Discussion Paper 06/4. Financial Services Authority. The responsibilities of providers and distributors for the fair treatment of customers

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1 Discussion Paper 06/4 Financial Services Authority The responsibilities of providers and distributors for the fair treatment of customers September 2006

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3 Contents 1 Overview 3 2 Areas for discussion 7 3 Next steps 8 Annex 1: The responsibilities of providers and distributors for the fair treatment of customers Annex 2: Illustrations of the responsibilities of providers and distributors The Financial Services Authority 2006

4 The Financial Services Authority invites comments on this Discussion Paper. Please send us your comments to reach us by 29 December Comments may be sent by electronic submission using the form on the FSA s website at ( Alternatively, please send comments in writing to: Treating Customers Fairly Retail Themes Division Financial Services Authority 25 The North Colonnade Canary Wharf London E14 5HS Telephone: Fax: dp06_04@fsa.gov.uk It is the FSA s policy to make all responses to formal discussion available for public inspection unless the respondent requests otherwise. A standard confidentiality statement in an message will not be regarded as a request for non-disclosure. Copies of this Discussion Paper are available to download from our website Alternatively, paper copies can be obtained by calling the FSA order line:

5 1 Overview 1.1 This Discussion Paper invites discussion and debate on our view of the respective regulatory responsibilities of providers and distributors to treat customers fairly. We committed to do this in Treating Customers Fairly Building on Progress (published in July 2005) and in the FSA Business Plan 2006/ We expect that publication of our views in this area will increase the effectiveness and efficiency of retail financial markets to the benefit of consumers. Further, firms have asked us to provide our views. Some have found that questions on responsibilities arise where they put TCF into practice. They and others also argue that some firms are not giving these matters appropriate emphasis. What we want to achieve 1.3 Our view as set out in this Statement is that the primary responsibilities of the product provider are to ensure that products are soundly designed for the target market, are sold with clear, understandable information (for distributors and, where relevant, customers) through appropriate distribution channels and perform as the provider promised. A distributor s primary responsibility is to ensure that the customer has the information they need, that (for an advised sale) the product is suitable for the customer and post-sale service meets any expectations created The Statement is not intended to imply that a firm must take on the regulatory responsibilities of other firms in the distribution chain. Why we want to achieve it 1.5 A customer s experience should not be affected by whether a product was provided and distributed by a single institution or by two or more institutions. 1 In terms of product providers, we estimate that to be 765 providers; comprising 50 wholesale firms, 400 retail provider groups, 30 major retail groups and 285 smaller firms. We estimate that the Statement is relevant to around 22,000 distributors including independent financial advisors, mortgage and insurance intermediaries. Financial Services Authority 3

6 1.6 We believe that, where firms follow the approach to their responsibilities set out here, there will be an increase in the effectiveness and efficiency of retail markets. While there is no presumption that all firms need to alter their behaviour, some providers are likely to design and target their products with greater care, provide higher quality information, monitor distribution channels more effectively at a high level, and better analyse the performance of products post-sale. 1.7 Similarly, some distributors will be encouraged to bring more scrutiny and inquiry to information that they receive from product providers and this should lead to fewer cases of unfair outcomes for consumers where, for example, a distributor wrongly assumes that a product is suitable for customers. 1.8 In addition to these benefits to consumers, provider and distributor reputations should be enhanced. Why we are focusing on this particular aspect of TCF 1.9 We have already suggested to industry that a useful starting point in achieving fair treatment of customers is for senior management to think of TCF in terms of the product life cycle. Depending on the precise nature of a firm s business, this could mean addressing the fair treatment of customers at the following stages: product design and governance; identifying target markets; marketing and promoting the product; sales and advice processes; the remuneration of sales forces and advisers; after-sales information and service; and complaints handling. This Statement gives the FSA s view of the respective responsibilities of product providers and distributors under the Principles during the product life-cycle summarising duties owed to the consumer or to another firm, especially where a number of firms are involved While many firms have reviewed their respective responsibilities under the Principles over recent years, the experience of our supervisors is that problems persist at the level of interface between providers and distributors. For example, we have received complaints from distributors about the poor quality information supplied to them by providers. By the same token, we have been made aware of instances where distributors have failed adequately to process or query information supplied to them by providers (for example, when offering advice or issuing financial promotions). We are also aware of instances where providers have failed to alert distributors with ongoing obligations to customers to material changes that need to be communicated to customers (for example, with endowment mortgages). 4 DP06/4: Fair treatment of customers (September 2006)

7 Why we are taking this particular approach 1.11 In accordance with our more principles-based approach, this Statement is an articulation of what we believe the existing Principles for Businesses mean. The aim is to improve industry behaviour and so reduce unfair outcomes for consumers without providing new prescriptive requirements. The Statement does not add any new regulatory responsibilities either for providers or distributors it merely captures existing responsibilities Supervision: Once finalised, this Statement will be a useful tool for our supervisors, particularly when they deal with TCF issues at firms. However, it will not change the way that we approach supervising TCF or other issues. Supervisors may use the Statement in their discussions with firms. The issues it covers will continue to be dealt with in our supervision work as they are now, for example in the risk assessment framework we use for supervising firms (ARROW) or in pieces of focused thematic work Enforcement: We only take enforcement action under the Principles where at the time the breach occurred it was reasonably predictable that the conduct in question was in breach of the Principles. We would not be able to rely on this Statement as evidence of predictability for conduct that occurred before it is published in final form and, for conduct that pre-dates the finalised Statement, we would need to demonstrate such reasonable predictability by other means We are aware of the current initiatives by trade associations to help their members better understand how responsibilities are divided between different firms in the distribution chain, and we welcome them. In some cases these initiatives are joint efforts by trade associations which represent providers and distributors respectively. However, we do not think that industry action alone will lead to the change in firms behaviour that we think is needed in this area. This is because trade association activity is unlikely to cover the whole of the financial services sector. Furthermore, we consider that, without our intervention, at least at a high level, trade associations will have no baseline on which to build their efforts. We do, however, view this Statement as complementary to trade association efforts, and would be happy to see a combination of our work in this area and industry initiatives leading to fairer outcomes for consumers. Structure of this Paper 1.15 Section I of the Statement (Annex 1 to this paper) provides a high-level overview of these responsibilities under the Principles and detailed rules. Of course, the responsibilities owed and what they require will depend on the particular circumstances of each case. Financial Services Authority 5

8 1.16 Section II (Annex 2 to this paper) explores this further in the context of particular industry sector case studies, being mortgage, general insurance and investment (stakeholder pension, UCITS III and structured products). We have chosen these case studies to illustrate a range of issues across key retail sectors but they are not a comprehensive analysis of all the distribution chains that exist in the financial services industry, nor are they necessarily the most likely scenarios. Rather, they identify particular issues in distribution chains that we think it is useful to illustrate. We have set these illustrations in particular industry sectors but the issues each case study covers may occur in a range of or all sectors. Consequently, a firm that operates in one sector may find pertinent issues in any or all of the case studies relating to a variety of fairness issues. Who should read this paper? This paper is aimed at regulated firms involved in the supply of products or services to retail customers. The paper is relevant to firms of all sizes, but we will shortly publish a separate guide for smaller firms to help them navigate this paper. The paper should lead to improved outcomes for consumers and will be of interest to consumer groups. However, the proposed Statement relates to responsibilities within and between firms so the paper will not be of direct interest to most individual consumers. 6 DP06/4: Fair treatment of customers (September 2006)

9 2 Areas for discussion 2.1 Do you agree that this Statement accurately reflects the respective responsibilities of providers and distributors under the Principles? 2.2 Do you consider that firms are already acting in line with the obligations referred to in this Statement? 2.3 Where a firm is not yet meeting the obligations referred to in the Statement, what is the likely cost to the firm of bringing their activities into line? 2.4 Do you agree that we are the right body to publish this Statement? Financial Services Authority 7

10 3 Next steps 3.1 This paper invites discussion and debate on the FSA s views of the key responsibilities of providers and distributors to each other and the endcustomer. We would particularly welcome your views on the Areas for Discussion set out above. 3.2 Please let us have your comments on this Discussion Paper by 29 December We will make comments publicly available, unless respondents request otherwise. 3.3 We will finalise and publish this Statement in the light of comments received. We expect to do this in March Markets in Financial Instruments Directive 3.4 The Markets in Financial Instruments Directive (MiFID) is a major part of the European Union s plan to create a single market in financial services. MiFID comprises two levels of European legislation: the Directive itself (adopted April 2004) and implementing measures. 2 We intend to publish the new rules and guidance in the Handbook implementing MiFID by the end of January 2007 and they will come into force on 1 November We believe that the proposed Statement is likely to be compatible with the requirements that will apply after the implementation of MiFID. 3 However, the development of those requirements continues and we will keep the relationship between MiFID and the proposed Statement under review and will revisit it in our feedback on responses to consultation. In particular, it is likely that some of the terminology and cross-references in the Statement will need to be updated once the new conduct of business rules implementing MiFID come into force. 2 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004, on Markets in Financial Instruments; and Commission Regulation implementing Directive 2004/39 EC 3 For further information about MiFID you may wish to see the following page on our website. We have published several documents to help firms as they prepare to implement MiFID and to engage stakeholders in discussion: 8 DP06/4: Fair treatment of customers (September 2006)

11 Annex 1 Statement of responsibilities of providers and distributors 1. Introduction 1.1 When seeking to establish the responsibilities of providers and distributors to customers, it is important to have regard to the following: Principles for Businesses; Detailed rules and guidance; and The Financial Services and Markets Act 2000 and subordinate legislation, other legislation and case law. 1.2 Under the Principles for Businesses (Principles), 1 various responsibilities are owed by product providers or distributors to retail customers or each other in a way that has an impact on the retail customer. Detailed rules within the FSA Handbook further specify what these responsibilities are in certain defined circumstances. This Statement gives our view on what the combination of Principles and detailed rules require respectively of providers and distributors in certain circumstances to treat customers fairly. It aims to give our views where the industry tells us it would be useful. However, it is not, and does not seek to be, a complete exposition of all of a provider s or distributor s responsibilities to the customer or to each other; nor does it alter, replace or substitute applicable rules, guidance or law. Section I of the Statement provides a high-level overview of responsibilities under the Principles and detailed rules. Of course, the responsibilities owed and what they require will depend on the particular circumstances of each case. Section II explores this further in the context of particular industry sector case studies, being mortgage, general insurance and investment (stakeholder pension, UCITS III and structured products). The case studies are not a 1 See PRIN2 The Principles. Annex 1 1

12 comprehensive analysis of all the distribution chains that exist in the financial services industry, nor are they necessarily the most likely scenarios. Rather, they identify particular issues in distribution chains that we think it is useful to illustrate. We have set these illustrations in particular industry sectors but the issues each case study covers may occur in a range of or all sectors. Consequently, a firm that operates in one sector may find pertinent points relating to a variety of fairness issues in any or all of the case studies. 1.3 This Statement is intended to be relevant to all regulated firms involved in the supply of products or services to retail customers. Our intention is not to change the existing (implied) responsibilities of providers or distributors in delivering fair outcomes for customers. Nor does this Statement seek to determine or change whether or how consumers can seek redress in an individual case or from which firm in the supply chain. Instead, it is simply our articulation of existing regulatory responsibilities. This Statement does not determine or change whether or how one firm in a distribution chain may seek redress from another firm; this too will depend on the circumstances of the case. 1.4 The supply chain may not comprise only authorised firms, but this Statement does not deal with the position where an unauthorised firm is involved unless expressly stated otherwise. 1.5 In the Statement we examine the application of the Principles for activities in the United Kingdom, unless expressly stated otherwise. 2. Interpretation 2.1 In this Statement we use the word must where an action is specified in a Principle or detailed Rule; we use should where we think a firm should consider a particular action (not specified in a Principle or Rule) at a reasonably high level to comply with a Principle (not that they should follow a detailed and prescribed course of action). We use may where an action is only one of a number of ways of complying with a Principle. Customer 2.2 Where we refer to the customer in this Statement we use it as a convenient name for the end-customer in the retail supply chain (which may include potential customers in a given case). However, it is important to note that the term customer as used in the Principles or detailed rules themselves is a defined term in the FSA Handbook. This Statement does not seek to alter or affect any definitions within the Handbook. 2 Annex 1

13 Provider 2.3 We use provider to include persons who offer services such as portfolio management through distributors as well as those who develop, manage or package products such as life insurance, general insurance or investment products or who develop or enter as lenders into mortgages. Distributor 2.4 We use distributor to mean those persons who then make up the rest of the supply chain taking the product or service to the customer. This could include, for example, financial advisers, third party administrators, appointed representatives, banks, building societies, portals, wrap platforms, multi-ties, fund supermarkets and those who sell insurance as a secondary part of their business. 3. The responsibilities in summary 3.1 The primary responsibilities of the product provider are to ensure that products are soundly designed for the target market, are sold with clear, understandable information (for distributors and where relevant, customers) through appropriate distribution channels and perform as the provider promised. Providers key responsibilities therefore include: the design and testing of products and an assessment in broad terms of their suitability for different types of customer; selection of appropriate distribution channels; provision of appropriate information to distributors and, where relevant, customers; monitoring of the end result i.e. in broad terms, to monitor whether there is any indication that products are ending up with the right type of customer, whether the products continue to deliver what the provider promised, and acting when they do not; and delivering prompt post-sale service e.g. claims handling. 3.2 A distributor s primary responsibility is to ensure that the customer has the information they need, that (for an advised sale) the product is suitable for the customer and post-sale service meets any expectations created. Distributors key responsibilities therefore include: ensuring that the distributor understands the provider s information about the product and, if the distributor is not clear about that information, questioning the provider and considering whether to distribute the product; fully considering customer needs and circumstances (where advised) so the product can be properly matched to the customer; and Annex 1 3

14 ensuring that post-sale service is consistent with that they led a consumer to expect. 3.3 Clearly the market contains more complex arrangements and the Statement takes account of some of these structures. These include: when multiple distributors act in a chain; when distributors commission products, so can be responsible for product design; and when pure manufacturers create components that are later subsumed into retail products designed and marketed to customers by retail manufacturers. Principles for Businesses 3.4 The Principles for Business apply to all authorised firms. This Statement looks particularly to the following Principles: Principle 2 ( A firm must conduct its business with due skill, care and diligence ); Principle 3 ( A firm must take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems ); Principle 6 ( A firm must pay due regard to the interests of its customers and treat them fairly ); and Principle 7 ( A firm must pay due regard to the information needs of its clients and communicate information to them in a way which is clear, fair and not misleading ). 3.5 What a firm has to do to meet the requirements of a Principle will depend on the circumstances, including the riskiness or complexity of the product or portfolio, who the firm is dealing with (another firm or a customer, for example) and the financial sophistication of the target market. 3 Firms should bear all of these factors in mind in order to interpret the requirements of the Principles in a way that is proportionate. 2 In the context of component pure products being subsumed into larger 'retail' products, we are aware of the current debate about the wrap platform aggregation. The debate centres on the question of whether wrap platforms empower users (i.e. advisers) to 'aggregate' component parts into a new product or simply to aggregate products into a convenient portfolio-platform. In the former case the wrap user would count as a retail manufacturer of a new product; in the latter the wrap user would count as a distributor of a third party provider's products. Given the ongoing status of this debate we have not broached the topic of wrap platform 'aggregation' in this paper. We would, however, welcome any industry feedback on the matter. 3 Prin 1.2.1G. 4 Annex 1

15 Detailed rules and guidance 3.6 In some cases, the meaning of a Principle is elaborated by a detailed rule or guidance in the FSA Handbook. We have referred to some individual detailed rules or guidance in this Statement. 4 Legislation and case law 3.7 Legislation and case law can have an impact on providers and distributors responsibilities. Within the scope of this Statement it is not feasible to provide a comprehensive statement of relevant legislation and case law. However, it is worth noting that the English Courts recently required a product provider to contribute substantially toward compensation paid by a distributor to a customer, in the circumstances of the particular case before the Court Product life-cycle: role of the provider 4.1 Providers and distributors who are involved in product design should consider the impact of their action (or inaction) on the customer in various stages of the product life-cycle as illustrated further below. 4.2 As noted above, it is possible that a product manufacturer creates a product to meet criteria or designs specified by a distributor. In such instances, many of the responsibilities described below, particularly in respect of product design, fall to the commissioning distributor, as retail manufacturer of the product, rather than the pure manufacturer of the commissioned product. Of course, if the pure manufacturer delivers a product which fails to meet the agreed specification, the retail manufacturer may seek its own redress under the contract between them or the applicable law. That said, the pure manufacturer must act with due skill, care and diligence in accordance with Principle 2 and, where it conducts a regulated activity for the underlying customer (for example, it enters into a contract with a customer), must comply with Principle 6. Other Principles and detailed rules may also apply. 4.3 It is also possible that a product manufacturer creates components that are later (and possibly without the component manufacturer s knowledge) subsumed into retail products designed and marketed to customers by retail manufacturers. In such instances, the pure manufacturer may not have a contractual or other relationship with the underlying customer. The pure manufacturer may not be aware (nor is it necessarily the case that it ought to be aware) of whether the retail manufacturer is using the product for itself or for an underlying customer. However, the pure manufacturer should act with due skill, care and diligence in designing its products (Principle 2). The skill, care and diligence that are due under Principle 2 will be determined taking 4 The guidance in this Statement should be taken as guidance on detailed rules, where relevant, as well as on the Principles. 5 Seymour & Seymour v Caroline Ockwell & Co [2005] EWHC Annex 1 5

16 all the circumstances into account. These may include the manufacturer s knowledge of whether the product or service is provided to a firm, rather than an underlying customer, and the information needs of the firm. In addition, the pure manufacturer will normally be obliged to communicate information to the retail manufacturer in a way that is not misleading (Principle 7). 4.4 Product Design 4.5 In the area of product design, Principles 2 and 6 are particularly relevant. When undertaking product design, the provider should identify the target market, namely which types of customer the product is likely to be suitable for. Depending on the nature of the product and its general risk profile, the provider may do this by identifying which types of customer the product is not suitable for which in a given case may be just by establishing whether the product is appropriate for the mass market or not. 4.6 As part of the process of identifying the risks posed by the product to the target market, the provider should consider stress-testing the product to identify how it might perform in a range of market environments and how the customer could be affected. The provider does not need to stress-test a product which can have no variation in its performance (for example a straightforward general insurance policy). The provider is less likely to need to stress-test a product whose performance is directly linked to market movements (for example a unit trust of market-traded shares). Stress-testing becomes more important where a product is, for example, geared or has pay-outs which are indicated or promised in the product s description but not guaranteed. 4.7 When stress-testing, the provider should consider the vulnerability or level of financial capability of the target market and should include the stress-testing of any product features which could lead to sharp variations in the product s performance. For as long as a product is available for purchase, and during the life of the product, the provider should from time to time review this assessment of risks posed by the product in case it needs to make material changes to the original assessment. 4.8 The provider should also consider, under Principle 3, which systems and controls it will need to manage adequately the risks posed by product design. 6 6 e.g. SYSC (Senior Management Arrangements, Systems and Controls) and COB 3.6.1R (Confirmation of Compliance). 6 Annex 1

17 Financial Promotions and other Information for Customers 4.9 When a provider communicates, or causes to be communicated, a promotion to consumers, Principles 6 and 7 and the detailed financial promotions rules in the Handbook are especially relevant. 7 In particular, providers should consider their target market, including its likely level of financial capability and must communicate information in a way that is clear, fair, not misleading and balanced Even where financial promotions or distribution are undertaken by a distributor, the provider may need to meet specific information provision requirements for customers for example Key Features and Key Facts documents. 9 Furthermore, to meet its obligations under Principle 7 (for example), the provider should consider what other information the customer may need to understand the product, its purpose and the risks. The provider should also consider under Principle 3 which systems and controls it will need to establish to manage the risks posed by financial promotions and any detailed rules that may apply In producing financial promotions, terms and conditions or other material which customers may rely on, product providers may have obligations in addition to the above under the general or statute law (for example in negligence and misrepresentation or under the Unfair Terms in Consumer Contracts Regulations 1999). Provision of Information to Distributors 4.12 Where a provider uses a distribution channel other than its own sales force or its own advisers, the distributor needs information from the provider about the product that is being sold. In certain circumstances, a distributor required by a rule to obtain information will be in compliance if it can show it was reasonable to rely on information supplied by another person. 11 In producing statements that distributors may rely on, product providers may also have obligations under the general or statute law, for instance in negligence and misrepresentation In considering what information to provide to distributors, the provider should pay regard to Principle 2 in particular. Firstly, where information is designed for distributors alone, the provider should make clear that the information is not intended for customers to use. The product provider should apply due skill, care and diligence (Principle 2) when preparing information for distributor use, so that the information is sufficient, appropriate and comprehensible in substance 7 e.g. COB 3 (Financial promotions); ICOB 3 (Financial promotions); MCOB 3 (Financial promotions). 8 e.g. COB 3.8.4R (Non-real time Financial Promotions: Clear, Fair and Not Misleading), COB 3.8.8R (Form and content of financial promotions); ICOB 3.8.1R (Form and content of Non-investment Financial Promotions); MCOB 3.6.3R (Form and content of non-real time qualifying credit promotions). 9 e.g. COB 6.1.4R (Product disclosure); ICOB (Information responsibilities of insurers and intermediaries; Provision of information to retail customers; and Provision of information to commercial customers); MCOB 5.4 & 5.5 (Illustrations general; and Provision of illustrations). 10 e.g. SYSC (Senior Management Arrangements, Systems and Controls) and COB 3.6.1R (Confirmation of Compliance). 11 e.g. in circumstances in which the firm was required to obtain information COB 2.3.3R (Reliance on others); ICOB 2.4.2R (Reliance on others); MCOB 2.5.2R (Reliance on others). Annex 1 7

18 and form. As part of meeting that requirement, the provider may wish to consider what information the distributor has, their likely level of knowledge and understanding, their information needs and what form or medium would best meet those needs (which could include discussions, written material or training as appropriate). Amongst other information, the provider could include information on the generic risks that the product presents and the target market The level of information or assistance that a provider should offer to a distributor depends in part on the nature of the relationship between provider and distributor. For example, where the provider manufactures a product to meet a distributor s own specifications, the information that the distributor requires may be less Similarly, where the provider is a pure manufacturer providing a component of a packaged product to a retail manufacturer, the pure manufacturer should take care that information provided to the retail manufacturer is not misleading and is rendered with due skill, care and diligence (Principle 2). Selection of a Distribution Channel 4.16 A provider should pay particular regard to its obligations under Principles 2, 6 and 7 when deciding which channels are appropriate for distribution of its product, for example deciding whether to sell through independent financial advisers, tied adviser or by direct offer. Providers should consider whether this is a product where customers would be wise to seek advice A provider is not responsible for what the distributor says when the distributor gives advice or makes sales, although where a provider has not supplied sufficient, appropriate and comprehensible information to a distributor, the distributor may be entitled to seek redress from the provider in the courts under the general law. However, in complying with Principle 2 in particular, the provider should consider keeping the quality of its distribution under review at a strategic, high level. This could include consideration of sales volume in relation to the expected size of the target market and of whether a distribution channel is no longer appropriate to the product being sold. The provider should act when it has concerns, for example by ceasing to use that distribution channel. Post-sale Responsibility 4.18 In the post-sale environment, under Principle 7 in particular the provider may need to provide information to the customer. Some but not all information requirements are contained in specific rules. 12 In supplying information direct to the customer, the product provider must ensure it is clear, fair and not misleading under Principles 6 and 7 and meets the detailed rule requirements e.g. COB 6.3 (Post-sale confirmation: life policies); COB 8 (Reporting to customers); ICOB 7 (Claims handling); MCOB 7 (Disclosure at start of contract and after sale). 13 e.g. COB 2.1 (Clear, fair and not misleading communication), COB 8 (Reporting to Customers), ICOB 2.2.3R (Clear, fair and not misleading communication), and MCOB 2.2.6R (1) (Clear, fair and not misleading communications). 8 Annex 1

19 4.19 The provider may not have direct interaction with the customer, for example if intermediation is undertaken by a wrap platform. This means that in exercising its post-sale responsibility, the provider will in this situation only deal with the distributor (for example the wrap platform in charge of an aggregate account) and supply it (not the customer) with information. The application of the Principles in such circumstances will depend on the precise relationships involved but, as a minimum in all cases, the provider should ensure that the information it provides to the distributor is rendered with due skill, care and diligence under Principle 2. To meet that responsibility, the provider may wish to consider what information the distributor has and their likely level of knowledge and understanding As part of meeting the requirements of Principles 6 and 7 in respect of the customer, the provider should consider the extent to which it needs to regularly review products (in particular the more risky products) whose performance may vary materially to check whether the product is continuing to meet the general needs of the target audience that it was designed for, or whether the product s performance will be significantly different from that the provider originally expected and communicated to the distributor or customer at the time of the sale. 14 If this occurs in a way that will have material negative impact, the provider should consider whether and how to inform the customer of this (to the extent the customer could not reasonably have been aware) and of their option to seek advice. Of course in a given case the provider may also be responsible for giving redress to the customer Under Principles 6 and 7 the provider should consider communicating to the customer contractual breakpoints such as the end of a long tie-in period that may have a material impact on a customer that the customer cannot reasonably be expected to recall or know about already Providers should act promptly when handling claims or when paying out on a product that has reached maturity (Principles 3 and 6 are particularly relevant). In doing this, the provider should meet any reasonable expectations that may have been created in the customer s mind with regard to how the process would be handled. The product provider should also meet the requirements of Principle 3 in terms of establishing and maintaining customer complaint-handling systems. 5. Product life-cycle Role of the distributor 5.1 Distributors should consider how their relationship with product providers or reliance on information supplied by providers can have an impact on the fair treatment of customers. 14 e.g. SYSC G (Management information); SYSC G (Business strategy). Annex 1 9

20 Product Design 5.2 A distributor will be likely to carry some responsibility for product design where the distributor s decisions have driven or influenced the design of the product (for example because the distributor has commissioned a product from a provider with criteria specified by the distributor). A distributor is not likely to have responsibility for the product design where it has merely communicated market data on what its customers would like to buy to the provider and the provider has independently designed or redesigned a product in response. Financial Promotions 5.3 Where a distributor communicates financial promotions direct to customers the distributor s responsibilities are set out in particular in Principles 6 and 7 and the financial promotions rules. 15 The distributor also should be satisfied that its systems and controls for compliance of financial promotions are adequate (Principle 3). 5.4 In passing on a promotion created by a product provider, the distributor must meet the requirements of the principle of due skill, care and diligence (Principle 2). 16 However, a firm will not contravene the financial promotions rules where it communicates a promotion produced by another person provided the firm takes reasonable care to establish that the other person has confirmed compliance with the relevant detailed rules, amongst other matters. 17 Provision of Information at or before the Point of Sale 5.5 When passing provider material to customers, the distributor should ensure that it understands the information provided about the product as part of its Principles 2, 6 and 7 obligations in particular. To do this the distributor should, for example, consider whether the information was intended only for distributor use and whether, if designed for the customer, it is appropriate for the target market. 5.6 Where material is unclear, the distributor is more likely to meet its Principles 2, 6 and 7 obligations to the customer if it asks for answers from the provider before providing the material to the customer. The distributor may need to explain the information to the customer. It should ask the product provider to provide additional information where that seems necessary to understand the product adequately. The distributor should consider whether it will distribute the product if it does not understand the product sufficiently. 15 e.g. COB 3.8.4R (Non-real time Financial Promotions: Clear, Fair and Not Misleading), COB 3.8.8R (Form and content of financial promotions); ICOB 3.8.1R (Form and content of non-investment financial promotions); MCOB 3.6.3R (Form and content of non-real time qualifying credit promotions). 16 Seymour & Seymour v Caroline Ockwell & Co [2005] EWHC COB 3.6.5R, ICOB 3.7.5R, MCOB 3.9.5R (Communicating a financial promotion where another firm has confirmed compliance). 10 Annex 1

21 5.7 Distribution chains may involve several distributors consecutively. In such distribution chains, distributors may find that they pass information to or receive it from another distributor. In considering what information to provide to a further distributor in the chain, the distributor should pay regard to Principle 2 in particular, giving thought to how the further distributor will use the information. Where the information is for distributors alone, the distributor should make clear that the information is not intended for customers to use. In meeting its Principle 2 obligation, the distributor may wish to consider what information the further distributor requires and the likely level of knowledge and understanding of the further distributor and what medium may suit it best for the transmission of information. This is particularly where the further distributor is arranging policies for the customer. 5.8 The FSA Handbook also contains specific rules about information that must be provided to customers. 18 In certain circumstances, a distributor required by a rule to obtain such information will be in compliance if it can show that it was reasonable to rely on information supplied by another person. To do this the distributor should, for example, consider whether the information was intended only for distributor use and whether, if designed for the customer, it is appropriate for the market at which the distributor will target it. The general or statute law (notably mis-statement and misrepresentation) also applies to statements made by a distributor to a customer. Selection of Product Providers 5.9 When a distributor is deciding which product to recommend to a customer in the context of an advised sale, the distributor must consider the nature of the product and how it fits with the customer s needs and risk appetite. To act with due skill, care and diligence (Principle 2), to treat its customers fairly (Principle 6) and to properly assess suitability, a distributor undertaking an advised sale should consider what impact the selection of a given provider could have on the customer in terms of charges or possibly, where information is available to the distributor, how efficiently and reliably the provider will deal with the distributor or customer at the point of sale (or subsequently, such as when queries arise or a product reaches maturity). 18 e.g. COB 6 (Product disclosure and the customer's right to cancel or withdraw); ICOB 5 (Product disclosure); MCOB 5 (Pre-application disclosure). Annex 1 11

22 Post-sale Responsibility 5.10 A distributor s responsibility to a customer after the point of sale in many circumstances is in part determined by any contract or agreement with the customer. In discharging its obligation to treat its customers fairly (Principle 6), the distributor should bear in mind any contractual obligation it has to the customer, for example to provide ongoing advice or periodic reviews of a product s performance. In connection with this, the distributor should consider its responsibility under Principle 3 to maintain adequate systems and controls to deliver on such reviews. The distributor should also consider any implied or express representations it made (during meetings, correspondence or promotional material, for example). Where a customer has reasonable expectations based on the prior statements of a distributor, for example that a product s performance will be monitored the distributor should meet these expectations if it is to treat its customers fairly (Principle 6) Where involved in handling claims or paying out on a product that has reached maturity Principles 3 and 6 are particularly relevant. In this regard, the distributor should meet any reasonable expectations that may have been created in the customer s mind with regard to how the process would be handled. The distributor should also meet the requirements of Principle 3 in terms of establishing and maintaining customer complaint-handling systems. Distributors should also pass any communications received from customers (intended for or suited to providers to act upon) to providers in a timely way. 12 Annex 1

23 Annex 2 Some illustrations of the responsibilities of providers and distributors These case studies are not a comprehensive analysis of all the distribution chains that exist in the financial services industry, nor are they necessarily the most likely scenarios. Rather, they identify particular issues in distribution chains that we think it is useful to illustrate. We have set these illustrations in particular industry sectors but the issues each case study covers may occur in a range of or all sectors. Consequently, a firm that operates in one sector may find pertinent issues in any or all of the case studies relating to a variety of fairness issues. 1. Mortgage Illustration Sub-Prime Mortgage Product Provider Distributor Customer Sourcing System Introducer Mortgage Lender A Packager Mortgage Broker Network Principal (with ARs) Customer (e.g.) Customer with impaired credit The distribution chain in this scenario 1.1 In this scenario the mortgage lender is the provider and the mortgage broker is the distributor (through the broker network). 1.2 The Lender does not offer advice or a direct sales channel. Instead it distributes its sub-prime products through brokers. Some of the brokers it uses have their own sales and advice staff while others are networks who sell through their own Appointed Representatives ( ARs ). Annex 2 1

24 1.3 The Lender provides details of a sub-prime, floating-rate product to sourcing systems and awaits requests from brokers. The Lender also provides technical product details to all brokers it uses to explain how the product works, its pricing and the commission the Lender will pay the broker. The Lender receives the customer s application for a particular mortgage from the broker (possibly through an electronic application system) for consideration. If it agrees to grant a mortgage (after making whatever enquiries it considers necessary, for example about the customer s income or the valuation of the property), the Lender will make a formal mortgage offer to the customer. Once the customer accepts this and all other legal formalities are completed the Lender releases the mortgage advance (usually to the customer s solicitor). 1.4 Broker Network Principal advertises a full advice service to sub-prime customers. Broker Network Principal is attracted by a specific sub-prime product which it may have seen advertised in the Lender s marketing material or by searching on the sourcing system. 1.5 Introducer Website handles all online responses generated by Broker Network Principal s adverts. Introducer Website passes on details of suitable applicants to the network. Broker Network Principal then distributes leads to ARs according to geography. ARs then contact leads. 1.6 A Customer with impaired credit responds to an advert placed by Broker Network Principal in the press by filling out an online form with his personal details. Later the Customer receives a call from Broker Network Principal and after a brief discussion about the Customer s needs the Customer meets one of the ARs. At the meeting the AR talks the Customer through the Initial Disclosure Document illustrating the extent and cost of the AR s services. The AR then undertakes a fact find and uses the sourcing system to assess the most suitable product for the Customer. It recommends a particular mortgage to the Customer and issues a personal illustration on behalf of the Lender also using the sourcing system. The Customer decides to go ahead and completes a mortgage application form which the AR sends to the Lender. 1.7 Once the loan has been arranged in principle, the AR passes the application form back to Broker Network Principal. The latter uses the services of an unauthorised packager company that packages up all the paperwork which Broker Network Principal needs to send to the Lender (e.g. payslips, employment record, credit check) along with the mortgage application. Provider/Distributor responsibilities in this scenario 1.8 Set out below are the responsibilities for the regulated firms in this scenario as outlined in Section I of this Statement. 2 Annex 2

25 Product Design 1.9 Because the mortgage under offer is a sub-prime product (enabling customers with impaired credit ratings to access qualifying credit), to meet Principles 2 and 6 the Lender should be especially careful when it comes to identifying the target market and any risks that the product presents to this market. In particular, the Lender may wish to identify which type of customer the product is not suitable for because of their access to prime, more costefficient mortgages. Since the Lender s mortgage product has a very narrow range of possible key variables (the rate as well as any early repayment charges), the Lender in this scenario need only undertake limited product stress-testing from the Customer s point of view that will allow it to show how the Customer s repayments will change when interest rates move The Lender must also comply with requirements relating to charges associated with the mortgage as detailed in MCOB 12 (Charges). Selection of Distribution Channel 1.11 To meet its obligations under Principles 2, 6 and 7 in selecting distribution channels for this sub-prime mortgage, the Lender should consider matters including how to select distribution channels which will take the product to the target market (i.e. those which deal with sub-prime customers), whether it should select sub-prime specialist distributors only and whether this sub-prime product is one where customers would be wise to seek advice The Lender should monitor distribution to customers through the channels it has chosen at a high, strategic level. To do this, the Lender may monitor sales volumes and check that these volumes are in line with the expected size of the target market for the channel. The Lender should act if it has concerns, for example by reviewing its information disclosure to the distribution channel or by investigating the channel further The Introducer Website is an unauthorised entity. The Broker Network Principal should ensure that the involvement of the Introducer Website as part of its operation does not adversely affect its ability to treat its customers fairly. Selection of Lender 1.14 To act with due skill, care and diligence (Principle 2) and treat its customers fairly (Principle 6), the AR should take into account what impact selecting a given Lender could have on the Customer. Financial Promotion 1.15 Responsibilities relating to financial promotions fall on both the Lender and Broker Network Principal. Annex 2 3