Retail investment strategy: Resistance to inducement ban and other proposals by the European Parliament

Plans of the Commission

In the framework of the Capital Markets Union, the EU has adopted measures since 2015 to create a genuine single market for capital. Within the framework of this project, legal reforms are also planned that are to serve the protection of small investors.

In her first draft, the responsible EU Commissioner Mairead McGuinness had envisaged a comprehensive ban on commissions. This provided that in future the remuneration of financial services should not take place through commissions ("inducements"), which are paid to the investment firm in the case of a successful brokerage of financial instruments. The background to this initiative is the assumption of the EU Commission that investment firms would be incentivised to not orient their investment services primarily towards the needs of their clients, but would prefer to recommend such products whose distribution is remunerated by a higher commission.

This position meets with great resistance from the financial industry and various political circles. They fear that the alternative remuneration model of independent fees will lead to small investors making their investment decision without prior professional advice to avoid fees for their services. However, the risk of making the wrong decision would be significantly higher than without advice, thus doing a step backwards to investor protection.

We have already reported on this and looked at the various arguments for and against the proposed commission ban.

What is planned instead?

After the aforementioned opposition to the planned regulations, the Commission adjusted the retail investor strategy in key points (we reported on this in detail).

Probably the most important change is that the originally planned, comprehensive commission ban has been softened and should now only apply to execution-only transactions that have not been preceded by advice. However, the Commission reserves the right to subsequently introduce a commission ban if the planned regulations do not produce satisfactory results with regard to investor protection within a three-year observation phase.

Furthermore, the current proposal provides for a so-called "benchmarking": For this purpose, the European supervisory authorities ESMA and EIOPA are to determine benchmarks in the future, to visualise the usual price for financial products. According to the current proposal, investment firms whose products exceed these benchmarks must explain their reasoning for doing so.

As a further measure, a best-interest test is planned, which would oblige investment firms to select the most cost-efficient financial instruments from an appropriate range of products that are suitable for the customer and have similar characteristics. From this selection, one or more products should then be chosen which do not have additional features that are not necessary for the client's investment objectives and cause additional costs.

Current opposition from the Parliament

Although the updated proposal responds to the demand for a waiver of the provision ban, criticism from the financial industry did not fall silent. In particular, the benchmarking and the best-interest test represent an intervention in the market that leads to distortions and counteracts the goal of investor protection.

The European Parliament now joins this criticism: Stéphanie Yon-Courtin, the responsible ECON rapporteur, clearly criticised the Commission's plans.

According to her, the softened ban on commissions does not solve the underlying conflict of interest. In contrast, it would be more effective to maintain the high level of trust of investors in investment firms and to promote the quality of advice by extending transparency regulations. To this end, the retail investor strategy must provide instruments and improvements. The rapporteur considers the aforementioned possibility of the Commission to introduce a provisional ban retrospectively to be unsuitable, as it expresses a bias on the part of the Commission. This would give the impression that the Commission was preparing a comprehensive ban on commissions to be introduced gradually. Instead, she proposes an extension of the observation phase to five years and a broadening of the criteria of assessment. This is to include potential conflicts of interest, the development of costs, the extent of retail investment in the capital markets, consumer protection and the relevance of distribution regulations.

Further, the rapporteur is critical about the "benchmarking". Such interventions could lead to a disruption of the market and disturb product diversity as well as suppress possible innovations. In order to avoid this risk, it would be necessary to define the benchmarks for benchmarking more precisely. Nevertheless, the rapporteur supports the goal of determining the best possible price-performance ratio. However, under the proviso of developing a "correct" and "balanced" approach to this. Yet, this should be done within the framework of a political debate. The current proposal would not set the standards precisely enough.

With regard to the planned best-interest test, the rapporteur proposes adjustments. Instead of cost efficiency, the quality of the investment product should be the subject of the test. For this purpose, the product should be determined on the basis of its performance, the risk level, the costs and fees of an insurance-based investment product or on the basis of any underlying investment options, which products are best suited to the needs and objectives of the investors. Because, it would not only be the price that matters.

Relevance for the retail investor strategy

The rapporteur's criticism reveals that improvements to the retail investor strategy are necessary. On the one hand, it becomes clear that an approval of the European Parliament for the current proposal is questionable in view of the clear position of the competent ECON Committee. On the other hand, it is clear that the criticism of the financial industry has not gone unnoticed, but has found support in central decision-making bodies of the Union. In this respect, it is worthwhile to continue bringing this into the political debate. We will continue to track the developments.

With the kind support of Manuel Traub, research assistant.