1. The long wait
If you are familiar with the European bubble, you will know the financial sector has eagerly been awaiting publication of the European Commission’s (EC) retail investment strategy – or RIS – published on Wednesday 24 May.
It has been billed as the latest review of how to ensure the trust of retail investors to increase retail investment in the European economies, falling under the wider Capital Markets Union (CMU) package.
The RIS proposal reviews five existing EU legislative texts; the Markets in Financial Instruments Directive (MiFID), the Insurance Distribution Directive (IDD), the Packaged retail investment and insurance products (PRIIPs), Solvency II (SII), and the Directive relating to undertakings for collective investment in transferable securities (UCITS).
Long before its publication, there was an intense and polarised battle between the financial sector and the EC on the level of the costs retail investors pay. The core was on whether there should or should not be a (total or partial) ban on the payment of inducements and commissions.
A total ban is avoided, but as we detail below, we believe we are facing a transformative proposal based on the suspicion that most of the EU financial industry is taking too much from EU consumers, and not giving enough back in return.
2. Polarised oppositions
So, why the very vocal public debate? Well, proponents of a ban on commissions, including the European Consumer Association BEUC, say that inducements create a conflict of interest for intermediaries when giving financial advice, as it may encourage the sale of certain products (that carry more favourable commissions) over others that could in fact be a better fit for the consumer. The EC agrees. Some advocates of a ban have even mentioned a figure of 25% additional cost for the consumer as a result.
Those in favour of retaining commissions, including large parts of the financial sector, counter this view with the need to ensure that consumers feel able to seek financial advice. They argue that the charging of fees up-front to consumers would discourage this. They also argue that failing to obtain financial advice may lead to consumer reluctance to enter into financial contracts. Without consumer confidence, consumer investments will not be optimised, to the detriment of the European economies.
And what of the European Parliament’s (EP) position? Well, it is, unsurprisingly, divided. MEP Ferber, EPP coordinator, led the discussions, pushing against a ban in late 2022 with letters to Commissioner McGuinness. He noted, amongst others, that reliance on robo-advice is a cheap solution to resolve the risk of an advice gap. He concluded that, ultimately, standardisation would not lead to an improvement in investor protection. Overall, however, the majority of the EP appears to be on the “ban side” of the debate. The S&D event of 13 April, entitled ‘EU Retail Investment Strategy: Making Financial Markets work for Consumers’, clearly demonstrated this. The focus on encouraging the use of ETFs was strong.
So this leaves Member States. Where do they fit into the discussion? A partial ban affects all Member States to varying degrees – except the Netherlands, which introduced a full ban on commissions in 2013. Many of them – directly contacted by their national financial intermediaries – took strong positions before the proposal came out. At least nine of them, among them the largest countries, expressed their dismay at the prospect of a full ban on commissions – France even going public.
3. The content of the proposal – the Commission opts for a plan B
So, what is actually included in the proposal?
As it stands, the proposal contains a staged approach to inducement (depending on the types of service provided) and a soft ban on commissions, meaning there would be no broad ban except for transactions that are ‘execution only’. ‘Execution only’ refers to trades restricted to only the execution of the said trade, without the client receiving advice. In this sense, the European Commission is sticking to its position, which was widely leaked ahead of publication, but is able to show it has listened to stakeholders, including the financial sector.
But there is more. At the heart of the proposal there is the requirement for manufacturers not to approve a product that does not “deliver Value for Money” to retail investors. This is in effect capping costs by other means, and is done in two steps. First there is a PRIIP- based Value for Money test. This test will be cost-driven and not yield/return driven. Costs must be identified, quantified and assessed internally by both the manufacturer and the distributor. But there is a catch, an additional layer and a de facto cap. This assessment must also be done against an external benchmark which is to be established by ESMA and EIOPA at a later stage (and endorsed by the EC via delegated acts). ESMA and EIOPA, the EU supervisory authorities in charge of regulating and sometimes supervising some specific financial entities, have taken positions on costs and charges retail consumers pay: they are too high. And as you may correctly have assumed, any deviation from this external “benchmark” will introduce a presumption that costs and charges are too high. If this presumption is not overturned, then the manufacturer shall not approve the product.
In other words the Commission did not cave in. We are facing a radical change in retail financial products: a multiproduct EU-driven cap on costs. The commission policy ends up with product governance now being cost driven. This policy is based on the suspicion that most of the EU financial industry is taking too much from EU consumers, and not giving back. All this will exist in parallel to stricter requirements for continuous professional development for professional advisors.