The European Commission in May 2024 announced its (RIS), which aims to increase the participation of retail investors in financial markets, boost trust and transparency, and prevent misleading marketing, explained Norman Finster, partner at EY Luxembourg and moderator of a panel on the RIS during the Association of the Luxembourg Fund Industry’s Global Asset Management conference in Kirchberg on 19 March 2024.
It will affect regulations such as the Markets in Financial Instruments Directive (Mifid), the Undertaking for Collective Investment in Transferable Securities (Ucits) Directive, the Alternative Investment Fund Managers Directive (AIFMD), Solvency II and the Insurance Distribution Directive. Though the text of the directive is not yet finalised, noted Finster, “asset managers, product manufacturers and distributors will have to prepare for what is to come and how it will impact their business.”
Cheap doesn’t necessarily equal good
Part of the proposal includes a value-for-money benchmark for investment products. How, asked Finster, will the cost element impact products?
For Christian Machts, chief administrative officer at Fidelity International, when listening to consumer protection agencies, the message seems to be that whatever is cheap, is good. “So there’s a clear favour for ETFs [exchange-traded funds].”
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But this view is too simplistic. There’s an additional, important element--“the quality of the service delivered by distributors or asset managers--which should be in scope. So it isn’t that easy to say that a cheap product is a good product,” he argued. “We definitely have to review that.”
Policymakers across Europe also seem to use standardised testing and a “one-size-fits-all” model--but this is realistically not the case and doesn’t take into account many industries, said Machts. “What we need to talk about more is empowering investors and ensure that their individual needs are heard” and reflected in the product. “The whole exercise is more complicated than just saying, ‘ETFs are good.’”
“Advice has a cost”
The RIS also has proposals concerning the mitigation of conflict of interest and bans on inducements. “Some market participants believe that this will further drive, on the distributor side, the value-added services for the higher customer band. But at the same time, there is fear that the lower customer segments will be left with fewer choices,” said Finster. “Where are the opportunities and threats?”
“The fundamental question we’re trying to address with the retail investment strategy is: is banning all or parts of the inducements going to favour retail, to push retail to invest in financial products? That’s the name of the game. My view is actually quite the opposite,” replied Pierre Jond, CEO of Amundi Luxembourg.
For Jond, there are two categories of clients: the ones that pay for advice and those that use their banks to buy financial products. When it comes to that second category, “57% of products sold in Europe are sold through banking networks.”
“Advice has a cost,” said Jond. It’s like going to the doctor. When you go to the doctor, when you go to a specialist, you need to pay for it. And when you go to see a banker, it’s the same thing: the banker will ask for a “modest contribution to bring their expertise to the table.” Advice from banking networks is remunerated through “rebates,” which are “fully transparent and fully disclosed since Mifid II,” he noted. “People are fully aware and the fees are fully disclosed to the investors.”
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Imagine, said Jond, that you have an entrepreneur who has just sold their company and has €50m of cash sitting in their bank account. There would be no shortage of people ready to take on this entrepreneur’s business, he said.
Now, imagine another scenario. Imagine a retail investor who has €5,000. Their level of financial literacy is having watched The Wolf of Wall Street and they’re not willing to pay for advice. “Do you think I will have many friends trying to sell or promote advice to me?”
What’s going to happen, he posited, is that high-net worth individuals willing to pay for advice or having substantial wealth to place will get advice--that’s not a problem. But for the clients at the lower end of the segments, they’ll walk into their banking institutions and end up with saving accounts instead of investment products.
As of 2022, . “Ban inducements? It’s going to stay that way,” argued Jond. And that defeats the goal of trying to get more retail participation into financial markets.
A new category of technology-supported advice is starting to emerge, he added. But when it comes to advice from robo-advisors, he asked, how precise is that going to be? How left-field will that be? His “educated guess” is that it would drive investors towards ETFs. “I’m an ETF house, I don’t mind. But is that the best outcome for the retail [investor]? I don’t know. The jury’s out.”
Preparing for the new rules
The new rules are expected to be applicable from 2026 and on, but with the implications involved with the RIS, it’s not too early to prepare. “This legislation goes deeper and wider,” said Micaela Forelli, CEO at M&G Luxembourg. It will impact the whole financial services sector. “For us, as asset managers, and for the funds that we manage, it’s going to be prudent to assess what are the models we have in place today, compared to what are the requirements of the rules.”
There’s still uncertainty with regards to the timing and the final text, but teams in compliance, regulatory development, and product management, governance and development will have to continue to track it (or start tracking it, in case they haven’t already begun).
This is going to be a change in mindset, a change in strategic setup for companies
“I think it would be also prudent that this significant piece of regulation is put on the roadmaps of management change teams,” Forelli added. Other teams--front-of-house, operational, investment--should also have pre-assessments. “Think strategy, because this is going to be transformative.”
“This is going to be a change in mindset, a change in strategic setup for companies, and not so much as only a change in processes,” she said. “It needs to be led by the top, from the top, and will have to be guided through from top leadership and the boards to make sure that it’s addressed.”
Lessons learned from the UK
Value for money is a key element in the EU’s retail investment strategy. Will this really help achieve more participation of retail investors, or is it counterproductive?
The UK is a market that is “well-advanced on the topics of consumer protections,” replied Forelli. In the United Kingdom, the Financial Conduct Authority’s came into force in July 2023. As part of Consumer Duty, firms need to “undertake fair value assessments as a way of demonstrating if the price a consumer pays for a product or service is reasonable,” according to the FCA.
But “if you think about what all the companies that operate in the UK had to go through with the assessment-of-value reports, there is evidence and data that all of the efforts put into the assessment-of-value reports--efforts, costs, information--to provide these reports to the market…has been totally disproportionate to the interest that retail investors or their advisors put into reading them. Which is virtually nothing,” said Forelli. “So one has to question the proportionality and the justification of initiatives like this. So it’s good to have already examples and information and data to inform the European Commission and all the European authorities…to legislate in an appropriate and justified way.”
It puts a bit more obligation on distributors to think about the outcomes for end clients, said Rafal Kwasny, conducting officer at Franklin Templeton. To carry out assessment of value, they had to perform peer review, bring on external consultants, collect information, produce reports for the board--and basically prove that products delivered value to clients. Collecting data from distributors takes time, he noted, and by analysing this data, manufacturers will be able to assess whether “good value” is delivered to clients.
How to encourage retail investor participation
Finally, if you had a “a seat at the table with lawmakers,” asked Finster, what would be the best way to encourage retail clients to invest in financial markets?
For Machts, the answer is “freedom of choice.” Investors should be able to choose their products and choose their pricing model. “I think we went already too far regulating prices and products,” he added. “That really harms competition.”
During the covid lockdowns, Jond noted, many people started investing in financial products. But some of them were investing in cryptoassets, based on advice provided by an influencer. In terms of priorities, “I’m just wondering, if in terms of investor protection, crypto should not be more of a higher risk.”
Financial literacy is the key for Forelli. “The European authorities could pull themselves together and put a mandated [financial] education model in secondary school,” she said. The curriculum should include topics like investing for the long term, financial life planning or how compound interest works. More “familiarity” is crucial.
“I would go for the concept of a kind of simplified advice,” said Kwasny. The €5,000 client needs a “simple solution,” and this is better than nothing.