Staff incentives in consumer credit – putting customer experience front and centre

The FCA has completed a thematic review of staff incentives, remuneration and performance management in consumer credit firms. The outcomes of this review have been published this week in a consultation paper, which also sets out the FCA’s proposals in terms of new rules and guidance as a result of its findings. The consultation period runs until 4 October 2017.

The FCA has found that there is a material risk of poor customer outcomes as the incentive schemes and performance management processes currently employed by consumer credit firms are based on volume or value of sales or collections.

The FCA is consulting on a new rule designed to impose a high level requirement that consumer credit firms understand the risks that their incentive schemes might pose to customers and have in place adequate procedures and measures to detect and manage such risks.

Firms should now start thinking about how they might restructure incentive schemes and performance management processes to shift the focus away from profitability and refocus on customer outcomes and service.

Outcome of Review

In its 2015/2016 Business Plan the FCA explained that it wished to build on the FSA’s previous work around incentive schemes and announced that it would be reviewing incentive schemes at consumer credit firms. The purpose of the review is to assess how the firms manage the risk that their reward arrangements could encourage undesirable behaviours that might lead to poor outcomes for consumers.

In summary, the FCA reviewed the incentives and performance management policies and practices for sales and collection staff at 98 consumer credit firms operating in a range of sub-sectors, including:

• high cost short term credit;
• catalogue and internet shopping firms;
• store and credit card providers;
• hire purchase;
• primary and secondary credit brokers; and
• debt collectors.

The FCA has recognised that many of the firms included within the review are taking positive steps regarding rewarding and incentivising staff including taking on board previous FSA guidance. However, it has also found that many of the firms in the review sample had high risk elements in their incentive schemes and had either not recognised the risks this poses to customers or had not taken sufficient steps to manage those risks.

These high risk elements were found in 40% of firms sampled but the issues were more acute amongst those firms for whom consumer credit activities are ancillary to their main business purpose (e.g. motor dealers, retailers) where the figure rose to 64%.

The FCA found that risks arising from incentive schemes arose generally where staff earned bonus or commission payments based on volume or value of sales or collections. At 32% of the firms reviewed there were staff who received a major element of their pay in the form of a variable element such as this. This included 15 firms where staff were paid on a pure commission basis.

The FCA has identified particular features of incentive schemes that it says serve to heighten the level of risk involved. These included schemes where:

• commission accounts for the majority (or all) of customer facing staff pay;
• different rates of commission is earned for different products (particularly substitutable ones);
• products sold on different terms; or
• the rate of commission varied depending on reaching certain targets.

New Rule & Guidance

The good news is that the FCA has acknowledged in its proposed non-Hanbdook guidance that there is no “one size fits all” approach to incentives and controls. Indeed, this seems to be reflected in the new rule that the FCA is proposing it introduces as section 2.11 in the Consumer Credit Sourcebook (“CONC”), which comprises:

• A high level rule requiring firms to have establish and maintain adequate measures, procedures and policies to:
  • Detect any risk to customers as a result of its remuneration or performance management policies, procedures and practices; and
  • Manage this risk.
• A proportionality provision that requires firms, when they are deciding how to comply with the high level rule, to take into account the nature, scale and complexity of their business (including the nature and range of financial services and activities undertaken)

In the guidance the FCA is proposing, which comprises both Handbook guidance and detailed non-Handbook guidance, the purpose of the new rule is stated be the amplification of existing requirements under PRIN3 (the requirement that firms must take reasonable care to organise and control their affairs responsibly and effectively, with an adequate risk management system) and SYSC4.1.1R (the requirement that the firms must have robust governance arrangements that will enable effective processes to identify, manage, monitor and report the risk that it is or might be exposed to) in so far as these requirements apply to identifying and effectively managing risks to customers that may arise out of that policy’s procedures and practices for the remuneration and performance management of their employees, appointed representatives and agents who interact with customers.

Potential Costs to Firms of Proposals

In its cost benefit analysis the FCA has considered both one off costs that firms might incur in terms of designing new or revised incentive schemes; reviewing and amending their approach to performance management; and introducing or amending policies and procedures for detecting and managing risks.

The FCA has indicated that for firms with up to two employees it is anticipated the costs of the proposed changes would be irrelevant and expect the cost to those firms to be zero or minimal.

In respect of other firms the FCA has estimated both one off costs of compliance and ongoing costs as follows:

Category of Firm	Estimated Number of Firms Impacted	Average one-off Costs per Firm (£)	Average Ongoing Costs per Firm (£ P/A)
Firms with 3-15 staff	7,398	69	–
Lending (more than 15 staff)	1,013	2,231	1,565
Credit Broking (16-500 staff)	1,814	6,944	1,800
Credit Broking (more than 500 staff)	98	16,000	4,840
Debt Collection (more than 15 staff)	415	5,420	1,043
Total Impacted Firm	10,738	1,786	536

Comment

The FCA’s findings are unlikely to be of great surprise to those engaged in the consumer credit sector, and it is certainly no surprise that the outcome of the FCA’s thematic review is essentially that incentive schemes in the sector currently focus to heavily on sales/collection volumes and targets, which can at least be in tension with (if not always in direct conflict with) customer interests and the fair treatment of customers.

Although we are now only at consultation stage, there can be a reasonable expectation that the proposed provisions will be adopted in spirit even if not precisely in their current form. However, it would be prudent for firms to now start looking at:

• The balance between fixed pay and a variable element;
• How any variable element of staff pay is constituted – the variable element should not only be tied to sales/collections volumes/targets but should also include (or alternatively comprise) a requirement tied to positive customer outcomes/treating customers fairly. The balance should be such that failure to meet the customer requirement has material impact on the variable element of staff pay;
• Possible conflicts of interest where managers are remunerated and incentivised based on the financial performance of the teams/departments they manage;
• The focus of performance management discussions – there should be a move away from focus on volume or profitability-based performance measures and a re-focus on discussion about customer outcomes/quality of service and customer experience; and
• Understanding and monitoring risks presented by incentive schemes – looking at quality monitoring by independent and capable staff focused on customer outcomes and not just process-based monitoring.

There will, of course, be challenges in making these changes. Not least, it will be necessary to review carefully the terms of existing employment contracts to ensure the legality and enforceability of unilateral changes to staff pay and incentive schemes. However, as the FCA notes in its proposed guidance, there are potential benefits to firms in terms of increased customer loyalty, improved staff satisfaction and an overall decrease in default rates. There is an argument that early adopters of this new approach could steal a march on competitors.

We will provide a further update when the FCA publishes its Policy Statement on this issue in Q1 of 2018.

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