Parliamentary Commission on Banking StandardsWritten evidence from the Office of Fair Trading

Introduction

1. The Office of Fair Trading (OFT) welcomes the opportunity to submit information to the Parliamentary Commission on Banking Standards, in particular its examination of issues of cross-selling and mis-selling in banks. This document provides the OFT’s response to the letter of 6 December from Colin Lee, the Chief of Staff and Commons Clerk for the Commission and summarises the OFT’s involvement in work related to the sale of payment protection insurance (PPI) by banks.

Summary

2. As the Committee is aware, several regulators worked on PPI. The OFT, as first phase investigator, examined concerns with competition, including the structure of and conduct within the PPI market. The Competition Commission (CC), following a market investigation reference from the OFT, undertook a detailed investigation into competition in the sector and imposed remedies designed to improve the working of this market. The FSA, as the regulator of insurance products and the primary regulator for banks, took action to stop the mis-selling of PPI and to ensure consumers could obtain redress for this mis-selling.

3. The OFT is working closely with the FSA to help ensure that PPI and possible PPI replacement products are not subject to mis-selling practices and that there is full transparency around the sale of these products to consumers.

The OFT’s Remit and PPI

Remit, legal powers and guidance

4. The OFT’s mission is to make markets work well for consumers. Markets work well when businesses are in open, fair and vigorous competition with each other for the consumer’s custom.

5. We pursue this goal by:

Encouraging businesses to comply with competition and consumer law and to improve their trading practices through self-regulation.

Acting decisively to stop hardcore or flagrant offenders.

Studying markets and recommending action where required.

Empowering consumers with the knowledge and skills to make informed choices and get the best value from markets.

6. The OFT has a number of legal powers, the most relevant of which to work on PPI are the following:

The Consumer Credit Act 1974 requires most businesses that offer goods or services on credit or lend money to consumers to be licensed by the OFT. Trading without a licence is a criminal offence and can result in a fine and/or imprisonment. The Act also requires certain credit and hire agreements to be set out in a particular way and to contain certain information.

The Competition Act 1998 is designed to make sure that businesses compete on a level footing. It does so by prohibiting certain types of anti- competitive behaviour (the Chapter I and Chapter II prohibitions). The OFT has strong powers to investigate businesses suspected of breaching the Act and to impose tough penalties on those that do.

The Enterprise Act 2002 has wide-ranging implications for businesses and consumers. The Act makes a number of important reforms, which are designed to address abuses that harm customers and fair-trading businesses alike and thus encourage productivity and enterprise. It gives the OFT and other bodies responsible for consumer law enforcement stronger powers to seek court orders against businesses who breach certain consumer protection laws. This act also provides a basis for the OFT’s market studies and market investigation references.

Super-complaints, market studies and market investigation references

7. The latest guidance documents which explain the OFT’s approach to super- complaints, market studies and market investigation references are the following, and are available from the OFT’s website:

Super-complaints—guidance for designated consumer bodies, July 2003, OFT5141

Market studies—guidance on the OFT approach, June 2010, OFT5192

Market investigation references—guidance about the making of references under Part 4 of the Enterprise Act, March 2006, OFT511.3

Consumer Credit and PPI

8. The OFT does not regulate PPI products under the Consumer Credit Act 1974 (CCA).

9. Unsecured credit products (including loans and credit cards) and some second charge mortgages are regulated under the CCA. In accordance with the Consumer Credit Directive, the cost of PPI must be included in the APR for the credit agreement where PPI is mandatory, or a condition of obtaining credit on the terms advertised (for example, because an interest rate discount is offered if PPI is taken). There is, however, no requirement to show the cost of PPI in other cases.

10. The OFT administers the licensing regime under the CCA, and (together with local authority trading standards services) has powers to take enforcement action concerning breaches of the CCA or other consumer protection legislation. In considering fitness to hold a consumer credit licence, the OFT can take account of unfair practices whether or not in relation to regulated credit business. Although it would in principle be open to the OFT to consider mis- selling of PPI in relation to fitness, in practice, we would generally see this as being primarily an issue for the FSA, as the regulator of insurance products and the primary regulator for banks.

Interaction with the CC and the FSA

The CC

11. The OFT’s interaction with the CC is governed by the relevant provision of the Enterprise Act 2002. In summary, the OFT can investigate markets which it considers are not working well for consumers. This work can lead to a number of outcomes, including a market investigation reference to the CC.

12. The CC carries out inquiries (which are limited by statute to a maximum of two years). The CC can make statutory Orders or undertakings to remedy any adverse effects found in the market and/or make recommendations to Government.4

13. The OFT is responsible for the monitoring, enforcement and review of remedies put in place by Order or through undertakings.5

14. The following are instances where the OFT and CC may liaise:

Remedy design—the CC undertakes its inquiry and can involve the OFT in discussions on remedies; however, the final decision rests with the CC as to determining appropriate remedies.

Remedy implementation—the practicalities of putting remedies in place.

This stage can involve discussion with the CC.6

Monitoring and enforcement—this activity is carried out by the OFT, while ensuring that the CC is aware of the overall performance of remedies. This can also involve evaluations of the effectiveness of remedies once they have been in place for a number of years.

Review: the CC can review remedies where the OFT considers that there are reasonable grounds to suspect that there has been a change of circumstances as described in section 162 of the Enterprise Act 2002.

The FSA

15. The OFT’s work in relation to PPI addressed the effectiveness of competition in the PPI market, with the reference to the CC being on the basis that the OFT had found features of this market which restricted competition to the detriment of consumers. The OFT’s response to the Citizens Advice super-complaint, market study and market investigation reference were not focused on mis-selling. The FSA, as the regulator of insurance products and the primary regulator for banks, took action to stop the mis-selling of PPI and to ensure consumers could obtain redress for this mis-selling.

16. At the time of the market investigation reference in February 2007, the OFT noted that the PPI industry had been working with the FSA to try to remedy the problems relating to sales standards which were identified by the FSA during its two thematic reviews. The focus of the FSA’s work at that time was to improve selling practices and standards to ensure consumers receive suitable products that meet their needs.

17. Both the OFT and the FSA recognised that the FSA’s action on selling practices and standards would not resolve the broader competition issues which the OFT identified and which were the focus of the OFT’s work. The OFT liaised closely with the FSA throughout the OFT market study and the public consultation which followed, and the OFT did not consider that the FSA’s consumer protection powers or its work with trade associations made a market investigation reference to the CC inappropriate.

18. The OFT’s more recent interaction with the FSA in relation to PPI is described in paragraphs 51 to 57.

Leadership of the Office of Fair Trading

19. The Enterprise Act 2002 established the OFT as a body corporate, with a Chief Executive Officer, Chairman and Board. Before this, the OFT existed as support for the Director General of Fair Trading. Recent Directors General, Chief Executive Officers and Chairmen have included the following:

John Bridgeman—appointed as Director General of Fair Trading in 1995

Sir John Vickers—appointed as Director General of Fair Trading in 2001 and Chairman and Chief Executive Officer of the OFT in 2003

Philip Collins—appointed as Chairman of the OFT in 2005

John Fingleton—appointed as Chief Executive Officer of the OFT in 2005

Clive Maxwell —appointed as Chief Executive Officer of the OFT in 2012.

Remit and responsibility concerning PPI

20. The following staff had responsibility for the OFT’s work on PPI:

Jonathan May—Director of Markets and Policy Initiatives during 2005 – 2007.

Appointed as Executive Director in 2007 and retired from the OFT in 2010.

Sean Williams—appointed as Executive Director in 2007 and left the OFT in 2008.

Clive Maxwell—appointed as Executive Director in 2010 (see paragraph 19 above).

Robert Laslett—appointed as Executive Director in 2010 and left the OFT in 2012.

Changes to the structure of the competition, consumer and consumer credit regimes

21. We summarise the key changes affecting or expected to affect the OFT in the next two years below, while noting that these changes are in some cases subject to legislation which has yet to receive Royal Assent.

Competition and market functions

22. The Enterprise and Regulatory Reform Bill,7 which is due to gain Royal Assent in 2013, is expected to abolish the OFT and CC and in their place create the new Competition and Markets Authority (CMA). This change is considered to mark a significant step forward in the development of the UK’s competition regime, building on the work of the OFT and the CC. This Bill is also expected to formalise, in legislation, the markets work carried out currently by the OFT and CC.

23. The CMA is likely to be expected to work within new statutory timescales. The following description is based on the existing version of the Enterprise and Regulatory Reform bill as at December 2012:

If it intends to make a market investigation reference (MIR), it will be required to consult on doing so within six months of launching a market study.

If it decides not to make an MIR following a request to do so, it will need to reach that decision within six months of launching the market study.

Market studies (whether or not resulting in an MIR), will need to be concluded within 12 months—including securing undertakings in lieu of a reference, where this is the outcome.

The statutory time limit for market investigations will be cut to 18 months, with powers to extend this by six months in some circumstances.

The CMA will need to implement remedies from an MIR within a six-month time limit that may be able to be extended by four months in some circumstances.

24. The new CMA would be expected to carry out similar work and to have broadly similar powers to the OFT and the CC. Consequently, if a similar issue to PPI were to be examined, the OFT would expect outcomes to be similar, although the process would be expected to be streamlined so as to deliver outcomes more quickly and efficiently. The streamlined process may arise from the combination of the OFT and the CC as part of one organisation (with the expected application of statutory timescales for this work), which would reduce any duplication in the work carried out.

25. The OFT has already taken steps to improve the speed at which it delivers markets work, including market studies and market investigation references. For example, in its recent work on the private motor insurance market,8 another example of the OFT, CC and FSA working jointly, the OFT launched a call for evidence in September 2011, publishing the response to this and launching a market study in December 2011. The market study was published in May 2012 and a reference to the CC was made in September 2012.

26. During its work on the private motor insurance market, the OFT had concerns about the provision of motor legal protection cover to drivers and therefore called upon the FSA to work with private motor insurers to ensure that drivers would have access to appropriate information when purchasing this product. The OFT was concerned about the complexity of the product offering and that the way that it was being sold may make it difficult for consumers to assess the product’s potential value for money. The OFT considered that the FSA, as industry regulator, was best placed to take this action because it would be able to use the Financial Services and Markets Act to ensure that consumers are being treated fairly when the product is sold.9

Consumer law enforcement

27. From April 2014 the CMA will inherit the OFT’s current powers to enforce consumer law, both as a remedy following a market study and to take enforcement action in order to address problems with consumer choice. It is expected to focus on complex and market-wide cases. The CMA will inherit the OFT’s leadership role for unfair terms in consumer contract regulations and will also retain the OFT’s international enforcement responsibilities.

28. The reforms are expected to strengthen the national leadership of Local Authority Trading Standards Services in order to ensure they can address national and cross-boundary issues. Separate arrangements will be put in place for England and Wales, Scotland and Northern Ireland.

Consumer credit regulation

29. On 27 January 2012, the Government published the Financial Services Bill.10 The Bill, and the policy document which accompanies it, contain a decision in principle to transfer the regulation of consumer credit to the Financial Conduct Authority (FCA).

30. The Government and the FSA are expected to publish a consultation setting out the proposed approach to consumer credit regulation early in 2013.

Memorandum of understanding between the OFT and FSA

31. In the case of financial services regulated by the FSA, a memorandum of understanding sets out how the OFT and the FSA work together.11 In broad terms, the FSA takes a lead role in such areas. A similar arrangement is expected between the FCA and the OFT and subsequently the CMA.

The OFT’s Work on PPI

Super-complaint from Citizens Advice

32. On 13 September 2005, Citizens Advice submitted a super-complaint to the OFT asking the OFT to look at concerns in the PPI sector. It was based on a Citizens Advice report, “Protection Racket: CAB evidence on the cost and effectiveness of payment protection insurance”.12 Citizens Advice stated that the evidence presented in its report suggested that the features of the PPI market seriously harmed the interests of consumers. At the time, Citizens Advice noted that there were three main areas of concern:

consumers paid excessive prices for PPI;

the protection consumers bought was partial, with evidence of high pressure and unfair sales tactics; and

the administration of PPI claims was slow and could be unfair, and could leave consumers facing additional charges or serious debt enforcement action.

OFT action following the super-complaint

33. The OFT published its response to the super-complaint on 8 December 2005.13 In this, the OFT identified a number of issues which pointed to the sector not working well for consumers and which indicated the need for a more detailed examination:

Consumers faced difficulties in respect of (a) gaining information they needed about alternative suppliers and (b) the technical nature and/or lack of transparency of the information available to them.

There were high costs or other barriers to entry for stand-alone PPI providers.

There was a wide degree of variation in pricing in the sector.

Gross profit margins appeared high14 —PPI claims ratios were estimated to be 15—20%, which was low compared to other general insurance products.15

34. As a consequence of these concerns, on 4 April 2006, the OFT launched a market study to look in depth at the PPI sector. In carrying out the study, the OFT took account of views expressed by the PPI industry, relevant trade associations and consumer organisations. The OFT liaised closely with the FSA to ensure a joined up approach to the sector, and noted that the FSA was addressing a number of issues including mis-selling of PPI at the time the market study was carried out.

35. The market study found the sector to be worth around £5.5 billion in 2006 (the CC revised this figure down to £4.4 billion) and the OFT acknowledged that PPI could provide worthwhile cover for some consumers. However, evidence suggested that the way in which consumers purchased PPI, their understanding of the product and the quality of the information available to them hindered competition. Specifically, the OFT found that:

Consumers did not shop around for the best deal on PPI.

The complex nature of PPI made comparison between different policies difficult.

Consumers in some cases assumed, were told or given the impression that taking out the PPI would help with the application for credit.

36. While there may have been competitive pressure operating upstream between providers, the OFT saw no evidence that this pressure was feeding down to consumers as:

The point of sale advantage experienced by distributors meant that there was little competitive pressure at the key point at which consumers bought the insurance

Stand alone providers, who might otherwise be thought to offer a competitive pressure, had difficulty accessing consumers and faced substantial start-up and marketing costs to attract custom.

37. The evidence also showed that PPI had low claims ratios when compared to other insurance products and, with no evidence to suggest costs were high, it seemed reasonable to assume that distributor profitability was sizeable. Evidence on commission rates, which looked to be high compared with other general insurance products, reinforced this conclusion.

38. On 19 October 2006, the OFT signalled its intention to refer the PPI market to the CC and published its analysis of the market for public consultation.16 On 7 February 2007, the OFT referred the UK PPI market to the CC for further investigation.17

39. Further details of the OFT’s analysis in relation to pricing, profitability, and the PPI market and how it functioned are described in the response to the super- complaint, the market study report and related research, as well as reasons for the reference to the CC. These documents are provided in Annexes A, B and C to this submission.

Findings and remedies from the CC inquiry

40. In its report published on 29 January 2009,18 the CC found that businesses that offered PPI alongside credit faced little or no competition when selling PPI to their credit customers. To address the lack of competition, the CC introduced a package of measures to introduce competition in the market including:

A ban on the sale of PPI during the sale of credit products and for seven days afterwards.

A prohibition on single-premium policies.

Personal PPI quotes.

Annual statements.

Measures to make sure that improved information is available to consumers to make it easier for them to compare and search for products and switch policies at a later point.

41. The CC found that most of the UK’s more than 12 million PPI policies were sold at the same time as a consumer took out a loan, credit card or other type of credit. The CC found that many consumers:

were unaware that they could buy PPI from other providers

Rarely shopped around to compare prices and terms and conditions of PPI policies

Rarely switched PPI providers.

42. The resulting point-of-sale advantage made it difficult for other PPI providers to reach credit providers’ customers and, in the absence of such competitive pressure, consumers were charged high prices.

43. The CC introduced a range of measures to get remedy the adverse effects on competition found in the PPI market, giving consumers the time and ability to make a considered and informed choice and other providers the chance to compete far more effectively with the initial credit provider. The intention was that competition would provide consumers with lower prices and better choice.19

44. The CC tackled the biggest barrier to competition in the PPI market, the credit providers’ point-of-sale advantage, by essentially stopping PPI providers from completing sales of PPI until seven days after the sale of the underlying credit product. This was intended to open up the market, giving consumers time to search the market once they have secured credit, and giving other providers the opportunity to offer their PPI products to these consumers. Consumers who decide that they want the PPI offered by their credit provider can contact that provider to purchase it the day after the later of either the end of credit sale or the receipt of a PPI quote.

45. The CC also intended that consumers would be provided with the information they need to take advantage of this opportunity to search the market. PPI providers must provide binding personal quotes to consumers; provide certain information in marketing materials and provide information for use in price comparison websites.

46. In addition, the CC decided to make it easier for consumers to switch their PPI policy at a later point if a better deal becomes available. For this reason, single- premium policies were to be banned, as these locked in customers to their current provider. Annual statements were also to be required to help show consumers how much their policy costs and of their ability to switch, while other elements of the remedies package were designed to help consumers find whether there are better-value policies available to them.

The Payment Protection Insurance Market Investigation Order 2011

47. The CC implemented its remedies by way of an Order.20 This came into force in stages between April 2011 and April 2012 and its effects are summarised below:

Bans the sale of PPI at the point of sale of credit to ensure that consumers have time to consider whether they wish to purchase PPI, and to consider offers from competing providers and providers of other insurance products.

Bans the sale of single premium PPI.

Controls the marketing messages that can be given about PPI to facilitate easier comparison between different companies’ PPI products.

Requires quotes for PPI to be given using pro-formas set out in the Order to enable consumers to compare competing offers more easily.

Obliges PPI providers to provide whatever information is required to Money Advice Service to help set up a price comparison web site for PPI products.

Requires consumers to be given annual reviews using pro-formas set out in the Order.

Requires PPI providers to provide OFT with regular detailed compliance reports to help OFT address any areas of non-compliance and, over time, to gauge the effectiveness of the Order.

Requires the largest PPI providers to have mystery shopping exercises undertaken annually.

Work Following the CC Inquiry

Monitoring and compliance with and enforcement of the PPI Order

48. In relation to monitoring compliance and enforcing the CC’s Order, the OFT has not received any complaints from consumers or others concerning possible breaches of the CC’s Order.

49. Compliance reports indicate there have been isolated breaches. These appear to have been corrected.

50. The OFT considers that, based on the queries from PPI providers about the implementation and interpretation of the CC’s Order as well as levels of compliance, PPI providers appear broadly to be conscientious about compliance.

Action to avoid similar problems arising

51. In general, the OFT, FSA, Financial Services Compensation Scheme and the Financial Ombudsman Service work closely with each other. For example, during 2011, these organisations formed a Co-ordination Committee, which met substantively for the first time in February 2011. The Committee is intended to strengthen co-ordination and promote continued discussion of the topics rather than to present a comprehensive account of the issues or a set of agreed conclusions.21

52. Specifically, in relation to PPI replacements, we have been working in conjunction with the FSA since June 2010 to develop policy and guidance on the appropriate treatment of payment protection products which may be developed as PPI replacements.22 Payment protection products include both insurance products such as short term income protection (STIP) and non-insurance products such as debt freeze/waiver.

53. Insurance products are subject to the FSA’s Insurance Conduct of Business (ICOBS) rules, and potentially also the CC’s Order. Non-insurance products are regulated under the FSA’s Mortgage Conduct of Business (MCOB) rules where they are linked to a first charge mortgage and under the Consumer Credit Act where they are linked to a regulated consumer credit agreement (including a second charge mortgage or credit card).

54. A consultation document was published jointly by the FSA and the OFT on 1 November 201123 on proposed guidance to firms in relation to payment protection products, and the FSA also hosted stakeholder meetings (jointly with the OFT) in December 2011/January 2012.

55. The draft guidance included a list of key messages for firms, which for CCA- regulated products comprised the following:

Firms should be aware of the relevant statutory provisions and how these may impact on payment protection products.

In particular, there should be adequate transparency regarding the nature, price and implications of payment protection products.

Firms should ensure that they treat actual and potential customers fairly and do not engage in unfair or improper business practices.

Failure to do so, or to comply with relevant statutory provisions, may cast doubt on fitness to hold a consumer credit licence and may lead to enforcement action by the OFT.

56. The OFT section of the draft guidance set out illustrative examples of unfair/improper business practices in relation to debt freeze/waiver, potentially impacting on fitness to be licensed, including:

Misrepresenting the nature or extent of the facility, or the associated terms and costs, or failing to explain these adequately.

Pressurising the consumer to opt for the facility or offering undue incentives to do so, or misrepresenting the position if the consumer does not opt for the facility.

Failing to make clear how the facility will operate and the associated procedures and implications, including in relation to claims.

Failing to make clear any significant exclusions or limitations on eligibility or any restrictions on the benefits available.

Failing to have proper regard to the consumer’s needs and circumstances, particularly where advice is offered.

Unduly restricting the consumer’s ability to opt out of or cancel the facility, or to switch to an alternative product, or imposing charges which are excessive or disproportionate.

57. We aim to publish final guidance, together with a summary of responses, in January 2013.

58. As discussed above, it is proposed that consumer credit regulation will transfer to the FCA. This may be a trigger to review developments in the market and consider whether there may be a need for detailed rules, aimed at establishing a consistent regulatory regime across the different product types.

Other areas of cross-selling by banks

59. On 13 July 2012, the OFT launched a programme of work on retail banking.24 The objective of the programme of work is to achieve a more competitive and consumer focused retail banking sector. Specifically, the OFT wants to see the retail banking sector to evolve in the following ways:

The banking sector is more customer-focused. Providers’ products are well- suited to their customers’ needs and are provided in a way that makes it easy for customers to make well-informed decisions about how and when they are used.

Consumers are sufficiently engaged with their banking services to drive competition. Banks equip their customers to make better decisions about which products they use, and how they use them. This will stimulate banks to compete for customers’ business on things that matter to them.

Competition between banks (and from non-banks) is driving providers to operate more efficiently and to innovate. Effective competition between banks encourages them to perform more efficiently, meaning that lower costs are passed on to consumers and businesses, potentially in innovative new ways.

Consumers have a broad choice of provider. The sector is less concentrated, and “challenger” banks and/or new technology provide scope for increased competition from outside the traditional banking model.

Barriers to entry and expansion are lower. Credible new players are able to join the market and have reasonable prospects for attracting the scale of customer base needed to achieve the economies of scale required to operate effectively.

60. The first project within this programme of work is a review of the personal current accounts market, following the OFT’s study of this market which was published in 2008. At that time, the OFT found that personal current accounts were an important gateway product, leading to sales of other products. This was found to arise from the regular contact customers have with their current account provider and the level of information the provider has about consumers. The main retail banking products where consumers also hold a personal current account with the same provider included personal loans, investments, credit cards, insurance, savings and mortgages.25

61. The 2012 review of the personal current account market will be providing an updated picture of the importance of personal current accounts within the wider retail banking context. This report is expected to be published in January 2013.

18 December 2012