David Murray’s Financial System Inquiry has lifted the lid on one of the worst kept secrets in the financial services industry – product disclosure is not working. Product disclosure statements – the hallmark of Australia’s disclosure regime - haven’t kept retail investors safe from shams or inappropriate products, nor have they improved consumers’ financial literacy.
The FSI has seized the opportunity to call for a new approach to regulating financial products – one that still involves disclosure but complements it with other regulatory levers. While it’s a welcome move, the Panel’s focus on regulation ignores a basic and more pressing issue – how can we improve financial literacy in Australia?
FINANCIAL PRODUCT DISCLOSURE
Australia’s current disclosure regime is predicated on the ‘more is better’ principle. That is, give consumers as much detailed information about a financial product as possible and this will ensure they are well-equipped to make an informed decision.
Unfortunately the principle relies on two flawed assumptions. First, that consumers have the financial literacy to understand the information contained in product disclosure statements, and second, they have time and the motivation to read PDS’ that can run to hundreds of pages in length.
Short form disclosure has been introduced with a view to addressing these issues of length and complexity, however consumers are left to navigate a shorter document with endless amounts of information which is incorporated by reference and located elsewhere.
In its Interim Report, the FSI panel specifically mentions the length and complexity of disclosure documents as clear obstacles to the disclosure regime’s efficacy.
The idea of using disclosure to inform consumers was originally seen as a smart way of protecting the public while at the same time giving maximum flexibility to product issuers in how they designed financial products.
In practice however, it has become a box ticking exercise driven by an industry culture of legal compliance rather than a focus on how to best serve customers.
The result is product disclosure documents that, while legally compliant, are filled with legal and financial jargon and are the antipathy of reader-friendly.
It’s no surprise that many disclosure documents are never read.
INQUIRY’S ASSESSMENT – A NEW REGULATORY APPROACH IS NEEDED
The FSI Panel has put the deficiencies of disclosure under the spotlight in its Interim Report concluding it’s time for a better regulatory model – one in which disclosure is only part of the solution.
David Murray backed this up in his speech to the National Press Club, arguing it may be appropriate “to develop an alternative approach that is not simply more detailed rules.”
SO, WHAT ARE THE ALTERNATIVES?
The FSI Panel supports moving to a ‘disclosure plus’ regulatory model where (effective) disclosure continues to play an integral part but is no longer the holy grail.
Unremarkably, the Interim Report suggests disclosure would be significantly improved and more meaningful for consumers if documents were shorter, written in plain English and presented information in a standardised manner so consumers can compare products easily.
Expanding public access to financial product and service information through online comparators and choice engines is another recommendation made by the Panel.
OPTIONS BEYOND DISCLOSURE
Of real interest are the Panel’s policy options that involve alternatives to disclosure. They include:
Regulating particular financial product features that are clearly detrimental to consumers or frequently abused. The ban on early exit fees from home loans is an example of this type of targeted regulation as is the introduction of caps on interest rates for credit contracts.
Moving towards mandated product design with simple features and fee structures, an example being MySuper.
Putting positiveobligations on product issuers about the suitability of their products for retail clients. An issuer could be required to state the particular classes of consumers for whom the product is suitable and for whom it is unsuitable. A more stringent alternative would be to require the issuer to state the product’s suitability for a particular individual.
Give ASIC the power to ban products or product features and prescribe the marketing terminology used for more complex or risky products.
WHAT WILL WORK? AND WHERE IS FINANCIAL LITERACY?
The FSI Panel’s options beyond disclosure are to be applauded. However, there is no silver bullet solution that will overcome the shortcomings well known to those in the industry. This issue needs a holistic approach with a mix of disclosure and non-disclosure measures.
What is disappointing is the absence of “financial literacy” as an option worthy of further consideration. The latest ANZ Survey of Adult Financial Literacy in Australia revealed 36% of Australians find dealing with money stressful, even when things are going well, and 73% don’t know how much money they will need when they retire. A third of Australians also find their superannuation statements difficult or very difficult to understand.
The ANZ study also found that those struggling most with financial literacy are young people under 25 years, people working in blue collar occupations, and those on lower incomes.
Against this backdrop, a genuine and meaningful focus on financial literacy for all Australians (young and old) must form the foundation of any new approach to informing and protecting consumers. The FSI Panel’s suggested policy options do not diminish this need especially in an era when people are expected to actively manage their financial affairs.
In a welcome move, ASIC recently launched its new National Financial Literacy Strategy 2014-2017. The strategy’s five action areas are
- educate the next generation, particularly through the formal education system;
- increase the use of free, impartial information, tools and resources;
- provide quality targeted guidance and support;
- strengthen co-ordination and effective partnerships; and
- improve research, measurements and evaluation.
In commenting on the launch, Paul Clitheroe (Chair of the Australian Government Financial Literacy Board) said:
“Being good with money can improve our lives and the lives of those we love. As the saying goes, an ounce of prevention is worth a pound of cure.”
Indeed a paradigm shift is needed in the way the financial services industry thinks about protecting consumers and serving their interests, and financial literacy must be at the centre of any new approach. Such an approach is not without its own challenges, but those challenges should be no excuse for avoiding the issue altogether.