FCA's probe of advice charges carries across retail finance

This aricle was produced by Thomson Reuters Accelus Regulatory Intelligence.

An old trick involved invoicing people who had just died for an expensive umbrella. The umbrellas were obviously unnecessary and often never delivered, but distracted relatives would pay up. Swap the dead for customers who have already received advice and
the umbrella for annual reviews, and you have the gist of a problem with advice firms' ongoing charges, which the Financial Conduct Authority (FCA) is investigating.

In February, the FCA asked 20 of the largest advice firms for information about their ongoing charges and how they were reassessed under the Consumer Duty. It was not the first time the FCA raised concerns about charges for unnecessary or fictional services. They also appeared in "Dear CEO" letters from December 2022 and January 2023, ahead of the Consumer Duty's introduction last July and again in a December 2023 webinar.

"We're seeing too many firms providing a service which the client doesn't actually need," Kate Tuckley, the FCA's head of consumer investments, told the webinar.

"And the worst example of that is where a customer is paying for a service, for example, an annual review, which it doesn't actually get at all."

Non-existent and unnecessary charges
There are two main strands to the FCA's investigation of ongoing advice charges. Repeatedly charging customers for a service they never receive verges on fraud, and firms should ensure it does not happen. If firms charge such fees deliberately, as the FCA clearly suspects, then they have engaged in misconduct, should determine who is responsible and self-report to the regulator.

"The FCA knows that financial advisers' ongoing services provide a litmus test for the quality of their conduct and culture," said Michael Lawrence, principal consultant on the wealth team from the financial regulatory consultant Bovill. "Its work in this area has been designed to review a key element of the advisory business model whilst also assessing how firms have implemented the Consumer Duty."

The investigation's other strand is seeing how firms assess whether individual customers need an ongoing service and, if so, whether the service provided is fair value in accordance with the Consumer Duty. This aspect is more complicated and has implications for all retail sector firms.

Advice firms are especially vulnerable to an investigation of fees because most firms adopted an assets-under-management (AUM) fee model after the Retail Distribution Review (RDR) prohibited funding advice via product-linked commissions. The proportion of advice firms' revenue derived from ongoing charges based on a client's AUM rose from 60% in 2016 to 77% in 2022, and a recent study found 98.7% of firms use the AUM fee model.

FCA challenges have already affected some firms, including the listed national undertaking St James' Place. After criticism for opaque charges, it announced plans in July 2023 to lower ongoing fees. After more FCA pressure, St James' Place lowered charges again in October 2023 and scrapped an early withdrawal penalty. In February, it set aside £426 million to cover claims from customers charged for ongoing services they never received. Each event lowered the firm's share price.

As for the investigation's possible impact, the payment protection insurance (PPI) debacle also involved people being sold something unnecessary and cost UK banks £48.5 billion in fines and compensation. Australia's 2019 Hayne Commission report into banking
and superannuation misconduct, which included charging advice fees to deceased customers, had a profound effect throughout the country's financial industry.

Consumer Duty
Instead of enjoying a little schadenfreude at advice firms' expense, those in other sectors should ensure they are not themselves charging for unnecessary services and that their business offers fair value under the Consumer Duty. The FCA has used fair value questions to justify interventions in several areas, including interest on investment customer cash balances, guaranteed asset protection (GAP) insurance and car finance.

"Each of these interventions reveals a little more on how the regulator is applying the Consumer Duty price and value rules at the coalface in each sector," Lawrence said.

"It's therefore important for all firms to ensure their frameworks for assessing fair value keep pace with the latest regulator developments and that the outputs stand up to scrutiny."

Firms should have reviewed their processes throughout the customer relationship chain ahead of the Consumer Duty's introduction to check they deliver across its four outcome areas: products and services, price and value, consumer understanding and consumer
support. The Consumer Duty is not about one-off reviews. The FCA has stressed that firms need to be continually improving, and they are obliged to monitor consumer outcomes under PRIN 2A.9.

"A good 'catch-all' test is for firms to ask themselves which aspects of their service design and charging models have changed because of the Duty," Lawrence said.

"If the answer is 'none,' then it will be important to document the rationale for this decision. And it will also be worth checking that the decision has been subject to appropriate, independent challenge."

Fair value assessment
The hardest part of most Consumer Duty product and service reviews is the fair value assessment. Firms need to be able to provide a view of the overall costs to the consumer, including non-monetary and distribution expenses, said Simon Collins, a UK managing
director in the financial services team of the legal and compliance consultancy Konexo.

"Importantly, the fair value assessment should not be generic and should be product- or service-specific and reflect different target market segments," Collins said.

"Taking into account the profit margin on a product or service is important, as are non-financial costs, such as the time needed to make a decision about a product, such as cancellation."

Under PRIN 2A.8.3-2A.8.5, firms must prepare an annual report based on their PRIN 2A.9 outcomes-monitoring, showing whether they are fulfilling the Consumer Duty and suggesting necessary action. This must be scrutinised and, if necessary, challenged by the board and approved by the board member designated as the firm's Consumer Duty Champion.

"The first annual report is due to be delivered by July 31, and it is expected that the FCA will undertake thematic work to review the quality of these reports," Collins said.

"The annual report should be able to demonstrate how the firm has evidenced that it has delivered the four Consumer Duty outcomes."

No paid-for service can be fair value if it is unnecessary. A complication with ongoing services is that even if a firm judges the service necessary for a customer one year, it may not be the next. Fair value assessments for ongoing services should also consider the quality of customer communications and service delivery.

"Firms should focus on whether clients understand the service they're getting, whether services are delivered as promised and whether services are delivered well," Lawrence said.

"The last two areas are particularly important, as ongoing services can only deliver their key benefits if they take place and advisers use the outputs to ensure solutions remain suitable for clients' updated needs and objectives."

[Authored by Tim Hitchcock, Thomson Reuters Regulatory Intelligence].