The purpose of this article is to:
• Provide an overview of the temporary product intervention rules.
• The potential triggers that might precipitate the use of the rules.
• Show how firms can potentially identify ‘risky’ products.
• Illustrate measures that can reduce the potential problems when intermediating a product subject to rules.
The regulator has not specified the precise scenarios under which it would use its powers, but it would be concerned about a product that was poorly designed, impeded competitive processes or undermined market integrity. The following are examples of potential triggers:
• Products that are sold widely outside its target market with the prospect of widespread detriment.
• Products with complex features, structures or comprising esoteric assets.
• Product features or charges that result in limited benefit or poor value for money.
• Misaligned incentives arising from excessively high margins or cross-subsidies if sold as a bundled or tertiary product.
• Products designed to take advantage of poor competitive forces.
The legislation provides the FCA with considerate latitude to intervene through the rules. It can:
• Prohibit authorised firms from entering into specific agreements unless certain requirements have been satisfied.
• Prevent authorised firms from performing an activity that results in the holding of a beneficial or economic interest unless certain requirements have been satisfied.
The types of measures it could invoke include:
• Variations to product terms and conditions to include, exclude or amend certain product features.
• Revisions to marketing materials.
• Restrictions on sales or marketing of a product at wholesale or retail level.
• Outright bans on sales to all, or particular segments, of consumers
The actual degree of ‘intrusiveness’ will be directly related to the scope and scale of potential consumer detriment. While consumers who invest in products after the rules were introduced would not automatically be entitled to compensation, they would only need to demonstrate to the Financial Ombudsman Service or a court of law that the arrangement was subject to the rules. For consumers who invested prior to the introduction of the rules, they would have to demonstrate that advice was unsuitable or as a result of some other malpractice.
The FCA board will make the ultimate decision- about the rules after the specific issue had been considered by a working group and board sub-committee. The rules will only last one year and on expiry the FCA can only extend the provisions through permanent rules with consultation. The FCA is not required to review the rules once in place, but may do so to ensure they are functioning as intended and have not resulted in any unintended consequences or market distortions. The review may result in:
• Publication of further guidance.
• Revocation of the rules.
• Amendments to specific requirements underpinning the rules.
In order to understand the potentially disruptive nature of the rules, let us consider how the FSA may have exercised them with respect to single premium payment protection insurance. The potential triggers for the rules were:
• A tertiary product with high margins cross-subsidising the margins of a loan.
• A premium capitalised on a loan with interest charged on the capitalised sum.
• If the typical duration of a loan was less than the loan term with no pro-rata refund of the PPI premium.
• If it was not possible to switch the PPI product once set up.
• Poor claims experience.
• Poor selling practices.
In addition to strengthening point of sale selling practices, disclosure and mandating past business reviews, the rules would have enabled the FSA to:
• Cap remuneration to the equivalent of other general insurance products.
• Remove certain product features, such as exclusions.
• Order firms to offer pro-rata refunds of premium on early repayment of the loan.
• Prevent sales through certain distribution channels.
• Direct firms to de-couple the sale of the insurance product and loan.
• Completely restrict the sale and marketing of the products.
These measures, although temporary, would have acted as a brake on the market while other longer-term solutions were put in place.
Although the above example is a non-investment product, the rules carry severe implications for intermediaries operating in the investment advice market. So what steps can intermediaries take to reduce and avoid or minimise these adverse consequences of advising on solutions subsequently subject to the rules?
First, firms should perform due diligence on any non-standard solutions that display complexity, esoteric or exotic assets or if they have little experience of advising on them. This should encompass a thorough scrutiny of the product literature for an understanding of the structure, underlying assets and overall level of charges. Firms should be able to form a view on what role the product may play in its clients’ portfolios and the key drivers of investment performance, including the scenarios under which it could fail. If there are any inconsistencies or points of clarification, this should be obtained from the provider and if ambiguity still exists, the product should not be distributed.
The next stage is to consider the ‘fit’ with the firm’s client base and whether distribution should be restricted to certain client segments, channels or advisers. When setting distribution strategies, firms should have an idea of total amount of investments expected to be secured, volume of cases for every adviser or average investment or every client. These metrics should form the basis for compliance monitoring and senior management oversight of distribution. The final piece of the jigsaw is to ensure all relevant staff have received training and are competent to advise on a particular product.
The rules represents a landmark shift in the regulation of markets by allowing the regulator to intervene earlier and further up the value chain. The actual powers are very wide and enable the FCA to intervene to advance its regulatory objectives. The types of reasons the FCA would use them could be if a product has design flaws, impedes effective competition or creates market integrity issues.
The ramifications for both providers and intermediaries are significant and herald the onset of an era of ‘disruptive regulation’. Their use could precipitate the precise event it is seeking to avoid, resulting in consumer detriment and reduced market competition. In order to reduce the potential adverse consequences, firms should apply a regulatory lens when considering the distribution of new, innovative or niche products. They should set distribution strategies that optimise the commercial opportunities while reducing its regulatory risk.
Esrar Moitra is consulting director of Optima Regulatory Strategies
Box out
The FCA’s temporary product intervention rules allow it to take action on specific products, its features or sales and marketing practices where it believes prompt action is necessary to advance its regulatory objectives without the normal consultation process. The powers complement existing handbook rules and regulatory tools, such as variation of permissions or imposition of specific requirements on firms. The key point is that the measures are a temporary intervention for a maximum of 12 months while a longer-term solution can be devised either by the market or through further regulatory intervention.
Key points
The FCA would use the rules for products that were poorly designed, impeded competitive processes or undermined market integrity
The actual degree of ‘intrusiveness’ will be directly related to the scope and scale of potential consumer detriment.
The ramifications for both providers and intermediaries are significant and herald the onset of an era of ‘disruptive regulation’.
