Behavioural economics provides unequivocal evidence that when consumers are faced by an overwhelming decision they are most likely to do one of three things: inappropriately oversimplify it, put it off or check out completely. As a result, providing more disclosure may not only fail to benefit consumers, but it could even cause people to abdicate responsibility for their financial affairs to an even greater degree than they do already.
On March 28th, the Canadian Securities Administrators (CSA) published the final rules for CRM 2, the second phase of its Client Relationship Model initiative. This regulation is intended to achieve the laudable goal of helping consumers evaluate the value they are getting for the fees they pay for investment advice. It proposes to do this by increasing awareness of two key things:
- the total cost of the investment services (most notably embedded commissions in mutual funds)
- the rate of return earned on the client’s investment portfolio.
At first blush, access to this new information about fees and returns would appear to be a great thing for consumers. Certainly, investors have a right to know about the incentives that are accruing to their advisor and his/her firm. This information is fundamental to one's ability to evaluate the value that they're getting for the fees they pay and also to determine whether their advisor's interests are aligned with their own. However, before so much turmoil is inflicted upon the industry, regulators need to be clearer about whether they should be using a machete or a scalpel.
Anyone who has worked for a bank, utility, telco or other large statement-producing organization can imagine how daunting it will be for investment firms to comply with these rules. While the three-year transition period may appear generous, this is actually a relatively short interval given the magnitude of the change required. After all, only now that CSA has finalized its rules can Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA) – the Self-Regulatory Organizations governing investment and mutual fund dealers – begin the process of translating CSA's rules into regulation for their respective members. Only once this is done, wealth-management firms can begin the process of designing new statements, training staff to use them properly and developing communications plans to educate consumers about the new disclosures.
While the new rules only require annual reporting of costs, the potential permutations are endless. Firms are unlikely to report one big number for total fees without some explanation. Those explanations would vary based on whether the client deals in the branch, brokerage or private wealth channel, and it's not unusual for clients to use more than one. Beyond this, there is context to be provided around what proportion of the fees go to the advisor vs. the firm, why fees vary by asset class or product and even future fees like deferred sales charges that may or may not be levied on the account if the investment is held for a certain period. Consider also, that most investors have multiple accounts often with different institutions so they will need to understand multiple approaches to this reporting.
Similar complexities apply in the realm of performance reporting and the implications of selecting benchmarks, consolidating accounts and establishing cost.
Getting these newly complex statements right is vital for firms and their clients: Study after study has demonstrated that consumers find investing to be an incredibly overwhelming process. Behavioural economics provides unequivocal evidence that when consumers are faced by an overwhelming decision they are most likely to do one of three things: inappropriately oversimplify it, put it off or check out completely. As a result, providing more disclosure may not only fail to benefit consumers, but it could even cause people to abdicate responsibility for their financial affairs to an even greater degree than they do already.
The British regulator, Financial Conduct Authority (FCA), has been a trailblazer in considering the role of behavioural economics in regulation. They have been publishing papers on it for years and are making it an increasingly central pillar of regulatory design. In a recent press release CEO Martin Wheatley declared "I want the FCA to bring a more human face to the regulation of financial services; a more pragmatic approach to regulation. Not only to defend against sharp practice but also to encourage better decision making among consumers." It is worth noting that the U.K. regulator's emphasis on behavioural economics is complemented by an outright ban on trailer fees and other commissions embedded in investment products. (Learn more about how the FCA is using behavioural economics in regulation by downloading their white papers at www.fca.org.uk/.)
Greater accountability is coming to the investment industry, and rightly so. However, consumers will experience greater benefits if regulators encourage member firms to consider human decision-making norms in the structure of their rule-making. These could include things like using comparisons to contextualize information, metaphors to explain concepts and above all, simple language and clean report design. There is a tremendous opportunity for firms that are brave enough to explore these approaches.
Amelia Young is the founder of Upside Consulting Group Inc., a management consulting practice that helps service firms identify and strengthen their sources of differentiation.
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