The New "Consumer Duty" For UK Financial Services Firms

The FCA has proposed a new "consumer duty" that will apply to most firms it supervises where products and services are offered to ‘retail customers’. In effect, the FCA says the duty will amount to a higher statutory standard of care for consumers than results from the FCA's current set of Principles for Business and conduct rules. It is intended to stop short of being an actual statutory or general law "duty of care", even though the standard is said to reflect the common law concept of how 'a reasonable prudent firm would act'; and it will not create a fiduciary duty or advisory obligation where one does not already exist. I guess 'cakeism' is not confined to Downing Street! Final rules are due by 1 August 2022 and firms should have until 30 April 2023 to fully implement the changes needed to comply (but will need to be able to demonstrate their progress toward implementation when asked). The scale of change should be 'seismic' - like simultaneously preparing for 'Treating Customers Fairly' and the Senior Managers and Certification Regime while trying to run a business (or changing all four wheels on a race car, mid-corner). But whether it will actually deliver better outcomes for consumers remains to be seen... Please let me know if you would like any help.

Scope of the Consumer Duty

As explained further below, the consumer duty will be delivered in a framework of three elements: a new 'consumer principle'; some 'cross-cutting rules'; and 'four outcomes'. 

A concept of "reasonableness" will apply to all three elements. This is intended to create an 'objective standard of conduct' that could reasonably be expected of a prudent firm which carries on the same activity in relation to the same product or service; and with the necessary understanding of the needs and characteristics of its customers (based on the needs and characteristics of an average customer). Factors that can influence what is reasonable include:

• the nature of the product or service being offered or provided;
• the nature of the firm’s role and relationship with customers; 
• the potential of the product or service to harm consumers (higher risk means additional care); 
• the complexity of the product or service (again, more complex products and services involve extra care); 
• the role of the firm in the distribution chain; 
• the reasonable expectations of consumers, based on the nature and quality of the product or service as presented and previous interaction with consumers;
• the specific characteristics of consumers, recognising and responding to their diverse needs, including vulnerability or protected characteristics.
  

The scope of the 'duty' will be the same as the current 'conduct of business' rule books or other applicable regulation (e.g. for payment services); and exemptions from financial promotions rules, for example. Firms in a chain will need to agree where their responsibilities meet.

The Consumer Duty applies to products and services offered to ‘retail customers’, as defined within the scope of the FCA Handbook in each sector. For example: 

• consumer credit: the Consumer Duty applies to all regulated credit-related activities;
  
• deposit-taking: the duty applies to consumers, micro-enterprises and charities with a turnover of less than £1m (in line with the banking customer test);
  
• insurance: the duty follows the position in the Insurance Conduct of Business Sourcebook (ICOBS), so does not apply to reinsurance or contracts of large risk sold to commercial customers;
  
• investments: the duty applies to business conducted with retail clients as defined in the Conduct of Business Sourcebook (COBS);
  
• mortgages: the duty follows the position in the Mortgage Conduct Business Sourcebook (MCOB), so applies to all regulated mortgage contracts, but not, for example, unregulated buy-to-let contracts or commercial lending. Where the owner of a mortgage book is unregulated but a regulated firm is the loan servicer, the Consumer Duty would apply 'in an appropriate and proportionate manner to their function';
  
• payment services: the duty applies to business conducted with consumers, micro-enterprises and charities in line with the Payment Services Regulations 2017 (so will not apply to the extent that certain rules can be contracted out of for larger corporate/charity customers, for example).

There are some exclusions, but the duty can apply to prospective customers as well as unregulated activity that is ancillary to regulated activity. 

Firms will need to take additional care to ensure vulnerable consumers achieve outcomes that are as good as those of other consumers. 

Framework of the Consumer Duty

A new consumer principle: The FCA will add a 12th Principle for Business ("A firm must act to deliver good outcomes for retail clients"). This is considered to be a higher standard than "A firm must pay due regard to the interests of its customers and treat them fairly" ('treating customers fairly" or 'TCF'). While this overarching standard of conduct is 'clarified and amplified' through 'cross-cutting rules' and four (non-exhaustive/exclusive) 'four outcomes' it must be judged on its own, in terms of what is reasonably expected given the nature of the firm's role and the product or service it offers. 

Cross-cutting rules: Firms must: 

• Act in good faith (characterised by honesty, fair and open dealing and consistency with the reasonable expectations of consumers);
  

• Avoid causing foreseeable harm to customers (including taking proactive steps to avoid it where that is within the firm’s control);
  

• Enable and support customers to pursue their financial objectives (establishing an environment in which consumers can act in their own interests; understanding consumers’ behavioural biases and the impact that their vulnerability can have on their needs; using their knowledge of how consumers behave to enable and support them to make good decisions). 

The “four outcomes”: 

• the quality of firms’ products and services: these must be 'fit for purpose'; designed to meet consumers’ needs; and targeted at the consumers whose needs they are designed to meet, with different requirements for firms depending on their role in the distribution chain as 'manufacturers' and/or 'distributors';
  

• the price and value of products and services: the FCA wants both manufacturers and distributors to ensure the pricing represents fair value to consumers and to regularly assess that outcome;

• consumer understanding: firms’ communications must consistently support consumers by enabling them to make informed decisions about their products and services, giving consumers the information they need, at the right time, and presented in a way they can understand. Communications must be clear, fair and not misleading, as well as tailored in various ways, accurate, relevant and timely; and
  

• support for consumers: must meets consumers’ needs throughout their relationship with the firm, to enable them to realise the benefits of the products and services they buy and ensure they are not hindered from acting in their own interests. 

Impact of the Consumer Duty

The impact of the Consumer Duty will be enormous on an industry that tends to see compliance as a bolt-on to commercial operations and a cost-centre rather than an inherent part of product development lifecycle, even if policies, processes and procedures incorporate the concept of 'Treating Customers Fairly' and require legal/compliance checks and approvals.

The FCA expects firms to consider and determine what behaviours, policies, procedures, monitoring and feedback/reporting is necessary for them to satisfy the Consumer Duty - and be able to demonstrate how they have implemented the duty. 

Firms will need to be proactive and show that their focus is on consumer impact/outcomes rather than the firm's own compliance processes; and acting reasonably, rather than merely 'taking all reasonable steps' to comply with the duty and related rules.

The FCA expects senior managers to be responsible for ensuring the Consumer Duty is met across any business areas that they are responsible for, rather than mandating one senior manager as solely responsible under the Senior Managers and Certification Regime (SM&CR). There will be a new rule requiring all conduct rules staff within firms to “act to deliver good outcomes for retail customers” where their firms’ activities fall within scope of the Consumer Duty. 

In these circumstances, it would seem that the implementation process will be similar to preparation for the introduction of 'Treating Customers Fairly' principle as well as SM&CR, but the FCA will expect  to see more evidence of the impact of the higher standard both culturally and in terms of changes to organisation, policies, processes and procedures. 

The scale of change should therefore be 'seismic'. But whether it will actually deliver better outcomes for consumers remains to be seen... 

Please let me know if you would like any help.

 

A Quick Guide To Carbon Credits And Why DLT/Blockchains May Help

Fans of 'net zero' and 'cryptoassets' alike need to get to grips with developments in the markets for carbon credits, as recently explained in the ISDA paper on the legal implications of voluntary carbon credits ("VCCs"). Voluntary emission reduction/removal schemes are those not mandated by law - so there's no fine or penalty system as there is for EU allowances trading scheme, for example. ISDA recommends that VCCs should be recognized as a form of (intangible) property in each jurisdiction, just as the UK Jurisdiction Taskforce’s statement on the status of crypto assets and smart contracts provided legal certainty under English law that cryptoassets are capable of being owned. Distributed ledger tech/blockchains also seem apt for recording/tokenising/trading VCCs as their state/status may change often, and that will be of interest to many stakeholders in different countries, running different software/systems... but I appreciate that's a lot to take in/on!

What are VCCs?

VCCs are issued under certain non-statutory standards by, say, an industry body, to certify the reduction or removal of carbon dioxide from the atmosphere (one VCC means the relevant body has certified that one tonne of CO2 has been reduced or removed ("one tCO2e")). The VCC might be 'cancelled' or 'retired' and included in the accounts of the original project operator to meet its own emissions reduction obligations or sold buyers who book them as a way of neutralizing their own emissions. In the case of a sale, the revenues generated help fund either the original or subsequent reduction/removal project. A cancelled/retired VCC is removed from circulation, just like the carbon it represents. While not subject to a statutory regime, some VCCs may be recognized for statutory compliance so the distinction between 'mandatory' and 'voluntary' credits is blurring. There remains a distinction between a VCC that qualifies for compliance in a mandatory scheme (making it a distinct legal instrument) and one that can be swapped for a mandatory unit (merely facilitating compliance with the scheme using the mandatory units, but at least 'recognized).

Challenges

Quality/Standardisation: concerns over 'greenwashing' mean the quality of the underlying project affects the quality of the VCC. Buyers focus on the project methodology used to generate the VCCs and the impact of projects. Standardization is therefore challenging. 

Double Counting: It's critical to avoid the benefit of the carbon reduction corresponding to the VCC being claimed more than once (e.g. a VCC sold to a third party for offsetting also being used to avoid the obligation to purchase carbon credits; or where different schemes cover the same activity (renewable energy certificate and carbon offset). 

Pricing: a lack of reliable, transparent price discovery means buyers have little comfort they are paying the right price and sellers may struggle to fund projects. 

Article 6 of the Paris Agreement/COP26: this aims to establish a new international carbon market, whereby countries set their own contributions through the trading of emissions reductions (internationally transferred mitigation outcomes ("ITMOs")). Countries could purchase emissions reductions from others who've already met their target. There are rules on ITMO transfers; the potential to link emissions trading schemes; a process for trading carbon credits from emissions-reduction projects; a framework for cooperation with inactive countries (e.g. through development aid).  The implications for VCC markets will be clearer after the rules are further developed (e.g. whether VCCs should be treated as ITMOs) but this complexity will likely reduce the supply of VCCs, ease of transacting and liquidity in the near term. 

Fragmentation: The fragmented nature of the VCC markets by geography and different schemes, registries, carbon standards, methodologies, and VCCs themselves hampers standardization and the development of an effective, liquid market.

Legal Treatment: the legal nature of VCCs differs in that they can be viewed as intangible property in one jurisdiction but a 'bundle of contractual rights' in another. That means different rules for how VCCs can be created, traded and retired; how security is taken and enforced; and how VCCs would be treated on insolvency. In theory, there are several potential different jurisdictions whose laws could apply to a VCC: the jurisdiction of the register in which the VCCs are recorded; the jurisdiction of incorporation of the registrar; the governing law of the carbon standard rules and/or registry rules; and/or the law of the location of the project from which the VCCs are generated.

Steps could be taken in national legislation and international treaty to resolve differences. Distributed ledger technology (DLT) could record VCCs in the ledger where digital assets are considered intangible property. For instance, in the context of the EU Emissions Trading regime, the German Emissions Trading Act (TEHG) provides that if EUAs are registered in a person’s account, the account is deemed to be correct and that person has legal title to the EUAs; and the EU Registry Regulation provides for legal ownership of allowances and the finality of transactions.

Importantly, the legal status of a VCC as an asset in itself is distinct from the legal treatment of a transaction in relation to that VCC, so an instrument used as the basis for a transaction relating to a VCCs could be subject to financial regulation (e.g. a listed future, an OTC forward or option or a unit in a collective investment scheme), even if the underlying VCCs themselves are not considered regulated financial instruments.

Fungibility: to aid the development of a liquid market, VCCs should be interchangeable for the purposes of satisfying transfer obligations between traders. This is not a feature of the asset itself but the context. Banknotes are fungible to satisfy payment obligations, but are not fungible for tracing purposes (each note is serialized). A unique serial number does not preclude a VCC from being fungible, so the issue is whether and why the market will treat different VCCs as interchangeable for the purposes of settlement/delivery [this raises interesting questions as to whether/when non-fungible tokens (NFTs) might actually be 'non-fungible'...]. Fungibility of VCCs depends on:

• Commonality of unit of measurement: each VCC corresponds with one tCO2e reduced or removed;
  
• market acceptance of common standards for vetting the approval and verification of VCC-producing projects, at least by an agreed approach to segmenting the market as a whole;
  
• Adherence to generalised carbon standards and registry rules, as opposed to only specific registry rules. interoperable registers;
  
• Locating registers in jurisdictions that provide clarity over the legal treatment of VCCs;
  
• Targeted legislative amendments in jurisdictions where elements of the VCC lifecycle are dependent on a local statutory regime (e.g. what rights do traders, non-debtor counterparties or the holders of securities have against each other or intermediaries acting for either participant in the event of insolvency in a particular jurisdiction).
  

Conclusion:

ISDA recommends that VCCs should be recognized as a form of (intangible) property in each jurisdiction, just as the UK Jurisdiction Taskforce’s statement on the status of crypto assets and smart contracts provided legal certainty under English law that cryptoassets are capable of being owned. 

Distributed ledger tech/blockchains also seem apt for recording/tokenising/trading VCCs as their state/status may change often, and that will be of interest to many stakeholders in different countries, running different software/systems...

That's an awful lot to take in/on!