Clifford Chance

On 7 December 2021 the UK Financial Conduct Authority ("FCA") published its second consultation on its proposed new Consumer Duty that would set higher expectations for the standard of care that firms provide to their retail consumers.

Although the consultation covers all regulated firms dealing with retail customers, perceived issues in the general insurance sector are prominent in the consultation. The move to a Consumer Duty follows a succession of consultations and reports which focus on consumer outcomes in the GI sector e.g. the GI Pricing Practices Market Study (2020), the thematic review into GI Distribution Chains (2019) and, further back, the GI Add-Ons Market Study (2014).

The consultation sets out revised proposals for the Consumer Duty, new draft Handbook rules and guidance and key feedback from the first consultation published in May this year. The consultation is notable for three reasons; the potential impact of the new rules on firms, the way the FCA has sought to address concerns on the scope and application of the rules, and the FCA's stated approach to implementation.

A "significant shift"

The consultation confirms that the FCA intends to introduce the Consumer Duty next year and that it expects that this will lead to a "significant shift" in the culture and behaviour of firms, with a firm needing to consider the new measures “at every stage of its processes and at every level of its organisational structure”. This aligns with the recent trend we have seen from the FCA's own transformation and its focus on being more assertive and innovative in its regulatory approach. It also aligns, more broadly, with the prevailing view shared between HMT and the FCA that the existing rulebook and regulatory frameworks is not fit for purpose as markets, technologies and attitudes towards effective regulation have changed. It is notable that the Consumer Duty is itself derived from a mandate given under the Financial Services Act 2021.

Scope and application

The consultation provides much-needed detail on the proposals set out in the first consultation and attempts to address industry concerns around the scope and application of the duty. Of particular note:

• The new 'Consumer Principle', which is intended to represent the overall standard of behaviour the FCA expects from firms servicing retail clients, would be an outcome based principle defined as a duty to "deliver good outcomes for retail clients". This was preferred to the alternative option "to act in the best interests of retail clients" as it was considered to better capture the shift required on firms to consistently focus on consumer outcomes and put the onus on firms to put customers in positions where they can act in their own best interests.
• The application of the 'Cross-Cutting" rules, which describe the FCA's expectations of firm's conduct and how the Consumer Principle will apply in practice, have been clarified. Notably the FCA has confirmed that the FCA intends to require firms to: (i) act in good faith; (ii) avoid causing foreseeable harm to customers and (iii) to enable customers to pursue their financial objectives. There will be no requirement for firms to take "all reasonable steps" in connection with the "Cross-Cutting" rules, as had previously been proposed, following industry concerns about the onerous and potentially overly procedural nature of such requirement.
• The proposed right for customers to initiate Private Right of Action (PROA) proceedings against firms for loss caused by a breach of the Consumer Principle (or any of the FCA Principles for Business) will not be introduced.  This was strongly resisted by industry given the potential extension of liability beyond existing common law duties and contractual duties to customers.
• The FCA has provided a detailed Appendix of "non-Handbook guidance" on the Consumer Principle, "Cross-Cutting" rules and the 'four outcomes' (clear customer communications, products and services designed to meet consumer needs, effective customer service and fair value in pricing) in an attempt to provide guidance to firms on the required scope and expectations on firms in terms of complying with the new Consumer Duty rules.
• Guidance includes that:
  • The FCA does not consider the Consumer Duty to be open-ended and the general principle that consumers should take responsibility for their decisions continues to apply and is not deemed to be overridden by the Consumer Duty.
  • The rules are designed to be proportionate and while firms will need to apply the rules for all products or services, the requirements are less onerous for simpler products with less risk of consumer harm.
  • The FCA does not anticipate making market interventions such as price caps or other price interventions but reserves the right to use their regulatory tools to make such interventions where competition is deemed not to be working or markets are deemed as failing to deliver fair value. Rather the aim is to require firms to consider the price of the product or service and the role it plays in fair value.
  • Firms without direct engagement with retail customers will still be caught by the rules if they are in the distribution chain and that this may include firms in the wholesale market.

Implementation

Lastly, the consultation suggests a marked shift in how the FCA intends to implement the duty. The FCA's stated expectation is that implementation would be "iterative" and that they will engage with firms to determine good practice in terms of implementation and reviews of products and services. The FCA is also considering whether and how they can give more regular updates to firms on what they are seeing in the market and their views of it to provide further clarity to firms on their expectations.

Conclusions

The consultation attempts to provide some much needed clarity on significant new introduction to the rulebook. While this is helpful, outcome-based regulation always presents challenges and firms will need to identify what changes are required in practice to their businesses to satisfy the requirements. In particular, how do firms address the requirement to take a more pro-active and consistent approach to consumer interests? It also remains to be seen what effect the new rules will have on the insurance market. Taking the positives first, the response from consumer bodies has been broadly supportive and, if implemented properly, the duties may help address poor behaviours and increase trust in the industry. However, notwithstanding the checks and balances proposed in the consultation, there inevitably remains a risk that this could lead to insurers removing exclusions from policies (that are contrary to customer expectations) leading to higher pricing but increased claims, which may put pressure on profitability, drive consolidation and reduce competition. It may also stifle innovation as insurers are unclear on the regulatory response to new products.

The FCA requests feedback by 15 February 2022, with new rules expected by 31 July 2022. As the consultation does give rise to several issues, we encourage insurers and intermediaries to engage with the consultation process and we would be very happy to discuss any proposed feedback response.