The Financial Ombudsman Service reforms are worse than I first thought

I’ve been spending some more time looking at the Financial Services and Markets Bill over the past week, trying to understand the concerns of some of those who are more worried about the impact of the proposed Financial Ombudsman Service reforms than I have been up till now.

The key headline is that the Treasury is reforming the “fair and reasonable” test, to ensure there is total alignment between FCA rules and FOS decisions – putting an end to the alleged problem that FOS has been writing regulation via the backdoor.

As I’ve written before, the premise that these reforms were built on was always false.

The false premise

The idea of the FOS being a quasi-regulator is something that corners of the financial services industry have been complaining about since it was first set up 25 years ago.

I’ve still seen no clear evidence that this is the case – and the Treasury has never presented any during the two years that these new rules have been created.

The fundamental thing that the industry dislikes is that FOS decisions can appear inconsistent. That’s because, the power to decide whether a firm has acted “fairly and reasonably” will always depend on the exact circumstances of the case they are looking at.

Two FOS cases can look very similar but have different outcomes - and often that is entirely legitimate because there are small nuances that turn the case one way or the other.

I'm not saying the FOS is perfect - not by a long shot. I’ve seen some wild decisions – both in favour of the customer and against. And it’s right that we work towards ensuring there is as much consistency as possible. But to my mind that comes down to good training, the right expertise for complex cases and a better understanding of the the thematic issues that are arising across their caseload.

The primary legislation that is making its way through the House of Lords takes a much more heavy-handed approach.

If the law is passed without amendment, it now limits the application of the fair and reasonable test as follows:

“A complaint may be determined in favour of the complainant only if, in the opinion of the Financial Ombudsman— at the time the disputed act or omission occurred, either— the act or omission did not comply with an FCA rule applying to the respondent, or there was no FCA rule applying to the respondent that related to the act or omission, and the disputed act or omission was not fair and reasonable in all the circumstances of the case.”

Certainty is illusive in a principles-based world

When the consultations were first published, I brushed away the amendments to the fair and reasonable test, because I didn’t think they would have any impact.

The FCA is moving to a more principles-based rulebook, and it seemed to me that as long as the FOS could have regard to the Consumer Duty – then it didn’t really need the fair and reasonable test. The Consumer Duty already puts an onus on firms to prove that they are working to deliver good customer outcomes; to prove that they’re giving customers clear information that helps them make an informed decision; that proves they are offering fair value; and proves that they are providing appropriate levels of customer support to help them achieve their financial goals.

This is a high bar that, frankly, most of the industry are nowhere close to meeting in its entirety. And armed with these rules, I felt the FOS would have all the powers it needed to continue to protect consumers.

But what gives me pause about the new system is the new referral mechanism which will exist between the FOS and the FCA. The details of how that will work are not in the bill – and the Treasury have said these will be defined in secondary legislation.

That, in itself, is a worry. As secondary legislation is not subject to the same level of scrutiny as primary legislation – and can often skirt through Parliament without any friction.

But even before we know the detail, the Treasury’s intention is becoming clearer. If there’s any ambiguity about the intention of the FCA rules – then FOS will have to make a referral to the FCA before it makes a decision. And the suggestion is that it may need to do this whenever a case relates to the principles of regulation – as opposed to a clear cut rule.

The nature of principles-based regulation is that there is ambiguity – and from a firms’ perspective, it’s about bringing the evidence to prove that you lived up to those principles. Given that we are in the process of peeling back the rulebook in favour of principles, then it seems as though we may see a growing and eventually unmanageable number of cases being referred to the FCA and ultimately delayed as a result.

The Treasury admits that it expects the volume of referrals to be high in the early days of these new rules. And the FCA is not resourced with its own mass complaints team to deal with this volume.

Could this legislation backfire?

Secondly, is there a risk that this process ends up having unintended consequences that backfire for industry. Let’s say that the Ombudsman wants to rule that an insurer needs to pay a claim, as it cannot prove that its policy wording was written in a language that its customer can understand – surely a confirmation on this point from the FCA would put the whole industry in a difficult position. With a formal interpretation from the regulator that contracts were unenforceable if consumers cannot understand the language, it would potentially invalidate thousands of policies.

As I said, Consumer Duty sets a bar well above where the industry operates. Consumer understanding is one of the clearest indications of that. Most financial communications are jargon heavy and impossible for the average consumer to understand. But this is an open secret – and the FCA expects firms to see the challenge and be working to achieve it.

If it came out tomorrow and said that all contracts that didn’t meet this high bar were invalid – there would be chaos.

The 10 year time bar also doesn’t make sense. And I’ve already written about that.

So it seems to me that at best, these changes will not address the problems that they were created to solve – and at worst they will amount to delay and a tangible watering down of consumer protections.

No consumer engagement

It was great to meet the Economic Secretary to the Treasury to discuss these concerns this week. She was engaged and understood our concerns. But this was the first hearing that consumer groups were given on these reforms. The problem was stated as an incontrovertible fact back in the November 2024 Mansion House speech – but no evidence was given and consumer groups were not engaged. UK Finance, the ABI, financial services CEOs have been in and out of the Treasury every week since this Government was elected. Take a look at the Linkedin pages of the CEOs of these bodies.

New leadership is on its way. I fear it may be too late to stop this Bill – but we will certainly be working as hard as we can to get changes made.