We now take a more detailed look at one of the proposed new powers for the Financial Conduct Authority (FCA) which has the potential to impact on the claims environment of regulated firms.
Product intervention powers
In early 2011 the FSA released a discussion paper inviting feedback on the critical issue: when should the FSA intervene in the financial product chain and what should those intervention powers be? The FSA's traditional approach to this issue was based on the underlying assumption that most retail financial products are suitable for some customers. Consequently, regulation has focused on the point-of-sale, covering aspects such as promotions, disclosure and selling practices. However, in recent years and in light of repeated and significant retail mis-selling scandals, the FSA concluded that this approach alone was not providing the right level of consumer protection.
It is now proposed that new product intervention rules (which are intended to complement, not substitute, the existing rules relating to the assessment of suitability at the point of sale) will give the FCA the ability to limit or prohibit the marketing of products. Rules may require certain product features to be included, excluded, or changed, promotional materials to be amended, or restrictions (or in serious cases, a ban) imposed on sales or marketing of the product .
The FCA may also make provisions that specify the consequences of contraventions of the product intervention rules. The penalties for contravention could include:
- An agreement (or part of an agreement) is deemed unenforceable against a person
- The recovery of money or property paid or transferred by a person
- The payment of compensation for any loss sustained
Such penalties will not be able to be applied retrospectively, rather only to sales or agreements entered into after the rule came into force
One of the most significant aspects of the new power is that, if the FCA decides to apply product intervention rules to a particular product, it will not be required to consult on the proposed rules (or prepare a cost-benefit analysis) before implementation if the FCA considers (i) that the delay involved in public consultation would be prejudicial to the interests of consumers and (ii) the decision to make the rules is in line with advancing its consumer protection or competition objectives.
Where the powers are exercised without consultation, these are referred to as "temporary" product intervention rules. This is because they must cease to have effect within 12 months of the day on which they come into force, albeit the FCA can revoke the rules before the 12 month period expires. However, it may not make further temporary product intervention rules which are substantially the same within a year of expiry. If the FCA is seeking to make product intervention rules which apply for longer than 12 months, these must be consulted on.
In April 2012, the FCA published a draft policy statement setting out how it proposes to implement its new product intervention powers on a temporary basis. This document was prepared to assist Parliament whilst considering the Bill and, while it is likely to be amended and refined going forward, the key points to note from this draft statement are:
- How the rules will be made: The FCA will discuss any proposed rule with the Prudential Regulation Authority (PRA) and give their comments due weight and consideration'. The decision to make any temporary product intervention rules will be taken by the FCA Board, which will then publish a statement to include the rationale behind the rules, together with details of next steps. The FCA may review, revoke or amend any such rule at any time it is in force
- Relevant considerations: When considering whether to introduce temporary product intervention rules, the FCA will have regard to whether the rules would be appropriate and effective in addressing consumer detriment, as well as being proportionate and beneficial. The FCA must also consider the scale of detriment to the market and any specific classes of people affected and also the six principles of good regulation which are set out elsewhere in the Bill
- Usage: Temporary product intervention rules may be used where products: (i) are being sold outside their target market or are generally unsuitable for the target market; (ii) involve a significant incentive for inappropriate targeting of consumers (for example, in relation to its commission structure); or (iii) is considered inherently flawed (for example, offers such poor value or has such disadvantageous features it is unlikely to be of benefit)
Past mis-selling case studies
The draft policy statement was accompanied by three examples of how the proposed product intervention powers might have been utilised in respect of previous market issues:
- Single premium payment protection insurance (PPI): The proposed product intervention rules appear to have been informed and influenced in a significant way by the regulatory experience and response to the PPI mis-selling scandal. PPI products involved a number of detrimental features such as barriers to switching providers, lack of transparency (for example where single premium PPI was added to the loan amount), disproportionate commission structures and poor point of sale disclosure. Indeed, some categories of customer were ineligible to make a claim (for example, the self-employed). It is suggested that temporary product intervention rules could have been used to apply a cap on the maximum profit at a level equivalent to other general insurance products or on remuneration on sales of single premium PPI for a one-year period
- Structured capital at risk products: SCARPS are structured investments which were heavily marketed to retail customers in the late 1990s/early 2000s. At the time, regulators adopted a disclosure-based approach to address issues surrounding transparency and quality of information provided to consumers, but this was unsuccessful as it could not address risks relating to product design and distribution. It is suggested that temporary product intervention rules could have been used to prevent SCARPs from being sold without advice, possibly also applying a requirement for additional scrutiny of the customer's attitude to risk
- Mortgages: In 2009, the FSA indicated that it was considering prohibiting certain combinations of high-risk indicators (for example, impaired credit history, irregular income, high debt to income ratio, etc) in mortgage products which present an undue risk of consumer detriment. While this was never followed through, it is suggested that temporary product intervention rules could be utilised to address such an issue by, for example, introducing a temporary rule preventing sales of mortgages to consumers deemed to be at highest risk as means of reducing the risk of consumer detriment while longer term solutions are considered or consulted on
To what products might these powers be applied going forward?
Assuming that the proposed new product intervention rules survive Parliamentary scrutiny and remain in the Bill when enacted, to what products might they be applied once the new regime is operational?
Each year, the FSA publishes a number of reports identifying the risks it perceives to the UK financial services market in the coming 12-18 months. These publications are incredibly helpful in terms of identifying likely claims themes for regulated firms. The Retail Conduct Risk Outlook published in March 2012 focused particularly on the growing complexity in retail investment products and services, which the FSA believes are more likely to be mis-sold than traditional or vanilla financial products. In particular, the FSA identified the following as products of concern:
- unregulated collective investment schemes (UCIS)
- absolute return funds
- traded life policy investments (a type of UCIS commonly referred to as "death bonds")
- exchange traded products
The FSA also highlighted concerns about product bundling due to issues in and around transparency.
It is important to note that, in anticipation of these new powers, the FSA has already started to take steps towards more aggressive and earlier intervention, albeit it is still constrained by the need to consult in most circumstances. This is particularly illustrated by FSA guidance in April this year that traded life policy investments are high risk products that should not be promoted to the vast majority of retail investors in the UK.
UCIS - a taste of things to come?
UCIS are not subject to the same investment limitations as regulated collective investment schemes and, as a result, they are generally considered to be a high-risk investment as the assets they invest in can be volatile and illiquid. While many UCIS are designed for institutional investors, the FSA has found that some are being sold to categories of retail investors for whom such products are viewed as inappropriate. This is despite rules being in place which limit the promotion of unregulated schemes to the general public in the UK other than to certain specific categories of investor. Indeed, in a 2010 review of UCIS sales, the FSA found that only 25%, appeared to be suitable for the customer. Purchasers may not be covered by the FOS or FSCS if the product experiences problems. This is not a small issue with limited consumer impact; rather, in 2011 the FSA estimated that the UCIS retail market in the UK was worth approximately £2.3 billion.
Enforcement action has so far been taken by the FSA against seven firms and 13 individuals (predominantly for failing to comply with the financial promotion rules or rules on suitability of advice) and, to date, financial penalties to the tune of £300,000 have been imposed. In some cases, regulatory permissions have also been removed.
In June 2012, the FSA issued over 250 supervisory letters to UCIS providers and distributors. These required an attestation from the firms' compliance officer that adequate systems and controls to manage UCIS-related risks were in place.
In addition, the FSA is currently consulting on proposals to ban the promotion of UCIS and similar products to the majority of retail investors in the UK. The proposed rules would allow for promotions aimed at a more limited audience of sophisticated investors and high net worth individuals for whom UCIS are deemed to be more suitable. Products that pose similar risks to UCIS, such as qualified investor schemes and pooled investment special purpose vehicles, will likely also be caught by the new rules. The deadline for responses to the latest FSA paper is 14 November 2012 and final rules are expected in the first quarter of 2013.
In the context of UCIS we have seen the FSA utilise many different approaches and powers including thematic reviews, consumer warnings, enforcement action, additional compliance requirements and now a consultation on rule changes which will significantly limit their sale in the retail context. It is clear that the FSA (and soon, the FCA) intend to come down hard on practices which may and do give rise to consumer detriment and the proposed new product intervention powers will facilitate a speedier regulatory response to actual and potential consumer detriment.
While this is a laudable aim, there is concern that temporary intervention powers could be applied in a way which, on the one hand addresses poor performing firms, but at the same time negatively impacts on compliant firms and compliant product sales. If a temporary intervention rule is introduced, and subsequently significantly amended or revoked, one can see how this might encourage complaints from consumers about sales which they would not otherwise have complained about and/or about sales which were in truth compliant.
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