Ever since the 1930s, regulators have been obliging investment firms to disclose costs, charges and market data to customers. The idea has been to protect investors from sharp practice and the consequences of their own inexperience. Two regulators have now called such protection into question.

The regulators are the Australian Securities and Investments Commission (ASIC) and the Dutch Authority for the Financial Markets (AFM). Their recently-released joint report claims that disclosure (information that firms must send to their customers by law) is necessary but no guarantor of good results for customers. It states: "we cannot assume that disclosure alone, including warnings, will be effective in protecting consumers, enabling good decision making and driving competition from the demand side." It does not explain, however, why anybody would ever think such a thing in the first place.

The findings

All 61 pages of the report present facts and figures to prove the well-known fact that disclosures are not the be-all-and-end-all of "consumer protection." It is, however, full of ambiguities. For example, it states that "disclosure cannot solve complexity that is inherent in products and processes." Many products and processes are indeed complex, but the report does not say why this is a problem to be solved. Its only interesting use of the word "complexity" is in the phrase "computational complexities," in which it says that people find it hard to make choices because they lack the mental capacity to calculate. Very numerate people, it finds, are only slightly better at making decisions about investments than others. It does not say whether - or why - self-aware people who know about this problem might plump for complex products and processes in the first place, except to suggest (but not state outright) that "few (if any) financial products and services are not complex."

The many monographs and pieces of research from which the report draws include an online Dutch banking study of the effectiveness of a warning in credit advertisements (it appeared that the credit warning had hardly any direct effect on consumers' behaviour) and another Dutch analysis of decision-making behaviour and "potential interventions" (rules that the Government and its regulators might impose) in the consumer credit market. The findings of the latter are optimistic.

Decisions about financial products and services are particularly complex because people often make them infrequently and therefore have few opportunities for feedback and learning. They may have an emotional dimension, which is always a trap for the unwary. They may require trade-offs over time, perhaps between present and future benefits. They may involve uncertainty about unknowable future states of the world and our own future behaviour which even we might not predict well. Products and services often involve risk – something that most of us are not good at judging. The report adds: "Moreover, these (mis)judgments are made by both the general public and experts alike – particularly when experts rely on their intuition, rather than available data."

In ASIC’s experience, disclosure has proved particularly ineffective in improving consumers' understanding of the amount of risk involved in a product or service.

Sabotage!

Some firms make their products and processes strategically complex, thereby confusing consumers. Regulators are constantly on the lookout for bundled products and prices, confusing and opaque ‘discounts’ and unclear fee descriptors. A credit cards, for instance, is an inherently complex product because it is at least three products in one – a non-cash payment facility, a credit facility and a means of withdrawing cash. The bank that issues it often makes things more complicated by bundling and marketing it with other financial products (such as insurance) and loyalty points, making it more difficult for people to separate the price and value of each feature – especially as some of the costs and benefits are immediate and others happen in the future.  

Firms can also make processes strategically ‘sludgy’ by including excessive, unnecessary frictions that make it difficult for people to do what they want. They can make products easy to get into but hard to get out of. The more products and processes are made complex, the harder they are to explain and understand. Some firms can also make disclosures strategically complex, perhaps by making them hard to find or understand.

The report says that any attempt to simplify disclosure does not ‘solve’ complexity because, as Professors Omri Ben-Shahar and Carl E Schneider assert, the complex is not simple and cannot easily be made so. ‘Simplification’ often amounts to the simplification of language only and not concepts or problems.

The KIDs aren't all right

The AFM conducted similar research, asking consumers to decide which bond to invest in, having looked solely at one of two shorter documents (a four-page summary prospectus or a three-page Key Information Document or KID of the kind used for Undertakings for the Collective Investment of Transferable Securities or UCITS), or a combination of both documents. They were technically able to make the best choice, because in the controlled setting there was one offering that dominated the other two bonds; costs and risks were lower or equal and yields were equal or higher. On the whole, the people who read the KID made better decisions about investing – one-third (34%) of them correctly invested everything in the dominating bond (for the summary prospectus this was 24%, and for the combined disclosure this was 31%). However, 66% of participants who were given the KID still invested some or all of their available assets in suboptimal options. This meant that some forms of disclosure performed significantly better than others but no one type of disclosure helped all consumers.

In a nutshell

The report, then, has implied (but not stated or proven) that most financial decisions are complex. It has concluded that few consumers pay attention to disclosures and that firms sometimes work hard to obfuscate the benefits of disclosures. Context matters and no universal approach to disclosure can meet the needs of all. Warnings can backfire because they do not always work as intended - to make this point the report quotes the British Financial Conduct Authority's point that "warning fatigue" can waylay people, who often ignore, overlook, misunderstand or misremember warnings.

The subtext

One would expect a report such as this to lead directly to an exhortation for regulators to overburden firms with more draconian rules, using the relative uselessness of disclosures as a pretext. The report stops short of this, merely stating that it behoves policy makers, regulators and practitioners to "progress public policy discussions beyond disclosure, and understand and address consumer harms on a case-by-case basis." It goes on to state, somewhat farcically, that "no one regulatory tool can be a cure-all for all regulatory problems," but does imply that regulators ought to lay down more rules to govern product design, governance and distribution. It is anybody's guess whether this report is the harbinger of a new wave of rulemaking in Australia and Holland.