The retrospective application of rules: feedback on the call for examples

We asked firms to provide examples of the retrospective application of regulatory rules. 

Summary 

The regulator must operate in a way that is clear, consistent and predictable. We are aware of concerns among some firms that we (and our predecessor, the FSA) have acted in a retrospective manner, and have therefore undertaken some work to understand where these concerns come from and assess any issues. This work began in 2013 with our ‘Expectations Gap’ exercise, and we followed this up in 2014 with a wider call for examples of where firms believed we had acted retrospectively. This was designed to help us better understand the issues, identify any problems and address our regulatory approach if necessary. This report summarises the analysis of the responses we received.

We asked for examples of when firms believed the regulator had applied a more demanding standard or interpretation of the rules after the event, with the benefit of hindsight. We received 36 responses, raising a number of issues. None of these reflected retrospection in the specific terms outlined, but many raised wider questions about regulatory behaviour.

Most examples referred less to the retrospective application of rules than to issues which had persisted, perhaps for some time, in the market and to which we, or the FSA before us, had turned our attention. The concern raised was that previous inaction suggested either approval or regulatory indifference, and firms had taken this as a sign that they could continue, for example, selling certain products. Some respondents therefore felt that when the regulator had turned its attention to a particular situation it was, in effect, changing its mind.

We want the FCA to be more forward looking. To achieve this, we have put in place steps to improve the way in which we identify issues and problems in the market, allowing us to intervene at an earlier stage. However, there will still inevitably be occasions where it will take time before problems become apparent. Nonetheless, we hope the measures we have taken will help avoid the perception of retrospection. 

We also agree that there is scope to improve our communications with firms. This was identified through the Expectations Gap project in 2013 as an area to focus more effort. Firms need clarity on what is expected of them and we need to make sure that we use the range of tools available to us to clarify matters rather than confuse firms.

We have already increased the number of targeted emails we send out and have begun a monthly newsletter, sent electronically to all those small, regulated firms who do not have named supervisors. This is to help ensure that firms are better aware of and clearer on our expectations.

Background 

Firms have a right to be confident that their actions are measured against the standards, rules and principles in place at the time. Indeed, there are legal restrictions on applying regulatory standards with retrospective effect, in particular if we sought to remove vested rights or if the consequences of our approach were unfair.  Furthermore, firms, as made clear in our enforcement guide, can only be judged where, at the time of an action, a breach of principles was reasonably predictable. In addition, the FCA has, in a number of speeches by senior executives, shown a desire to a predictable and consistent regulator. We have therefore been concerned that there has been criticism from firms that we (and our predecessor) have on occasions acted in a retrospective manner; that we looked at issues with the benefit of hindsight and judged them on standards that had not been in place at the time. If there was evidence of this, it would be something we would take very seriously.

During the 2013 Expectations Gap work, it appeared that, while stakeholders remained of the view that we act in a retrospective manner, they found it hard to identify specific examples of this sort of action. However, by its nature, the Expectations Gap project was limited in its scope and did not reach out to all our stakeholders.

We therefore decided to carry out a further consultation and issued a call for examples on our website on 21 August 2014. In this we said: 

We remain interested to hear from firms about times when they believe the FCA (or the FSA) applied its rules retrospectively. That is, applied a more demanding standard or interpretation of the rules after the event with the benefit of hindsight.

The consultation was open for seven weeks, closing on 10 October. We did receive a number of responses after that date and these have also been included in the analysis.

Analysis of responses 

In total we received 36 responses to our call for input, broken down as follows:

  • Individuals                  16
  • Intermediaries             8
  • Product providers       4
  • Trade Associations      7
  • Other                           1         

The issue most frequently mentioned was the treatment of Traded Life Policy Investments (TLPIs) and in particular the FSA branding them as ‘toxic’ and the consequent fall in their value. Eighteen responses were specifically, and exclusively, related to this. However, this was a criticism of the FSA’s comments, rather than of the regulatory or supervisory approach to the products applying a more demanding standard or interpretation of the rules after the event with the benefit of hindsight.

The FCA believes that the FSA’s intervention in this market was justified. In November 2011, the FSA issued guidance for consultation because it did not regard TLPIs as suitable investments for the mass retail market and was concerned that these investments might be reaching investors for whom they were not suitable. These concerns had been made public a number of times before: the FSA warned the industry of its concerns about TLPIs in February 2010 in a speech by the FSA’s then head of investment policy, reproduced on the FSA’s website; and the issue was highlighted again in its Product Intervention Discussion Paper published in January 2011; and in its Retail Conduct Risk Outlook paper published in February 2011. The industry had not heeded these warnings and the market showed signs of inappropriate growth into the retail sector, with new TLPI products ready to enter the market in place of products that had already failed. A stronger, clearer warning to the industry and retail consumers was warranted. The FSA issued the guidance for consultation to address urgent concerns about the growing risk of consumer detriment posed by the TLPI market.

The second most-frequently mentioned issue (by 8 respondents) was the Financial Ombudsman Service (FOS) and the Ombudsman’s decisions. One respondent said:

‘The main threat of retrospection emerges from the interplay of regulatory activity in which rules laid by one body can be reinterpreted by another, notwithstanding the change in approach that it might contain.’

While there were no significant examples of retrospection, there were general statements of concern with the perceived approach of the Ombudsman.

The Ombudsman is required by the Financial Services and Markets Act 2000 to make decisions based on what is fair and reasonable in all the circumstances of the case. The Ombudsman does so taking into account relevant law and regulations; regulators’ rules, guidance and standards; codes of practice; and (where appropriate) what the Ombudsman considers to have been good industry practice at the relevant time. This is wider than the rules and guidance that come under the remit of the FCA. Individual complaints are decided on their own facts and do not make precedents. That said, firms that operate in accordance with our rules, and in particular, with our principles of business, are unlikely to receive an Ombudsman decision against them. Additionally, we do recommend firms ensure that lessons learned as a result of determinations by the Ombudsman are effectively applied in future complaint handling (DISP 1.3.2AG), and firms are required to put in place reasonable steps to ensure that in handling complaints it identifies and remedies any systemic or recurring problems (DISP 1.3.3R).

In many cases, the response covered not only retrospection, but other broad issues of how the regulator has operated in the past, or operates now. For instance, two respondents cited two different issues that appeared to imply that in the process of supervision we were going further than the rules stipulated. (One example was a firm being informed during a Supervisory visit that it had to obtain more information from counterparties than was detailed in the JMLSG guidance. Another was in relation to market abuse, basing enforcement on proposed ESMA implementing measures).

Others raised a variety of topics about regulation generally (e.g. the Gender Directive or the growth in claims management companies). For the purposes of this response, these comments have not been included.  However, there were a number of other suggested examples which specified retrospection as an issue and these can be grouped under two broad headings, “Things which have persisted for some time without comment” and “New interpretations based on new methodology”:

Persistent issues 

The issue had persisted for some time without FSA/FCA comment but now the Regulator is saying there has been bad practice

Under this broad heading there were a number of suggestions of retrospection. These were:

  • pensions mis-selling
  • endowments mis-selling
  • PPI mis-selling
  • Arch Cru
  • interest rate hedging products (IRHP)
  • capital at risk products
  • the legacy business review
  • S166 reviews

In most of the cases, the respondents had concerns that the regulator had been aware of market practice at the time and had, at some point, decided to review past business and decided that mis-selling had occurred. There was no suggestion, however, that the regulator had applied standards or rules not in place at the time of sale.

This criticism presents a challenge for the FCA. The regulator’s aim is to be forward-looking. Sometimes, the fact that there has been a problem with advice or selling practices may not become clear until some time after the event and it is only at that point that action can be taken. That may require a review of past business. While we do not believe that this is an example of retrospection, as we have defined it, we do appreciate the concerns of industry and the challenge that past business reviews pose for them.

We are very aware of the risk of hindsight bias and actively take steps to avoid it. Thus, when we have set out the methodology for undertaking the work on exercises like those on interest rate hedging products, we have taken steps to base the remedial exercise on rules in place at the time of the conduct giving rise to the problem, precisely in order to avoid retrospection.

In the case of past business reviews, such as s166 reviews, or the review of legacy products, the challenge from industry is that it is not possible to consider these except through the lens of the present. We are careful to ensure that we only impose a s166 review where it is appropriate and proportionate to do so and ensure that the review is assessed against the rules in place at the time. The current review of legacy products covers the fair treatment of long standing customers in life insurance and we have made it clear that we enter into this work to gain a better understanding of how this area functions. We will be looking at how people in closed accounts are being treated, including the question of the service that consumers receive in relation to those accounts, the information they receive and whether these investments are still appropriate. This is not a review of the sales practices for these legacy customers and we are not looking at applying current standards retrospectively – for example on exit charges.

In two cases, more specific examples were provided of how some of the issues mentioned above were dealt with in a way that some felt had been retrospective. First, a firm had a TCF supervisory visit where a number of files were checked. These files included Arch Cru sales, and no negative comments were received at the time. Subsequently the regulator branded the products as ‘toxic’, which appeared to have been a reassessment after the event. However, this was a wider ‘treating customers fairly’ visit rather than a review of individual sales. In the case of Arch Cru, the FSA’s view of these products was informed by a number of complaints that had been received. This caused the FSA to focus on the sale of these products specifically and whether the right suitability standards had been met.

 

Secondly, there were two specific issues raised from the IRHP example.

  • First, that the guidance on the expectations of break cost disclosure did not recognise that best practice and interpretation of ‘clear, fair and not misleading’ had changed significantly since 2001.
  • Second, that redress calculations were based on a ‘maximum term’ of alternative products that might have been purchased which implied a customer would not have bought an alternative product with a maturity of more than five years.

With the case of IRHP, we undertook significant work to ensure that we applied the standards in place at the time of sale. Our assessment of the disclosure of break costs was based on the rule in force at the time. Therefore, the pre-2007 analysis was based on PRIN 2.1.1 R and the rules in COB. For the period after November 2007, the analysis was based on Principles and rules in COBS.

In relation to the calculation of redress, ‘maximum’ term does not represent the application of a rule.  It is a tool for indicating what is likely to amount to fair and reasonable redress, in much the same way that adding 8% simple interest to redress offers is a proxy for fair and reasonable consequential losses.  

A respondent suggested that ‘firms have been held to standards under the appropriateness rule which had not been prevalent or expected by the FSA at the time of the sales’. However, we used the rule in place at the time and required standards to be met. The subsequent review and redress reflected not a change in interpretation but recognition of firm failures to abide by the rule and subsequent substantial customer detriment.

There were two examples raised suggesting improvements in FCA communication, particularly to firms. One response related to SIPP due diligence (where the level of detail requested of a firm appeared out of line with the high level guidance already provided) and suggested that there is a lack of clarity in relation to the role of guidance and how that is given. The implication is that the existing rules are subject to retrospective clarification. This is an issue which we had already identified through the Expectations Gap work and we have committed to carry out further work to improve our communications with firms and clarify guidance and the role of speeches and other less formal comments.

Similarly concerns were raised about our approach to social media and financial promotions. It was suggested firms were unaware that financial promotions through social media had to be compliant with the rules and contain the required risk warnings – which implies that firms had not fully taken on board existing messages. As the respondent said:

‘Whilst the FCA had given this message to firms over the course of a number of years through a range of informal communications, firms may not have understood that there was an explicit requirement to take action.’

We note that in the examples detailed in the section above, the criticism of the FCA, and of the FSA before it, is not that the regulator acted retrospectively, but acted too late. We recognise this as a serious challenge to the FCA, and we have put in place measures which we hope will allow us to intervene earlier.

New methodology 

Issue of a new interpretation based on a new methodology

A respondent raised a question that if a new methodology, such as behavioural economics, suggested that a firm’s actions had exploited consumer behavioural biases in a way that was unfair, did it follow that it had always been unfair. This could be seen as retrospective – using a new technique to judge past actions could fall into that category. However, we would argue that if a practice is unfair, it is unfair, and the regulator should have the tools to fulfil its objectives, primarily appropriate protection for consumers. However, we are conscious of hindsight bias and we continue to be vigilant against the risks that we judge actions by rules not in place at the time.

The second suggestion was that the regulator has changed its view on the value of disclosure. Where once that was viewed as sufficient (eg in warning consumers of the end of a teaser rate) it is now seen as insufficient because of the greater awareness of consumer inertia. The example provided was how the regulator treats the sale of savings products which revert to a minimum AER at the end of a bonus period. Inevitably, studies into specific markets will consider the extent to which consumer biases are exploited. Where we consider these have been done in a way that may lead to consumer detriment we should have the freedom of action to change industry practice, either through guidance or rule changes. Importantly, any such guidance or rule change would only apply to future business, past sales would not be judged by the new standards.

A variant on the categories above is a situation where the regulator held a view and has subsequently appeared to change its mind for future instances. The example offered of this was the use of dealing commission to pay for research, where it was suggested that the 2012 paper on conflicts of interest in asset adopted a more demanding position than had previously been the case, specifically in relation to the issue of corporate access management (FSA Report, Conflicts of interest between asset managers and their customers: identifying and mitigating the risks, November  2012). The respondent said that the regulator’s interpretation of the rules had grown more stringent over time, such that new rules, to ‘clarify’ the existing situation, were required this year.

We recognise that this can lead to frustration and would clearly limit instances where this happens. However, the regulator has to have the freedom to change its mind where it believes to do so would fulfil its objectives. On this case specifically, the 2012 supervisory review found that most firms in the sample did not have sufficient controls to ensure they met the requirements under COBS 11.6, and could not demonstrate to the FSA how particular goods and services they had acquired with dealing commission met existing rules and evidential provisions. This is an example of recognising that firms were not consistently complying with the rules as market practices evolved, and that this had to be addressed through a clarification of our rules.  We subsequently consulted on these changes in CP13/17 (FCA, CP13/17 - Consultation on the use of dealing commission rules, November 2013). Moreover, this would only be retrospective if we took action it in relation to behaviour in the past, rather than holding firms to a new standard for the future.

There is also a brief example referring to recent FCA thematic work on best execution (TR14/13).  It is argued that the FCA’s reference in the report to a ‘four-fold cumulative test’, set out in an opinion from the European Commission in 2007, is effectively proposed as a new standard.

Again, this does not appear retrospective given the Commission Opinion was referred to in an FSA Policy Statement in 2007 and cross-referred to in our best execution rules when implemented at that time.  The recent Thematic Report does not change the legal status of the Commission Opinion, and referred to it as relevant material for firms to consider in interpreting aspects of the best execution rules.

Conclusion 

We received 36 responses to this call for input. The number of responses may suggest that the issue is one of perception – principally created by the fact that the FCA continues to work on a number of legacy issues.

However, firms did use the opportunity to raise some questions about the nature of the FCA’s regulation. While many of these did not relate to retrospection by applying new interpretations to rules and behaviour in the past, there were examples where firms felt the FSA/FCA had intervened late as a result of risk crystallising and there were general concerns about decisions made by the financial ombudsman.

We have, however, found this feedback very valuable and recognise that there have been a number of genuine issues raised during this call for input which, while not necessarily directly related to retrospection, are related to the way we regulate firms. These suggest that there is scope to improve regulatory practices and include the following:

  •  The desirability of improving firm communication and clarifying the way we give guidance
  • The need to recognise that fast-paced technological change may mean that rules become inappropriate and that there may be a need to consider how we use waivers in these circumstances
  • The need to intervene at an earlier stage to avoid the development of problems over a long period, particularly where firms draw a conclusion that the regulator does not perceive there to be a problem

We are already acting on a number of these. The issue of firm communication and the status of Guidance is one that has already been picked up through the Expectations Gap project and we are working on that now. The fast pace of change and the implication of new technology for the rule book is something we have identified as an issue ourselves and are addressing through Project Innovate.

In relation to improved communication with firms, we have done a lot of work in this area over the last year. As examples, our Firm Communications team held over 100 events in 2014, including compliance workshops; we issue Regulation Roundup on a monthly basis to update firms on the latest news from the FCA; we proactively engage with trade bodies to ensure they are aware of our thinking; and we have looked to provide more guidance, more good and poor practice examples and looked at more creative, engaging ways to present information to firms of all sizes. 

We also recognise that reactive regulation and belated intervention will give rise to perceptions of retrospective action and hindsight bias, which is clearly undesirable.  It is our intention that the FCA will become a more forward-looking regulator. As we said in our launch document: ‘We will act more quickly and decisively and be more pre-emptive in identifying and addressing problems before they cause harm, with our senior staff involved in supervision issues at an earlier stage. We will deliver this through a risk-based and proportionate approach, recognising the diversity among firms and markets.’ In this way, we can expect to have fewer examples going forward where we may have taken action on poor behaviour that had persisted for some time, so reducing the perception of retrospection in the market. Nevertheless, the regulator has to be able to act where it finds examples of poor behaviour, judged by the standards in place at the time of the misconduct.