Consumer outcomes: A truth universally acknowledged
A Speech by ASIC Deputy Chair Karen Chester at the AICD Leaders’ Lunch, Brisbane, 29 November 2019
I would like to begin by acknowledging the Traditional Custodians of the land on which we meet today, and pay my respects to their Elders past, present and emerging. I extend that respect to Aboriginal and Torres Strait Islander peoples here today.
My thanks to the AICD for the invitation to speak today. Always wonderful to do so in my state (and town) of origin. And at a time of inflection for our financial system post the Royal Commission. For me one enduring good has been the AICD. The Institute has continued to lead governance endeavour by supporting professionalism and contributing to thought leadership on what good governance is in theory but also in practice.
Today I want to talk about a quiet yet seismic shift in the approach to consumer protection. And why it matters for what we see in the aftermath of the Royal Commission. In doing so, I will cover three aspects. First, the welcome recognition and reality that we’re moving beyond a reliance on disclosure for delivering good consumer outcomes. Second, ask and answer why this move beyond disclosure has happened only now. And finally, why this is a significant turning point, for government, business, regulators and ultimately consumers.
The impetus for this shift is the sunlight of a Royal Commission. Sunlight brought to poor consumer outcomes. Because, with both thanks and apologies to Jane Austen, ‘today it is a truth universally acknowledged that a firm in want of a good fortune must be in want of good consumer outcomes.’
This now universal truth that consumer outcomes matter – is today self-evident. In a global sense, as disconnections loom large and loud across public, political and business arena. Where elitism and hubris have bred contempt and where losing touch with ‘real people’ has seen geo-political rifts. It heralded a democratically installed US President who crowed after a primary victory: “I love the poorly educated”.
And while Australia has historically proved pretty much immune to this, the Royal Commission suggests that cannot always be assumed. Where fairness – or doing the right thing – is no longer the default conduct for many in our financial system. Where vested interests drowned out the consumer voice and legislation succumbed to exceptionalism. And that exceptionalism proved a breeding ground for poor conduct. With, devastating consequences for real people. The Royal Commission’s 75 arresting case studies – all the personification of poor consumer outcomes.
From ASIC’s perspective, these case studies represent but a sample of the consumer harm. If we consider just four streams of remediation (consumer credit insurance, add on insurance, fee for no service, and deficiencies in financial advice) collectively the count comes to more than $790 million of remediation to more than 1.2 million consumers. Let’s pause here – over 1.2 million real people remediated more than $790 million, their money. Not a regulatory burden, not a cost of doing business. And we know there is much more to be repaid. For we have all seen, and demonstrably so, that what harms consumers, hurts business and ultimately shareholders.
And here we need look no further than the rising tally of remediation provisioning, currently just tipping over $10 billion. The mismanagement of non-financial risk crystalising from financial risk to financial cost. And to reflect on the scale of that cost to business, it’s worth recalling the Bank of England Governor (Mark Carney’s) 2017 estimate that the total post GFC cost of misconduct for banks globally was $US230 billion. So our $10 billion Australian tally is in step, when adjusted for the size of our economy, but distinguishable on timing and more a case of mismanaging non-financial risks.
And there are other ways the bottom line of business has suffered. For today intangible assets such as reputation, IP and customer base account for over 89 per cent of total corporate value, as compared to under 25 per cent 40 years ago. So the loss of trust eroding a broader value base. And to cite just one survey by Deloittes: only 49 per cent of Australians trust their bank to keep its promises and less than a third (or 26 per cent) trust all banks to keep their promises.
So consumer outcomes and the consumer voice matter. And both business and government alike ignore them at commercial and political peril.
The four lines of defence
So what has gone wrong in Australia’s financial system. And here it helps to consider in turn each of the four lines of defence needed for markets to deliver fair outcomes. The first line of defence being public policy. The second line the consumer themselves. The third the conduct of firms and their directors. And the fourth and final line of defence, the regulator. And all demonstrably breached in the Royal Commission’s thoughtfully curated case studies.
Our first line of defence: public policy
Turning to the first line of defence – public policy. Why has public policy failed to deliver fair consumer outcomes in the financial system?
Beyond the ‘capital P’ public policy architecture nurturing (or not) effective competition in these markets, Commissioner Hayne identified the cumulative and damaging exceptionalism that took hold in the legislative norms of conduct for the financial system. The (dis)honour roll call of sectors that secured exceptional treatment, addressed in no less than 11 of the Royal Commission’s recommendations: financial advisers, insurers, mortgage brokers, credit providers.
And perhaps we ought to pause for a ‘warning Will Robinson’ moment. To recall how the loud voice of exceptionalism drowned out the consumer voice. As we accelerate to legislate the Royal Commission’s recommendations in less than 12 months. It’s an ambitious legislative reform program. And one that should be spared a Ground Hog Day of exceptionalism. For the voice of exceptionalism is anything but exceptional.
A second important reason why public policy failed to deliver fair outcomes is despite incontrovertible behavioural research and evidence we remained welded to our reliance on disclosure for consumer protection.
ASIC released an incredibly important report in October this year – Disclosure: Why it shouldn’t be the default. A must read for policy makers, a must read for regulators, and a must read for corporate Australia. And why? The report presents three decades of research and evidence to explain why mandated disclosure and warnings have all too often failed to deliver intended consumer outcomes. Or even worse, have backfired, contributing to consumer harm.
As the Report’s 33 case studies from the last 10 years demonstrate, all forms of mandatory disclosure and warnings can and have failed. And they can fail across the broad range of financial services and products (credit, insurance, investments, superannuation, banking and financial advice).
This public policy failure is not specific to Australia. Our report is a co-publication with the Dutch Authority for the Financial Markets. And case studies in the report are drawn from the Netherlands, the US and the UK, as well as Australia.
Nor are the limits of disclosure new. Rather, our report mainstreams more than three decades of behavioural science, captured in the disclosure journey. For instance, a quick search of google scholar tells us that 868 articles address the ‘limits of disclosure’ in the past 20 years alone.
This disclosure journey can also be traced through the last 20 years of financial services inquiries in Australia. From 1997 when Wallis declared that “disclosure regulation is at the core of any scheme to protect consumers as it allows them to exercise informed choice”. Fast forward to 2014 when Murray recognised that “disclosure can be ineffective for a number of reasons”. And now this year when Hayne calls out that “this idea of ‘disclosure’ underpins the now teetering edifice of PDSs and FSGs”. Our report shows just how on the money Commissioner Hayne was.
Yet disclosure remains way too sticky and our post disclosure evolution of public policy has a way to go. We hope our report helps to more than nudge that evolution.
So allow me to let the report speak for itself by sharing just three of the 33 case studies.
Number one, research by ASIC in 2011 with real consumers seeking retirement advice found a large gap between the quality of the advice and the consumers’ own assessment of, and trust in, that advice. Where 86 per cent of consumers considered the advice they received to be good and 81 per cent said they trusted the advice ‘a lot’. Yet assessors (alongside a 12 person expert reference group) rated just 3 per cent of that advice as ‘good’ advice, 58 per cent as adequate, and most troublingly, 39 per cent as poor. This is just one of many cases which illustrate that disclosure cannot solve the complexity inherent in financial products and services. Nor does it ease the contextual and emotional dimensions of financial decision making, both at the point of purchase and over time.
Number two, this time illustrative of how disclosure can backfire in unexpected ways. A large body of international research has found that displaying the minimum repayment figure on credit card statements reduces the amount that consumers repay – an effect known as anchoring. Behavioural experiments carried out by the UK FCA found that removing the minimum repayment amount increased the value of repayments by nearly 20 per cent.
Number three of the 33 case studies, deals with mandatory disclosure of conflict of interest in financial advice this time in the US. When conflicted advisers provided ‘bad advice’ and disclosed their conflict, 81 per cent of consumers followed that bad advice. Yet when the conflict wasn’t disclosed, only 53 per cent of consumers followed the bad advice. And why? The disclosure of the conflict backfired – it translated into a trust dividend for the adviser as opposed to the intended consumer protection of scepticism by the consumer. A loyalty loss.
One important learning from these case studies is the vital role that government has to play to ensure that the policy architecture takes into account the choice architecture. By choice architecture I mean the features in an environment, noticed and unnoticed, that influence consumer decisions and actions. Neither policy architecture nor choice architecture can be neutral – with both inevitably impacting both firm and consumer behaviour and outcomes.
And perhaps even more importantly, the over reliance on disclosure has inadvertently permitted and arguably enabled poor market conduct – business decisions that have led to poor consumer outcomes. As ASIC has observed over a number of years ‘anything goes as long as you disclose’.
Our report answers the $10 billion question, why has disclosure so often failed as our first line of defence to protect consumers?
The short answer is because disclosure has been expected to do too many things that it is not equipped to do. And there are limits to what it can do.
First and foremost, disclosure cannot solve for the complexity of the financial system. Particularly when that complexity is firm induced, including consumer frictions or ‘sludge’ (think easy to get into, hard to get out of products). Think the 40,000 investments options offered by our APRA regulated superannuation funds. As the Productivity Commission called out, "what is often passed off as competition is more accurately described as persistent marketing and brand activity designed to promote a blizzard of barely differentiated products and ‘white labels’”. And this proliferation of little used and complex products has increased fees without boosting net returns.
And a second limit is that disclosure has been expected to compete for consumer attention. It is the core business of firms to capture consumer attention and influence decisions. And firms have the means, opportunity and experience to do so effectively. But no less than six quantitative studies consistently reveal, only 1 in 5 consumers would say they had even read a disclosure document. And this is before even assessing whether they understood and acted upon the disclosure as intended.
This weak traction of disclosure is in stark contrast with the persuasive power of what Robert Cialdini describes as the ‘weapons of influence’ used by firms. Think advertising. Think marketing. Think sales tactics – face to face and now online with real time nudges informed by smart algorithms. But also more subtle and oftentimes more impactful weapons such as the creation of trust through social factors, the manipulation of emotion, the strategic timing and ordering of offers, the use of defaults and sludge, and the list goes on. All of which can be used at every stage of product design and distribution. The choice architecture. And the future of choice architecture in a world of real time nudges by smart phones powered by smart algorithms fuelled by consumer data.
And today in Australia these weapons of influence have too often been used to nudge consumers towards products and services that are not fit for purpose or that prioritise commercial interests over consumer outcomes.
Think what Justice Jagot has described as 'systemic sharp practice' in the recent ASIC v Westpac Securities Admin Ltd decision. Where the court found that Westpac had “carefully calculated” how to roll over their customers’ funds into Westpac accounts by giving personal advice but portrayed as general advice.
Disclosure has proved no defence against the totality of sharp practice – manifest in choice architecture.
What does this all mean for public policy going forward? If as, we universally acknowledge, consumer outcomes are what matters. Then it is outcomes, and not inputs like disclosure, that should inform public policy for consumer protection. Because disclosure is an input – one of many – which may or may not result in good consumer outcomes. And while we recognise that disclosure remains necessary, it is by no measure sufficient to deliver good consumer outcomes. We can no longer presume that disclosure will work and must be alert to arrest potential backfires.
So it’s time to call time on our over reliance on disclosure.
And important first steps have already been taken in this public policy evolution. Product intervention powers now enable ASIC to impose fit for purpose interventions in the market for a finite period of 18 months. When we have evidence of significant consumer detriment.
Since April this year we have the power to intervene in the market when we have evidence of significant consumer detriment (our new product intervention power). And we have already identified this high hurdle of significant consumer detriment and sought to use these powers three times in 6 months. To address significant consumer detriment as it relates to short term credit, over the counter binary options and the distribution of CFDs, and add-on financial products through caryard intermediaries.
And the book end to our product intervention powers are the design and distribution obligations (that come into effect in April 2021). A business and ultimately consumer game changer that will require firms to design and distribute products to meet the financial needs, situation and objectives of the target market to which they are sold.
Now we have a way to go to mainstream design and distribution obligations. And perhaps the KPI for its success will be ASIC rarely having to contemplate using our product intervention powers – our PIP.
These regulatory tools enable consumer outcomes to be placed front and centre by the regulator and business. And signal a turning point in public policy moving beyond disclosure.
Second line of defence – the consumer
Placing the onus on consumers to inform and protect themselves without also requiring firms to take responsibility for the design and distribution of their own products has produced poor consumer outcomes. It’s time to rebalance – financial services firms need to share (with consumers) the responsibility for better consumer outcomes.
Again misplaced faith in disclosure has a lot to answer for here: the assumption being that if we give consumers the ‘right’ information, consumers will be adequately armed to self-protect against poor outcomes. As the Royal Commission and our recent report on disclosure shows, this has more often than not proved a chimera.
To take another of our 33 case studies in the report, more than half of consumers (some 59 per cent) who were provided with either a product disclosure statement or a ‘simplified’ key fact sheet could not identify the objectively best of three home insurance policies.
This does not, I hasten to add, mean that these nor any other consumers are deficient. As Nobel Laureate Richard Thaler calls out, “consumers are not dumb, the world is hard.” Let’s unbundle this a little further.
First, and as Financial Counselling Australia’s CEO, Fiona Guthrie has observed “whenever there is a story about some experiencing financial hardship, many people simply blame the victim – they’re lazy, crazy or stupid.” But as another Nobel laureate, Daniel Kahneman has identified, nobody has the time or the resources to fully analyse all of the available information and fully maximise their utility with every choice. And as humans there are limits to our cognitive capacity and naturally occurring and exploitable behavioural biases.
Second, that the world is hard, and to this I would add, particularly the financial world. Even the most ubiquitous financial products are complex (think credit cards and insurance) and can involve multiple complex factors and conceptually abstract matters such as risk, probability and uncertainty. And as I have said previously some complexity is unnecessary and firm induced: think ‘sludge’, product bundling, opaque pricing, to name a few.
All this means that the current burden on consumers is unfair. Fiona Guthrie is on point again here. She describes how the blaming mindset (consumers are lazy, crazy or stupid) might seem innocuous, but such mindset can play out in dangerous ways…. “including absolving firms of their share of responsibility for outcomes.
In this vein, financial literacy is also no silver bullet. For example, academic colleagues from the US and Europe jointly conducted a meta-analysis of the relationship of financial literacy and of financial education to financial behaviours. They looked at 168 papers covering 201 prior studies. And they found that interventions to improve financial literacy explain only 0.1 per cent of the variance in financial behaviours studied. And that, like other education, financial education decays over time. Even large interventions with many hours of instruction have negligible effects on behaviour 20 months or more from the time of intervention.
David Halpern, the head of the UK’s behavioural insights or ‘nudge unit’ that was born in 10 Downing Street, has observed it’s “just kind of crazy” to think that we can help people make better financial decisions with education. Because, as David Laibson from Harvard University and others have shown, we are not going to turn people into financial experts.
This is borne out too in the Australian context. In the decade plus that adult financial literacy has been measured in Australia, aggregate levels have not gone up despite the sizable investment that has been made in financial education over many years. Professor Richard Thaler’s take is that “financial literacy is impossible”.
Our report on disclosure also speaks to the limits of financial literacy and education as a consumer protection tool. Research shows that there is little difference between the capacity of humans to differentiate good deals from bad when we have to take into account more than two or three factors. And this is regardless of financial literacy. In a study conducted by Pete Lunn and colleagues from Ireland’s Economic and Social Research Institute, all participants struggled to get this right and those with high levels of numeracy and education performed only slightly better than those without.
Where this leaves us is with a recognition that, like disclosure, financial literacy and education do not in and of themselves shift the dial for consumer outcomes in the financial world. As US author and journalist, Helaine Olen has observed, financial literacy can be “a noble distraction from actual consumer protection. That’s why the financial industry loves it.”
Again this is not to say financial literacy does not have an important role to play – it does. But it’s just not a ‘silver bullet’ solution.
This all important recognition of the limited firing range of the disclosure ‘silver bullet’ is central to the Royal Commission recommendations. For the Royal Commission represents more than a tilt away from disclosure. And other demand side remedies like financial literacy. The overwhelming majority of the Commission’s recommendations – some 55 – are about better firm conduct. 16 recommendations go to system checks and balances (the regulator and future reviews), and only 5 recommendations to the demand side (the consumer).
This supply side heavy lean by the Royal Commission speaks directly to the need to correct the imbalance in responsibility for outcomes. This is not a regulatory pendulum swing, it’s an important evolution of public policy: sharing responsibility for outcomes with both consumers and firms.
And there is much in this shared responsibility for business as well as consumers: particularly consumer centric firms, and those seeking to arrest freefall beyond the $10 billion remediation provisioning tally. And for boards to have confidence that they are managing non financial risk. Or more simply, they are generating sustainable revenues and shareholder turns. And not toxic and unsustainable ones.
Third line of defence: firms and their directors
Which leads me to the third line of defence, the conduct of firms and their directors. It cannot be overstated the rolefirms inevitably play in consumer outcomes, be they good or bad.
It is timely then to reflect on why the third line of defence (firms and their directors) has been breached and what opportunities there are to bolster this line of defence and shift the dial on consumer outcomes. These are important questions because as Hayne says, ultimately responsibility for change lies not with ASIC as the regulator, but the firms – their executive, their boards and ultimately their shareholders.
The body of three decades of evidence from behavioural science is most helpful here in explaining what amounts to a business blind spot for consumer outcomes. It tells us that this blind spot has grown because of three interrelated gaps: gaps in empathy, gaps in evidence and gaps in incentives.
First the empathy gap:identified by Professor Sunita Sah of Cornell University in her report, Conflicts of interest and disclosure. And notably a report commissioned and published by the Hayne Royal commission. For me another must read. Professor Sah talked about the ‘ethical fading’ that can occur when the salience of business issues pushes ethical issues aside. In practice this can involve a failure of firm directors and staff to stand in the shoes of their customers. In a similar vein the (John Laker led) CBA Prudential Inquiry last year concluded, CBA’s continued financial success “dulled the senses of the institution”. And as Hayne observed, “pursuit of profit has trumped consideration of how the profit is made”.
Closing the empathy gap first and foremost requires firms to appreciate the value of the consumer voice. And consumer voice, not meaning customer satisfaction with services (which as APRA has identified can be a poor, exploitable indicator). But rather a real understanding of what outcomes matter to their consumers and are they being delivered.
And ASIC has identified that closing the empathy gap also requires firms to understand the limits and vulnerabilities of their customers. And in doing so, not exploit innate constraints in human cognitive capacity and exploitable behavioural biases.
In short, to close the empathy gap firms must care about consumer outcomes.
In order to care about outcomes, firms must first know about outcomes. And that brings me to second gap, the evidence gap. There is a paucity of data about consumer outcomes that is perverse in today’s data and analytics driven world. In business, as in other domains, these outcomes often appear to be assumed or disregarded, rather than evidenced. Kirk Chisholm has observed that “all solutions to existing problems must be based on how people behave, not on how we think they should behave.” To this I would add, endeavours to improve outcomes should be based on what those outcomes actually are, not what we think they should be.
So data matters. And part of improving consumer outcomes means improving data and systems. And ASIC has recently identified that there is much room for improvement here. From our recent total and permanent disability (TPD) insurance review where we found critical absences of data – without which insurers cannot identify the value of their products to consumers. And cannot identify the problem points in their claims handling.
From the two ‘canaries down the mine shaft’ areas of focus of our Close Continuous Monitoring program – customer complaints handling and incident and breach management. And from our Corporate Governance Task Force review of the oversight of non-financial risk.
Close Continuous Monitoring and Corporate Governance Task Force have further revealed what we learned from the Royal Commission and the CBA Prudential Inquiry about unnecessary complexity. And much in the form of product proliferation. Unnecessary for the consumer. And much of it making it difficult for Boards to hear the consumer voice. And the crunch point here again is that systems and data have not kept pace with that complexity. And why? Because products have become both the means and the end. When products should be the means to an end and that end being good consumer outcomes. And why we find ourselves in a world of lost consumer voice, unnecessary complexity and sludge to keep the consumer anchored. And now the stark realisation that complexity is at a huge cost not only to consumers but to business and ultimately shareholders, as toxic revenues ultimately become a long legacy of business costs.
So overdue investment in getting data and systems right is an essential precursor to moving beyond the Royal Commission legacy. It creates a real opportunity, in a post disclosure governed world, for ‘weapons of mass influence’ to be repurposed towards good consumer outcomes.
This forges the link between firms doing the right thing and their own interests. And this ties in with the third and final gap: the gap between firms’ incentives to profit and their incentives (or lack thereof) to improve consumer outcomes. Again, Professor Sunita Sah’s research is on point here. Professor Sah identified it is the very existence of conflicts of interest that leads to self-serving bias by advisers, and as we’ve seen other players in design and distribution of financial products and services.
The Royal Commission recommendations make real inroads to remove conflicts and align incentives. Think the review of ending grandfathered commissions; and the mortgage broker ‘best interest’ duty. The impact of his Royal Commission as well as ASIC’s work over many years also provide a powerful motivation for firms to close both their incentive gap and their empathy gap.
And on the flipside, fairness – doing the right thing – can and should be seen to create commercial value.
When I say do the right thing, note emphasis on do. We heard a lot of positive sentiments from CEOs at the Royal Commission. But as Jane Austin also tells us, "It isn't what we say or think that defines us, but what we do."
So firms ought to: understand consumer outcomes, monitor those outcomes and deliver those outcomes. Design and offer products that deliver value – not surprises – and are sold fairly. Design ‘choice architecture’ that it is fair for consumers. And tackle head on complexity in financial services and products that are unnecessary and harmful to consumers and ultimately a value loss for shareholders.
Fourth line of defence – regulators
So finally to the fourth line of defence, the regulators. We see our role as being a change agent provocateur to get incentives aligned. And consumer outcomes as the universal truth to align the interests of firms and regulators. And this also offers the prospect of reducing regulatory burden going forward. We can do this through enforcement but also through our weapon of mass influence – transparency.
I’ve talked about the importance of understanding outcomes, and of understanding how poor practice leads to poor outcomes. ASIC will support this endeavour with the use of transparency as a regulatory tool. Michael Hodge QC talked about keeping the ‘night light on’. Beyond the Royal Commission, this is ASIC’s job – to keep the night light on.
Our new use of transparency as a regulatory tool is manifest in our twin strengthened supervisory programs – our Close and Continuous Monitoring (to date on complaints handling and breach monitoring) and our Corporate Governance Taskforce. And transparency here takes two forms. First, providing frank and fearless (written) feedback to the leadership of corporates on our entity-specific findings. And second, reporting publicly on our observations and findings across the supervised cohort – outlining the ‘distribution’ of findings – from the good, not so good and poor. Now importantly here the firms themselves (armed with their individual feedback) can then identify where they are in the distribution. And so can any Board, by asking their management the questions we did of the supervised cohort.
Our use of transparency as a regulatory tool should not be viewed as a burden by firms. More a valuable insight into how they are faring, and importantly how they are faring relative to their competitors. Sharing this information and findings publicly allows firms to drive improved industry behaviour and encourage more effective competition. Ultimately to improve consumer outcomes.
We’ll also be naming more names. As we have recently done in relation to TPD insurance claims; director and officer oversight of non-financial risk; buy now pay later; breach reporting; and credit providers. In each of these cases transparency had regulatory value and purpose. We’ll also continue to use mechanisms, such as public hearings, that critically lend transparency, accountability and legitimacy. And we’ll continue to call out sludge and other weapons of mass influence where they harm consumers.
The near-term design and distribution obligations (DDO) are another vehicle enabling regulators and business alike to embed good consumer outcomes.
The importance of the design and distribution cannot be overstated. They should prove the legislative nudge to better prioritise consumer needs. And firms should view meeting these obligations as an investment in commercial value. It’s an insurance policy against a loss of commercial value – think the risk of remediation bills in future, being PIP’d by ASIC or a Royal Commission Mark II. And all the Royal Commission case studies would have scored a fail on DDO.
We will release our draft guidance on the design and distribution obligations for consultation in the not too distant future.
But one question the boards of financial services firms ought to ask their senior executives now. Are we getting ready for DDO? Do we have the data we need to ask and answer some fundamental business questions? Because that’s pretty much what DDO really entails.
On a final note, moving beyond our over reliance on disclosure can also translate to a reduction in regulatory burden. Here an opportunity for government. To revisit the legislative obligations for disclosure by business.
But much of the reduction in regulatory burden rests with business becoming consumer centric. Closing the gap, doing the right thing, using weapons of mass influence as a means to the right end – being good consumer outcomes. And restoring balance between the consumer’s personal responsibility with the firm’s responsibility to do the right thing by those consumers. A simple but universal truth.
 From the UK Financial Reporting Council’s July 2016 report ‘Corporate Culture and the role of Boards’.