The EU retail investment strategy: Navigating the future of the financial retail market

On 24 May 2023, the European Commission proposed a retail investment strategy package, amending MiFID II, UCITS, AIFMD, Solvency II and IDD, to increase retail investors’ participation in financing the economy.

The package mostly strives for more clarity in the communication, prevention of misleading marketing, mitigating potential conflicts of interest and increasing retail investments’ value for money.

The European Parliament and the European Council are taking different views on some material items. A trilogue should start soon to reach an agreement on this new strategy.

To unpack the implications of this evolving regulatory landscape, Laurent Massinon, Partner at DLA Piper in Luxembourg, and Pierre d’Ormesson, Partner at DLA Piper in France, offer their complementary perspectives. Together, they decrypt the forthcoming shifts under the RIS and identify strategic pathways for market players to ensure compliance and turn regulatory obligations into growth opportunities.

 

Could you let us know what the main issues are with retail investment and whether the RIS will solve them?

Pierre d’Ormesson: “The EU Retail Investment Strategy (RIS) legislative proposal is built as a response to the observation that retail investors are underinvesting in EU financial markets.

The EU Commission notes that if retail investors have high savings rates – over 17% for French households in 2024 – their investments are limited compared to the US, which explains part of the EU’s weaker growth.

The EU Commission’s findings are that EU retail customers face challenges with a poor value for money (VFM) ratio, lack of investment transparency and understandable information, and conflict of interests between the manufacturers and distributors of retail investment products.

RIS’ main objective, which is echoed by the 2024 Draghi Report on EU competitiveness, is ultimately to restore investor confidence by increasing their protection and interests. The current positions from the Commission, Parliament and Council take different approaches to remedy these issues and don’t provide for a harmonised set of RIS rules.

Some major EU financial trade associations have expressed disappointment and even concern regarding the proposed RIS measures, which could in practice be counterproductive to the objective of revitalising the EU Capital Markets Union (CMU). A lot is expected from the inter-institutional trilogue process to reach a compromise that will deliver on that objective.”

 

Do you foresee any friction between the concepts of “best interest test” and VFM?

Laurent Massinon: “The concepts of ‘best interest test’ and VFM can create some friction in the context of retail investment strategies.

The best interest test emphasizes that financial advisors and institutions should act in the best interests of their clients, prioritising their needs and objectives over profit motives. This means recommending products or services that truly serve the client’s goals, even if those options might not be the most profitable for the advisor.

VFM focuses on ensuring that the products and services offered to consumers deliver sufficient returns. This often implies a comparison of various investment options based on performance, fees and quality.

 Going further, we might be able to expect the following frictions:

• Conflicting objectives: there could be situations where a product that’s deemed to be in the client’s best interest might not offer the best VFM. For example, a lower-cost investment option might have a better long-term performance trajectory, but a less immediate appeal compared to a higher-cost, commission-heavy product that an advisor would benefit from directly.

• Subjective interpretations: different stakeholders might interpret what constitutes ‘best interest’ and VFM differently, leading to conflicts in advice provided to investors. What an advisor considers valuable might not align with a client’s understanding of getting good value.

• Regulatory challenges: competent authorities will need to carefully frame rules ensuring that both principles can coexist. Striking a balance where advisors are incentivised to meet clients’ best interests without compromising on providing VFM can be challenging.

• Consumer perception: investors might feel confused if they perceive a disconnection between being advised on what’s in their best interest while questioning the overall cost-effectiveness of those recommendations.

While both concepts aim at protecting investors and enhancing their experiences, the goal of achieving harmony between them requires careful regulatory frameworks and increased transparency in financial advising practices.”

 

What is your view on benchmarking within the VFM requirement?

Laurent Massinon: “Benchmarking in the VFM requirement is a key aspect of the EU retail investment strategy, ie retail investors should receive fair value for the products they invest in.

Manufacturers and distributors will have to assess whether a product will deliver value for retail investors. To base the assessment on more objective criteria, they should also compare the product with the relevant benchmark to be developed by the European Securities and Markets Authority (ESMA) or the European Insurance and Occupational Pensions Authority (EIOPA) on the basis of supervisory data.

Benchmarks are a comparison tool aimed at ensuring that the pricing model is more objective. A deviation from the relevant benchmark should introduce that costs and charges are too high, meaning the product doesn’t deliver VFM unless the manufacturer/distributor can demonstrate otherwise.

Benchmarking will help to compare the costs and performance of different investment products, making it easier for investors to understand what they’re paying for and whether it’s justified

By implementing a structured pricing process and assessing the eligibility of costs, the strategy tries to protect investors. 

Regular benchmarking can drive competition among product manufacturers, encouraging them to offer products of better value to stay competitive.

Overall, benchmarking in the VFM requirement is designed to enhance investor protection, increase transparency, and promote fair competition in the retail investment market.

Having said that, I’d still be cautious regarding the introduction of benchmarks for the following drawbacks:

• They might not be available for all products and in particular for new products.

• They can indirectly lead to a price control and push manufacturers/distributors to propose only ‘simple’ products.

• They can lead to herd behaviour where investors mimic the market movements rather than making independent investment decisions based on their own analysis.

• Relying too heavily on benchmarks might restrict the ability to adapt strategies to changing market conditions or individual goals, as investors might stick to traditional indices instead of exploring innovative or alternative investments.

• Benchmark comparisons often focus on relative performance but might ignore other critical factors like risk management, asset allocation and overall financial planning.

• As benchmarks will rely on data reported by manufacturers/distributors to their national competent authority and then by the latter to ESMA/EIOPA, the quality of the reported data will be crucial and will add an administrative burden and costs on manufacturers/distributors.

From a policy perspective, there’s still some inter-institutional debate regarding benchmarking as although the Commission wants the benchmarks to be public, Parliament thinks they should only be used as a supervisory tool.”

 

Does RIS focus too much on the product cost over better overall product value?

Laurent Massinon: “The EU retail investment strategy often emphasises cost due to the growing awareness among investors about fees and their impact on long-term returns. However, focusing solely on cost can sometimes overshadow other critical factors that contribute to overall product value. For this reason, I would also take the following aspects into account:

• Performance: while low-cost products can be attractive, they might not always deliver the best performance. It’s essential to evaluate how an investment performs relative to its peers, rather than just considering its expense ratio.

• Quality of management: active management strategies might come with higher fees, but they could generate superior returns through skilled management. Evaluating the track record of the fund manager or investment team is crucial in assessing overall value.

• Asset allocation: a well-diversified portfolio might incur some costs, but the benefits of risk management and potential for higher returns can outweigh these costs. Proper asset allocation tailored to a client’s goals can be more valuable than simply opting for the lowest-cost options.

• Tax efficiency: some investments offer better after-tax returns even if they have higher upfront costs. Understanding tax implications can play a significant role in evaluating value.

• Service and support: retail investors often overlook the value of service provided by advisors, such as guidance, financial planning, and support during market downturns. The relationship and support offered can have a lasting impact on overall investment success.

In essence, the cost aspect is a critical factor, but it’s important for investors to adopt a holistic approach that considers performance, quality, and the broader context of their financial goals. Balancing cost with these aspects can lead to a more comprehensive evaluation of product value.”

 

Could you give us more information about the way that inducements will be treated? Have the issues linked to them been properly addressed?

Pierre d’Ormesson: “The regulation of inducements has been at the heart of the RIS European debate to date.

RIS EU Commission proposal aims to provide a new framework for financial incentives and inducements, with the objective to eliminate potential advisory biases by reducing the risk of conflicts of interest between retail investors and distributors, in particular those linked to remuneration schemes:

• Prohibiting trailer fees for investment services without advice, such as in the context of Receiving and Transmitting Orders (RTO) or selling without advice. The effects of these bans will be assessed three years after the directive’s entry into force, and this could eventually lead to a total ban on retrocession.

• Enhancing transparency and information provided to investors regarding payment of commissions, their costs and implications on the expected returns of a product (notably through detailed reports being made available to retail clients on the performance of their investments), with financial intermediaries being compelled to attest compliance to the rules with their national supervisory authority.

The EU Parliament and Council take different positions as regards the Commission’s proposal on inducements. Parliament supports a ban on incentives for financial advisors, while the Council allows inducements to be maintained in the context of execution-only sales (sales without advice). It’s worth noting that the Council adds a set of enhanced guarantees to cover any potential conflict of interest (increased transparency requirements and measures to ensure an advisor acts in the exclusive interest of the investor), and that there would be no intragroup exemption or preferable treatment for inducements paid by entities belonging to the same group.

The upcoming trilogue will be instrumental as to the landing position of EU institutions on inducements and financial incentives when dealing with retail investors.

Member states that have already implemented measures restricting or prohibiting the use of incentives that decide to apply stricter measures would be authorised to do so under the RIS regime. This means that we may still experience EU market fragmentation on this particular topic.”

 

Are the changes linked to investor categorisation needed and why?

Pierre d’Ormesson: “Part of the French industry has argued that MiFID II protections are too burdensome for certain investors who currently fall under the retail category. The current framework allows investors to qualify as professionals upon request if they meet certain criteria, such as conducting a certain number of significant transactions, holding – for at least one year – a professional position in the financial sector that requires a certain market knowledge or holding a portfolio that exceeds a EUR500,000 threshold.

Some market players have been calling for the introduction of a new client category or the lowering of the existing professional client requirements as it could give retail investors more comprehensive access to capital markets while maintaining an appropriate level of protection.

This facilitation is picked up in the RIS proposal and positions from the EU Parliament and Council. Notably, the Commission proposal of lowering the wealth threshold from EUR500,000 to EUR250,000 makes it possible for clients coming from member states with lower average GDP per capita to request a categorisation under the professional category. Moreover, relevant education or training could also become a possible fourth criterion to the MiFID client categorisation rules.”

To understand how RIS could impact your business, or if you have any questions, feel free to reach out to Laurent Massinon and Pierre d’Ormesson: