Is behavioural economics the way forward for advice?
The FCA wants firms to adopt behavioural science tools to ensure that any financial advice, services or products offered do not take advantage of human nature. Eight weeks into the new regime and we are already witnessing a distinct change in regulatory style. Gone are the large stick and small carrots. Laboratory coats and safety goggles are donned in preparation for ‘field trials’.
Having attended the recent FCA presentation at the London School of Economics on the importance of applying behavioural economics within regulatory directives, it is clear the industry needs to get its head around the implications for the adoption of behavioural science and its associated tools.
Behavioural economics is not new. It was introduced in the 1970s when Daniel Kahneman and Amos Tversky first started questioning the fact that human beings are not perfectly rational, particularly when it comes to money, and proposed that the fallibility of human nature should be factored into the management of our everyday lives, including our financial affairs.
What is new is the adoption of the associated tools for ‘nudging’ consumer behaviour into making better financial decisions and the industry to design better products and services around such regulatory structure. The Government has already cottoned on with its behavioural insights team, which encourages policy to be written around influencing better personal health care, utility use and payment of tax.
The FCA and behavioural economics
The regulator recognises the fact that humans operate two systems of thought: intuition (fast, effortless) and reasoning (slow, deliberative). We have a penchant for the former, which can lead to favouring inertia or the status quo. The FCA will thus want to ensure that any financial advice, services or products offered do not take advantage of this natural tendency. A clear example is the PPI mis-selling scandal, which relied on people’s implied acceptance that the product was appropriate for their circumstances.
By recognising and defining human biases, the regulator can then assess consumers’ and firms’ behaviour and the impact of competition and then apply behavioural analysis in various ways, including identifying risks to consumers, understanding root causes of problems and designing effective interventions. Indeed the field trial the FCA conducted recently illustrated how consumers can be nudged to respond to a regulatory letter. By simplifying the message, using bullet points and less official language, responses increased by over 10%.
But what does this mean for industry practitioners, particularly those who still remain sceptical or bruised by previous regulatory experiences?
The good news is that behavioural economics provides great strategies to use when times are tough and client trust needs nurturing. With so much market turbulence and regulatory change, influencing adviser firms and their clients’ behaviour can quickly develop the right co-operative culture to ensure sustainable growth and trusted client and regulatory relationships.
This can be done through a three-step process:
• Change management: Ensuring that the firm has the right leadership team, board structure and governance system is important. Encouraging full participation of all relevant staff members in any change structure is crucial for buy-in and a smoother journey.
Ensuring organisational tendencies such as overconfidence, over-planning, narrow framing or loss aversion are recognised and managed will mean a robust, client centric business model is built.
• Client engagement: How often do adviser firms send surveys to their clients? It rarely happens. Yet this is one of the most cost-effective and best ways for ensuring clients feel they are heard, understood and services are tailored to their needs.
Using technology such as online valuations and social media to create an interactive, online client centre will also enhance trust and engagement. Client segmentation by defining the relationship between client and firm, rather than just financial worth, creates great client value. This can also aid recognition that people deal with their money in different ways. Social science also tells us that adviser personality traits are imposed on their clients. Firms have to ensure their advisers understand their impact in client meetings. Adopting such approaches will ensure a firm’s services are designed around its clients’ needs and meet the “client best interest rule” as well as TCF requirements.
• Risk management: In its previous “assessing suitability” papers, the FSA wanted to ensure that the services and tools used were appropriate and suitable for clients. Focusing on the development of soft skills and improving organisational behaviour will help facilitate a robust risk management process by:
➢ devising and implementing focused client questioning skills to establish risk attitude and loss capacity;
➢ creating a system to identify clients exhibiting un-vocalised unease and those best suited to lower risk strategies;
➢ implementing a safety check system to ensure client informed consent is gained;
➢ ensuring the firm’s management information and data is collated and used efficiently and effectively.
By adopting behavioural economics as part of its regulatory strategy, the FCA is exhibiting its own human side. FCA chief executive Martin Wheatley spoke of the fact that the regulator is accountable, has its own biases to manage and needs to build better relationships with those it regulates. By understanding and adopting behavioural science, adviser firms, product providers and distributers can now ensure they align themselves with regulatory practice and build high relationship capital with all of their stakeholders along the way.