Formula to prove price transparency would benefit all, says FSA

Formula to prove price transparency would benefit all, says FSA

Aug 15 2007 Joanne Wallen

The Financial Services Authority published a couple of academic "occasional papers" last week, but does it really take 36 pages of algebraic formulae to conclude that consumers would be better off if the pricing of financial products was more transparent?

I have nothing against academics. I used to be one — well, in between theatre group and the students union bar at any rate. But the paper, entitled "Modelling Changes to Consumer Welfare Caused by Reduced Price Transparency", states what to most of us is the blindingly obvious.

Scattered among the hieroglyphics there are some concise, if obvious, conclusions. "A reduction in price transparency that makes it more difficult for consumers to understand product charges has the effect of increasing the prices charged by all providers." In other words, firms can get away with charging consumers more by making it difficult for the consumer to have a clue what he or she is paying for.

"Dominant providers" we are told, "benefit the most from reduction in price transparency." Roughly translated, this suggests that when people are not given the facility to compare prices accurately, they tend to stick with the big-name brands.

This in turn, the report says, creates "monopoly power," which further weakens competition among product providers. "This leads to an increase in the prices charged by all providers and in providers' profits, at the expense of consumer welfare."

Comparing products

The less educated consumer suffers most from this lack of price transparency, since he is either incapable of understanding, or does not have the time to consider, the subtleties of all of the different charges that might affect the overall cost of one product compared with another.

All of which is good common sense, but here come the hieroglyphics. "Only consumers of sufficiently high ability ... exert effort in information processing and buy from the cheapest provider, whilst the remaining consumers remain uninformed and buy at random."

Consumer detriment is present whether they buy investment products directly from a product provider or via a financial adviser. "A well-functioning market for financial advice can help to improve consumer information and thus to reduce the negative effects that lack of price transparency generates on consumer welfare. The better the functioning of the market for financial advice, the lower will be the prices of retail investment products," the report says.

That said, where financial advisers are influenced in their product recommendations to customers by "commission bias", or where they are simply incompetent, this can offset the benefits to consumers. Presumably this is why the FSA launched its retail distribution review in the first place.

The report suggests that "for this reason enforcement action and compensation claims for unsuitable advice are crucial policy instruments to reduce the effect of lack of price transparency in the market for retail investment products".

It also suggests that it would be more beneficial for consumers if the FSA were to look at introducing "a policy that directly helps consumers to compare product charges by increasing the level of price transparency in the market".

The views and the opinions expressed in 'hot topics' are that of the individual authors and not necessarily those of the Securities & Investment Institute.