April 8, 2024

By Sebastiaan Bierens, EU Financial Services Analyst

The UK financial services landscape faces a host of underappreciated risks from new consumer protection laws. We believe the upheaval in the industry is just beginning, and Europe is likely to follow suit.

The United Kingdom’s Consumer Duty—a host of new consumer protection rules requiring companies to act in the interest of their customers—entered into force in July 2023. The rules broadly require firms to offer better support, improve customer understanding and ensure products and services meet customers’ needs and provide fair value. The Consumer Duty covers all financially regulated firms.

The UK financial services landscape faces a host of underappreciated risks from new consumer protection laws. We believe the upheaval in the industry is just beginning, and Europe is likely to follow suit.

While the Duty has already affected some practices and industries that can be seen as outliers, we expect wide swaths of the financial services industry that have avoided the spotlight to get caught up in upcoming headwinds and challenges from the Consumer Duty.  Notably, these include:

• Contracts for Difference (CFD) Brokers: One of the key requirements under the consumer duty is to prevent foreseeable harm to retail customers CFD brokers.  CFDs are derivatives that allow investors to bet on the direction of stocks, currencies, or commodities without owning them. A large proportion of retail customers lose money when trading CFDs. For example, Plus500 (PLUS) reports that 81% of retail investors lose money when trading CFDs, while 69% of retail investors lose money when trading CFDs with IG Group.

• Zero-Interest Credit Cards: While zero-interest cards ostensibly help people save money, the reality is most income that companies who offer them earn comes from is fees assessed on people who fail to pay off their balance or miss a payment after the introductory period. The FCA clarifies that profits should not be derived from bad customer outcomes. Most zero-interest credit cards have a significantly higher average interest percentage rate (APR). This is often unclear to consumers from the onset, including additional fees attached to such credit cards.

• Platform Fees: Investment platforms and wealth managers, like Hargreaves Landsdown, Quilter, and AJ Bell (AJB), charge customers a platform fee, often tiered depending on the amount invested or a flat percentage of the total amount invested. While platform fees have trended downwards, some continue to have high fees relative to the added value or benefit this presents to the customer”. Moreover, the profit margins of platform fees tend to be high and, therefore, more likely to draw FCA interest.

• Trading Fees/Dealing charges: HL charges consumers £11.95 (c. $15) per trade in shares on investment trust, exchange-traded funds (ETFs), gilts, and bonds if a customer makes less than 10 deals per month. Competitor AJB currently charges £9.95 but announced a reduction to £5 per trade from April 2024 onwards. HL may face difficulties justifying the current level of trading fees, particularly when investors do not frequently trade (e.g., less than 12 trades) every month.”

• General Insurance Value and Exclusions: The FCA’s general insurance value measures data for 2022, published in September 2023, show that next to GAP insurance, other policies offer poor value for money based on very low claims ratios. For example, excess protection, often sold as an add-on to motor insurance, has a 14% claims ratio—meaning only $14 is paid out for every $100 that is paid in. Personal accident insurance has only an 18% claims ratio. Related to the policy’s value are exclusions of coverage, which are often very obscure, and people may believe they are paying for something not covered by their insurance policy.

• Incentivising trading through “gamification”: According to the FCA, these practices can harm consumers by encouraging risky short-term trading. Instead, the FCA wants firms to design and deliver customer journeys that support good outcomes.

We are already seeing the implications for other areas of the industry. The FCA prioritised certain areas where it believes significant levels of consumer harm are occurring and should be remedied. Work is underway in these higher-priority areas, which could have a material impact on the revenue-generating ability of firms operating in these sectors.

• Interest earned on consumers’ cash balances: The FCA stated in December 2023 that retention of interest by firms is not providing fair value and may cause foreseeable harm to customers. The FCA did not give further guidance on what retention levels would be acceptable, but it effectively outlawed a practice referred to as double dipping – i.e., retaining interest and charging customers on cash deposits. Hargreaves Lansdown (HL) and AJ Bell’s (AJB) profits are boosted by cash balances but had to continuously increase interest rates offered to customers. Other investment platforms, such as IG Group (IGG), do not offer any interest on uninvested cash balances – while it generates £70.2M in earnings. 

• Ongoing financial advice: The FCA is concerned that firms are charging ongoing advice fees in situations where this is not appropriate and where the levels of ongoing advice are deemed inappropriate compared to the service provided. This forced St James’s Place (SJP) to set aside £426 million to refund clients not provided the services they should have been or overpaid for ongoing financial advice.

• Insurance premium finance: The FCA’s head of insurance, Matt Brewis, labelled premium finance a poor product that essentially acts as an additional tax on the less financially well-off who cannot afford annual premium payments.

• Fund management charges: Despite being in force for several years, the FCA noted in August 2023 that fund managers continue to cluster around price points instead of reducing fees. Saint James Place, for example, most recently reduced its annual management charges of 14 funds following the underperformance of those funds but because of having to offer fair value.

• GAP insurance: In February 2024, the insurance industry agreed to suspend sales of guaranteed asset protection (GAP) insurance following findings by the FCA that only 6% of the amount customers pay in premiums is paid out in claims.

Policy intervention in the UK is often replicated – with a few years delay – across the EU. We expect the same here.

Policy intervention in the UK is often replicated – with a few years delay – across the EU. We expect the same here. Some of those signs can already be seen in supervisory statements from the European Insurance and Occupational Pension Authority (EIOPA) on differential pricing practices, warnings on high commission levels, and the EU Commission’s proposed Retail Investment Strategy (RIS), which introduces amongst other things requirements that investment products offer “fair value.”

Capstone will closely monitor the fallout of the consumer protection laws and their implications across the financial services industry. We think this is just the beginning of a host of subtle yet significant shifts that will cast a large shadow. It will be important for companies and investors to read the fine print.

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