What the FCA’s New Consumer Duty Means for UK Payments Providers

In July 2022, the UK Financial Conduct Authority (FCA) published Policy Statement 22/9: "A new Consumer Duty Feedback to CP21/36 and final rules" (containing FCA 2022/31 Consumer Duty Instrument 2022), alongside Finalised Guidance 22/5: "Final non-Handbook Guidance for firms on the Consumer Duty", confirming its plans to introduce a Consumer Duty and setting a 12-month period for firms to implement the new rules.

The aim of the Consumer Duty is to set higher level and more transparent standards of consumer protection across financial services, including firms in the wholesale market, even if they do not have a direct relationship with retail customers. For this purpose, the FCA has opted for adopting an approach based on outcomes rather than prescriptive rules.

This regulatory analysis focuses on what actions need to be taken by payment services providers (PSPs) to be compliant with the new Consumer Duty requirements. It also highlights the timeframe for the implementation of the consumer duty obligations and the FCA’s cost-benefit analysis.

Background

On July 17, 2018, the FCA published a discussion paper (DP18/5) on a duty of care and potential alternative approaches, in which the authority considered the possibility of introducing a “new duty” for firms within financial services when dealing with consumers. The new duty was defined as both “a duty of care and a fiduciary duty”, where “a duty of care is a positive obligation whereas a fiduciary duty is largely a prohibition”.

In May 2021, the FCA published a consultation paper (CP21/13) on a new Consumer Duty, and identified various situations and practices that may contribute to positioning consumers in a weaker position in their relationship with firms, including:

• “Sludge practices”, defined as “an excessive friction that hinders consumers from making decisions in their interests, by taking advantage of their behavioural biases”.
• Weaker bargaining position, asymmetries of information, consumer inertia, lack of understanding or behavioural biases.

The FCA uses academic literature (references are included in this list) to define “behavioural biases” as “specific ways in which normal human thought systematically departs from being fully rational”. According to Occasional Paper No. 1: “Applying behavioural economics at the Financial Conduct Authority” of April 2013, biases can lead people to misjudge situations; for example, depending on the manner in which information is presented, consumers may change their opinion in a way less favourable to them.

Those kind of practices from firms, as stated in CP21/13, may cause harm to consumers, such as:

• Making it more difficult to reach informed/timely decisions.
• Buying products which are not appropriate for them.
• Sustaining higher costs.
• Receiving low-quality services from firms.
• Finding it difficult to switch and obtain a more favourable deal.

In CP21/36: A New Consumer Duty: Feedback to CP21/13 and Further Consultation from December 2021, the FCA provided answers to the feedback received in response to CP21/13 and introduced a cost-benefit analysis, as detailed below.

Consumer Duty unfolded

FG22/5: "Final non-Handbook Guidance for firms on the Consumer Duty" sets out the following three elements of the Consumer Duty:

• Consumer Principle (Principle 12), which establishes that “a firm must act to deliver good outcomes for retail customers”, including both direct and indirect clients of the firm. Indirect clients are the ones with whom the firm does not have a direct relationship.

As long as the firm can prove that it has complied with the Consumer Duty, the “good outcome” is limited to the scope of the firm’s role and does not translate, for example, into the firm ensuring that an investment brings good results.

Principle 12 prevails over Principle 6, which establishes that “a firm must pay due regard to the interests of its customers and treat them fairly”, as well as Principle 7, under which, “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”. As explained in the FCA Handbook - PRIN 2A.1.17, Principle 12 implies higher and stricter requirements of firms and has a broader application in relation to a firm’s retail market business than the requirements provided by the requirements in Principles 6 and 7.

• Cross-cutting rules, which operate together, provide that a firm must:
• Act in good faith, requiring firms to adopt an honest, fair and open behaviour. According to the FCA, the following cannot be deemed acting in good faith: not taking into consideration retail customers’ interests; trying to reach their objectives by “manipulating or exploiting retail customers”; taking advantage of a retail customer or their situations; and “carrying out the same activity to a higher standard or more quickly when it benefits the firm than when it benefits the retail customer, without objective justification”. (PRIN 2A.2.3)
• Avoid causing foreseeable harm to retail customers, which may be caused by both act and omission. This does not mean that a firm has a responsibility to prevent all harm, as long as a firm reasonably believes a retail customer understands and accepts the product’s inherent risk.(PRIN 2A.2.13)
• Enable and support retail customers to pursue their financial objectives, including providing appropriate information to the consumers and ensuring that the consumers are given the possibility to switch and/or exit the product with no unreasonable impediments. (PRIN 2A.2.20 – 2A.2.22)
• Four outcomes which set more detailed expectations for firms’ business conduct in the following areas:
• Governance of products and services, for example “a manufacturer must maintain, operate and review a process for the approval of: a product; and significant adaptations of a product”.
• Price and value.
• Consumer understanding.
• Consumer support.

Costs

The FCA has estimated the following costs for firms to meet the Consumer Duty requirements:

• Total one-off direct costs ranging between £688.6m (of which £110,304 for larger firms and £332,103 for smaller firms) and £2.4bn (of which £262,203 for larger firms and £1,279,110 for smaller firms).
• Annual direct costs ranging between £74.0m and £176.2m (of which £5,272 for larger firms and £43,081 for smaller firms).
• Indirect costs for potential loss in profits due to changes firms make to their product; these costs, according to the FCA, should be borne by the customer.

Total one-off direct costs and annual direct costs include costs incurred to adapt firms’ policies, train staff, maintain IT infrastructure and monitor compliance.

Benefits

In response to the comments received on its cost-benefit analysis, the FCA answered that it is not possible to quantify the benefits of the Consumer Duty due to its preventive nature. However, the FCA added that it does not expect the duty to limit competition and innovation, as its application presupposes the use of the reasonability principle and a proportionate application of the FCA’s rule. The FCA specifies that “reasonability” has an objective meaning and “will also be assessed on the facts and so will involve judgements from firms at the time”. For this purpose, the following factors will be considered: the nature of the product or service being offered or provided; the specificities of the retail customer(s); and the firm’s position in relation to the product or service.

The FCA expects that the duty will drive competition by promoting higher standards across the industry, higher levels of consumer protection and by encouraging firms to compete at these higher standards.

The FCA expects its new Consumer Duty to benefit consumers by:

• Offering products and services which better correspond to their needs.
• Reducing the need to seek compensation or redress.
• Saving time.
• Decreasing psychological stress.
• Decreasing the number of situations where individuals can be harmed.
• Making them more confident and increasing their participation in financial markets.

FCA’s expectations from PSPs – Who is accountable for implementing the Consumer Duty?

FG22/5 identifies firms authorised under the Payment Services Regulations 2017 (PSRs) and Electronic Money Regulations 2011 (EMRs) as being subject to the Consumer Duty. Specifically, it applies to all consumer credit activities and to business conducted with retail consumers that are micro-enterprises and small charities with a turnover of less than £1m.

The definition of “retail customer” for payment services is provided in the FCA Handbook glossary of definitions under “retail consumers” at point 2(e), which refers to FCA 2019/5 Annex A.

In the payments sector, the duty applies to all the entities involved in the distribution chain (for example, the e-money issuer is responsible for the agent and the distributor that carries out activities on its behalf) and “to the PSP activities [that] can determine or have a material influence over retail customer outcomes”. The FCA considers “material influence” as the ability to make or influence decisions with respect to any of the following:

• “The design or operation of retail products or services, including their price and value.
• The distribution of retail products or services.
• Preparing and approving communications that are to be issued to retail customers.
• Engaging in customer support for retail customers.”

The FCA currently excludes payment and e-money firms from the Senior Managers and Certification Regime (SM&CR), which provides that all the senior managers are responsible for the ongoing application of the consumer duty. However, the FCA expects these firms “to ensure that they have senior management oversight and accountability for the Duty, and to ensure that their staff are acting in accordance with the requirements of the Duty”.

FCA’s approach and enforcement action

The FCA stated that it will communicate its expectations to firms, consumer organisations and stakeholders, especially during the implementation period, for which timeframe is set out below, of the consumer duty.

The FCA will also monitor and support firms during the implementation period and, when the duty is in force, will identify practices that do not meet its expectations and will take action, such as requirement or variation of permission powers.

In case of serious misconduct by firms against the duty, the FCA will investigate and, when deemed necessary, will use its deterrent and remedial powers, such as issuing fines against firms and requiring actions to compensate harms suffered by customers as result of not complying with the duty.

In April 2022, the FCA published a set of metrics, which will be further developed and updated throughout 2022/23 to assess its accountability. These metrics include four consistent topline themes expected from firms: fair value; suitability and treatment; confidence; and access. The first two themes are similar to the expected outcomes of the Consumer Duty; in particular, they apply in the following manner:

• Fair value – to establish whether consumers receive fair prices and quality.
• Suitability and treatment – to establish whether consumers are being sold suitable products and services and receive good treatment

Deadlines and next steps

Implementation deadlines:

• October 31, 2022: firms should have implementation plans to comply with the new standards.
• April 30, 2023: manufacturers should have completed reviews to meet the results rules. Manufacturers are firms “that create, develop, design, issue, operate or underwrite a product or service”. Regulated activity or activities connected to providing a payment service or issuing e-money are considered to be services being manufactured.
• July 31, 2023: rules start to apply to new and existing products or services that are open to sale or renewal.
• July 31, 2024: implementation deadline for closed products or services. A closed product is a product “where there are existing contracts with retail customers entered into before July 31, 2023 and which is not marketed or distributed to retail customers (including by way of renewal) on or after July 31, 2023”.

More detailed outcomes and data are expected to be gathered by the FCA, including at sector level, to assess the compliance status across the concerned industries. The FCA will collect data from firms and will use publicly available sources, as well as its existing data.

Conclusion

The FCA has identified, via reviews of the financial markets, poor practices (such as sludge practices) and situations where the consumer is in a lesser position in respect to the firm, such as a weaker bargaining position, asymmetries of information, consumer inertia or lack of understanding or behavioural biases. These practices and situations have led the FCA to develop a new Consumer Duty, which will enter into force on July 31, 2023, with the intention of applying a more outcome-focused approach than prescriptive rules to ensure customer protection. In the meantime, firms have been required to develop implementation plans by October 31, 2022 and to complete reviews by April 30, 2023.

The Consumer Duty sets the FCA’s expectations from firms, such as acting in good faith and preventing foreseeable harms to consumers. The FCA has stated that it will monitor the status of compliance with the duty and it will engage with firms during the implementation period to support them. However, after the entry into force of the duty, it will take actions, including issuing fines, where it deems that firms have breached their obligations under the duty.