Financial planners are under scrutiny as never before and there is a consensus building that there should be a clear distinction between information, sales and advice about financial products. But will this solve the problems of individuals who buy financial products that are not good for them?
We may strip out the dodgy planners and demand higher standards for entry into the financial advice business, but is it the advice that is the problem or the products on offer? Indeed, our biggest scandals have involved both advice and products. We need to be sure that planners who morph back into sellers do not sell dodgy products.
There is a lot of talk about “safety” in financial markets. Our laws go to inordinate lengths to ensure that individuals do not borrow more than they are able to repay. Borrowers who get into financial difficulties are able to ask a lender to reconsider their circumstances and alter the conditions of a loan. There is no such safety net for investors.
For tangible products, there are safety standards, product warnings, product recalls, compensation if defective products damage people, buildings or other goods, and compensation if products fail to meet their description, are not fit for a declared purpose or desired result or are not of acceptable quality.
We should consider whether the mandatory quality consumer guarantees in the market for goods and services, product safety requirements and the suitability standards in consumer credit are applicable to financial products.
It should not be controversial to require that financial products live up to their description. If I am prepared to live with a high level of risk, I don’t want to be lumbered with a low risk financial product that will not give the same chance of high return. If product manufacturers, issuers or suppliers describe a product in one way and at the time of acquisition it does not meet that description, why should they not be liable?
There is already an implied warranty in every financial services contract with a consumer that the service is fit for any particular purpose or desired result if the consumer makes this known to the supplier. We can easily extend this obligation from financial services to financial products.
The consumer guarantee of acceptable quality applies irrespective of a communicated purpose or desired result. It speaks to community standards. The test is what a reasonable consumer fully acquainted with the product, including hidden defects, would regard as acceptable. Assessing this could take into account the product and statements and representations about the product. It could not guarantee future rates of return but it could assess reasonable expected rates of return at the time of acquisition. It may be possible to build a future time frame into this.
Mandatory guarantees with consequences for failure to meet the standard should ensure that consumers get what they have bargained for and what the community expects they should receive.
Will this be enough? Some financial products may be toxic and should not be in the market at all or should not be sold to certain categories of individuals. Think about highly risky managed investment products linked to reverse mortgages with no stop on negative equity. Here there is a role for banning products, product warnings and even financial product recalls. We have already banned negative equity in reverse mortgages.
Should we consider a mandatory suitability assessment before financial products are sold? Are all products suitable for every individual and for every individual at each stage of life? A young person in a good job may be able to sustain the risk of loss for the chance of return. A retiree may require financial products that husband the investment. A ninety year old may not need longevity risk insurance. This may be sensible for a young person.
The suitability assessment would take into account the needs and requirements of the individual. This is what financial advisers must already do. But it is only their advice which must be in the best interests of the client and advice which must meet the standard of appropriateness. Why not ensure that the financial product as sold is in the best interests of the particular consumer.
The objective of the financial system is to meet the needs of the real economy and the needs of financial citizens. As the population ages and lives longer, we need a strong competitive economy and individuals need robust financial resources. We cannot afford individuals who had hoped to be independent in retirement having to rely on a social safety net because they were sold inappropriate, unsuitable or defective financial products.
This article was first published in the University of Sydney Business School
