EU Retail Investment Strategy: Discussions on a Possible Ban of Commission-based advice

While this has been considered by the responsible EU Finance Commissioner Mairead McGuiness to ensure consumer protection, industry associations are expressing strong criticism.

What would a possible commission ban regulate?

Up to now, remuneration for brokering financial products to retail investors, for example by way of investment advice (so-called Zuwendungen within the meaning of the German Securities Trading Act - Wertpapierhandelsgesetz), has often been linked to the actual conclusion of a contract for a financial product. The issuer of the brokered product pays a commission to the intermediary of the product after conclusion. The amount of the commission paid depends mainly on the volume of investments collected and the term of the financial product.

The criticism of this remuneration model is in particular that it can create an economic disincentive for the investment advisor to act according to primarily his own economic interests - and not those of the customer. Since the commission is higher the more financial products are brokered, this can create an incentive not to look too closely at the appropriateness or suitability of the product for the retail investor. In addition, there could be an incentive to give priority to the product that promises the highest commission.

Because of these potential disincentives, the EU Finance Commissioner now wants to ban perfor-mance-based commissions in the retail investor market in favor of a fee-based model.

What are the arguments in favour of commission-based business models?

Proponents of performance-based commissions, however, see the threat to effective consumer protection precisely in the planned commission ban. The fact that the remuneration of the invest-ment advisor is only linked to the conclusion of an investment creates broad access to individual-ized advice. If a fee is charged to the retail investor for advice independent of an investment, this leads to more consumers making investment decisions without expert advice and therefore mak-ing transactions without advice in order to save high fees. This increases the risk of making the wrong financial decisions.

Precisely because the amount of the commission is based on the size of the investment made, a consumer-protective system of cross-subsidization is made possible: the higher commissions on larger investment volumes are used to finance investment advice for investors with less capital. This not only enables comprehensive advice, but also creates access to professional investment advice for everyone.

The legal control function of the applicable capital market regulation must also be taken into ac-count for the question of possible negative incentives, in particular the MiFID II regime implement-ed in Germany in the Securities Trading Act. According to this, investment advisors are on the one hand already fundamentally obliged to act in the interest of the client. Specifically, they are also comprehensively obliged to provide the client with information on commissions received, for ex-ample, from the issuer or another third party, and to break these down into cost information. These payments must be recorded in a register that can be viewed by the supervisory authority and are subject to qualitative requirements.

Alternative models

One alternative to commission-based remuneration is the fee-based model mentioned above. This establishes a remuneration entitlement for advisory services that is not dependent on perfor-mance and, in the view of the EU Finance Commissioner, is intended to lead to advice that is in line with the interests of the client. Since the remuneration of the advisor is now independently se-cured, it is promoted that this advisor also completely advises against a financial product, if it is not meaningful for his/her client.

In addition, the fee model leads to lower prices for financial products, as the issuers no longer include the costs of performance-based remuneration in their prices. Even if this saving through the fee to be paid does not result in a benefit for the retail investor, it is better ensured that advice is given in a manner that protects the retail investors.

Securities trading law already regulates independent fee-based investment advisors who are en-tered in a register and provide advice solely on a fee basis. However, the economic success of this regulation seems to know its limits, as the register kept by BaFin lists just 18 investment advisors. It seems that retail investors are rarely willing to pay for the services of investment advisors.

Other proposals are also being raised in the discussion - sometimes also by consumer advocates - who do not want to see commission-based remuneration banned in principle for the reasons mentioned above. For example, it is suggested that advisory and acquisition costs could be mandatorily allocated over the entire product term in order to avoid one-off commissions that are not included in new contracts.

Outlook

Whether the commission ban will find its way into the EU strategy on retail investors is still a matter of dispute.

While the financial services industry regards the blanket rejection of gratuities - and thus of com-mission-based business models - as illegitimate and opposes the planned commission ban, proponents consider the existing sales apparatus to be over dimensioned and expect the commission ban to lead to a correction.

Most recently, the discovery of a calculation error in a study intended to serve as the basis for the retail investor strategy led to renewed criticism. Contrary to the statement of the study, commis-sion-based financial products were not 35 percent more expensive than products without commis-sion compensation. The additional costs determined in the study on the basis of 176 financial products would only be between 24 and 26 percent after adjustment for the calculation error; however, this value is also already the subject of discussion. The high acquisition costs are also often used by the EU Finance Commissioner as the main argument for a commission ban.

The commission ban has also been discussed in the German parliament. The CDU and CSU parlia-mentary group in the German Bundestag recently submitted a “small parliamentary inquiry” to the German government. This contains 34 questions, which concern among other things the effects of a commission prohibition for the development of the private age precaution or the restrictions of fees in the fee consultation. The German government, however, has not yet provided an answer.

In any case, it should be clear that a commission ban in the retail investor market would have a considerable impact on the structure of the investment advisory industry in Germany.

With the kind assistance of Manuel Traub, research assistant.