What does consumer duty mean for Fintechs?

This article first appeared in DIGIT News, 5 September 2023.

In this contributed piece for DIGIT, Aidan Campbell, partner; and Jamie Marshall, senior associate at CMS break down the cascading effects of the Financial Conduct Authority’s (FCA) new Consumer Duty.

The Financial Conduct Authority’s new Consumer Duty came into effect on 31 July 2023. It represents a step change in regulatory expectation and regulatory burden for in-scope firms.

The Duty is broad in scope and may catch some firms unawares, particularly firms in the e-money, payment services and crypto sectors that are not otherwise in all cases subject to the FCA’s rules.

What is the Consumer Duty?

At the top level, the Duty requires firms to act to deliver “good outcomes” for retail customers, an enhancement from the previous requirement to “treat customers fairly”. The FCA does not define what “good outcomes” means for the purposes of the Duty. Firms must establish this for themselves on the basis of what is reasonable.

The top-level requirement is underpinned by requirements to act in good faith, avoid causing foreseeable harm to retail customers, and enable and support retail customers to pursue their financial objectives.

These requirements are underpinned by four outcomes: products and services, price and value, consumer understanding, and consumer support.

To comply with the Duty, firms must be proactive in identifying any business lines in scope of the Duty, establishing what “good outcomes” means, and taking steps to deliver those outcomes in practice.

Who and what is in scope?

Broadly, the Duty applies to firms who provide or distribute regulated investments or services to retail customers. In-scope products can include investments such as units in funds or bank accounts, or financial services such as investment management, brokerage / intermediary or robo advice services.

All FCA authorised firms are caught, but so are some non-authorised firms, such as payments and e-money firms.

A firm is subject to the Duty to the extent it is able to determine or materially influence retail customer outcomes. A firm can therefore be subject to the Duty whether it provides a product or service to a retail customer directly, or to other firms who themselves directly service retail customers (a so-called “distribution chain”).

However, the more remote a firm is from the end retail customer, the less likely it is to be able to determine or materially impact retail customer outcomes, and so be responsible for them under the Duty.

What does this mean for fintechs?

Many fintechs are likely to fall within scope of the Duty, even where they operate solely on a B2B basis.

Fintechs should analyse their businesses to identify whether any business lines have Consumer Duty “touchpoints” and, if so, what processes and procedures are required to ensure compliance with their obligations under the Duty.

While fintechs should consider the Duty as a whole as part of this exercise, some areas are likely to be of particular interest.

Extension to e-money and payments firms

E-money and payment services firms are expressly caught by the Duty. Such firms are not in all cases required to be authorised by the FCA, and so may not typically expect their activities to be subject to the FCA’s rules. It is therefore particularly important that such firms are aware of how the Duty will affect them and take proactive steps for compliance. In February 2023, the FCA issued a letter to payments and e-money firms to help them implement and embed the Duty more effectively, which such firms should consider.

Unregulated distributors

Fintechs may distribute products or services which are subject to the Duty via distributors who are not themselves subject to the Duty, for example distribution of savings account products by banks via deposit platform offerings.

The use of unregulated distributors is not prohibited under the Duty, although the FCA has stated that firms should consider the potential impact of unregulated distributors on customer outcomes, suggesting it considers the use of such distributors to create additional risks.

Firms using unregulated distributors should obtain robust contractual guarantees regarding distributors’ activities – for instance requiring distribution of products only to the identified target market, and the provision of management information on that distribution – and maintain regular oversight so they are able to step in where necessary to safeguard customer outcomes.

Embedded finance providers dealing with unregulated distributors (such as online merchants) should consider whether they are exposed to particular risks as a result.

Where an embedded finance provider is fully in control of the customer journey from the point at which the retail client is introduced to it by the online merchant, it may be able to satisfy itself that it will be able to ensure compliance with the Duty entirely (or almost entirely) through that customer journey and its own client-facing materials.

If aspects of the customer journey occur in the online merchant’s systems ecosystem, or the provider will otherwise be reliant on the merchant to comply with its obligations under the Duty, the provider will need to consider the impact of this on the outcomes retail customers will receive.

Providers should consider whether is is neccesary or desirable to obtain contractual guarantees from such online merchants, taking into account the provider’s regulatory risk tolerance.

Cryptoassets and financial promotions

Crypto firms are not typically subject to the Duty but may be indirectly impacted in respect of marketing activities, under rules being brought in by the government and the FCA.

Under those rules, the issue of cryptoasset marketing communications will be subject to the UK financial promotion restriction and the FCA’s rules.

Broadly, the financial promotion restriction prohibits the marketing of financial services other than by certain permitted persons.

Breach of the financial promotion restriction is a criminal offence and can lead to 2 years’ imprisonment and/or an unlimited fine.

From 8 October 2023, the only persons permitted to issue crypto marketing communications to UK consumers will be FCA authorised firms, other persons where the relevant communication has been approved by an FCA authorised firm (or where an exemption applies), and crypto firms registered with the FCA for anti-money laundering purposes where the communication relates to their own crypto business.

Persons issuing crypto marketing communications who do not fall into one of these categories will breach the financial promotions restriction. All such persons will need to ensure that the communications they make or approve comply with stringent new requirements under the FCA’s rules, for example to be fair, clear and not misleading.

The FCA has said it does not propose to apply the Duty to registered crypto firms communicating their own financial promotions, but FCA authorised firms will need to ensure compliance with the Duty for communications that they communicate or approve.

These changes will raise the standard which crypto marketing must meet in the UK. Crypto firms issuing their own marketing will be subject to an increased compliance burden, while FCA authorised firms are likely to be less willing to approve crypto communications, particularly as they will be responsible for their compliance with the Duty.

This is likely to have a chilling effect on the marketing of crypto to consumers and to increase costs to crypto firms.