Complex vs simple financial instruments: What is in best interest of customer?

Several financial advocates and regulators have argued forcefully for simplicity in the design and pricing of financial products so that customers can fully comprehend what they are buying and can compare multiple pricing options across different providers. This focus on simplicity intensified after the 2008 global financial crisis which exposed the world to complex financial products and their supposedly inherently harmful nature, directly leading to, for example, the creation of the Consumer Financial Protection Bureau (CFPB) in the US. In light of these events, simplicity in the design of financial products and services have become inextricably linked to the regulators’ view of customer protection.

An overly zealous enforcement of the principle of simplicity on financial products and services, combined with a consumer product-led FMCG style marketing associated with these products by providers and the inability of regulators to keep pace, has ensured that this principle has crept into the very design of financial products, often at the cost of optimal financial outcomes for the consumer. As Professor Zywicki argues, “an undue focus on simplification risks sacrificing functionality in order to fit the product’s attributes into the straitjacket of the preferred disclosure format, rather than fitting disclosure regulation to the product’s substantive attributes”.

In a well-functioning market, there is a strong need for customers to understand exactly what the functionality of a product is and whether the price charged for any improved functionality is consistent with the value that it provides to them. For instance, a customer looking to buy a mobile phone would understand the benefit she could get from additional features such as higher storage or processing power even while she may not fully understand the details of their technical working. She would also be able to estimate the incremental value to her, of these features above that of the basic operating model, and her choices (and in aggregate, the very behaviour of the market) would be guided by it. Likewise, for financial services and products, the product attributes need to be communicated through a disclosure regime that emphasizes clarity, comprehensibility, and completeness but it is not at all clear that it is in the interests of the customer to take a reductionist approach towards product design itself by reducing its complexity and therefore its associated functionality merely so that the customer can understand how the product is constructed.