Why cross‑subsidies should matter to boards, even in the absence of formal FCA rules or requirements
Ensuring compliance amid FCA scrutiny
In this report, we highlight the FCA’s (Financial Conduct Authority) increasing focus on rooting out cross‑subsidies that it sees as harmful to its competition and consumer protection objectives. The continued importance the FCA places on firms’ business models has led it to scrutinise firms’ use of cross‑subsidies across a number of papers and market studies. While there are no specific rules or requirements around cross-subsidies in the FCA’s handbook1, the FCA has linked the issue of cross‑subsidisation to a number of conduct concerns, particularly in the areas of product suitability and the fair treatment of customers. These conduct concerns, alongside worries about cross‑subsidies harming effective competition, have led to concerted regulatory interventions across a wide variety of markets and sectors.
The report also explores the FCA’s approach to price discrimination, a topic which it has often discussed alongside the issue of cross-subsidisation. While these are distinct practices, price discrimination and cross-subsidisation share common
features and can result in similar regulatory concerns.
A comprehensive understanding of the FCA’s perspective on cross‑subsidies and price discrimination will enable boards and senior managers to understand how these business model practices may lead to regulatory concerns about the fair treatment of customers or the effectiveness of competition in the markets in which they operate. We have therefore analysed the FCA’s stance and approach to date in order to identify what types of cross‑subsidy and price discrimination it is likely to be concerned about and where its future review work may fall. We go on to set out some practical steps that firms can take to minimise the regulatory risks in this area.
"The continued importance the FCA places on firms' business models has led it to scrutinise firms' use of cross-subsidies across a number of papers and market studies."
Cross‑subsidies: what they are and why they matter to the FCA
The FCA has long stressed the importance of firms’ business models to its regulatory approach, a point re‑emphasised in its recently published Approach to Supervision document.
A key aspect of firms’ business models that we see the FCA putting under an increasingly bright spotlight is cross‑subsidies. The FCA has explored the issue of cross‑subsidisation as part of its market studies and policy papers, and has intervened where it has viewed cross‑subsidies as having harmful effects on consumers and markets; for example in the cash savings market or through insurance auto‑renewals.
In an Occasional Paper (OP) on “Price discrimination and cross‑subsidy in financial services”, the FCA sets out its framework for assessing cross‑subsidies, and articulates the principles that underpin its approach. It defines cross‑subsidisation as a situation where a firm charges a price below economic cost (i.e. is loss making) for some consumers or products/ services, but recoups this loss through the profitable sale of another product/service; or the same product/service to another, profitable group of consumers. Cross‑subsidies may either be between consumers – where one group of consumers is charged below the economic cost of providing a product, paid for by the firm charging another group of consumers above the cost price – or between products, where a firm’s profits from one type of product or service are used to provide another at a loss.
Importantly, the FCA does not see cross‑subsidisation as a problem per se. As a result, the FCA does not take a blanket approach to cross‑subsidies, a point emphasised throughout its OP, which notes that assessing whether a cross‑subsidy is harmful “requires a case‑by‑case assessment based on detailed data.”
Nevertheless, firms should be aware that an evaluation of cross‑subsidies will be an increasingly important part of the FCA’s scrutiny of firms’ business models and its market studies, and that cross‑subsidies falling foul of the FCA’s approach are likely to prompt regulatory intervention.
About the EMEA Centre for Regulatory Strategy
The Center for Regulatory Strategy is a source of critical insight and advice, designed to help clients to anticipate change and respond with confidence to the strategic and aggregate impact of national and international regulatory policy.
For more information about the Regulatory Outlook 2018 please contact Ronald Koppen or Eelco Schnezler via the contact details below.