The complexity of many financial products and the lack of consumer understanding about their risks is a key focus for ASIC. Despite a clear mandate not to pre-vet disclosure content, ASIC is using its “soft power” to influence the design of securities offering documents. The first cab off the rank it seems is hybrid securities which ASIC believes are not well understood by investors. The “soft power” ASIC will be applying arises from behavioural economics.
The traditional view of “economics” assumes people are rational, and that they make optimal and consistent investment decisions.
But we all know from experience that people don’t always make the best or the same decisions.
This is where behavioural economics theory comes into play. It takes into account the psychology behind people’s ‘less than rational’ choices. A classic example of irrational economic behaviour is “retail therapy”: shopping to improve one’s mood.
It also analyses how people make decisions based on the way information is presented – what do you buy – yoghurt that “contains 10% fat” or that is “90% fat free”?
Governments are now using behavioural economics to understand the real drivers behind consumers’ decision making. They then use that information to “nudge” or “shove” consumers to make choices the government desires.
An example is the UK Government’s “Behavioural Insights Team” (BIT) – otherwise known as the “Nudge Unit”. Established in 2010, the BIT has used behavioural economics to influence citizen behaviour in several policy areas, including encouraging people to sign up for organ donation – by identifying the most influential message – “If you needed an organ transplant, would you have one? If so please help others.”
The BIT also identified an effective way to increase the number of people who pay tax on time – by including at the start of a letter the factual statement that “9 out of 10 people pay tax on time”..
Over recent years the Australia’s Commonwealth and various state governments have seen the benefit of behavioural economics in improving regulatory design. The UK Financial Conduct Authority in its 2013 Occasional Paper No1 also outlined how it will use behavioural economics research in the regulation of financial conduct.
Now, through two studies announced on 18 March 2015, ASIC is using behavioural economics in a more direct way than previously. The first of these research initiatives is unremarkable – going to the best design of ASIC’s communications with directors of firms in liquidation so as to increase their compliance with their legal obligations.
The second – ASIC Report 427 is more interesting – it flags the use of behavioral economics to design consumer protection messages that should be included in financial product promotional materials. In this case, the focus is on hybrid securities.
When it comes to hybrid securities, ASIC has a real concern that consumers who invest in these products do not adequately understand or assess the risks they are exposed to.
However, ASIC states that many of the protections normally available when regulating other products—such as license obligations imposed under an AFSL—are not available when regulating hybrid securities.
Accordingly, ASIC has tailored its regulatory approach for hybrids, relying primarily on disclosure regulation.
ASIC has reviewed what it considers is necessary for “clear concise and effective” disclosure for hybrid offer disclosure documents. ASIC says that it wants to work with issuers of hybrid securities to improve disclosure by including information on the features and risks of the product but in a way that is sensitive to the biases that behavioural economics has identified in all investors.
The behavioural research now being undertaken by ASIC is directed at identifying consumers’ biases when assessing risks associated with hybrid securities (and their comparison against other investments).
Expect to see the findings of the research come into play in ASIC’s interactions with industry and consumer education programs in the near future.
But the use of the findings is likely to surface in new ways.
ASIC does not endorse, approve or verify the content of prospectuses, however on request, it reviews and provides feedback before they are finalised. Similarly, ASIC cannot mandate the structure of prospectuses. It has no legislative mandate to do so. Yet it can influence prospectus content and form through its review process or the way information is presented. In this exercise of “soft power”, ASIC’s views and desires are often accepted and reflected in the final form of the document.
Armed with this research ASIC may now strongly “suggest” the incorporation of certain messages, or the sequence in which information is provided – where that message or sequence has been shown to lead to better investment decisions by consumers.
This may well be at odds with the content or format that a sponsor may wish to present – but hard to resist given ASIC’s position, and the resulting transaction risk from not knowing how ASIC will react if its “suggestions” are not adopted.
Expect to see behavioural economics playing a greater part in ASIC’s approach to market participants. For those involved in the issue of hybrid securities and the development of prospectuses, ASIC Report 427 will give an indication of the areas where ASIC may take a heightened level of interest, or where it may seek to ensure certain messages are conveyed.
And the next question is – in what other areas will ASIC seek to exercise soft power?
The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.