Consumer Duty: Fair Value Frameworks

With under three months to go until the implementation of the Consumer Duty, the FCA has published the findings of its review of fair value frameworks.

The FCA assessed 14 fair value frameworks and has provided practical insights into how to approach what is considered to be one of the most challenging aspects of the Duty: ensuring that consumers receive fair value at all times.

The review was carried out against five core criteria:

1. Understanding of fair value,
2. Assessing value,
3. Considering contextual factors,
4. Assessing differential outcomes, and
5. Data and governance.

1. Understanding of “Fair Value”

The FCA has defined the fair value outcome as “ensuring the price the customer pays for a product or service is reasonable compared to the overall benefits”. Many of the frameworks reviewed included a copy-and-paste of the principles and factors included in the Final Guidance for the Duty, and the FCA has deemed this to be good practice. Further, the review has made it clear that firms must consider the application of the fair value outcome both generally and at the product-specific level.

One key area of improvement identified was that some firms had not clearly identified their role in the product chain, meaning that they are not able to discern which sections of the Duty are relevant to them. Further, the FCA has encouraged firms to not rely on high-level arguments – it wants to see concrete actions that have been taken.

2. Assessing Value

A broad approach to assessing value, incorporating both monetary and non-monetary costs, has been identified by the FCA as the best way for firms to ensure that they are meeting the fair value outcome. The best frameworks included guides that challenge, question, and prompt those responsible for reviewing the value assessment to critically analyse the outcomes received by consumers. A further example of good practice identified was the inclusion of profit margins as a fundamental component in firms’ assessment of value. Although the FCA acknowledged that it can be difficult to discern profit margins on a per-product basis, they have been deemed to be a “relevant factor” in assessing fair value. This is because, in a 2017 Asset Management Market Study, the FCA considered that “the persistently high levels of profit earned by asset management firms suggest that … investors may not be achieving value for money.

On the other hand, the FCA has taken a dim view towards the use of generalised templates that do not take into account the different characteristics of products that may influence the determination of fair value. Similarly, the FCA also pointed out that a failure to carry out qualitative assessments of value, which consider the quality of the product or service, is a direct contradiction of FG22/5.

3. Considering Contextual Factors

One particularly interesting point raised through the Review was an indication by the FCA that firms must consider behavioural biases, such as instant gratification and overweighting potential losses, and determine how these may impact consumers’ decision-making. As mentioned in a previous speech, it is also expected that firms have carried out their spring cleaning and removed sludge practices that inhibit consumers from making effective decisions.

As highlighted under other criteria, the FCA is critical of poorly-defined and broad-brush approaches towards assessing the fairness of their pricing structures.

4. Assessing Differential Outcomes

The FCA has deemed segmentation analysis to be an effective way of ensuring that different groups of consumers do not receive differential outcomes. Specific examples provided include: considering the value received by subsets of consumers at risk of paying higher fees or charges and how consumers using different channels receive different outcomes.

Conversely, overreliance on averages that may disguise outliers has been deemed to be a practice that requires improvement. Further, firms are expected to be able to demonstrate how groups of customers on differential pricing structures all receive fair value.

5. Data and Governance

A well-structured approach towards carrying out value assessments was highlighted by the FCA as a crucial part of firms’ approaches. The best frameworks scheduled reviews to take place according to expected renewal patterns or the expected holding period of a product, and identified trigger points that would require the value assessment to be reassessed.

Points-based approaches did not score as highly with the FCA; these frameworks were found to often have been implemented with little thought as to how thresholds are drawn. Additionally, the FCA expects firms to consider value in absolute as opposed to relative terms.

In summary…

With the implementation date of the Duty rapidly closing in, the FCA is keen to ensure that firms are well-prepared. Novatus can offer a range of services from rapid health-checks, validation and review of implementation plans, and full implementation covering each stage of the implementation timeline. We can draw on a wealth of experience in advising your peers meet their Consumer Duty milestones, as well as other previous customer-orientated regimes such as Vulnerable Customers Guidance.

If you would like to discuss our services further, please contact Hugo Warner, Head of Risk Advisory – hwarner@novatusadvisory.com.