4.2 The regulation of sales – customer classification
You will now look at the way that the sales of products to customers are regulated. This is a key aspect of regulation given the plethora of episodes where products have been mis-sold to the disadvantage of the public.
The FSA set out key principles for the proper selling of financial products in their Treating Customers Fairly (TCF) code (FSA, 2006). Subsequently these principles and rules have been extended – particularly by its ‘Conduct Risk’ strategy and the Retail Distribution Review (RDR) which we will look at later this week. However, ‘TCF’ still underpins the way that the FCA expects sales to be conducted.
Treating Customers Fairly (TCF)
1 – Culture Consumers should be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture.
2 – Customer needs Products and services marketed and sold in the retail market should be designed to meet the needs of identified consumer groups and targeted accordingly.
3 – Information Consumers should be provided with clear information and are kept appropriately informed before, during and after the point of sale.
4 – Advice Where customers receive advice, the advice should be suitable and take account of customers’ circumstances.
5 – Product performance Consumers should be provided with products that perform as firms have led them to expect. Additionally the associated service should be both of an acceptable standard and as the customers have been led to expect.
6 – Flexibility Consumers should not face unreasonable post-sale barriers imposed by firms to change products, switch providers, submit claims or make complaints.
One of the key principles of a risk-based approach to regulating the sale of products is to categorise the customer – the rule here is that the less sophisticated the customer is deemed to be, the greater the protection that should be afforded when products are being marketed and sold to them.
The FCA defines three customer status categories:
- Retail clients – the general public and any other customer not falling within the two other categories below.
- Professional clients – largely firms and other entities that operate in the financial markets and have some expertise in financial matters.
- Eligible counterparty – this category covers those entities that are deemed to be expert in the financial markets.
The classification process involves both qualitative tests – involving forming an assessment of the customer’s knowledge – and quantitative tests relating to size of the customer’s investment portfolio and the number of materially sized transactions they undertake on a regular basis.
The system of categorisation has certain safeguards built into it – the default being that, where there is doubt, higher (rather than lower) levels of customer protection should apply. Thus professional and eligible counterparties can seek the higher protection given to retail customers. Additionally, the firms selling the products may initiate a reclassification of their customers to enforce a higher level of protection on them, and to minimise the risk of selling products within a regulatory framework that is inappropriate, given their customers’ level of financial sophistication. So the clear principle here is that if either party to a business relationship is in doubt, then higher levels of protection should apply.
The firm also needs to supply details of the terms under which it will provide the service – usually in the form of a ‘key facts’ or equivalent statement.