The National Audit Office (NAO) has published a report on the current state of the regulatory response to financial services mis-selling. It focuses on (1) the level of co-ordination between the Financial Conduct Authority (FCA), the Financial Ombudsman Service (FOS), the Financial Services Compensation Scheme (FSCS) and HM Treasury; (2) whether the FCA's current measures to prevent and detect mis-selling are effective; and (3) how redress is provided to consumers.
The NAO's report makes for interesting reading, highlighting some positive developments in the handling of mis-selling cases over the past five years. But, the overall tone of the report suggests there is considerable work to do to improve the consumer experience. In particular, that regulatory and cultural change to prevent future mis-selling scandals, such as payment protection insurance (PPI), needs to be more effective.
The NAO also says the evidence does not show any clear reduction in the extent of mis-selling. The report is likely to prompt further soul-searching within the FCA as it strives to find better methods for encouraging firms to change culture and ways of preventing future behaviours that cause detrimental consumer outcomes. Also, how to improve existing experiences for the consumer where mis-selling has already occurred and redress is due.
Notably, the NAO found that;
1. The FCA’s strategic approach to managing the interventions it makes in response to mis-selling is still evolving and there is a risk that interventions may not be well coordinated, meaning the FCA cannot be sure that it has chosen the most cost-effective way of intervening.
2. The FCA and the FOS work hard to coordinate their activities, but haven’t yet convinced firms that they have succeeded in doing this. The NAO found examples of duplication of effort by the FCA and FOS, which means duplication of costs for firms. The NAO suggests more needs to be done here to bring down barriers to cooperation.
3. The costs of regulatory responses to mis-selling and of arranging for redress for consumers are substantial and, some gaps in the FCA’s understanding of the costs of its activities could hamper its decision-making. The total operating costs of the FCA, FOS and FSCS in 2014-15 exceeded £830 million. This is payable by financial services firms. But, ultimately, this is passed on by firms to consumers in the form of increased fees and charges etc. In addition, nine firms paid £300 million for independent reviewer work relating to swaps mis-selling. Again, this is likely to have been passed on to consumers.
4. The FCA's approach to compliance may have a disproportionate effect on smaller firms and it does not routinely undertake post implementation reviews, which could improve its understanding of the actual impacts of regulatory interventions.
5. Regulation aimed at preventing the sale of unsuitable products could have unintended consequences, such as discouraging innovations that could benefit consumers. The FCA has established an innovation hub to allow firms to develop new services and products in an environment of regulatory support, advice and challenge.
6. Increased regulation of incentive schemes, the forthcoming Senior Managers Regime and significant fines and redress payments all appear to have had a substantial impact in reducing the incentive for firms to mis-sell products. In the period from April 2013 to October 2015, the FCA imposed nearly £300 million in fines for mis-selling totalling £298 million, not including the cost to firms of paying redress to consumers. But, the NAO says the FCA still has problems tackling behaviours at middle management level and smaller firms continue to find it difficult to know how to comply with mis selling regulations.
7. The FCA lacks good evidence on whether its actions are reducing overall levels of mis-selling and the data it does analyse is skewed towards past history rather than telling the FCA whether there is a present mis-selling problem or trend that ought to be addressed. More sophisticated data analysis would undoubtedly help here, although the FCA says it is taking a more active approach than its predecessor to identifying and responding to risks related to mis-selling, particularly for new products. In particular, the FCA has identified pension reforms as a possible trigger for future mass mis-selling, and is acting to prepare itself for the problems that may arise.
8. Banks’ handling of complaints has been poor, requiring ongoing action from the FCA and the FOS. Inadequate complaint handling by financial services firms has been a factor in many cases of alleged mis-selling going to the FOS for adjudication, and in increased use of claims management companies by consumers. Although the statistics suggest improvements in complaints-handling, there has been no decrease in the volume of complaints going to the FOS (+60% of which are upheld). This suggests a continued trend of consumer agitation for better outcomes than firms routinely give for mis-selling.
9. Probably linked to the ongoing inadequacies found in the handling of complaints, the NAO found the FCA failed to formally evaluate redress schemes, making it hard to assess whether schemes achieve their intended outcomes. But, the FCA has started work to identify common principles that should feature across its redress schemes suggesting potential improvements could be on the horizon.
10. The FOS has continued to provide an effective service to complainants following a massive increase in complaints, but it has struggled with a backlog of older PPI cases. The NAO also found that nearly half of complainants thought the FOS failed to settle disputes in an acceptable length of time.
11. Consumers' lack of awareness of the FOS or reliance on claims management companies has led to poor outcomes, particularly a failure to receive full compensation for mis-sold products. Around 80% of PPI complaints to the FOS come through claims management companies. The NAO estimated that so far claims management companies have received up to £5 billion of the £22.2 billion of compensation paid out to consumers of PPI.
12. The FCA’s strategic overview of the risks associated with mis-selling and its understanding of the cost-effectiveness of different interventions and redress schemes, are currently hampering its ability to respond effectively when problems emerge.
In its diagnosis for future action the NAO makes further recommendations for each of the FCA, FOS and HM Treasury. For the FCA, it should:
a) Work more closely with the FOS to assess the effectiveness of redress schemes, drawing on a variety of indicators to help it and others to judge whether its actions on mis-selling are achieving their intended effects.
b) Develop a stronger understanding of the effect on costs to firms and consumers caused by its approach to handling mis-selling issues and corresponding redress schemes.
c) Introduce a formal approach to evaluating redress mechanisms, including their costs, rates of uptake by consumers and how quickly they provide redress to consumers.
d) Look at alternative approaches to deciding whether products are mis-sold, including assessing firms on the basis of direct testing of customer understanding.
e) Consider whether its current rules prevent potentially valuable innovations.
For FOS, it should:
a) Work with the FCA to improve firms’ complaints handling, to develop better measures of the quality of complaints handling, and to publish the results, as well as working with financial services firms to help consumers to access redress without using claims management companies.
b) Publicly explain how quickly it expects to clear the backlog of PPI cases on current assumptions about caseload, and report progress regularly. Given the likely increase in cases in the run-up to a possible deadline for claims, it is vital that it deals with the current backlog well before this date.
For HM Treasury, it should:
a) Take steps to improve the FCA’s accountability by removing certain restrictions on the disclosure of information that the FCA holds on firms.
b) Consider in any future legislation or regulation of claims management companies publishing information about their impact on consumer compensation and capping the amount claims management companies can charge their customers.
If you would like to discuss any of the matters detailed in this article then please contact Jake McQuitty or Emily Benson in the Financial Services Regulatory team.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at February 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.