House of Commons - Treasury

Select Committee on Treasury Third Report

Consumer Protection

THE NEED FOR CONSUMER PROTECTION

9. In many areas of life, the consumer can make an informed decision between goods and services on offer, and choose the one offering the best value for money and most suited to his or her needs. Depending on the level of competition, market forces should therefore operate to provide value for money and suitable products. The Consumers' Association told us, however, that this was not the case with financial products: "the market failure is quite extensive: low consumer confidence, poor quality products, widespread mis-selling of a number of products".[13]

DEFINITION OF "CONSUMER"

10. The draft Bill sets out "the protection of consumers" as one of four "regulatory objectives" (Clause 2) and goes on in Clause 5 to explain that the degree of protection needs to be appropriate to the degree of risk of the investment, the degree of experience and expertise of the consumer, and the general principle that consumers should take responsibility for their decisions. It then defines consumers as those who use (or are or may be contemplating using) any services provided by regulated bodies or "who have rights or interests derived from ... the use of any such services by other persons".

11. Ms Barbara Saunders, Chairman of the PIA Consumer Panel (and now Chairman of the FSA Consumer Panel), pointed out that this definition would include "people who are substantial regulated firms", and would have preferred a definition excluding activity carried out "in the course of a trade, business or profession".[14] Ms Sheila McKechnie of the Consumers' Association wanted some aspects of small businesses to be included.[15] Ms Hewitt thought it "important that the FSA should have regard to the full range of consumers ..." but pointed out the provision in the draft Bill that "the nature of the protection they give consumers is appropriate to the nature of the consumer".[16]

12. One concern expressed to us was that dealing with retail and wholesale services in the same regulatory framework would put quite unnecessary burdens on the wholesale end of the business. Dr Taylor said: "it will be very difficult adequately to separate out the protection of the retail investor from the much lighter degree of regulation which is required in the inter-professional markets".[17] The provisions to which we referred in paragraph 10 about the protection being commensurate with the expertise of the consumer are relevant here.

13. The British Bankers' Association (BBA) said that it understood that "the principle of this point [the need to differentiate retail and wholesale business] has been accepted, but great effort will be required to make sure that the way it is worked out in statutory objectives and rules does not undermine it". It pointed out that the criterion for deciding on the regime to be applied "is the nature of the customer, not the nature of the supplier".[18] However, the Association of Private Client Investment Managers and Stockbrokers (APCIMS) said that this system should not be applied too rigidly, and wanted to draw a distinction between the type of advice its members gave (for which the client pays) and that given by an adviser paid by commission.[19]

14. Mr Davies said that the FSA's current proposals were for a three-way split, distinguishing between market professionals, expert end users (such as "the corporate treasurer of a large company"), and the retail sector.[20]

15. The draft Bill makes clear that different types of consumers need different levels of protection. Given this provision, we see advantages in the wide definition of "consumer" in the draft Bill.

ACCOUNTABILITY OF THE FSA TO CONSUMERS

Consumer Representation and the FSA Board

16. The FSA is a private limited company, whose board members are appointed by the Treasury. We examine later in the report (paragraph 56) more general concerns about the suitability of this structure, but consider at this point whether the FSA is sufficiently accountable to consumers.

17. Ms McKechnie called for some FSA board seats to be allocated to consumer representatives.[21] Mr Howard Davies, Chairman of the FSA, however, said that "all board members were there in their personal capacities, all of them representing the public interest whether or not their background was in the industry or ... in consumer groups. I believe at the moment we have an entirely reasonable balance ... but I think that it would be more difficult to operate the governance of the Authority if individuals came to that Board and were required to have a particular hat on throughout."[22] Ms Hewitt agreed that all the board members should "feel a real sense of commitment ... to all the objectives" rather than the objective of consumer protection being seen as the "property" of a particular member of the board "and perhaps less of a priority for the others".[23]

18. We expect the Treasury, in making appointments to the FSA Board, to strike a balance in the expertise and background of its members, and expect them all to be willing to take account of the need to pursue the objective of protecting consumers as much as the other objectives.

The Consumer Panel

19. The FSA has appointed a consumer panel, choosing its members from more than 300 applicants. Three of its eleven members were previously on the PIA consumer panel.[24] Although the panel is intended to be independent, witnesses pointed out that there was no provision in the draft Bill requiring its establishment, and that the FSA was responsible for its funding. Hence there is the perceived risk that the FSA could lessen the influence of a hostile panel by restricting its funding.[25] However, Sir Andrew Large said: "if it were felt by consumers and consumer organisations, for example, that the Consumer Panel was not doing a proper job, I am pretty sure that they would say so very, very quickly".[26] Ms Saunders described the PIA consumer panel (also non-statutory and funded by its parent body) as "no poodle", and said that it had become "a group with specialist knowledge conducting independent research, ... contributing to the formulation of policy but from an external perspective".[27] Ms Saunders said that the FSA consumer panel could be given statutory recognition either by requiring the FSA to establish formal mechanisms for taking consumer interest into account, or to build the requirement for a panel into the Bill.[28] Mr Davies had no objection to the appointment of the panel (or of the Practitioners Forum, mentioned in paragraph 66) being made a requirement in the Bill.[29] Ms Hewitt did not expect the panel to feel "the slightest bit inhibited because of the source of their funding", but would respond to the point.[30] The Treasury have now announced that the establishment of practitioner and consumer panels will be a statutory requirement.[31]

20. We welcome the Government's decision to give statutory recognition to the consumer panel, and believe that, in order that it can be seen to be completely independent, its budget should be independent of the FSA.

THE FOUR REGULATORY OBJECTIVES

21. As mentioned in paragraph 10, the protection of consumers is one of the four regulatory objectives set out in the draft Bill. The other three are market confidence;[32] public awareness (see paragraph 32); and the reduction of financial crime (see paragraph 84). Several witnesses questioned whether these objectives should be presented in an order of priority, and some suggested other objectives.[33] Sir Andrew Large, however, said "there will be cases where there will be differences of weight that have to be given to different objectives".[34] The PIA Consumer Panel called for the objective of consumer protection to be an "overarching objective",[35] and for the introduction of a fifth objective of promoting competitiveness.[36] This was supported by Ms McKechnie, who said that the current competition between companies was mainly in the amount of commission they paid, and also called for an objective of improving the products.[37]

22. Mr Davies thought that the four objectives "dovetail with each other quite neatly", and were related rather than being "targets that are moving away from each other all the time".[38] He said that adding the promotion of competition as an objective might interact with the objectives of the Office of Fair Trading (OFT).[39] Ms Hewitt confirmed that she did not want to make the FSA "a competition authority" and also said that the four objectives would work together and that the order in which they are listed in the draft Bill was not intended to reflect an order of priority.[40]

23. As we have received many representations about the inadequacy of competition in the field of financial services, we attach particular importance to improving competition. The Government should consider whether this can be done better by adding this as a fifth objective for the FSA, or whether primary responsibility should remain with the OFT.

CAVEAT EMPTOR AND THE ROLE OF PRODUCT APPROVAL

24. The general principle "that consumers should take responsibility for their decisions" (Clause 5 (2) (c)) is the draft Bill's embodiment of the legal principle of caveat emptor (let the buyer beware). In 1984 Professor L. C. B. Gower wrote: "regulation in the interests of [investor protection] should be no greater than is necessary to protect reasonable people from being made fools of".[41] The FSA told us that it "believes that the role of regulation is to protect consumers—especially retail consumers—against those risks which they are not in a position to assess and cannot reasonably be expected to assume".[42]

25. There are various risks in financial products from which consumers might need protection:

(a) reckless or fraudulent running of the business, causing it to lose money;

(c) a product which although suitable offers poor value for money (e.g. because of high management charges or severe cancellation charges).

The Consumers' Association however accepted that it is impossible to regulate to prevent market risk.[44]

26. In our report The Mis-selling of Personal Pensions,[45] we examined the alternative approaches of regulation: regulating the process to check whether suitable advice was given and the suitability of the product assessed; or regulating the product so that only those meeting defined criteria could be offered for sale.

27. Ms Saunders said that "there is a danger in seeing the product or process as alternatives. ... I think you need a degree of both."[46] Ms McKechnie said that "the previous legislation regulated the process and that makes it cumbersome, somewhat expensive and, by and large, it did not achieve the desired outcome".[47] Regulation of products would not necessarily impose a heavy burden, and every financial product had to be submitted to the Inland Revenue anyway. She rejected the argument that product regulation would deter innovation[48] and said that a possible compromise approach would be that process regulation would be maintained for products not meeting minimum standards.[49] Commission should be spread over the lifetime of the product.[50] Ms Saunders called for a requirement in the Bill that a product should be fit for its purpose.[51] Sir Andrew Large warned about the danger of the "halo effect", whereby approval of a product might be taken to be a guarantee.[52]

28. Barclays Bank, in written evidence, argued against the FSA regulating the design and cost of investment products. They said this approach risked "the creation of a situation like that in Germany where all investment products are very similar as regards terms, price, and investment performance, no matter which company markets them. Competition is stifled and customers are denied meaningful choice".[53]

29. Mr Davies reminded us that a European directive prevented requiring "pre-notification" of life assurance products, hampering product regulation in this field; but regulations could require disclosure of costs, enabling comparative tables to be drawn up. This would go "quite a long way" towards product regulation; however, there would always be the need for advice and questions of suitability, "which product regulation cannot deal with",[54] except where a product is offered with no advice at all.[55] Ms Hewitt also mentioned the insurance directive but said that the FSA would have "the scope, if it feels that is appropriate, to regulate products or move in that direction".[56]

30. In our report on pensions mis-selling, we asked the Treasury to publish a paper to assist the debate on process-based versus product-based regulation.[57] The Treasury's reply was that it "will be for the FSA to determine its own approach ... the FSA is fully committed to consulting ... Product regulation does have a place in the regulation of collective investment schemes. But taken too far, there is the risk that the effect of regulation might be to standardise products to such an extent that competition between products becomes limited and the scope for innovation is consequently restricted. In examining these issues, therefore, the Treasury would need to ensure that the appropriate balance is struck between the needs of regulation and the benefits of competition".[58]

31. We look to the FSA to strike the right balance between the various methods of regulation, in the light of their assessment of the best way to protect the consumer and encourage competition.

CONSUMER EDUCATION

Promoting awareness

32. One of the aims of the FSA, "public awareness", is defined in Clause 4 as including "promoting awareness of the benefits and risks associated with different kinds of investment and other financial dealing" and "the provision of appropriate information and advice". This is likely to be a considerable task, as Ms Saunders told us that, in a survey of 1,100 people in 1998, none had heard of the FSA, and that 80 per cent of the population view the financial services market as "baffling".[59] Ms McKechnie called for better advertising.[60]

33. Mr Davies said that the FSA was planning to produce fact sheets and provide a help line for retail consumers and that it was looking at activities of regulators in Australia and the United States, where "town meetings" are held to draw attention to the financial decisions consumers have to make.[61]

34. We emphasise the importance of public awareness both of the types of products available, with their benefits and risks, and of the financial system and the role of regulation. Accurate, comparable information from product providers is an essential part of this.

Persistency of Pensions etc.

35. The PIA publishes an annual survey of the persistency rates of life and pensions policies.[62] The PIA Consumer Panel's own research is that a third of personal pensions cease being contributed to within four years and a fifth of whole-of-life insurance policies sold through some outlets cease within two.[63] Mr Davies said that this was "one of the aspects which causes us the most concern", indicating the need for improvement in the disclosure regime and the "best advice and suitability regime"; the figures suggested that "people are being sold products which are not suitable to their circumstances", although "you would not expect 100 per cent persistency because there are unexpected life events that happen to people which cause them to lapse".[64] Similar points were made by Ms Hewitt.[65] We expect the FSA to continue and refine the practice of the PIA of publishing information about persistency rates. The FSA should aim to inform the public as to the nature of the financial products that are available, to encourage the development of more flexible products and to ensure that information is published which will enable consumers to judge whether providers are making disproportionate gains in the early years of, and upon the early surrender of, their financial products.

Accessibility

36. The Association of Friendly Societies said that the "biggest challenge" for the Government, regulator and industry was "the delivery of cost-effective products to lower income groups with appropriate consumer protection". They said that the FSA's cost-benefit analyses required by the draft Bill needed to be "applied to individual types of provider and product rather than on an industry-wide basis".[66]

37. Ms McKechnie did not believe that greater emphasis on regulation in recent years had reduced access to financial advice.[67] Ms Hewitt said that the Treasury was working with banks to ensure that their services were available to people on low incomes. Difficulties arose in proving identity, in the absence of bank branches in some areas, and in some potential customers' fears of finding themselves with an overdraft. The Treasury has established a task force involving credit unions and banks to tackle these problems. The Banking, Insurance and Finance Union suggested that the FSA should "have regard to the need for access to appropriate financial services for all sectors of the community".[68] Ms Hewitt "was not persuaded" that the FSA should be given a specific objective on social and financial exclusion.[69]

38. We believe that the Government's agenda for extending access to such financial services as savings and pensions will involve the FSA in issues of social and financial inclusion. The FSA will want to develop adequate and sensitive systems for monitoring and regulating, to encourage innovative products suitable to the markets being served and to ensure that providers and consumers will not face unnecessary obstacles in gaining access to these particular markets.

SCOPE OF THE FSA

39. Schedule 2 to the draft Bill contains a list of regulated activities and regulated investments, but Clause 11(1) provides that the exact limits of the scope of regulation are to be prescribed by an order made by the Treasury. If such an order seeks to regulate activities not covered by the lists in Schedule 2, it requires the approval of both Houses of Parliament.[70]

40. The Government explained that their intention was that the scope of regulation "should broadly cover the types of business regulated at present". It went on to say that one important change is the increase in the external oversight of Lloyd's of London, and that pre-paid funeral plans may be included.[71] Notable exclusions from the scope of regulation are mortgages and long-term health plans; others are occupational pension schemes, credit cards and other unsecured credit.[72]

Mortgages

41. Sir Andrew Large, who is now Executive Deputy Chairman of Barclays Bank plc, said that he was personally "really quite agnostic" about whether mortgages should be brought within the Act.[73] The PIA Consumer Panel pointed out that "not all the players are included" in the industry codes, and that there are no sanctions if they do not work;[74] they recommended that mortgages should be brought within the scope of the Act, citing the support of all 220 respondents to a survey of consumer and voluntary organisations.[75] The reasons given to support this were that mortgages were becoming increasingly complex, that the OFT have estimated that there are more complaints to trading standards and Citizens' Advice Bureaux on mortgages than on second hand cars, and that it is often "the biggest single investment that any individual makes". Ms Saunders also pointed out that many mortgage marketers will be regulated firms anyway.[76]

42. By contrast, the BBA advocated the continuation of the voluntary code, which implied "a level of regulation which matches their risk profile as products".[77] Mr Sweeney, Director of the BBA, said that codes were flexible, responding faster to changes in the market, involved the commitment of the industry, and cost less; also, it was unwise to load any further burdens on the FSA while it is beginning its work unless "pre-eminently and obviously" necessary.[78] The Independent Review Body to monitor the banking code and the mortgage code was receiving extra funding and was discussing its compliance and sanctioning powers.[79] However, the BBA expected that the FSA would treat failure of banks to comply with the mortgage code (and the banking code) as "a supervisory issue of concern".[80]

43. The Council of Mortgage Lenders (CML) told us that they had been working with the Treasury to produce a "study plan" to define the information to be gathered on the operation of the code. This includes a quarterly survey of all CML members. The CML also drew our attention to a recommendation of the Better Regulation Task Force that mortgages should not be brought within the scope of the Bill at least until the Treasury review; the Task Force adds: "even were the code found to be not fully meeting its objectives, it might be more appropriate or effective to amend it than to introduce replacement legislation".[81]

44. Mr Davies considered it reasonable to "monitor the code of practice for a while and then do a rigorous cost benefit analysis of whether statutory regulation could improve on the procedures of the code of practice". He pointed out that some of the complaints pre-dated the code.[82] Ms Hewitt confirmed that she would review the operation of the mortgage code in 1999 (she reminded us that it came into operation in July 1997 for lenders and in April 1998 for intermediaries) and that mortgages could be brought into the scope of the legislation by order. Mortgages already came within the unfair terms regulations and small ones within the Consumer Credit Act. OFT was looking at redemption penalties.[83]

45. We remain concerned that mortgages, often the biggest single transaction an individual makes, are proposed to remain outside the scope of financial regulation. We will expect to see clear and detailed justification for any decision by the Treasury to continue the voluntary regime for the regulation of mortgages beyond the review due later this year. Furthermore, we expect the Treasury to include in its justification an assessment of the conduct of those mortgage providers who have not signed up to the existing voluntary code.

Long-term Health Plans

46. We received written representations from Commercial Union and the PPP Healthcare Group that long-term health plans should be included within the scope of regulation, to enable consumers to have confidence in the product.[84] Ms Hewitt said that the issue would be reviewed once a Royal Commission had reported.[85] We expect the Government to publish its conclusions on the regulation of long-term health plans at an early date.

Recognised Professional Bodies

47. As mentioned above (paragraph 4.(a)) Recognized Professional Bodies (RPBs) are no longer to be responsible for regulating their own members' provision of financial services. The Institute of Chartered Accountants in England and Wales (ICAEW) told us that a large number of members of RPBs gave general management and financial advice to their clients, particularly small and medium sized entities, and this advice could easily stray into the area of regulated financial services, because of the current, rather loose, provisions of the 1986 Financial Services Act. Advice coming within the scope of the Act could include "generic" advice (as distinct from advice on specific products) and incidental investment work done in the course of non-investment business. As a result, most advisers have had to obtain authorisation or curtail their advice. Although the professional bodies are discussing with the Treasury the possibility of removing the need for such "unnecessary" authorisation, the ICAEW thought that this route might prove ineffective.[86] Mr Swinson, President of the ICAEW, pointed out that accountants would continue to be regulated by bodies recognised by the Department of Trade and Industry for their auditing and insolvency work, so they were not benefiting from the establishment of a single regulator.[87]

48. The Law Society did not believe that the system of dual regulation would be cost-effective ... and considered it "vital that solicitors' firms do not require authorisation unless they are providing mainstream investment business services". They raised concern about the costs, and pressed for enough time to discuss the mechanics of a dual regulation system with the FSA.[88] The Faculty and Institute of Actuaries also called for a clearer definition of "investment business", so that firms which the Institute currently regulates do not have to seek authorisation unnecessarily.[89]

49. Mr Davies justified the new treatment of RPBs on the basis of consistency: "if the same type of transactions are going on and the same advice is going on then they should be treated in the same way". The FSA was trying to ensure that only those "actually marketing investment advice" needed to be authorised, and that it might wish "to delegate its monitoring back to the professional body" but with the FSA's rule book.[90]

50. We accept in principle the case for the FSA to have direct regulatory powers over professionals who provide financial advice; but the definition of "financial advice" needs to be drawn as narrowly as possible to prevent unnecessary regulation, and measures should be put in place to avoid unnecessary duplication of effort by the FSA and the RPBs.

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