How does a regulator decide when profits are unfair?

John Howard side

The proposed power to ban the sale of financial products for 12 months could prove to be a powerful tool for the new Financial Conduct Authority. It is hoped product intervention will allow the regulator to halt misselling of an unsuitable product in its tracks.

The theory is that the use of such a power in the past would, for example, have stopped the sale of payment protection insurance before it got out of control.

But the Treasury has insisted that the new regulator publishes and consults on a set of principles governing the circumstances in which it will use the new banning powers – and surely there will need to be a robust appeal process over what could otherwise look like arbitrary decisions about the “safety” of particular products.

Drawing up these principles will not be easy and several aspects of the regime are proving tricky for the FSA/FCA to crack. Staff there are in the process of identifying indicators of potential consumer detriment which might lead the regulator to impose a ban, like the complexity of a particular product.

One of the more controversial indicators is “excess profit”. If the return a firm gets from a product reaches a very high level, the FSA/FCA view is this could indicate consumer detriment.

The regulators acknowledge it is not possible simply to equate high returns with an unfair product and they have not yet worked out how this measure should be defined. The view of excess profit could have very widespread effects.

The Treasury’s latest guidance on the Financial Services Bill says the FCA will not prescribe prices in the manner of some of the utilities’ regulators and in the past the FSA always proclaimed it is not an economic regulator. The FSA/FCA is trying to maintain this stance while intending to take action over what it sees as unjustifiably high prices. In a Radio 4 Moneybox interview, Hector Sants explained the regulator might say a product should be £10 less but not set the price from the outset.

So when do pricing and profits become “unfair” and deserving of intervention? Just because a company is making a big profit on a product does not necessarily mean it is being unfair to customers. Substantial returns could be fair if customers are getting a cracking deal. What is unfair is if high profits are producing losses to clients through misselling or bad product design.

Much more difficult to judge is where high profits are not producing detriment but are not producing much benefit either. Should this be grounds for intervention? Joe Garner, head of HSBC in the UK, says: “One important element of fairness is that there is a balance between the value that the customer and the bank receive over time.”

This will be a tough one for the regulator, excess profits are emotive but the circumstances in which they can be said to be unfair will be very tricky to unravel when at the moment everyone, from politicians to protesters, are still trying to work out just what fairness means.

John Howard is former chair of the Financial Services Consumer Panel and special advisor to Huntswood