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The Consumer Duty: What MiFID II investment firms need to know

Written by Douglas Moffat

The Consumer Duty: What MiFID II investment firms need to know

The Consumer Duty: What MiFID II investment firms need to know

What is The Consumer Duty?

The Consumer Duty is an imminent FCA Regulation which sets high expectations for the standard of care that firms give to customers in retail financial markets. It includes the addition of a new consumer principle, set to be added to the FCA Handbook, which captures the purpose and sentiment of the regulation as a whole:

Principle 12

“A firm must act to deliver good outcomes for retail customers”

The Consumer Duty imposes a higher level of attention to customer outcomes than before. In practice, this means that Principle 12 supersedes the existing, lower standards of care outlined in Principles 6 and 7, wherever the Duty applies. In the regulation, The FCA explains that the principle is supported by 3 cross-cutting rules:

The cross-cutting rules

  1. Firms must act in good faith towards retail customers
  2. Firms must avoid causing foreseeable harm to retail consumers
  3. Firms must enable and support retail customers to pursue their financial objectives

The cross-cutting rules also inform and are supported by four outcomes which define, at a greater level of detail, firms obligations across key areas of the customer relationship:

The relationship outcomes

  1. The products and services outcome - Firms must create and distribute products and services that are suitable for their intended purpose.
  2. The price and value outcome - Firms are required to address factors that may result in products or services that are unfair or of poor value, including unsuitable features that may cause foreseeable harm or hinder customers from using the product or service effectively.
  3. The consumer understanding outcome - Firms should communicate in a manner that facilitates consumers’ comprehension of their products and services, including their characteristics, potential risks, and the consequences of their decisions.
  4. The consumer support outcome - Firms are expected to provide support that is tailored to their customers’ needs. Such support should empower consumers to achieve the benefits of the products and services they purchase, pursue their financial objectives, and act in their own interests.

Implementation and scope

Following two consultation papers issued in 2021, the FCA published finalised guidance on 27 July 2022. The most significant changes made in the finalised rules were in the areas of implementation. Notably, the implementation period has been extended from 9 to 12 months, and the final deadline has been pushed to the end of July 2023. In the meantime, firms were required to produce approved implementation plans before the end of October 2022, which the FCA has since been reviewing. In January 2023 the FCA published its findings, raising ineffective prioritisation, overconfidence in existing systems and inter-firm collaboration as three areas of concern that require attention from firms.

The scope of the regulation is broad, encompassing all firms under the FCA’s remit, such as banks, insurance companies, and investment firms that provide products and services to retail customers. These firms are required to not only review their immediate sales channels but also account for the impact of their products and services across the entire distribution chain. This includes a requirement for firms to clearly articulate the target market to their distributors, and to notify the FCA when they become aware of another firm in the distribution chain that is not complying with the Consumer Duty which requires not just management information but also strong oversight and management of the distribution channels.

How will The Consumer Duty impact MiFID investment firms?

MiFID II investment firms are those which offer Investment services and activities as defined and regulated by the directive. Such services are increasingly demanded in retail markets, and the broad scope of consumer duty means that these firms now face further regulation. This is understandable, against a backdrop of fears that under informed, or even vulnerable individuals might be harmed when engaging in the market for investment products or services. This is especially relevant in the context of MiFID II Investment services and activities, which can be highly complex and risky and where significant harm has already been realised (e.g. Retail investors losing significant amounts of money through exposure to high risk, leveraged products such as Contracts for Difference). MiFID II investment firms are therefore likely to face much greater scrutiny under the duty

For instance, MiFID II investment firms which transact directly with the consumers of MiFID II regulated products and services, such as asset managers, will be accountable for various requirements under the duty:

  • Providing a thorough understanding of the product and its alternatives
  • Suitability assessment (including risk appetite both from the customer’s financial objectives but also from their ESG objectives)
  • Outcomes testing
  • Risks of harm

Firms operating further back in the distribution chain, such as market makers, will also be accountable for ensuring that their actions do not result in harm to consumers. They must clearly define the appropriate target markets and distribution channels and, further, that they achieve the best possible outcomes as measured by factors including transparency, price, venue and speed. In this area, MiFID II and Consumer Duty crossover significantly, as MiFID II already mandates this behaviour through best execution rules. Regardless of where they are situated in the distribution chain, firms need to gather the necessary data to demonstrate compliance with regulations.

The role of technology?

When operating at the speed, scale and complexity of MiFID II firms, complying, and proving compliance, with such high standards will require the use of technology. Trade and transaction surveillance technologies, for instance, provide firms with the capability to observe and analyse the outcomes of their activities, thereby potentially identifying instances where consumers may be adversely affected. These technologies are highly aligned with the cross-cutting rules of duty that refer to consumers’ behavioural biases as a crucial factor for consideration. By leveraging surveillance technologies to monitor trade and transaction activities, firms can identify any instances where consumer behaviour may be influenced or manipulated by these biases, thus helping them to address and mitigate any potential harm to consumers.

eComms surveillance technology can also help MiFID II firms to comply with the Duty. By allowing firms to monitor their internal and external communications, firms can ensure that they are taking appropriate actions to achieve the best outcomes for customers. Further, the resulting audit trail can serve as part of a package of evidence to prove compliance. The latest technologies are built for added convenience and intelligence - integrating unstructured communications (including voice) data from any platform, utilising machine learning and natural language processing to automate the flagging of suspicious records and presenting these cases alongside subsequent trade or transaction activity that may be related.

Best execution, as discussed, is a requirement that sits comfortably in the intersection of MiFID II and Consumer Duty. As such, MiFID II firms will already have some measures in place, and most will utilise technology to support compliance. Consumer Duty therefore serves as an opportunity for firms to review their current systems and ensure they are up to speed with the best-in-class products, which automate the tracking and reporting of best execution performance data (e.g. trade reason codes and the outcomes of off-market rate checks) and trigger workflows in the event of a tolerance breach, enabling firms to react, as mandated by the duty, where foreseeable harm may occur.

On the whole, Consumer Duty is a highly demanding and complex regulation which presents significant challenges to firms and how they comply. Critically, it is potentially impossible to prove compliance in the absence of up-to-date technology. However, firms which embrace technological change will also achieve second-order benefits of greater operational efficiency, data insight and customer satisfaction. Make sure that your firm is equipped to take Consumer Duty for what it is - an opportunity to serve customers’ true needs in order to build relationships that last.