Consumer Protection and Consumer Choice Consumer protection and. the Single Market A fresh approach to breaking the deadlock

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1 Consumer Protection and Consumer Choice Consumer protection and the Single Market A fresh approach to breaking the deadlock

2 Consumer Protection and Consumer Choice Consumer protection and the Single Market: A fresh approach to breaking the deadlock A report by The European Financial Services Round Table February

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4 Contents Foreword p 4 Executive summary p 6 Chapter One The benefits of a single market in retail financial services A single market in financial services p Quantifying the benefits of a single market to the retail consumer. p The serious obstacles which need to be tackled p A patchwork of consumer protection regimes p Differences are not justified by consumer needs or preferences.. p 19 Chapter Two Consumer protection regulation: recent experience Attempts at European harmonisation: a mixed scorecard p Getting the balance right p 25 Chapter Three An alternative approach to consumer protection within the EU Preserving choice, protecting the vulnerable p Dealing with complexity p Providing the right information is the key to good decisions..... p Towards a common set of standards and principles p Putting the approach into practice p 37 Chapter Four A blueprint for change The need for fresh thinking p Breaking the deadlock: adopting a multi-track approach p Harmonisation where essential, convergence where necessary.. p Accelerating the decision-making process p The next steps p 50 Members and mission of the EFR p 53 3

5 Foreword The creation of a single European market is one of the most tangible benefits of the European Union. It has delivered huge benefits to the European consumer and has been a major spur to economic growth. European leaders have agreed that extending these benefits to the area of financial services is now a priority. However, to achieve that goal, it is necessary to tackle some of the roadblocks, which have so far held up progress in this most vital of areas. It is against this background that the European Financial Services Round Table is seeking to launch an informed debate about the degree and nature of consumer protection that is needed for a single market in retail financial services. The industry is at one with consumer groups and the European Commission in believing consumers must be properly protected within a single market for retail financial services. Consumers need reassurance that their rights will be fully protected if they are to have confidence in the industry and the products and services it provides. At present regulation is largely a national affair with wide variations in the approach taken in each Member State. The question is how we can most effectively create enough convergence between these national regimes to enable a single market in retail financial services to become a reality. A key concern in seeking to accelerate the process of harmonisation is to ensure that regulators and legislators at both EU and Member State level are mindful of the fact that regulation has a cost. We will be doing consumers a disservice if, in our efforts to achieve harmonisation, we end up depriving them of the very benefits in lower cost and increased choice that an open, competitive market is meant to bring. Clearly, some of the differences in 4

6 product design and specifications within the EU are a result of differences in national contract law or civil law, which will not be easy to change. However, we believe that by changing the approach to harmonisation, it should be possible to achieve much more progress on consumer protection legislation than has been the case until now. Our guiding principle should be how best to protect the consumer within a dynamic, competitive European market. This is not just a luxury. Europe s demographic time bomb needs to be defused. That has to mean a greater role for self-provision through a healthy competitive private sector savings industry. The enlargement of the EU to include the new democracies of Central and Eastern Europe should give a new sense of urgency to the issue. Without the developed welfare states of the West, they will have to rely even more heavily on private pensions provision, which in turn will require a competitive private sector industry. We recognise that our approach will require a shift in attitude on the part of governments and the EU institutions, as well as the industry itself. However, we believe that every customer in Europe is entitled to benefit from the best deals, the lowest rates and the most innovative products available irrespective of where they live. The current deadlock must be addressed. Pehr G Gyllenhammar Chairman of the European Financial Services Round Table Michel Pébereau Sponsor of the EFR Steering Group on Consumer Protection 5

7 Executive Summary The Financial Services Action Plan European leaders have singled out financial services as a priority area for European action. The Financial Services Action Plan endorsed by European Heads of State and Government at the Lisbon Summit in 2000 clearly identifies the need for an efficient, competitive financial services sector as part of a broader effort to stimulate the European economy. In an attempt to assist the European Union in its efforts to speed up the creation of a genuine single market in financial services, the European Financial Services Round Table (EFR) - whose members include the chairmen or chief executives of leading banks and insurance companies within the EU - is producing a series of studies identifying the key issues that have up to now impeded progress towards a single market in financial services and proposing some potential solutions. The current situation, a patchwork of consumer protection regimes Among the most sensitive of the issues that need to be addressed is that of consumer protection. Because of the complex nature of many financial services products, and the life changing consequences for individuals of market failure, there is broad agreement on the need for measures to protect the consumer, in addition to prudential and systemic regulation. However, because each Member State within the EU has developed its own consumer protection regime, a patchwork of different regulatory regimes has been created. Without agreement on how these regimes can be harmonised or at least achieve a significant degree of convergence, progress towards an integrated European market in retail financial services will be impossible. A common European approach has to strike the right balance There is a major opportunity here to improve the welfare of Europe s citizens. A truly integrated market would bring more choice, lower costs, and more innovative retail financial services products within the reach of a wider population. However, if those benefits are to be secured, it is important that in seeking to create a harmonised European framework for consumer protection, legislators do not lose sight of the need to take a balanced approach. Excessively intrusive or prescriptive legislation will add to costs and inhibit innovation. They will therefore nullify the very benefits that they are designed to bring. It will not be in the interests of retail consumers if attempts to achieve a single market result in harmonisation on the basis of the most stringent regimes. We would commend an approach based on a considered assessment of what is the best way of protecting consumers rights. The track record of the European Union in this area is mixed. The need for a common and balanced approach was recognised by the European Commission in its proposals of May 2002 for improving consumer protection policy (1). But, while 6 (1) Communication from the Commission to the European Parliament, the Council, The Economic and Social Committee and the Committee of the Regions Consumer Policy Strategy , COM (2002) 208 final, 7 May 2002

8 the Commission has explicitly recognised the importance of consultation with consumer representatives, the lack of industry consultation has sometimes caused problems. The proposed Consumer Credit Directive (2) is an example of where the Commission is making a genuine effort to address the very complex issue of consumer protection. However, the European institutions are now under pressure to substantially redraft the proposal because of the negative implications in the first draft which have been highlighted in the debate. Breaking the deadlock: adopting a multi-track approach It is for that reason that the EFR has come up with its own proposals for breaking the deadlock in this area of policy. As a general rule, the EFR believes appropriate, informative and meaningful disclosure is a more effective way of protecting the consumer than direct regulatory intervention for example through price caps or outright banning of specific types of product, and that should be the basis on which the creation of a European consumer protection regime is built. Rather than seeking a big bang approach to harmonisation, the EFR has proposed a multi-track approach: Firstly, the adoption by both national and European Union legislators of a set of standards to which all involved in consumer protection within the EU should sign up. Their purpose is to lay down the broad principles that consumers can reasonably expect to see applied in the area of consumer protection. The result should form the basis of Common Core Standards that should have the force of law and would cover those issues deemed to be essential for an adequate consumer protection regime. Secondly, once the Common Core Standards are adopted, attention would shift to the implementation of these standards through detailed case-by-case rules. These Common Consumer Protection Rules would have to be fully harmonised at a European Union level to ensure consistency of approach. Thirdly, and this could take place in parallel with the detailed work on implementation of the Common Consumer Protection Rules, there will need to be a concerted effort by both the European Commission and national authorities to deal with those regulations which already exist at national level but are not covered by the Common Core Standards and therefore fall outside the agreed EU definition of what is essential to guarantee an adequate level of protection for consumers. As in the area of corporate governance, the principle of comply or explain should be applied: Member States working with the European Commission will be able to examine whether national exceptions are justified by real need and if so explain the reasoning behind them. If they cannot be justified or the Explanation is felt to be inadequate, they will be asked to remove these exceptions. Alternatively, they may conclude that there is in fact a more general Europe-wide problem that may require action at EU level. Either way the aim is to ensure that the barriers created by conflicting national regulatory frameworks are removed while ensuring that consumers enjoy a level playing field in terms of choice, price and levels of protection. ( (2) Proposal for a Directive of the European Parliament and of the Council on the harmonisation of the laws, regulations and administrative provisions of the Member States concerning credit for consumers, presented by the Commission COM(2002) 443 (final), 11 September

9 Finally, once sufficient convergence has been achieved, it will be much easier to agree on how to remove the remaining restrictions on the provision of retail financial services and move to a genuinely free internal market. Accelerating the decision-making process In advocating this approach, we have to be aware of the following issues that will have to be overcome: There will be areas where it will prove difficult to achieve consensus over what is or is not necessary as a guarantee of consumer rights Many national rules may remain in areas not covered by the Common Core Standards and Member States may be reluctant to remove these specific rules, even if they are not justified The EFR has looked at two different ways of addressing these obstacles. One approach would be to move to mutual recognition as soon as the Common Core Standards and the harmonised Common Consumer Protection Rules that flow from them had been agreed, in order to open national markets fully to cross-border business. A more radical variation would be to introduce mutual recognition pending harmonisation, as an overt way of encouraging Member States to agree to harmonisation. The alternative approach would be to continue to apply the host country principle in areas where Member States have not been able to agree harmonised standards and rules, or pending agreement on such standards and rules. This would avoid the risk of consumers being confused by products which do not comply with the rules they are used to. Both approaches have their advantages and disadvantages. Both entail significant consequences for consumers, providers and markets. Therefore, the EFR believes further debate is needed before it will be possible to come down definitively in favour of one approach or the other. Another option altogether might be to adopt a pragmatic approach based on case-by-case decisions. In any case, the necessity to accelerate the decision-making process and to agree rapidly on Common Core Standards should act as a focal point for debate. Towards an agreed set of principles The EFR believes that the following principles should form the basis of any sound approach to regulation in the consumer protection field: Regulation must be clear, relevant and proportionate New legislation should be adopted only after there has been a proper assessment of its impact and consultation with both industry and consumers Each product or service should have to comply with only one set of consumer protection regulations There should be a robust prudential regime For both customers and industry there needs to be consistency in the way the rules are interpreted and enforced by the regulator 8

10 The EFR also believes that the typical customer has a right to expect the following from the industry and regulators: That they ensure product providers provide the appropriate information to enable customers to take an informed decision on whether the product suits his or her own personal needs and circumstances: - There is an emphasis on quality of information not quantity - The consumer should not be overburdened with too much information - Standardised information (for example Annual Percentage Rate) has a place but only where it demonstrably aids decision-making Customers should be given time or opportunity to reflect, either before committing themselves or through specific measures such as a right of withdrawal Regulators should allow flexibility in product design Customers should be able to receive advice tailored to their personal circumstances, but as an option only if they want it Regulators should ensure there is a cheap and easy scheme for consumers to obtain redress where they are sold wrong or inappropriate products or improperly advised These five principles could form the basis of the Common Core Standards, which the European Union should adopt in accordance with the multi-track approach proposed by EFR. Conclusion The EFR believes that this approach needs to be refined through a wider debate with consumers, legislators and regulators at both Member State and EU level, and within the industry itself. However, the EFR firmly believes that there is here a basis for making real progress. 9

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12 Chapter One The benefits of a single market in retail financial services A single market in financial services There is a wide degree of consensus at European level of the need to complete the single market in financial services. Studies have demonstrated that Europe s fragmented market for financial services creates significant avoidable costs both for industry and individuals. Removing the obstacles will yield enormous benefits to businesses and individuals alike. An earlier study (3) for the European Financial Services Round Table (EFR) in February 2002 estimated that a single market in financial services could add up to 0.7% a year to European GDP growth. Such a positive impact on GDP growth has been confirmed by the European Commission s own studies. Financial services are an increasingly important industry in their own right. As manufacturing declines in importance as a source of economic growth and of jobs, so the importance of services in general and financial services in particular will increase. The market in consumer credit alone is growing by 7% a year on average within the EU. This is just the tip of the iceberg. Eliminating the legal and non-legal barriers to trade and investment in financial services would yield significant economies of scale. This would lower the cost of capital to industry and reduce the burden of charges on customers, both retail and corporate. It would mean more competition, more choice for consumers and more opportunity for best practice and innovation to become standardised across the European Union. This is turn would give a further spur to savings and investment. In spite of this consensus endorsed by EU leaders at the Lisbon Summit in 2000, in practice progress has been painfully slow and - at a retail level - almost non-existent. In an attempt to assist the European Union in its efforts to speed up the creation of a genuine single market in financial services, the EFR - whose members include the chairmen or chief executives of the leading banks and insurance companies within the EU - is producing a series of studies and reports aimed at identifying the key issues that need to be resolved and some potential solutions which could break the gridlock. This report, which addresses the issues of consumer protection, is part of that series Quantifying the benefits of a single market to the retail consumer Chapter 1 A single market in retail financial services would deliver real tangible benefits to ordinary consumers. It would mean greater choice of product and lower cost. (3) The Benefits of a Working European Retail Market for Financial Services, Friedrich Heinemann and Mathias Jopp, 2002, 11

13 Chapter 1 This is because suppliers would be able to spread their overheads over a wider customer base than they can in the current fragmented European market place. The benefits will be greater in smaller countries where it is difficult to achieve significant economies of scale because of the limited size of the home market. In an attempt to quantify these benefits, in 2002 the EFR commissioned two academics, Friedrich Heinemann and Mathias Jopp, from the Zentrum für Europäische Wirtschaftsforschung and the Institut für Europäische Politik to research the problem. Their report, The Benefits of a Working European Retail Market for Financial Services, is one of the most comprehensive studies in this area to date. Enabling producers to offer products freely across borders would allow customers access to the most innovative and competitive products in the EU instead of limiting them to the ones that local producers are able to provide. In smaller countries such as Portugal, Belgium or the Netherlands where economies of scale are harder to achieve, the impact would be substantial. They gave this example: the range and choice of mutual funds could go up by times if the barriers to non-domestic suppliers were removed. But the real benefits would come from companies that already operate in more than one country being able to sell the same or similar products to a wider customer base than they can within today s fragmented market. Currently, the wide differentiation in legal and regulatory specifications between Member States means that products have to be designed, produced, marketed and serviced separately for each Member State. Most of those differences are a result of different regulations that are imposed on the industry by national regulators seeking to protect consumers. Moving to a single harmonised consumer protection regime would make it possible for providers to service more than one Member State without the costly investment in duplication of systems that they currently require. That would allow greater standardisation of product and service levels and centralisation of operations. The result would be lower costs. In a competitive market, these costs would in turn be passed on to consumers in the shape of lower charges, and more competitive interest rates on both savings and credit products. Many of these benefits would accrue even without full harmonisation, provided there is progress from the current status quo. Greater convergence would allow a degree of standardisation, which would significantly reduce the cost required to service more than one European market. One only needs to look at other industries, such as the motor industry, to see what is possible. Carmakers have to deal with significant residual differences in national taste and, in some cases, of safety requirements. However, there is now sufficient convergence within the EU of safety standards to enable most major manufacturers to standardise their model range and centralise design and assembly of vehicles in a few key locations while servicing the whole Continent with a limited number of national variations. Because of the fragmented nature of the market, cross-border mergers and acquisitions (M&A) within retail financial services have been limited. The wide variation in regulations between Member States makes it very difficult to extract 12

14 the kind of synergies that would justify large-scale mergers and acquisitions crossborder within the EU. Removing those obstacles would trigger substantial consolidation of the industry through M&A. The winners would be those companies that were more efficient, better managed, and more responsive to consumers. The losers would be the ones that lack the scale and expertise to deliver the requisite levels of service and range of product to an increasingly demanding clientele. Either way, the customer would be the ultimate winner in the end. The mutual fund industry offers a good illustration of current problems but also what might be possible in a genuinely open market. The economics of the industry would be transformed if the industry were able to offer the same products to customers throughout the EU. For instance, if European fund management companies were able to run funds of an average size similar to that in the US this would generate cost savings about 5.3 billion Euro annually. This would enable managers to offer customers lower fund charges. That in turn would make savings more attractive and boost the amount of money Europeans are prepared to set aside for their retirement. In the process, we would be creating a virtuous circle: greater volumes, leading to lower unit costs, and lower charges, lower charges in turn making it more attractive to save. Increased competition would also add to the downward pressure on costs and force the pace of innovation. Moreover, with less of people s savings eaten up by charges, the EFR suggested in 2002 (4) that the pension resulting from a given level of contributions could be increased by 10% or more. Greater competition would also force down the cost of borrowing. Currently there is a wide disparity within the EU in the margins that banks make on interest from consumer loans, depending on how competitive the local market is. Opening up closed markets to competition from the most efficient EU producers would force borrowing rates down across the board. It would also provide greater opportunity for innovative products to become more generally available within the EU. A simulation (5) shows that if banks had been forced by a more competitive market place to pass on lower interest rates to mortgage borrowers more quickly, the benefits would have been significant. In the period , when wholesale market rates were falling, a typical customer with a 100,000 euro loan would have saved 2,550 Euro a year in Italy, 1,690 Euro in Spain, 1,580 Euro in Portugal and 790 Euro in Ireland The serious obstacles which need to be tackled Consumers naturally have greater trust in familiar brands. However, there is no reason why, given certain minimum standards, customers would not welcome the opportunity to shop around. Customers no longer pay much attention to the country of origin or manufacture when purchasing a refrigerator or a hifi. There is no reason why in time customers could not be just as comfortable buying insurance or mutual funds from the best provider irrespective of nationality. To get to that point, however, will require a serious assault on the obstacles that stand in the way of an integrated market in financial services. (4) One Europe, One Pension Affording the Future, a report by the EFR, June 2002 (5) The Benefits of a Working European Retail Market for Financial Services, Friedrich Heinemann and Mathias Jopp,

15 Chapter 1 Obstacles to full integration of EU financial retail markets demand side supply side natural - differences in language, culture - consumer trust in established national suppliers - distance and the desire for handshake (personnal contacts) - information costs caused by natural factors (e.g. cultural differences, differences in general legal tradition) - sunk costs of market incumbents - bias for home products in etablished distribution channels - some smaller national EU markets commercially not attractive policy-included - discriminatory tax treatment of foreign financial services/products - existence of a national currency (Denmark, Sweden and UK) - insufficient knowledge about cross-border redress procedures - information and adjustment costs caused by national differences in regulation (e.g. supervision, consumer protection, accounting standards) - obstacles to cross-border information flows (e.g. due to limited access to foreign credit registers) - competitive privileges of dosmestic suppliers (e.g. trough goververment ownership) - shortcoming of Internal Market rules (e.g. though slow EU legislative adjustments to new developments) - particular costs of cross-border operations (e.g. money transfers, identification procedures) The Benefits of a Working European Retail Market for Financial Services, Friedrich Heinemann and Mathias Jopp, Zentrum für Europäische Wirtschaftsforschung and Institut für Europäische Politik Report to European Financial Services Round Table The existence of widely different consumer protection regimes within the European Union is not the only reason why integration has proved difficult. But it is a very important factor. The report, by Friedrich Heinemann and Mathias Jopp, The Benefits of a Working European Retail Market for Financial Services identifies a number of issues hampering further integration of the financial services market. Some of these such as differences in language and culture which the authors describe as natural barriers are not in the gift of legislators to change. However, the others which they call policy-induced barriers - are all factors that could be tackled - given the political will. Furthermore, many of the cultural issues they identify as natural are themselves a consequence of lack of familiarity. This would naturally fall away once the other barriers were removed. To illustrate their thesis, the authors investigated the sectoral impact of specific barriers. Their study of the insurance sector, for instance, highlighted the fact that measures designed to protect the consumer in practice act to protect domestic producers at the expense of foreign suppliers. The effect is to reduce competition and restrict consumer choice. Broad EU principles exist. However, companies continue to have to adapt to the rules of 15 different countries. Each has different, sometimes widely different views on what constitutes best practice. The cost burden this imposes falls most heavily 14

16 on smaller, specialist firms. It also impacts more heavily on smaller countries, where the opportunities for economies of scale are more limited. Internet start-ups have faced particular difficulties in meeting the regulatory costs associated with entering a new market. The extra cost burden is more of an issue for these kind of businesses since their business model relies more heavily on being able to compete more effectively on costs than established bricks and mortar providers. For mutual funds the principle of host country responsibility for advertisement and marketing makes it impossible to have a pan-european advertising campaign or marketing strategy. The European Commission has done its own polling of consumers views on retail financial services. A survey published in September 2002 (6) found that consumers were put off buying financial services products from non-domestic suppliers because of lack of information and uncertainty over their rights if anything went wrong. Significantly, a large majority of consumers said they wanted greater harmonisation of consumer protection standards on an EU-wide basis A patchwork of consumer protection regimes The relatively complex nature of many financial services products, and the life changing consequences for individuals of market failure, have prompted most industrialised countries to create detailed consumer protection regimes. These cover both credit and savings products. In addition most countries have, or are adopting, detailed pensions regulation, which also contains measures designed to protect consumers. However, these consumer protection regimes have developed largely in isolation. Over time they have evolved in radically different directions. The result is a market fragmented on national lines. Because of these different regimes, providers are unable to offer the same products in more than one Member State The table below illustrates the nature of the problem. Taking the example of consumer credit, it shows how widely approaches to regulation differ between Member States in this area. (6) Eurobarometer 56: Europeans & Financial Services European Commission / Health & Consumer Protection Directorate General, 11 September

17 Chapter 1 Product design Selling Joint and several liability Consumer Credit Regulations Across the EU Consumer Protection Requirements Maximum and minimum amounts Maximum lending rates Use of reference rates Early repayment Offer Contract APR Withdrawal rights Examples of differences between national regulations Regulatory requirements generally define a floor and a ceiling for the amount of the credit. The level of floor and ceiling varies widely between Member States. Outside these limits different requirements, or no requirement, apply. Regulatory maximum lending rates apply in some Member States (France, Belgium, Portugal, Netherlands, for example); definition and calculation of these rates, when they apply, are different. Finance companies may be obliged to link their lending rates to official reference rates (Denmark, for example). Various and more or less stringent conditions may apply to early repayment: for example in France the provider is not entitled to charge any fee for this. In some Member States (Germany, Spain, UK), no regulatory requirements apply to the shape of the offer. In other Member States (France, Belgium, Italy), regulatory requirements apply to the offer, which must be written and include obligatory mentions. In France, templates for the offer are laid down by the regulation. Regulations generally require the insertion of obligatory terms in contracts, but the lists of which terms are different. In France, templates for the contract are laid down. Various definitions and calculations of the APR (annual percentage rate of charge) apply across the EU. Some Member States give the consumer an option to withdraw; other Member States do not (Netherlands, Denmark). When withdrawal rights apply, conditions and periods differ between Member States. In the United Kingdom, there is a system of pure joint and several liability, which gives the consumer a right to act directly against the lender when he receives faulty goods or services, financed by the credit. 16

18 At one end of the range are Member States such as France and the Benelux. Here lenders are subject to very detailed product regulation and to price caps. At the other end of the range is the UK where regulators allow the market place to set interest rates. This is in spite of the fact that the EU adopted legislation as long ago as 1987 with the expressed aim of creating a common market in credit (7). Yet, as this table shows only too well, a single market is as far away as ever. The exercise can be repeated for most categories of financial services products with similar results. For example, companies selling pensions are required in most Member States to provide potential customers with projections illustrating the likely payouts on retirement. Unfortunately, the basis on which those illustrations have to be calculated (see panel on page 18) varies from country to country. This is because the key variables, in particular, the projected investment return and allowance for inflation, are set by a different regulator in each case. This is just one example of the different regulatory approaches which affect the design and marketing of financial services products in Europe. To arrive at a point where we can have a single European pension product would require a radical review of the regulation across the EU. (7) Consumer Credit Directive, 87/102/EEC, adopted in 1987 and amended in 1990 and

19 3 rd Pillar Pensions Projections of Benefits Chapter 1 The requirements governing the calculation of projected benefits for premiums paid towards 3rd pillar pensions products vary widely across Europe. In the UK the regulator requires a provider to give projections of benefits, at the time of entering into the contract, according to three different rates of assumed return. Calculations are performed assuming 5% p.a., 7% p.a., and 9% p.a. investment return on premiums to be paid during the period up to retirement. However providers are encouraged to reduce these if they feel that it is appropriate to their funds. The regulator will allow, although it is not a requirement, a provider to show a single further projection showing the combined effect of investment growth and inflation in order to provide a real rate of return projection. This is based on the mid range projection rate of 7% p.a. with prices inflation specified at 2.5% p.a. Although providers are permitted by the regulator to produce projections assuming investment returns at any rate less than the maximum allowable rate of 9%, it is absolutely prohibited to provide a projection at a higher rate, irrespective of the past performance of the investment fund. The situation is very different in France where the nature of any projections is left to the provider. It would be usual to assume different rates of projection depending on whether the underlying investment fund is bond related or a mutual fund. In the case of a bond link one large provider currently uses a maximum rate of 4.5% p.a., but where a mutual fund is used the rate might vary between 6.5% p.a. and 8.5% p.a. There is no requirement to show a range of possible outcomes, as in the UK. Although there is not a requirement to show the impact of inflation, such projections can be produced, at the discretion of the insurer. In the Netherlands there is a regulatory requirement to provide three separate types of projections, although the investment return to be assumed is specified for only one type. This requires a projection assuming an investment return on premiums of 4% p.a. In addition it is required to provide a projection based on the historical rate of return achieved by the investment funds underlying the product (assuming at least a 5 year history): this is calculated by the provider but must be justified to the regulator upon request. Finally a projection assuming a pessimistic outcome must be provided: again the provider chooses the investment return to be used but must justify the choice to the regulator on request. There is no requirement to show inflation-adjusted returns. In Italy the regulator requires insurers to provide projections for traditional contracts at 4% p.a. and 6% p.a. investment return. These returns are not adjusted for inflation. Our last example is that of the traditional life insurance and annuity insurance benefits available in Germany. In this case the benefits are partly guaranteed. An insurer must provide a guaranteed rate of return on premiums, which must be at least zero percent (i.e. the value of the benefits from the policy are at least equal to the premiums paid) but may not guarantee more than 3.25% p.a. currently. The customer is also entitled to participate in the additional profits made by the company, which are not guaranteed. Since part of the benefits is guaranteed, projections are only required for the non-guaranteed element of these projections. Whilst there is no obligation to provide projections of benefits, the supervisory authority requires that any projections are realistic and not misleading. It is usually the case that projections are provided in nominal terms, without adjustment for inflation. Projections in terms of showing accumulated lump sums, and their conversion to annuities, or deferred annuities also show variations across Europe. There is no one single accepted approach. 18

20 1.5- Differences are not justified by consumer needs or preferences Such differences would make sense if they were justified by a wide variation in consumer needs and behaviour. However, there is no compelling evidence that consumers within the EU differ widely in their needs or preferences. The reason for these disparities is purely historical. Because regulatory regimes have developed on purely national lines without reference to any common European standard, they have evolved in different and often incompatible ways. An example is the prohibition of cold calling, which is forbidden in Germany, for instance, where it has evolved from a series of court rulings. In other countries such restrictions would be regarded as a restraint on trade and a denial of consumer choice. Unless a common approach is agreed on these and other questions, the financial services market will remain fragmented and customers will continue to lose out. Studies of European consumers have shown that it is possible to use the same broad categories to analyse consumer behaviour in different European countries. National differences can be exaggerated (see charts below). Other factors such as age, level of education and wealth are far more important in influencing consumer behaviour. % Country comparison Financial service segmentation Traditional Confident Dependent Disengaged Total Belgium Czech France Germany Italy The Poland Spain Sweden UK RepublicNetherlands Source: Planning for consumer change in Europe, 2000 The Henley Centre c The Henley Centre Ltd All rights reserved 19

21 Chapter 1 Segment summaries Conservative Traditional (25%) Women (59%) Older Single/couple (56%) Independent Risk averse Dependent (26%) Women (58%) Younger Family (66%) Worried Rely on family Risk averse Source: Planning for consumer Change in Europe, 2000 In Control Out of Control Confident (24%) Men (61%) Middle-aged Family (59%) Clued-up Unconventional; risk taking Disengaged (25%) 50:50 Men:Women Younger Carefree Uninvolved; disinterested Unconventional; risk taking Progressive The Henley Centre c The Henley Centre Ltd All rights reserved Financial services companies have found that the segmentation they apply for marketing purposes works equally well in a large variety of national markets. Customer types appear with remarkable consistency. Although there is some variation in the distribution of those types between countries, the differences are not great. Significantly, there is no obvious correlation between the spread of these customers in a particular country and that country s historical approach to regulation. For instance, there is nothing in these tables which suggests that customers in say Germany, which is often seen as taking a more restrictive approach, are inherently more conservative and less willing to take big financial decisions themselves, than say the UK, where regulators have traditionally been regarded as being at the more permissive end of the spectrum. 20

22 Chapter Two Consumer protection regulation: recent experience Attempts at European harmonisation: a mixed scorecard The need for a common approach was recognised by the European Commission in its proposals of May 2002 for enhancing consumer protection policy (8). The May 2002 paper gives three primary objectives: A high common level of consumer protection - explicitly bringing into line (through a combination of directives, standards and promotion of best practice ) different regimes and minimising Member States ability to adopt a different approach. Effective enforcement of consumer protection rules - building consumer confidence by demonstrating that suppliers (and Member States) are being obliged to adhere to robust rules. Involvement of consumer organisations in EU policies - demonstrating that the voice of the consumer is being heeded. Greater alignment of policy - and implementation - across Member States would deliver clear benefits to the consumer. The proposal for a Directive concerning unfair business-to-consumer commercial practices in the internal market (9), which the European Commission adopted on 18 June 2003, is also a step in the right direction. The Directive attempts to clarify consumers rights regarding unfair commercial practices. It also sets out consistent rules across the EU in this area. In place of the plethora of national rules and contradictory court judgements, currently governing law in this area, the Directive sets out a common, general prohibition on unfair commercial practices. These are defined by a clear set of rules, which, subject to some amendments, should leave ample room for business to continue to innovate. Chapter 2 Moreover, the Directive ensures EU-wide standards of protection. Businesses, therefore, will only have to comply, as far as regulation on unfair practices is concerned, with the requirements of their country of origin when selling to consumers elsewhere in the EU. Furthermore, since the Directive intends to fully harmonise EU requirements relating to unfair business-to-consumer commercial practices, Member States will not be able to gold-plate the regulations in this area and re-impose restrictions through the back-door. These initiatives, welcome as they are, will nevertheless do little in practice to roll back the complex and numerous obligations Member States are able to impose on providers through existing legislation. The Directive defines what is considered unfair. (8) Communication from the Commission to the European Parliament, the Council, The Economic and Social Committee and the Committee of the Regions Consumer Policy Strategy , COM (2002) 208 final, 7 May 2002 (9) Proposal for a Directive of the European Parliament and the Council concerning unfair business-to-consumer commercial practices in the Internal Market, COM (2003) 356 final, 18 June

23 Chapter 2 But it does not set down an agreed definition of what constitutes fair. In most Member States, it is not enough to not be unfair. National regulations will then go on to define fairness. They therefore will impose further conditions that will remain even after the proposed Directive on unfair practices comes into force. This will undermine the objective of achieving true convergence of regulations across the EU. The financial services industry wants to see proper standards of consumer protection applied consistently across the EU. Customers are entrusting their financial well being to their financial services provider. They need to be confident that the industry is worthy of that trust. Confidence of that kind is something that is built up over generations and is one of the industry s most precious assets. The industry needs to be sure that there are common standards of consumer protection that are accepted by all and that competition is on the basis of improved service levels and efficiency, not by cutting corners on standards of behaviour. Nor, however, will it be in the interests of retail consumers if attempts to achieve a single market result in a ratcheting up of the overall regulatory burden. The European Legislators must be alive to the risk of harmonisation resulting in overregulation. This would add to the burden of cost on the industry and inhibit innovation. On both accounts, the customer will be worse off as a result. Clearly there are those who believe that the industry cannot be trusted to behave responsibly and that, without detailed, prescriptive regulation, even the most sophisticated consumer is vulnerable to exploitation. However, it is wrong to assume that a light touch regime which goes with the grain of the market necessarily results in worse outcomes for consumers than a more restrictive regime based on detailed product regulation. The European Commission recognises the importance of striking the right balance. But, while the Commission has explicitly acknowledged the importance of consultation with consumer representatives, it sometimes has not given the same weight to the views of the industry. The lack of industry consultation has caused problems. The proposed Consumer Credit Directive (10) is an example of where the Commission is making a genuine effort to address the very complex issue of consumer protection. The examples chosen show that there is a need to take the initiative at European level in this area. However, the European institutions are now under pressure to substantially redraft the proposal because of the negative implications in the first draft which have been highlighted in the debate (see panel on page 24). Oxera, an economic consultancy, was asked by the UK banking industry to quantify the effect of the Directive being adopted in its original form. The analysis (11) concluded that the Directive, as proposed, would result in a fall in UK annual consumer spending of around Euro 5.8bn, and cut overall GDP by 0.2% a year. It would also, they found, result in some two million people being denied access 22 (10) Proposal for a Directive of the European Parliament and of the Council on the harmonisation of the laws, regulations and administrative provisions of the Member States concerning credit for consumers, presented by the Commission COM(2002) 443 (final), 11 September 2002 (11) Assessment of the Economic Impact of the Proposed EC Consumer Credit Directive, Report prepared by Oxera for the Association for Payment Clearing Services, the British Bankers Association, the Finance & Leasing Association, and the Council of Mortgage Lenders, July 2003,

24 to credit or seeing their access to credit severely restricted. In addition, the report highlighted the value that consumers attach to the flexibility offered by products such as credit cards, overdrafts and the newer style mortgages coming on to the market. Most of those products would not be able to meet the requirements of the proposed Directive and would have to be withdrawn from the market. For example, the Directive would require the customer to re-sign credit agreements every time the borrowing limit is changed. This is incompatible with the rolling nature of many of these credit instruments. The industry has also criticized the fact that the Directive would impose a duty on credit providers to provide advice to all consumers before approving credit. There is little hard evidence that consumers believe they need detailed advice from their bank or credit provider on how to manage their finances day-to-day. Nor would customers necessarily favour revealing detailed personal information to a credit provider of the kind required for the lender to meet its obligations under the new Directive. In some cases, they may already have a trusted adviser such as an accountant, lawyer or qualified independent financial adviser. There is a similar problem with the new Investment Services Directive (12). Again the proposed Directive is operating on the presumption that retail investors should not be sold financial services without advice, irrespective of whether or not they ask for it. The result is a proposal that would almost certainly drive execution-only stockbrokers out of business, despite their huge popularity with users. Of course, it is not always the Commission that is at fault alone. Many issues are very complex and need full commitment from all stakeholders involved. On various occasions the efforts of the Commission to achieve stronger harmonisation were opposed by the Members States. For example, the Directive on Distance Marketing of Consumer Financial Services was substantially amended by Member States. The result was a Directive very different from the one the Commission proposed. The final text included provisions allowing Member States to retain or, in some cases extend, restrictive measures that the Directive, as originally drafted, had sought to eliminate. As a result, the objective of harmonising consumer protection regulation in this area was substantially undermined. (12) Proposal for a Directive of the European Parliament and of the Council on investment services and regulated markets COM(2002) 625, 19 November