The FCA’s new Consumer Duty came into force on 31 July with the aim of improving standards of consumer protection.
The Duty includes rules and guidance that set expectations for the conduct of financial services firms in four areas (known as “the outcomes”). These are:
- the governance of products and services;
- price and value;
- consumer understanding; and
- consumer support.
Reflecting on the new guidance ICAEW’s Head of Financial Services, Reuben Wales focuses on the “price and value” outcome as particularly challenging for firms.
“In the financial world, the notion of ‘fair value’ has never been more relevant,” he says. “For retail customers, the Consumer Duty requires regulated firms to evaluate whether the total price paid for financial products or services is reasonable in relation to the benefits provided.”
For some products this is highly judgemental, confirms Wales, and will be informed by a consideration of all the fees, interest and charges earned and the costs incurred by the firm to provide.
In respect of benefits, firms will need to consider the nature and quality of what is being provided. In doing so, they will need to reflect on how different customers value certain features of a product above others.
Why a focus on fair value?
The nature of financial services products is such that firms often hold significant information asymmetry over their customers. Firms typically know:
- which customer groups are more likely to consume more or less of a service;
- which customers pose a greater risk or cost more in terms of recoverability or claim; and
- which customers are likely to benefit the most.
It’s for these reasons that the regulator has rightly sought to level the playing field for customers. To ensure that what they receive from regulated firms is appropriate to them and, importantly, delivers good value.
The process of determining fair value is far from simple. There are a large range of factors to assess; some are easily quantified, others are not.
Five factors firms must consider
Wales outlines five factors and challenges that firms will need to consider in determining whether they are successfully delivering fair value.
Time horizon can often be a material factor in determining fair value. It informs:
- the lasting benefit of any upfront discount,
- the probability of contingent fees and charges being levied at some point,
- how prices might vary through the business cycle, and
- in what instances the value proposition of the product might evolve.
Despite many products in financial services having a contractual end date, it is nonetheless the case that consumers often retain the services of a particular firm over several years. This might be through an open-ended product such as a current account or instead through automatic or opt in renewals as we see in insurance.
“Firms will need to consider the behavioural life of the product or service they are offering and the likelihood that the use case extends beyond the contractual term,” says Wales.
Contingent fees and charges
Products often attract additional fees and charges that are levied upon certain events within the product life cycle. Examples include early repayment or redemption, late payment, transaction, and renewal fees.
While not all customers can expect to incur these, some will, depending on the customer, product type and the stage of the economic cycle we find ourselves in.
Wales confirms that firms will need to consider the probability fees are levied and whether or not these are commensurate with the benefits being received.
Traditionally consumers have relied upon a small number of financial institutions to cover their financial needs. Within banking, for example, the average consumer might rely upon their provider for deposit and lending services, as well as access to transactional banking and possibly insurance.
Firms benefit from cross selling as it lowers their customer acquisition costs and allows for greater economies of scale. Under the new Duty, firms will need to consider how the advantages of cross selling are factored into the prices charged to customers. Where products and services are bundled, firms must ensure that constituting parts and the overall package provides fair value.
A higher interest rate environment impacts the economics of many products within financial services. Take savings products as an example, which have increased from historical lows of late due to a higher interest rate environment.
Business cycle is also a key factor. For example, the prospect of a recession may heighten the risk that borrowers are unable to repay financial commitments, so firms may look to compensate for this risk with higher financing costs.
Inflation is also acting as a driver of higher prices for many financial products. For example, within insurance, firms may reduce policy coverage in response to inflationary pressures impacting claims costs.
Firms will need to continually revise their assumptions as to what delivers fair value as the economic situation evolves. The Duty requires ongoing assessment of value throughout the life of the product, not simply at the outset.
Firms will also need to consider any non-financial costs that a consumer may incur. This could include, for example, the time to access, assess and act to buy, amend, switch or cancel a product.
Under the new rules the FCA expects that firms will not impose unreasonable non-financial costs on consumers. This could include, for example, unclear information that makes it hard to work out how to cancel a contract.
The challenge for financial services firms is that this consideration increases the complexity of the value assessment they need to make. Alongside an increased range of factors to consider, firms must also decide how to judge what customers value, and then there is a lack of quantitative metric to price the non-financial cost.
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