Friday, November 09, 2012

Finding the right path in consumer protection

by Anand Sahasranaman.

The recent approach paper of the Financial Services Legislative Reforms Commission has brought a fresh focus on consumer protection. What are the possible frameworks for financial consumer protection in India, and what would be the core elements of an ideal framework? This is the question that the IFMR Financial Systems Design Conference 2012 sought to answer. The Conference titled Envisioning the Future of Financial Consumer Protection in India was held at IFMR Trust, Chennai, on 31st August and 1st September 2012.

The Conference was designed to take a first principles look at financial consumer protection, deliberately setting aside constraints that reflect the current realities of the Indian context of consumer protection. The conference was organised to carry out deliberations around three stylised approaches to consumer protection, namely: an Emphasis on Disclosure, an Emphasis on Eliminating Conflicts of Interest, and an Emphasis on Suitability. In reality, any consumer protection framework would include elements from all three approaches, and the objective in setting up the conference as a debate between approaches was meant to sharply identify the way in which these approaches would fit into an overarching framework for India.

Keeping in mind the two-fold agenda of creating a framework for solving the current failings of the Indian market and providing a meaningful long-term solution for consumer protection in view of the future of Indian finance, Suitability emerged as the paradigm of choice to be placed at the heart of the consumer protection framework for India. The Suitability framework shifts the onus of consumer protection from the buyer to the seller of financial services through legal liability on the latter. However, it was also felt that very important aspects of Disclosure and Eliminating Conflicts of Interest would need to be built around this foundation of Suitability.

A Suitability Framework

Suitability is defined to be a process that pervades all functions within financial services manufacturers, intermediaries, and their representatives, such that at all points of time, the provider acts in the best interests of the consumer. The power of the Suitability framework will derive from the imposition of legal liability on financial services providers to act in the best interest of consumers, and thus decisively shift the onus of consumer protection from the buyer to the seller.

Suitability will not take away the right of the consumer to choose. The final decision, on whether to accept the financial advice or buy the product recommended by the seller must always lie with the consumer. What Suitability is meant to ensure is that the consumer gets expert unbiased recommendations that are in her best interest.

For Suitability to be realised, every citizen must have the right to be provided suitable advice or recommended suitable products. The principle of Suitability needs to be enshrined in mother regulation and the interpretation of suitable behaviour would be best determined by the build-up of case law precedents over time, thus ensuring that our understanding of Suitability comes from the realities of the financial marketplace and its evolution over time

Role of Disclosure in Suitability Framework

India has so far relied on caveat emptor, or a disclosure based framework of consumer protection. Participants however noted the fact that increased disclosure has resulted in information-overload for consumers and, along with behavioural biases, led them to make sub-optimal decisions resulting in bad financial outcomes. Despite this, it was felt that there were aspects of Disclosure that would be essential in a Suitability framework. Within the Suitability framework, it was felt that disclosure of real time transaction level data that could be meaningfully analysed be analysed by neutral third parties - industry analysts, financial advisors, market aggregators, media - or "wholesale" consumers could be useful in developing comprehensible welfare enhancing consumer-level outputs. Other aspects of Disclosure such as the need for comparators and benchmarks for products, and the need to make some financial terms commonly understood were also deemed important.

Eliminating Conflict of Interest in the Suitability Framework

Regulatory regimes all over the world have used a variety of approaches to eliminate conflicts of interest that exist within providers of financial services. The most common approach is to disclose the existence of such a conflict to consumers and let the consumers decide for themselves. Within the Suitability paradigm, however, eliminating conflicts of interest is naturally built through the legal liability channel. Even in scenarios where is it is not possible to separate out advice from sale, given the legal liability in the form of a fiduciary responsibility on the provider, the provider is obligated to ensure that they act in the best interests of the consumer, ahead of their own self-interest.

The conference also raised a number of questions for research on the Suitability framework related to its implementation, legal framework, regulatory and institutional costs as well as lessons from international experiences.

The detailed conference proceeds can be found here.

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