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How does a regulator decide when profits are unfair?

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Former Financial Services Consumer Panel chairman John Howard on the dilemmas facing the Financial Conduct Authority around its new product banning powers.

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

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Readers' comments (9)

  • I think 80% profit on payment protection would have been sufficient justification for intervention, but so would the sale of payment protection to people who could not possibly claim on the policy.

    The regulators have always had the power to question the activities of the bank sales forces and the terms of the products they sold but it is quite clear that they did not use them.

    An FSA director once told me that payment protection insurance was "better than nothing", how on earth will the new powers be used effectively when such ill informed opinions exist?

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  • If it's different shaped wheel, then chances are it will fall off at some point!

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  • It's not so much the products that are bad, but the 'advice' that goes with them. PPI is a good product in the correct circumstances. The profits were made as it was sold to everyone in situations where people could not make a claim.

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  • A very valid point from Brian Deane, namely that costing the product is not the only aspect. One also has to look at a companies overall strategy. Many companies go in and out of the annuity market in order to balance their exposure in various areas. A number of companies are likely to be carrying "excess" profits on some products in order to offset the losses they have experienced on Stakeholder products. Banks took excess profits in various areas to offset the cost of "free" banking. Recently ScotEq posted a trading loss, primarily because of compensation payments.
    Companies are not in business to make losses. Sorting out whether a product is generating "excess" profit in such circumstances will be a very difficult and sensitive process, so do not expect transparent company accounts.
    The only practical reason for using the power to delay a product is that its structure is inappropriate to the retail market. Which means that the regulator will have the power to control innovation in the markets.
    As they say - be careful of what you wish for. Giving the FCA these powers may look intelligent; there is no guarantee that intelligent people will use them. RDR is perhaps an interesting example.

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  • Innovation will surely be the victim here. Companies innovate to get ahead of competitors and thus cammand a premium price in amarket before competitors catch up. Look at say Apple - they have done this well and make excess profits - payback for their innovation. Motor manufacturers also do the same.

    Will the FS inductry lose out with no incentive to innovate if the regulator prevents any excess profit - everyone will aim to be a fast follower - except with no one at the leading edge, innovation will die.

    Interested in other views.

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  • Recently replaced a life cover policy with exactly the same contract but through me as an IFA rather than the bank who sold the original one difference in premium to the client 40% less premium! How are they going to protect the clients on matters like this?

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  • Agree with alot of these commens re. misales not toxic products.

    Also have noticed some providers are now offereing annuities from L&G and Pru with their pension retirement packs as they no longer do annuities, problem is they are taking 3 times the standard commission which affects the rates. A bit rich when you think they do not offer advice.

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  • So let's say that a company has plans for a new style product and during the development stage they ask the FSA for their views? What sort of answer would the company be likely to get? None, I say.
    The FSA will not make a comment until after all the work has been done and therefore new products would become a rarity. The FSA (or whoever) will claim that they've protected the public from unsuitable financial products and the Daily Mail, along with Dave and his lot, will agree.
    To avoid customer detriment, why not ban everything? You know it makes sense.

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  • "Hugh Jeego", so what?

    Be careful if you start wanting intervention over the price somebody pays for something, because you can be undercut. That makes you the expensive one, which means you are the one you are asking to be disciplined.

    Good advice is non negotiable, however, price is market driven, to complain otherwise because it was sold by a bank is simply the usual small person syndrome.

    Technically, I would argue that 40% extra is a small price to pay for ending up with live cover rather than sitting there without...

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