Complexity threatens stability, confidence and competition

The Superannuation Consumers’ Centre says complexity threatens stability, confidence and competition.

Complexity has emerged as a significant threat to the stability of the financial system. It  undermines confidence, understanding and is impeding competition, the Superannuation Consumers’ Centre says in its submission to the Financial System Inquiry.

The new consumer body says innovation may be a great strength of the financial services sector but it is also one of its weakness because not enough people, including the experts, know what is really going on.
“Much of the innovation in the sector has been in highly complex products that few people fully understand, “ says chair Jenni Mack

“Complexity is undermining confidence in the system, not least because some complex products have proved very dangerous and destructive of people’s life savings.”

The Super Consumers Centre says the GFC exposed the dangers posed by complex products that few consumers and many in industry and government understood, such as mortgage-backed securities, collateralised debt obligations, over-the-counter derivatives, credit default swaps, and mezzanine products.

“It was not only consumers who didn’t understand the system –it seems no-one really did:  not regulators; not fund managers; not hedge trader or investment banks” Jenni Mack says.

“And the GFC has not abated the flow of complex structured products offered to retail consumers.”

The submission also notes that complexity impedes competition because it robs consumers of the capacity to drive markets.

“In financial markets complexity means that consumers often don’t know what they have bought before or after purchase. Worse still, those consumers turn to help them – financial advisers – don’t always understand what they are selling,” the submission says.

Consumers can only drive markets when they can properly signal their desires to markets. Consumers can do this best with simple products that they (and their advisers) can understand. 

Competition on unnecessary features – effectively bells and whistles –  that consumers neither understand nor need, pushes up costs and exploits consumers’ inherent incapacity to exercise rational choice and distorts the market away from the needs and interests of consumers, the Super Consumers Centre says.

However the rise of big data – properly harnessed – may be able to help consumers.  The submission quotes US “nudge” academics Thaler and Tucker who say “a potent mix of modern technology and new government policy… may empower consumers in new ways giving them the ability to comparison shop more easily and make better choices.”

“This will have big implications for companies that currently gain market share through “deception and obfuscation – or by taking advantage of consumer laziness”.  This type of disclosure may make markets more efficient.

The UK midata project[1] and the US Smart Disclosure Policy aims to give consumers better control of their data and encourage businesses to develop tools to enable consumers to make effective use of that data, the Super Consumers Centre notes. 

The full submission is available here.