Is the Consumer Duty the way forward for the regulatory framework?

Bruce Stephen and Lindsay Lee
Brodies LLP

FCA regulation is a jigsaw puzzle of high-level principles, required outcomes, and detailed mandatory rules.

Within that jigsaw the Consumer Duty is the FCA's flagship outcomes-focused regulation piece.

The risk with the current state of affairs is that there is potential for inefficient duplication and inconsistency across the different pieces of the regulatory puzzle and a lack of clarity of how the Consumer Duty pieces fit with the other more detailed mandatory rules. In its Call for Input the FCA is seeking views on this and how far the Consumer Duty should be swapped in place of specific rules and guidance.

The Consumer Duty has been in place for over a year for open retail products and services, and has recently been extended to closed offerings. In contrast to many of the FCA's more prescriptive rules which are targeted at preventing particular harms, the Consumer Duty is focused on outcomes rather than processes. It requires firms to deliver good consumer outcomes in four areas - products and services, price and value, consumer understanding and consumer support - but does not specify the detail of how firms go about doing that.

The Call for Input teases out some of the arguments for and against high-level, principles-based regulation compared with more detailed mandatory requirements under rules and guidance. It also raises the possibility of a hybrid approach.

Why might high-level rules be more appropriate?

High-level rules are flexible, adaptable to changing conditions and allow firms to tackle harms and deliver good outcomes within the context of their own businesses. By contrast, detailed prescriptive rules can be complex and can struggle to fully address ever-changing drivers of harm and new product developments.

Where a 'tick-box' approach to detailed rule compliance can lose sight of the spirit of the rules, high-level rules focused on outcomes can promote a wider compliance culture. The Consumer Duty makes delivering good outcomes a business-wide issue, engages senior managers and gives regulatory compliance a strategic role.

For firms comfortable and confident in making subjective decisions around compliance without the structure of detailed rules, the Consumer Duty can be empowering; those firms can determine how they deliver good outcomes and develop internal processes and strategies, and products accordingly. In this way, outcomes-focused high-level principles can promote innovation and competition.

Or are detailed rules the better approach?

Detailed rules can provide more certainty, transparency and consistency for both consumers and firms.

Regulation based on high-level rules supplemented by guidance can make compliance harder, particularly for small firms and new entrants, given the level of investment required in assessing customer needs and then continually monitoring to ensure any changes to those needs are identified with consequential changes to the product and customer journey potentially.  Interpretation risk can also be higher for outcomes-focused rules. The Consumer Duty offers flexibility of compliance but requires firms to have developed an interpretation of the rules and what they mean for their business, so they can make subjective decisions around compliance.

High-level rules can simplify and reduce the length of the FCA's rules, but the related supporting guidance can be extensive. For new entrants, reviewing and becoming familiar with the Consumer Duty requirements as they appear in the FCA Handbook together with the full supplementing suite of guidance, good and poor practice examples, post-implementation reviews, speeches, webinars and Dear CEO letters requires a level of resourcing which could stretch budgets for product implementation.

While high-level rules may have more durability and require fewer amendments as conditions change, they can also take longer to implement than detailed rules, which can mean a larger consumer harm risk window.

What about a hybrid approach?

A hybrid approach would involve relying on the outcomes-focused Consumer Duty to an extent but also keeping more detailed rules where they give a more effective or clearer regulatory position. In many ways the hybrid approach is where we are at the moment but the aim would be to remove some of the unnecessary duplication and any potential inconsistencies.

What happens next?

It seems likely that the next step in the FCA's shift towards high-level rules will result in a hybrid regulatory approach with a larger relative number of high-level rules and ideally a rationalisation of the more detailed mandatory rules.

While some firms might view this as the best of both worlds, blending the advantages of outcomes-focused rules with the certainty of detailed rules where risks of harm are greatest, others may be disappointed by a perceived failure to grasp the nettle and commit more fully to high-level rules. Other firms will be concerned about the impact that even a small further shift to high-level rules will have on their compliance costs as they have to deal with yet more imprecise rules accompanied by yet more lengthy guidance that require considerable thought and interpretation for their businesses.

The next steps are likely to be complex. For each detailed rule where there is an identified Consumer Duty overlap and for each detailed rule that is earmarked for a replacement by an outcomes-focused rule, the aims and benefits of the detailed rule will need to be assessed in the context of avoiding harm.  Further work will also be required to iron out identified uncertainties around how the Consumer Duty and other FCA rules fit together.

The Call for Input closes on 31 October 2024 and the FCA will engage further on next steps later this year.

Bruce Stephen is a partner and Lindsay Lee is a senior associate in banking and finance at Brodies LLP.