Thank you for inviting me to speak to you today. I am delighted to be here.
In my remarks today, I plan to focus on three aspects of your role and to set out their relationship to the fair treatment of your customers. These are:
- Business strategy and its governance;
- Risk management and oversight; and
- Reward.
But before I do that, I will say just a few words on the positioning of Treating Customers Fairly within the FSA’s regulatory strategy – now that the December deadline is behind us. As you will be aware, Treating Customers Fairly has now moved into the FSA’s core supervisory work. Put simply, this means that it is now a key aspect of supervisory reviews (Arrow reviews), it remains key to the small firms supervisory strategy, and that you can expect to continue to see it reflected in both our thematic work and our enforcement action. Firms are expected – and by that I mean senior management, including the Board - to be able to demonstrate to themselves and to us that they deliver fair outcomes to their customers.
And of course – as I have remarked to previous audiences - it could hardly be otherwise. TCF covers not just our Principle 6 ('a firm must pay due regard to the interests of its customers and treat them fairly') but also several of our other principles for businesses, including: Principle 2 (conducting business with due skill, care and diligence); Principle 3 (taking reasonable care to organise and control affairs responsibly and effectively with adequate risk management systems); Principle 7 (client information needs) and Principle 9 (suitability of its advice and discretionary decisions for customers). Moreover, we have made clear our view that difficult market conditions pose particular risks to fair outcomes for consumers. We therefore must and will continue to take decisive action where we find (actual or potential) consumer detriment, and this will include taking action against senior management where necessary.
With that as context, I would like to turn to the role of the Board in achieving fair outcomes, and then to three aspects of your role already mentioned.
Role of the Board in delivering Treating Customers Fairly – the right culture
Above all else, the Board affects a firm’s ability to deliver fair treatment of customers through the culture that it supports or allows to persist throughout a firm.
We explained what we meant by ‘culture’ in the context of Treating Customers Fairly in 2007 when we published a ‘culture tool’, looking at some key factors which drive the firm’s behaviour. These were: leadership; strategy; decision-making; controls (including the use and existence of appropriate MI); recruitment, training and competence; and reward.
And the significance of culture was very evident to us when we came to assess firms against the March 2008 deadline. Those firms that showed good practice against that deadline (ie they were able to measure whether they were treating their customers fairly) had treated TCF as something which needed to be built into the firm's culture. In particular, they tended to have built fair treatment into the commercial strategy – not necessarily in name; the senior management were involved – they knew what measures they wanted to see and could use to drive change; there tended to have been a focus on reward and incentives; and customer feedback was taken seriously.
There is of course a very strong overlap between the factors that we suggest create a culture and the responsibilities of a Board. It goes without saying that leadership (the first factor suggested in the FSA framework) is central: where there is strong leadership with a clear vision of what treating customers fairly means for the firm, it is more likely to have a culture which is geared towards delivering fair consumer outcomes. Today though, I want to go beyond that and focus, as I have suggested, on strategy, controls and reward.
Business strategy
On strategy, an area where your role is key, the relevance of Treating Customers Fairly is relatively simply put – the strategy you set needs both to be compatible with the fair treatment of customers and to encourage it. Customers in the financial markets are often not sufficiently financially capable to identify for themselves the firms that treat them unfairly, which means that the market may not give you reliable signals – through share prices or customer loyalty – of what is going on. Instead, Boards need actively to consider the likely impact of their strategy decisions, and to ensure that the effect of what is decided is to promote fair treatment of customers.
I should note two further points here:
First, a growing number of firms tell us that Treating Customers Fairly is positively good for them commercially (that is, they are able simultaneously to meet both shareholder and customer expectations) – and that even if consumers cannot identify what is unfair when it happens to them (at least not in a timely way), the firm can nevertheless retain and grow their customer base through fair treatment;
Second, over time we would expect the FSA’s financial capability work to increase the extent to which customers understand what is happening to them, and therefore to increase the degree of customer-based challenge directed at firms that treat them unfairly.
At present there are also other factors that might cause you to revisit your strategy, and when doing so I would urge you to keep your customers in mind.
The first is market conditions, which have put pressure on life insurers’ earnings and excess capital, increasing the operational risks they face and reducing the scope for risk-taking. And general insurers too need to ensure that they underwrite for profit – bearing in mind that results are less likely to be supported by reserve releases and investment returns than in the recent past. In responding to these pressures you will play an important role in ensuring your actions are consistent with the interests of your customers.
This applies in the short term – when, for example, with-profits insurers may be seeking to implement planned management actions (such as imposing or increasing charges to policies, reducing terminal/annual bonuses and imposing or increasing Market Value Reductions (MVRs) on surrender), or general insurers may be seeking to introduce changes to their terms and conditions. And in the longer term, the recessionary economic environment is likely to exacerbate the effect of and bring forward any pressures on an insurer’s particular business model. In both cases you need to be convinced that any actions recommended to you do not result in policyholders being treated unfairly.
Another factor giving rise to strategic debate is the Retail Distribution Review, which creates strategic choices and challenges for life insurers. Most importantly, insurers will need to think about how they will compete for business in future with competition focused so clearly on the consumer and not the adviser. More specifically, our proposal on adviser charging, which means adviser firms setting their own charges rather than receiving commission from product providers, creates decision points for product providers. Some may want to offer facilities for deducting adviser charges from investments and will therefore need to make changes to their systems. Others may choose to let adviser firms make their own arrangements to collect charges (potentially involving third parties like platforms) and will be working out what they need to do to create commission-free products.
Whatever the strategic issue, what we will be expecting, and looking for, is that in determining actions to tackle the circumstances and future direction of the firm, Boards have taken account of their obligations to continue to treat customers fairly.
Governance
In determining its strategic response, a Board may need of course to take appropriate advice. In this regard, I wanted to make a few comments on Boards with with-profit funds and their need to take advice from a With-Profits Committees or similar arrangement. Here I should stress first – because firms sometimes suggest that we have implied otherwise – that we are entirely clear that it is the Board’s responsibility to ensure that with-profits policyholders are treated fairly. Equally, however, we have very clearly said that – given the conflicts that can arise between shareholders and policyholders and between generations of policyholders - there must be some independent judgement in assessing the appropriateness of the management of the with-profits fund and compliance with the PPFM.
You will know that, when we carried out thematic work in 2007 (which I acknowledge is now some time ago), we found that some firms’ arrangements for acquiring such independent judgement were restricted to monitoring compliance with the PPFM, rather than thinking about the broader outcome that the governance arrangements are intended to achieve. As a result, in some firms, the range of issues referred to their independent oversight function was more limited than we expected it to be. Boards (and senior management more widely) need to ensure that their With-profits Committee - or other source of independent judgement – are consulted on all significant issues affecting with-profits policyholders interests. For clarity this includes matters such as changes to investment strategy, charges and bonuses.
We accept that independent judgement can be provided in different ways. We also agree that the Board could take a different view to any independent input it receives. That said, and whatever the form of the arrangements, our intention is absolutely that the with-profits governance is an important and powerful input to the running of the firm and to securing fair treatment of customers. In the thematic work already mentioned, we found potential weaknesses in the governance arrangements in some firms in a number of areas. I wrote to Chief Executive Officers setting out these and restating our expectations. This will be a key area of focus in relevant Arrow reviews going forward, as well as in our review of the implementation of the with-profits regime announced as a part of our response to the TSC Report in this area.
Risk management/oversight
Having looked at strategy and governance I should now like to turn to controls – in other words, the Board’s role in the identification, oversight and management of risk.
In the context of the Treating Customers Fairly initiative, we have of course focused extensively on the creation and use of appropriate management information. We see the receipt and challenge of that MI as key to the Board’s (and wider senior management’s) oversight of the treatment of customers. We expect the Board to be challenging the executive - where is the evidence on actual outcomes (as opposed, for example, to processes)?; what does it tell you?; does it really demonstrate that the firm is treating its customers fairly and if not what is happening about it? Of course, there will be more detailed MI produced within the firm and it is not necessary for the Board to see excessive granularity, but one of the big lessons of the TCF initiative is that firms are often not delivering to their customers what their senior executives believe that they are, and Boards must therefore ask for sufficient evidence to see the position for themselves. It goes without saying that their own interest in the position will drive culture within the firm.
In many ways, we are asking you to address your obligations on the treatment of customers similarly to the way you addressed the challenge of integrating risk and capital management with the introduction of ICAS. Here we have seen real evidence that Boards now have a much better appreciation of the risks on insurers’ balance sheets and in their business models, and a greater ability to manage those risks. We would like to see the same shift in the case of TCF – Boards equipped with appropriate management information, and better able to understand and manage their risks.
(In passing, I would like to mention the relationship between TCF and the ABI’s Customer Impact Scheme. Those of you that are members of the scheme will see some important parallels with TCF:
The need for senior management engagement with customer issues;
The need to measure performance; and
The need to self-audit and demonstrate what is being achieved.
We very much welcome this focus. There is also an important difference in approach though and that is the focus in some areas on customer satisfaction rather than fairness. As I hope you realise we think this is a very important distinction – Boards may wish to take an interest in satisfaction but, given the limits to consumers financial capability, they need to make sure that they are also addressing and measuring fairness. I know that the ABI is currently looking at how the scheme can more closely align with TCF – including considering undertaking some qualitative consumer research on fairness to underpin this.)
Dealing with serious failings / concerns previously highlighted by the FSA and ensuring the lessons have been learned
Management information that measures fairness (as against the TCF outcomes) is not the whole answer: as noted above, a Board needs to take an interest in whether it is driving action and (to an appropriate extent) what that action is. And you can expect us to be particularly interested in areas where we have previously noted regulatory concerns. To be explicit, any firm that continues to have a material outstanding issue in any area where the FSA has previously highlighted poor practice is particularly likely to be deemed to be at significant risk of not treating its customers fairly overall, and we will take appropriate regulatory action as a result. It would be sensible for Boards to ask the executive about such areas in particular.
In this context I would draw your attention to just one key area: communications with policyholders.
Providing clear information is essential for delivering fair outcomes for consumers. Over the past eighteen months we have published results of: thematic work on insurers’ communications with existing customers; the quality of Key Features Documents issued to new or potential customers; and Open Market Option communications. We have also reviewed insurance comparison websites; financial promotions; and the clarity and fairness of terms used in insurance contracts. In all cases improvements were needed, and in all cases we expect firms to have reviewed the results, checked whether they applied in their case, and put matters right.
Reward and incentives
How reward and incentives are aligned with a TCF culture
Turning now to reward. This is of course key – in short, the incentives that result can either promote fair treatment or give rise to risks and/or conflicts of interest which then need to be managed. Given current preoccupations, I would like to spend just a few minutes on two key dimensions of this – senior management reward; and remuneration post RDR.
Senior management reward
As already mentioned, in 2007 we published a TCF document that focused on the cultural drivers of firm behaviour that highlighted the significant impact that reward has on individuals’ behaviour. During the current market turbulence, we have seen further recognition and comment on the link between executive remuneration and behaviour. In October last year, we published a Dear CEO letter setting out our position on this and, although of particular relevance to banks, the general principles are more broadly applicable.
In that letter we noted that Boards should ensure that they have effective structures in place to set remuneration policies and monitor remuneration levels throughout the firm. We also set out some views on poor practice and some initial thoughts on good practice and I would encourage you to consider these points - the letter is available on our website. The examples provided included practices consistent with what we had already communicated to industry through the TCF culture framework.
For example, that we are concerned where firms incentivise staff only on the basis of their financial performance – if reward is linked only to selling, the cultural signal within the firm is very strong, the risk that unsuitable sales are made increases, and those sales must therefore be managed much more closely. And similarly, where a firm or employees within that firmare remunerated differently for selling different products, this can of course lead to a risk of selling a less suitable product over a more suitable one and the resulting conflicts need to be closely managed.
Remuneration post RDR
All of which brings me back to the Retail Distribution Review. As I have already mentioned, in June we will consult on rules that require adviser firms to set their own charges and which will bring to an end the current practice in the UK of product providers offering adviser firms amounts of commission for selling their products.
This change is important because, in the longer term, we do not believe that consumer trust and confidence in investment advice can be achieved while the potential for commission to bias that advice continues to exist.
This belief is based on the view that the way firms are managed when the commission model is applied is the root cause of many quality of advice problems. However, we acknowledge that a commission model, per se, is not necessarily flawed. And while poor practices may frequently be associated with firms using commission-based models, they are not confined to such firms. Instead, it will remain key in our view to recognise that employee reward comprises a number of elements (not just financial remuneration) and that consideration of the resulting incentives is a risk management issue.
Conclusion
In conclusion, you will see that all of what I have covered today brings us back to why we began the focus on TCF four years ago. We wanted to achieve a step-change in how firms (in aggregate and, where relevant, individually) treat their customers. We wanted to achieve it via senior management exercising its responsibility to place fair treatment at the centre of the corporate culture. All directors, executive and non-executive, play a key role in determining that culture - by setting it or by providing the right checks and balances in it.
We remain very focussed on assessing firms against the TCF Outcomes going forward and taking tough action where we find short-falls. In our ongoing supervision, we will form our view of a firm’s delivery with reference to that firm’s management information (where we believe it is robust); direct testing of the consumer experience (for example through call listening, mystery shopping, file reviews, and reviews of consumer communications); and examination of any other relevant, up-to-date evidence (such as the results of recent thematic work). After many years of work, we would expect firms to be delivering a very strong performance. This does not mean 100% delivery on all occasions, but – on rare occasions when things go wrong – we would expect senior management to have put in place clear accountabilities and timelines for taking action.
Both of us will I hope benefit in a long-lasting way from the new thinking and new tools developed in the life of this initiative, and if - as I hope – it delivers a step change in outcomes for consumers – this will be hugely to the benefit of both them and the industry going forward.
