Fund firms face the prospect of EU rules setting standards of “value for money” for their investment products under the Retail Investment Strategy due to be unveiled on 24 May. This could include disincentives, for example, to charging active management fees for an investment that underperforms an index fund. For all the discussion of a ban on inducements for investment advice, the commission has decided to propose a more limited inducement ban on execution-only investments.
A representative of an organisation representing EU investors and financial service users is pleased with the proposed limited ban.
“That was something we called for in the first place,” said Arnaud Houdmont, the director of communication at Better Finance. “Since the very beginning, we called for at the very least a ban on execution-only services.”
European retail investors thinking about what to do with their money face important obstacles diminishing their ability to “take full advantage of capital markets,” a much-discussed leaked draft of the Retail Investment Strategy said. The document noted that “some investment products incorporate unjustifiably high levels of costs and consequently do not always offer Value for Money to the retail investor.”
Low levels of trust
A recent Eurobarometer survey showed that only 38 per cent of consumers are “confident that the investment advice they receive from financial intermediaries is primarily in their best interest.”
In an attempt to address that, the leaked strategy proposes “an enhanced framework to further improve transparency, in particular as regards costs, strengthened rules against misleading marketing communication, rules to ensure impartial and high-quality advice as well as that products distributed to retail investors offer the prospect of value for money.”
No major changes from this draft version are expected in the final strategy, according to EU observers following the situation in Brussels.
Benchmarks may take years
Financial professionals concerned about whether their investments will meet the value for money test will have to await benchmarks devised by the European supervisory regulators: the European Securities and Markets Authority, known as Esma, and the European Insurance and Occupational Pensions Authority, Eiopa. Esma on Wednesday said that it wants the strategy to stop “undue costs” in funds.
The leaked strategy document suggests “value for money” could minimise undue effects from inducements. Better Finance’s Houdmont sees the concept as in some ways a diversion. “On one hand, the fact that other key priorities for individual investors are now being discussed, such as value for money, is a good thing”, he said. “On the other hand, it’s also a diversion in order to talk about something else than the inducements.”
But, he said, the process of working out on value for money rules could take years.
The value for money approach was already highlighted back in February by Benjamin Accadia, a partner within EY’s Business Consulting practice in Luxembourg. Answering questions by Investment Officer he said that it is a way to “balance appropriately the costs/benefit of investing and not focus solely on costs, ” noting that “this could be facilitated by the introduction of the concept of value for money”, if the concept is “designed and scoped adequately”.
Active fees for passive performance
Houdmont wondered whether the benchmarks might follow the example set by the UK’s Financial Conduct Authority, which has sanctioned funds that charge active fees but deliver returns that don’t even outperform an index fund.
Despite much discussion over the prospect of a full ban, the European Commission concluded in the leaked version that a full ban “would entail significant and sudden impacts on existing distribution systems, with consequences that are hard to predict.”
“The commission has understood the issue at hand, and has really worked towards an inducements ban,” said Houdmont. “but the pressure from the industry and from certain member states with the aim of protecting their homegrown industry seems to have been too big.”
More information unhelpful
“There are pros and cons to a ban,” said EY’s Accadia back in February, but “it is widely admitted that retail investors do not always understand the impact of commissions on their investments despite progress made after the introduction of stricter transparency rules under MiFID II and even more transparency/disclosure may not necessarily lead to better-informed investment decisions.”
A Brussels-based lobbyist familiar with the negotiations said that part of the story is that statistical problems were found with a major study, carried out by Kantor, that the European Commission had relied upon to make the case for a total ban and said that the Commission was divided on the issue.
European Commissioner Mairead McGuinness in January told the European Parliament that this assessment concluded that inducements have a negative impact on the net returns that retail investors can expect. “The Retail Investment Study shows that products where inducements are paid are on average 35 percent more expensive for retail investors than investment products where no inducements are paid,” McGuinness said. “And maybe it’s worth repeating that figure, 35 percent.”
The lobbyist also said there appear to be some missed opportunities in the strategy. There is a consensus among several parties that all the attention paid to the inducements ban has taken attention away from other useful measures. For example, there is wide support for harmonised conflict of interest regulation across different categories of retail savings products. This however isn’t mentioned in the leaked retail investment strategy.