In our article of May 21, 2024, published in Reuters, we highlighted that Fair Value is central to the Consumer Duty Framework. However, we argued that Fair Value in this context differs significantly from its application to financial instruments.
Therefore, rather than treating this as a benchmarking exercise for price, firms must carefully develop a comprehensive fair value model to meet the FCA’s objectives and expectations. While firms have made notable progress in developing a fair value assessment framework, we believe there is still more to be accomplished.
Two overriding principles must be kept in mind.
- The focus of consumer duty is on delivering good outcome and NOT the cheapest product or service
- Fair value can shift over time and therefore its assessment and adjustments is a continuous process
Fair Value Assessment Framework: Our Approach
A certain level of abstraction and subjectivity in approach to developing fair value framework is expected, especially in the first few iterations. In its reviews FCA did point out instances where the firms relied on high-level or unevidenced arguments that their business models or ethos are inherently fair value
The framework must be objective, precise and based on granular assessment criteria. In our view, this is predicated on three distinct dimensions – all are important and are interdependent:
- Product and Customer Objectives
- Internal Considerations and Cost Analysis
- Benchmarking
The following develops on these dimensions and offers a protocol, within the FCA guidelines, for developing fair value framework. This could be applicable to firms across industry sectors:
1. Product and Consumer Objectives:
- Purpose: the reason for buying the product or service. What is the customer trying to achieving. For example, borrowing in itself cannot be the ultimate goal
- Target Market: the particular group of consumers that are the target for the product. Also, which group of consumers the Product is NOT suitable for and must be excluded from sales efforts.
- Alternatives: what are the alternatives available to achieve the same objective and does the Product provide a utility compared to the alternatives. It must be noted that the comparison here is not with the similar product offering in the market but the alternatives paths to reaching the ultimate goal. For example the goal may be the cost effective commute rather than owning a car.
- Limitations and Risk: What are the limitations of the Products and what are the risk factors. Could these risks factors (such as interest rates, property valuations, tax regulations) result in (i) consumers not being able to achieve objectives (ii) cause harm in the future
- Appropriateness: If the Product appropriate for the consumers in the context of their objectives and are there any features or risks that may not be fully understood by the consumers
- Communication: Is the commination clear to the intended target market. Do we need to provide scenario analysis or detailed disclosure with examples
2. Internal Considerations and Cost Analysis:
- What are the various variables that are considered while pricing the product. These should be clearly documented and would typically include:
- The internal funding costs
- The credit risk considerations. For example, consumer segments representing higher risk would typically require higher credit premium to be charged. However, care must be taken to make sure that this does not make the Product unaffordable for the specific segments and if there are other ways to mitigate the credit risk
- Distribution and marketing costs or other costs involved in making the product accessible to the target market
- What is the defined process for changing the price in response to the change in these variables? How is that going to affect the firm and will it put it at risk?
- What is the return required by the providers of the capital and is it reasonable level considering the target market or excessive to the extent that it could cause harm in the future
3. Benchmarking
- Are there are other Products with similar features being offered to the same target market
- Is our Product priced in line with the other similar Products available to the target markets
- Are there any differentiating features that either (i) mitigates future risks for consumers more effectively (ii) or make the Product likely to achieve consumers’ objectives and hence demands a premium. Care should be taken to ensure that these differentiating features are not superfluous and do not reduce the risk or assist in achieving objectives
- The firms must have access to extensive data to be able to undertake effective benchmarking
With extensive experience in financial services sector and implementing concepts promoted by consumer duty rules, Fieldfisher Capital is uniquely positioned to help clients develop their framework. This is further supported by a strong team of regulatory lawyers at Fieldfisher LLP.
This article first published in Thomson Reuters Regulatory Intelligence: Sign up
