Implementing the Consumer Duty across the product lifecycle- key considerations for asset managers

At a glance

• We have identified some key considerations for asset managers as they implement the Consumer Duty (the “Duty”) across the product lifecycle.
• When identifying target markets and designing products, asset managers will need to consider whether any target markets have a greater propensity for vulnerability, carry out robust product testing to avoid foreseeable harm, and ensure that their products do not include features that take advantage of behavioural biases. They should also note the FCA’s feedback on shortcomings in compliance with existing requirements in this area.
• When setting their distribution strategy, asset managers will need to consider how this aligns with their value assessment for products and services that are in scope of the price and value outcome. They should also consider the results of customer communications testing, which in some cases may require changes to sales processes. And they may need to apply commercial pressure on distributors to obtain the information they need to discharge their responsibilities under the Duty.
• Given the low levels of financial literacy amongst some groups, firms will need to consider their risk appetite carefully when testing customer communications. Communications should be tested across different groups within the target market, including those with varying risk appetites, educational backgrounds, and characteristics of vulnerability.
• Although the Duty’s price and value rules give firms a lot of discretion on how they assess value, in our view the FCA will still expect firms to do a robust assessment, since an insufficiently granular analysis can lead to poorly evidenced conclusions.
• Firms will need to consider how much to invest in customer support given the increased requirements in this area. Where asset managers do not have direct relationships with retail customers, they will still need to support distributors adequately to meet end customer needs.

Overview

Asset managers have until April 2023 to complete product reviews for existing open products and services, so that they can share information with distributors and remedy any identified shortcomings before the July 2023 deadline. This blog sets out some key considerations for asset managers as they implement the Duty across the product lifecycle.

Scope

Some firms are still grappling with questions over exactly how the Duty applies to their business, especially in cases where the immediate client is professional but they could have a material influence on outcomes for retail customers. The FCA clarified in its webinar that where an firm’s role is limited to operating within a mandate determined by another firm, this does not in itself constitute a material influence on retail customer outcomes under the Duty. However, if the firm determines the design, branding or customer communications then this would be in scope. In addition, the FCA is consulting on amendments to clarify that the Duty still applies to funds where there is a minimum investment of £50,000 or more, and to situations where an asset manager has a material influence over customer outcomes in a defined benefit occupational pension scheme.

Identifying target markets and designing products

While most of the requirements under the products and services outcome are similar to the existing product governance requirements in PROD 3, there are some areas where the rules go beyond PROD 3, including preventing foreseeable harm, and considering customer vulnerability and behavioural biases. While asset managers can choose to comply with PROD 3 instead of the products and services outcome, they will still need to consider these additional areas as they are embedded in the cross-cutting rules (acting in good faith, avoiding foreseeable harm and supporting clients to achieve their financial objectives).

It is important for asset managers to consider whether any target markets have a greater propensity for vulnerability. For example, if a product is aimed at post‑retirement years or young savers, certain vulnerability characteristics may need to be considered. Product testing will need to consider the impact on each group of customers in order to avoid foreseeable harm. Firms will also need to ensure that their products do not include features that take advantage of behavioural biases, such as high exit fees, hidden charges, or products that are too complex for the target market to understand.

Firms also need to ensure that they are adequately complying with existing requirements in this area, as the FCA has previously highlighted a number of shortcomings. Particular areas of focus include identifying a sufficiently granular target market, identifying a negative target market as well as a positive one, scenario and stress testing that adequately consider product-specific characteristics and a wide range of scenarios, ensuring that the product is meeting a genuine customer need, and setting out clearly why certain ESG benchmarks are used and their composition.

Distribution strategy

With the exception of authorised fund managers (AFMs) managing UK authorised funds - which are exempt from the Duty’s price and value outcome - firms will need to consider their value assessments when setting their distribution strategy. For example, firms may set a maximum total cost of distribution that they believe is compatible with the product providing value to end customers. Firms will need to work with distributors to understand the total cost to the end customer, which can be difficult in complex distribution chains. If high distribution costs result in the product being poor value, asset managers will need to discuss with distributors how this might be improved or consider changing distribution channels.

The results of customer communications testing may also affect firms’ distribution strategy. For example, where the target market consistently does not understand certain product features despite efforts to improve communications, the firm may need to sell the product with advice or introduce positive frictions into the sales process (e.g. mandatory videos explaining product features).

Although product manufacturers are already required to obtain information from distributors on end‑client data trends for the purposes of their product reviews, this has often been difficult in practice. In the context of the Duty, the FCA has reiterated the importance of this information being shared and suggested that manufacturers need to apply commercial pressure if distributors do not provide the information. Given the importance of this issue, asset managers will need to factor it into their distribution strategy and would be advised to set out their expectations in distribution agreements.

In view of the new requirements for a firm to notify another firm in the distribution chain if it thinks it has caused or contributed to harm to retail customers, and to notify the FCA if it becomes aware that another firm is not or may not be complying with the Duty, firms will need to set up a process for collating relevant information and set clear risk tolerances for what kind of information is reportable. They will need to balance the need to report enough to ensure they are compliant against the desire to minimise reports which may turn out not to be substantiated.

Customer communications

Asset managers will need to consider their risk appetite carefully when deciding which communications to test and how, which groups of people to test the communications with, and how to interpret the results. This is a challenging area given low financial literacy amongst some groups - for example, the FCA has cited research which found that one in seven adults has literacy skills at or below those expected of a nine to 11 year old, and its Financial Lives Survey found 34% of adults have poor or low levels of numeracy involving financial concepts.

In our view, firms should at least test key information such as costs and charges, fund objectives and investment policy, risk and reward profile, performance and redemption terms. It would also be worth testing communications on features that might be new or unfamiliar to the target markets, such as strategies and key performance indicators relating to sustainability. Communications should be tested across different groups within the target market, including those with varying risk appetites, educational backgrounds, and characteristics of vulnerability. They should consider how to create and reach a diverse sample for testing - for example, doing all their testing online may exclude certain groups who may be less likely to use the internet but could still buy the product offline.

Firms should use the findings of testing to make their communications more accessible where possible. Where the content of the communication is prescribed (e.g. UCITS KIID, PRIIPs KID), limited changes can be made to the document but supplementary information could potentially be provided. Here it will be important to strike a balance between providing enough supplementary information required for good customer understanding but not so much as to overwhelm. Where the content is prescribed but firms have some discretion on format (e.g. in the prospectus), firms can still explain industry jargon, highlight key information upfront and signpost to further detail.

Where adapting communications is not sufficient, firms may need to adapt their target market, product design or sales process. However, we think that where possible firms should strive for better communication rather than removing features from products that are difficult to understand but might enhance the performance of the product.

Value assessments

The Duty’s price and value outcome rules apply to products and services that are not in scope of the existing value assessment rules for AFMs. In many ways the price and value outcome rules are less prescriptive than the existing FCA value assessment rules for AFMs, and this can make it challenging for asset managers to know what level of detail their assessment should go into. In our view, although the Duty’s rules are less prescriptive, the FCA will still expect firms to do a robust assessment. In the findings of its review of AFM value assessments, the FCA notes that an insufficiently granular analysis can lead to poorly evidenced conclusions, and the FCA is unlikely to be happy with this in the context of the Consumer Duty either.

The Duty’s price and value rules require asset managers to consider how their distribution strategy aligns with their value assessment, which is not required under the existing rules for AFMs. Unduly high distribution costs may result in poor overall value for products which may require firms to reassess their distribution strategy, as outlined in the section on distribution strategy above. Asset managers should also be mindful that distributors will be carrying out value assessments of their own under the Duty, and this could lead to some poorer value products being removed if the distributor cannot justify its fees in context of the overall value of the product.

Value assessments carried out under the Duty will not need to be published or disclosed to retail investors, unlike the existing rules for AFMs. However, firms will still need to provide a summary to distributors, and there is not yet an established industry practice on how much detail to report or in what format. Asset managers are not expected to share commercially sensitive information with distributors, but distributors will need to understand at least the benefits of the product to the target market and the cost and charges, and be able to assess whether their fees cause the product to become poor value.

Customer support

Firms will need to consider how much to invest in their customer support given the increased requirements in this area. Where asset managers have direct relationships with retail customers, they will need to note the FCA’s view that firms should not give preferential treatment to new or prospective customers compared to existing customers. The FCA is also alert to “sludge practices” (i.e., creating friction points that deter customers from acting in their own interests e.g. requiring too much administration to switch a product), and these can happen inadvertently if there is not enough investment in customer support. Firms should consider providing a range of channels for customer support, given that some customers may find it difficult to access support online, and customers with disabilities may have different needs in terms of communication methods.

Where asset managers do not have direct relationships with retail customers, they will still need to provide adequate support to distributors to ensure that end‑customer needs can be adequately serviced. Firms may wish to obtain feedback from distributors on their support and how this could be improved for the benefit of end retail customers.

Ongoing monitoring

In our survey of asset managers conducted earlier this year, the evidentiary burden and data quality required to produce the annual report to the Board was rated as one of the biggest challenges in implementing the Duty. Asset managers will need to identify the relevant sources of data to support outcomes testing, including what type of information and how frequently it is collected. Our paper on outcomes testing sets out some considerations for firms in this area.

Under the Duty, firms will need to monitor whether particular groups of customers, including vulnerable customers and customers with protected characteristics, get worse outcomes than other customers. The FCA does not expect firms to collect new data about customers’ protected characteristics but to use any existing information they may have, and data protection laws make it difficult to share information about individuals across the distribution chain. Where asset managers do not have direct relationships with retail customers, they will need to work with distributors to identify how customer outcomes might vary across different groups of customers.

Conclusion

The Duty places a higher expectation on asset managers to be proactive in ensuring good customer outcomes. To achieve this, firms will need to embed the principles of the Duty throughout their business model and strengthen their business processes across the product lifecycle.

Read our other insights on the Duty

We have produced a wide range of thought leadership on the Duty. Our previous blogs which are relevant to asset managers include:

• Consumer Duty implementation plans: what do Boards of investment managers need to focus on?
• FCA finalises Consumer Duty rules
• Results of our Investment and Wealth Management Survey on the impacts of the FCA's Consumer Duty
• How will the FCA’s proposed Consumer Duty affect asset and wealth managers?
• Duty Calls - How Should Internal Audit Tackle the Consumer Duty?