Applicability and impact of the FCA’s new Consumer Duty on MiFID investment firms | Deloitte UK has been saved
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The FCA has stated that the Duty applies to all firms that can determine or have a material influence over retail customer outcomes. This could include firms in the wholesale market, even if they do not have a direct relationship with retail customers. The following examples demonstrate the impact this could have on various transaction chains.
Example 1: Brokers and Investment Platforms.
In the above example, a non-advisory client of an online investment platform has an order filled through two liquidity providers. All firms above will be caught by the Duty.
The investment platform that maintains the direct customer relationship will have to record information (for example, risk tolerance/ vulnerability), map out the consumer journeys, and consider outcomes testing, suitability, and the risks relating to foreseeable harm.
The two brokers in the chain will also be caught by the Duty because the efficacy of their order executions and transaction costs will impact on the consumer outcome. Best execution, which is incorporated in MiFID 2 requires firms to provide the best possible result when executing client orders, accounting for factors such as price, a priority for retail investors, speed of execution, and market impact. Although firms will already have arrangements in place to ensure best execution, the incoming Duty provides an opportunity to review the robustness of the monitoring and ensure that it includes comprehensive Transaction Cost Analysis (TCA).
Example 2: Spread bet on a commodity related equity and client purchase
In this example, the spread firm manufactures the product, sets the charges, the spreads, and other variables such as borrowing costs, maximum leverage, and slippage factors. The spread bet firm also maintains the direct client relationship and distributes the product.
The spread bet firm above will be caught directly by the Duty and is also the manufacturer and distributor of a high-risk product with leverage (if the market moves against the client’s position, the investor can lose more than their initial margin). This represents a high-risk position in relation to the Consumer Duty and detailed outcomes and suitability testing will be required in addition to data collection to evidence adherence to the FCA’s rules.
High-risk products are not only high-risk to the customers that invest in them but are high-risk from a Duty perspective and firms distributing or manufacturing products in the value chain are likely to experience enhanced regulatory scrutiny.
The FCA aims for a 50% reduction in the number of consumers investing in high-risk investments who indicate a low-risk tolerance or demonstrate the characteristics of vulnerability by 2025. This is likely to have a significant impact on the business models of firms who manufacture and offer these products to retail clients.
According to the Financial Lives Survey 2020, the proportion of UK adults with characteristics of vulnerability increased significantly over March 2020 - October 2020 to 53%. Other investors have a low-risk tolerance and may also exhibit characteristics of vulnerability.
The FCA’s expectations are that vulnerable customers must experience outcomes as good as customers without characteristics of vulnerability. The Regulator considers effective monitoring and evaluation by firms to be integral to achieving this.
Where evidence emerges that consumers who have protected characteristics are disproportionately experiencing harm or are at high-risk of experiencing it, the FCA expects firms to be proactive in reviewing their conduct and taking reasonable steps in mitigation.
Firms need to take particular care when communicating with customers in vulnerable circumstances and think carefully about how they test consumer understanding. This could include using third-party organisations who represent the needs of vulnerable consumer groups.
In relation to investments, the Duty does not apply to customers who elect to be treated as professional clients under the Conduct of Business Rules (COBS). However, the FCA is clear that a firm must not encourage a client to elect to be a professional counterparty to avoid its obligations under the Consumer Duty as this in itself may be a breach of the Duty.
If a firm is aware that a customer has been incorrectly classified by another firm in the distribution chain, it should reclassify the customer and provide the correct level of consumer protection. Distribution firms are required to share information to support manufacturers when reviewing products or services. Where firms do not comply with this requirement, they may therefore be in breach of the Duty.
Where products or services are bought by both retail and non-retail customers, the FCA does not consider that it would be appropriate to exclude such products or services from the scope of the Duty. Therefore, it is likely that the consumer duty will apply to products sold to professional counterparties, which are also marketed to retail investors.
The FCA is clear that trading venues such as multilateral trading facilities (MTFs) and organised trading facilities (OTFs) run by authorised persons are subject to the new Consumer Duty (FG22/5 2.34).
The Consumer Duty aims to deliver a significant shift in firms’ conduct and culture, moving from the process based Treating Customers Fairly (TCF) requirements to an outcomes-focussed regime and will require firms to collect various data sets, test outcomes, and report these to the FCA. A firm’s board should review and approve an assessment of whether the firm is delivering good outcomes for its customers which are consistent with the Duty at least annually. This should include evidence of challenge and scrutiny and firms mist consider the roles of the second and third lines of defence.
The FCA requires firms to have a Consumer Duty implementation plan signed off by their board ready for inspection by October 2022.
Our team at Deloitte are on hand to guide you through the entire process, from assessing how the Duty will impact on your business model to implementing and monitoring the new requirements. We can assist with:
Mike leads the Banking Regulation team in the London Banking & Capital Markets Group. Having founded the Deloitte regulatory practice in 1992, Mike has a wide ranging knowledge of UK Prudential Regulation Authority and Financial Conduct Authority regulation, as well as increasing knowledge of European Central Bank/European Banking Authority regulation. His remit includes capital and liquidity, governance, conduct, and specific reporting requested by the regulators and clients. He leads the regulatory response on key audit clients and is involved in Brexit work from a governance and processes as well as capital, liquidity and conduct perspectives.
James is a Senior Manager in Deloitte’s Banking and Capital Markets Regulatory Advisory team, based in London. James has sixteen years experience in the financial services industry. James spent five years at the FCA as a Lead Associate in Wholesale Banking Supervision supervising a portfolio of European, Middle Eastern and African Banks. James spent fourteen months as a Senior Supervisor at the Central Bank of Ireland (CBI) in the Wholesale Market Conduct Supervision team supervising banks and principle trading firms. James’ regulatory experience includes Conduct Risk, MiFID II, Market Abuse, Corporate Governance and Financial Crime.
Kirsty is a Senior Manager in Deloitte’s Banking and Capital Markets Regulatory Advisory team, with a focus on Retail and Wholesale conduct regulation. Kirsty is a former FCA lead supervisor, having spent almost 7 years supervising retail and wholesale banks, small investment, and corporate finance firms.
Dave Lawes is a Senior Manager in our Regulatory Assurance practice. He is a former regulator with over 10 years of experience as a supervisor of Banks and Market operators. He is a CFA charter holder and a published author on financial markets.