Flavour of the year: messages from recent thematic reviews

FCA appears, on the face of it, to have been relatively quiet of late. Its main activities have ostensibly been those forced on it by the need to implement key EU legislation, not least MiFID 2, the IDD and PSD2. There have been many speeches on FCA's approach to regulation, the importance of culture and conduct and, of course, Brexit. But there has been relatively little by way of consultation and policy papers and enforcement actions.

It would be dangerous, though, to assume FCA is not busy. In this article, written for Compliance Monitor and published in April 2018, Emma Radmore looks at the messages from some recent thematic reviews (whether or not by that name) and what we might expect over the coming months.

Fair treatment of existing interest-only mortgage customers

The only Thematic Review published under the banner "TR" so far in 2018 relates to how lenders have been treating their customers who have interest-only mortgages since FCA's last deep-dive into the area some five years ago. FCA had identified fair treatment of these customers as a risk in its 2017/18 Business Plan, as the numbers of customers with this type of mortgage now reaching maturity is increasing, while fewer lenders now lend on this basis.

The findings of the review were, on the whole, positive. FCA found lenders were contacting customers to establish their repayment plans and provide appropriate guidance when the customer needed it, and that they were contacting customers regularly. It also found the lenders understood their books and provided a wide range of options and flexibility for customers struggling to repay.

One area that could be improved is earlier and more effective engagement with customers. Firms that managed to engage early could offer customers a better range of options, but many reported customers did not want to engage. Some firms used unqualified staff to "triage" customers, which FCA found could mean that some customers who would have benefited from advice did not receive it.

FCA acknowledged that consumers should take responsibility for managing their repayments and that lenders are not obliged to help them find solutions. It has also taken some initiative itself by publishing a consumer information leaflet to encourage borrowers to talk to their lenders. But, still, it noted some ways in which some lenders within its sample could improve the way in which they engage with their customers and better meet the expectations of Principle 6. FCA did not feel the need to amend its existing guidance (FG13/7), but did include examples of good and poor practice in its review document.

Customer Understanding: Retail banks and building societies and Strategic Review of Retail Banking Business Models

FCA's previous Thematic Review came six months earlier, and followed a similar concern, but in a different business sector. This review looked at what banks and building societies did to assess the levels of customer understanding of the products and transactions their providers offered – again, with a view to ensuring the firms met the expectations of Principle 6.

Again, this review followed up on a previous review. Again, FCA found an improvement in how firms worked to assess customer understanding in both advised and non-advised sales. FCA found all firms had been making changes to address the PCBS recommendations and identified areas of good practice that it urged other firms to follow. It will use the review to inform its ongoing Strategic Review of Retail Banking Business Models.

The Strategic Review was launched in April 2017 and has three main aims:

• For FCA to understand retail banking business models in greater depth
• For FCA to understand how "free-if-in-credit" banking is paid for
• For FCA to understand the impact of changes and the potential consequences for its objectives. It noted particularly the reduced use of branches and the increased use of digital services.

FCA has developed a series of hypotheses which it plans to explore. Among its areas of focus are:

• Assessing whether developments such as Open Banking and digitalisation are eroding the importance of the Personal Current Account as an anchor product and the gateway to cross-selling of other products. FCA is concerned that if customers move their PCAs banks may no longer be able to use them to fund longer term lending. As an allied point, FCA is looking into how business bank accounts work attractively, as they do tend to levy charges.
• The tendency of consumers to stay with the same provider and product for years, meaning the provider does not have to offer incentives to stay. As a result many providers have a back book of accounts at unattractive interest rates, and mortgages with rates not as good as they could be. Because of this behaviour, challenger banks find it harder to grow their market share as they have no lucrative back book against which to offset attractive "front book" rates.
• The problem of unsecured consumer credit, which FCA says has reached pre-financial crisis levels with the clear consequence that, if consumers are going to be unable to repay these debts, there will be implications for banks' profitability. FCA wants to understand the levels of exposure to sub-prime or non-standard credit risks.
• How banks are investing in technology and whether it is effectively combating the risks they face from increasing intermediation and advice meaning customers are more likely to switch products more often. FCA is particularly concerned about the effects on vulnerable consumers of changes.
• Understanding how bank capital requirements affect the business models of different banks – FCA will be looking, for example, at the implications of the leverage ratio on banks with high volumes of low-risk mortgage lending, and the need for some banks to hold significantly higher capital than their competitors.
• Returning to PCAs, FCA is keen to establish whether vulnerable PCA customers are particularly profitable for banks and whether this creates consumer protection issues if, for instance, these consumers use unsuitable products.

FCA's work is well underway and a further report is expected before the summer.

Retail banking: product governance review

Linked to these studies is the latest review in FCA's product governance work. In March it published the result of its review into how well banks consider customers' needs when designing and selling products and in in their after-sales services. It wanted to assess how firms identify and respond to risks whether arising from customer needs or external factors, how their product governance frameworks challenge risk management assumptions and how the reviews identify potential harm to consumers and provide effective management information and use customer feedback.

The review did not focus on compliance with specific rules but rather looked at how the overall culture of the firm was embedded in the product governance framework.

FCA found several good practices had emerged, for example:

• All the firms in its survey had product-focussed committees
• Senior managers were involved in the decision-making process and were clear on their lines of accountability
• Firms understood the need to cover all stages of a product's life cycle and worked to continually improve their frameworks
• While product design processes were usually established and embedded, some firms could work more on review processes.

The review threw up no major concerns, but FCA suggested some improvements firms could make, not only on the review process but also in providing clearer information to customers particularly on withdrawal options and putting in place measures to test customer understanding, as recommended by the PCBS, and as explored by FCA in the Thematic Review discussed above.

High cost credit

In January, FCA published an update to its on-going work on high-cost credit. It reported that, since its report in mid-2017 which identified key areas of concern in the sector, it has now observed an emerging picture for the case for intervention. That said, it also sees the risks of applying some of the more traditional intervention measures in some cases, and it looking at how it can protect the interests of customers by ensuring it does not take steps that might restrict availability of credit to customer who can afford to repay. FCA's main areas of concern are:

• Overdrafts: FCA is particularly concerned at the proportion of revenues from unarranged overdrafts, and is building this into its larger review of business models discussed above
• Rent-to-own: FCA thinks there is still more work to be done to further reduce the risk of consumer harm where they use rent-to-own services, especially when there are add-on products
• Home-collected credit: FCA is particularly concerned about instances of additional borrowing being taken out when there is still money outstanding from previous loans which is incorporated into the new loan. It is looking at information it has asked firms to provide about their lending patterns and refinancing practices
• Catalogue credit: FCA has commented the complexity of charging structures and repayment options means many consumers are unlikely to understand key features any may not be making informed choices.

FCA is now working on consulting on alternatives to high-cost credit.

Motor finance

In March, FCA gave an update on its review of the Motor Finance Sector, which is due to complete in September. Its main concerns are around affordability, specifically among customer with lower credit scores (these account for only around 3% of lending, but have higher default and arrears rates). It also wants to look more closely at how firms are managing the risks around commissions incentivising dealers to arrange more expensive finance, and whether customers are being provided with enough information in an accessible manner.

Closet trackers

A further update in March focused on the authorised funds market, and the risks to investors of closet tracker funds and closet constrained funds. FCA is concerned that these funds look like and charge fees similar to active funds while being managed in a manner more akin to passive funds. FCA wants to be sure investors have clear information. In a review of investor information on 84 funds, FCA found only 20 funds adequately described how investors' money was being managed. It has already worked with firms to improve documentation and firms have paid compensation to funds and investors.

Dear CEO letters

Another part of FCA's weaponry is the "Dear CEO letter". These often, but not always, stem from a thematic or other review, and require CEOs of firms to take notice of, and sometimes communicate to FCA about, specific areas of regulatory concern. This year, FCA has sent Dear CEO letters on:

• Second charge lenders and responsible lending
• Failings in distribution of CFD products
• Authorised push payment fraud
• Quality of prudential regulatory returns

What's next?

FCA recently published its business plan for 2018-19, which hints at some form of review and report in several areas, including:

• Money laundering in the e-money sector
• Assessing the risks of outsourcing and third-party providers using a mixture of thematic and firm-specific work
• Remuneration arrangements
• Reviewing how firms use data and publishing a Memorandum of Understanding with the Information Commissioner's Office
• Understanding firms' pricing practices in general insurance
• Understanding levels of consumer undersaving for retirement (separate to the delivery of a package of remedies as part of the Retirement Outcomes Review)
• Finalising the review of high-cost credit products
• A thematic review of money laundering in capital market
• Monitoring compliance with conflicts requirements
• Launching a market study on credit information
• Publishing the interim mortgage market study
• A thematic review of commission between credit brokers and other firms (this is already underway)
• Reviewing the motor finance market
• Assessing the impact of FAMR and the RDR
• Reviewing high-risk and complex investments
• Reporting on the investment platforms market study
•  Publishing the interim report on the wholesale insurance brokers market study
• Publishing the findings of the call for input on access to travel insurance
• Continuing thematic work on understanding charging in the debt management sector
• Concluding the first phase of diagnostic work on value in the tradesman, travel and motor ancillary elements of the insurance distribution chain following FCA's review of delegated authority and appointed representatives

What can firms expect?

It's clear from the most recent reviews and updates that protection of retail consumers, especially those who may be vulnerable because of their financial literacy or poor credit score, is at the forefront of FCA's mind. However, it is alert to other risks to its regulatory objectives as well, as we can see from, for example its two themed reviews into money laundering risks. And, while its work on banking and credit continues apace, it is also continuing to devote resource to issues in the general insurance market.

Findings from recent reviews have shown an encouraging trend in firms to put in place appropriate governance standards, which in turn has led to improved culture and less concern over consumer outcomes. However, there are clearly still areas which concern FCA, whether because of the nature of the customer, the product or changes in the market. And, as ever, firms should check FCA updates, whether given directly, or via FCA's website or speeches, to assess whether they should be reviewing or updating their customer facing documentation or internal policies and procedures. Just because FCA is publishing noticeably fewer enforcement notices than it was a couple of years ago does not mean it is any the less active.