Cash ISAs: Response to supercomplaint

Transcription

1 Cash ISAs: Response to supercomplaint by Consumer Focus June 2010 *Under strict embargo until 1100 on 29 June 2010* OFT1246

2 Crown copyright 2010 This publication (excluding the OFT logo) may be reproduced free of charge in any format or medium provided that it is reproduced accurately and not used in a misleading context. The material must be acknowledged as crown copyright and the title of the publication specified.

3 CONTENTS Chapter/Annexe Page 1 Executive summary 4 2 Introduction 15 3 Cash ISA regulation 19 4 Competition in the cash ISA market 27 5 Transferring a cash ISA 45 6 Transparency of interest rates on cash ISAs 61 7 Bonus rates on cash ISAs 72 8 Conclusion 80 A Parties consulted 88 B Cash ISA omnibus survey 91

4 1 EXECUTIVE SUMMARY 1.1 Consumers save money through a variety of means and for many purposes. Financial institutions that receive those savings are able to lend that money out to others, helping consumers and businesses to invest. It is therefore important for consumers, but also the wider macroeconomy, that savings markets work well. 1.2 Cash Individual Savings Accounts (cash ISAs) are a tax-advantaged form of savings account, introduced in the UK in Interest earned on cash ISA deposits is not subject to income tax. Cash ISAs are an important part of consumers' savings in the UK, with approximately 17.5 million consumers having a total of 143 billion saved in cash ISAs in They are the second most popular low-risk savings product after standard savings accounts On 31 March 2010, Consumer Focus submitted a super-complaint regarding cash ISAs to the Office of Fair Trading (OFT). Consumer Focus raised a number of concerns, but the executive summary noted '[t]he main grounds of this super-complaint centre on the apparent exploitation by providers of consumer inertia and confusion in the market.' 3 Their concerns can be summarised into the following three areas: 4 1 The market value of cash ISA funds had risen to 158 billion by 5 April 2009 see The number of consumers with a cash ISA in 2008 was 17.5 million see 2 Consumer Focus super-complaint: Cash ISAs, Table 1 on page 8. 3 Consumer Focus super-complaint: Cash ISAs, page 4. 4 In the conclusion of the super-complaint (page 27), Consumer Focus raised six issues that it wanted the OFT to address. These are all addressed in this report. The super-complaint, Consumer Focus super-complaint: Cash ISAs, is available here OFT1246 4

5 transferring cash ISAs was taking too long and there were arbitrary rules preventing transfers into some of the most attractive accounts interest rates were not sufficiently transparent, and consumers were being attracted by temporary bonus rates that subsequently fell substantially Consumer Focus concluded that 'the result of these apparent abuses is that providers have been able to reduce the average interest rate paid on cash ISAs, after the initial 'bonus' period, at a rate faster than for other saving accounts and mortgage accounts.' 6 The cash ISA market 1.5 The cash ISA market has become more concentrated in recent years as a result of retail bank mergers, leading to a moderate level of concentration. However, there do not appear to be any major barriers to entry or expansion that are dampening competition. 1.6 The nature of competition in the market is largely focused on interest rates offered. Our analysis shows that while the interest rates offered on cash ISAs have declined since 2008, they have not fallen by more than the Bank of England base rate has fallen. Interest rates on other savings products have fallen by less than cash ISAs, but this is because they typically started at a lower level and cannot fall below zero. 1.7 On this basis, it does not appear that the structure of the market is substantially harming consumers. 5 Consumer Focus super-complaint: Cash ISAs, page 4. 6 Consumer Focus super-complaint: Cash ISAs, page 4. OFT1246 5

6 Transferring a cash ISA 1.8 Consumers need to be able to change their provider to ensure that they get the best possible deal. This ability to change provider exerts a degree of competitive constraint upon providers. Consumers can only change their cash ISA by requesting a transfer via the provider of their new cash ISA. They are unable to withdraw their money themselves and put it into a new cash ISA without losing their tax advantage, making the way in which providers handle transfers more important than usual. 1.9 In its super-complaint, Consumer Focus argued that cash ISA providers' processes for transferring savings between cash ISA accounts are unnecessarily bureaucratic and inefficient. It also argued that some cash ISA providers impose arbitrary rules prohibiting transfers into some of the most attractive accounts. It concludes that this prevents consumers switching between products to get the best deal We have found that there are problems in transferring cash ISAs: transferring cash ISAs takes just over 26 calendar days on average and 25 per cent of transfers take longer than 30 calendar days 7 transfers are frequently affected by delays in administration by cash ISA providers and, in some cases, problems such as poorly completed or lost forms, and there can be a gap of up to five days during which interest is not accrued when consumers transfer their cash ISA We also found that the best cash ISA accounts that allow transfers in have offered a slightly lower rate on average than the best accounts that do not, 8 but only 14 per cent of cash ISA accounts placed restrictions on 7 OFT analysis of cash ISA providers' responses to OFT questionnaire based on data covering the period 6 April 2008 to 6 April Over the last three years, the best cash ISA accounts that allow transfers in have offered 4.15 per cent on average, compared to an interest rate of 4.62 per cent for those that do not allow OFT1246 6

7 transfers of funds in 2009, 9 there are still many cash ISAs allowing transfers in with interest rates substantially above base rate and there may be reasons why cash ISA providers need to be able to limit access to certain accounts The number of problems faced by consumers in transferring their cash ISA, and the frequently long transfer time even when problems do not arise, may be deterring consumers from moving their funds to another cash ISA During the course of our work we engaged with cash ISA providers to discuss the transfer of cash ISAs. As a result of this process the British Bankers' Association (BBA), the Building Societies Association (BSA) and the Tax Incentivised Savings Association (TISA) have agreed to amend their guidelines to reduce the maximum period for completion of the endto-end process for cash ISA transfers from 23 to 15 working days. The revised guidelines will come into effect on 31 December The BBA, BSA and TISA have also agreed to explore how best practice can be more widely implemented to reduce the problems that consumers face in transferring their cash ISAs by 31 December In addition, the industry has agreed to produce and publish a consumerfriendly summary of its cash ISA transfer guidelines. This summary will be made available to all consumers from 29 June 2010 through the BBA, BSA and TISA websites. 10 We expect cash ISA providers to use the consumer friendly guide to explain the transfer process to consumers. transfers. Source: OFT analysis of Defaqto cash ISA database Rate calculated by taking an average of the highest cash ISA rates offered in April 2008, 2009 and OFT analysis of Defaqto cash ISA database The publication on 29 June will reflect existing timelines and will be updated on 31 December 2010 when the revised guidelines become effective. OFT1246 7

8 1.15 Cash ISA providers have agreed to submit to their relevant industry body monthly information on how long cash ISA transfers take. 11 This information will be summarised and reviewed against the new 15 working day limit. Summary information will be sent to the FSA In the past the industry has not always followed the transfer times in its guidelines. It is therefore important that the new guidelines are followed. To ensure this happens, we recommend that: HM Revenue & Customs (HMRC) change its guidance to reflect the new industry guidelines and considers whether the tax rules should similarly be amended the Financial Services Authority (FSA) refers to the new guidelines in the Banking Conduct of Business Sourcebook (BCOBS) 12 and reviews the information on cash ISA transfer times provided to it by the BBA and the BSA, in addition to any information that the FSA receives about relevant complaints, and if the new industry guidelines are not being followed, the FSA considers taking action itself under its Banking Conduct Regime paying consideration to BCOBS In order to ensure that consumers are not adversely affected if delays occur, we consider that consumers should receive the interest rate on 11 This does not apply to those cash ISA providers who process less than 5,000 transfers per year. These smaller cash ISA providers, typically, do not take a substantial amount of time to process transfers. 12 BCOBS 5.1.8G currently reads 'A firm may find it helpful to take account of the European Banking Industry Committee Common Principles for Bank Account Switching and the British Bankers' Association/ Building Societies Association/ Tax Incentivised Savings Association Cash ISA Transfers: Guidelines.' 13 BCOBS states 'A firm must provide a prompt and efficient service to enable a banking customer to move to a retail banking service (including a payment service) provided by another firm.' OFT1246 8

9 the cash ISA to which they are transferring no later than 15 working days after requesting the transfer, whether or not the transfer has been completed. Therefore, we recommend that: consumers complain to their provider if their transfer takes longer than 15 working days, and in resolving these complaints cash ISA providers ensure that consumers are no worse off than would have been the case if the guidance had been followed, whilst not requiring consumers to work out which provider is at fault The new guidance is one of the factors that the Financial Ombudsman Service (FOS) will be able to take into account in settling complaints between consumers and cash ISA providers There may be some additional benefit from bringing the transfer time down below 15 working days. We therefore recommend that the industry consider adopting an electronic system for transfers. The BBA, BSA and TISA have committed to undertake a feasibility study to take this recommendation forward The BBA and BSA have agreed to ensure that consumers start to accrue interest no later than two days after the funds are received from the old provider. We do not believe that this is sufficient. We consider that consumers should receive interest for every day during the transfer process since the OFT understands that one of the providers has the consumers' money at all times during the transfer process. We note that a number of providers already backdate interest from the date of closure of the existing cash ISA account. This ensures that consumers receive interest on every day. 14 Under the rules set for the FOS, the Ombudsman decides each complaint based on what the Ombudsman believes is fair and reasonable in all circumstance of the case. This includes taking into account the law, codes of practice, and regulatory rules, guidance and standards that applied at the time. Further information is available at OFT1246 9

10 1.21 We recommend that cash ISA providers ensure that consumers receive interest on every day during a cash ISA transfer and that the FSA consider the case for taking action under BCOBS or for amending the BCOBS rules or guidance if providers do not follow this approach Finally, we recommend that consumers review the interest rates being paid on their cash ISAs regularly, comparing them with the rates available from competitors, and consider transferring when better deals can be found. The OFT also recommends that consumers consider the full range of cash ISA providers and cash ISAs available, including providers that do not offer bonus rates and cash ISAs that offer fixed rates. Transparency of interest rates on cash ISAs 1.23 It is important that consumers have all the relevant information to make effective comparisons between different products. In the case of cash ISAs, the interest rate is a key piece of information Consumer Focus highlighted an apparent lack of transparency around the provision of interest rate information for cash ISAs, making it difficult for consumers to compare providers to get the best deal. Consumer Focus noted that, since 1 May 2010, most consumers receive notification when any bonus interest rate ends and when there is a material adverse change in the interest rate. However, it also noted that there remains no requirement to indicate the prevailing interest rate on statements We have found that: information on interest rates is readily available to those consumers who want to find it online, at branches and over the telephone, but most consumers do not know what their interest rate is, and are therefore not motivated to 'shop around' for the best deals From 1 May 2010, most consumers have received notification when any bonus rate period ends. The notification of the end of bonus rates does not apply to those cash ISAs designated as 'payment accounts'. OFT

11 Through our discussions, the BBA 15 has agreed that its members will voluntarily send the same bonus rate notifications to holders of payment accounts as to holders of non-payment accounts. This will take effect from 1 July We welcome this development At the time of writing, only a limited number of the major cash ISA providers place interest rate information on cash ISA statements. Our analysis suggests that those providers that put interest rates on statements cover around 15 per cent of the market. We consider that providing interest rates on statements makes it significantly more likely that consumers are aware of their rate The OFT has worked closely with the industry to extend the provision of interest rates on cash ISA statements. The BBA and BSA have agreed that their members will, on a voluntary basis, provide interest rates on cash ISA statements delivered in paper and/or electronic format. National Savings & Investments (NS&I) have also agreed to put interest rates on their statements. These changes will be implemented in time for the 2012 ISA 'season' 16 at the latest, though we expect some providers may do so earlier Many of the arguments for interest rates being on cash ISA statements are likely to apply to other savings accounts as well. The FSA may therefore wish to consider amending its guidance that firms 'consider' putting interest rates on statements to state that firms 'should' do so. 17 Bonus rates on cash ISAs 1.30 Some cash ISA products offer bonus rates of interest, that is a higher level of interest for a specified period of time, often a year. Whilst these 15 Building societies do not treat any of their cash ISA accounts as payment accounts and therefore this issue does not apply to them. 16 The cash ISA 'season' is generally thought to be between February and May. 17 See BCOBS 4.2.1R. OFT

12 bonuses can increase the return that consumers receive, it is important that they do not prevent consumers from comparing cash ISAs and making effective decisions about which cash ISA to invest in Consumer Focus argued that the practice of offering bonus rates means that a large number of accounts are paying 'next to no interest' We have found that: the number of cash ISAs accounts that have bonus rates has risen since the Bank of England base rate fell to very low levels in 2008 the majority of cash ISAs accounts do not have bonus rates our analysis suggests only 11 per cent of cash ISAs open to new customers offer bonus rates, and 19 it is reasonably clear in advertising and marketing that bonuses are temporary and, as noted above, from 1 May 2010 cash ISA consumers will receive notification when their bonus ends After considering the evidence, we did not find any information suggesting there is substantial harm caused by firms offering temporary bonus rates of interest. We do not consider it appropriate to require cash ISA providers to transfer consumers to identical accounts with higher interest rates automatically Greater transparency of interest rates and better transfer processes should help to reduce the number of consumers either on a low rate without realising it, or on a low rate but unwilling to transfer due to a perception that problems will occur During our consultations with consumer groups and individual consumers, a number of proposals have been put forward to address 18 Consumer Focus super-complaint: Cash ISAs, page OFT analysis of Defaqto data of cash ISA database OFT

13 their concerns around bonus rates. Given that some of these have the risk of unintended consequences, and the lack of evidence of significant harm to consumers from bonus rates, we consider that the most appropriate approach at this time is to improve the transparency of cash ISA interest rates and the transfer process through the initiatives and recommendations outlined above. Conclusion 1.36 As identified by Consumer Focus, for the cash ISA market to work well it is important that consumers have the appropriate information to compare providers and that they are willing to transfer to new providers. The OFT welcomes the constructive engagement that we have had with cash ISA providers to address the shortfalls in transparency and transfers that Consumer Focus highlighted The initiatives and recommendations outlined above should increase consumers awareness of their interest rate and make them more confident in the transfer process, which in turn should alleviate any concerns regarding bonus pricing. For individual customers to make the most of their cash ISA savings, they need to use the information available to shop around for the best account for their needs, and to hold providers to account for delivery of transfers in accordance with the new guidelines. The more active and engaged consumers are, the more pressure will be placed on providers to meet their customers' needs This work has focused on cash ISAs. However, there may be some read across from our findings here to other markets and we would encourage financial service providers to consider this. Many of the issues raised by the super-complaint are similar to those covered in our work on personal current accounts, as is the broad approach used to deal with them. While many financial products will not have the same restrictions around transfers as cash ISAs, the issues raised and solutions identified may be of relevance to products such as pensions and mortgages. We continue to consider that important information should be transparent to consumers across all financial services and that transfer processes should be efficient. OFT

14 1.39 We also believe that providers should think more broadly about whether there is asymmetry in their relationships with consumers if they levy fees when consumers miss a payment date for example, but are not prepared to offer redress voluntarily, without being asked, when their own processes are delayed or go wrong. OFT

15 2 INTRODUCTION 2.1 This chapter sets out the issues raised in the super-complaint submitted by Consumer Focus, the legal basis for making a super-complaint and how the OFT has gone about considering these issues. Issues raised in the super-complaint 2.2 On 31 March 2010, Consumer Focus submitted a super-complaint to the OFT relating to cash ISAs. Consumer Focus regarded aspects of the market for cash ISAs, and the conduct of many providers, to be causing significant harm to consumers Consumer Focus raised a number of concerns, but the executive summary noted '[t]he main grounds of this super-complaint centre on the apparent exploitation by providers of consumer inertia and confusion in the market.' 21 Their concerns can be summarised into the following three areas: 22 providers' processes for transferring savings between cash ISA accounts were unnecessarily bureaucratic and inefficient, and some cash ISA providers imposed arbitrary rules prohibiting transfers into some of the most attractive accounts there was a lack of transparency about interest rates for old cash ISA accounts, making it difficult for consumers to compare accounts and get the best deal, and many providers attracted savers with high initial or bonus interest rates which then dropped substantially, leaving savers with uncompetitive long term rates. 20 Consumer Focus super-complaint: Cash ISAs, page Consumer Focus super-complaint: Cash ISAs, page Consumer Focus super-complaint: Cash ISAs, page 4. OFT

16 2.4 Consumer Focus concluded that 'the result of these apparent abuses is that providers have been able to reduce the average interest rate paid on cash ISAs, after the initial 'bonus' period, at a rate faster than for other saving accounts and mortgage accounts.' 23 The super-complaint process 2.5 The right to submit a super-complaint was created by section 11 of the Enterprise Act 2002 (EA02). A super-complaint is defined under section 11(1) EA02 as a complaint submitted by a designated consumer body that 'any feature, or combination of features, of a market in the UK for goods or services is or appears to be significantly harming the interests of consumers.' Consumer Focus is a designated consumer body for the purposes of the EA Section 11(2) EA02 requires the OFT, within 90 days after the day on which it receives a super-complaint, to publish a response saying whether it has decided to take any action, or take no action, in respect of the complaint and, if it has decided to take action, what action it proposes to take. The response must state the reasons for the OFT's proposals (section 11(3) EA02). 2.7 This document represents the OFT's reasoned response to the supercomplaint from Consumer Focus. It focuses on the issues raised in the super-complaint and therefore does not consider other savings products. Information gathering 2.8 We have gathered evidence from a wide range of sources and sought the views of a variety of stakeholders. We reviewed the information in the super-complaint, as well as further information submitted by Consumer Focus, and tested both for their accuracy and relevance. 23 Consumer Focus super-complaint: Cash ISAs, page 4. OFT

17 2.9 Interested parties were invited to comment on the super-complaint. As part of this, specific information requests were sent to cash ISA providers. In addition to meetings with the BBA, BSA and TISA, a number of discussions were held with cash ISA providers to discuss their submissions. A full list of the stakeholders consulted can be found in Annexe A We conducted a consumer survey 24 and issued a questionnaire on our website for cash ISA investors to complete. We also reviewed s and letters regarding cash ISAs that we received from individual consumers. A number of meetings were held with consumer groups, such as Which? and Money Saving Expert, in addition to Consumer Focus We have reviewed the regulations and legislation that affect cash ISAs. Meetings were held with the relevant government bodies such as HM Treasury (HMT), HMRC, FSA and FOS We have conducted our own background and in-house research into the cash ISA industry and the issues raised in the super-complaint. We reviewed a number of reports on cash ISAs and drew upon historical data on cash ISAs and their interest rates from the Bank of England and Moneyfacts. 25 A database of all cash ISAs available in each of the past ten years and their main terms and conditions was sourced from Defaqto. 26 Structure of the response 2.13 Chapter 3 provides a brief introduction to the most important regulations that affect cash ISAs. Chapter 4 describes the market for cash ISAs, 24 A summary of the results from the consumer survey can be found in Annexe B. 25 Moneyfacts is a price comparison website that provides data on a number of financial products, including cash ISAs. 26 Defaqto Ltd is a financial research company. OFT

18 investigates the interest rates cash ISAs are paying and considers consumer behaviour and how this affects how the market works. Chapter 5 considers issues around the cash ISA transfer process and areas in which this can be improved. Chapter 6 considers the transparency of cash ISA interest rates and ways in which this may be improved. Chapter 7 explores the effect of cash ISA providers offering temporary bonuses to consumers. Chapter 8 sets out our conclusions and next steps. OFT

19 3 CASH ISA REGULATION 3.1 This chapter describes the development of cash ISAs and sets out the regulatory framework in which the providers of cash ISAs operate. Formation and development of cash ISAs 3.2 ISAs were introduced by the Government on 6 April Similar to TESSAs (Tax Exempt Special Savings Accounts) and PEPs (Personal Equity Plans) both of which ISAs replaced ISAs allow for taxadvantaged saving by not taxing the interest, dividends or capital gains deriving from assets within the account which would otherwise be liable to income or capital gains tax The Government s stated motivation for developing ISAs was to provide a more flexible savings product in order to extend the 'saving habit' to a wider section of the population than those who had already invested in either a TESSA or a PEP. 28 In its Pre-Budget Report of November 1997, the Government stated its concern that around half the population had little or no savings and expressed its hope that ISAs would encourage long-term saving amongst those on lower incomes In addition to being tax-advantaged, funds contained within an ISA were intended to be both easily accessible and transferable to other financial products. In its 2000 Budget Report, the Government stated that flexibility was an important strand to its savings strategy and described 27 While PEPs and TESSAs still existed after 1999, all subscriptions were stopped then. TESSAs were five year fixed accounts (and so all expired by 2004) and any remaining PEPs were converted into ISAs in Budget Report, paragraph Pre-Budget Report, paragraph OFT

20 how funds held in an ISA could be easily withdrawn to purchase other assets or transferred into a stakeholder pension ISAs were originally introduced in three main forms: the mini cash ISA, the mini stocks and shares ISA and the maxi ISA. In 2008 following an HMT consultation, the Government abolished the maxi / mini distinction for ISAs. The intended aim of this reform was to simplify the products, increase flexibility for investors and encourage more competition between ISA providers. 31 ISAs now come in just two forms: the stocks and shares ISA and the cash ISA. Initially, ISAs were only guaranteed to run for 10 years from 1999, but as part of a package of reforms in 2008, the Government announced its intention to make ISAs permanent beyond In 1999 the annual subscription limit was set at 7,000, of which 3,000 could be invested in a cash ISA. Following changes in 2008, it became possible to transfer funds held in a cash ISA to a stocks and shares ISA, though it is not possible to transfer assets held in a stocks and shares ISA into a cash ISA. In April 2008, the subscription limit rose to 7,200, of which 3,600 could be deposited in a cash ISA. Annual subscription limits were increased again in October 2009 to 10,200, of which up to 5,100 can be invested in a cash ISA, for those aged 50 and over. In April 2010 this was extended to all other investors. In the June 2010 Budget, the Government confirmed that it will index link annual ISA subscription limits for both cash and stocks and shares ISAs from Cash ISAs have been successful at attracting investors. The amount of money saved and the number of cash ISAs subscribed to in each year has grown steadily up to April 2008, as shown in Figure 3.1 below Pre-Budget Report, paragraph Individual Savings Accounts: proposed reforms, HM Treasury, 2006, paragraphs OFT

21 Figure 3.1: Number and value of cash ISAs subscribed to in each year, Number of cash ISAs subscribed to (000s) in each year (bars) Value of Cash ISAs subscribed to (millions) in each year (line) Source: HMRC, table In , approximately 143 billion was held in cash ISAs by around 17.5 million consumers. 32 The average total funds held by each cash ISA holder in was approximately 8,000. Cash ISAs are used for a diverse range of saving aims, as had been anticipated when they were introduced. 33 Cash ISAs have also attracted savings by those on low incomes in , approximately 30 per cent of cash ISA consumers 32 The market value of funds as of 5 April 2008 is available here and the number of consumers with a cash ISA is available here Data for the number of consumers with a cash ISA in was not available at the time of writing. 33 From the OFT's website questionnaire for cash ISA investors we found a number of reasons for wanting to save in a cash ISA including the low degree of risk associated with cash ISAs, their tax free nature and attractive interest rates on offer. OFT

22 had an income of less than 10, The regulatory framework 3.9 The rules governing the day-to-day management, transfer and promotion of cash ISAs have three main sources: the statutory instruments that established ISAs (and the subsequent amendments) guidance produced by HMRC in interpreting the relevant statutory instruments, and the Banking Conduct of Business Sourcebook (BCOBS) The Payment Services Regulations 2009 (PSR) also apply to some ISA accounts. HMRC guidance 3.11 The first regulations governing the administration and transfer of ISAs were laid before Parliament in The regulations specify the annual subscription limits and identify the qualifying investments that can be held as well as detailing the rules for operating ISA accounts. The key features for subscribing to, transferring, and withdrawing from a cash ISA, according to the ISA regulations, are that: 34 Table 9.10 available here shows that 4,272,000 consumers out of a total of 14,069,000 cash ISA consumers who do not also have a stocks and shares ISA, had an income of less than 10,000 in The proportion of consumers with both a stocks and shares ISA as well as a cash ISA who had an income of less than 10,000 was 21 per cent. 35 The Individual Savings Account Regulations 1998 (SI 1998 No. 1870), The Individual Savings Account (Insurance Companies) Regulations 1998 (SI 1998 No. 1871), The Personal Equity Plan (Amendment) Regulations 1998 (SI 1998 No. 1869), and The Insurance Companies (Overseas Life Assurance Business) (Compliance) (Amendment) Regulations 1998 (SI 1998 No. 1872). OFT

23 investors may only subscribe to one cash ISA per tax year investors may withdraw money subject to any terms and conditions imposed by the ISA provider from the cash ISA without losing any tax benefits already accrued, and a transfer must take place directly between one cash ISA provider and another HMRC approves ISA providers, and the ISA regulations stipulate the information that needs to be reported by ISA managers in order that HMRC can monitor subscription limits. Systems operated by ISA managers should ensure that oversubscription is not possible. Banking Conduct of Business Sourcebook 3.13 BCOBS came into force in the UK on 1 November 2009 and is overseen by the FSA. It is a set of rules and guidance, which firms offering deposit-taking accounts must adhere to when dealing with banking customers (defined as consumers, micro-enterprises and charities). As cash ISAs are deposit-taking saving accounts, all providers offering a cash ISA will be subject to BCOBS Cash ISAs may also dependent on the individual product's specific characteristics fall within the definition of a 'payment account', as set out in the Payment Services Regulations (PSRs). 36 From our discussion with cash ISA providers, we have been informed that there are a small number of cash ISAs that fall into this category. If a cash ISA is a 36 The PSRs are a set of regulations that implement the Payment Services Directive (PSD). This is European Community legislation which aims to harmonize the rules relating to retail payment services across the European Economic Area. The PSRs came into force in the UK on 1 November 2009 and most aspects are overseen by the FSA. OFT

24 payment account, the PSRs also apply 37 and BCOBS does not apply to the extent that it would overlap with the requirements of the PSRs There are also some cash ISA providers who, regardless of the type of cash ISA product they offer, are not subject to the PSRs. These include credit unions, municipal banks and NS&I Two of the FSA s Principles for Businesses are also of particular relevance to this super-complaint: 39 Principle 6: 'A firm must pay due regard to the interests of its customers and treat them fairly.' Principle 7: 'A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading.' 3.17 Reinforcing Principles 6 and 7, Chapter 2 of BCOBS seeks to set high standards for communication to banking customers by ensuring that the needs of consumers are taken into account and that any information provided to a consumer is transparent. Specifically, BCOBS 2.2.1R states that: 'a firm must take reasonable steps to ensure that a communication or a financial promotion is fair, clear and not misleading.' 3.18 Chapter 4 of BCOBS deals with information to be communicated to a banking customer. The 'appropriate information rule' at BCOBS 4.1.1R requires a firm to provide or make available appropriate information about a retail banking service and any deposit made in relation to that service: 37 The PSRs require, among other things, relevant information, including the interest rate, to be set out in a 'framework contract'. Any change to the framework contract must be notified to the customer two months in advance, unless the change is to the advantage of the customer. 38 See BCOBS 1.1.3R and 1.1.4R. 39 The principles are available here OFT

25 in good time in an appropriate medium, and in easily understandable language and in a clear and comprehensible form This should ensure that the banking customer can make decisions on an informed basis BCOBS 4.1.2G also provides guidance on the rule concerning appropriate information. It states that if a firm such as a cash ISA provider wishes to make a material adverse change to any interest rate (except where the interest rate changes because it tracks a publicly available rate), the cash ISA provider should provide 'reasonable notice' of this change on paper or in some other durable medium before this change occurs, whilst also taking into account any notice period required by the customer in order to terminate the contract Under BCOBS 4.2.1R, a firm such as a cash ISA provider must provide its customers with statements on paper or in another durable medium subject to certain exceptions. The two exceptions most relevant to cash ISAs are: where a passbook that records transactions is provided, and where the service is provided at a distance by electronic means and the customer has the ability to access the account balance, view transactions and give instructions via this distance medium There is no obligation under BCOBS for cash ISA providers to provide the rate of interest on statements. However, BCOBS 4.2.2G, in interpreting BCOBS 4.2.1R, states that a firm should 'consider 40 indicating the rate 40 Emphasis added. OFT

26 or rates of interest that apply to a retail banking service in each statement of account provided or made available to a banking customer.' OFT

27 4 COMPETITION IN THE CASH ISA MARKET 4.1 This chapter considers competition in the cash ISA market. 41 It looks at the market structure and assesses the relative decline in cash ISA interest rates compared to other savings products and other retail funding sources. It concludes by introducing some issues around consumer behaviour that have a bearing on how the market operates. Concerns raised by Consumer Focus 4.2 In its super-complaint, Consumer Focus raised a number of concerns regarding competition in the cash ISA market, quoting the Financial Services Consumer Panel which argued that 'competition in this market appears to have dried up.' Consumer Focus described the recent decline in cash ISA interest rates as being greater than other comparable products and notes the widening spread between cash ISA interest rates and residential mortgage interest rates. 43 Consumer Focus also presented market share data on cash ISA providers, noting 'the dominance of the major high street banks in the cash ISA market.' The evidence used by Consumer Focus to support its concerns includes: 41 It should be noted that the OFT has not carried out a full relevant market definition exercise in this reasoned response. The use of the term 'cash ISA market' should not be interpreted as meaning the OFT considers this the appropriate market definition for the purposes of competition law. 42 Consumer Focus super-complaint: Cash ISAs, page Consumer Focus super-complaint: Cash ISAs, page Consumer Focus super-complaint: Cash ISAs, page 9. OFT

28 the average spread in rates of return between cash ISAs and other savings accounts (instant access and notice) has significantly narrowed 45 between 2004 and 2007, the spread between the average rate of return on cash ISAs and existing home mortgages 46 was 0.8 per cent and between 2008 and 2009 it rose to 2.5 per cent 47, and analysis of all products on a comparison website 48 suggests that the best paying (non-isa) savings products offer slightly higher returns than the best paying cash ISA products Consumer Focus stated that '[s]ome commentators have drawn the conclusion that providers are failing to pass on the full tax relief to savers.' 50 Market structure 4.6 In this section we describe several structural indicators to give an assessment of whether there are any structural features of the cash ISA market that adversely affect competition, and thus cause harm to consumers. It considers whether existing providers or potential entrants provide a competitive constraint that creates an incentive to innovate and provide consumers with products they value. The threat of losing 45 Consumer Focus super-complaint: Cash ISAs, page This figure does not differentiate between fixed rate and variable rate mortgages. 47 Consumer Focus super-complaint: Cash ISAs, page 22. Comparable figures are provided for new home mortgages also. 48 Moneymadeclear website, accessed on 1 March 2010 ( 49 Consumer Focus super-complaint: Cash ISAs, page Consumer Focus super-complaint: Cash ISAs, page 16. OFT

29 business should spur innovation and provide incentives to offer better rates of return and higher levels of service. 4.7 Further, where a market is highly concentrated, with high barriers to entry and expansion and a fragmented consumer base unable to exert buyer power, it might be expected to raise greater competition concerns than one that does not have these features. 4.8 As a first step, we have estimated market shares in the cash ISA market between March 2007 and April 2009 (measured in terms of the number of customers per provider). These market shares are provided in Table 4.1 below. OFT

30 Table 4.1: Market shares, by number of customers Market share Cash ISA provider Mar 2007 Apr 2008 Apr 2009 Halifax Bank of Scotland Lloyds Banking 19.4% 14.9% 21.3% 51 Lloyds TSB/ Cheltenham & Gloucester Group 5.8% 8.8% Abbey 7.9% 6.1% 14.8% 52 Alliance & Leicester Santander 4.3% 2.6% Bradford & Bingley 2.7% 2.6% Nationwide Building Society Nationwide 9.6% 13.2% 14.6% Portman Building Society Building Society 2.2% Royal Bank of Scotland Group % 8.8% 13.1% HSBC % 7.9% 8.5% Barclays/Woolwich 4.6% 7.0% 6.3% Britannia Building Society 3.0% 2.6% 4.2% Co-operative Bank 1.2% Na 55 National Savings and Investments 0.9% Na 2.8% Northern Rock Na Na 1.2% Yorkshire Building Society 1.2% Na 1.1% ING Direct Na Na 1.0% Yorkshire Bank/Clydesdale Bank 1.1% Na 0.5% Others % 25.5% 10.5% Source: OFT calculations based on Mintel ISAs, Finance Intelligence Reports (June 2007 August 2009) 51 Refers to Lloyds Banking Group, which includes Lloyds TSB, Halifax, Birmingham Midshires, Cheltenham & Gloucester, Intelligent Finance and Scottish Widows. 52 Refers to Santander UK which includes Abbey, Alliance & Leicester and Bradford & Bingley. 53 Includes Direct Line. 54 Includes First Direct. 55 Data not available for these rows from Mintel reports. 56 This category includes respondents who did not know who their cash ISA provider was. OFT

31 4.9 Table 4.1 shows that the cash ISA market has become more concentrated since The Herfindahl-Hirschman Index (HHI), a tool commonly used to asses the level of concentration in a market, showed that concentration rose from a figure of 880 in 2007 to 1,228 in The recent increase in concentration is, in large part, due to the mergers that took place in the wake of the financial crisis. 58 It is not clear if this level of concentration will persist. Table 4.1 shows that market shares fluctuated from year to year for many providers. Indeed, the changes in market shares for some providers are quite pronounced from 2007 to For example, on the above calculations, RBS's market share as measured by customer numbers has doubled over this period, whereas Yorkshire Bank/Clydesdale's has halved. The fluctuating market shares suggest that providers can, and do, win business from one another Barriers to entry and expansion are an important determinant of how a market evolves. 59 If there exist high barriers to entry or expansion (such as the need to have a branch network or recognised brand), then potential new entrants will find it harder to enter the market and exert a competitive constraint on existing firms. If there exist barriers to expansion, there will be reduced incentives to providers to offer more competitive offerings to attract new customers to increase market share. 57 The HHI is the sum of the squares of each firm's market share. An HHI index of 1,228 can be regarded as indicative of moderate concentration. 58 It should be noted that over the period in question there were mergers between, among others, Lloyds TSB and Halifax Bank of Scotland, Abbey with Bradford & Bingley and Alliance & Leicester, Co-operative Bank and Britannia Building Society in addition to Nationwide and Portman Building Society. 59 The OFT is currently considering barriers to entry, expansion and exit in retail banking more generally and will be reporting back later this year. See for further details. OFT

32 4.12 A large branch network is useful for a cash ISA provider since it allows firms to sell cash ISAs to existing customers. However, firms can enter on a small scale without a significant branch network by using telephone and internet banking. For example, ING Direct entered the market in 2007 without a branch network, and as Table 4.1 shows, by 2009 was one of the top ten providers Our analysis of data provided by Defaqto shows that 23 per cent of available cash ISAs cannot be opened in branches, that is, they can only be opened via the internet, phone or post. This reflects research by Mintel 60 which suggests that the internet is likely to become an increasingly important access point for savings and investment products. Thus, while the branch network will still be important, other distribution channels will allow new and existing cash ISA providers to offer consumers alternative ways to access their products We have also been informed by cash ISA providers that it is possible to enter the market through a partnership arrangement, whereby a provider brands a cash ISA but contracts out the management and operation of the cash ISA to a third party. For example, Family Investments provides cash ISA products for the Post Office. 61 This further suggests that it is possible to enter the market without incurring significant sunk costs, meaning that barriers to entry are not insurmountable On the basis of the above analysis, while the cash ISA market has moderate levels of concentration, this is largely the result of recent mergers. We have not identified any significant concerns around the structure of competition in the cash ISA market and nor do there appear to be any major barriers to entry or expansion that are dampening competition. 60 Deposit and Savings Accounts UK, May 2009, page See OFT

33 Cash ISA interest rates 4.16 As the Consumer Focus super-complaint noted, cash ISAs are a popular form of savings product, coming second only to savings accounts: 34 per cent of adults hold cash ISAs compared to 59 per cent having savings accounts. 62 Our consumer survey revealed that of those surveyed who hold cash ISAs, 35 per cent hold more than one cash ISA (which translates into 15 per cent of all consumers) Cash ISAs have motivated saving by UK consumers. Our consumer survey suggested that 30 per cent of cash ISA investors regularly deposited funds into their cash ISAs, but the majority (over 60 per cent) deposited money only when they could afford to do so. Over 10 per cent of respondents stated that since opening their cash ISA they had never deposited further money Respondents to our consumer consultation noted that the main reasons for investing in cash ISAs related to their tax free status and low risk. Consumers use cash ISAs (and ISAs more generally) for a number of purposes. An HMRC report 64 found that most investors used cash ISAs for non-specific savings reasons: 22 per cent said that they were saving for a rainy day or an emergency, while 21 per cent were saving for no specific reason. Ten per cent of investors were saving for retirement pensions and six per cent cited saving for a house deposit or home improvements as their main motivation. A survey conducted for HMRC Consumer Focus super-complaint: Cash ISAs, page Consumers may hold more than one cash ISA for a number of reasons. It may be that they have opened additional cash ISAs to take advantage of high interest rates that are only available to new money or they are prevented from depositing additional money into their existing cash ISA. Alternatively it may be the case that consumers simply do not close their old cash ISAs. 64 HMRC Research Report 38: Savings in ISAs. 65 HMRC Working Paper Individual Attitudes to Saving: Effects of ISAs on People's Saving Behaviour, Report 38. OFT

34 further found that around a third of respondents said that they would not have saved as much had cash ISAs (and ISAs more generally) not existed Despite regulatory limitations, cash ISA providers can, and do, compete across a range of dimensions. Our research suggests that key product features on which providers compete include: the interest rate offered on cash ISAs (including whether the interest rate is fixed, variable or tiered) how often interest is paid distribution channels through which cash ISAs are sold ways to withdraw money conditions around withdrawal, and quality of service However, as a survey for Money.co.uk notes, the key determinant in choosing a cash ISA provider remains the interest rate offered. 66 The tax advantage available on cash ISAs result in them being generally more attractive than other savings products with the same gross interest rate. However, if the gross interest rate on an alternative savings product was sufficiently higher than that of a cash ISA to outweigh the tax advantage, consumers may consider the alternative savings product as a more attractive option. Therefore, to an extent, alternative savings products might be considered a substitute for cash ISAs by consumers, and these substitutes may therefore exert a degree of competitive constraint on cash ISAs. 66 In a YouGov survey for Money.co.uk, the most commonly suggested factor by consumers in choosing a cash ISA was 'finding the best interest rate available at the time.' This survey is available at: OFT

35 Comparison with other products 4.21 In its super-complaint, Consumer Focus presented data from the Bank of England showing the decline in the average rate of interest on cash ISAs against other savings accounts before and after the financial crisis. A similar graph to the one presented in the super-complaint is provided below in Figure 4.2. Figure 4.2: Average rates of return for cash ISAs and savings accounts not including any bonus rates offered on those accounts, April 1999 March Interest rate Ap r- 99 Se p- 99 Fe b- 00 J ul- 00 De c- 00 M ay- 01 Oc t- 01 M ar- 02 Au g- 02 Ja n- 03 Ju n- 03 No v- 03 Ap r- 04 Se p- 04 Fe b- 05 J ul- 05 De c- 05 M ay- 06 Oc t- 06 M ar- 07 Au g- 07 Ja n- 08 Ju n- 08 No v- 08 Ap r- 09 Se p- 09 Fe b- 10 Average interest rate for cash ISAs (instant access with no bonus rate) Average interest rate on instant access savings accounts (no bonus) Source: Bank of England 4.22 Figure 4.2 above shows that the spread between the average interest rate available on cash ISAs and instant access savings accounts significantly narrowed around October The spread between cash ISAs and instant access savings accounts fell from 2.59 per cent in April 2007 to 0.28 per cent in March However, the cash ISA interest rate remains above that of instant access savings. This does not indicate OFT