This guide is subject to UK law and was last updated on 7th February 2011.
How far should a financial regulator be allowed to interfere with product design and price in the interests of protecting consumers?
This is the key question posed by the Financial Services Authority (FSA) in a discussion paper published on 25th January 2011.
More specifically, should the regulator intervene earlier to ban financial products or certain product features before they can cause harm to consumers? Should new products have to be pre-approved and what controls, if any, should there be over how much they cost?
Traditionally, the FSA has concentrated on the rules governing conduct at the point of sale rather than questioning the way products are designed. But, the discussion paper admits, this approach has not been sufficient to prevent large-scale mis-selling of pensions, endowments and payment protection insurance in the past.
Early in 2010, the regulator adopted a more interventionist strategy, aiming to step in earlier in the product life cycle in order to identify and mitigate potential problems before they cause widespread consumer detriment.
The FSA now wants to open up a public debate on how far it (and, in future, the proposed Consumer Protection and Markets Authority) should be allowed to go. Under Government plans for financial services regulation, the CPMA will take over as conduct regulator and consumer champion by the end of 2012.
In his foreword to the discussion paper, FSA chairman Lord Turner said the suggestions being put forward range from introducing more prescriptive requirements for firms when they are developing new products to specific product interventions. "The crucial issue is how far along this spectrum of earlier and more intense interventions we should progress," he said.
"This debate comes at a critical time as the scope and powers of the CPMA are being discussed by the Government, Parliament and stakeholders. It is fundamental to shaping the regulatory philosophy of the new organisation."
Lord Turner comments: "Our analysis has led us to the conclusion that a significant shift in approach is required but there are important tradeoffs to be struck – between consumer protection and consumer choice, between effective regulation to prevent customer detriment and the costs that that will inevitably impose."
The paper proposes tightening up existing guidance on firms' product "governance" - the procedures they have in place to ensure their products are designed and distributed in a way that ensures firms are treating customers fairly.
Current guidance (the "Responsibilities of Providers and Distributors for the Fair Treatment on Customers Guide", or RPPD) could be upgraded to rules. In addition, new, more prescriptive rules could be introduced to make sure products are better targeted and designed to mitigate risks to the customer, that any charges are reasonable and that the products are distributed in such a way as to guard against mis-selling.
New rules might also impose ongoing duties on provider firms to ensure that products are actually reaching the intended market and to consider what should be done if they are being sold more widely than expected.
The sort of products that would be affected would be financial contracts for retail customers – such as bank accounts, general insurance, mortgages, investments and pensions. The paper. however, asks whether a similar approach should be taken to services such as online platforms and discretionary management services.
The paper puts forward for discussion a range of possible interventions, from the most to the least intrusive. At the top end of the scale is product pre-approval - whether the regulator should approve all new products before they enter the market.
In addition to the massive resourcing implications for the regulator, this would add significant delay and costs to product development and is likely to stifle innovation. In short, the FSA questions whether acting as product gatekeeper would be practical or desirable.
But it suggests there may be a case for pre-approving specific products where it has particular concerns. Alternatively, there could be some sort of pre-notification requirement for certain types of product or for specific firms.
This, the paper suggests is likely to reduce customer choice: "However, as part of a new financial services regulatory philosophy that tolerates fewer product failures, this might be inevitable," it states.
"It is important for the industry and society to offer views and expectations on how the market should be regulated and where the correct balance lies between choice and consumer protection."
The next option is banning certain products altogether - or alternatively banning or mandating certain product features. This might include setting minimum standards.
The paper acknowledges that blanket bans may simply result in products being cleverly designed to avoid the prohibition, while those that are not banned may be perceived by consumers as having been specifically "approved" by the regulator.
"However, because product bans will be extremely effective in rapidly stopping consumer detriment, we believe they are a tool that should be considered in future, in appropriate circumstances," the paper concludes.
There are already rules relating to excessive charges in some parts of the market. But the paper asks whether there should be a specific requirement for firms to ensure their charging structures are appropriate for the product and its target market and whether they should have a duty to identify the point at which a product ceases to provide value for money.
Significantly, the regulator does not rule out price capping in future: "Price capping is the most radical price intervention and would involve us making difficult judgments about the appropriate price we regard as consistent with good consumer outcomes," the paper states. "However, we consider that it is an option that should remain open."
If price caps are used, the FSA says they would be an interim measure in extreme circumstances, until a more long-term solution could be found.
Another option is whether there should be a duty to benchmark advice against a low-charged suitable substitute product.
There is already a rule, known as RU64 which requires advisers recommending a pension that is not a stakeholder pension to explain in writing why the recommended policy is at least as suitable as a stakeholder pension.
The paper asks whether this approach should be extended to advised sales of certain other products, possibly using the Treasury's proposed range of simple financial products as benchmarks.
Other, less intrusive interventions put forward in the paper include increasing the prudential requirements on providers to reflect the risk to consumers posed by different products, making greater use of consumer and industry warnings and specifying products that cannot be sold on a non-advised basis.
Bruno Geiringer, an insurance Partner at Pinsent Masons, the law firm behind OUT-LAW.com, said:
"Whilst the FSA is not proposing to adopt product pre-approval, some of the other forms of intervention may be justified, such as banning the distribution of certain products through non-advised channels.
"This approach, if implemented, would be consistent with the recent MiFID consultation. But it would cut right across the proposed strategies of some banks that are closing their advice outlets and looking more towards online direct sales."
Geiringer added: "Long-term insurance products can be difficult for consumers to understand and compare. Advice should reduce the information asymmetry between the provider and the consumer. The problem is that current advice services are not working well, hence the reforms being implemented under the Retail Distribution Review."
"There is a great deal of potential change on the financial services horizon at the moment, all of which will have a significant impact on insurers' compliance and legal risk. Responses to this paper need to be taken very seriously and considered carefully at the very top of the insurance industry."
Comments on the discussion paper should be submitted to the FSA by 21st April 2011.
Contact: Bruno Geiringer ([email protected] / 020 7418 7306)
See: the Discussion Paper (75-page / 587KB PDF)