The Retail Investment Strategy Unlocks Trust in Capital Markets 

Key takeaways

• The European Union looks at the US as the best example of capital markets globally. Since the advent of the Capital Markets Union in 2015, a multitude of complex legislative measures have been implemented to make European capital markets more vibrant.  
• The Retail Investment Strategy is a new package of legislative measures conceived under the Capital Markets Union 2.0 aimed at fostering participation of retail investors to European capital markets.   
• Phased ban on inducements and Value for Money assessment are the most important reforms under the Retail Investment Strategy, in one with an opening to full digitalisation in retail disclosure.

The US are renowned in the world for many things, including the advanced state of their internal capital markets. So high is the praise and deep the respect for American capital markets that for a few years now the plan of authorities in Europe has been to shape their capital markets in a fashion similar to the US. That has happened so far mostly via coordinated legislative measures in the financial services sector.  

The Capital Markets Union, as the specific action plan is called, was introduced for the first time in 2015. The original action plan of the European Commission focussed on addressing the state of fragmentation of European capital markets from two specific angles. Create new financing avenues for local small and medium enterprises and new investment opportunities for European retail investors and savers. The first iteration of the Capital Markets Union was successful and resulted in a most notable reduction of some of the burdens that European investment funds experienced in accessing the European single market. Also, as part of the same iteration, new rules for long term investment funds were also introduced.   

In 2020 the European Commission kicked off the Capital Markets Union 2.0. With an even more ambitious goal, the new action plan wants this time to establish trust and foster retail investors participation to European capital markets. The main tool to achieve this goal is the so-called Retail Investment Strategy.   

Comparing the state of capital markets in the US and Europe 

One of the most interesting premises of the Capital Markets Union remains the parallel of the state of capital markets in the US and Europe. That parallel underpins again the Capital Markets Union 2.0. It remains inherently difficult to compare saving and investing habits of American and European households. From the old days, when stockbrokers visited their clients on a weekly basis to collect checks, to the automated payments on investment platforms of nowadays, exposure to capital markets is historically ingrained in the culture of American households. For the good and the bad. And so is the belief that, through ups and downs as well as cyclical market crashes, exposure to capital markets is always a rewarding move over the course of time.  

According to some of the research carried out by the European Commission in the preparatory works of the Retail Investment Strategy, the European market for retail investments remains characterised by low levels of participation compared to international peers. More specifically, the percentage of household assets held in securities in Europe is still way lower – nearly half – compared to the one in the US. When looking at the current situation in Europe, retail investors and households still see financial markets as something overly complex and exoteric. For that reason, the typical household in Europe tends to rely on low yielding bank savings for their broad investment needs.  

Whilst there is much that the reforms proposed can help achieve, part of the problem here comes down strictly to enhancing financial literacy in Europe. Participation of retail investors to capital markets across European member states varies already based both on historical reason and socio-economic conditions. However, the success of the Retail Investment Strategy lies in making sure across the Union retail investors become educated on financial matters first. Acquiring the required knowledge will help them be more confident when it comes at investing their savings in capital markets that are trustworthy and easier to access, without them having to rely on an investment advisor necessarily.  

Paving the way for a better retail investor journey 

From a technical perspective, the choice of the European Commission relative to the delivery of the package of new legislative measures for the Capital Markets Union is the one of an Omnibus Directive. This approach will allow with a single piece of regulation to tackle the amendment of the various existing legislative frameworks affected by the initiative, these being the UCITS, AIFMD, MiFID and IDD amongst the others. And where indeed no legislative package can per se resolve the issue of fostering trust of retail investors in capital markets in Europe, the European regulatory framework on investor protection, as it currently stands, offers significant room for improvement. 

The pillars of the Retail Investment Strategy can be summarised as follows: 

1. improving cost transparency;  
2. reducing risks of misleading marketing communications; 
3. promoting high quality impartial financial advice;   
4. offering Value for Money to retail investors.  

These pillars reflect the main problems the European Commission identified in the investment journey of retail investors and that discourage them to participate to fully participate to capital markets and reap the benefits of doing so. Retail investors encounter too many difficulties in accessing information on investment products that is comparable, easy enough to understand and can support their independent investment choices. The risk that retail investors are not able to understand marketing information presented via social media in an unrealistic manner is also high. Not to mention the shortcomings in the manufacturing and distribution processes of investment products and the inherent conflicts of interest linked to the inducements model. Lastly, there has been little to no attention over time to the fact that certain investment products come with disproportionately high costs for investors and offer no real value for money for their investments.   

High Pragmatism on the Issue of Inducements 

A note on the methodology adopted as part of the retail investment strategy is appropriate on the point of inducements, where there seems to be consensus on the detrimental effects that these have for consumers. Showing high pragmatism, European Authorities have designed their new approach on inducements on the realistic acknowledgment that a complete ban on inducements, whilst being the most effective measure, could have consequences hard to predict at this stage. For the manufacturing and distribution system having been essentially designed based on inducements, a full ban enforced overnight would impose a very costly realignment of distribution processes with the risk of something breaking in the process at least.  

The solution proposed attempts to strike the right balance between the need for innovation and protection for retail investors and the realities of the status quo of distribution processes. A staged approach, with a ban on inducements in so-called execution only situations, where no advice is rendered to investors, coupled with stronger rules around best interest of clients as well as disclosures on inducements.   

Value for Money? 

Closing the circle on the work carried out by ESMA and other national competent authorities on the undue costs of UCITS and AIFs, with the Retail Investment Strategy Europe is catching up with the UK and introducing its own Value for Money assessment. In layman terms, value for money means that retail investors should be offered cost effective investment products. European authorities have expressed their clear vision that the fund market in Europe shall elevate its own standard and prevent that inefficiently managed funds can get to the market.   

The soon to be introduced value for money assessment will have repercussion on the governance structure of fund management companies, with the introduction of an additional layer of governance consisting of the clearly documented process for pricing assessment of investment funds. All funds will have to be assessed in their cost and pricing structure, whether already on the market or just about to be authorised. Fund management companies will be required also to report instances of excessive charges in funds and act for the reimbursement of costs to investors.   

As part of the value for money assessment, fund management companies and distributors will also have to use official market benchmarks. These will be prepared by ESMA and the other supervisory authorities. Costs charged by existing and new investment products will be assessed against these benchmarks and justified in comparison to the ones applied by other products of the same category already on the market. Whether as a result of these rules retail investors will have to end up into simpler and plain vanilla type of investment products is a different question.   

Modernising Retail Disclosure and the Key Information Document 

For what concerns the pillar of the disclosures and as a corollary to the Omnibus Directive, we also have a proposal to modernise the Key Information Document under the PRIIPs Regulation.  

The PRIIPs regulation is not new to improvements and many amendments have already been proposed over the course of the recent past. As part of the implementation of the overall retail investment strategy, it is now proposed to adapt existing disclosures to the ever-evolving needs of retail investors. Increased digitalisation provides the opportunity to present the key investor information in a more attractive way. And the PRIIPs regulation needs to catch up with digitalisation and offer the flexibility required to allow for full presentation of this information in a new and digital fashion. In the eyes of the European Commission, the benefits of personalisation in the presentation of the key investor information are multifaceted. Reducing the visual overload of information for retail investor is one of them, which in turn will facilitate the comprehension of the features of specific PRIIPs. And the degree of personalisation in presenting the key investor information should not stop at cosmetic level. The plan of the European Commission is to include a degree of customisation in the key investor information provided in an electronic format. Retail investors should be able to obtain information tailored to the specific amounts to be invested as well as the holding period to be inserted online when reviewing the key investor information of a PRIIPs. 

Whilst indeed a laudable initiative, the shift to an electronic format for retail disclosure, with the ability to customise certain information, is not entirely original. At a closer look, fund disclosures in an electronic and customisable format were already part of the approach proposed for the new retail disclosure in the UK. There remains though a significant difference between the two approaches. As we know, the key investor information document under the PRIIPs regulation will be entirely superseded in the UK by the new retail disclosure, electronic and customised. That is because the UK was never fond of the PRIIPs regulation and decided to entirely scrap it as part of its regained sovereignty vis-à-vis the European Union with Brexit.

As part of the retail investment strategy, instead, the European Commission intends to leave unaltered the requirement to produce a key investor information document under the PRIIPs regulation and just wants to add the ability to use an electronic format with customised features. The three-page key information document should always be drawn up in accordance with Article 8 according to the European Commission proposal and available on the PRIIPs manufacturer’s website also for download.   

Conclusions 

2024 will be a year of elections in Europe. It is notoriously difficult in these periods to be able to push forward an agenda of significant reforms like the ones of the Retail Investment Strategy. We expect that significant headwinds to these reforms will also come from the industry. Questions and criticism abound on issues like the official benchmarks to be used in the pricing assessment as well as the costs involved with the transition to a fully digital regime for retail disclosures.  

However, as Europe wants to aggressively pursue the digital and green transition, it remains of paramount importance to ensure that more than a significant amount of capital can transition to strategies that support these broader goals of the European Union. Accordingly, fostering participation of retail investors to capital markets remains of paramount importance, in one with continuing to make appealing to managers the use of new European vehicles and structures that sustain the same broader goals of the European Union.