April 10, 2013 11:27 pm

FCA targets exploitative tactics

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Martin Wheatley©FT

Martin Wheatley, chief executive of the Financial Conduct Authority

The head of the Financial Conduct Authority has said it will draw on behavioural economics to identify and stop sales tactics that exploit investors’ fears and biases.

Martin Wheatley said the new watchdog would be swift to take action when retail customers were encouraged to act against their interests.

The FCA will seek products and companies that could be taking advantage of known human frailties and follow up with supervisory visits and mystery shoppers – people dispatched to test the customer experience.

The regulator, which took over from the Financial Services Authority last week, is also studying ways to use “nudges”, small changes that steer customers in a positive way towards decisions that are good for them.

“I want the FCA to bring a more human face to the regulation of financial services; a more pragmatic approach to regulation. Not only to defend against sharp practice but also to encourage better decision making among consumers,” Mr Wheatley told an audience at the London School of Economics on Wednesday night, according to a prepared text.

“‘Buyer beware’ becomes hard to defend when unsophisticated customers are buying seriously complicated financial products, where the risk of failure is far more dangerous than a decision in the supermarket to buy three bananas instead of one,” he said.

Two research papers issued on Wednesday by the watchdog offered the first concrete examples of how the FCA intends to protect consumers from their own worst impulses and stop companies from taking advantage of them.

In “Applying behavioural economics at the Financial Conduct Authority” the authors note that motor insurance buyers are twice as likely to sign up for add-on products, such as legal or breakdown cover, if they are presented with it as a default option than if they have to affirmatively choose it.

Customers are more likely to sign up for ancillary insurance policies when they are sold alongside much more expensive items and therefore appear cheaper, the paper suggests. Similarly, when choosing between index tracker funds, investors tend to opt for the one that has chosen the most flattering time period to illustrate its past results.

Supervisors will be encouraged to watch for this kind practice and to question sales tactics that appear to be taking advantage of common customer biases. They may also ask companies to change the way information is presented.

The paper suggests the FCA will be taking a second look at companies when customers persistently buy products that do not appear to be in their economic interest. A red flag will be when customers choosing between nearly identical products opt for the one with higher fees or lower returns.

“The FCA wants to make sure customers are far more easily able to compare product prices and to assess their value. We want the regulatory system to use behavioural economics to ascertain whether people are being put off switching products through inertia, inattention or even the simple fear of regret from making a wrong decision,” Mr Wheatley said.

At the same time the FCA is looking at “nudges” to help customers make good choices. “Encouraging consumers to claim redress: evidence from a field trial” reports on original research done by the watchdog to try to improve response rates to letters offering customer redress.

At the moment the response rate to such letters is abysmal – less than 2 per cent – when the amounts involved are small. FCA staff worked with a bank to tweak the letters in subtle ways. They doubled the response rate by shortening the letter by 40 per cent or including a sentence in bold saying the claims process would take five minutes. Rewriting the bullet points at the top of the letter was even more effective, nearly tripling the response rate.

“Subtle changes to the presentation of information can have large effects. The cumulative effect of our [changes] is statistically and economically meaningful,” wrote the authors, Paul Adams and Stefan Hunt.

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