The reasonably circumspect, the gullible and the plain stupid

1. The reasonably circumspect, the gullible and the plain stupid Consumer protection under the Unfair Commercial Practices Directive and the financial services industry Willem van Boom April 2013

2. Main points • Regulation of B2C commercial practices in financial services • Must balance ‘individual responsibility’ against societal need for systemic stability • Has to respond to local needs, situations and practices • Must be in line with the maturity of the market • Must be flexible to respond to new developments • The UCP Directive does not perform well on any of these issues; it • Relies largely on the ‘informed choice-making’ homo economicusmodel • Neglects not only the gullible and plain stupid but also the homo heuristicus • Erroneously assumes maximum harmonisation strikes the proper balance • Stifles rather than nourishes innovation in consumer protection in financial services • Therefore, the exclusion of financial services from the maximum harmonisation scope of the Directive was a wise decision; maintaining it is even wiser

3. Structure of my talk • 1. Main features of the UCP Directive • 2. Someexamples of dubiouspractices in financial services thatillustratethe need for • Balancing ‘individual responsibility’ against societal need for systemic stability • Responsiveness to local needs, situations and practices • Consistency with degree of maturity of the market • Flexibility to respond to new developments • 3. Why the UCP Directive’s framework does not always suffice • 4. Why leaving leeway to member states is the best option • 5. The 2013 Review by the European Commission

4. 1. Mainfeatures of the UCP Directive

5. General UCP framework Directive 2005/29/EC of 11 May 2005 (OJ L 149/22) (Unfair Commercial Practices Directive) Consumer Protection from Unfair Trading Regulations 2008 (the CPRs) S.213 Enterprise Act 2002: FCA is designatedenforcer

6. General UCP framework • Practice: any B2C act, omission, communication, etcetera, connectedwitheconomicmotives • Before contract conduct (eg., Incomprehensible or ambiguous general contract terms) • After sales conduct (eg., switchingbarriers, aggressivedebtcollection)

7. Unfair = practice‘contrary to the requirements of professional diligence’ which materially distort or are likely to materially distort the economic behaviour of the average (targeted) consumer with regard to a product or service • Misleading actions andomissions: false, deceptive, omittingmaterial information, etc. • Aggressive: byharassment, coercion, or undue influence, has potential for significantly impairing freedom of choice or conduct General UCP framework

8. General UCP framework • Annex: practicesdeemed unfair • Eg., bait advertising, bait & switch, promotionalpyramidschemes • Eg., “Requiring a consumer who wishes to claim on an insurance policy to produce documents which could not reasonably be considered relevant as to whether the claim was valid, or failing systematically to respond to pertinent correspondence, in order to dissuade a consumer from exercising his contractual rights”

9. The average consumer, who is reasonably well informed and reasonably observant and circumspect as interpreted by the European Court of Justice • The average consumer test is not a statistical test but a normative test by national court/authorities • Particular groups of vulnerable consumers (elderly, children) are gauged according to the average member of their group • The UCP Directive seems to protect the average homo economicus, not the gullible, inattentive, uninterested or distracted homo heuristicus

10. Maximum harmonization • Level playing field andinternal market rhetoric • More restrictive national rulesbanned • Breadth of scope is enormous • nationalcourts & agenciesneedtoapply the general standard case-by-case; supplementing Black List is prohibited • Eg., genericprohibition of bundlingproducts is notallowed (ECJ 2009; 2010) • Exceptions • UCPD is without prejudiceto contract law (art. 3 (1)) • Specific EU rules on UCPs have priority (art. 3 (4)) • MS may impose more restrictive rules on financial services (art. 3 (9)) • Financial services exception up for review

11. 2. Some examples of dubious practices in financial services

12. PaymentProtection Insurance • PPI seemstobe a particular UK ‘problem’ • Most complained over financial product • Number of (successful) claims on PPI low compared to other types of insurance • Agressive marketing (over-the-counter & bundled sales) • Commissiondriven sales • Consumers do notconsider the needfor the product • About half of themdon’t even knowthey have/had one • Dissuasive claims handling; broadcoverageexceptions • Interventions: • OFT finingfor unfair practices • CompetitionCommission Order forrestructuring product and commercial practices (unbundling sales process)

13. Dutch “stock lease” products • 1990s retail product; no specificregulations in place • Aggressivelymarketed, targetting (also) lesseducated & lessaffluent classes • For as little as €20 per month, the impecuniouscouldprofitfrom the stock boom andbuildequity in a short period (2, 5 yrs.) • None of the productsclearlycommunicatedconceptssuch as ‘borrowing’, ‘loan’ or ‘risk of residualdebt’ but emphasised ‘profit’ and ‘saving’ • Inherentlydangerous product (borrowing money to ‘lease’ stock), onlyviableunder the assumption of continuouslyrising stock value • Millions of policiessold; billions in debtincurred • Interventions: steady increase of regulationstandardising information and marketing methods • Supreme Court: UCP ‘averageconsumer’ wouldreadcarefully, seethrough the sales talk andbeaware of the risks

14. Other examples • Long-term equity building endowmentpolicies • Recent German research show that most of these policies do notreachmaturitysinceconsumersmostlyoptforearlytermination • Structuralmismatchbetween product features andneeds? • Why do we have them? Marketing methods (eg., bundlingwithmortgages) andbarriersto exit/switch byrestrictive & ambiguous contract terms • ‘Pyramidschemes’ – unsustainable product based on perpetual recruitment of participants (eg Ponzischeme) • A product whichprobablyonlybecomesviablewhenusingUCPs • Completelybanned in variouscountries

15. 3. Why the UCP Directive’s framework does not always suffice

16. The ‘success’ of an unfair commercial practice is a reciprocal process: it takes two to tango • Real consumers sometimes perform below the standard of the ‘average consumer’ • Across Europe, around half of consumers (52%) tend to take the first product they see when obtaining a current bank account or credit card (Eurobarometer 2012/373) • Real consumers can be intellectually lazy, inert, uninterested, gullible, plain stupid but also: underprivileged with ‘back against the wall’, less resilient or lacking ability to defer gratification • There is limited opportunity forlearningfrommistakes • Someproductsyouonlybuyonce • 56% of individuals who own a financial product have not purchased any of these within the last five years (Eurobarometer 2012/373)

17. Example: development of Dutch home owners’ mortgage types Interest only Unit-linedequity investment basis Equitysavingsbasis (withprofitsendowment) • Then: 1990s ‘cowboy’ banksstartedhanding out easy mortgageloans, enticingconsumerstoride the ever higher waves of property priceincreases • Intricatebundling of products, drivenbyundisclosedcommission-basis • Influencing‘averageconsumers’ with financial products is more subtlethan the ‘informedchoice’ paradigmcanaddress • The ‘greed button’ is easilypressed– no matter howaverageyou are • The systemicconsequencescanbeenormous – callingfor more drasticinterventionthan the UCP framework offers • Now: legislativeframework of full transparency of agent commissions, c.a.r., unbundling of products, andeffectively a prohibition of interest onlymortgages Life insurance basis Non-linearcapital & interest repayment Lineair capitalrepayment other

18. In financial services, subtle commercial practicescanbelinkedwith product andmarket features (eg, credencegoodsandintransparentmarkets) • Therefore, national regulators needto go beyond the ‘informedchoiceparadigm’ • Byweighingandbalancingvariousconsiderations • Cf. relevant aspects to balance by FCA • Differences in consumer risk appetite, experience and expertise • Consumer needs for timely provision of information and advice that is accurate and fit for purpose • An appropriate ‘level of care’ provided by service providers having regard to the degree of risk involved and the capabilities of the consumers in question • the differing expectations that consumers may have in relation to different products • the needs of different consumers for information that enables them to make informed choices • the general principle that consumers should take responsibility for their decisions • the ease of access to services for consumers in socially or economically deprived areas • switching ease

19. Therefore, sectoral rules: • May do more for the gullible and plain stupid consumer • May do more toaddresslocalconsequences of consumerinertiaand disinterest • Byvaryingfrom “informedchoicemakingparadigm” tointervention in “access toproducts” • Within “informedchoicemakingparadigm” • Eg., communication and promotion of financial products needs to be clear, fair and not misleading (eg., avoiding small print, misnomers) • Eg., mandatoryuse of standardisedconcepts (eg., APR) andpresentations (eg., keyfactsillustrations) • Eg., mandatoryuse of wealth warnings, eg. “Your home may be repossessed if you do not keep up repayments on your mortgage.” (MCOB 3.6.13) • Eg., mandatorydisclosure of agent remunerationarrangements • Withinintervention in ‘access toproducts’ • Prohibition of doorstepselling of financial products, telemarketing etc. • Interest rate caps forconsumer credit • Outrightbans on productsbecausethey are alwayspushedbyusingUCPs (eg., pyramidschemes) or feed on deprivation (eg., paydayloans)

20. As a result, the “informedchoice” paradigm is valuable but maynotbesufficient • UCP framework stresses ‘individual responsibility’ through informed choice-making • However, it does not address specific needs for systemic stability • In manyconsumers, the ‘blind greed’ button is easilypressed – riskingsystemicinstabilities • The UCP framework is built on open-texturedstandardstobeapplied on case-by-case basis (Black List is exhaustive) • The exhaustive Black List obstructs flexibility to respond to new developments • Whereasstability of some financial productsmaybebetterservedbystandardisedrules • The needforsuchstandardisationdepends on national setting andinstitutionalframework

21. 4. Why leaving leeway to member states is the best option

22. What is relevant for one market may not be relevant for others • Starkdifferences in maturation of marketsbetween EU15 and NMS12 • Eg., 27-28% of Romanian/Bulgarianconsumers have a currentaccount(Eurobarometer 2012/373) • Consistent lack of cross-border competition: 94% of consumers have never purchased financial products in other MS, 80% would not consider buying a financial product in another EU country

23. Different markets, different needs: • The Netherlands needs a standard notificationperiod of 3 monthsforannouncing new interest rates at end of fixedrateperiodtoavoid UCP of late notification

24. 5. The 2013 Review by the European Commission

25. EC Report March 2013 • “The results of the investigation conducted in the areas of financial services (…) indicate that it would not be appropriate to [have full harmonisation in financial services UCPs]. The main reasons are: • the higher financial risk in respect of financial services (…) (as compared to other goods and services); • the particular inexperience of consumers in these areas (combined with a lack of transparency (…) of financial operations); • particular vulnerabilities found (…) that make consumers susceptible to both promotional practices and pressure; • the experience of the competent financial enforcement bodies with a nationally grown system; • and finally the functioning and the stability of the financial markets as such.”

26. Conclusions • The conclusions of the Commission are in line withfindings • The Commission’sreasoning, however, seems at oddswith the Directive’s ‘informedchoice’ paradigm • The ‘informedchoice’ paradigm is notsufficientto warrant correct functioning of B2C markets in financial services • Furtherregulatorypolicies are tobedesigned at national level, addressinglocalneedsandsituations