The Consumer Duty: How to Create a Product Approval Process
The Consumer Duty requires firms to formally take steps to understand the features of their products including risks and benefits for their target market. The duty goes one step further to establish the framework within which the assessment must take place and even a set of criteria. This assessment, the product approval process, can be viewed as the first line of defence against poorly functioning products and services. In this scenario, the second line is the product review stage.
As firms continue to get to grips with the detail as set out in PRIN 2A, the structure and content of new and amended processes will begin to form. This article provides some suggestions about the creation and formation of the product approval process.
The first consideration is the point in time the process must be undertaken. PRIN 2A requires the approval process to be completed whenever a new product or service is being created or significantly altered. Aside from the obvious question in relation to the definition of ‘significantly altered,’ firms are often asking us for advice as to what falls within the definition of “product” and “service.” The FCA sets out the following definition:
(1) any specified investment distributed or to be distributed to retail customers; and
(2) any service which involves or includes the carrying on of a regulated activity or an ancillary activity, providing a payment service, or issuing electronic money and activities connected to providing a payment service or issuing electronic money which is:
(a) provided directly to a retail customer;
(b) provided by Firm A to Firm B (further to an arrangement between them) for the purpose of enabling Firm B to distribute a specified investment to a retail customer or provide a regulated activity directly to a retail customer (for example providing a credit reference for the purposes of mortgage lending or consumer credit); or
(c) provided by Firm A to Firm B (further to an arrangement between them) to enable Firm B to operate or procure performance of the terms of a specified investment, or a credit agreement, that has been distributed to a retail customer (for example debt collection).
(3) The term ‘product’ is intended to refer to the distribution of a specified investment or provision of a service generally and not, unless the contrary intention appears, to arrangements with or in relation to individual retail customers.
As you can see the definition is extremely wide, incorporating any regulated activity or activity which is supplementary to the regulated activity, even where this is not provided directly to the retail customer. Any new ‘product’ will first need to be approved.
The approval process will generally firstly identify the key features and benefits of the product, before setting out its target market. This is a logical order as the approval team will easily be able to identify the type of customer the product will be beneficial for. As part of assessing the target market the characteristics of the target market - including risk profile and any vulnerabilities which may impact the product performance - should be noted. Ultimately firms need to assess whether there is a defined benefit to the target market.
The design of the product must also be assessed. This step should usually set out the key risks of the product and steps taken, within the product’s design, to mitigate such risks. Firms should be looking for aspects of the product which prevents its full usage, whether from vulnerabilities or other identified risks. Firms need to ensure the product will provide good value; the results of the value assessment can be utilised for this part, for details on the value assessment see: The Consumer Duty: Value Assessments.
Legal and regulatory obligations must be recorded, and steps taken to ensure the product is compliant, whilst still delivering the benefits already identified. Built into PRIN 2A are testing requirements which can be met as part of the product approval process. Questions such as ‘has the product been tested including scenario analysis which assesses whether the product meets the identified needs, characteristics and objectives of the target market, including identified needs, characteristics and objectives of retail customers in the target market with characteristics of vulnerability?’ can assist.
Ultimately the testing will need to demonstrate that the product is providing good outcomes for customers. Where deficiencies are identified these should be mitigated prior to approval. Again, evidence of mitigating actions can be recorded as part of the approval process.
The purpose of the approval process is not to prevent products and services from entering the market but to make sure firms properly consider their design. In the majority of cases products won’t be right for all customers, in which case distribution arrangements can be formulated to ensure that they are targeted towards those who will benefit.
This all sounds a lot and it is, however we’ve done the hard work for you and have pulled out the key requirements, including them in a template which can be purchased here: Consumer Duty Product Approval Process.