response to the commission green paper: financial services: meeting consumers' expectations

1. INTRODUCTION AND SUMMARY

Financial services, although often marketed as “products,” cannotsimply be bought and sold as if they were cans of beans. They arecomplex, difficult to compare, and often involve substantial expen-diture over a long period. Impartial advice is hard to obtain.

To date, the Single Market has brought about the right of compa-nies to sell financial services in any Member State. Although therehave been some advances for consumers, there has been no corre-sponding right for consumers to

buy financial services in any MemberState, a situation aggravated by the lack of practical means of redressif problems arise.

The Commission’s Green Paper, Financial Services: MeetingConsumers’ Expectations, fails to address these fundamental issuesand thus fails to live up to its title.

2. SPECIAL CHARACTERISTICS OF FINANCIAL SERVICES

2.1. Special Characteristics

Financial services markets have a number of special characteristicswhich need to be taken into account when considering the protec-tion that consumers need. These include the complexity of the market,the long-term nature of many contractual relationships between con-sumers and financial services organisations, inadequate consumer skillsand experience, and the role of the financial services adviser.

Journal of Consumer Policy

20: 379–394, 1997. 1997 Kluwer Academic Publishers. Printed in the Netherlands.

Consumers in Europe Group, and JeremyMitchell of the International ConsumerPolicy BureauResponse to the Commission Green Paper:Financial Services: Meeting Consumers’Expectations1

2.2. Complexity of the Market

The consumer buying a financial service is faced with considerableproblems of comparison and choice. Financial services are not stan-dardised products which can be easily compared. They tend to behighly differentiated, with very varied characteristics. For example,the consumer who wants to buy goods on credit may have the choicebetween hire purchase, or a secured or unsecured loan. The loan maybe repaid over a fixed period or when the borrower chooses, while“revolving” credit is available on credit cards. The rate of interest maybe fixed for the period of the loan or may be variable. Also, therange of different types of financial services organisations providingcredit to consumers is very wide. It includes not only banks, buildingsocieties and finance houses, but also co-operative credit unions,the Government (through the Social Fund), moneylenders and pawn-brokers.

The market for savings and investments is an even more compli-cated example. The different types of financial service on offer toUK consumers include:

• Bank and building society deposit accounts, which vary consider-ably in the rate of interest offered and the speed with which theconsumer can get access to cash. TESSAs (Tax Exempt SpecialSavings Accounts) provide a variant for those prepared to lockup their savings for five years in return for tax free interestpayments. Some Government National Savings products (Ordinaryand Investment Accounts) compete more or less directly with bankand building society accounts, while others (Savings Certificates,NS Income Bonds and NS Capital Bonds) also compete with insur-ance-linked products. There are special NS products for pensionersand children.

• Insurance-linked products, which cover a wide range from pureinsurance (for example, term insurance, mortgage protection andfamily income benefit) through varying mixtures of insurance andinvestment. They include with-profit and without-profit endowmentpolicies, unit-linked policies, annuities, guaranteed income bondsand guaranteed growth bonds. Many policies are sold in conjunc-tion with mortgage loans. There are different types of personalpension plans, linked to investment funds of various kinds.

• Collective investments, such as unit trusts, some of which aremanaged by insurance companies and others by separate fund

380 Consumers in Europe Group

managers. They may be bought with a single lump sum paymentor by regular savings plans. Investment trusts offer an alternativeform of collective investment, and legislation has just been passedto allow the introduction of a new form of collective investment,open-ended investment companies (OEICS). Subject to a statu-tory maximum limit, many collective investments may be held inthe form of PEPs (Personal Equity Plans), which offer certaintax advantages. Some collective investments are offered by “off-shore” financial services organisations not covered by UK lawand regulation.

• Direct investment in equities, perhaps also using a PEP, or invarious forms of government securities.

However, choosing from this extensive and bewildering array ofdifferent forms of saving and investment is only the first decisionthat the consumer has to take. The second stage, the choice of finan-cial services organisation or “brand” is even more complicated. Forexample, the UK consumer who has decided to invest in unit trustsis faced with choosing between more than 160 unit trust manage-ment companies. Many of these offer a range of 20 or more differentcategories of unit trust (for example, Growth, European, Commodity,Energy).

Product complexity and very extensive choice are not, of course,confined to the markets for credit and for savings and investment. Theyare found in the markets for banking services generally, payment cards,life insurance, general insurance and car insurance. They are likelyto increase in future, with the slow but inexorable transition from whathave been overwhelmingly national markets in EU Member Statesto a single market.

2.3. Long-Term Relationships

Another distinctive feature of many financial services is that the rela-tionship between the consumer and the financial service organisationis frequently a long-term one, based on a contract which may lastfor 20 years or longer. This applies particularly to life insurance, butalso to mortgage credit and a range of banking services. It has threeimplications for consumer protection and information:

* The consumer needs assurance that the financial service organi-sation will still exist and be able to fulfill its obligations when

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the contract matures – or that compulsory arrangements are in placeto ensure that the consumer does not suffer financial hardship ifthe organisation goes out of business. Consumer confidence in thecontinuity of the market place is critically important, not only toconsumers but also to the financial services industry.

* Financial service organisations should not penalise consumers whohave reasons for withdrawing from the relationship – for example,by imposing harsh financial penalties on consumers who wish torepay loans early or to surrender life insurance policies. Forexample, a consumer paying premiums on a 10-year with-profitslife insurance policy, who needed to surrender it after two years,might at worst only get back 39% of the premiums already paidfrom Company A, compared with 102% from Company B (Officeof Fair Trading, 1994b).

* It is often extremely difficult for the unguided consumer (andoften indeed for the consumer with guidance) to forecast futurevariations in financial performance between financial service organ-isations. For example, the first range of TESSAs (a deposit-basedproduct, not subject to the inherent volatility of stock markets)maturing at the end of 1995 produced interest ranging from a highof £3,346 to a low of £2,484 on an investment of £9,000 over a fiveyear period. In this instance, the size and general reputation ofthe bank or other financial service organisation was of no help tothe consumer – some of the UK’s biggest and best known bankswere among the worst performers (Which? January 1996). Equity-based products are susceptible to even wider variations. In theyear ending 17 August 1996, out of 121 UK unit trusts investingin European markets, performance ranged from a profit of 38.8%to a loss of 3.2%. Again, there was no observable correlationbetween investment performance and the size or reputation of thefinancial services organisation managing the unit trust.

2.4. Consumer Skills and Experience

The diverse and complicated market place for financial services makesconsiderable demands on consumers’ skills in acquiring and usingeffectively the information needed to make the right choices. Formaleducation does little to prepare people for decisions which have majorfinancial implications. In this context, the provision of informationmay not on its own be a sufficient basis for effective choice.


A good example of this is offered by a study of consumers’ under-standing of APR (Annual Percentage Rate of interest). This showedthat less than a half (46%) of a sample of adults correctly statedwhat APR stood for. On a generous interpretation, the proportion ofthe population who might be expected to draw the appropriate con-clusion from a comparison of APRs – that a lower APR indicates bettervalue for money – reached no higher than 64%. It is no surprise thatthose leaving full time education early, the unemployed and thosedoing manual jobs had a lower than average understanding of themeaning and implication of APR (Office of Fair Trading, 1994a).

The inadequacy of many consumers’ skills is compounded by thefact that any one consumer takes decisions about such financialservices as mortgage credit, life insurance, and savings and investmentinfrequently. As the Personal Investment Authority Consumer Panelhas pointed out:

Most people tend only to think about such things when they are prompted by achange in circumstances: the birth of a first child, perhaps, or a house purchase, or abereavement . . . These events will be relatively few and far between. Thus eachmajor financial decision tends to be different from the last. Each new decision maypose fresh problems in a landscape that is only marginally more familiar than thelast (Personal Investment Authority, 1995).

Consumers do not therefore have much opportunity to acquire cumu-lative experience in taking decisions or to assimilate changes in thenature and cost of what is on offer. One result is that wide varia-tions in price persist. For example, surveys show that the annualpremium for insuring a typical family car varies from £154 to £245and for insuring a house from £101 to £259 (Which? April 1995).These are instances of how lack of consumer experience in the marketfor some financial services allow less efficient, high cost financialservice organisations to stay in business.

2.5. The Role of the Financial Services Adviser or Intermediary

The part played by the financial services “adviser” could in prin-ciple be of critical importance in countering the imperfections of thefinancial services market-place, by compensating for the consumer’slack of skills and experience. It is, however, a role that is full ofambiguity. Traditionally, consumer trust has stemmed from the quasi-professional nature of the person providing advice. No doubt thereused to be a widespread assumption that advice given by a bank


manager, for example, was in the interests of the consumer rather thanthe bank. Many financial services organisations of all kinds havetried to retain this professional aura in increasingly commercial timesby calling their own sales staff or agents “advisers.” Almost cer-tainly, many consumers have an uncertain impression of the primaryallegiance of the person with whom they are dealing and are unawarethat the advice they are being given may be skewed by the patternof remuneration to the organisation or the individual.

However, the availability of truly independent advice is of greatimportance to most consumers. Survey results show that 88% of con-sumers considered it either essential, very important or fairly importantthat independent advice should be provided if the consumer wantssomeone to give advice on his or her finances – that is, advice onall the products on the market, with the adviser not being linked toany particular company. Only 2% considered it not important. Againstthis, only 14% disagreed with the statement that it is difficult to getadvice on financial services that is truly independent, compared with57% who agreed (National Consumer Council, 1994).

There is, therefore, every reason to support the conclusion of thePIA Consumer Panel that “Consumers do not feel they have suffi-cient expertise to exercise choice, but do not have confidence inadvisers to act in their interests” (Personal Investment Authority,1995).

3. CONSUMER NEEDS

What do the special characteristics of the market for financial servicestell us about consumer needs? Consumer protection should be built onthe following principles:

* Consumers should be able to have confidence in the safety and continuity of the market place.

Because of the long-term nature of many financial services relation-ships and their importance to consumers, consumers must be confidentthat obligations to them will be met as and when they fall due.Financial services organisations must therefore be financially sound,committed to the long term and directed and managed with integrity.This requires high minimum standards of prudential regulation, notonly for those financial services organisations which are established


within the EU, but also for those which are allowed to offer theirservices in EU Member States.

Consumers should be entitled to rely on high standards of prudentialregulation. They should not have to make their own assessment ofthe financial soundness of the financial services organisations withwhich they deal. If a financial services organisation fails, therefore,consumers should be entitled to compensation.

* Consumers should be given the information they need to take effective decisions.

This is an especially difficult area over the whole range of financialservices, because of the complexity of the market place and the short-comings in many consumers’ skills and experience, outlined above.

* Detailed consideration should be given to consumers’ informa-tion needs for different financial services, especially to the optimalform, timing and content of such information, and to where theresponsibility for conveying information should lie.

* Better product definitions are needed. Key features for each typeof product should be identified and defined, to provide a base forcomparisons.

* Consumers should be protected from exploitation of their vulner-ability by financial services organisations.

Recent years have seen a succession of large scale mis-selling of finan-cial services in the UK, including home equity plans and personalpensions. There have also been outright scams carried out by somefirms. The distinctive character of financial services markets meansthat consumers may be particularly vulnerable to abuses of the mar-keting and sales process.

Consideration should be given to what particular forms of protec-tion are needed. Also, consumers need to be safeguarded against theuse of unfair terms in standard contracts for financial services.

* Consumers should know the status and allegiance of whoever isgiving them advice about financial services and should have accessto truly independent advice.

* Advisers should be obliged to attain specific training and compe-tence qualifications and should be licensed by a professionalinstitute or regulatory body.


The information that financial service organisations are requiredto provide is important in helping consumers to reach the rightdecision. Independent consumer information of the kind found inWhich? test reports is also of great value to consumers when choosingfinancial services.

However, in many cases these sources need to be supplementedby advice or guidance which is tailored to the circumstances and needsof the individual consumer. The consumer needs to know the statusof the person who is giving advice, whether the advice relates to themarket as a whole or only to the products of one particular financialservices organisation, and the source and amount of any remunera-tion paid to the adviser. In any event, the consumer should have accessto truly independent advice – that is, advice which is based on theinterests of the consumer, rather than on the interests of the personproviding the advice or any financial services organisation.

4. THE EU FRAMEWORK – THE CURRENT SITUATION

4.1. Freedoms to Sell

The strategy for developing the single market for financial serviceshas been based primarily on securing three freedoms for the finan-cial services industry – freedom of movement of capital, freedom ofestablishment and freedom to supply services across frontiers. Thesefreedoms for the supply side of the market have been secured througha system of “home country” control and common minimum stan-dards of prudential supervision.

4.2. Uncertain Consumer Strategy

The consumer benefits of this strategy are likely to be implicit ratherthan explicit. In particular, it has been assumed that consumers willprofit from wider choice and lower costs stemming from EU-widecompetition in financial services markets. It is too early to come toany overall conclusion about the likely scale of these benefits or thespeed with which they may be realised.

However, it is clear that virtually no progress has been made inestablishing a genuine, EU-wide single market for consumers of somefinancial services. While financial services organisations may havebecome more active players in the international takeover scene, there


is still little or no genuine cross-border or branch-based competition.For example, the BEUC/Test Achats survey earlier this year on homeinsurance showed, not only that there were wide variations betweenMember States in both risks and premium levels, but also that it wasvirtually impossible for a consumer to buy home insurance in anotherMember State where conditions and prices might be more favourable.

As well as this major uncertainty about any significant consumerbenefits stemming from the “grand design” for the single market forfinancial services, there is little evidence of a coherent EuropeanCommission strategy to build effective consumer information and pro-tection provisions into the measures that have been introduced. Instead,we have a patchwork. Consumer safeguards vary enormously fromDirective to Directive, depending mainly on which Directorate-Generaldrew up the proposal in the first place.

Even when initial draft-proposed Directives include significantconsumer protection provisions, they are often deleted or diluted fol-lowing intensive lobbying by the financial services industry of theEuropean Commission, the European Parliament and (through pressureon governments of Member States) of the Council of Ministers. Recentexamples of this are the exclusion of financial services from the scopeof the Distance Selling Directive and the lowering of financial ceilingsin the draft Directive on Cross-Border Credit Transfers. Industrylobbying against consumer interests was also responsible for the lastminute transformation of the draft Directive on Payment Systems(1988) into a non-binding Recommendation, a change which has haddamaging effects on compliance.

4.3. Some Positive Consumer Benefits of Current EU Measures

Against this generally unsatisfactory backcloth, it is only fair to saythat there are some examples of Commission initiatives whoseconsumer protection and information aspects do go some way towardsmeeting consumer needs. These include consumer credit, paymentcards, prudential regulation and compensation schemes.

4.4. Consumer Credit

The First and Second Consumer Credit Directives (1987 and 1990)which, while open to improvement along the lines proposed in Reporton the Operation of Directive 90/88 (COM(96)79 final of 12 April


1996), are nevertheless relatively comprehensive and beneficial toconsumers.

4.5. Payment Cards

In theory, the content of the Recommendation on Payment Systems(1988), again open to improvement along the lines proposed in theDraft Working Document on a Commission Policy concerning NewMeans of Payment (21 June 1996), provides some valuable consumersafeguards, especially in limiting consumers’ liabilities when cards arelost or stolen. However, the Commission’s proposal that an amendedtext should still be a Recommendation rather than a Directive is aserious lapse in view of the established weaknesses in compliance withthe provisions of the original Recommendation (see Knobbout-Bethlem, 1990, and Mitchell & Thomas, 1994). The form of thisinstrument therefore remains a major weakness.

4.6. Prudential Regulation

As laid down in the Banking, Investment Services and CapitalAdequacy Directives, high standards of prudential regulation of banksand investment services firms contribute to meeting the first of theconsumer needs specified above, that consumers should be able tohave confidence in the safety and continuity of the market place.

4.7. Compensation Schemes

The setting of harmonised adequate minimum standards for schemeswhich compensate consumers if a financial services organisation failsto meet its obligations offers consumers a significant benefit. Thishas already been achieved in the banking sector. It is hoped that currentproblems with the draft of the Investor Compensation Directive willneither delay its mid-1997 implementation date nor result in a dilutionof its provisions. Effective compensation schemes make a major con-tribution to consumer confidence.

These successes are the exception rather than the rule. The patch-work approach that has characterised the Commission’s approach tothe consumer protection aspects of financial services has meant thatthere are very considerable gaps. The final section of this submis-sion identifies these deficiencies and puts forward proposals fordealing with them.


5. GAPS IN CONSUMER PROTECTION: RECOMMENDATIONS FOR

ACTION

5.1. Consumers’ Right of Access to Financial Services Throughoutthe EU

It is an imbalance in the Commission’s strategy for establishing asingle market for financial services that the three freedoms beinggranted to financial services organisations, identified in Section 4.1above, are not balanced by a freedom for consumers to buy finan-cial services anywhere in the EU.

This “fourth freedom” would not only be a valuable benefit toconsumers who want to seek out the best value for money, but wouldalso make a substantial contribution to the development of a genuinelyEU-wide single market.

The Green Paper rightly identifies the refusal to supply financialservices to non-residents and non-nationals as a consumer concern.It should not be under-estimated. The virtual impossibility of obtaininghome insurance on a cross-border basis has already been mentioned.There are similar obstacles which impede cross-border motor insur-ance, consumer credit, mortgage credit and other insurance andbanking transactions.

The Green paper asserts that “. . . since contractual freedom is anessential principle of contract law, Community law cannot obligefinancial institutions to accept clients, be they national or foreign.Consumers suffering discrimination can only address themselvesto national courts.” This is a highly debatable argument in favourof inaction by the Commission. The contractual freedom invokedis already considerably qualified by Community law. For example,refusal to supply may already contravene Community law whenit represents abuse of a dominant position (Commercial Solvents,Hugin and CLT cases, in relation to Article 86 of the Treaty ofRome).

Of course, a financial services organisation should have theright not to engage in a contract with an individual consumer if theexercise of that right is based on a matter of commercial judg-ment. What is being argued is that block discrimination againstnationals or residents of all or specified other EU Member Statesshould be outlawed as wholly contradictory to the aims of the singlemarket.


* The Commission should examine as a matter of urgency the possibility of proposing a Directive which would prohibit refusalto supply to any EU consumer on grounds of nationality or residence.

5.2. Consumer Information

It has already been stressed in Section 3 above that, if consumersare to play an effective part in financial services markets, they shouldbe given the information they need to take effective decisions. Ifthey are denied this information, they will be more likely to takedecisions which are not in their own best interests. This in turn willlead to imperfect markets and inefficient suppliers.

The current situation is extraordinarily variable as between differentEU financial services directives. A few, such as the Consumer CreditDirective and the proposed Cross-Border Credit Transfers Directive,include provisions which require financial services organisations toprovide consumers with specified information, but most do not. Whileit is accepted that consumers may have different information needs fordifferent financial services, there does not seem to be any logic inthe current variations.

* The Commission should develop a systematic strategy to coverthe information requirements in financial services directives, basedon research into consumers’ actual information needs.

* This should include better product definitions. Key features for eachtype of product should be identified and defined, to provide a basefor comparisons.

5.3. Control of Mis-Selling and the Provision of Advice

Existing financial services directives are virtually silent on criticallyimportant matters involved in the provision of advice to consumersbuying financial services, such as the declaration of the status of theadviser and the amount and source of the adviser’s remuneration. Theyare also silent on mis-selling by advisers and intermediaries.

Current directives do not include any provisions governing the mar-keting and advisory activities of intermediaries. The Green Paper statesthat the Commission is currently examining the question of unregu-lated credit intermediaries, but this is much too limited an approach.


* The Commission should consider what needs to be done to ensurethat the third and fourth consumer needs identified earlier (inSection 3) are met. That is, that consumers should be protected frommis-selling by financial services organisations, that they shouldbe told the status and allegiance of whoever is giving them adviceon financial services, and that they should have access to truly inde-pendent advice.

* Advisers should be obliged to attain specific training and compe-tence qualifications and should be licensed by a professionalinstitute or regulatory body.

5.4. Dispute Resolution

Using the courts is not a practical proposition for the consumer whois in dispute with a financial services organisation – the balance offinancial and legal resources is all on one side. In recent years, alter-native dispute resolution procedures, often in the form of ombudsmanschemes, have been a successful development in some sectors, forexample in the banking sector in the UK, Ireland, Belgium, theNetherlands and Denmark.

There is explicit provision for national complaints handling bodiesin the Consumer Credit Directive, but only as an alternative to twoother surveillance systems. The proposed Cross-Border CreditTransfers Directive obliges Member States to ensure that there areadequate and effective means for the settlement of disputes. However,neither instrument specifies the criteria that dispute resolution systemsshould meet. Other financial services directives have nothing to sayon this important matter.

The need for effective dispute resolution procedures outside theformal court system has been demonstrated by the success of suchschemes where they have been set up. However, not all EU MemberStates and not all financial services sectors are covered. In some coun-tries, the schemes do not meet minimum standards, in that they arenot sufficiently independent of the industry, are unable to secureredress for consumers or are inadequately publicised. Many are unableto deal with disputes about cross-border transactions.

* The Commission should develop a strategy for ensuring that thefinancial services sector is comprehensively covered by public orprivate dispute resolution schemes which are independent, properly


funded, well publicised, and which have powers to deal with cross-border complaints and to secure redress for consumers. Proceduresshould be speedy, simple and inexpensive for consumers.

* Dispute resolution schemes should be complemented by an appro-priate legal framework. The possibility of establishing a Europeanfinancial services ombudsman should be considered by theCommission.

5.5. Payment Cards and Other New Payment Methods

It has already been pointed out in Section 4.5 above that, whilethe content of the 1988 Commission Recommendation on PaymentSystems is generally satisfactory, the form is not. Research has shownthat compliance with the Recommendation is very variable, as betweendifferent provisions of the Recommendation and as between differentcountries.

* In developing its policy on payment cards and new paymentmethods, the Commission should have the firm intention of intro-ducing a binding Directive rather than a Recommendation.Experience shows that compliance with a non-binding instrumentin this area is very variable, leaving many consumers without effec-tive consumer protection safeguards.

5.6. Mortgage Credit

The Commission has encountered considerable difficulties in tryingto make progress with a directive covering mortgage credit. Theproblems arising from the different legal structures for the owner-ship of land have, it has been claimed, presented an insuperable barrier.However, the outcome is that there is not even the faintest sign of asingle market for mortgage credit.

* The Commission should examine the possibility of resuming workon mortgage credit, aiming at a directive limited in scope to thefollowing consumer protection issues:– advertising and marketing of mortgage credit– information requirements (including the use of APR)– selling methods– the role of intermediaries


– rights to early repayment– the availability of dispute resolution and redress systems.

5.7. Distance Selling

It is extremely unfortunate that lobbying by the financial servicesindustry removed the financial services sector from the scope of theDistance Selling Directive. This lack of a specific regulatory frame-work runs against current market trends, which involve much greateruse of distance selling technologies (including the telephone and theInternet) for selling financial services, both within frontiers and ona cross-border basis. The fact that many of the technologies do notrecognise national boundaries emphasises the importance of the issue.It is certainly not self-evident, as some parts of the financial servicesindustry have claimed, that existing directives already cover every-thing that is necessary to ensure consumer protection.

* The Commission’s expressed intention “. . . to examine the positionof consumers with regard to the development of distance selling”(Green Paper, p. 14) is welcome, but does not go far enough. Therapidly growing use of new technologies to sell financial servicesmeans that the preparation of a draft Directive covering this impor-tant issue is a matter of urgency.

NOTE

1 The text of the Green Paper (Com (96) 209 final, 22 May 1996) can be found inthis journal, Vol. 20, 1997, pp. 99–116.

REFERENCES

Knobbout-Bethlem, C. E. (1990). A survey of implementation of the EC Recom-mendation Concerning Payment Systems. Consumentenbond and BEUC.

Mitchell, J., & Thomas, W. H. (1994). Payment card terms and conditions. Edinburgh:International Consumer Policy Bureau.

National Consumer Council (1994). Consumer concerns. London: NCC.Office of Fair Trading (1994a). Consumers’ appreciation of “Annual Percentage

Rates.” London: OFT.Office of Fair Trading (1994b). Surrender values of life insurance policies. London:

OFT.Personal Investment Authority (1995). Consumer panel report. Personal Investment

Authority.


THE AUTHORS

The Consumers in Europe Group is an umbrella body for UK organisations con-cerned with the effects of European Union policies and proposals on UK consumers.Communications regarding this response should be directed to the Consumers in EuropeGroup, 20 Grosvenor Gardens, London SW1W 0DH.

Jeremy Mitchell, of the International Consumer Policy Bureau, is a member ofthe Scottish Consumer Council and a former Director of the National ConsumerCouncil.


response to the commission green paper: financial services: meeting consumers' expectations

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