July 18, 2022 — Price regulation in the EU financial services industry historically has been seen as a last resort. It has been used in instances of rampantly excessive consumer harm or when all other attempts to boost competition have failed.
But in the aftermath of a long-brewing cost-of-living crisis that has had gasoline poured on it by the effects of the COVID-19 pandemic, whipsawed consumers now are front-of-mind for regulators. We believe this will have enormous implications on “business as usual” for regulators and the financial services industry—specifically on prices and on the question of which business practices constitute consumer harm. We also expect regulatory pressure on the financial services industry to grow—a development we believe the market and industry do not fully appreciate.
The root of this action started a few years ago. The UK’s Financial Conduct Authority (FCA) introduced price regulation for payday lenders in 2014, inspiring several US policymakers to step up their own efforts, and for workplace pension schemes in 2015.
In a next step, the FCA issued a discussion paper on “fair pricing” in financial services in October 2018. This ultimately resulted in a ban on “price walking”—a discriminatory practice where existing customers incur a loyalty penalty over new customers. The main reason the FCA wanted to intervene was to address discrimination in the differential pricing between new and loyal customers with a similar risk profile. This industry practice had triggered a significant shift in pricing of motor and home insurance products as first-year premiums rose to offset losses in insurers’ back books.
However, the FCA also required motor and home insurers to offer fair value products without specifying what this entails. This was the first time the regulator noted that certain insurance products could be too expensive and cause consumer harm. This stance took root during the COVID-19 pandemic, when the FCA and other regulators worldwide nudged insurers to offer rebates to motor clients or asked home insurers to extend coverage as people were working from home.
While motor and home insurance brokers have been trying to justify their fees and commission rates rather than reduce them, the FCA has been clear that “benchmarking” commission rates and fees among peers is insufficient evidence that pricing is fair.
Looking ahead, we expect swelling regulatory price action. Starting in April 2023, the FCA’s fair value rules will be extended beyond motor and home insurers to all entities it regulates. While the FCA may not see itself as a price regulator, large parts of the market will experience price regulation. Firms whose revenues stem from interest payments, commissions, or fees should keep their eyes wide open for the first fair value enforcement case, which we expect is around the corner.
Meanwhile, the regulatory framework applicable to all securities in Europe, the second markets in financial instruments directive (MiFID II), and the Insurance Distribution Directive (IDD) are under review. The European Securities and Markets Authority (ESMA) advised the European Commission, which is in charge of amending EU laws, to consider the effects that a ban on inducements such as commissions would have on the distribution models in Europe and the actions that should be taken to mitigate the risk of undesired consequences of such a ban.
Similarly, the European Insurance and Occupational Pensions Authority (EIOPA) on 29 April set out the pros and cons of a number of policy options to regulate the payment and receipt of inducements, including a total ban on inducements. EIOPA is following in the FCA’s steps and seeking input regarding differential pricing practices, particularly those concerning price walking. So far, Ireland and the UK have banned price walking. Others, including the Netherlands, Italy, and Sweden, are investigating the practice more closely.
The rising cost of living is impacting large swaths of people across the EU. The FCA found that 27% of the UK population has low financial resilience. Politicians all over the world are under pressure to alleviate the cost of living in all aspects of life. We expect that this pressure will seep through to regulators, which may have an increasingly strict interpretation of what fair value means for consumers. We believe the FCA and other regulators will use the current fair value rules and forthcoming “consumer duty” often and effectively. Similarly, current political pressure in European nations could sway regulators to adopt a stricter approach on inducements, the ongoing MiFID II review, and the forthcoming review of the IDD, particularly when more specialised regulatory authorities are encouraging the European Commission to take more far-reaching measures. As the twin crises of the global pandemic and cost of living drag on, expect financial service regulators to sharpen their teeth and prepare to bite.
ABOUT THE AUTHOR
Director, European Financial Services
Read more about Sebastiaan here.