Banking StandardsLetter from Andrew Haldane, Executive Director, Bank of England

You requested my thoughts on whether the financial services industry should have a statutory duty of care to customers, following your letter of 19 November and Lord McFall’s question to me at the PCBS hearing on 7 November. Here are some reflections on that question, bearing in mind that this bundle of issues is somewhat off the Bank’s patch.

First, it is widely recognised that customers require protection when dealing with financial firms. The imbalance of bargaining power demands, in the interests of fairness, that freedom of contract be tempered by law and regulation. This is the purpose of much “conduct” regulation.

Currently, this protection is achieved mainly through:

the FSA’s powers, including its general rule-making power, based on its statutory objectives;

the Consumer Credit Act 1974;

the Financial Ombudsman Service’s (FOS) powers to provide redress; and

general statutes requiring “fairness” in contracts.

Some of these are derived from European legislation.

Taking these in turn, the FSA has a general objective of “securing the appropriate degree of protection for consumers” (the “Consumer Protection Objective”). Many of the Authority’s rules and standards are designed to promote and support this objective. Some of the rules made by the FSA to support this objective are presented as high level “Principles”, with which all authorised firms are required to comply. These Principles include requirements to “treat customers fairly”. If firms do not treat customers fairly, the FSA can take enforcement action, such as by imposing fines. It can also require firms to provide redress directly to people who have suffered.

The FOS is the main route for individuals—retail customers—to have their complaints dealt with directly if they are not satisfied with the response they receive to complaints they make to a firm. The FOS looks at what is fair and reasonable and requires firms to respond appropriately. It can order financial compensation to be paid to bank customers.

Alternative routes for customers who are dissatisfied with the response to a firm to a complaint include suing the firm for breach of FSA rules (although not for breach of the Principles, as these are currently excluded), or under the common law for negligence or breach of contract.1 However, the unequal position of an individual in bringing an action in court against a firm, in terms of resources and information as well as the time it would take, make litigation a much less attractive route compared to seeking redress through the FOS.

How will this differ under the FCA? The Financial Services Bill gives the FCA the same consumer protection objective as the FSA currently. However, the list of things that the FCA must “have regard to” is expanded and includes:

“the general principle that those providing regulated financial services should be expected to provide consumers with a level of care that is appropriate having regard to the degree of risk involved in relation to the investment or other transaction and the capabilities of the consumers in question”.

The new law will therefore guide the FCA to a greater extent than at present, providing at least some of the potential benefits of a statutory “duty of care”. If necessary, adherence to this “general principle” could be further strengthened. For example, the Financial Services Bill could require the FCA to give priority to this principle and/or specify how the principle is to be translated into action through rules. Although discretion is normally left to a regulator to make such rules, there is precedent in the existing FSMA and in the Banking Reform Bill for specifying things about which the regulator must make rules. The FCA could already strengthen its rules (subject to constraints of European legislation), for example by applying the “best interests” requirement more broadly.

Looking beyond the duties that can be imposed through the regulator, statute law already provides some further protection. For example, the Supply of Goods and Services Act implies a term into contractual arrangements that services must be provided with reasonable care and skill. And the Unfair Contracts Terms Act and the Unfair Terms in Consumer Contracts Regulations also limit freedom of contract, in favour of the consumer, by rendering certain contractual terms unenforceable. In certain relationships, the case law goes further and imposes a fiduciary relationship. For example, in the financial services industry this duty is supplemented in some places by FSA rules such as requirements around the “best execution” of client’s orders.

So there is already a body of law, rules and standards which intervene between customers and firms. In some places the intervention is minimal and allows a high degree of freedom of contract; in others, where the level of customer dependency is greater, the fiduciary standard applies. This makes sense: the relationship between a firm and its customer can take many forms—from taking deposits to agency broking. Imposing the same standard of behaviour in all cases would be too intrusive.

Are there significant gaps or shortfalls in the current conduct standards made under FSMA with which a general statutory duty of care would assist? The FSA has indicated previously that a specific statutory fiduciary duty in the Financial Services Bill would not necessarily clarify or resolve all the kinds of specific issues and tensions in varied financial services relationships, which tailored requirements under existing rule-making powers can address. In addition, there are various “codes of conduct” which firms sign up to on a “voluntary” basis. An example would be the Lending Code, which is sponsored by the BBA, the Building Societies Association and the UK Cards Association. Although such codes are not legally binding, breaches would be taken into account by the FOS where relevant to a consumer complaint.

Without reaching a strong view on its merits, it is against this backdrop that a new statutory “duty of care” on firms would need to be assessed. The relevant test seems to me: what would such a duty add over the existing provisions outlined above? Certainly, the nature of the duty and how it would apply in particular circumstances would have to be carefully defined to differentiate it from alternative courses of action and to ensure it could be applied in practice. That is because the courts would not have the benefit of a substantial body of case law to guide interpretation of such duties.

Against this background, it is possible that the kind of statutory strengthening suggested above, including imposing obligations on the FCA to make rules for specific consumer protection purposes, might be a more expeditious method for improving consumer protection.

20 December 2012