Fintech and product mis-selling – have you learned lessons from the analogue age?

• United Kingdom

• Financial services
• Financial services - Digital Financial Services
• Financial services - Retail finance

27-03-2018

As the financial services industry moves into the digital age, are firms adequately safeguarding against the conduct risk pitfalls that lie ahead?

Today’s world is driven by technology. From smartphone banking apps, to the arrival of automated, “robo-advice”. Consumers want the most up-to-date, simple, yet effective digital technology – and they want it now. Firms seek to launch new and exciting products to market as quickly as possible and to continuously develop those products to move with technological advances. The commercial rewards for developing fintech that captures the market’s imagination are potentially enormous. Against the backdrop of such pressures, are firms giving adequate consideration to long-term conduct risk? Are there lessons to be learnt from the past decade of financial mis-selling “scandals”?

Mis-selling in the analogue age

Over the last decade or so, the industry has ridden a roller coaster of mis-selling scandals, including endowment mis-selling, interest-rate hedging products and, of course, the behemoth that is PPI, to name just a few. These were products developed in the analogue age. Much of the focus of fintech is to gain market share by improving customer experience. However, digital technology cannot on its own insulate product providers and distributors from conduct risk.

These are some of the key lessons for the digital era that we think firms can learn from the mis-selling scandals of the analogue age:

• Compliance is no guarantee of protection – Regulation seldom keeps pace with market innovation. It is the hallmark of analogue mis-selling scandals that practices which were compliant at the point of sale have subsequently been judged to have been nefarious by the time regulation has caught up with the market.
• Evidence is everything – The history of analogue mis-selling teaches us that: (1) mis-selling complaints about the products of today will not materialise for many years; and (2) (however misconceived a mis-selling complaint is) in practice, the burden is likely to be on the product provider or distributor to prove that the product was not mis-sold. Against such a backdrop, product providers and distributors need to retain and preserve evidence for the long term.
• Claims management is now an industry – Analogue mis-selling has created a financial services claims management industry. Claims management companies are constantly exploring new avenues to challenge products. We can expect this to continue into the digital age.
• Digitisation changes the law – development of the law on which mis-selling claims are based has been incremental but even so, over the medium term we have seen meaningful changes in the legal framework – for example in respect of unfair relationships. We expect the pace of change to accelerate as law and regulation tries to keep up with technology. Topical examples include the evolution of rights to compensation without proof of loss for equality and data privacy claims.
• Dispute resolution forums are evolving – the last decade saw the mechanisms of choice for resolving consumer mis-selling disputes evolve from the County Court, to the Financial Ombudsman Service, to proactive remediation under regulatory oversight. These mechanisms will continue to evolve and firms need to future proof their processes and strategies against future trends.

• Supply chains are becoming more complex – the once relatively simple relationship of firm – broker – consumer has fragmented as multiple parties become involved in the digital sales journey. This trend will accelerate with open banking and PSD2. The implications for where liabilities will ultimately fall are opaque.

Approaching these issues in the digital age

Think “conduct risk”, not “compliance” – Horizon scanning goes beyond considering regulatory developments which are in the pipeline and instead entails the holistic consideration of the manner in which business is conducted. The underlying causes of mis-selling in the analogue world can be broadly attributed to: (1) overselling the value that products will bring to customers; (2) failing to adequately explain risks to customers; and (3) making unconscionable profits.

Law and regulation have evolved to address these underlying issues and this is likely to continue in the digital age. The hallmark of that evolution has been an element of retrospection. Firms complain they are assessed in the past against the standards of today. In a principles based system that will continue and firms can only protect themselves by embracing a customer focused conduct risk mind-set rather than a rules based compliance approach.

Firms will also need to guard against taking too much comfort from often finely judged assessments of whether regulation applies. Those regulatory perimeters will flex as technology evolves and are a classic area where reinterpretation by courts and regulators has retrospective effect.

Build-in evidence retention – As the pace of change accelerates, the risks associated with evidence retention may increase. Firms need to consider how they will prove in 6 years’ time, or possibly longer, things such as: the statements or claims they made about their product were substantiated; each iteration of their terms and conditions was brought to a customer’s attention; the logic of their algorithm operated fairly; their product did not discriminate on the basis of age, gender, or disability; and the manner in which they made their profit was sufficiently transparent to the customer.

Digital technology may present new opportunities to capture and maintain evidence about the customer journey like never before. However, the pace of change may also mean that firms will find themselves trying to defend mis-selling claims in circumstances where the underlying technology has become obsolete. Firms will also need to consider whether a changing data protection and information security landscape places limitations on the retention of key evidence.

Prepare for challenge – Whether they have merit or otherwise, it is inevitable that firms will receive complaints or mis-selling claims about their products. Firms should plan for how they will deal with challenges. Claims management companies thrive on challenging products or sales processes that are seen to be complicated or opaque. The arbitrators of any claims (whether they be judges or ombudsmen) are likely to be individuals who may not understand your technology or your product. How will you explain the complexities of your product or business model to lay people in a way which is seen to be comprehensive and transparent? How will you evidence that your explanations are accurate?

Our experience is that firms often under-estimate the extent to which institutional knowledge is vulnerable to staff turnover and divestments. A digital audit trail often requires contextual evidence and ultimately avoiding liability requires witnesses able, and willing, to interpret and explain it to an often unsophisticated audience.

The forums in which these challenges will be determined will also continue to develop. While inherently expensive for firms, the court system allowed firms to defend (or settle) each claim in relative isolation, to limit disclosure and to deploy technical legal defences. Protracted timescales allowed firms the space to develop sophisticated strategies behind closed doors. That environment is changing. Increasingly firms must proactively remediate and self-report to regulators, rather than react to individual claims. Where individual claims are pursued, the forum of choice will usually be the FOS and increasingly potentially alternative forms of adjudication or arbitration as seen in other sectors and jurisdictions. These forums will increasingly require a cards on the table approach, much shorter timescales and will determine compensation based on broad concepts of fairness rather than narrow legal principles.

These developments will place significant pressure on firms and their senior managers to build cultures and processes which respond effectively when products come under attack. It will also test far in the future the contractual arrangements and technology relationships that are being built now between industry partners.

Learn more

The information above is only a snapshot of our experience. Whether you are designing a new product, preparing to seek investment in your product, or looking to acquire a fintech firm, we can help you identify, manage and safeguard from risks associated with mis-selling in the digital age.

For more information, please come and see us at our Digital FS and Fintech seminar in London on 24 April 2018 – click here for further details.