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"retail distribution review": ombudsman implications

December 2008

We at the ombudsman service recognise that there is a public-policy objective to increase the amount which consumers save, invest and put aside for pension provision, provided this does not expose them to mis-selling. There are no easy or perfect solutions: rather, there is a balance of risks.

In the "middle ground" between full independent advice and "execution-only", any lack of clarity about the nature and extent of the service which the financial business is providing to the consumer has the potential to increase the number of cases referred to the ombudsman service.

If a financial business intends to sell an investment to a consumer on the basis of advice that is focused on some limited aspect of their financial position and needs, or on a "non-advised" basis, it is for the financial business - as the professional - to make this clear to the consumer.

It is not necessary that consumers should understand the regulatory requirements that surround the sales process. But it is essential that they should understand the extent to which they can rely on the financial business and the extent to which it is a case of "let the buyer beware".

1 the retail distribution review (RDR)

1.1
The RDR was launched by the Financial Services Authority (FSA) to consider the future retail distribution of investment products. The RDR has significant implications for the work of the Financial Ombudsman Service, and the work of the ombudsman service also has some implications for the RDR. Key documents published by the FSA [opening in PDF format] in connection with the review include:

1.2
The FSA's November 2008 feedback statement distinguishes independent advice from sales services. Independent advice will involve new requirements. Sales will include a spectrum of services ranging from advice that is not independent, through simplified advised and "non-advised" "guided-sales" processes, to "execution-only" business. The cost of advice (whether independent or non-independent) will be separately disclosed. A Professional Standards Board will raise advisers" professional standards.

1.3
This policy statement records the ombudsman service's current thinking on some aspects of the RDR. Work on the RDR is continuing, and our views may develop as further details emerge. This policy statement relates mainly to sales processes, particularly in the "middle ground" between (at one extreme) what is clearly independent full advice and (at the other extreme) what is clearly execution-only. It also touches on some implications of the proposal that the new Professional Standards Board should create a new code of ethics for advisers.

2 background - public policy and private risk

2.1
Key issues include:

  • the balance of risks in aiming for the public-policy objective;
  • the roles of the various stakeholders in progressing the RDR; and
  • how attractive the result is for consumers and financial businesses.

2.2
We at the ombudsman service recognise that there is a public-policy objective to increase the amount which consumers save, invest and put aside for pension provision, provided this does not expose them to mis-selling. We wish the FSA well in tackling this difficult issue, and we have been working closely together. There are no easy or perfect solutions: rather, there is a balance of risks.

2.3
The public-policy objective is more likely to be achieved through processes that are appealing to both consumers and financial businesses. The processes should not appear off-putting or too time-intensive for consumers, whilst not exposing them to undue risk. And the processes should also be commercially attractive (taking into account the resources invested, the potential profit and the potential risk) to businesses that treat their customers fairly.

2.4
It is for financial businesses to design their products and processes within the law and the FSA's requirements. And it is for the FSA to set the regulatory regime within the constraints of UK and European Law, including particularly the Markets in Financial Instruments Directive (MiFID).

2.5
What we at the ombudsman service can do - based on our experience of dealing with cases where things are alleged to have gone wrong in the past - is to point out some areas where there may be a risk of increasing complaints to the ombudsman service, and also to suggest some possible ways of mitigating those risks.

2.6
In doing so, our intention is to help the RDR to succeed. Pointing out potential areas of risk now, before the risks crystallise, will give the FSA an opportunity to progress the RDR in ways that:

  • minimise those risks, and reduce the potential for future disputes to be referred to us; or
  • recognise the risks, but decide that they are outweighed by other considerations.

2.7
The risks we foresee lie principally in the "middle ground" between (at one extreme) what is clearly independent full advice and (at the other extreme) what is clearly "execution-only" - the potentially grey areas of "guided sales" and "non-independent advice" (which some commentators consider to be a contradiction in terms).

2.8
As indicated in the FSA's November 2008 feedback statement, we have been involved in round-table discussions with the FSA and representatives from banks, insurers and consumer bodies. We were heartened by the positive and cooperative way in which all parties approached the discussions.

2.9
Amongst other things, the Association of British Insurers (ABI) and the British Bankers" Association (BBA) generously shared with us the results of independent consumer research, which they had jointly commissioned, about the sort of process which they called "assisted purchase" - and to which the FSA has given the working title of "guided sales". The ABI/BBA's experimental "assisted purchase" process did not inevitably lead to an outcome where the consumer was encouraged to invest. In some circumstances the outcome was that the consumer should not invest at all - but should reduce debt or should seek full advice.

2.10
Additionally, outside the round-table discussions, the FSA showed us (in confidence) a few innovative prototype sales processes, with the consent of the financial businesses which had devised them. This was helpful in identifying some issues that might arise.

2.11
Meanwhile, a few other financial businesses appear to have approached the RDR primarily as a means to reduce or eliminate their own risks of potential claims from consumers, which is perhaps ironic in relation to processes focused primarily on selling consumers risk-based investment products.

3 potential processes - advice or sales

3.1
Key issues include:

  • the extent to which the processes encourage consumers to invest;
  • whether the processes includes what a court (or ombudsman) would consider to be advice;
  • how far financial businesses can ensure their staff stick to the designed processes; and
  • whether new processes might create potential wider-implications issues.

3.2
The looming recession increases the need for consumers to provide for their futures - but memories of recent financial turmoil are likely to make consumers even more reluctant to buy financial products, and financial businesses even more cautious in contemplating business risks. Indeed, it might be argued that the public-policy objective will not be achieved unless some consumers are persuaded to buy products that they do not currently believe they need. To facilitate that, without also facilitating mis-selling, will require considerable care.

3.3
We have no reason to doubt the view, expressed by many industry players, that there is unlikely to be significant take-up in the consumer mass-market unless the sales processes involve, at the very least, some degree of legitimate encouragement. And banks and insurers do not appear to have found it easy to devise potential sales processes which provide sufficient legitimate encouragement for the consumer without also involving, at least, an implicit personal recommendation - triggering the suitability requirement.

3.4
At an earlier stage in the RDR, the FSA indicated that it was prepared to consider the possibility of a modified regulatory regime, within the constraints of MiFID and UK law. But, as indicated in its November 2008 feedback statement, the FSA has not yet been persuaded that a special regime is necessary.

3.5
It may be that this arises, at least in part, because some of the work by banks and insurers appears to have concentrated primarily on trying to devise processes that seek to exclude regulated advice and a personal recommendation. As one industry member conceded in private, it might perhaps have been more fruitful if these banks and insurers had focused first on devising processes which worked well for customers and potential customers and then considered how the rules applied (or might need to be changed).

3.6
Some of the prototype models devised by the industry, although intended to avoid regulated advice, were considered by the FSA to involve regulated advice - and were considered by us to involve what is legally advice, whether regulated or not. As indicated in the FSA's November 2008 feedback statement, the legal concept of what constitutes advice is broader than the definition of regulated advice. So a process which avoids regulated advice will not automatically avoid what a court (or an ombudsman) would consider to be advice.

3.7
A financial business which aims to encourage consumers in the mass-market to buy investments may find it difficult to restrain its staff from providing what will be interpreted as advice. So it might be safer for financial businesses to accept that, and to develop the concept of what has been called in the past "focused advice". Chapter 5 of this paper refers to the development of guidance on this.

3.8
A separate issue arises in connection with some of the prototype RDR-processes devised by the industry - where these involve identifying appropriate products as a result of mapping individual consumers, and particular products, to one of a number of "people like you" categories. Such processes increase the potential for wider-implications issues to arise from cases referred to the ombudsman service.

3.9
With conventional full advice, an ombudsman's decision in an individual investment case will seldom have wider-implications. That is because the case is likely to turn on suitability, and the assessment of each consumer's needs and circumstances will differ. But "people like you" processes raise the potential risk that an ombudsman decision on some future case, which turns on the mapping of an individual consumer or product to a "people like you" category, might have read-across implications for many other sales that employed the same process.

3.10
In view of this, the industry might possibly wish to consider creating some process for foresight-based validation (and periodical review) of the mapping. To be truly persuasive about what was thought appropriate at the time, the process would need to involve robust consumer representation. Such a process could be developed as a voluntary option, for those financial businesses that want to reduce future wider-implications risk.

4 clarity for consumers - about the process and risk/reward

4.1
Key issues include consumer understanding of:

  • any limitations on the service provided by the financial business;
  • the different aspects of risk; and
  • the risk/reward ratio.

4.2
As the FSA's November 2008 feedback statement indicates, it is important for the consumer to understand the nature and extent of the service being provided by the financial business. The FSA will be conducting consumer research, which may inform the terminology that is needed to ensure consumers understand.

4.3
In that context, it may be helpful to refer back to aspects of the research on consumer capability which the FSA commissioned from the Personal Finance Research Centre at Bristol University. This suggested, for example, that consumers' capability (and understanding) in financial planning and choosing products is less than their capability in managing money - and that increased capability correlates more with age than education or income.

4.4
Many of the disputes we deal with at the ombudsman service arise because of a fundamental mismatch between the consumer's understanding and the financial business's understanding of the nature and extent of the service that was being provided. So, in the "middle ground" between full independent advice and execution-only, any lack of clarity about the nature and extent of the service which the financial business is providing to the consumer has the potential to increase the number of cases referred to the ombudsman service.

4.5
If a financial business intends to sell an investment to a consumer on the basis of advice that is focused on some limited aspect of their financial position and needs, or on a non-advised basis, it is for the financial business - as the professional - to make this clear to the consumer. It is not necessary that consumers should understand the regulatory requirements that surround the sales process. But it is essential that they should understand the extent to which they can rely on the financial business and the extent to which it is a case of "let the buyer beware".

4.6
There is quite some way to go in achieving this. The ABI/BBA-sponsored research suggested that (even in test conditions) consumers do not currently understand the distinctions between "information" and "advice", or what is meant by a "personalised recommendation". Of the consumers who went through the experimental ABI/BBA "assisted-purchase" programme:

  • 67% thought they had been given a personalised recommendation based on their needs and circumstances; and
  • 69% thought they had been given guidance/information to help them make their own decision based on their financial needs; indicating that a significant number believed they had received two different types of service simultaneously.

4.7
So there is a clear need for the consumer research which FSA has promised to undertake, to establish descriptions for different types of services that will be truly meaningful to consumers. And it should not be assumed that existing terms, such as "execution-only", are understood. We hope that this research will also cover ways of explaining both risk and the risk/reward ratio. Our experience in the ombudsman service shows that there is currently no shared language to explain these concepts.

4.8
"Portmanteau" descriptions of products as low/medium/high risk are not very helpful to consumers. They become more meaningful when unbundled into:

  • risk to capital;
  • risk to income/growth; and
  • risk of not matching inflation.

4.9
Untutored consumers hope to find investments that combine a low risk with a high return. But the risk/reward ratio suggests that the potential return on an investment is broadly proportionate to the risk involved - because safer investments usually command a higher initial price. Unless consumers are helped to understand the risk/reward ratio, any new processes may have a bias towards low-risk, low-return savings products - which may not fulfil the public policy objective, especially around provision for retirement.

4.10
Whatever the sales process used, a commonly-used and consumer-friendly set of language - to explain clearly the nature of the service being provided, what is meant by risk, and the link between risk and reward - would facilitate matters for both consumers and financial businesses, and minimise the potential for future disputes.

5 guidance for financial businesses - where the boundaries lie

5.1
Key issues include:

  • how far uncertainty can be reduced by FSA guidance;
  • how far reduced uncertainty means reduced scope for innovation; and
  • what "focused advice" might mean in practice.

5.2
The November 2008 feedback statement indicates that the FSA is not currently minded to create a new rules regime. But the feedback statement includes some helpful material on what existing rules do (and do not) require. Potentially, there may be scope for further clarification by guidance - in one form or another. Options include:

  • general guidance published by the FSA;
  • individual guidance issued by the FSA to individual financial businesses; or
  • published industry guidance that has been "confirmed" by the FSA.

5.3
Our strong preference is for general (published) FSA guidance. This is likely to be highly influential with ombudsmen when they are deciding individual cases, and so it holds out the prospect of reducing uncertainty for financial businesses and consumers in relation to potential claims.

5.4
It is likely to be impracticable for ombudsmen to take into account a host of (unpublished) individual FSA guidance to different financial businesses. Rather, it would be better for any general guidance to be updated regularly in the light of individual developments.

5.5
The FSA has stated publicly that it will not confirm industry guidance which purports to affect the rights of third parties (which includes consumers taking cases to the courts or to the ombudsman service). This means that FSA-confirmed industry guidance is unlikely to reduce uncertainty in relation to consumer claims.

5.6
It might perhaps be helpful if the FSA built on the material in the November 2008 feedback statement, and explored further explanation of what is (and is not) possible in the context of "focused advice" - with particular reference to the ways in which the financial business's obligations can (and cannot) be limited. For example the FSA's May 2007 insurance sector briefing [opens in PDF format] indicated where advice could (and could not) be limited in the context of with-profits. Something similar in the wider context of the RDR might well be helpful.

6 other ways to reduce risk - clarifying factors taken into account

6.1
Key issues include:

  • the extent of any information a financial business already holds about a consumer; and
  • the implications of means-tested state benefits and taxation policy.

6.2
A financial business may hold information about a consumer additional to that obtained from any advice or sales process (for example, a bank may already hold, through other channels, information about a customer's income, liabilities, property and/or other assets). It would be prudent, as part of the advice/sales process, for the financial business to make it absolutely clear to the consumer that it has not taken into account any information it already holds through other channels.

6.3
Additionally, consider the position of a financial business advising a 30-year-old consumer about pension provision. How far is it realistic to take account of what means-tested state benefits might be in more than 30 years time, and the tax treatment of contributions throughout the intervening period? One possibility would be for the FSA to enable the setting or agreement of a realistic "benefits/taxation horizon" - beyond which a financial business would not be required to take account of potential future changes to means-tested state benefits and taxation policy when giving advice.

7 professionalism - we are not a disciplinary body for advisers

7.1
Key issues include:

  • we consider complaints against financial businesses;
  • there has to be loss or material inconvenience; and
  • we do not investigate the conduct of individual employees.

7.2
We note the interesting proposals, set out in the November 2008 feedback statement, from the FSA's professionalism working group. The group envisages that the ombudsman service will:

  • take account of the proposed code of ethics for advisers;
  • consider consumer complaints against advisers; and
  • exchange information about conduct with the proposed Professional Standards Board.

7.3
We have agreed to explore these issues with the FSA. It is currently envisaged that the code of ethics will bind only individual advisers and not the financial businesses for which they work. But our role is to consider complaints against financial businesses, rather than their individual employees. And we may not know the professional status (or sometimes even the identity) of the employees involved in the relevant transaction. This would make it difficult for us to take the code into account.

7.4
We consider whether or not the financial business was responsible for causing the consumer loss or material inconvenience. We do not consider whether the financial business, or any individual within it, has breached any obligation that did not result in loss or material inconvenience. The ombudsman service is not a disciplinary body. Where we identify a systemic problem or some other major concern about a financial business, or a member of its staff, we alert the regulator - so that it may consider regulatory action. But it is for the regulator, using its own powers, to investigate and assemble any evidence.