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Freshfields Risk & Compliance

| 8 minutes read

Feels like MiFID III? - The Commission Proposal on the EU Retail Investment Strategy and what it means for firms

In the heated discussion around the ban on payment for order flow, the proposal on the Retail Investment Package (the Proposal), adopted on 24 May 2023, seems to have somewhat fallen between the cracks despite the announcement as “the most ambitious legislative proposal since the inception of EU financial regulation”. 

It is therefore worth taking a closer look at the numerous changes to the EU investor protection rules set out in MiFID II, IDD and the UCITS/AIFM Directives and the PRIIPs Regulation, which we have summarized below and explain what they mean for firms.

Why are the EU investor protection rules changing?

The Proposal marks the culmination of a process that goes back to the Commission’s 2020 Capital Markets Union Action Plan and its core finding. EU retail investors do not participate sufficiently in capital markets compared to other economies or in short: Too many deposits, not enough shares, bonds and funds. The Commission identified three key factors for this: a “lack of trust” of retail investors in financial services, not sufficient “value for money” due to high costs of products and services and conflicts of interest where distributors receive commissions from manufactures when selling investment products to retail investors.

The Proposal aims at tackling these deficiencies by introducing targeted changes to the EU investor protection rules. While these changes mostly increase the administrative burdens for EU financial intermediaries, the Proposal also provides for relief to firms in some respects, most importantly by allowing for a simplified “upgrade” of sophisticated retail investors to the status of professional clients.

Starting with the big one: Will there be an inducement ban?

The Proposal introduces an inducement ban for non-advised sales, i.e. a ban on inducements paid from manufacturers to distributors in relation to the reception and transmission of orders, or the execution of orders for or on behalf of clients. The ban sits alongside the existing MiFID inducement ban when providing independent investment advice and portfolio management. Similarly, exemptions under MiFID’s existing inducement ban would also apply to the new ban on inducements for execution-only sales without, however, materially altering its sweeping scope (exemptions include payments which enable or are necessary for the provision of the investment services, payments in relation to research etc.). Additional exemptions introduced by the Proposal are fairly limited in scope:

  • Minor non-monetary benefits not exceeding EUR 100 are allowed if they are clearly disclosed to clients.
  • The ban does not apply if investment firms provide advice to the same client relating to one (or more) transactions covered by the same advice.
  • The ban does also does not cover fees or remuneration received or paid from an issuer for placement and underwriting services.

Despite its heft, part of the industry may feel that it has dodged a bullet since the Commission had originally considered a complete ban on inducements for investment advice (see our earlier blog post). This does however not mean that a later ban on inducements for the provision of investment advice is off the table. The Proposal is part of what the Commission calls a ‘staged process’, which in a first stage introduces the partial ban together with revised safeguards for advised sales (see below), and in a second stage, an assessment of inducements and the impact of the newly introduced rules three years after the adoption of the Proposal. In the Commission's view, the partial ban could thereby pave the way to a further expansion towards a full ban, i.e. it could be a device to ensure “a smooth and gradual transition into such new system”.

  • Payment for order flow

Further, an accompanying inducement ban targeting the controversial practice of payment for order flow (PFOF) may still from the MiFIR reform package currently negotiated in parallel. After the French and the Czech presidency failed to form a compromise among Member States on whether or not to ban PFOF, recent developments suggest that the Council and the EP have reached political agreement to introduce a general ban on PFOF in relation to retail clients and opt-up professional clients but allow Member States to grandfather PFOF for services provided to clients in their jurisdiction where the firm is located (i.e. domestic clients) with a phase out period until 30 June 2026. 

If enacted, the ban on inducements for non-advised sales can be expected to have a significant impact on the distribution and execution model for products currently sold through execution-only channels. One aspect to watch will be whether the ban of inducements will lead to more in-house distribution or other models that would allow firms to still reap the rewards of inducements while not running afoul of the inducement rules. Further, the ban will not affect all products equally since inducements paid by product manufacturers to distributors only affect part of the product universe typically offered through execution-only channel and, therefore, may contribute to a stronger dichotomy between advised sales of more complex products with an inducement component and inducement-free execution-only sales of less complex products.

  • Improving the quality of investment advice

The Proposal also seeks to improve the quality of investment advice where firms continue to receive inducements. The obligation of firms to act in the best interest of their clients is strengthened by a new ”best interest” test which replaces the ‘quality enhancement’ test that firms currently have to meet when receiving inducements. For advised sales, to act in the best interest of their clients, financial advisors have to, as a minimum,

  • base their advice on an assessment of an appropriate range of financial products,
  • recommend the most cost-efficient product from the range of suitable financial products and
  • offer at least one financial product without additional features which are not necessary to the achievement of the client’s investment objectives and that give rise to additional costs, so that retail investors are presented also with alternative and possibly cheaper options to consider.

Finally, the presentation of information on costs, associated charges and third-party payments shall be standardised – ESMA is asked to develop regulatory technical standards that will set out the specific format and terminology that firms must use. Moreover, an annual statement will be introduced setting out clearly the costs and the investment performance and disclosure rules are built out to require firms to explain the purpose of inducements and quantify their impact on expected returns of the relevant product.

What is the rationale behind the new product governance rules? 

The Proposal suggests changes to the product governance rules to ensure that products offered to retail clients offer good “value for money”. The existing product governance frameworks will be complemented by new requirements on manufacturers to set out a ‘pricing process’ for PRIIPS, AIFs and UCITS allowing for the identification and quantification of all costs and charges, and an assessment whether such costs and charges do no not undermine the value which is expected to be brought by the product. Products that deviate from the relevant benchmark must not be approved, unless the manufacturer is able to establish that costs and charges are justified and proportionate – i.e. the presumption that costs and charges are too high must be rebutted. At the level of the distributor, a supplementary requirement is introduced to quantify distribution costs and perform an overall price assessment against relevant cost and performance benchmarks.

Will there be stricter rules for marketing communications?

The Proposal introduces a number of new provisions to address the risk of unbalanced or misleading marketing communications and to clarify the responsibilities of investment firms in relation to marketing communications, including when using digital channels and when relying on third parties. This includes

  • investment firms being required to have a policy on marketing communications and practices, which the management body should define, approve and oversee;
  • new requirements in relation to marketing communications and practices including  advertisements will need to be fair, clear and not misleading;
  • a new liability regime for investment firms who will  be responsible for the content and compliance of marketing communications, regardless of whether influencers or other third parties have been paid or simply incentivized to create promotional content. In such cases, if the marketing communication is misleading, NCAs may require the cessation of the communication or fine the investment firm who is remunerating the influencer.
  •  a new requirement  to display risk warnings in all information materials concerning “particularly risky products”.

What are the other proposals? 

  • Suitability and appropriateness

    The suitability assessment criteria will be expanded to require portfolio diversification: advisors will need to consider whether a product is suitable for a client in view of his existing portfolio composition. The appropriateness test will be expanded to encompass the capacity to bear full or partial losses and the risk tolerance of clients (aspects that are, currently, only required as part of the broader suitability test). In case of a negative appropriateness assessment, the intermediary will only be allowed to proceed with the transaction at the client’s explicit request.

    It is difficult to foresee if the additional requirements will provide meaningful benefits to retail clients or will mainly result in more “red tape” to navigate for firms. A potential significant impact could result from the requirement to obtain information from clients not only about their knowledge and experience but also about their capacity to bear full or partial losses and their risk tolerance as part of the appropriateness test (and not just the suitability test) provided that the product is not fit for distribution in an execution-only channel where no appropriateness test is required.

    The Proposal also allows for a more “limited” suitability assessment when providing independent investment advice. Provided that the product universe is generally restricted to well-diversified, non-complex and cost-efficient financial instruments, firms do not have to obtain information on the knowledge and experience of clients or the client’s existing portfolio composition.

  • Professional standards

    The proposal promotes knowledge and competence requirements for investment advisors which are currently included in ESMA Guidelines legal requirements. Compliance has to be proven by obtaining a certificate and the rules also require ongoing professional training for investment advisors.
  • Client categorisation

    The Commission acknowledged that provisions on client categorisation are disproportionate in relation to more sophisticated and experienced clients who stand apart from the average retail investor and who may not necessarily need the same level of protection. Accordingly, the Proposal adjusts the eligibility criteria for “opt-up” professional clients. The amendments foresee a reduction of the wealth criterion from EUR 500,000 to EUR 250,000 (in cash deposits and/or financial instruments), and the insertion of a fourth criterion allowing firms to consider relevant education and training that a client has received. The amendments also allow legal entities to qualify as professional clients upon request by fulfilling certain size criteria related to their balance sheet, net turnover and/or own funds.

  • Cross-border business 

    To tackle difficulties in supervising the cross-border activities of investment firms, new reporting obligations will be introduced for investment firms and credit institutions on their cross-border activities, when they provide investment services to more than 50 clients, including information on the type, scope and scale of services provided in each host Member State, the total number and categories of clients for each host Member State, the number of complaints and the type of marketing communications used in host Member States. 

What’s next?

The Proposal is subject to an extended feedback period until 28 August 2023 before the feedback is summarized by the Commission and presented to the European Parliament and Council with the aim of feeding into the legislative debate.  In parallel, the Proposal has been referred to the Committee on Economic and Monetary Affairs (ECON) of the European Parliament and the Council has started its discussions. Given the extent of the Proposal, a compromise position will likely not be reached before 2024. Following its enaction, any proposed changes will have to be implemented by Member States within 12 months after the entry of force of the revised Directive and applied within 18 months from that date and, therefore, not before 2025.

This is the most ambitious legislative proposal since the inception of EU financial regulation. Mairead McGuinness, Commissioner for Financial Services, Financial Stability and Capital Markets Union


mifid, consumer protection, financial institutions, regulatory, retail, financial services, retail markets, investment trading and markets, europe