At a glance
- The FCA’s new Consumer Duty requires all financial services firms to assess the value of their products and services where these are directly or indirectly sold to retail customers. This is an extensive exercise and, with less than a year until the expected implementation deadline, firms may struggle to complete their assessments in time.
- Firms in some sectors are already subject to detailed rules on assessing value. While these firms will still need to carry out additional work to comply with the Duty, their experience to date provides useful insights into the key challenges associated with developing and performing value assessments. This blog discusses these challenges so that other firms can learn from them as they prepare to comply with the Consumer Duty. It has been written for product manufacturers but may also be relevant to distributors.
- Agreeing key terms and responsibilities, sourcing the necessary data, and developing the assessment framework will take firms longer than they may expect. Firms will need to leave sufficient time for these activities and liaise closely with other parties (for example, distributors) to gain their buy-in and co-operation.
- Where firms uncover poor value, they will need to take appropriate action to address it. With increased scrutiny on value, firms will need to make strategic choices about what products to offer, at what price and to whom.
Under the FCA’s new Consumer Duty (‘the Duty’), all financial services firms need to ensure that their products and services provide fair value to retail customers. Manufacturers must ensure that their products provide fair value to retail customers in the target markets for those products, and to consider their value assessment when selecting distribution channels. Distributors need to assess their fees against the extent and quality of their services and consider whether their fees would result in a product ceasing to provide fair value to the customer.
While firms in sectors such as asset management and insurance are already subject to rules on assessing value, for firms in other sectors (for example retail banking or consumer credit), performing detailed value assessments is a new requirement.
For products or services sold or renewed after the Duty comes into effect, the assessment must be performed before the end of the implementation period (currently expected to be 30 April 2023). In a recent Deloitte survey of wealth and asset managers, over half of the respondents (52%) said they had not yet begun to prepare for the Duty. With less than a year to the deadline, many firms have their work cut out to assess the value of their products and services. This blog identifies some of the key challenges experienced by insurers and asset managers when undertaking value assessments. Understanding these challenges can help firms plan their value assessment process more effectively.
We set out in the Appendix a high-level road map for firms to consider as they plan their assessment processes.
The first step of a value assessment is to identify the products in scope and the persons responsible and qualified to undertake the review. This can take longer than expected as there is often confusion over key terms and responsibilities. In the insurance sector, for example, where there may be several variations of the same product, many firms spent considerable time agreeing how to define a product or how material a variation needed to be before it was considered a new product. Firms also need to identify which products are sold directly or indirectly to retail customers. There will be cases where the firm’s immediate client is non-retail but the end customer is retail (e.g. an asset manager servicing a pension fund), and the rules will apply in these cases in a way that is proportionate to the firm’s role and impact on customer outcomes.
Similarly, there can be lack of clarity between entities in the value chain about whether they are product manufacturers, co-manufacturers or distributors, and what role and responsibilities they therefore have in relation to the value assessment.
Firms may need to undertake discovery work to understand how key terms are understood amongst different parts of the value chain and will need to engage distributors at the outset to reach agreement on roles and responsibilities in relation to the assessment. Where firms are co-manufacturing products, they will need to agree how to split responsibility. In the insurance sector, we have seen examples of firms agreeing a ‘lead manufacturer’ who is responsible for leading the review with co-manufacturers then responsible for providing relevant information and data.
Once firms (and their counterparties) have a clear understanding of in‑scope products, grouping them based on their features and risk-profile can increase the efficiency of reviews. Fewer groups mean fewer reviews but firms should take a risk-based approach and be cautious about grouping products at too high a level as this can result in important distinctions being missed. The FCA rules on value assessments for insurance products provide a helpful steer on the factors firms should consider when grouping products (see PROD 4.2.34E). These include the risk and complexity of the product, the nature of the target market and the nature and type of distribution channels.
Poor data will impede firms’ ability to undertake robust assessments. Early in the process, firms need to identify what data they have and what additional data they need to source both internally and externally. Common challenges in gathering data include:
Data on costs across the distribution chain - obtaining comprehensive and consistent data on costs charged throughout the value chain can be challenging, particularly where there are multiple entities involved. Distributors may be reluctant to disclose to other entities what they consider to be commercially sensitive data or be concerned about the burden that collating and providing the data places on them.
The draft Duty rules are less detailed than PROD 4 (the value assessment rules for non-investment insurance products) on the issue of considering distribution costs in the manufacturer’s value assessment, and there is also no explicit rule requiring distributors to provide the data. This may lead to confusion for manufacturers about how detailed their assessment of distribution costs needs to be, and pushback from distributors reluctant to provide the data.
Nevertheless, under the draft rules, manufacturers are required to consider the expected total price paid by the retail customer and consider the value assessment when selecting distribution channels, so manufacturers need to give some consideration as to how the distribution arrangements affect the expected value of the product. They will need to work constructively and collaboratively with distributors to access the necessary data and may need to re-evaluate commercial relationships where distributors consistently fail to provide it or do not agree to keep their costs within certain parameters. The format of data requests will also need to be carefully considered to ensure that data received maps across to the value assessment.
Internal data on costs - under the Duty, firms may consider, as part of the assessment, the costs they incur in manufacturing or distributing products. In the asset management sector, the FCA has been encouraging firms to undertake a ‘bottom up’ analysis of how much it costs to provide each product or service, by working out how much it actually costs to provide each product rather than simply allocating total costs between products based on assets under management. The FCA has notably also urged firms not to assume that high profits are acceptable just because they are typical across the industry.
External data on costs - if firms choose to compare charges against comparable products or services in the market, there can be challenges associated with creating a robust peer group. Charging structures and product/service features vary, and this can make it hard to find enough exact matches. For some products or services, there is less publicly available data on charges, or customers may be able to negotiate discounts to the publicly stated price. Firms should consider how they can make their peer groups as robust as possible and be transparent about any data limitations in their assessment. In the asset management sector, some firms have used third party providers to collate and provide some of the relevant data.
Developing the value assessment framework
The FCA has not prescribed the form of the assessment, and the criteria firms must consider are high level. In developing their assessments, firms need to strike a careful balance between flexibility and consistency. The assessment needs to flexible enough to take account of product or service-specific features but be sufficiently consistent to ensure that results are comparable and firms can demonstrate that they are not ‘cherry-picking’.
We set out in the Appendix a high-level framework for firms to consider when developing their value assessments.
Setting thresholds - to begin using their assessment framework, firms need to have an initial idea of what constitutes value. They will need to set thresholds for each of their value criteria, such as key performance indicators for the product’s performance or quality of service, or the maximum level of product charges that are acceptable relative to comparable products or to the costs incurred by the firm in manufacturing or distributing the product. Firms should review and recalibrate these thresholds as they progress through their review and the quality of their data improves. Setting thresholds will involve making judgement calls. For example, at certain times, actively managed, growth or income investment funds inevitably underperform the market and their benchmarks, but firms will need to decide how long they can tolerate underperformance before the threshold is breached.
Scorecards - in the asset management sector, many firms use scorecards to assess value against different value indicators, often with a red, amber or green rating for each value indicator. It is important that each indicator is considered individually, so that a red rating on one indicator is not ignored simply because the other value indicators are rated green. The FCA found that some firms gave heavier weighting to a fund’s performance than to other value considerations, meaning potential concerns in other areas were not escalated. A red rating on any value indicator should trigger a discussion at the relevant committee or Board.
Early in the process, firms need to identify which board or committee will have primary responsibility for reviewing the value assessments and ensure that this body is closely involved as the value assessment methodology is developed. Many firms have been grappling with where the governance for the Duty should sit given its broad scope, with firms often choosing the Board Risk Committee, Product Governance Committee or Conduct Risk Committee, and some firms setting up a new Conduct and Client Outcomes Committee. Whichever committee firms choose, they need to ensure that the remit of the committee is appropriate and membership is broad enough to provide adequate challenge of the assessment framework and results.
The assessment itself is typically performed by the first line, with oversight from the second and third line. Where assessments are performed by the first line, the review team must be independent of product/proposition teams to deal with conflicts of interest
Where firms find that a product does not offer fair value, they will need to take appropriate action. This could include cutting fees, improving the benefits of the product, reducing non-financial costs to the customer (for example, removing unnecessary barriers in customer service), or reviewing the distribution strategy if it is not supporting the value of the product. While the FCA is not intending to apply the Duty retrospectively, firms will need to ensure that their products provide fair value on a forward-looking basis. This means that firms will need to make strategic decisions about which products to offer, at what price and to whom.
Based on the experience in the asset management and insurance sectors, some products will emerge as outliers in providing poor value and firms will need to take corrective action. In its feedback to the asset management industry, the FCA said that firms had been quicker to cut fees for outsourced service providers than their own fees. To be credible, firms will need to apply a similar standard to their own fees as they do to other firms. We also expect that the value assessment process could contribute to downward pressure on distribution fees, since many firms will need to give more consideration to how distribution costs affect the value of their products than previously.
Firms preparing to do in-depth value assessments for the first time can learn from the challenges experienced by asset managers and general insurers. Firms already undertaking value assessments under sectoral rules will need to consider what additional areas they need to assess under the Duty.
Overall, the value assessment exercise will be a significant piece of work and will have implications for firms’ business model and strategy. Firms will need to start early and engage third parties, including distributors, as well as the board or committee that is overseeing the assessments.
Firms must also avoid seeing the completion of the first round of assessments as the end goal. Notwithstanding the significant operational challenge they face in getting over the line, the assessment of value is an ongoing requirement that will need to be ‘baked into’ firms’ ongoing product review processes.
Read our other insights on the Duty
We have produced a wide range of thought leadership on the Duty. Our previous blogs set out the key implications of the Duty for:
- firms across the financial services sector
- asset and wealth managers
- retail banks and consumer credit firms
- non-bank payment firms
You can also read our insights on the FCA’s feedback on value assessments in the asset management sector, the FCA’s product governance rules for GI firms, and how GI firms can leverage their existing work on product governance to meet the requirements of the Duty
Please see the attached PDF for a high-level framework for firms to consider when developing their value assessments.