Within the European Union, several legal instruments regulate the protection of investments (MiFID II, IDD, PRIIPs, UCITS, and the AIFM Directive). While this legal framework aims to harmonize standards and create an integrated financial market where investors are effectively protected, the level of retail investor participation in capital markets remains very low. In this context, after a period of analysis and consultation initiated in 2021, the European Commission unveiled in May 2023 a proposal on a “Retail Investment Strategy for Europe”.
In consideration of these low retail investment rates (I), the EU proposes a strategy (II) emphasizing the concept of “value for money” (III) and addressing the sensitive issue of inducements (IV).
I. A Low Retail Investment Rate
Although European households generally have high savings rates, only 17% of their assets were invested in financial securities in 2021, according to Eurostat figures. This percentage is significantly lower than the proportion of assets that American households hold in similar financial instruments, which is 43%.
Several observations have highlighted issues revealing barriers to retail investment:
- Lack of confidence: 45% of retail investors are not convinced that the investment advice they receive from financial intermediaries is in their best interest[1]. As a result, these same investors feel they receive poor returns on many financial products.
- Misunderstanding: 38% of retail investors express uncertainty about the alignment between their interests and the investment advice received from financial intermediaries[2]. Thus, these investors find it challenging to obtain relevant, comparable, and easily understandable information to make their decisions, with some commercial communications being unrealistic or even misleading.
- Costs: finally, retail investors bear fees that are on average 40% higher than those borne by institutional investors[3]. There is thus a conflict of interest between manufacturers of a product and its distributors due to retrocessions of fees from the former to the latter.
Based on these findings, the European Commission published a legislative package proposal for a “strategy for retail investors” on May 24, 2023, including two texts:
- a proposal for a revised Omnibus Directive amending several directives for the financial sector (MiFID II, UCITS, AIFMD, Solvency II, and IDD), and
- a proposal for targeted amendments to the PRIIPs regulation (pre-contractual information on “packaged” financial products).
On April 23, 2023, the European Parliament voted on compromise amendments to the legislative package proposed by the Commission. On June 12, 2024, the Council of the EU then adopted its own negotiating position. These respective positions pave the way for interinstitutional negotiations between the European Commission, the European Parliament, and the Council of the EU (the trilogue).
II. Implementing a Genuine Retail Investor Protection Strategy
The protection of retail investors is a true guiding thread of the RIS and revolves around 5 elements:
- Making information on investment products and services available to retail investors readily accessible and understandable.
- Ensuring that investment products provide a real return on investment.
- Ensuring that any financial advice given is aligned with the interest, needs, and objectives of the investor.
- Protecting retail investors from misleading commercial practices that focus on the benefits of an investment while minimizing the risks: investors are particularly increasingly exposed to emerging risks on social media and new communication channels.
- Ensuring consistent and effective enforcement of the provisions across the European Union.
These measures also align with the goal of improving the functioning of the single finance market pursued by the Capital Markets Union (whose 2020 action plan is nearing completion). All these points aim to reconcile both the imperatives of protecting European retail investors and the requirements of remunerating financial intermediaries for concluding investment opportunities. This reconciliation is exercised through the concept of “value for money” and the regulation of inducement practices.
III. The Importance of the Concept of “Value for Money”
The new concept of “return on investment” (value for money) is central to the RIS legislative package. This highly discussed concept particularly affects product governance and oversight rules. The intention is to limit product offerings that present little or no value for money for retail investors. Thus, the new rules arising from the RIS place the burden on manufacturers and distributors of financial product to assess whether the costs and charges associated with a product are justified and proportionate to its performance, and to the objectives and strategy pursued by a retail investor.
The Council of the European Union has addressed this issue and agreed that European supervisory authorities – the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA) – would prepare benchmarks to ensure compliance with value for money at the Union level. The goal is for manufacturers and distributors to compare their investment products to similar groups of European products to identify those lacking good return on investment. However, instead of being mandatory in the manufacturers and producers’ product governance process, these benchmarks are designed as supervisory tools, developed to assist national competent authorities in identifying investment products with unsatisfactory cost-performance ratios.
While this “value for money” requirement is intended to apply across the entire spectrum of the RIS (investment products and insurance products), the ACPR had already taken the lead in insurance distribution by issuing a recommendation to manufacturers and distributors. The latest version, dated June 28, 2024, includes recommendations on moderating fees for unit-linked life insurance products. This ACPR recommendation follows EIOPA’s statement of November 30, 2021 considering that a unit-linked product offers good value for money for a customer when its costs are reasonable and proportionate to the benefits (performance, guarantees, coverage, and services) it offers to its target market.
IV. Regulating Inducements
The question of inducements has been central to the debates that stirred the European Commission when presenting the main issues of the RIS. Inducements, also known as “commissions” or “retrocession fees,” is the most prevalent practice of intermediary remuneration in the European Union. Commissions are received in return for sales without execution, and thus, do not involve the provision of investment advice. This practice contrasts with the fee-based remuneration used in the UK and the Netherlands.
Mairead McGuinness, the European Commissioner for Financial Services, had argued in favor of a total prohibition on inducements received by a financial intermediary on the sales of financial products[4]. Such prohibition sought to mitigate the risks of conflicts of interest between the financial intermediary and their client. However, proponents of this form of remuneration also highlighted one of its benefits: the fact that inducements would allow the mutualization of costs and risks associated with advice, thereby providing access to advice for a broader audience (which is one of the main goals of the RIS). Conversely, promoting fee-based remuneration would restrict advice to only wealthy individuals.
Faced with opposition from several Member States, notably France, the Council of the European Union ultimately endorsed, by its agreement on June 12, 2024, the validity of the inducement-based remuneration model for financial intermediaries, while rigorously regulating it. To prevent potential conflicts of interest, the Council strengthened the guarantees accompanying inducements:
- A new uniform criterion specifying the obligation for advisors to act in the client’s best interest, a duty common to MiFID and IDD: this test aims to clarify the criteria for paying an inducement. If a criterion is not applied by any of these professionals, they must demonstrate to the competent supervisory authority that the general principles have been taken into account (and justify this consideration in their internal policies or procedures on inducements). Among the criteria proposed by the Council are items like considering qualitative criteria (such as compliance with applicable regulations), or ensuring that the inducement is based on a clear and easily understandable calculation method.
- Enhancing transparency and communication of information on payments considered as inducements, their costs, and their impact on the performance of the proposed investments (for example, by providing periodic reports to retail investors on the status and performance of their investments), noting that the concerned financial intermediaries must be able to demonstrate compliance with these principles to their national supervisory authority.
- Use of peer product benchmarks designed by ESMA and EIOPA.
Additionally, the Council further strengthened guarantees by introducing “general principles on inducements” that must be adhered to by any investment firm when paying or receiving inducements. According to these fundamental principles, inducements should not lead firms to recommend certain products over others, should not be disproportionate to the value proposition offered, and inducements paid by entities belonging to the same group should be treated the same as others (no intra-group exemptions).
Member States that have already implemented measures restricting or banning the practice of inducements and that decide to introduce such bans in the future or apply/decide to apply stricter requirements than those under Union law, would be allowed to do so. This represents a minimum harmonization solution, which will leave some fragmentation of the single market. However, the evolution of the framework is not final, as the review of these inducement provisions is scheduled for five years after the text’s entry into force.
[1] Eurobarometer, 2023
[2] Eurobarometer survey on the level of financial literacy in the EU, 2023
[3] ESMA, Report on costs and performance, 2023
[4] Speech to the ECON committee on January 29, 2023