Protecting vulnerable stakeholders - fairness in global financial markets

Abstract

The damage caused by the financial crisis of 2008-2010 affected millions of people, who saw their savings and investments wiped out, as well as losing their homes and jobs. The nature and severity of the losses at the height of the crisis, even today, illustrate how even the most prudent people, living modestly and striving to save for their future financial security, now find themselves in a situation of permanent vulnerability to the decisions of major financial institutions. The pressing question is how to better protect the most vulnerable stakeholders in the financial markets. It is not only important, but also timely, to look at the problem from an equity perspective.

The financial crisis has revealed the shortcomings of financial markets, in terms of their operation, transparency and accountability. In developed countries, with the dismantling of employer-sponsored pension schemes, people have had to make decisions about how to invest their retirement savings. However, many of these investors lack the information, skills and time to make informed decisions. Markets were originally designed for people who could afford to lose their investments, not for people seeking secure investments for the future. Although the explicit aim of financial market regulation is not to distribute wealth, the rules and practices observed by these markets have had direct and indirect consequences on this distribution. Since we are now deeply involved in financial markets, it is important that they are as fair as possible.

The term " fairness " is difficult to translate and render accurately in French; it encompasses both the notions of "equity" and "justice". In the realm of financial market policy, it means deepening our understanding of these markets, taking into account the views of others and striving for a more equitable situation. The ways in which we react to fair or unfair situations have both a physiological and a social aspect. The physiological aspect of fairness originates in the brain. Research in cognitive neuroscience, although still in its early stages, suggests that in the individual, the definition of fairness results from a complex interaction between brain chemicals, such as oxytocin, generating instinctive reactions to justice or injustice [1]. Our brains react positively to fair or just treatment, activating a reward system; similarly, we react negatively to unfair or unjust situations [2]. Thus, empirical work by Fehr and Schmidt reveals that individuals are prepared to forgo certain material advantages in order to make things fairer and more equitable [3]. This elementary definition of fairness is also subject to social influences. It seems that the greater the distance between the decision-maker and the victim of injustice, the less sensitive the brain is to harm caused to others, notably because the social environment has the power to alter neurochemicals and thus modify reward systems [4]. This discovery could help explain why financial intermediaries and derivatives traders, when implementing their high-risk strategies, chose to ignore the harm caused to the financial security of hundreds of thousands of people, far removed from their everyday reality.

Definitions of fairness based on consideration of the point of view of others have their roots in a distinct field. According to Aristotle, a sense of fairness is an essential human characteristic, necessary for the proper development of human beings within the framework of fundamental social practices [5]. Immanuel Kant put forward the idea that the actions of each individual should be considered as if they were destined to become universal laws [6]. So, when it comes to defining the particular rules or norms that should govern our activities in the financial markets, we need to decide whether we would like to see these rules or norms applied to everyone, including ourselves. According to Rawls, observing fair processes could lead to a better distribution of resources, so that the least privileged members of society would benefit the most. If individuals had to decide on the distribution of goods without knowing to what extent they would be the beneficiaries, they would ensure that such distribution was fair to all [7].

With the proliferation of financial products, people are obliged to rely on a financial advisor to guide them through the complex world of savings and investments. In many countries, the norm for financial advice remains a lack of fairness towards small investors, who find themselves in a vulnerable position. One of the most common misconceptions about small investors is that the person providing them with financial advice or information is acting in their best interests; but in Canada, and in a number of other countries, the only obligation of financial advisors is to "know their client". All financial advisors should have a fiduciary duty to act in the best interests of their clients. Currently, all lawyers and teachers are subject to a fiduciary duty.

In all fairness, only one standard should apply to the relationship between financial advisor and investor: the best interests of the client [8]. Institutions that design financial instruments should be obliged to create at least some of them for the type of investors now involved in the markets, and thus meet the need for safe, low-risk products.

In addition, access to basic banking services, including consumer protection, should be available everywhere. Worldwide, more than 2.5 billion people have no bank account, no access to credit, credit cards and other basic banking services [9]. The lack of equitable access to these basic services has led to a proliferation of predatory lending around the world. Consumersneed fair access to credit. Banks should be required to offer affordable credit to low-income borrowers, with low interest rates and longer repayment periods, as there is an important relationship between access to financial services and individual well-being. Fairness requires the creation of regulatory and practical standards to establish a fairer context for financial security. This is only the first step, but it is an important one, giventhe current financial instability.

References

[1] P Churchland, Braintrust, What Neuroscience Tells Us about Morality (Princeton U Press, 2011); P Reiner, "How Reliable are Attributions of Fairness?", in J Sarra, ed. An Exploration of Fairness: Interdisciplinary Inquiries in Law, Science and the Humanities (Carswell, 2013).

[2] E Tricomi et al, "Neural Evidence for Inequality-Averse Social Preferences" (2010) 463 Nature 1089; G Tabibnia, A B Satpute & M D Lieberman, "The Sunny Side of Fairness: Preference for Fairness Activates Reward Circuitry" (2008) 19 Psychological Science 339; Lawrence Ward, "The Dance of Fairness", in Sarra, supra, note 1.

[3] E Fehr & K M Schmidt, "A Theory of Fairness, Competition and Cooperation", (1999), 114 Quarterly J of Ec, MIT Press 817.

[4] Churchland , supra note 1.

[5] Aristotle, Nicomachean Ethics (350 BCE), translated by W.D. Ross (Canada Batoche Books, 1999).

[6] ImmaneuelKant, Kant: Political Writings, ed. by Hans Reiss (Cambridge University Press, 1991).

[7] John Rawls, Justice as Fairness (Harvard University Press, 1985).

[8] See Markets in Financial Instruments Directive (MiFID II), Directive 2014/65/EU of the European Parliament and of the Council of May 15, 2014; it marks an important development, particularly with regard to the customer interest standard.

[9] The Guardian, Caspar van Vark, "Examining the roles and future of microfinance", December 12, 2012.