To ban or not to ban?

The spectre of a Commission ban is once more stalking Europe. Having rejected the idea in favour of quality and disclosure restrictions when it updated Mifid, the European Commission is considering a comprehensive, EU-wide ban on inducements as part of its Retail Investments Review (RIS), due to be announced in Q4 this year.

Providers who witnessed collapsing structured products volume, shrinking offerings and disappearing advice following bans in the UK (2013) and the Netherlands (2014) fear repetition on a continental scale. That would of course be a disaster for industry and consumer alike. But how likely is the worst-case scenario?

The aims of a ban could be achieved by properly upholding existing Mifid rules

Esma asked the European Commission to study the cost-benefits of an inducements ban in 2020, having declared they were against a complete ban earlier that same year. The Commission then raised the prospect the following summer as it consulted on RIS.

According to a spokesperson: “No decisions have been taken.” They add that stakeholders responded in large numbers to consultation questions relating to inducements and conflicts of interest, indicating a topic “with strong and diverging opinions – particularly on the issue of a ban”. The Commission is still analysing the consultation responses, ESA advice, and so on. It is also known to have mandated Kantar to study the topic and is expected to make those findings public.

So the policy options remain open and range “from a full ban to simply ensuring the mechanisms around inducements are better understood by investors,” says a source close to the French structured products association, the Association Française des Produits d’Investissement de Détail et de Bourse (AFPDB).

“In the middle,” they add, “there could be a ban just on payment for order flow [PFOF, directing trades towards certain platforms or venues], which would not really directly affect structured products, but which could affect stockbrokers or retail platforms.”

Indeed, the Commission proposed a PFOF ban in November last year.

The French Banking Federation (FBF) recognised the threat early on. It, French financial markets association AMAFI and French asset management association AFG, worked with Italian (including ABI) and Spanish associations, engaging KPMG to study five European markets, including the UK and Netherlands. The resulting report highlights the benefits of the current choice between fee- and commission-based models and explores the dangers of banning commission. The study is being used to raise awareness among officials and may later become a resource for lobbying MEPs.

The AFPDB member says it was important to proceed this way, “because once the text is produced by the Commission it's a lot more complicated to amend it to create a different policy option than pre-empting the side effects of a ban now by educating policymakers before the text is written".

FBF CEO Maya Atig sent the study in a letter co-signed by 24 financial services organisations to the Commission, to Esma, and to the European Parliament. FBF and AFG representatives also presented it to the Commission’s Directorate-General for Financial Stability, Financial Services & Capital Markets, where it was apparently met at least without hostility.

Other forces are also positioned against a commission ban. French regulator AMF believes it would deprive investors of advice. Its response to the Commission’s RIS consultation also forecasts the “unwelcome effect of boosting the sale of in-house products by banking networks …to the detriment of open architectures”.

Eusipa director general Thomas Wulf (right) – speaking to SRP in a personal capacity – says the aims of a ban could be achieved by “properly upholding” existing Mifid rules. A ban could also prove dangerous, he says, leading to segregation of financial advice.

“The Commission have acted on the assumption, for which they’ve provided no evidence, that cash flows between professional market participants in relation to retail investors means consumers not being serviced properly,” he says in relation to payment for order flows.

Finally, a ban would have a pronounced buy-side effect. Market participants like ETF industry providers, argue outlawing inducements would create a better balance between actively managed funds with retrocession and ETFs and other low-cost funds in the retail portfolio. Ranged against them are many asset managers, structured product issuers, distributors and advisors.

Dutch regulator AFM is considered a chief proselytiser for the pro camp, as it promotes its own regulatory style across ESMA-regulated countries. It is joined by consumer associations like part EU-financed Better Finance, which has produced its own study, and some providers in countries with existing bans, who want to level the playing field. A spokesperson for Better Finance says: “Research shows that conflicted advisers – those who are dependent on commissions – can be up to six times more likely to give non-compliant or unsuitable advice… The main effect of this sales model is that distributors will promote… products for which they get commissions, and the higher the better.”

So, who is right? Key to the argument on both sides is the effect of bans implemented in the UK and Holland. Did they create a better outcome for consumers in terms of investment choice, advice, and total product cost? Did they result in the predicted collapse of volume for less mainstream products like structured products? And if it appears that they did, can that decline be explained solely by a commission ban, or have other forces brought about either or both?

Structured products veteran David Stuff (right), now MD of 1OAK Capital, offers a flavour of the impact of the UK ban in 2013, which he says more than decimated the market.

“‘Decimated’ implies a one in 10 reduction, but it’s nine tenths gone,” he says. Issuance in the Netherlands fell 70%+ between 2010 and 2014 as Dutch providers and distributors prepared for its national commission ban. We will investigate these national histories more thoroughly in the coming months.

Despite wreaking such havoc, the KPMG study concludes the ban has neither cheapened total product cost nor created the longed-for ‘independent advice’. Quite the opposite. In a European investment universe of €10,000 median portfolios, advice has disappeared in the UK and Netherlands for portfolios below €10,000, with the advice gap extending to portfolios as big as £100k in the UK and as eye-wateringly high as €500,000 in the Netherlands.

Total product costs meanwhile, have not been brought down in the Netherlands, where they are similar to the average in France, Italy and Spain, or in the UK, where they are higher.

And KPMG insists that the current Mifid model, in which inducements are subject to a quality enhancement test, leads to a wider product offering and more payoff diversity without an increase in costs.

Whether your initial inclination is to agree or disagree with that assessment, now is the time to get involved if you feel moved to do so. In a few short months, the world may be a very different place.

Notes: Esma declares it is against a ban, then later asks Commission to study the cost-benefits of one. The KPMG study “Commission-based remuneration vs. Fee-based remuneration: is there a better model for retail investors?” is available on the FBF and AFG websites. Better Finance’s position paper can be found here.

Main image: Vegefox.com/Adobe Stock Free Images.