumer protection and competition objectives as well as restore flagging confidence in the financial services industry among retail consumers.

The FCA’s US equivalent, the Securities and Exchange Commission (SEC), undertook similar steps to protect consumers through the SEC’s Regulation Best Interest (Reg BI) promulgated in 2019. Reg BI includes requirements that broker-dealers meet certain care and disclosure obligations to protect retail consumers.^[3] Unlike Reg BI, which provides clear-cut rules for market participants, the UK’s Consumer Duty compels firms to consider general principles aimed at enhancing consumer protection in the financial sector. As a result of FCA’s more subjective approach to regulation (i.e., focusing on “good outcomes”), we anticipate that implementation of the Consumer Duty may present challenges for firms required to comply and provide greater discretion in regulatory enforcement.

Background

Historical

The UK’s Financial Services and Markets Act, enacted in 2010, tasked the country’s existing financial services regulator, the Financial Services Authority (FSA), with ensuring that the following objectives were being met in the retail financial markets:

• market confidence

• financial stability

• public awareness through promoting public understanding of the financial system

• consumer protection

• financial crime reduction

When FSA failed to meet those objectives, Parliament created the FCA to regulate the financial services sector.^[4] The FCA’s mandate is to regulate the financial sector including, among others, banks, credit unions, investment managers, financial advisors, and insurance companies by focusing on consumer protection and regulating firm conduct.^[5] To meet that goal, the FCA has taken various steps such as establishing a Senior Managers and Certification Regime to increase individual accountability,^[6] publishing a Mission Statement explaining the Handbook of Rules and Principles (FCA Handbook) of treating customers fairly, and releasing the Duty of Care Discussion Paper which considered adopting a duty of care for regulated firms — all with the goal of improving culture and conduct in the financial services sector to better protect consumers.

Recent

Nevertheless, by 2021 there were significant questions as to whether or not the FCA was meeting its objectives, particularly with respect to consumer protection. In the Financial Services Act of 2021 (Consumer Duty Act), Parliament called on the FCA to conduct a consultation^[7] to determine whether it should expand its rules to include a duty of care to consumers. Shortly thereafter, the FCA released its first of two consultation papers exploring a Consumer Duty. Among the issues identified by the FCA in its first paper published in May 2021, as undermining consumer confidence in the financial services industry were: (1) information asymmetry between financial firms and consumers, (2) increasing complexity of products and services, (3) relatively weak bargaining position of consumers, and (4) a feeling that firms were putting their own profit interest ahead of consumer well-being. The second paper was published in December 2021, and incorporated additional public comment and feedback from industry participants.^[8]  

In the Financial Lives 2020 Survey, the FCA reported that (1) only 10% of consumers strongly agreed they had confidence in the UK’s financial services industry and (2) 30% of adults had low knowledge about financial matters.^[9] The findings identified in the FCA consultation papers were additional evidence of the frustration felt by retail consumers. Against this backdrop, FCA felt that additional oversight was necessary to avoid the mistakes that precipitated the Great Recession.^[10]

A New Consumer Duty

Rationale

To combat declining consumer confidence in the financial services industry and to satisfy an increasingly skeptical Parliament, FCA proposed implementing a new regulatory regime called the Consumer Duty. The FCA Consumer Duty Consultation identified the FCA’s goals as: (1) obtaining a higher level of consumer protection in retail financial markets; and (2) creating an environment where consumers are better equipped to achieve good financial outcomes from financial services. However, before FCA could implement rules and regulations to meet those objectives, the Consumer Duty Act required FCA to consult with market participants as to the scope of the consumer duty, the level of care firms should provide to consumers, and whether or not the proposed consumer duty would fulfill FCA’s consumer protection mandate.

Feedback

Following the consultation period, FCA published (1) the FCA Consumer Duty Policy Statement containing feedback to the proposed Consumer Duty and (2) the FCA Handbook, including the Principles for Businesses and Code of Conduct Sourcebook and related amendments, all of which are used as the basis for this client alert.^[11]

Financial Services Industry

While FCA described all market participants as supportive of the Consumer Duty and its objectives, industry groups and regulated firms expressed reservations over the subjective standards (i.e., good outcomes) behind the rules and how FCA planned to evaluate such outcomes and related conduct. Additionally, industry groups were concerned about the scope of the Consumer Duty and related liability.

Consumer Groups

Consumer groups, on the other hand, felt the proposed Consumer Duty did not provide adequate recourse for consumers. In particular, consumer groups advocated for the proposed Consumer Duty to contain a private right of action for consumers harmed by financial products or services. A private right of action, consumer advocates contended, would provide a strong incentive for firms to comply with the Consumer Duty.

General Duty

In July, concurrent with the publication of the policy statement, the FCA published the Consumer Duty Instrument 2022, which set forth the final rules and regulations implementing the Consumer Duty. In general, the Consumer Duty reflects an expectation by the FCA that firms should conduct their business to a standard which ensures an appropriate level of protection for retail customers. Through the Consumer Duty, FCA will focus on whether regulated firms are delivering good outcomes for their customers in addition to complying with applicable laws and regulations. FCA will evaluate whether regulated firms comply with the Consumer Duty by assessing firms’ products and services relative to the following four criteria:

1. Suitability and Treatment – Whether products and services are designed to meet the needs, characteristics, and objectives of their target markets and are distributed appropriately (Products and Services Outcome). The Products and Services Outcome is derived from Principle No. 9 that a firm must take reasonable care to ensure the suitability of its advice.^[12]

2. Fair Value – Whether there is a reasonable relationship between the price paid for a product or service and the overall benefit a consumer receives from that product or service (Price and Value Outcome).^[13]

3. Consumer Confidence and Information – Whether firms are providing consumers with timely, relevant, and understandable information to make informed decisions about financial products and services (Consumer Understanding Outcome).^[14] The Consumer Understanding Outcome is based upon Principle No. 7 where 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. Embedded in the foregoing is Principle No. 8, where a firm is required to manage conflicts of interest fairly.

4. Consumer Support – Whether firms provide sufficient customer service to enable consumers to realize the value of the products and services they buy and are supported in pursuing their financial objectives (Consumer Support Outcome).^[15]

All these criteria emanate from Principle No. 6 – a firm must pay due regard to the interests of its customers and treat them fairly.

Scope

The scope of the Consumer Duty and related enforcement mechanisms reflect FCA’s attempt to balance the concerns of industry groups and consumer advocates. In a nod to consumer advocacy groups, FCA decided that the Consumer Duty applies to all firms that can determine or materially influence retail customer outcomes.^[16] However, to assuage fears among “up-the-chain” or non-customer facing firms, FCA describes the Consumer Duty as applying “proportionately” based on the extent of a firm’s influence over retail customer products and services. In effect, a regulated firm’s responsibility (and exposure to liability) turns on its proximity to the customer and ability to influence customer outcomes. Additionally, firms are generally responsible only for their own conduct and not others in the distribution chain.

Enforcement

No Private Right of Action

In a victory for regulated firms, FCA declined to include a private right of action for consumers. Consumer groups worried that not attaching a private right of action would undermine the Consumer Duty since firms would not have an incentive to comply. Moreover, they worried that without a private right of action, FCA could not provide compensation for breaches of the Consumer Duty under the Financial Services Compensation Scheme.^[17] Despite these concerns, FCA reasoned that attaching a private right of action to the Consumer Duty would have unintended consequences, including a chilling of innovation and a withdrawal of products and services from the market. This is parallel to a breach by a regulated entity of the Principles for Businesses which can lead to disciplinary sanction, but not a private right of action.

Regulated Firm Responsibilities

Instead of a private right of action, FCA will enforce compliance of the Consumer Duty through an enhanced system of monitoring and mandatory governance changes at regulated firms. Broadly speaking, FCA expects firms subject to the duty to monitor and regularly review the outcomes that their customers are experiencing in practice, and to take action to address any risks to good customer outcomes. To this end, firms will need to develop a strategy to gather relevant information and data to inform their assessment of whether they are delivering good outcomes for customers.

Monitoring

Metrics

The breadth of the monitoring duty reflects FCA’s attempt to satisfy its broad consumer protection mandate. All firms subject to the Consumer Duty are required to assess retail customer outcomes arising from the products or services those firms produce or distribute, regardless of their proximity to consumers or the types of products sold. Moreover, instead of mandating particular metrics to monitor, FCA purposely wrote broad, outcome-focused criteria for evaluating the effectiveness of monitoring programs so that regulated firms across all industries could develop meaningful metrics for their own industries. By putting the onus on firms to identify and report on relevant data, FCA avoids the risk of inadvertently excluding firms for whom a centralized set of metrics might be inapplicable. The upshot is that all firms must identify meaningful metrics for evaluating retail customer outcomes in their industry segments with the aim of protecting consumers across all segments of the financial services industry.

To be sure, regulated firms objected to the intentionally broad reporting requirement, complaining that without specific metrics, firms would be required to devote substantial time and effort developing the capability and systems required to comply. In response, FCA published amended guidance detailing the kinds of information firms might consider, but it refused to articulate specific disclosures reasoning that it would be impossible to develop meaningful metrics for all regulated firms. Indeed, FCA “does not intend to exhaustively prescribe the information that firms should use to monitor the outcomes consumers are getting since applicable information will necessarily vary depending on the type of firm, its role in the distribution chain, the nature of the product, and the target market.” ^[18]

Avoidance of Foreseeable Harm

What is more, FCA further described the scope of the monitoring requirement by requiring firms to avoid “foreseeable harm” and monitor compliance of downstream or third-party partners. The Consumer Duty requires firms to identify whether the production or distribution of their products is likely to cause foreseeable harm to retail customers. When evaluating foreseeable harm, firms must evaluate all evidence and particular circumstances surrounding the sale and use of their products and, if foreseeable harm is identified, investigate the circumstances which led to the foreseeable harm “competently, diligently, and impartially.” The foreseeable harm analysis, in effect, creates a diligence requirement for non-customer facing firms, since utilizing a “fly-by-night” partner to distribute products or services would likely fail the foreseeable harm test. Moreover, while regulated firms are generally responsible only for their own conduct, the Consumer Duty compels firms to notify FCA of any suspected failure to comply with the Consumer Duty by any other firm in the distribution chain for that firm’s products and services.

Responsibility for Third-Party Outsourcing

Firms cannot shirk the monitoring and reporting obligations by outsourcing to third-party providers. In fact, FCA specifically states that “where firms are outsourcing or using a third-party provider and that provider is an authorized firm carrying out a regulated activity…. both the firm who are outsourcing the activity and the third party will need to monitor whether they are delivering good outcomes for their customers.”^[19]

Governance

The applicable governance requirement is designed to ensure that the Consumer Duty is “reflected in firms’ strategies, governance, leadership, and people policies, including incentives at all levels,” but there are no specific metrics firms are required to implement. FCA plans to send firms a communication later this year regarding its expectations for firms implementing the Consumer Duty into their strategy and operations.

Outcome-Focus

In sum, FCA’s attempt to balance the interests of market participants appears to have left both regulated firms and consumer groups dissatisfied.

Regulated Firm Uncertainty

On the one hand, because the rules for regulated firms are outcome-focused, regulated firms do not have certainty regarding proscribed conduct.

Lack of Any Enforcement Right for Consumers

On the other hand, consumer groups worry that the lack of a private right of action undermines any incentive for regulated firms to consider consumers’ best interests. Moreover, consumer advocates are concerned that FCA’s monitoring and governance rules defer policing to the regulated firms themselves.

Despite its shortcomings, all industry participants cheered the FCA’s focus on improving culture within regulated firms.

Timeline for Implementation

General

The Consumer Duty rules will apply to all new and existing financial products and services sold after July 31, 2023. So-called “closed products or services” — products and services where there are existing contracts with retail customers entered into before July 31, 2023, and which are not marketed or distributed to retail customers after July 31, 2023 — will be subject to the Consumer Duty rules on July 31, 2024.^[20]

Interim Milestones

Nonetheless, firms cannot wait until the effective date to begin implementing changes in response to the Consumer Duty rules. Instead, FCA published a list of milestones for firms to meet during the implementation period — some of which have passed or are imminently approaching:^[21]

End of October 2022

• Firms’ boards (or equivalent management body) should have formulated their implementation plans and been able to evidence that they have scrutinized the plans to ensure they are deliverable and ‘robust’ to meet the new standards. Firms should expect to be asked to share implementation plans, board papers and minutes with supervisors, and be challenged on their contents.

End of April 2023

• Regulated financial service firms should aim to complete all the reviews necessary to meet the four outcome rules for their existing open products and services so that they can share with distributors the information necessary for them to meet their obligations in relation to the Products and Services Outcome and the Price and Value Outcome.

End of June 2023

• Identify where changes need to be made to their existing open products and services to meet the Consumer Duty and implement these changes.

Impact Across the Pond

While the FCA establishes the framework for the new Consumer Duty, its counterpart, the SEC, published Reg BI in 2019 to address consumer protection issues in the US Under Reg BI, that a US broker-dealer interfacing with retail consumers has four significant obligations to those consumers: (1) disclosure, (2) care, (3) eliminating or disclosing conflicts of interest, and (4) complying with Reg BI.^[22] Reg BI goes further than the FCA’s Consumer Duty by stipulating specific rules related to each of these obligations, but, like the Consumer Duty, Reg BI also fails to establish a fiduciary duty.

On the whole, the FCA’s approach seems to be much more protective in theory since it aims to shift culture within firms themselves. However, its effectiveness remains to be seen due to the vaguer nature of the Consumer Duty requirement, as compared to Reg BI broker-dealer obligations. Notably, like the SEC’s rules, the Consumer Duty only applies to retail clients; it does not apply to institutional clients such as corporate entities and governmental bodies.

Takeaways

General

Firms operating under the regulation of the FCA’s Consumer Duty will need to take practical action to meet consumer needs to comply with this new duty. In this regard, regulated firms should:

• Consider consumer needs at every step of product design.

• Define their target markets to avoid sales to customers whose needs and objectives are incompatible with the product or service offered.

• Regularly review and consider the potential impacts of products or services on consumers, while disclosing any associated risks associated and ensuring that consumers understand those risks.

• Carry out value assessments and document how the price of a product or service provides fair value to customers.

• Communicate clearly and equip customers with the information they need to assess products and services to make informed decisions.

• Provide flexibility for consumers to exit any automated processes that may be in place.

• Ensure consumers receive flexibility in case of a major life event.^[23]

Vulnerable Customers

The Consumer Duty also outlines the steps that firms would need to take to protect vulnerable consumers by:

• Understanding customer needs.

• Maintaining staff that possesses the right skills and capabilities to address those needs.

• Designing products and providing flexible customer service to respond to consumer needs.

• Continuously monitoring and assessing that the needs are being met.^[24]

Final Words

Regulatory priorities have changed in the past few months due to significant leadership changes in the United Kingdom, with prior Prime Ministers insisting that regulations in the European Union and, thus, the UK, were too burdensome — a key factor prompting Brexit. In fact, in July 2022, the Financial Services and Markets Bill was introduced in Parliament.

A proposed ‘call-in power’ included in this bill would have allowed, among other things, (1) the HM Treasury to revoke (or amend) hundreds of pieces of retained EU financial services laws, (2) greater direction by the Government in the financial services regulator rulemaking process and (3) greater involvement by Parliament in this rulemaking process.

Simply put, a deregulation “scheme.”^[25]

However, the FCA has recently emphasized significant hiring in 2022 and expansion in cities outside the City, with the change in Government leading to a lessened focus on deregulation. In addition, the call-in power whereby the Government could overrule financial regulator decisions was omitted from the Financial Services and Markets Bill in November. This bill, which has already received approval in the House of Commons, is expected to be enacted in Spring 2023, according to HM Treasury.

Though there may be some flaws to the new Consumer Duty, especially as compared to Reg BI, it seems that ‘light-touch’ regulation may now be over in the United Kingdom.

Additional research and writing from Gio Singh, a 2022 summer associate in ArentFox Schiff's New York office and a law student at New York Law School, and Maria Ortega, a 2022 summer associate in ArentFox Schiff’s Chicago office and a law student at Loyola University Chicago School of Law.

FOOTNOTES

^[1] Financial Conduct Authority, A new Consumer Duty, Feedback to CP21/36 and Final Rules, July 2022, Policy Statement PS22/9, at 1.6 (FCA Consumer Duty Policy Statement).

^[2] FCA Consumer Duty Policy Statement at 1.16.

^[3] 17 CFR § 240.15l-1 (2019) (Reg BI Rules); see the Client Alert entitled “Does the SEC ‘Best Interest’ Regulations Go Far Enough,” dated August 1, 2022.

^[4] The FSA was abolished after the 2008 financial crisis revealed major flaws in how it approached regulation, and its functions were taken over by the FCA and the Prudential Regulation Authority of the Bank of England (PRA).

^[5] The FCA is responsible for regulating nearly 50,000 financial services firms in the UK. See About the FCA, Financial Conduct Authority (July 19, 2022).

^[6] FCA: Discussion Paper on a duty of care and potential alternative approaches, DP18/5, July 2018 (FCA Duty of Care Discussion Paper).

^[7] Consultation papers in the UK are policy documents released by UK governmental entities for public comment and feedback. They are similar to the preliminary rulemaking process by US governmental agencies.

^[8] See Financial Conduct Authority, A New Consumer Duty, Feedback to CP21/13 and Further Consultation, Consultation Paper CP21/36 December 2021 (UK).

^[9] A nationally representative survey of UK consumers that provides information about consumers’ attitudes towards managing their money, the financial products they have, and their experiences of engaging with financial services firms. See Financial Lives survey.

^[10] See the speech of CEO Nikhil Rathi, at FCA’s Our Role and Business Plan webinar, dated July 15, 2021, where, while working at HM Treasury at the height of the 2008 global financial crisis, he saw:

the catastrophic consequences when a toxic culture in some firms was mixed with a laissez-faire regulatory approach and lack of meaningful systematic risk oversight.

^[11] See FCA Consumer Duty Policy Statement.

^[12] In general, the Products and Services Outcome obligates firms to define a target market for their products and services and consider the specific needs of consumers within those target markets – including whether consumers have characteristics of vulnerability. Subsequently, firms should design their products and services to meet the needs of target customers and ensure that the distribution strategy is appropriate for the target market. Firms must also review and test whether their products meet the needs, characteristics, and objectives of the target market. Also see the SEC Reg BI Client Alert, which addresses customer suitability for (1) corporate securities under Financial Industry Regulatory Authority (FINRA) Rule 2111 and (2) municipal securities under Municipal Securities Rulemaking Board (MSRB) Rule G-19.

^[13] The FCA Handbook amendments require firms to ensure that their products provide fair value to retail customers in target markets for those products and obligates firms to carry out a value assessment review on a regular basis. See Amendments to the Principles for Business, 2A.4.2 R, Consumer Duty Instrument 2022. In a recent interview, Ozge Ibrahim, FCA’s Head of Competition Policy, described the fair value analysis as follows: “So, really what we want firms to do is to look upfront at that price and value equation, but then consistently through the lifetime of the product to make sure that it represents ongoing value for the customer in terms of the benefits that it's receiving, the way that it's using that product.” Transcript: Inside FCA Podcast Interview with Ed Smith. 

^[14] To meet the Consumer Understanding Outcome, firms must tailor all communications with retail customers to meet the information needs of such retail customers in a manner that is likely to be understood by such customers, taking into consideration the characteristics of such customers.

^[15] Rules related to the Consumer Support Outcome generally require firms to design and deliver support to retail customers that ensures such customers can use their products as reasonably anticipated, and includes appropriate protections to mitigate the risk of harm by giving retail customers the opportunity to understand and assess their options. Additionally, support services must ensure that retail customers do not face unreasonable barriers (including unreasonable additional costs) during the lifecycle of a product, including barriers to communication with the firm, costs related to switching or canceling products, accessing the benefits of certain products, and making complaints.

^[16] “Material influence” includes designing products for sale (including price and value), distributing products to retail customers, preparing and approving communications that are issued to retail customers, and engaging in retail customer support.

^[17] The Financial Services Compensation Scheme (FSCS) is the UK’s statutory deposit insurance and investor compensation scheme for customers of financial firms regulated by the PRA. FSCS pays out claims to eligible consumers or customers who file claims against failed or failing regulated firms.  

^[18] The FCA published a Discussion Paper on Future Disclosure Framework,’ DP22/6, December 12, 2022, seeking views on when and in what format information can be delivered to consumers; it is also considering who should have responsibility for producing such disclosure. Comments on this discussion paper are due by March 7, 2023.

^[19] Financial Conduct Authority, Finalised Guidance FG 22/5 Final non-Handbook Guidance for firms on the Consumer Duty, July 2022 p. 117 (UK) (FCA Finalised Guidance).

^[20] Query whether certain regulated firms will strategically close products and services as to delay implementation of Consumer Duty rules for an additional 12 months.

^[21] See Consumer Duty: Key Milestones, 2023.

^[22] See the SEC Reg BI Client Alert.

^[23] FCA Finalised Guidance p. 92.

^[24] FCA: Guidance for Firms on the Fair Treatment of Vulnerable Customers, Feb. 2021.

^[25] In the UK, the term ‘scheme’ does not have the same negative connotation it has in the US.