New FCA regime good for clients, tough on firms

The U.K.’s new consumer-protection standards will benefit clients, but financial firms will face increased regulatory risk, and their profits will come under pressure, says Moody’s Investors Service in a new report.

New rules and guidance took effect July 31 as part of the U.K. Financial Conduct Authority’s (FCA) new “Consumer Duty” — a set of reforms intended to enhance consumer protection and ensure that firms are prioritizing clients’ interests.

“[The rules] require firms to provide good outcomes for customers by acting in the customers’ best interests and avoiding foreseeable harm; helping them pursue their financial objectives, ensuring that products and services are fit for purpose, and ensuring that the level of service provided meets customers’ needs,” the report said.

To start, the rules apply to new products and services, as well as existing products when they come up for renewal. The scope will be extended to non-renewable products as of July 31, 2024.

Moody’s said consumers will benefit from the new regime, while adding risks and costs for industry firms.

“We expect the consumer-duty initiative to reinforce consumer protection in retail finance, and to help consumers make more informed choices,” it said.

At the same time, while the regulator’s non-prescriptive approach will “give firms flexibility to adapt and innovate,” Moody’s also expects profits to come under pressure throughout the financial sector. Firms will have to absorb some upfront implementation costs, and ongoing compliance costs, it said.

“These are primarily related to enhanced record-keeping and improved communication and support to ensure customers can make an informed choice from the range of products available,” the report said.

There will also be sector-specific implications for different parts of the industry.

For instance, the new rules will boost transparency requirements for asset managers, including disclosures on charges, fund and investment objectives.

“Asset managers will step up efforts to secure best customer outcomes,” it said.

They will also have to enhance the monitoring of distribution arrangements to curb the risk of mis-selling.

Banks and insurers will also face fundamental changes.

“Despite the benefits for consumers, the impact on lenders’ profitability will be negative, as a result of both the costs of implementation and likely impact on product design and pricing,” the report said.

“Pricing will become more transparent thanks to a new requirement for banks and other firms to share data on how they set prices, and on how their prices compare to the market average,” the report said,  noting that banks will likely have to accept smaller margins and to focus on products that give customers more flexibility but produces less revenue from fees and redemption penalties.

Additionally, banks will be expected to ensure that their struggling borrowers’ needs are being met, increasing the operating costs of servicing non-performing loan portfolios, but potentially also improving repayment rates.

“Overall, lenders will bear more interest-rate risk, and will need more dynamic hedging strategies to limit earnings volatility,” Moody’s said.

Insurers will also faced increased regulatory scrutiny, the report said.

“Margins may tighten as insurers attempt to demonstrate customer value, both for insurance products and bolt-on services, which can be a significant source of profit,” it said.

Moody’s said the risk of firms getting hit with regulatory penalties will increase under the new rules too.

“Because the new rules are outcomes-based rather than prescriptive, their implementation is open to interpretation, making inadvertent breaches more likely,” it said. “They also impose a wider range of duties and responsibilities on companies to protect their customers’ interests, which increases the range of potential breaches that could trigger supervisory intervention.”