Moloney, Niamh --- "Large-Scale Reform of Investor Protection Regulation: the European Union Experience" [2007] MqJlBLaw 8; (2007) 4 Macquarie Journal of Business Law 147
Large-Scale Reform of Investor Protection Regulation: the European Union Experience
NIAMH MOLONEY[∗]
Abstract
This article considers the Markets in Financial Instruments Directive 2004 which has introduced large-scale and dramatic reforms to investment services and trading markets across the European Union. Chief among these reforms is the new conduct of business regime which addresses all aspects of the investor/investment firm relationship. The promotion of informed investor choice and competent investor decision-making lies at the core of the new regime which is designed to construct an informed and competent cohort of retail investors for a choice-driven pan-EU investment services market. The new regime represents a landmark in EU investment services policy and the first time the retail markets have been the express target of EU policy-making.
This article outlines the main features of the new conduct of business regime, which will dictate, in great detail, regulation in all 27 Member States of the EU, and considers how it articulates the underlying themes of investor choice and competent investor decision-making which drive the new regime. Although the implications of the new regime remain to be seen, considerable risks exist with respect to how the reforms manage the costs of regulation, the impact of costs on choice, and, in particular, the assumptions the reforms make concerning disclosure and effective decision-making.
I The Markets in Financial Instruments Directive 2004 and the EU Regulatory Environment
1 The New Regulatory Environment
In April 2004, after lengthy and difficult negotiations between the Member States, the European Union adopted dramatic and large-scale reforms to the regulation of investment firms and the supply of investment services across the EU with the Markets in Financial Instruments Directive (MiFID).[1] It is the central pillar of the new regulatory architecture for EU financial markets adopted under the wide-ranging 1999 Financial Services Action Plan,[2] a regulatory reform agenda of some 42 measures which, after a hectic period of law reform, has recently completed and is now radically re-casting financial regulation across the 27 Member States of the EU.[3] The FSAP had two main objectives: the liberalisation and integration of EU financial markets through the harmonisation of national rules to support mutual recognition of national regulatory systems and pan-EU activity; and the regulation of the integrated pan-EU marketplace. Post-FSAP, and after a period of seismic change, the EU has emerged as the primary regulator for the EU’s financial markets.[4]
Under EU constitutional arrangements, MiFID, and the potentially very costly systems and procedural changes it demands of investment firms,[5] must be implemented by all 27 EU Member States in their national laws by November 2007.[6] The level of detail in the new regime is such that EU Member States now have very little discretion in their national regimes in implementing the MiFID rules. The EU, in effect, now governs this area, although supervision and enforcement of MiFID requirements is at Member State level. Supervision and enforcement is networked-based, and anchored, for the most part, to the home Member State of the investment firm. The UK Financial Services Authority (FSA), for example, is currently engaged in a massive exercise to implement MiFID which sees primary rule-making responsibility for investment services pass from the FSA to the EU.[7] The regulatory design choices made by MiFID are, therefore, critical for the effectiveness of regulation across the EU and its 27 Member States.
MiFID represents a dramatic and controversial reform to investment services regulation across the EU, has generated a tidal wave of reaction,[8] and is the subject of considerable controversy as firms adjust their systems to comply with its requirements.[9] The failure to engage in ex-ante cost benefit analysis prior to the adoption of MiFID has increased concerns,[10] although the European institutions have now committed to ex-post cost benefit analysis of MiFID and other FSAP measures.[11] At the same time, the EU market is now widely regarded as suffering from severe post-consultation fatigue following an extensive market consultation period, which has just completed with the close of the FSAP, and may be unwilling to spare the resources necessary to participate in effective ex-post facto exercises. There are, however, some signs of a movement towards more nuanced regulatory intervention in an attempt to reduce regulatory burdens on the investor/firm relationship, and particularly towards investor education as a key element of retail investor policy and a means of building competent investors.
2 MiFID’s Scope
MiFID is designed to apply a single European rulebook to wholesale and retail transactions in financial instruments and to the full range of investment services. It is considered by many to be the most significant reform ever to affect the European financial services industry and it will ‘significantly alter how firms operate their businesses and how they interact with customers.’[12] Under MiFID, detailed EU rules now govern the entire securities trading cycle from sophisticated investors trading on their own account to retail investors receiving investment advice and asset management services. MiFID also addresses order execution on stock exchanges and on alternative trading systems, and, in the Directive’s most controversial provisions, client order execution by investment firms against their proprietary trading books (the ‘internalisation’ of investor trade orders). The scope of MiFID extends from the initial licensing of investment firms, alternative trading systems (termed multi-lateral trading facilities), and stock exchanges, to the ongoing prudential, conduct, and record-keeping requirements imposed on these actors, to the detailed pre- and post-transparency rules and order execution requirements imposed on securities trading.
In particular, and the concern of this article, MiFID introduces new rules for the conduct of the investor/investment firm relationship. The MiFID regime is composed of the 2004 MiFID ‘level 1’ Directive, the 2006 MiFID ‘level 2’ Directive, and the 2006 MiFID ‘level 2’ Regulation.[13] Level 1 rules are adopted at a political level by the EU Member States (through the Council of the European Union which represents the Member States) and by the European Parliament, following procedures set out in the constitutional Treaty on European Union. The delegated level 2 procedure, however, allows for technical, detailed rules to be adopted by the EU’s executive body (the European Commission), which represents EU (rather than Member State) interests, advised by the Committee of European Securities Regulators, which is composed of representatives from the Member States’ national market regulators.[14]
II Building a Marketplace: the EU Context
1 The EU Retail Market
The volatile and sensitive retail market in which MiFID operates is key to any assessment of its reforms to the firm/investor relationship. MiFID has transformative ambitions. There is limited retail market activity in the EU at present and no real tradition of market investment. MiFID is a very ambitious measure which is designed to change retail behaviour and to build an active and informed retail community and a market culture. In effect, the MiFID regime aspires to the importation of the US ‘mass equity culture’ into the EU through a regulatory strategy. It represents an express attempt to release capital in the form of consumer savings into the EU securities market, promote long-term savings, and deal with the widespread governmental withdrawal from welfare provision (across the higher education, pension, and health sectors in particular) which is currently occurring across Europe. One senior Commission official, for example, has referred to the ‘prospect of a European retail equity culture,’[15]
while a key European Parliament Committee noted during MiFID negotiations that: ‘One of our most important objectives must be to produce a [MiFiD] framework which encourages savings. It is crucial to ensure proper protection for retail investors and to help build investor confidence.’[16] The European Commission also placed the MiFID reforms in the context of ‘investors turn[ing] to market-based investments as a means of bolstering risk-adjusted returns on savings and for provisioning for retirement’[17] and noted that ‘[p]rivate sector savings in Europe amount to some 20% of GDP - a valuable asset, if efficiently used, to stimulate growth and job-creation.’[18] An active pan-EU retail market has been linked to EC GDP increases of between 0.5 and 0.7%, lower prices for retail services, lower interest rates, and a reduction in the traditional home bias (and poor diversification practices) displayed by retail investors in selecting products and services.[19]
But retail investor activity is limited at present. Retail participation in the market is most prevalent in the UK, but there is little evidence of an active culture of retail market investment, with property investments dominant,[20] retail investors generally unsophisticated, expectations of returns low, and appetite for risk limited.[21] After an initial surge in share ownership following the privatisation programme of the 1980s, share ownership, for example, has fallen back.[22] Retail investors are now returning to the markets after the market shocks of the dotcom collapse and the series of financial disclosure scandals exemplified by Enron and Worldcom, albeit predominantly through collective investment schemes which remain the dominant form of retail investment.[23] Long-term packaged investment products (such as collective investment schemes and life assurance products with investment elements) dominate.[24] Similarly, in continental Europe direct participation in the equity markets is much lower, reflecting the lack of a tradition of market investment. Retail investor activity across the EU is, for the most part, directed toward collective, intermediated investment funds.[25] Direct cross-border offers of retail financial products generally remain the exception and ‘the degree of fragmentation in retail markets is still considerable.’[26] Overall: ‘Retail markets are not integrated … retail investors do not as a general rule operate cross-border, relying on national markets, and on collective investment schemes where they seek exposure to non-domestic markets’.[27] On average, only 5% of EU citizens have bought a financial product in or from another Member State.[28]
The EU’s new concern to support and promote the retail markets reflects a perspective common to the EU’s national regulators at a time when EU governments are withdrawing from welfare provision and promoting greater financial independence and literacy, stronger long-term saving patterns, and market-based savings.[29] The UK FSA which, traditionally, would be more strongly associated with promoting wholesale market concerns, has focused sharply on the retail markets and on promoting retail activity in recent years, reflecting wider concerns as to the need for greater financial independence as the government increasingly transfers risk to individuals.[30] The FSA is particularly concerned that a lack of capability in financial planning could exacerbate the acknowledged ‘savings gap’ in the UK economy.[31] In March 2007, for example, it presented imaginative proposals to liberalise retail investor access to hedge fund techniques through collective investment vehicles in order to capture the diversification and absolute return benefits of these investments for the retail market, while summer 2007 saw the FSA consult on groundbreaking proposals for a radical overhaul of the investment advice sector.[32] Recent public speeches of senior UK regulators also reveal a concern to achieve the best approach to managing the emerging retail sector, whether through regulatory intervention or less intrusive measures which are designed to build competent and risk-aware investors.[33] The UK FSA is currently the market leader in Europe on investor education issues and is devoting very considerable resources to investor education, in addition to building investor education into its new regulatory initiatives. The FSA, in pursuit of its retail market objectives, regards ‘confident and capable consumers’ as a key element of policy design in that they can exert a stronger influence on the market. In 2006 the FSA presented a major survey, the largest of its kind in the world, which presented a comprehensive picture of how people manage money, save, record their finances, and choose financial investments, on which it will base future retail market initiatives.[34] 2006 also the launch of a major investor education initiative designed to lay the foundations for sustained improvements in financial capability.[35] Industry is also focusing on the potential returns from the retail sector, with a trend emerging of complex, structured products being offered to retail investors[36] and related concerns emerging as to the degree of risk transfer to the retail community, not least given the recent upheavals in world credit markets.
MiFID is, therefore, a proactive measure and assumes a link between regulation and market behaviour, notwithstanding the dangers attached to this assumption. The relationship between law and financial market development has become the subject of a vibrant scholarship over the last decade or so. While the role played by law and regulatory design in supporting market development remains controversial, it is at least clear that a complex interplay of different factors, and different aspects of financial market intervention beyond the adoption of rules, including the effectiveness of public and private enforcement, drives financial market development.[37]
The prejudicial effects of over-regulation have recently come into sharp political focus following concerns as to a weakening in the competitive position of the US as the world’s leading financial market in the wake of the stringent requirements of the post-Enron Sarbanes Oxley Act 2002.[38] At the very least, the risks of law are becoming apparent. Nonetheless, the EU’s attachment in principle to law as a means of driving retail market development appears unshakeable.[39]
2 Regulatory Design and MiFID’s Assumptions
MiFID is, therefore, based on a problematic model which does not reflect market conditions. This matters as a heavy retail orientation tends to predict higher levels of regulation which can leak across into the wholesale markets and raise costs for the wholesale industry, unless client classification rules, which dictate the application of regulation, are very carefully constructed and applied. It also matters as the choices and assumptions MiFID makes as to investor behaviour and competence in the investor/investment firm relationship are potentially critical for the healthy development of the EU’s retail investment services markets and wider economic growth.
The MiFID investor/firm regime is ultimately based on a key assumption: the assumption dear to regulators worldwide that a relationship exists between investor protection (typically a proxy for regulation) and investor confidence. This assumption dominated institutional and political discussions on MiFID as well as market reaction, notwithstanding the uncertain relationship between law and regulation and the potentially unlimited power investor confidence as an objective lends to regulators.[40] Rather more proactively, the new investor/firm regime is also based on supporting investor empowerment and investor choice – an approach which the UK FSA has also adopted in recent policy documents.[41]
But regulatory design for the investment firm/investor relationship which is heavily based on choice and empowerment generates risks. Increasing choice and attempting to change investor behaviour may cause the investor to fall prey to opportunistic investment advisers and inappropriate products, even where disclosure is made available to support good decisions. This is particularly the case where disclosure is fragmented across different product and service dimensions and where retail investor policy is not developed holistically. Equally, ‘[i]ncreased competition...does not necessarily work to the benefit of consumers [of financial services]. There is no automatic link, for example, between wider choice sets and widespread consumer gains.’[42] Efficient retail markets, based on choice, need demand-side policy intervention which builds effective and informed investors, capable of exercising choice effectively.[43] While interventionist controls in the investor/firm relationship, particularly with respect to distribution and advice channels, have a critical role to play, effective investor education, which can reduce the risks of the advice channel and maximize the effectiveness of suitability and other requirements, is required if investor choice is to be appropriately realised. Choice can also be supported through the development, or appropriate regulatory or taxation-driven support, of a range of well-diversified retail investment products.
Investor choice is the gateway to MiFID’s regulatory regime for the broker/investor relationship. Depending on the service chosen, and on a spectrum from asset management and investment advice to execution-only services, investors can choose the level of protection and, implicitly, the cost of the service in question. Disclosure is the dominant regulatory mechanism, reflecting an assumption that the investor targeted by the investor/firm reforms is rational, competent, and capable of exercising informed choice: ‘to strengthen the demand side and promote good investment choices, e.g. for pensions, it is essential to increase transparency and comparability and to help consumers understand financial products.’[44] But the MiFID regime seeks to build a cohort of informed and competent retail investors on an insecure foundation of limited investor activity, scarce supervisory experience with mass retail participation, uncertainty as to the implications of wider retail participation in the market and the relationship between law and market activity, without stringent ex-ante assessment of which regulatory techniques and, in particular, disclosure formats and requirements, best promote investor capability, and without a secure basis of investor education. In effect, the new regime looks set to operate in a policy vacuum, notwithstanding the very considerable resources regulators internationally are increasingly devoting to regulatory design and studies into investor behaviour.[45]
III The Conduct of Business Regime
1 The Core Principles
The most dramatic reforms to the investor/investment firm relationship are contained in MiFID’s new conduct of business regime (Articles 19-22) and its related level 2 rules. The new conduct of business regime represents the first attempt by the EU to address all aspects of the firm/investor relationship and across the full range of services from execution-only to discretionary portfolio management, from marketing to pre-contract disclosure and contractual protections, and from initial advice and suitability assessment to order execution. It is designed to establish a rigorous investor protection regime in order, in part, to encourage the development of a stronger retail market. It has been described as one of the ‘the mainstays of investor protection.’[46] The conduct of business regime covers: a foundation obligation to act fairly, honestly, and in the best interests of investors (Article 19(1)); an obligation that information and marketing disclosure be fair, clear, and not misleading (Article 19(2)); the disclosure to be provided to the investor (Article 19(3)); suitability rules (Article 19(4)-(6)); the customer agreement (Article 19(7)); period client reporting requirements (Article 19(8)); addresses best execution (Article 21); and order handling rules (Article 22). It therefore covers the life cycle of the investor/firm relationship from initial marketing and disclosure through to suitability assessment and the customer agreement, execution and order handling requirements, and on to ongoing record-keeping requirements.
2 A Generic Regime
The conduct of business regime is, however, generic in nature and applies to a range of investment services including investment advice, portfolio management, and broking and execution-only trading services (Article 4(1)(2)). The level 2 regime, although detailed, is designed to be principles-based ‘establishing clear standards and objectives that investment firms need to attain rather than prescribing specific and detailed rules’ [47] – although this is more true of MiFID’s organisational and prudential requirements than the conduct of business regime. While in principle the level of intervention in the investor/investment firm relationship varies according to the particular service, the regime is not closely calibrated to particular risks, although there are some attempts to tailor the rules to the generic risks of asset management services at level 2. Hedge fund investments, to take one example, are increasingly being fed into investor portfolios across the EU through asset management techniques as concerns grow as to the ‘retailisation’ of the EU hedge fund industry.[48] The appropriate management of alternative investments generally has become a major policy priority for regulators across the EU. A common theme of the reform movement is that alternative investments and hedge funds should not be addressed through specific product regulation, but through intermediation and advice mechanisms, which operate downstream from the product designer.[49] Although policy is evolving, the current regulatory approach appears to be to focus on a threshold for access to hedge funds and on policing the application of generic conduct of business rules on investment advisers, particularly with respect to suitability, asset selection, and disclosure. Whether the generic suitability and disclosure disciplines adopted in the conduct of business regime for portfolio and asset management are sufficiently robust to meet this particular risk remains to be seen.
An emerging lesson from MiFID, therefore, is that while generic conduct of business rules for investment services have the benefit of flexibility, particularly for multi-service firms, they need to be sufficiently robust and principles-based to contain emerging risks which may cascade on to the intermediation and advice layer, particularly given the difficulties attached to effective product regulation. Effective supervision of how generic principles are applied is also essential.
3 Investment Advice
The provision of investment advice is at the heart of the conduct of business regime. As a market gateway for investors and as a key distribution channel for potentially risky investments and products, advice dictates the intensity of regulation. The EU investment advice industry is becoming an ‘increasingly important financial business in its own right with over 4,000 independent financial advisers in the UK, over 7,000 in Italy and larger numbers in Germany.’[50] Structurally, therefore, the regime assumes a need for intervention in the firm/investor relationship beyond disclosure and a degree of investor dependence and builds the conduct regime from that assumption.[51]
Investment advice is defined as the provision of ‘personal recommendations’ in respect of one or more transactions related to financial instruments (Article 4(1)(4)). An early test for retail policy and whether it would take a sharply paternalistic turn reflecting the immature nature of the market, emerged with the EU’s level 2 rules which amplify this key definition. Earlier drafts included generic advice on financial planning and asset allocation which was not linked to specific investment recommendations within the definition of investment advice. This approach was designed to reflect the reality that inexperienced investors are likely to place considerable reliance on general investment advice, particularly given current limited levels of investor education, and that advice can be provided to investors on a continuum from generic to specific. This provoked hostile market reaction given the costs involved in imposing suitability and related information-gathering requirements at a very early stage of the investment advice chain. The definition of investment advice was then scaled back to refer to advice which leads to specific personal recommendations, presented as suitable for that person or based on a consideration of that person’s circumstances, on particular instruments. This represents a robust approach to investor capability, excluding generic advice and reflecting a more cost-driven and, therefore, choice-conscious approach to the investor/firm relationship: it should also support initiatives such as the FSA’s proposed primary, generic advice regime. The potentially costly suitability obligation to gather information from the client is deferred until the recommendation becomes specific. But this approach also reflects a pragmatic approach to the different channels along which investors receive basic financial advice and education and the emerging awareness that regulatory intervention in the firm/investor relationship must be supported with ancillary strategies to build competent investors, particularly investor education: ‘the exclusion of generic advice….avoids the danger of regulating financial planning entities that, in many cases, operate as charities providing valuable financial advice free of charge.’[52]
4 Structure of the Investment Advice Industry
The investment advice regime does not, however, address the structure of the EU investment advice industry. It simply imposes conduct of business requirements on the provision of investment advice and does not further tailor the regime. But a major concern across the EU at present is the structure of the advice industry for the retail market and whether advice is provided by investment product providers (such as banks and investment firms) and their tied agents or through independent advisers. Although the independent advice sector is growing, investment products are typically distributed through product providers, usually banks.[53] A risk therefore arises of conflicts of interests in the advice process where the ‘adviser’ is part of, or tied to, the product provider, or remunerated on a commission, rather than an advice fee, basis. There is also a growing view that retail market reform requires a re-education of retail investors as to the value of independent advice and to the reality that this requires payment of a fee. Difficult questions of balance arise, however, where there is a concern to build greater retail participation and supply-side interest on the advisory side, and where it may be cheaper to distribute retail products through product providers.
The UK approach, for example, was, initially, to adopt a regime based on ‘polarisation.’ Only two forms of adviser were possible: (i) advisers who were representatives of product providers and only provided advice and sold their own products; and (ii) independent advisers who advised from the wide range of products available. Different regulatory treatment applied and the differentiation was designed to help investors label the type of advice offered and the risks involved. Conflicts of interest in remuneration in the advice process were therefore partially managed through a structural divide in the industry. Following extensive research, the FSA recently decided that this approach reduced choice. In a major exercise, in 2005 it moved to a ‘depolarisation’ model under which advisers are not restricted in the advice they offer, as a structural matter (although client classification and suitability rules, of course, apply). This structural reform (which is now under review) raises particularly sharp conflict of interest and disclosure risks for retail investors in the depolarised regime which are reflected in FSA rules. In particular, the level of commission-based advice is very high in the UK and the risk of mis-selling is regarded as particularly significant. Central to the regulatory treatment of this model is the requirement for an Initial Disclosure Document which makes clear to the investor the nature of advice being offered, including whether it is on the entire market range of investments, on a limited range of investments, or on the products of a single provider. It must also set out clearly fees and commission levels and explain any ties to investment product providers. The new MiFID regime, however, has caused some difficulties for the UK which has made an application to the EU (which has been approved) to maintain its specific disclosure and conflict of interest rules which are additional to the MiFID regime (and so would be outlawed under MiFID which does not allow Member States to adopt additional national rules – the so-called ‘goldplating ban’) but which reflect the particular risks of the UK’s retail marketplace.
The EU regime takes a simple, disclosure-based approach to the structure of the advice industry. Although the new EU regime does not impose product and advice restrictions on different types of adviser, detailed rules apply to the disclosure of fees and commissions to dilute conflict of interest risks where advice is provided in a potentially conflicted context and conflict of interest rules also apply. It remains to be seen whether these less interventionist techniques will be sufficient if the EU retail investment advice develops.
IV Conduct of Business: Disclosure
1 The Dominance of Disclosure
Disclosure dominates as a regulatory technique for managing the investor/firm relationship across the new conduct of business regime and is ‘designed to give regulators and investors the necessary tools to be able to discern and punish inefficiency and unprincipled conduct by firms.’[54] Choice and protection combine here: disclosure as tool of investor protection is expressly linked to disclosure as a tool for competent investor monitoring and exercise of choice. Article 19 addresses marketing, pre-contract, and contract disclosure, while Articles 21 and 22 cover disclosure in order execution. This reliance on disclosure suggests a strong characterisation of the investor as rational and reflects the regulatory strategy’s emphasis on informed investors and on limited intervention in the investor decision. The Article 19(3) information requirements, for example, are designed to ensure investors are: ‘reasonably able to understand the nature and risks of the investment service and of the specific type of financial instrument that is being offered and consequently to take investment decisions on an informed basis.’
2 Marketing Disclosure
Marketing disclosure is a major concern for EU retail policy given potential investor vulnerability.[55] The core disclosure obligation is set out in Article 19(2) which requires that all information, including marketing communications, which is addressed by an investment firm to clients or potential clients must be fair, clear and not misleading.
The related level 2 regime which amplifies this requirement is highly detailed, covering a range of risks and vulnerabilities. The level 2 requirements are specifically targeted to retail investors,[56] given their greater vulnerability and limited ability to bargain for disclosure and the material effect marketing communications have on investor decisions. Professional investors are regarded as protected by the general Article 19(2) requirement. The regime does not, however, require pre-approval of marketing communications or prescribe the content of marketing communications. In an attempt to support flexibility, it sets out the conditions with which information must comply in order to be ‘fair, clear and not misleading’ in accordance with Article 19(2). The main concern is with requiring key disclosures and risk warnings rather than on prohibiting particular forms of disclosure. Investor autonomy remains the dominant theme.
Investment firms must avoid accentuating the potential benefits of an investment without giving a fair and prominent indication of risk. Communications must not be disguised, diminish or obscure important items, statements, or warnings. Reflecting the current EU policy preoccupation with driving outcomes and changing firm behaviour, there is an attempt to incentivise firms to target their marketing communications appropriately by requiring that information be presented in such a way that it is likely to be understood by the ‘average member’ of the group addressed. While this is a challenging requirement given the different capabilities of investors, it is an innovative attempt to ensure that disclosure is related to investor profiles and that marketing of complex and risky products is not inappropriately targeted to vulnerable investors – particularly in an era of alternative investment.
There is also striking evidence of a concern to promote rational decision-making. Particular requirements apply to the use of a range of marketing disclosure techniques which are prone to investor over-reaction, such as suggestions of endorsement by a regulatory authority (prohibited), tax information (a warning must be provided that tax treatment depends on the individual circumstances of each investor), simulated historic returns, past performance indicators, comparisons, and projections. Common themes include prominent use of risk warnings and substantiation of claims. There are, however, some significant assumptions as to investor competence. Simulated historic returns are permitted (earlier drafts banned their use), but they are subject to risk warnings and requirements as to how the returns are constructed. Past performance information is permitted although restrictions apply: in a clear reflection of the dangers of investor over-reaction, past performance information must not be the most prominent feature of the communication; the information should extend over a 5 year period or, where the investment has a shorter history, over its whole life span, in no case for shorter than one year; sources of information must be clearly stated; the impact of currency fluctuations must be explained; the effect of commissions, fees, and charges must be disclosed; and the information must contain a prominent risk warning that past performance is not a reliable indicator of future results. Projections must not be based on simulated past performance, must be based on reasonable assumptions which are supported by objective data, and contain a prominent risk warning. Comparisons must be meaningful and presented in a fair and balanced way, the source of the information used for the comparison must be specified, and key facts and assumptions used to make the comparison must be included.
3 Disclosure to Investors
Article 19(3) is the core disclosure provision. It requires firms to provide appropriate information ‘in a comprehensible form’ to clients and potential clients about the investment firm and the services provided, the financial instruments involved, the proposed investment strategies (including risk warnings and execution venues), and the related costs and associated charges. The objective, as with Article 19 (2), appears to be to build an informed and empowered investor base.
The level 2 rules amplifying Article 19(3) require a formidable range of information (and the terms of the client agreement) to be provided to investors ‘in good time’ and in a ‘durable medium.’ The disclosure required includes information on the firm (including a summary (in the interests of cost management) description of the firm’s conflict of interest policy), the nature of the service(s), the financial instruments involved and their risks, arrangements for safeguarding client assets, and commissions and fees. Risk warnings, particularly with respect to financial instruments, form a key part of the disclosure strategy. A general description of the nature and risks of the financial instruments in question must be provided and must be sufficiently detailed to enable the client to understand the nature and specific risks of the instruments. Particular care is taken to calibrate the disclosure to the capacity of the investor – reflecting again the concern to build a competent cohort of investors. The risk disclosures (as to instrument risk, leverage risk, volatility and liquidity risk, financial commitments and contingent liabilities, and margin requirements), are to be relevant to the instrument and to the status and level of knowledge of the client.
Asset/portfolio management services are subject to extensive disclosure requirements. These requirements are set, however, in generic terms. The recent growth of alternative investments, an increase in retail appetite for these investments, and the increased risk of asset managers feeding riskier investments into investor portfolios, particularly where managers form part of multi-service investment firms holding own account portfolios of hedge fund investments and other riskier investments, may place considerable strain on the effectiveness of the Article 19(3) disclosure (and its related level 2 rules) regime in protecting investors. The asset manager must provide the investor with details as to the method and frequency of portfolio evaluation, any authorised delegation of the portfolio management service, the types of financial instruments which may be included in the portfolio and the types of transactions which may be carried out (including any limits), the management objectives, the level of risk to be reflected in the manager’s exercise of discretion, and any specific constraints on the manager’s discretion. In a proactive attempt to support competent investor monitoring, the firm must also establish an appropriate method of evaluation and comparison, such as a meaningful benchmark, based on the investor’s investment objectives and the financial instruments involved, which enables the client to assess the firm’s performance.
Some attempts are made to integrate the disclosure obligations applicable across the financial market sector, thereby reducing cost and building consistency across the disclosure regime as a whole. Where, for example, an investment firm provides a client with information about a financial instrument currently subject to a public offer and a prospectus has been published in accordance with EU rules, the client must be informed as to the availability of the prospectus. Similarly, the Article 19(3) obligations as to financial instrument disclosure with respect to informing an investor as to UCITS mutual fund investments (the ‘UCITS’ is the ‘gold standard’ retail investment product in the EU - a highly regulated mutual fund, subject to investment limits, diversification requirements, governance requirements, and disclosure rules)[57] are met through the UCITS simplified and summary prospectus, an information document expressly targeted to the retail sector and required under EU law. The extent to which product and service disclosure is integrated across the investment services regime will be critical to the regime’s success in building an informed and competent cohort of investors – particularly in the context of execution-only services (discussed further below).
4 Record
Keeping
Article 19(7)
requires the investment firm to establish a documentary record of the
firm/investor relationship, including the client
agreement. Under Article 19(8),
clients must receive adequate reports from firms on the services provided,
including on the costs
associated with transactions and services. The level 2
regime addresses execution reports and contract notes in some detail as to
timing and content. Detailed requirements are also imposed on portfolio
management reports, dovetailing with the attempts in the
Article 19(3)
disclosure regime to support investors in monitoring portfolio management.
Periodic statements must be provided every
six months. Clients may, however,
request statements to be supplied at three month intervals and, in another
expression of the regime’s
attempt to build a competent and proactive
cohort of investors, must be informed of their right to do so by the firm.
Critically
for the investor, the statement must include a comparison of
performance during the period covered by the statement with any agreed
investment performance benchmark.
5 Best Execution and Trading
Disclosure
Under
Article 21(2) firms must have a best execution policy which allows firms to
obtain the best possible execution result. Article
21(3) requires that the
policy include, in respect of each class of instrument, information on the
different venues where the firm
executes its client orders, the factors
affecting the choice, and those venues that enable the firm to obtain, on a
consistent basis,
the best possible result for the execution of client orders.
Article 21(3) also, and controversially, requires firms to provide
‘appropriate
information’ to clients on this policy prior to the
provision of the service, to obtain client consent to the policy, and,
where the
policy provides for ex-stock exchange /multi-lateral trading facility execution
(essentially, execution through internalisation
of the order by the investment
firm), to inform them of this possibility and obtain their prior express consent
before proceeding
to execute. Some attempt is made to manage the costs of this
system in that consent can be obtained in a general agreement, or in
individual
transactions.
The objective of this disclosure is to inform clients about execution, help them to compare execution services, and foster competition on a quality of service basis given the competitive order market context of the EU. It also operates as a control on conflicts of interests where a firm seeks to internalise trades. But the need for this disclosure remains questionable. Disclosure of this nature places an enormous burden on the retail investor and arguably operates at the limit of investor competence. The obligation here is most appropriately on the firm to make the execution decision according to the Article 21 best execution requirements, subject not to consent by the investor, but to enforcement procedures where best execution standards are not met. An additional decision-making point, which is only likely to confuse investors, is created in the interests of maximising disclosure and investor autonomy. The emphasis on execution disclosure also sits uneasily with how the regime regards the obligation to achieve best execution in retail trades. As outlined in Section VI below, one of the innovations of MiFID is to establish a clear price and cost benchmark for best execution for retail orders. This is justified in part on the grounds that retail investors ‘are unlikely to have the time or specialist knowledge to understand or evaluate detailed disclosures related to best execution [or have] the resources to make an effective comparative evaluation of the execution policy of the firm.’[58] Nonetheless, the policy attachment to some degree of disclosure remains.
At level 2, the regime is relatively light-touch and requires that firms simply provide investors with: (i) an account of the relative importance the firm assigns to the different factors feeding into best execution (including price, speed, costs, likelihood of execution and settlement, and size) or the process whereby the firm determines the relative importance of those factors; and (ii) a list of the execution venues on which the firm places ‘significant reliance’ in meeting its best execution obligations. The first of these requirements, requiring the firm to explain the often nuanced process through which the execution decision is made, may prove difficult for firms and inaccessible for investors. Reflecting the reliance throughout the disclosure regime on risk warnings, firms must also include a prominent warning in the execution policy to the effect that specific client instructions may prevent the firm from taking the steps set out in its execution policy to obtain the best possible execution result. These requirements, while remaining controversial, are considerably lighter than those originally proposed which met a hostile market response on the grounds that detailed execution disclosure would not be meaningful to investors, likely to overwhelm them, not relevant in that investors are only concerned as to the net result, and costly to compile. The development of this aspect of the disclosure regime reflects the overall emphasis on investor choice across the conduct regime, given the willingness to reflect market opinion and ensure regulatory costs are not passed on to investors and choice prejudiced as a result.
V Conduct of Business: Suitability
Although disclosure is the dominant regulatory technique of the conduct of business regime, MiFID does adopt a more interventionist approach under the new suitability regime. The introduction of detailed suitability requirements represents a major change to the EU’s retail investor protection regime and the high-water mark of the extent to which the new regulatory strategy for the retail markets intervenes paternalistically in the investor’s decision. The suitability assessment takes two forms: (i) the assessment of ‘suitability’ and (ii) the assessment of ‘appropriateness,’ depending in each case on the level of reliance on the investment firm. In a clear expression of the emphasis on investor choice and competence, execution-only services are not subject to suitability requirements. Investor choice therefore controls the operation of the suitability regime.
Under Article 19(4), where the firm provides general investment advice or portfolio management, an extensive suitability check is required. The firm must obtain the necessary information regarding the investor’s knowledge and experience in the investment field relevant to the specific type of product or service, financial situation, and investment objectives. Based on this information, the suitability check should enable the firm to recommend the investment services and financial instruments ‘suitable’ for the investor. The related level 2 rules on the information which must be obtained require the firm to obtain such information as is necessary for it to understand ‘essential facts’ about the client and for the firm to have a ‘reasonable basis for believing’ that the transaction meets the client’s investment objectives, that the client is able financially to bear the investment risks involved consistent with the investment objectives, and that the client has the necessary experience and knowledge in order to understand the risks involved. Information concerning the investor’s financial situation is expressly addressed: relevant information includes information on the investor’s source and extent of regular income, assets, investments and real property, and regular financial commitments. The information required concerning the investor’s investment objectives includes the investor’s time horizon, risk-taking preferences, risk profile, and the purposes of the investment. The level 2 rules also cover generic requirements as to how ‘suitability’ is assessed, including with reference to: the type of service, transaction and instrument involved; the nature, volume and frequency of the investor’s transactions; and the level of education, profession or former profession of the investor – a requirement likely to place some demands on the investment firm in terms of collection and application to the suitability assessment. Where information is not provided, the investment firm must not recommend investment services or instruments. The investment firm may not proceed even where risk warnings are provided, reinforcing the generally interventionist and paternalistic approach taken to the suitability assessment.
Under Article 19(5), a lighter touch ‘appropriateness’ regime is imposed. It applies where services ‘other than Article 19(4)’ services are provided. These would involve more limited, non-tailored, advice services, typically linked to general recommendations concerning a particular investment product, which do not come within the Article 4(1)(4) definition of investment advice, and which are not based on a close assessment of the investor’s circumstances. The appropriateness test applies in particular to sales of products which do not quality under the execution-only regime. The firm is to ask the investor to provide information regarding his/her knowledge and experience in the investment field relevant to the specific type of product or service demanded, so as to enable the firm to assess whether the service or product is ‘appropriate’. Unlike the suitability regime, failure to supply the information does not prevent the firm from supplying the services, as long as a risk warning is provided – greater investor autonomy and capacity is assumed for this level of service. The appropriateness assessment is directed towards a ‘one-off’ transaction by the investor, and not on the appropriateness of an overall portfolio of investments. Investor choice lies behind this classification: ‘the impetus behind a light touch sales regime is to simplify current sales practices, to reduce costs to the consumer and to encourage them to make active choices about the products or services offered’.[59] The level 2 regime is similarly light touch, particularly by comparison with the suitability regime. The firm is simply required to determine whether the client has the necessary experience and knowledge in order to understand the risks involved in relation to the specific type of product or service offered or demanded. The bulk of the suitability requirements are directed to the Article 19(4) advice regime. As with the execution-only regime, however, this lighter regime will demand effective disclosure concerning the products in question and competent investor decision making.
Where the service is execution-only suitability requirements are disapplied (Article 19(6)). Conditions apply: the investment may only concern particular identified ‘non-complex’ instruments, including shares, debt securities, and UCITS mutual fund units; the service must be provided at the initiative of the investor; appropriate risk warnings must be given as to the limited nature of the service; and the firm must comply with its conflict of interest obligations under MiFID Article 18. Execution-only is also supported by the background trading protections of the best execution and orderly trading regime (Articles 21 and 22) (Section VI below). The investor’s freedom to choose to sacrifice the benefits of full-service advice for low costs is therefore accommodated. Article 19(6) reflects the popularity of execution-only services with investors[60] and a policy assumption that investor choice of a low-cost, low-protection service should be supported. A light touch execution-only regime was also strongly supported by the market.[61] Promoting choice in this way means accepting that investors will make their own calculations as to the risk/return relationship, that they make ‘poor’ choices, and that they may choose to prioritise low-cost, low-support services. Execution-only is an inherently riskier service for retail investors but choice of a low-cost regime trumps a more interventionist, paternalistic response. The regime does, however, control choice by controlling the level of risk which can be assumed by the investor in suitability-free, execution-only trading by imposing conditions. Nonetheless, the conditions (largely based on disclosure and risk-warnings) assume a degree of competence and capability on the part of the investor. In addition, while the relatively wide range of investments (including third country securities) eligible for execution-only services should allow more effective investor diversification, the list may not adequately reflect the potential risk posed by mutual funds or shares in highly structured products traded on regulated markets (such as shares in companies which are, in effect, wrappers for hedge fund products). The level 2 regime has amplified what is meant by ‘non-complex instruments’ in an approach which supports wide investor choice and market innovation by characterising these instruments in broad terms as: non-derivative financial instruments; that are easily realizable; and that do not involve any liability in excess of the initial contribution. While effective product development is essential in building investor choice, and while this depends in part on the availability of low-cost, execution-only channels for retail-targeted products, the removal of advice requirements intensifies the risks attached to investor competence and the effectiveness of product disclosure. The dominance of disclosure as a regulatory technique is, however, asserted. Information on the ‘non-complex’ investment (structure, costs and other factors having a material effect on its performance) should be easily accessible and, reflecting the emphasis on competence throughout the disclosure regime, be ‘likely to be readily understood’ and allow the ‘average retail client’ to make an ‘informed judgment.’
VI Conduct of Business: Best Execution and Order Handling
MiFiD (Article 21) introduces a best execution obligation for the first time in EU investment services law for retail and professional investors. Best execution rules seek to address the information imbalance between the investor and firm as to price formation and to ensure that an investor’s trade is executed on the most favourable terms. They are critical for investor protection in the EU given that trading and order execution is increasingly fragmented across a range of competitive order execution venues, including stock exchanges, alternative trading systems, and investment firms who internalise trades by executing them against their proprietary securities portfolios. The Article 21 best execution regime represents a significant addition to the EU’s investor protection structure by channelling the benefits of competition in order execution to retail users.
Under Article 21(1) investment firms must take all reasonable steps when executing orders to obtain the ‘best possible result’ for their clients, taking into account price, costs, speed, likelihood of execution and settlement, size, nature, and another relevant considerations. As outlined in Section IV above, Article 21(2) requires investment firms to establish and implement effective arrangements, including establishing and implementing an order execution policy, to allow them to obtain the best possible result. Article 21(4) requires firms to monitor the effectiveness of their execution arrangements and policy and to identify and correct any deficiencies. This obligation to monitor execution quality across a potentially wide range of execution venues given the EU’s competitive order execution market has been the subject of very considerable controversy.
The more elaborate and complex best execution policy, however, and the more onerous the monitoring and reporting requirements, the greater the likelihood of costs being passed on to investors. The level 2 regime is designed to allow firms flexibility in execution design and in organising their business models and only sets out in general terms the criteria according to which firms should assess the relative importance of the best execution factors (including the status of the client as retail or professional). But in a reflection of the increasingly targeted approach to the retail markets, specific reference is made to the position of retail investors and the costs of execution, given that retail investors are largely concerned with overall price. The search costs involved if speed, market impact, and other factors important for professional investors were also considered would increase the costs of best execution while not reflecting retail investor needs. Level 2 therefore establishes a benchmark for best execution in the retail markets. Firms are to take the necessary steps to ensure that the best possible result is achieved for retail investors in terms of the total consideration, representing the price of the instrument and the execution costs. Other factors (speed, likelihood of execution and settlement, size and nature of the order, market impact, and other transaction costs) are to be given precedence over immediate price and cost considerations only where they are relevant in delivering the best possible result for the retail client.
Article 22 addresses the processing of investor orders and the management of conflicts of interest, requiring investment firms to implement procedures and arrangements which provide for prompt, fair, and expeditious execution of client orders, relative to other client orders and the trading interests of the investment firm.
VII Delivering Choice and Managing Costs: Calibrating the Regime and Retail and Sophisticated Investors
Whether or not the regime effectively delivers investor choice depends in part on the extent to which it manages the regulatory costs which can limit investor choice of provider.
Calibration is an underlying theme of the conduct of business regime. Although there are elements of this with respect to the application of the suitability disciplines and in the disclosure regime,[62] it is most apparent in the extensive retail and professional classification regime. Careful management of the retail and professional sectors allows the burden and benefits of regulation to be appropriately spread and risks to be assessed more appropriately.
One of the undercutting themes of the MiFID regime is that measures to protect investors should be adapted to the particularities of each category of investor and, in effect, their ability to bargain for protections – although the regime provides only limited full exemptions from the conduct of business regime, even for sophisticated parties. Under Article 19(10), the related level 2 conduct of business rules must take into account the retail or professional nature of investors. The level 2 suitability regime, for example, provides that firms may assume that professional investors (once so classified – see below) have the necessary level of experience and knowledge for the investment in question. The detailed level 2 disclosure regime is, for the most part, expressly targeted to retail investors – professional investors are deemed to be sufficiently protected by the principles-based disclosure requirements set out in Article 19. As outlined in Section VI above, the Article 21 best execution regime at level 2 also reflects the different needs of retail and professional investors.
MiFID (Annex II) contains detailed guidance on how to classify an investor as professional for the purposes of the new regime. The classification system is regarded as one of the potentially costly aspects of the new regime, given the need to classify clients according to detailed procedures and to re-segment the firm’s client base. Specified ‘professional’ investors include: authorised institutions, such as investment firms, collective investment schemes, and credit institutions, and sophisticated investors, such as governments and regional authorities and institutional investors whose main activity is to invest in financial instruments. These actors may request non-professional status. Where a client falls within one of the specified professional categories, the investment firm must, prior to the provision of any services, inform the client that, on the basis of the information available, the client is deemed to be professional and will be treated as such unless the firm and client agree otherwise. It is the responsibility of the professional client to request a higher level of protection when it deems it is unable to assess properly or manage the risks involved. A written agreement must be provided to this effect.
Other actors, typically private individual investors, may opt to be classified as professional on request, based on their meeting competence and asset-based tests, and to be subject, in consequence, to lighter conduct of business rules. This group should not, however, be assumed to possess the market knowledge and experience of the actors specified as professional. Any waiver or dilution of the protections of the conduct of business regime is only valid where an adequate assessment of the expertise, experience, and knowledge of the investor, undertaken by the firm, gives a reasonable assurance in light of the particular investments involved that the investor is capable of making investment decisions and of understanding the risks involved. Two of the following criteria must be met: the client has carried out transactions in significant size on the relevant market at an average frequency of 10 per quarter over the previous four quarters; the client’s portfolio exceeds EURO 500,000; and the client works or has worked in the financial sector for at least one year. Specific and potentially cumbersome procedures apply to the waiver process, including a written request by the client, a written risk warning by the firm as to the loss of protections, and a statement in writing by the client of awareness of the consequences. Firms must implement written internal policies and procedures to classify clients.
In addition, Article 24 expressly disapplies Articles 19, 21, and 22 from ‘eligible counterparties’ (defined at level 2, in essence, as ‘professional clients’ in accordance with MiFID Annex II), who enter into transactions with investment firms. It is designed to ensure that transactions by an investment firm on own account or on behalf of its clients with counterparties are not subject to conduct of business requirements.
The classification requirements are, however, proving to be complex in application and very costly. There is also strong market support for an express carve-out for professional investors from the suitability regime, which does not currently exist.[63] The classification regime is also producing some unforeseen effects in that it has provoked a rush to market riskier products to high net worth individuals who will be classed as retail investors once the MiFID regime is applied.[64]
VIII Confident and Capable Investors?
1 Regulatory Design
While effective investor choice may founder because of the costs of MiFID implementation, difficulties also arise with respect to MiFiD’s blue-print for competent investors who are able to exercise informed choice.
The disclosure regime does not make many concessions to limited ability or inexperience. But investor/investment firm disclosure addresses individual decision-making rather than, for example, price formation in the trading market context. It should take particular account of the decision-making process, the relevance, comprehensibility, and timeliness of disclosure, and the ability of individuals to use the information, not least as information provides the foundation for the regulatory strategy’s support of investor choice. The potentially helpful notion of the ‘average investor’ is, however, increasingly appearing across EU securities regulation, usually tied to simplifying the form in which disclosure is delivered. The ‘average investor’ also appears throughout the conduct of business disclosure regime, implicitly, with the regime reflecting some key weaknesses in decision-making, particularly with respect to risk assessment, the impact of costs, and the effective interpretation of financial data, and expressly, with the requirement for marketing communications to be appropriately targeted. Overall, however, the regulatory strategy assumes an informed retail community with high levels of competence in decoding information. Even discounting some of the more dramatic claims behavioural finance can make as to irrational investor behaviour,[65] this is rather at variance with the well-documented evidence of poor investor decision-making. The regulatory strategy also requires more nuance. The range of information provided will place considerable demands on an investor’s capacity to understand sophisticated financial information and may simply generate confusion. Firms might, for example, have been required to prioritise certain risk disclosures. The embryonic state of the retail market might also have suggested a requirement for basic disclosure concerning diversification, which is a well-known pitfall for retail investors.[66]
The suitability regime does intervene more paternalistically in the investor/firm relationship in the sensitive advice context. But investor choice, and the related need to reduce costs and regulatory burdens, is a recurring theme of the suitability regime. Where the investor opts for higher levels of advice, is choosing from a wide range of possibly complex options, and cedes greater control over the investment decision, progressively heavier obligations are imposed on the firm. Execution-only services leave the investor exposed and reliant on disclosure more generally, including company and mutual fund prospectuses, ‘tips’, analyst reports, annual reports, and ongoing and periodic disclosure requirements. Although there are some signs of the investor/firm regime integrating wider prospectus and mutual fund disclosure, gaps remain. Holistic development of disclosure policy calls for a ‘joined-up’ approach to the management of disclosure in the retail market. In particular, and as with much of the conduct of business regime, the execution-only regime must be placed within a investor education framework, given, in particular, the evidence of persistent diversification failures and of over-trading by investors.
Ultimately, large-scale investigations into the nature of retail investment services market behaviour are required for effective disclosure and choice-based policy-making. While considerable academic research has been undertaken in this area, particularly in the behavioural finance field, large-scale, detailed and regulator-sponsored assessments of investor trading and decision-making should yield important information as to the extent to which investors diversify, whether they trade too frequently, and how they allocate funds. This evidence could inform disclosure policy, suitability controls and the advice process (particularly with respect to execution-only), and, critically, investor education.[67] Evidence is also needed on how investor behaviour and financial capability varies across the EU, the risks and difficulties faced by investors, how investors are likely to exercise choice in an integrated market, and what disclosure formats, products, and services are most likely to promote effective and informed pan-EU investor activity. Some attempts are being made to experiment with formats and disclosure requirements for the EU retail market in the context of the UCITS mutual fund prospectus and Member States have been encouraged to examine the extent to which the UCITS retail prospectus has been successful,[68] but there is little evidence to date of ex-ante testing of the new investor/firm disclosure regime. The EU financial market reform agenda for 2005-2010, however, places heavy emphasis on how the effectiveness of rules can be ensured rather than on the adoption of new measures. In particular, ex-ante cost benefit analysis of any new financial market measures and ex-post review of current measures is now a pillar of EU policy, following considerable market demand. Whether the new disclosure regime for the investor/broker relationship will be appropriately assessed as it is applied will be an early test for the EU’s new commitment to evidence-based policy making for the financial markets.
2 Governance Risks
This failure to test retail-oriented regulation reflects in part the dearth of retail input on the development of the new regime. Governance risks are acute in the new conduct regime given the weight of market/supply-side opinion which informed discussion, as can be seen repeatedly in the development of the regime where reductions in regulatory costs and the promotion of investor choice has trumped protection. It is revealing that in the course of the ‘Consumer Day’ organised by the Committee of European Securities Regulators, which occurred after major consultations closed on the development of the level 2 rules by the Committee, a very different perspective (regardless of its merits) emerged on the level 2 regime.[69]
This is a problem for regulatory design for the retail markets generally in the EU. Consultation exercises are almost entirely dominated by industry and wholesale market interests. The statistics are stark. Across all the consultations held by the Committee of European Securities Regulators (which advises the European Commission on level 2 rules) from October 2002 until June 2005 on various FSAP measures, including the MiFID conduct of business regime, there were 1680 responses of which only thirteen represented consumer groups.[70] More specifically, of the seventy seven responses to CESR’s First Draft Level 2 Advice on the MiFiD regime[71] (of particular importance to the consumer sector as it covered CESR’s advice on the disclosure provided by investment firms to investors), only one (the Danish Shareholders’ Association) formally represented the interests of private investors.[72] Of the seventy eight responses to the Second Draft Level 2 Advice,[73] which addressed advice and suitability assessments, also of particular concern for retail investors, only four (the Danish Shareholders Association, the Swedish Shareholders Association, the Federation of German Consumer Organisations, and the UK Financial Services Consumer Panel) represented retail interests.[74] By contrast, market interests are becoming increasingly sophisticated in developing policy positions and building pan-EU and cross-sector lobbying networks.[75]
This matters with respect to substantive issues of regulatory design.[76] It also matters with respect to the general direction of policy-making. Particular policy questions, notably with respect to the wholesale markets, demand, of course, expert market advice which can reduce the severe information asymmetries the EU institutions can suffer from in financial market policy design.[77] But regulation is not composed of water-tight compartments and issues of concern to the wholesale sector can leak across eventually to the retail markets.
After a long period in obscurity and rather late in the day, weaknesses in consumer and retail governance have now been recognised by the EU institutions.[78] In a conscious attempt to build consumer governance capacity, the European Commission, which has become increasingly concerned as to retail governance,[79] constituted FIN-USE in July 2003 as an Expert Forum to examine financial services policies from the user/demand side perspective.[80] FIN-USE has become a robust and vocal policy actor and is increasingly appearing in EU consultations where previously there was little or no retail input. Following the 2005 White Paper commitment to promoting retail governance,[81] in May 2006 the Commission also established the Financial Services Consumer Group (FSCG)[82] to build financial expertise in the retail sector and provide more effective consumer input. Notably, the Commission has constituted these bodies in a deliberate attempt to build greater capacity, given the lack of expertise suffered by retail investor interests in assessing complex financial regulation, and to support the formation of a retail lobby in the EU which will ultimately influence policy formation.
3 Investor Education
Investor choice- and disclosure-based policy-making depends on an informed and competent investor base. Notwithstanding the undoubted sophistication of the new conduct of business regime, it rests on an insecure foundation in the absence of much more extensive information on how investors behave, but also in the absence of sound investor education policies across the EU. In the absence of a coherent education regime, the costly new disclosure regime is not only likely to be inaccessible to investors and amount to an inefficient use of resources, but it is also unlikely to address fundamental misunderstandings as to the nature and risk of market investing which must be addressed if a safe investment environment is to develop. Formal education policies can also help support investor choice by reducing the burden of costly protective, interventionist regulation and enhancing the effectiveness of disclosure.
Education is increasingly appearing in regulatory policy internationally as an essential element of an integrated strategy for the retail markets and as a less aggressive and risky way of influencing investor decisions.[83] The largely immature nature of the pan-EU retail investor base suggests that it is far too early for education to replace regulation.[84] But in one of the most striking developments in EU retail policy for investment services, the last two years have seen investor education become a recurring theme of the policy rhetoric as the EU moves towards a more nuanced and holistic appreciation of retail policy. In its 2005 Green Paper on Financial Services, the Commission called for education measures, stating that while the EU regime highlights disclosure, ‘unless consumers themselves develop the skills and knowledge needed to understand increasingly complex financial products, consumers cannot make well-informed investment decisions on the basis of this information.’[85] This theme re-appeared in the important December 2005 White Paper, which sets the financial services policy agenda until 2010, but was anchored this time to specific initiatives. Although the Commission argued that the prime responsibility for financial education lay with the Member States, it made a commitment to promoting a ‘pan-EU exchange of views on financial education, consumer literacy and best practice’ and to ‘facilitate common projects.’[86] Although investor education is probably best delivered at Member State level (with the UK FSA’s recent extensive, evidence-based initiatives in this regard perhaps providing a model of good practice), there is some room for EU policy direction. Education on how to manage disclosure, particularly with respect to comparability and the risks of pan-EC investing seems appropriate for a discrete EU initiative. As the basic elements of sound financial planning are not country-specific, and given resource strains in the accession Member States, an EU response seems warranted. A policy which addressed the essentials of effective market investment, such as the importance of diversification, the potential consequences of over-trading in the execution-only context, and the impact of transaction costs (which are the subject of extensive disclosure under the MiFID conduct regime), could form the core of an EU education strategy.
The EU is still in the very early stages of developing an investor education policy, although investor education is now a priority at the highest political levels. Most recently, the 2007 Green Paper on Retail Financial Services emphasises the role of education in building competent consumers of financial services.[87] More specifically, investor education has appeared in the current efforts to reform the UCITS summary prospectus for retail investors. As EU market interests are also beginning to advocate for retail investor education as part of the policy response to specific regulatory issues[88] (this development should be regarded with care as education can be used to dilute necessary regulation), it can be expected to become increasingly prominent as a policy instrument.
4 Supervision
Ultimately, however, successful management of the conduct of business regime, certainly in the EU context where there are limits on the ability of investors to take private actions,[89] depends on strong enforcement by supervisory authorities which will support the development of an effective compliance culture. The framework nature of the regime, and the emphasis on flexibility, suggests that supervision, not regulation, will determine the effectiveness of the new regime.[90] It success rests to a large degree, therefore, on pan-EU supervisory resources, the construction of a pan-EU supervisory culture, and on the effectiveness of supervisory monitoring and enforcement tools in building a compliance culture in investment firms.
IX Conclusion
The MiFID conduct of business regime represents a grand experiment in regulatory design, imposed on an immature but developing retail investment services marketplace. Whether it succeeds in supporting an informed and competent investor base, capable of exercising informed choice among a pan-EU range of competing services and products, depends on a number of variables which include: whether the regime appropriately manages the costs of regulation and delivers choice; whether the execution-only and appropriateness regimes sit securely within a wider disclosure framework; and whether the extensive new disclosure regime, which is largely traditional in design, can deliver real benefits to investors. As the evidence of the regime’s impact in practice begins to emerge and is appropriately assessed, it may prove a useful test-case for regulators internationally on the difficult question of how to promote greater retail engagement with the markets, support financial independence and literacy, and encourage safe long-term saving behaviour. The risks are high, however, given the potential costs and the failure to connect the regulatory strategy with wider investor education and governance initiatives and to engage in ex-ante testing of the key disclosure mechanisms at the heart of the new regime.
[∗] LL.B (Dublin, Trinity College), LL.M (Harvard). Professor of Capital Markets Law, University of Nottingham. Visiting Fellow, Department of Business Law and Taxation, Monash University. This article is based on a paper presented at a conference on ‘Financial Services Reform Second Anniversary – Where Next?’, organised by Monash University, Department of Business Law and Taxation (Melbourne, July 2006).
[1] Directive 2004/39/EC OJ (2004) L145/1. It has been described as a ‘sprawling directive with far-reaching implications for any firm involved in buying and selling securities in Europe.’ Editorial, Financial Times (London, UK), 23 August 2005, 14.
[2] See further N Moloney, EC Securities Regulation (2002).
[3] European Commission (‘Commission’), Implementing the Framework for Financial Markets: Action Plan, COM (1999) 232. Chief among the FSAP reforms were the financial market measures which addressed capital-raising and issuers, stock exchanges, market infrastructure (clearing and settlement), investment firms, and investors. For a review of the FSAP’s coverage see Commission, FSAP Evaluation, Part I, Process and Implementation (November 2005) (the FSAP Implementation Report).
[4] Most vividly exemplified, perhaps, by the use by the UK Financial Services Authority, one of the EU’s most powerful regulators, of an ‘intelligent copy-out’ technique when implementing FSAP measures in the UK national rule-book and by its recognition that ‘EU legislation has been the driving force behind much of the regulation affecting the European, and consequently the UK, financial services sector in recent years.’ FSA, Financial Risk Outlook (2006) 97.
[5] One-off costs to the UK investment services industry have been estimated at £877 million - £1.17 billion and ongoing costs at £80 million. FSA, The Overall Impact of MiFID (November 2006).
[6] Initial signs are not encouraging. By April 2007, only three Member States (Ireland, Romania, and the UK) had notified the Commission of full MiFID implementation in their national laws. The Commission is taking a robust approach to implementation with infringement proceedings launched against the Member States which have failed to implement the MiFID regime. Press Release IP/07/547 (24 April 2007). Market preparations have been similarly unsatisfactory. Over 60% of financial firms across the EU are expected not to be MiFID compliant by 1 November 2007. T Buck, ‘Few firms are ready for MiFID shake-up’, Financial Times (London, UK), 16 March 2007, 5.
[7] ‘Alongside more detailed issues lies the significant loss of flexibility that results from transferring regulatory obligations from rules made by quangos such as the FSA to international law.’ L Lodge and H Flight, ‘Time to back FSA’s efforts to gain clarity’, Financial Times, Fund Management Supplement (London, UK), 19 June 2006, 8. On the implementation process see FSA, Planning for MiFID (November 2005) and FSA, HM Treasury, Joint Implementation Plan for MiFID (May 2006).
[8] One of the more striking results was the establishment of MiFID Connect, an unusual and powerful grouping of the 11 major trade associations active in the UK financial markets which was formed in 2006 to support member firms in applying MiFID requirements and which has articulated a co-ordinated industry position on MiFID.
[9] The Association of Private Client Investment Managers and Stock Brokers (which represents the smaller investment firms and advisers) has stated that ‘t[h]ere will be something in it for us, but I doubt it will be proportionate to the change and the cost.’ In a similar vein, the European Banking Federation castigated the new regime as ‘too complex, cumbersome, and restrictive.’ D Hargreaves, ‘Balancing Act’, Financial World, April 2006, 16.
[10] One report has predicted that the scale of the regulatory reforms, particularly with respect to best execution and investor information, is likely to deter smaller brokers and those with specialist business models and to favour large, full-service investment firms. Centre for European Policy Studies, EU Financial Regulation and Supervision Beyond 2005 (2005), 9.
[11] Commission, Financial Services Policy 2005-2010, COM (2005) 629 (December 2005) (the ‘White Paper’), 6.
[12] FSA, Business Plan 2006-2007.
[13] Commission Directive 2006/73/EC OJ (2006) L241/26 and Commission Regulation (EC) No 1287/2006 OJ (2006) L241/7.
[14] This new EU law-making procedure, based on two levels of law-making for securities markets, is based on the recommendations of the Final Report of the Committee of Wise Men on the Regulation of European Securities Markets (February 2001). The Lamfalussy procedure and the regulatory reform agenda set out in the FSAP have dramatically recast financial services regulation across the EU and across all sectors of financial services activity.
[15] Speech by Director General Schaub of the Internal Market Directorate General on ‘Economic and Regulatory Background to the Commission Proposal for Revision of the ISD’ to the Danish EU Presidency Conference on ‘European Regulation of Investment Services’ (15 October 2002). Available on <http://www.europa.eu.int/comm/internal_market/speeches> , 3.
[16] Report to the Committee on Economic and Monetary Affairs on the First Reading of the MiFID Proposal (A5-0287/2003) 92.
[17] Commission, Explanatory Memorandum to the MiFID Proposal, COM (2002) 625 (the ‘MiFID Proposal’), 4.
[18] 2nd FSAP Report, May 2000, 3.
[19] ZEW/IEP, Report on ‘The Benefits of a Working European Retail Market for Financial Services’ (February 2002) for the European Financial Services Roundtable.
[20] FSA, Financial Risk Outlook (2005), 43.
[21] FSA, Financial Risk Outlook (2004), 62. Improvements in financial capability and in the ability of consumers to use increased levels of information to make better decisions have, however, been noted recently. FSA, Financial Risk Outlook (2007), 81.
[22] ‘Despite the fact that this initial venture may have precipitated a steady increase in the proportion of the UK population holding stocks and shares, and also encouraged a belief that purchasing stocks and shares was no longer a luxury pursuit enjoyed only by the risk and famous, some experts [consulted by the FSA for this study] still felt that the understanding of and proactive involvement in financial equity markets remains low for the overwhelming majority of consumers. It seems therefore that the long-term effect of privatisation on consumer involvement and investment in stocks and shares, and corresponding attitudes to finance has been relatively small, except among a small and informed segment of society.’ FSA, Measuring Financial Capability: An Explanatory Study (2005), 4.8.
[23] The Financial Times reported in April 2006 that investors were ‘putting more money into investment funds and deposit accounts than at any time since the height of the stock market boom as confidence in shares returns and individuals shoulder more responsibility for their own finances….investors ploughed £2.1bn into open-ended investment funds [in March 2006], the highest monthly inflow for six years.’ S Goff and J Chisholm, ‘Savings surge as retail sales show fall’ Financial Times (London, UK), 25 April 2006. The FSA has also reported that a benign macro economic climate has attracted consumers to new products and investment strategies. FSA, Financial Risk Outlook (2007), 77.
[24] This reflects in part favourable tax treatment through the UK’s Individual Saving Account (ISA) regime.
[25] Committee of European Securities Regulators (‘CESR’), Preliminary Progress Report ‘Which Supervisory Tools for the EU Securities Market’ (October 2004), CESR-333.
[26] Commission, Financial Integration Monitor (July 2005) 11.
[27] CESR, Preliminary Progress Report ‘Which Supervisory Tools for the EU Securities Market’ (the Himalaya Report) (October 2004), CESR 04-333f, 7. The European Commission has also recently acknowledged the weaknesses in retail market integration. Commission, Green Paper on Retail Financial Services in the Single Market, COM (2007) 226 (April 2007), 4-5.
[28] Commission, Financial Integration Monitor (2005).
[29] The ‘pension time bomb’ is a major preoccupation of EU securities market policy. The Council of the EU’s politically powerful Financial Services Committee, eg, has recently established a subgroup on ageing and financial markets. See Interim Report of the Subgroup on the implications of ageing on financial markets (October 2006) (FSC 4180/06).
The European Commission has also noted that ‘a further boost in the efficiency of pan-European markets for long-term savings products is needed urgently. The EU’s major structural economic challenge – its huge pension deficit – needs to be financed’ and that ‘as the public sector gradually withdraws from financing some aspects of social systems, there is a need for increased awareness and direct involvement of citizens in financial issues.’ White Paper, above n 11, 4 and 7. It has also argued that a ‘cost-efficient fund industry, where gains are passed on to end-investors, can be part of the solution to Europe’s pension deficit.’ Commission, Green Paper on Financial Services Policy 2005-2010, COM (2005) 177, Annex 16 and 17.
[30] FSA, Financial Risk Outlook (2007), 78. It noted the pressing need for financial independence as the government withdraws from pension provision, private sector pension provision moves from defined benefit schemes to defined contribution schemes (which transfer risk to the individual), the costs of higher education grow, financial responsibility for children extends into financing first homes, and increasingly complex patterns of employment and life style demand long-term financial planning and independence: at 78-80.
[31] Ibid 90. In 2005, the UK Pensions Commission reported that 11.7 million workers were not making any contribution to a private pension.
[32] FSA, Funds of Alternative Investment Funds (2007) (CP07/6). The summer 2007 review of retail distribution and advice proposes three types of regulated financial adviser: professional financial planners (subject to high levels of regulation, independent, and fee-based); general financial advisers (cannot be termed ‘independent’, less demanding regulation (but higher levels of prudential regulation), and commission-based); and mass-market primary advisers (lighter suitability requirements and simple advice related to simple products). The review is based on the assumption that, given low levels of financial capability, the risks of commission-based sales, the expense of investment advice (which reflects regulatory costs), and the relatively poor levels of professional training and testing in the advice sector, the ‘market for retail investments does not work efficiently – and certainly not as well as it could – serving neither the interests of consumes or firms, whether providers or distributors of retail financial services.’ FSA, A Review of Retail Distribution (2007) (CP07/1), 4
[33] See, eg, J Tiner, (outgoing Chief Executive, FSA), ‘Review of Retail Distribution in the UK’, 14 June 2006, addressing the need for high quality advice and expressing concern at poor levels of financial competence and planning and low rates of use of advisory services (only 21% of consumers consider taking professional advice when purchasing a financial product).
[34] FSA, Financial Capability in the UK: Establishing a Baseline (2006).
[35] FSA, Financial Capability in the UK: Delivering Change (2006).
[36] See, eg, the set of non-binding principles adopted by five leading trading associations concerning retail structured products (European Securitisation Forum et al, Retail Structured Products: Draft Principles for Managing the Provider Distributor Relationship (April 2006), available on <www.liba.org.uk>).
[37] This scholarship is spearheaded by the influential and controversial work of financial economists La Porta, Lopez de Silanes, Shleifer, and Vishny (LLSV). See R La Porta, F Lopez de Silanes, A Shleifer and R Vishny, ‘Law and Finance’, 106 Journal of Political Economy (1998) 1113. For a recent application see S Djankov, R La Porta, F Lopez de Silanes and A Shleifer, The Law and Economics of Self Dealing (2005), available on <http://ssrn.com/abstract=864645> . On the relationship between financial market development and enforcement see J Coffee, Law and the Market: the Impact of Enforcement (2007), available on <http://ssrn .com/abstract=967482> .
[38] Committee on Capital Market Regulation, Interim Report of the Committee on Capital Market Regulation (November 2006). The governor of New York has also recently announced the formation of a high level working group to modernise financial services regulation in the state and to maintain the competitive position of New York against the threat of London’s more flexible regulatory regime. B Masters, ‘Spitzer convenes top-level panel to update Wall Street Regulation’ Financial Times (London, UK), 27 May 2007, 1.
[39] The Commission is, however, rather evasive on the evidence supporting a more direct connection between EC policy intervention and positive financial market outcomes, simply stating that: ‘past actions have been proven to have a positive impact [on weaknesses in financial market integration].’ White Paper, above n 11, Annex II, Impact Assessment, 10.
[40] See, eg, the London Stock Exchange, London Stock Exchange’s Response to the Committee of European Securities Regulators, First Call for Evidence on MiFID (19 February 2004) <http://www.cesr.org> . Similarly, ‘Consumer protection rules can be a tool to enhance the confidence of investors as they venture into the large, multinational sector that is on the horizon.’ FIN-USE Forum, Financial Services, Consumers and Small Businesses: A User Perspective (October 2004) (the ‘FIN-USE Report’), 4.
[41] ‘If people know what they want and how to get it, the market for financial services becomes less one-sided and a lot more efficient. Consumers will be able to demand better, cheaper and more appropriate products and services.’ FSA, Building Financial Capability in the UK: The Role of Advice (2004), 1.
[42] FIN-USE Report, above n 40, I and, more generally, 4.
[43] In its 2006 Financial Risk Outlook, the FSA warned that ‘increased choice [in financial services] has been accompanied by increasing complexity in both products and wider financial decisions. Increased complexity and uncertainty could lead to consumers buying products that are not suitable for them and/or appropriate for their needs.’: at 8.
[44] White Paper, above n 11, 7.
[45] For a call for greater research into retail investor behaviour to inform regulatory design see H Jackson, ‘To what extent should individual investors rely on the mechanisms of market efficiency: A Preliminary Investigation of Dispersion in Investor Returns’, 28 Journal of Corporation Law (2003) 671.
[46] MiFID Proposal, above n 17, 26.
[47] Commission, Draft Commission Directive implementing Directive 2004/39/EC as regards organisational requirements and operating conditions (February 2006), Background Note, 5. The regime is designed to ‘create strong incentives for the firm to monitor its own activities’ and ‘foster a culture of compliance.’: at 6.
[48] See generally PriceWaterhouseCoopers, The Regulation and Distribution of Hedge Funds in Europe (2005). This is occurring in particular through listed closed-end hedge fund products usually listed on the London stock exchange and structured notes based on hedge funds.
[49] See, eg, Alternative Investment Expert Group, Report on ‘Managing, Servicing and Marketing Hedge Funds in Europe’ (2006).
[50] MiFID Proposal, above n 17, 30.
[51] The UK FSA also takes this position, arguing that while information can be used by confident consumers ‘many people will continue to find financial services bewildering and will want some customized help to identify their financial needs and so make better decisions.’ FSA, Building Financial Capability in the UK: the role of advice (2004) 1. The 2007 review, however, acknowledges that many savers cannot afford investment advice and therefore proposes a new primary, generic advice regime which benefits from low regulatory costs: above n 32.
[52] Commission, above n 47, 31.
[53] Bank distribution ranges from 86% in Spain to 34% in Germany.
[54] Commission, above n 47, 15.
[55] ‘It [is not] enough to place our faith in the commercial self-interests of market participants...a single case of cross-border mis-selling could compromise the entire project.’ Results of Commission Conference on financial integration, Brussels (23-24 June 2004) MEMO/04/160, <http://www.europa.eu.int/rapid> .
[56] The regime applies to all information (including marketing communications) which firms address to or disseminate in such a way that it is likely to be received by retail client or potential retail clients.
[57] UCITS refers to ‘Undertaking for Collective Investment in Transferable Securities.’ Directive 85/611 EC OJ [1985] L375/3.
[58] Commission, above n 47, 27.
[59] ECON Committee’s Recommendation for the Second Reading on the Council MiFID Common Position A5-0114/2004, Amendment 19.
[60] There are approximately 1.2 million execution-only customers in France, 3.5 million in the UK, and over 2 million in Germany. Several million retail investors across the EU also buy mutual fund investments without advice through direct offers and fund supermarkets. MiFID Proposal, above n 17, 42.
[61] The London Stock Exchange noted that it ‘is vital to investors, as to impose unnecessary costs on firms would remove a low cost dealing option for their clients.’ London Stock Exchange, Response by London Stock Exchange to CESR’s Second Call for Evidence (29 July 2004) 1.
[62] Application of the marketing communication rules is subject to a proportionality regime in that the intention is that the rules apply ‘in a way that is appropriate and proportionate taking into account…the means of communication and the information that the communication is intended to convey.’
[63] Supported by the British Bankers’ Association and the European Fund and Asset Management Association in particular.
[64] S Goff, ‘Loophole in MiFID for wealthy investors’, Financial Times (London, UK), 3 October 2006, 4.
[65] See, eg, L Cunningham, ‘Behavioural Finance and Investor Governance’ 59 Washington & Lee Law Review (2002) 767, D Langevoort, ‘Taming the Animal Spirits of the Stock Markets: A Behavioural Approach to Securities Regulation’ 57 NorthWestern University Law Review (2002) 135, and R Gilson and R Kraakmann, ‘The Mechanisms of Market Efficiency Twenty Years Later: The Hindsight Bias’ 28 Journal of Corporation Law (2003) 715.
[66] Jackson, above n 45, 687.
[67] See Jackson (ibid), 679 and 687 who suggests that the US SEC could produce a disclosure document, as part of its education strategy, showing how investors, in general, perform in the markets. For a similar call see also A Jackson, The Aggregate Behaviour of Individual Investors (2003), available on <http://www.ssrn.com/abstract=536942> , 2003, 25. The UK FSA has also called for research into pan-EC consumer behaviour, buying experience, and financial capability. See J Tiner Speech on ‘European Financial Integration: Progress and Prospects’ Commission Conference (22 June 2004) <http://www.fsa.gov.uk.pubs/speeches> .
[68] There is a major effort underway at present to redesign the standardised summary prospectus disclosure given to investors on the EC’s highly regulated ‘UCITS’ mutual fund product, as this prospectus is widely regarded by the funds industry and consumers as not meeting retail investors’ needs. Current indications suggest a ‘KISS’ format - ‘keep it short and simple’. Consumer testing is at the heart of this initiative. The considerable efforts being made to consult on the design change and to consider and market test different disclosure formats represent a significant change of direction in EU securities market regulatory policy.
[69] The Committee of European Securities Regulators (‘CESR’), MiFID Consumer Day – Summary of the Main Conclusions’, May 2005, CESR/05-350. By contrast with the formal consultation process which was dominated by market interests, support emerged for including generic investment advice as ‘advice’ (and subject to suitability), subjecting margin loans to suitability, and a prohibition on providing services where sufficient information was not provided for a full suitability assessment.
[70] H McKeen-Edwards and I Roberge, Efficiency Over Democracy? The Case of Monetary and Financial Services Sector Integration in Europe, cited in FIN-USE, The Consumers’ Voice in the European Financial Services Sector (January 2006).
[71] CESR, Advice on Possible Implementing Measures of the Directive 2004/39/EC on Markets in Financial Instruments – Consultation Paper (June 2004) CESR/04-261b.
[72] Responses available on <http://www.cesr.eu.org> .
[73] CESR, Draft Technical Advice on Possible Implementing Measures of the Directive 2004/39/EC on Markets in Financial Instruments – Second Set of Mandates – Consultation Paper (October 2004) CESR/04-562.
[74] Responses available on <http://www.cesr.eu.org> .
[75] The London Investment Banking Association has emerged as one of the leading lobbyists on EC financial market policy, building pan-EU positions among the European investment banking industry through its links with the Association Française des Entreprises d’Investissement (AEFI), the Italian Association of Financial Intermediaries (ASSOSIM) and the Swedish Securities Dealers’ Association, and developing alliances with major trade associations (such as the International Capital Market Association) as appropriate. See, eg, the detailed coverage of EC policy in its 2004 and 2005 Annual Reports.
[76] See, eg, the evolution of the MiFID conflict of interest regime during which market interests successfully lobbied against an abstention rule in the level 1 Directive where a firm could not organise itself so as to avoid a risk of prejudice to client interests through conflicts of interests. J Herbst, ‘Revision of the ISD’, 11 Journal of Financial Regulation and Compliance (2003) 211, 215-216. At level 2, CESR has displayed some willingness to face down market interests, albeit in a somewhat counter-intuitive fashion. Although it bowed to market pressure in removing a requirement that Chinese walls be used to establish independence from conflicts of interest through a separation of activities in particular circumstances, replacing it with a requirement that they be established where ‘relevant’, it refused to weaken its stance on conflict of interest protection for sophisticated counterparties in the face of strong market criticism. CESR, CESR’s Technical Advice on Level 2 Implementing Measures on the first set of Mandates, Markets in Financial Instruments Directive, Feedback Statement (January 2005) CESR/05-025, 23 and 25. Other notable changes in CESR’s position in the face of fierce market opposition include the removal of generic investment advice from MiFID’s investment advice regime and the scope of its suitability obligations.
[77] E Ferran, Building an EU Securities Markets (2004) 90-91.
[78] The Council has, eg, urged more effective retail participation (2587th Meeting of the Council Press Release, Council Conclusions (Economic and Monetary Affairs) (2 June 2004) 12).
[79] Retail governance has emerged as a major theme of the Commission’s post-FSAP agenda. In its 2005 Report on FSAP Implementation, eg, it acknowledged the criticism of poor retail and consumer involvement in financial services policy making and the need for concrete measures. Commission, above n 3, 17.
[80] Commission, Press Release IP/03/1119 (25 July 2003).
[81] White Paper, above n 11, 7-9.
[82] Commission, Press Release IP/06/806 (20 June 2006).
[83] See, eg, IOSCO’s recent report on retailisation of hedge fund investment which recommends investor education as a key element of any policy response. IOSCO, The Regulatory Environment for Hedge Fund, A Survey and Comparison (March 2006). In the post-Enron reform context, see L Cunningham ‘The Sarbanes Oxley Yawn: Heavy Rhetoric, Light Reform (And it Just Might Work)’ (2003) 35 Connecticut Law Review 915, 922, regretting that the Sarbanes Oxley Act-centred reform process did not include encouraging stronger markets through education.
[84] Levels of investor competence and understanding are low across the EU. In the UK, in 2006 the FSA presented a major survey which presented a comprehensive picture of how people manage money, save, record their finances, and choose financial investments (FSA, Financial Capability in the UK: Establishing a Baseline (2006)). The 2007 Green Paper on Retail Financial Services also points to studies suggesting low levels of competence in Ireland and France. Commission, above n 27, 15.
[85] Commission, Green Paper on Financial Services COM (2005)177, 18.
[86] White Paper, above n 11, 7.
[87] Commission, above n 27, 15-16. See also Commissioner Charlie McCreevy, ‘Increasing Financial Capability’ (Speech delivered at the Increasing Financial Capability Conference, Brussels, 28 March 2007) available on <http://www.europa.eu/rapid/> , in which he set out the Commission’s agenda on consumer capability in financial services.
[88] The recent consultation on the extension of the MiFID trade transparency regime for equity markets saw a call from sections of the market for enhanced investor education on the risks of bond markets (combined with background regulatory measures) as an alternative to bond market transparency rules. Commission, Feedback Statement, Pre-and Post-trade Transparency provisions of the MiFID in relation to transactions in classes of financial instruments other than shares (November 2006), 10.
[89] Including limitations on class actions. See generally Ferrarini, G, and Giudici, P, Financial Scandals and the Role of Private Enforcement: the Parmalat Case (2005), <available on <http:ssrn.com/abstracted=730403>.
[90] G Ferrarini, ‘Contract Standards and the Markets in Financial Instruments Directive’, 1 European Review of Contract Law 19.