Predictably Mistaken: The FCA and the use of economics, … · 2020-07-10 · The new FCA approach which we will look at here will be to use behavioural economics as a science in

International Inhouse Counsel Journal

Vol. 7, No. 27, Spring 2014, 1

International Inhouse Counsel Journal ISSN 17540607 print/ISSN 17540607 online

Predictably Mistaken: The FCA and the use of economics, psychology

and consumer bias in their new role of promoting competition in the

interests of consumers in financial services in the UK in 2014

LEE CALLAGHAN

General Counsel, International Markets (Europe and Asia) and Group Competition

Law General Counsel, Aviva plc, UK

Financial services and the new FCA (Financial Conduct Authority) competition role in

the UK. Why the changes, how will it work and how should you manage them?

The next phase of competition law reform in financial services in the UK.

Promoting competition in the interests of consumers.

The FCA and the use of behavioural economics in identifying market

correction.

Combining established competition law principles with certain “behavioural

biases” found in consumers.

The importance of assessing why consumers behave the way they do. Just

providing more information to consumers might no longer be enough.

Psychology, economics and the law. Three legs of the same stool.

Identifying underlying bias in existing consumer behaviour and how to

regulate financial services markets as a result.

What lessons might there be for other regulated sectors in the UK and

beyond? Is this a model other regulators globally will follow?

FIRST SOME CONTEXT AND BACKGROUND

For those of us who can recall how competition law in the 1980’s and indeed well into

the1990’s actually worked, the system in the UK was based on a decade’s old approach

with precious little focused economic context. With formal price controls only finally

coming to an end in 1980 with the introduction of the Competition Act, the regulator had

a choice of whether to use trade practices laws first introduced in 1956 and then extended

in 1976 or rely on the Fair Trading Act of 1973 to look at mergers and wider market

issues. It wasn’t until 1998, and so relatively recently, that things changed into what

would now be regarded as a much more modern approach to competition regulation in

the UK with successive governments having consistently failed to find enough

parliamentary time to reform and modernise the UK system of competition regulation

until then.

By1998 its fair to say very little had changed in almost 40 years and initially the regulator

in the shape of the OFT regarded their role as essentially a benign one; to sit in Acton

Town, in West London, and essentially act as a dumping ground for notifications from

industry if the “form” of their distribution agreement or wider competitive ‘practice’

happened to be caught by the specific wording of the trade practice laws then in force.

This preference for form over function or effect or any assessment of the real economic

impact of an agreement meant some tended to play safe and just register their agreements

with the OFT by sending it off to Acton, leading to a huge backlog before they were

actually assessed. Equally unsatisfactory was the other option of some firms probably

2 Lee Callaghan

ignoring the role of the OFT entirely and this was despite the fact that, unless registered

with the OFT, relevant agreements were deemed illegal, void and supposedly of “no

effect”. At the same time, for those that were registered, no real assessment of specific

consumer benefits or an agreement’s wider economic impact set against a proper

assessment of the relevant market was being conducted.

The financial services regulator regarded competition law and regulation as almost

entirely the preserve of the OFT and would have done very little to examine the role of

economics in regulating markets or to consider the impact of actual consumer behaviour

when looking at questions of overall market efficiency.

The law operated as a blunt instrument, forcing what could have been advantageous and

efficiency enhancing agreements into a legal straitjacket that almost focused on the

drafting used in the agreement to the exclusion of all else. As a result, no one was happy

with the system. For those that did notify, they will have spent significant sums in so

notifying the OFT of their arrangement or agreement and then waiting for OFT staff

members to respond, not knowing if they would have to alter the commercial deal

reached. At the same time, the OFT spent significant resources dealing with these

notifications and this impacted their ability to chase down and investigate hardcore cartel

behaviour and look more closely at the underlying consumer benefits and the economic

cause and its various effects.

Talking of cause and effect; two men were walking along the ice fields in Alaska one day

when they came across a hole in the ground about 3 feet in diameter. “ Wow, that looks

really deep” said one to the other. “Let’s throw something down it and listen for the

splash”. So they look around and see an anvil close by and so they haul it to the hole and

together they throw it down. Whoosh it goes, down the hole, at full speed but after a few

seconds no splash is heard, as it’s so deep. Suddenly, they hear the sound of very rapid

hoof steps approaching and to their surprise they see a goat suddenly appear in front of

them, breathing very hard. The goat then jumps in and it too disappears down the deep

hole! Confused, the two men then see a farmer walking over who comes up to them and

asks; “Hey, did you guys just see a goat around here as I can’t find it anywhere”. “Yes”

they reply, looking into the depths of the hole. “It just jumped straight down this deep

hole”. “But that’s impossible” says the farmer looking very confused. “You see”, he went

on, “I chained it up to an anvil”! (With thanks and acknowledgement to Jay Leno).

Clearly, against this backdrop consumers won’t have been happy either because whatever

industry and the regulators were up to, their interests seemed to be secondary as there was

no detailed look at consumer behaviours, whether as a result of bias or not, or what could

be done to improve their individual buying position. There was certainly no time given to

what role both industry and the regulator should play in ensuring that, although the

concept of “buyer beware “still existed, buyers could or should (where appropriate) be

“nudged “by either a regulator or an industry into certain behaviours because ultimately

this might have a beneficial impact on consumers but otherwise would not happen due to

consumer “behavioural bias”.

A behavioural bias has been defined by the wonderful Thaler and Sunstein in their book

“Nudge (Improving Decisions about Health, Wealth, and Happiness)”, (Richard H Thaler

and Cass R Sunstein, 2nd

Edition 2009) as;

“Specific ways in which normal human thought systematically departs from being fully

rational” (p4).

Compare this state of affairs as well with the law in Europe at the same time as

implemented by the terms of the EC Treaty under what was Article 85 and 86, which did

FCA’s Competition role in the UK 3

try to focus much more on economic behaviour and its impact on anticompetitive conduct

(but only of course in relation to trade that took place between member states). However,

detailed consumer buying behaviour and buying decisions were not that closely examined

either with resource being spent on notifying arrangements and agreements that might

have an anticompetitive effect for clearance from the Commission and which, for many

years, were without the benefit of any industry block exemptions or general “safe

harbours”. Certainly, little regard was given to understanding whether consumer buying

decisions resulted from the way sales processes were being designed or implemented or if

they were the result of conditions in the market place that individual companies could do

little to influence or change. There simply was no market review tool available.

THE NEW FCA APPROACH

The new FCA approach which we will look at here will be to use behavioural economics

as a science in itself in order to understand why errors in buying decisions might arise,

why they then persist and what can be done to reduce them. It is clearly not to try and

solve issues by just providing more information to consumers about prices, competitive

offerings or terms and conditions in the hope and expectation that consumers will

dutifully read all this information and then make a fully rational and fully reasoned

buying decision. Life, it turns out, just is not and never was like that!

What we now see is a starting point where it’s assumed people can’t but help make errors

when choosing and using financial products and a regulator then using insight from

psychology to explain why we all behave in the way we do, even if it doesn’t make a

huge amount of rational sense. These behavioural “biases” inherent in all of us can cause

people to misjudge important facts or choose on an inconsistent basis. What then happens

is that normal everyday human behaviour and the decisions that are taken on what to buy

leads consumers to be “predictably mistaken” or, in other words, knowingly wrong.

The approach the FCA is adopting is that it is predictable because, using psychology,

such a reaction or decision could have been foreseen given how the product is framed or

the buying decision reached or presented. Mistaken because if they had not acted this

way, they would have reached a different conclusion and therefore a better buying

decision than the one actually adopted. The key lesson learnt from psychology is that

most human decision making relies on intuition and is automatic rather than deliberate

and controlled because being deliberate and controlled takes far more effort, time and

personal involvement than intuition which essentially relies predominantly on gut feel

and quick reaction. The FCA claim is that normal market forces, if left to themselves,

will often not work to reduce these mistakes and so they need to introduce regulation and

market change. By applying behavioural economics, the theory is that a regulator can

move beyond plain intuition and allow themselves to be more precise in detecting,

understanding and remedying problems that arise from these common consumer buying

mistakes.

So, having fast forwarded to 2014, what we have now is the FCA saying that it is

essentially leading the next phase of the development of competition law in the UK for

financial services to address the perceived issue that has long roamed the corridors of

successive governments and regulators alike; how to get consumers to essentially “wise

up” and become more knowledgeable about the markets and products in which they are a

central part. At the same time, they want to use aspects of consumer behaviour to act as

the ultimate discipline on firms intending to mislead, mistrust or just simply obtain an

advantage from consumer mistakes made in their buying behaviour.

4 Lee Callaghan

THE FINANCIAL SERVICES ACT 2012

This heralds a different approach to how competition law in financial service’s markets is

to be regulated and delivers a brand new role to the recently set up FCA and which, for

the first time, has a duty to actively “PROMOTE “ competition. As a result, the FCA

say that they intend to anticipate challenges in the industry and not just react to them once

they have occurred. This essentially means a much more proactive approach than we will

have seen before and one that will result in the FCA actively looking for issues in

markets, not just waiting for issues to appear, and then trying to address them., At the

same time, the FCA say they want to encourage new entrants – so an obvious tall order to

fulfill. This promotion of competition is also to be done “in the INTERESTS of

consumers”. This aspect is also a new approach. So, why did we get here?

WHY THE NEW APPROACH?

The FCA will start from the premise that how products are designed and sold impacts

decisions that consumers make as to whether to buy them. As Thaler and Sunstein point

out in their New York Times bestseller Nudge and, as we all know ourselves, life is full

of products that suffer from defects and that, they identify, can be as a result of a failure

in basic design architecture to fully accommodate underlying principles of human

psychology. They give examples like leaving ATM cards behind in the cash machine

after money is withdrawn and that people made mistakes like this all the time until banks

finally reversed when the card was returned in the sequence.

Recently, I was sitting in an arrival’s lounge at Heathrow very early one morning when in

walked a partner from a leading law firm who acts as a major service provider to my

employer and who I have worked with on numerous projects over the last 20 years or so.

His team in Asia had just finished a major piece of work for us. It was good to see him

unexpectedly and we caught up on family and chatted before I had to rush off to catch my

connection (completely forgetting I had left my phone on charge in a nearby socket

invisible from view from where I was sitting as it was the only one available). This sort

of human error, caused mainly when you have finished your main task, occurs when you

forget things related to a previous task or step just like leaving behind an ATM card.

This type of mistake is known as a “post completion” error and they are obviously very

common. But what, the FCA argues, if errors like this influenced buying decisions and

led to common but perfectly predictable mistakes?

Choice Architecture.

The decisions people make on what and when to buy a product, whether they are life

insurance policies or other consumer goods, can be influenced by the “choice

architecture” designed around the whole buying process. Consumers and “choosers” are

human and so designers often need to plan for and take account of real life and that real

people do not always make choices that are the result of fully considered careful analysis.

Rather, what is often more likely is that a highly irrational choice is made based on

incompatible facts or someone’s own “gut feel” or their flawed past experiences that then

ultimately prove to be a mistake and so the reasons to purchase are ultimately the wrong

ones. At the same time, product providers can lower their own costs, some economists

believe, by ensuring that correct choices are made and mistakes avoided. Regulators will

also want to try and intervene if things can be done to prevent firms deliberately or (and

here’s the somewhat controversial part) inadvertently misleading consumers, so that they

can make the right final decision with the best economic outcome (for them anyway).

Status Quo Bias

If consumers do take the path of least resistance or the default option that requires the

least effort (the so called status quo bias), then increasingly regulators in any industry are

FCA’s Competition role in the UK 5

seeing their role as one to ensure the default option is also the fairest option and that the

opportunity is not also taken to extract extra profits or income from consumers going

down this well trodden path. As Thaler and Sunstein also point out in Nudge, the key

questions that might arise when thinking about how to design systems to sell products to

consumers are these; who uses, chooses, pays and then profits. A truly free market might

often solve these questions by giving producers an incentive to make good reliable

products and sell them at the right price to fully engaged and informed consumers. If

markets work well, then lots of healthy competition results. However, the FCA asks the

question; what though if this is not the case? Or, to be more precise, what if the products

or markets concerned are so complex or confusing or comparisons between products so

difficult as to result in consumers regularly making poor choices?

Chris Woolard, FCA. So How?

It has certainly been the case in recent years for many regulators to focus in on the issue

of price and information like a beacon and as a result give consumers more and more

information and data points in the belief that this would help them make rational choices

based on perfect comparisons between competing products, such as we have seen in

credit cards and their charges in the past.

Chris Woolard, the Director of Policy, Risk and Research at the FCA, in a speech

published in September 2013 and given at the Regulatory Policy Institute’s Annual

Competition and Regulation Conference, aside from setting out the significant changes

on how the industry will be regulated, was very open and said that regulators now think

far too much reliance had in fact been placed in the past on imperfect economic models

and an underlying belief that consumers can be expected to make the right decision if

only they were given all the right information. Yet… the most frequently used regulatory

response in the UK has been to provide yet more and more information to consumers!

As that famous UK comedy double act Morecombe and Wise would have said; “All the

right notes but not necessarily played in the right order”.

The new starting point of the FCA, in order to have what it calls an orderly and

competitive financial services market, is to have product providers place customers at the

heart of everything that they do and so offer them good value products and services. But

what does this mean if it’s not about giving them yet more data points to compare prices?

Indeed you might also ask how much more interventionist does this mean the FCA will

be when compared to how the FSA approached things and how does this fit with their

new competition remit going forward? The other obvious question is to ask on what

evidence will they base these decisions, given the use of econometrics is new, still often

challenged and can be open to interpretation.

To answer that question we need to look at how the FCA will operate in practice going

forward, how it will interact with industry and how and on what basis they will as Chris

Woolard commented;

“Use our judgement about the outcomes we think a product will truly achieve for

the target consumer; it means considering the root cause of a problem; it means

thinking beyond whether the sale was compliant; it means a greater understanding

of how consumers actually buy”.

But might the FCA be overreaching here in going beyond what the FSA had been doing

and where exactly does this leave the full time competition regulator, the OFT, which

itself is being transformed by its own merger (!) with the Competition Commission into

what will be the Competition and Markets Authority on 1st April 2014. Will there be

6 Lee Callaghan

resulting confusion between the regulators on their roles and priorities and a lack of

action or focus as a result?

In setting out the revised role for the FCA, Chris Woolard, in the same speech, described

a few of the challenges as well as how he saw things working in future. He comments on

what he sees as a lack of properly engaged consumers which can lead to firms having the

wrong incentives to act and which in turn makes competition problems potentially worse.

Obviously, he says, if we were all rational economists approaching buying decisions

without inbuilt bias then issues might not arise. He also points out the possible challenge

of consumers gaining experience or learning to be better at buying by making mistakes

but the challenges of doing that in the context of a long term financial product. He also

says it might be the case that a consumer does not have the full facts needed when

deciding to buy or those facts may have been provided but they are not, in the FCA’s

view, sufficiently available without “added layers of complexity”.

So, you need to make it real!

Chris Woolard also said;

“There is a need to prevent consumers relying on gut feel or their own bias or

indeed on those who have done the same. In other words to enable consumers to

exercise choice that is real.”

To achieve this the FCA is essentially starting again, pressing reset to change the

rulebook so that, they say, competition in the industry will work better. This involves,

even as you read this, the recruitment of more economists and targeted competition

training for staff to ensure the FCA really is capable of “promoting competition in the

interests of consumers”. It’s also the case that the FCA has embraced behavioural

economics in a big way so that issues of financial illiteracy are properly factored into the

assessment of how products are presented is really fair.

As a result, he makes the point that;

“We will be looking into markets where we think ineffective competition is leading

to poor outcomes for consumers. We will analyse markets from all angles, seeking

to understand interactions between both demand and supply side competition

weaknesses. At the end of a market study we will use our regulatory powers to

make any changes we think would improve the effectiveness of competition or refer

issues to the OFT and in future the CMA.”

He then sets out their program for the next 12 months, including the recent focus on

general insurance add-ons and which has just announced various remedies, SME

banking, the consumer cash savings market, retirement products, a market study on

pension annuities (and which has also just been announced) as well as asset management

charges for institutional clients.

The FCA OCCASIONAL PAPER NUMBER 1;

APPLYING BEHAVIOURAL ECONOMICS AT THE FCA.

The in-house economist team at the FCA have issued their very first occasional paper and

it is on applying behavioural economics at the FCA. These are leading papers issued to

encourage debate within policy makers, practitioners and academics and will in future

cover all aspects of financial regulation. The authors all work in the Chief Economist’s

Department of the FCA and it has had input from other FCA colleagues. Clearly, what

this paper says is important in setting the overall agenda and every lawyer working in

financial services (indeed in all other regulated industries) ought to get a copy as it sets

out the blueprint for what is about to follow from the FCA.

FCA’s Competition role in the UK 7

The overall approach is well summarised when the authors say with frank openness;

“The FCA will use insight from behavioural economics alongside a traditional

analysis of competition issues and market failures to assess problems in financial

markets and do so better than they have done in the past”.

Martin Wheatley, the CEO of the FCA, comments in the forward that the FCA has been

given an additional objective and duty to promote competition, which “we believe should

be on price and quality rather than on false focal points or strategies to exclude rivals at

point of sale”. To achieve this, he says, the FCA will first need to undertake an integrated

analysis of economic markets. In other words, it will need to understand how information

problems, consumer behavioural errors and firms’ competitive strategies combine to

produce observed market outcomes. He then makes the point that one of the biggest

changes that we will see relates to a new greater focus on understanding consumer

behaviour.

The paper sets out how assessing behavioural economics uses insights from psychology

to explain why we behave in the way we do and that most human decision making will

use thought processes that are based on intuition and are clearly often automatic rather

than deliberate and controlled. Given these in-built pre-programmed biases cause us to

misjudge important facts, be mistaken or even, as pointed out earlier, “predictably

mistaken”, the FCA sees a role for it to step in because they believe market forces, if left

to themselves, won’t correct the resulting errors.

The paper also asks are there, in fact, more problems in some parts of the financial

services industry to warrant all this focus and regulatory response? That’s the obvious

question to ask here. The FCA team say yes, they think so, given;

the complexity of some of the products concerned,

the inevitable trade off between present and future risks and returns,

consumers may well be asked to assess risk and uncertainty to a certain

degree, and

this will often involve the use of statistics to do so and that inevitably means

mistakes creep in and gut feel can take over. Also, past mistakes or lessons

learnt can easily be forgotten.

The Big Bang Moment.

So, that brings us to the big breakthrough (the competition/ economics combination big

bang moment if you like) which came when economists claimed they finally appreciated

that the inconsistencies that consumer bias can lead to could be tracked and that it was

possible to detect, understand and so crucially remedy consumer buying mistakes or poor

judgment.

The New Focus. Shaping consumer choice.

As the paper also sets out in clear terms, significant effort will now be spent on trying to

look at and detect bias in consumer behaviour and to do that the FCA will focus much

more on;

what preferences already exist?

are there beliefs that may be mistaken?

are consumers using shortcuts to make and reach a decision quickly?

In effect, exactly how products are presented to the market, how they are advertised

and packaged and how they are presented or “framed’ to consumers has suddenly

become as relevant to regulatory enforcement as the raw market power or market

shares of providers was for regulators 20 years ago. The FCA will want to assess the

8 Lee Callaghan

impact of biases on specific strategies of providers and what role they have in shaping

final consumer choice. The FCA is therefore going to be spending far more time

looking to see if consumers are making mistakes and why.

One legitimate challenge, which the author’s of the paper clearly recognise, is that if

mistakes are not apparent and consumers actually want to purchase a particular product to

fulfill a legitimate need, if a regulator were to still intervene and even prevent them from

doing so, will consumers end up being worse off overall? Looking at the customer

experience may help answer that.

The Customer Experience- two key recent speeches by FCA staff.

In relation to the customer journey in financial services and assessing what customers

really want, two recent speeches in November 2013, both published by the FCA, look

more closely at these issues. One was by Clive Adamson (the Director of Supervision at

the FCA and which he gave at the Insurance institute of London) and was called “Trust

and Confidence. Ensuring firms’ ethics are built around their customers”. The other was

by Chris Woolard again on “Improving the customer experience”. Both are very helpful

by highlighting where regulators may go with this theme, especially when compared with

what we have seen happen before.

Clive Adamson

Clive Adamson focused on the twin themes in outcome focused regulation of what

consumers are experiencing and how firms make money. This, he said, was about

encouraging firms to do the right thing in respect of their customers and involves

requiring firms to ask “should we” as well as the inevitable “could we”. He said the FCA

would be asking about and then assessing;

how business strategies are developed (this was previously looked at by the

OFT and CC in their market studies and inquiries previously but not with any

real sense of rigour and often broadly missed as a key theme in their reports),

how individuals are compensated (not really looked at before in detail in a

competition /financial regulation sense),

how frontline processes are designed and performed (this has been looked at

before but has not been focused on that much).

In the speech he also flagged up that vague corporate aspirations won’t result in clear

business practices or standards and won’t make them easily understood. He said that all

levels of management need to be engaged and so standards and practices need to be clear

for all to understand: what is acceptable and what is not. This was referred to as a “join

the dots” exercise which would look at;

things not done directly by a firm but still needed to be looked at with

different indicators,

how do firms respond to and deal with regulatory issues,

what do customers actually experience when dealing with front line staff, and

how is a product designed and what plays into this?

He also mentioned they would look at how firms escalated decisions internally and how

claims or complaints are handled. Also on his list were management compensation and

engagement of the Board and its own oversight. On this theme, the FCA would look at

delegated authorities and how they work, how distribution networks operated, the

company’s oversight of financial crime risks and claims handling and managing conflicts

of interest. It’s worth adding a last comment that he made as well, which was that the

FCA’s Competition role in the UK 9

FCA is not seeking to stifle innovation but to ensure products are developed that are

suitable for consumers and the role of the FCA was not to drive profitability from

businesses as a result.

Chris Woolard

On improving the customer experience, Chris Woolard (in a speech at the Tax

Incentivised Saving Association) said that he firmly believed that the consumer

experience was the dominant theme for financial services and directed firms to use their

energies in competing in the interests of consumers and to understand how consumers

really behave. However, he also made the point that he accepted that there remains a lot

of disagreement on what and how to do things. He mentioned the new FCA market

research and intelligence function whose role was to generate both research insights and

to use existing secondary research resources.

He also mentioned their important new consumer segmentation model (a type of big data

recipient) which will examine consumer characteristics, lifestyle attitudes, behaviours

and experiences. This assesses financial needs and vulnerability to risk by creating 10

(yes 10!) different consumer segments and then to use this data to target appropriately,

whether in relation to policy, enforcement or supervision and especially consider this

when looking at issues of vulnerability. He then flagged a special area they want to look

at; those firms he said who design terms and conditions for the firm, not their customers.

Bringing these different themes together.

It’s this new focus on how consumer choice is shaped and the role of competition law

that is the big step change. Whether the product design process, how it‘s marketed or the

way the sales process really works, the starting point now is that, if consumer bias is

present, each of these components can make it worse. The FCA’s view is that firms can

decide to compete in certain ways but that this may not be in the consumer’s best

interests.

Of course, one problem with this approach is what should a regulator do if those same

firms don’t know that the bias exists or that their hard fought for and won customers are

actually making mistakes when buying. The approach in the past has been that if a

product or service demand exists, firms should respond and fulfill it because if they don’t

someone else will. This is as true in financial services at it is in car manufacturing or

chemical production. The tricky bit for those of us in financial services is what should be

the response if the demand arises out of, or because of, a bias. Further, a firm may itself

be acting within what is already perceived to be a poorly functioning market or one that is

impacted by external factors beyond its control. In these cases, should regulatory action

be taken against the firm’s interests of being able to compete as hard and as best they can

in order to maintain their own market presence?

What will we see happening in practice?

What we will see in future is the FCA putting behavioural economics front and centre

into their regulatory practice over time. As also set out in the Occasional Paper Number

1, it seems apparent that the FCA will want to spend an increasing amount of effort on:

Spotting and then addressing risks to consumers. That means looking for

consumer bias that could lead to consumer detriment. Having done that, the

issue is how to rank the risks that are identified.

Looking at what is the underlying cause. They will ask is it an issue of how

individual companies are acting or is it a market wide issue? They will also

ask are buying decisions that are being made reasonable ones to make or are

10 Lee Callaghan

they impacted by some underlying bias so the need arises to look at the actual

need being met and what consumers really want.

Implementing a fix. Until relatively recently, the approach regulators tended

to adopt was to assume things could be addressed by giving the consumer

more data points and so often price or product information would be carried

on their web sites. Clearly, this step goes further and asks should the

regulator even intervene and if so, how? Having intervened, the issue then is

what happens as a result.

Conclusions

What really jumps out at you when you look at the evidence above is that the FCA, as a

financial services regulator with its new competition role, will behave in 3 distinctly

different ways compared to how this market has been regulated before.

1) How is it sold?

Not only will they ask what is the underlying purpose of a product and what does it exist

for but that they will go much further and assess in detail whether it is being used for that

purpose or something entirely different. The FCA has seen examples where some

consumers end up paying more for products and services than others do. This element of

cross subsidy may be the result of the more able or sophisticated being cross-subsidised

by the less able. The FCA will want to look closely at whether this arises as a direct result

of how the product was sold in the first place. Are the decisions to buy different

depending on how and when they are made? Assessing the consumer starting point and

awareness of products to meet certain needs will be a key focus.

2) Data gathering

Clearly, the FCA will in future be more focused on gathering focused data on firms and

markets in the first place before they act. A frequent observation by participants to past

market study inquiries is that regulators have asked for so much background data,

stretching over such a long period and in so many different ways, that it seemed like they

may not have entirely known what it was they were really looking for. Also, such studies

gave them an opportunity to ask for data that really had no obvious connection to the

central issues. It’s likely that we will see the economist teams work hard to fully frame

and assess data demands and hopefully take better account of the impact on firms who

have to supply this data. One issue that will be given a lot more air time is how widely

practiced behaviours are within a market and this will mean a lot more consumer-based

research and analysis of how the market as a whole is operating and the role that

consumer bias is having within it.

3) The use of “Nudges”

This is likely to be a new significant and sharper tool in the box for the FCA. They will

focus on trying to ensure better consumer decisions are taken by those who are naturally

biased in one way or another but do so without heavy-handed bans or directions and

without impacting freedom of choice. This is clearly the gold standard here when

regulating a market like financial services. Nudges are small prompts or default positions

which, if designed well and the way Thaler and Sunstein propose, can be a low cost

solution but which also leads to consumers then making better decisions for themselves

(even if this means they elect not to do something as the default option remains a good

choice to have made). We already see them used in all sorts of ways and they often work

by just giving more information in a targeted way at the most simple level or they could

go further and redesign the buying architecture that consumers experience at a more

sophisticated level. A nudge could be yet stronger in persuading consumers to do

something during the buying decision or impact the distribution chain or they can exist as

FCA’s Competition role in the UK 11

a road block to buying which can only be cleared after taking a certain type of advice. We

have seen even stronger versions where certain products are banned or features are made

illegal or, as a condition of a sale happening, certain features must be included.

And finally,

The question will inevitably arise what exactly is in the best interests of the consumer and

how does this fit with their own personal responsibility to act carefully and rationally and

take responsibility for their actions? The FCA will have to consider which measure is

most suited to the issue they have identified but when they do so they also need to take

account of the costs involved in what is proposed and the benefits that result. To do this

properly, the FCA will also look at things like; is it possible to side step the measures

proposed on firms, what happens to innovation, the relative position of more and less

sophisticated consumers, will consumers learn from previous conduct or will intervention

remove this as a possibility and is this a question for the FCA or should the law

intervene?

Overall, when looking at each area, the FCA will clearly be taking account of, and

allowing in models, the presence of consumer bias. This combination of insight from

using principles of behavioural economics together with the use of more traditional

competition and market failure analysis tools should allow them to look for the best way

to intervene in a market. That’s the theory. This then impacts how they set their future

policy, how they examine particular business models, behaviour and products and how

they combine evidence and take enforcement action forward. This has an immediate

knock on effect in deciding the future shape of the FCA and how those it regulates

communicate with their customers.

But much wider than that, and as the Occasional Paper puts forward, it’s also claimed

that behavioural economics should help work out and assess what is meant by ‘an

appropriate degree of consumer protection’ as this is the hot debate to-be-had. At the

same time, its use may (possibly) help assess what level of personal responsibility

consumers should be asked to bear themselves, so if things do go wrong, they only have

themselves to blame. Also, behavioural economics ought not to be providing a free

licence for regulators to intervene in markets to try and address every type of consumer

error. If consumers are not learning from mistakes to a degree, this loss of personal

freedom could be a bad outcome for all of us. Who is to judge if the economists are

always right?

What clearly has been needed all along are clear and better tools to analyse and assess

issues and then having done so, for them to give regulators some options to intervene in a

market in a focussed and less restrictive way, such as by using nudges. The fact that they

can also be more cost effective than approaches used in the past and maybe quicker to

implement than passing more laws should mean that market outcomes are improved more

quickly and effectively. The reality is that, if a regulator better understands how

consumers reach their decisions in the first place and how competing firms respond to

that, then this ought to mean the chances of implementing remedies that just don’t work

or that make things ultimately worse are avoided. At the same time, any unintended or

unforeseen knock-on consequences (or water bed effects) for consumers or markets as a

whole should be reduced. It will certainly be interesting to see how this area develops.

The other point to make is that there is clear “read across” from some of these

developments to other markets and other industries. What makes good sense by looking

at human inbuilt irrationality before considering how best to design how goods are sold

or services delivered, whether its healthcare, housing or the domestic supply of internet

services or energy, means the approach to competition regulation that the FCA are

12 Lee Callaghan

looking at should be equally applicable in and to other markets. If consumers are

naturally biased, they will use instinct, gut feel and will guess in other areas of their

buying decision making. Behavioural economics could offer an opportunity to other

regulators, whether they have a competition remit or not, to better assess how consumers

might be predictably mistaken in making those decisions and so how they might design

nudges and other less interventionist but more focused remedies to address that

imbalance. But the way it’s then used and implemented needs to be carefully considered

by regulators as behavioural economics remains a controversial area and can easily be

misused.

***

Lee Callaghan is the General Counsel at Aviva plc for their international markets in both

Europe and Asia. He has over 25 years of legal experience in industry, having been called

to the Bar in England and has worked in the UK motor industry, chemical industry and,

for the last 13 years, at Aviva. He is the Aviva plc Group Competition Law General

Counsel. He also serves on the Editorial Board of the IICJ.

Aviva is the UK’s largest insurer and a top 10 global insurer that operates in general, life,

healthcare and asset management markets worldwide.