Transparently Opaque: substituting complex rules and regulatory oversight for transparency and market discipline

In an interesting article, Associate Professor Daniel Schwarcz discusses the role of transparency in our financial system.  He focuses on insurance products and introduces the idea of a financial product being "transparently opaque".  Such a financial product substitutes complex rules and regulatory oversight for transparency and market discipline.

Regular readers are aware of many areas of finance that are transparently opaque including, but not limited to, structured finance securities and banks.

Broadly construed, transparency‐based consumer protection encompasses regulatory interventions meant to increase awareness of relevant market information among consumers and investors, or those who might police the market on their behalf, such as regulators, academics, stakeholders, public interest groups, or journalists.

Professor Schwarcz highlights two key aspects of transparency.

First, the role of regulators in ensuring access to relevant information.

Second, the users of transparency are consumers, investors or those who might police the market on their behalf.

Transparency‐oriented regulation can address at least four types of regulatory concerns in financial markets. 

First, it can improve consumers’ understanding of the products they ultimately purchase, and thus their capacity to use those products effectively. 

Second, it can promote better matching of consumers with appropriate financial products. 

Third, transparency can promote market discipline by ensuring that firms will be penalized through decreased demand for their products or increased public scrutiny if they attempt to increase their bottom line in ways that harm consumers. 

Finally, market transparency can promote regulatory discipline by facilitating the public’s ability to identify problems in regulated markets and hold regulators accountable for failing to prevent those problems.

Please re-read the highlighted text and the issues that transparency addresses.  Regular readers should be very familiar with this list.

Unfortunately, effectively promoting transparent consumer financial markets is not easy.

How true!

One of the reasons that promoting transparent financial markets is not easy is that market transparency promotes both market discipline and regulatory discipline. It shines a bright light on regulators not doing their job.

As a result, regulators actually have an incentive to support transparently opaque and substitute complex rules and regulatory oversight for transparency and market discipline.